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What Percentage of Income Should Be Saved to Be Financially Responsible?

by Flexo on May 1, 2009

in Saving

I’m pointing out a recent article featuring advice from Walter Updegrave, a senior editor of Money Magazine. Recently, he was asked to quantify the percentage of income that any individual should save in order for this particular action to be considered “financially responsible.” Normally, the advice I’ve seen suggests a rate somewhere between 10% and 20% of income, so I was expecting Updegrave’s advice to head in that direction.

Rather than providing a hard percentage, Updegrave took a more nuanced approach.

Well, as much as I’d like to be able to tell you to save 10%, 15% or whatever and you’ll be fine, it’s impossible for me to do that without knowing a whole lot more about you. The percentage of income that’s appropriate for you will depend on your income, age, the amount of money you’ve already saved, your employment prospects and, most important, how much you’re willing to forego immediate gratification for current and future financial security.

It is good to see writers admitting that personal finance advice is not one-size-fits-all rather than going for the knowledge-nugget. Knowledge-nuggets are like those chicken nuggets at that fast-food restaurant with the yellow double arch-shaped letter. They’re tasty, but not very healthy, and you get sick of them after about 25.

Every individual is surrounded by a unique situation, and that should be reflected in personal finance advice.

Tips on the other hand can be general enough to apply to a large swath of individuals. Updegrave answers the reader’s question as best as possible without knowing anything about the individual, but then leads into a few savings tips that are applicable to just about everyone: Start building an emergency fund (and here are 50 tips for building one), be serious about investing for retirement, and find additional ways to save such as automating your savings.

If nothing else, saving 10% of your income is a good start if you’re not saving anything, and saving 20% of your income is a good next step if you’re saving 10%.

3 steps to financial security: Save, save, save, Walter Updegrave, Money Magazine, April 30, 2009

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Eight Tips for Living Through a Recession

by Flexo on March 27, 2009

in Saving

If you have been affected by the recession, perhaps by losing a source of income, you may not want to hear suggestions for turning a bad situation into an opportunity. In fact, the idea of turning challenges around for your own benefit is in line with the annoying soundbites that productivity gurus sell. But I firmly believe that it’s best not to let things happen around you without reacting and adjusting. Here are some ideas to keep you moving while the world is slowing down.

1. Reassess your finances. If your income has changed, you may find yourself increasing debt at a faster rate or worse. I suggest going back to the beginning by following the map set forth in Take Control of Your Finances. This involves reevaluating your goals, your income, your expenses, and organizing your savings and investments.

2. Consider your primary and secondary skills. If you are out of work, and particularly if you have experienced difficulty finding a new place of employment, it is easy to feel your skills are not appreciated. Perhaps this is a good opportunity think creatively about different ways to apply your skills or hone your other talents. In college, did you have a minor in a different area than your major? If you did, chances are you have marketable skills in some other activity. During my first two years of undergraduate studies, I had difficulty choosing my minor, switching from computer science to psychology. If necessary, I would enjoy pursuing either of these paths.

3. Turn your hobby into your own business. I have found that many people are reluctant to take the avocation they enjoy and turn it into a profitable endeavor. I can understand this; I work almost constantly these days between my day job and everything else I do. But if that day job were to disappear, there would be no question that I’d use this as an opportunity to ramp up my projects. I have already turned my hobby — blogging and building communities — into a business. Now my newer hobby is photography. I have tons to learn about this new hobby (and I still have tons to learn about personal finance), but if blogging were my “day job,” I might have take on photography as a more serious hobby, and possibly turn that into a business of its own.

4. Go back to school. Modern educational technology has made it convenient to earn another degree. You can take classes online in the comfort of your own home or you can go on campus and hang out with the young co-educational students. Do not focus on the return on investment (ROI) for the funds you put into additional education. Learning a new skill or studying an interesting topic has intrinsic value that can’t be measured by a financial analyst.

5. Consider frugality. I admit I’m not a big fan of most frugality tips out there. In the past, many frugal tips have required a lot of effort and therefore remained under the domain of people without other timely responsibilities. But online coupon websites and other modern technologies take a lot of work out of frugality, so this now is an option for more people. Frugality means different things to different people, so today’s recession provides an opportunity to explore and decide on where you can intelligently save money.

Check out this extensive list of frugal tips from Being Frugal.

6. Eliminate your credit card debt. Credit card interest is expensive. You don’t have to be frugal to realize that interest is in most cases an unnecessary expense if you spend less than you earn. If you’re out of a job, this can be difficult, particularly if you do not have enough income to cover the minimum payments. Call your credit card companies to see if they can assist you by lowering or forgoing your payments until your income returns. If not, perhaps they will lower your interest rate. It never hurts to ask, and ask a supervisor if the first customer service representative won’t provide satisfaction.

If you do have income, start the debt avalanche, the least expensive, quickest, and most efficient way to get out of debt.

7. Eliminate meat from your diet. I love a perfectly cooked, rare filet mignon. But meat, even steak from the grocery store, is expensive.

If you drop red meat, poultry and fish from your diet, you’ll find plant proteins cheaper than the equivalent amount of animal protein. The cheapest cuts of beef, such as ground round, average $3 per pound in U.S. cities (lean and extra lean); boneless chicken breasts cost $3.40 a pound; and canned tuna is about $2 per pound. Contrast that with dried beans and lentils at less than $1 a pound and rice well below $1 per pound… Even tofu, the chicken of the vegetarian world, is usually well under $2 a pound. Go Vegetarian to Save Money, MSN Money

Healthy diets help you save money later in life with fewer visits to the doctor.

8. Sell your extra stuff. The great thing about eBay is its enormous reach, bringing people from anywhere interested in owning anything closer together. There’s a market for practically anything transferable on the auction website. Sell your clothes, your furniture, your electronics, your art, your classic video games, and your baseball card collection gathering dust in the attic. Don’t expect to consistently make a lot of money selling your old items on eBay unless you own something truly rare. One drawback of the aforementioned reach is that lots of people are selling the same things you are.

But if you can create something original and use eBay to sell that product, you may be in a good position to earn a consistent income.

What would you add? How are you surviving this economic recession?

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Can an Emergency Fund Be Too Big?

by Flexo on March 18, 2009

in Saving

Being prepared for financial emergencies is a primary step on the path to creating and maintaining solid footing, but as with other good things, too much of a positive can be negative. Every individual’s or family’s situation is unique, so it’s difficult to prescribe a hard and fast rule about the right size of an emergency fund that applies to everyone. Having three to six months’ worth of expensive in accessible cash is a good start, but many people will find that this will be too much or not enough.

I’ve suggested taking a holistic view by breaking your emergency fund into five (six) levels including cash on hand, a high-yield savings account, sellable investments, available credit, friends and family, and possibly readiness to reduce expenses. These options range from stagnant to flexible in terms of what they allow you to do with your money. For example, if you keep a small amount of cash ready under your mattress to use if you can’t access your bank accounts, that money loses purchasing power due to inflation the longer it stays outside the financial system. High-yield savings account may match or exceed inflation and investments may beat inflation over time. Access to credit allows you to invest more while still providing an option to help during an emergency, and friends and family can occasionally be tapped if necessary without risking your credit (just your reputation).

As we travel further down the list, more of your money is freed to work for you, invested for the future. If you are comfortable with the latter options, and if you are experienced with credit and not in danger of falling into debt, it’s better to tilt your emergency plan in that direction. I wouldn’t recommend keeping more than one year’s worth of expenses in a savings account narrowly beating inflation if at all, and the more other options are available, like credit and other somewhat liquid investments, a tiered approach will allow you to have your assets work for you.

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New Study Outlines Importance of an Emergency Fund

by Flexo on March 16, 2009

in Saving

This is timely information consider I wrote this morning about establishing a small emergency fund before taking on the task of accelerating debt payoff. Last week, Liz Pulliam Weston from MSN Money provided details from a summary of different savings studies over the past few years. I discovered this article today.

According to the survey results, having just $500 in the bank corresponded to a large difference in stress, quality of sleep, quality of health, and productivity. The study also shows that income level has nothing to do with this. In both low and moderate income households, the average income for households who have saved at least $500 were about the same as the income for those who had not.

Better health and greater productivity save money in the long run. Even if it doesn’t sound like a good idea to start an emergency fund before directing all of your excess income towards paying off debt on the surface thanks to evaporating savings interest rates, there are many ways a small cash cushion can pay off in the long run.

Want to sleep better? Save $500, Liz Pulliam Weston, MSN Money, March 12, 2009.
Understanding the Emergency Savings Needs of Low and Moderate Income Households [pdf], Stephen Brobeck, Consumerism Federation of America, November 2008.

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8 Ways to Create Your Own Stimulus Check

by Flexo on February 26, 2009

in Saving

In 2008, millions of people received checks or direct deposits from the government in an effort to stimulate the economy. The extra cash certainly helped many families and individuals, who, like the banks that received TARP funds later in the year, cushioned their bank accounts and paid off debt. Some used the found money to contribute directly to the economy, but not enough people purchased products and services to prevent the global economy from collapsing. It’s usually argued that one of the strongest aspects of distributing checks of this type to the public is to boost confidence in both the market and those in power.

The economy is now worse than it was when the 2008 economic stimulus payments were sent out. The American Recovery and Reinvestment Act of 2009 was recently created to continue the attempts to boost the economy. This time, however, there will be no stimulus checks. Instead there is a new tax credit, the “Making Work Pay” credit, which will allow employees to keep more of the money they receive in each paycheck.

Starting in April, employers will adjust withholding automatically for qualified workers. This will result in $44 additional take-home pay after taxes for individuals, and $89 additional for those who selected “married” on the W-4 employee withholding form. Economists believe this small increase in pay will stimulate the economy more effectively than the equivalent lump sum payment of $400 ($800 for married couples). A lump sum payment is more likely to be saved, used to pay off debt, or spent all in the same place, while a little extra in each paycheck will help families incorporate the money into regular spending, like dining out in restaurants or buying groceries. This helps taxpayers circulate the money in the community rather than hoarding it in a bank account.

But lump sum payments are often better for the individual, even if they don’t stimulate the broader economy as effectively. So here are eight ways you can create your own stimulus check by turning the small weekly or biweekly increase into a larger benefit or by finding other income or savings that can be effectively used to boost your finances.

1. Save the Making Work Pay credit. If you receive a paycheck biweekly, you will be taking home $20 or $39 extra each time. Set up direct deposit to automatically transfer that amount into a high-yield savings account like FNBO Direct. With the interest you earn, by the end of the year you’ll have more than the $400 (single) or $800 (married).

2. Work extra hours. If your boss allows you (mine doesn’t) and if you get paid extra for doing so (I wouldn’t), spend an extra hour a day in the office. Assuming a salary of $40,000 or $20 per hour, and a benefit of time-and-a-half for working beyond 40 hours a week, you could earn an extra $7,500 by working one extra hour a day for one year.

3. Turn your hobby into a business. If you like creating and assembling furniture, building computers, knitting, or making jewelery, consider getting serious about selling your products. These could be things you don’t need to make yourself, as well. A coworker of mine recently started hosting jewelery parties, where she enlists her friends to host their own jewelery parties. I believe it’s some kind of multilevel marketing scheme, but it works for her. With this kind of side job, she doesn’t have to make her own jewelery; she just receives a percentage of what is sold as well as free jewelery.

4. Become a tutor. You can leverage your knowledge by offering to share it with others, perhaps middle school or high school students, for a fee. You only need a few students a week to earn a couple hundred dollars a month. Science and mathematics are always in demand, but you can do well if you have skill with musical instruments, test taking, or a foreign languages.

5. Get your bar tending license. A former coworker found that my company wasn’t providing her with enough income, so she started working in a friendly neighborhood bar on the weekend and one day during the week. With tips, she was able to earn several hundred dollars a night.

6. Sell your stuff. You must have unnecessary items around the house. eBay and the Amazon.com Marketplace come in handy here. Thanks to the websites’ reach, you can find buyers for almost everything. Old books, DVDs, electronics equipment, and games are all items you may no longer want but might be in demand.

7. Cut back your spending. Yes, this is typical financial advice you can find anywhere, good for any economic condition. But if you’re financially struggling right now, it’s time to take this idea seriously. I don’t have to tell you many of the easy ways to quickly reduce your spending, such as reducing your ECRD Factor, cutting back your cable bill, switching to compact fluorescent light bulbs, and reducing your energy consumption.

8. Request your cash back rewards. It’s getting much more difficult to take advantage of credit card offers. Credit card companies are dropping rewards programs, raising interest rates, and lowering credit limits. But if you do use a cash back credit card, claim your rewards. I request a check about once a year for a few hundred dollars from one card, while the business card automatically credits my account once a year. These payments provide me with a “stimulus” that I don’t take into account until I realize it’s time to receive the reward.

What else can you do to find extra money to stimulate your own personal economy?

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The Paradox of The Paradox of Thrift

by Flexo on February 16, 2009

in Best Of, Saving

If you’ve been paying attention lately, you might have heard that throughout the economic recession, Americans have been saving more of their income. Some economists worry that saving, while good for the individual, can be harmful to the economy as a whole. This is commonly called, “the paradox of thrift,” a theory developed by John Maynard Keynes, a popular economist who in the early 20th century saw spending as the basis of an economy.

Keynes looks at a recession as a vicious cycle, illustrated here:

  1. Less money is being spent by consumers.
  2. Demand for products and services decreases.
  3. Businesses reduce production and eliminate jobs to meet demand.
  4. Unemployment increases, resulting in less income for saving or spending.
  5. Rinse and repeat.

In this model, it is theorized that saving more money can eventually result in having less money to save on an aggregate level. The only thing that can break this cycle is something external. In our case, it is the government. The first treatment was “stimulus,” payments given to taxpayers (from current or future tax receipts) to help “stimulate” the economy.

The reaction, when this didn’t work, was that this wasn’t enough to break the cycle, and more stimulus was needed to noticeably affect the economy. The government decided to go directly to businesses, providing them with the capital needed to finance shovel-ready projects, hire more employees, and keep aggregate income up so consumers would feel that their money is better spent spent.

The easiest argument against the validity of the paradox of thrift is that, for the most part, there is no such thing as saving money. Money is either spent now or it is spent later. Another possibility is that it is invested now and transferred to a business, and the business either spends it now or spends it later. When you decide to spend money later, in almost all cases, you put the money into a bank account, which provides the bank with more funds with which to provide loans to businesses now.

As long as banks to continue to loan out money, the economy doesn’t decline. But as we see now, thanks to the “credit crunch” (which we haven’t been hearing about as much recently), that’s not happening.

In short, it’s not consumer spending or saving, but the financial industry’s refusal to lend money to credit-worthy businesses that is keeping us amidst the recession.

The paradox of thrift, the idea that saving more money was bad for the economy, was invented when personal rates of saving were much higher and consumer credit was all but nonexistent. At this time in American history, “saving money” meant keeping cash under a mattress outside of the banking system. Perhaps the paradox of thrift was a reality at that time, but despite its popularity in the news recently, it probably no longer applies to America’s modern economy. Many economists now agree that this aspect of Keynesian economics has seen better days.

Does the government need to step in to break the cycle, like Keynes suggested? Probably, but it needs to take the right actions. Helping tax payers with $400 over two years is not enough because it doesn’t have a large enough effect for the majority of Americans in order to restore consumer confidence.

The economy is broken at the lending level, and that’s where the government should focus. Banks need to lend money to credit-worthy customers. If they refuse, the government can step in, and they have a number of options, with approaches ranging from near-socialism to capitalism, including:

  • buying the banks, nationalizing the industry, and changing the way banks do business
  • buying controlling shares in the banks and making management decisions to lend (responsibly)
  • investing in the banks with the requirement that the money be used to increase lending
  • providing tax incentives for institutions that decide to increase responsible lending
  • creating a federal bank that accepts deposits and lends its funds to compete directly with private banks

Continue to save money and spend less than you earn. It’s not a patriotic duty to spend it on products and services you don’t need, despite what you might hear. There is no need to sacrifice your future financial well-being for the sake of the greater good. It wouldn’t work, anyway. The economy will be sorted out with or without the house you buy now rather than a year from now.

Some interesting reading on the paradox of thrift: Paradox of thrift on Wikipedia, Frugal living is bad for the economy from Associated Press, Consumers Don’t Cause Recessions from the Mises Institute, and The Paradox of Thrift: RIP from Cato Journal.

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Your Emergency Fund: What Qualifies as an Emergency?

by Flexo on August 18, 2008

in Saving

Having an emergency fund, money set in an easily accessible location like a savings account earmarked for certain situations, is one of the first steps to being financially secure. This is common advice, particularly among financial advisers. Ideally, one wouldn’t tap the emergency fund at all. That sacrifices some earning power because even high-yield savings accounts lose ground to inflation. In return for that sacrifice comes some stability. With an emergency fund in savings rather than the stock market, you don’t have to worry about a potential loss if you need the money in a down market.

If you can plan in advance and protect yourself, you can help reduce the sting of an emergency.

There is, however, a difference in opinion about which circumstances qualify as emergencies. The biggest emergencies would arise with any event that eliminates an income source for an extended period of time.

Legitimate emergencies

Sudden job loss. For many people, the primary source of income, and thus the ability to pay for expenses, is a job. Most people in the United States trade their time and effort for a paycheck, relying on a company, small or large, to accept that time and effort and provide remuneration. When job loss is sudden, the primary source of income could disappear just as quickly. Very few of us are “entitled” to a severance bonus, providing a cushion to ease the fall for a period of time, so we must plan accordingly.

It’s dangerous to place your ability to earn income in a sole decision maker focused on a company’s bottom line. As an individual, we each must take our income into our own hands as much as possible, and that includes always being prepared for job loss. Part of that preparation involves having an emergency fund available, keeping a current resume, networking with colleagues, seeking recommendations, and studying the industry.

Even with preparation, the loss of a job can be damaging to your finances, and the effect can last long after you find your next job.

Death or medical emergency of a family member. While life insurance can help deal financially with death, it doesn’t cover everything. There is an entire industry designed around planning for death, but an emergency fund will always be necessary. As relatives age or gradually experience a decline in health, you have time to develop expectations and prepare financially, but unfortunately, death is not always this graceful. Emergency funds can be used to help pay for these hopefully infrequent events, from flights to visit distant family members to final arrangements.

Hurricane KatrinaActs of nature. In New Orleans prior to Hurricane Katrina, residents wary about hurricane damage to their homes were encouraged to buy insurance policies covering wind and rain damage. Many insurance policies provided no relief following Katrina because the damage done to homes was determined to be due to flooding. According to USA Today, only one-third of homes carried federal insurance which included protection from flood damage. Many residence thought they were covered in the event of a hurricane, but the insurance companies disagreed.

A typical emergency fund with three to six months’ worth of expenses may not have solved all problems in this situation, but it could have helped. Natural disasters are not always as damaging as Hurricane Katrina, and planning for total destruction will in most cases be excessive, but when designing an emergency fund, it’s helpful to factor in what is likely for your location.

car accidentCar accidents. Auto insurance is generally helpful when it comes to covering for damage due to car accidents, whether caused by you or another party. Often, insurance won’t cover everything you need. Your emergency fund may need to at least cover your deductibles, but also fill in any gaps left after payments arrive. The fund can help pay for a new car if needed.

Surprise tax bills. While review and planning should prevent this occurring, occasionally the IRS finds something overlooked. It happens to even the most diligent. The IRS will usually allow a payment plan to extend repayments over time for an additional fee, but an emergency fund can help cover the liability.

Delay in income. I used to work for a non-profit which, before I had started working there, had a nasty reputation of not keeping enough funds in their payroll account to cover the paychecks for the ten or so on staff. I’ve had friends working for start-up internet-based companies who were asked to forgo paychecks for a time period for the good of the company in its initial building stages. With an emergency fund with three to six months’ expenses, you won’t be in danger of failing to cover your bills. Once the paychecks catch up, you will be able to re-establish the emergency fund.

If delays in income extend longer than six months — personally, I would only accept this from an employer for a month at most, if at all — it is time to find a new job, if possible.

Sudden relocation. Usually, if your employer determines that your job should move from New York City to Ogden, Utah, they will compensate you for your relocation. That isn’t always the case, and your option may be to forgo opportunities within your company and business by quitting your job or accepting the relocation and the accompanying expenses. The decision is personal, but it’s better to be prepared to face the consequences.

What does not qualify as an emergency?

I’ve heard of people using emergency funds for expenses that are clearly not emergencies. While everyone’s definition of an emergency is different, if you want to make the best use of your money, I would suggest not tapping money earmarked for emergencies for these expenses. That said, you can save separately for these expenses.

beachVacation. It’s great to get away from your daily responsibilities for a time, but even if your therapist recommends an immediate vacation, you shouldn’t dip into the money set aside to cover emergencies.

A buying “opportunity” in the stock market or real estate. If you’re interested in timing the market or want to buy a house for the fun of it, save separately for the occasion. Most people overestimate their ability to time the market and could find themselves on the losing end of an investment at the moment they need the cash for a true emergency.

Out-of-town visitors. You just heard your friend from college would be in town for a weekend, and she’s suggested getting together for an evening out. If you don’t have extra cash flow at the moment, you might want to suggest a frugal option. Don’t feel you have to impress her by going to the fanciest restaurants and clubs, particularly if you have only your emergency fund available.

Mid-life crises. Recently divorced and quickly aging? It’s time to buy a convertible sports car. That seems to be the accepted path, but it can be a dangerous road to travel, particularly if your ex-wife has half or more of your money. Don’t dip into your emergency fund to buy a new sports car just because you want to feel young again. It may, however, be time to get together with an old college friend for an evening out.

Keeping up with the Joneses. The Joneses buy what they buy because they have no problem with debt. If you’re conscious about spending, you’ll never keep up with the Joneses in the accumulation marathon, nor should you feel the need. They’ve added a sun room and an in-ground swimming pool, but for all you know, they could be paying for it for years. Resist the temptation to match or exceed appearances, whether with debt or by tapping the emergency fund.

What do you think?

I’m sure there are many emergencies and an infinite number of non-emergencies I’ve neglected to mention. I will also bet the total of my emergency fund that some readers will disagree with some of my classifications. (Gambling: not an emergency; Paying your bookie: possibly an emergency.) Please share your thoughts.

Photo credits: au_tiger01, daveynin, and rayced

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Twitter Poll: How Much Do You Have in Your Emergency Fund?

by Flexo on August 11, 2008

in Saving

Earlier today, I asked via Twitter how much everyone has in their emergency fund in relation to their monthly expenses. Here are some of the responses. (I assumed if the message wasn’t sent privately and if the twitter account wasn’t protected that I could re-post the source of the responses.)

  • nodebtplan: 3 months of expenses in our emergency fund
  • takingcharge: currently only enough to get me through a month or less, but working on saving enough for 3-6 months
  • taliaishere: 3 months in the emergency fund, but am working towards 6 months-that would be much more comfortable
  • Gblogger: Depends on what I count — we stopped segregating specific emergency funds a while back. But at least 6-10 mos.
  • dreamscostmoney: 3-5. It used to be 3, but then I decreased my monthly expenses, so it’s probably closer to 4 or 5.
  • BurgBarbL: I have about 1.5 months’ worth of expenses in my emergency fund.
  • Private: In my emergency fund? One. Not great, I know. But with my new salary, I’m on a plan to make that three.
  • SunFinancial: I don’t have a dedicated emergency fund. All are accumulated in one savings account.
  • bargainr: 9 months

Among these responses, the average (while taking the low end of anyone who responded with a range) is about 3.5 months. Not bad! I have about 3 months’ worth of expenses in my account called “Emergency Fund,” but I have about an additional four times that amount across a variety of savings accounts.

If you’re interested in participated in occasional polls, follow me on Twitter. For those who don’t know, Twitter is a “social media” tool that allows you to broadcast and receive quick and short text updates. I promise not to send spam or to bombard you with “new post” updates. Mighty Bargain Hunter has a list of 118 personal finance bloggers who use Twitter, but many only provide automated “new post” notifications, duplicating an RSS feed.

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