Welcome, visitors from The Dallas Morning News! This is the next installment in a series at Consumerism Commentary about taking control of your finances. Please consider subscribing to the Consumerism Commentary RSS feed for updates.

If you’re on your way to spending less than you earn, then you’re going to need a good place to put your excess income. Even before setting savings goals and before establishing an emergency fund, it’s best to let your cash earn as much interest as possible while staying somewhat accessible. High-yield savings accounts are the best options.

Typical savings accounts at most banks pay an interest rate well below 1%. With conservative estimates of inflation running 3% to 4%, you’re losing purchasing power quickly by leaving your money in these accounts. In the last several years, internet banks paved the way for higher interest rates. Theoretically, these banks without branches could afford to pay higher rates because the companies lacked the expenses associated with owning a network of branches on street corners or in strip malls. More recently, traditional brick-and-mortar banks added more accessible high-yield savings accounts to compete with these offerings.

Interest rates have fluctuated over the past few years and we’re currently at one of the low points. Great interest rates are harder to find, but there are a few quality savings accounts offering 4% or close to it. While you may barely beat inflation at this rate, the purpose of a savings account is not long-term investment. You want to cash available to you within a day or two. All it takes to withdraw your cash is perhaps an online transfer and a visit to an ATM.

You shouldn’t just chose the savings account with the highest interest rate. Banks offer high interest rates because they want to compete for your deposits. If any particular bank is in the midst of a capital crisis—if they don’t have enough cash on hand to pay their expenses and liabilities—they will raise rates to attract more customers. For example, earlier this year, Washington Mutual raised rates several times and was frequently at the top of the list of interest rates. The purpose of this plan was to receive more cash. In the end, Washington Mutual failed and was bought by JP Morgan Chase.

Despite turmoil through bank failures, mergers, and acquisitions, there is very little risk in savings accounts. The FDIC insures these deposits on behalf of the banking industry. As long as you stay within the coverage limits, you should be able to access your money even in the event of your bank going out of business or being taken over by another bank. There may be a delay in your ability to access the money, but that is not typical

I have two recommendations for high-yield savings accounts. I am a new customer and new fan of FNBO Direct, the online division of the First National Bank of Omaha. I’m not the only fan of this account. Recently, Kiplinger Magazine honored FNBO Direct as the “best online savings account.” As of today, the online savings account offers a 3.25% APY. Since opening my FNBO Direct account in September, my experience with FNBO Direct has been smooth.

My other recommendation is ING Direct. With the Orange Savings Account’s 2.75% APY, this is not the highest rate you can find. ING Direct was one of the first banks to popularize the idea of branchless banking, and they have historically offered great interest rates. All reports indicate that customer service is fantastic and they have one of the best websites for navigating your accounts. It’s also very easy to organize your money at ING Direct into different labeled subaccounts. With ING Direct you can earn up to $525 in bonus interest my participating fully in their referral program.

Last Friday, I wrote about newcomers to the high-yield party, including Venture Bank Direct, ShoreBank, and DollarSavingsDirect. I also maintain an index of the popular high-yield savings accounts, organized by interest yield on the first $1 of deposit. The list was updated last night to include the rate changes from the past few weeks, and there have been several.

The high-yield savings account is an important piece of healthy finances and it will come into play as someone further develops money management acumen. Here are six tips for optimizing your savings:

1. Open the high-yield account. It will take only minutes to be approved, but funding your account electronically may take several days.
2. Keep your change. Use a jar to collect your excess coins every day and take the jar to the bank.
3. Automate your savings. Set up Direct Deposit for your paycheck so you’re saving first, withdrawing for expense later.
4. Divert small, unnecessary daily expenses to savings. If you spend $10 on two gourmet coffee drinks each morning, switch to one $2 Dunkin’ Donuts regular coffee and deposit the $40 you save each week into your savings account.
5. Hide your savings from yourself. Try to forget that you have money stashed away earning interest and survive without it.
6. Make your raise invisible. If you receive a 3% increase in your salary, increase the amount you leave in savings each month.

If you do things right, the money in your high-yield savings account should grow each month. It feels good to be in control of savings.

Image credit: Redvers

This should come as no surprise to Consumerism Commentary readers or anyone who has spent time reading anything relating to basic money management advice. Once you’ve decided to improve your financial condition and spent some time tracking your spending, you may have come to the conclusion that your situation declines each month because you’re allowing more money out the door than what’s coming in.

Spending more than you earn isn’t feasible for the long term. However, if looking at finances from month to month, even those fully in control of finances will have some instances in which monthly cash flow is negative. Variation is possible over short periods if savings if accessible or debt is available. Over longer periods, the variation should smooth out. The only way build your wealth over the long term outside of investments is to keep your spending lower than your income after averaging out monthly variations. Certain life events may require large outlays in the short term, like buying and furnishing your first home or starting your first professional job. While there are ways to save money when navigating these events, it’s not uncommon for spending to exceed income for a short time.

If after analyzing your current finances you see that your savings is decreasing or your debt is increasing due to negative cash flow, here is how to approach the point of reversing that trend. Read the rest of this article »

After deciding that it’s time to get a handle on your finances, find a way to accurately track the way you handle everything involving money. Before deciding to take action, you may have estimated your income and expenses, but now the details matter. Here is how to get to the details.

Every cent is important at this point. That will change later on; as you grow as a master or mistress of your money, you can ease the pinch on the penny. But in the beginning of this journey, you should record everything. From the $5 check from your grandmother on your birthday to your $75,000 annual performance bonus, and from the $1.99 music download to the $28,150 car, you must write it all down in some form.

There is a purpose to this madness. By tracking every detail of your money, you get a real picture of how much you’re spending. Many people don’t know off the top of the head how much they spend on lunches with coworkers every month or how much they spend on cigarettes or coffee. This process can be very enlightening, and in some cases, it might provide motivation in itself. By tracking your finances accurately, you’ll be poised to make better decisions about where to spend your money.

You don’t need to start with fancy software. Sometimes, low tech can be most effective, especially when starting out. Pads and pencils are portable as well, and they are great tools for keeping track of your cash spending while you’re on the move. The first step is to choose the method that will work best for you.

Desktop software

Intuit Quicken is the king of financial tracking software. Unfortunately, the software is not cheap. Quicken 2009 Deluxe, the most basic version available this year, costs $45 through Consumerism Commentary. You can connect to banks to download your deposits and withdrawals and credit card companies to download your charges and payments. Microsoft Money Plus is another option offering similar features. Both of these programs cost money to use. For those who don’t use Windows-based computers, MoneyDance is a good choice, but this software is not free, either.

If you’re looking for software that is free to use, take a look at GnuCash. GnuCash also has a portable edition which allows you to take your financial data with you and access the program anywhere you can jump on a computer. (Thanks to Dave Stinner who reminded me about Gnu Cash.)

Web software

Quicken Online Edition is now free. Here’s a review of the service. Mint (reviewed here), Geezeo, and Wesabe offer similar features to help you track your money.

While web software offers seamless integration with online access to your banks, it has some limitations. These web applications are not designed to keep track of your cash spending, which may be the most important requirements for accurately tracking your expenses.

Mobile software

Keeping track of the money you spend while you’re out is a challenge, at least for me. It helps to ask for receipts for all transactions so you can collect them and record the amounts at night when you’re home. I’m experimenting with software for mobile phones that allows you to keep track of your spending. SplashMoney works with my BlackBerry as well as iPhones. For Quicken users who enter transactions while away from the computer and sync them to desktop Quicken later, Pocket Quicken may be a good option. This software runs on Palm and Windows Mobile devices.

Paper

For people who prefer old-fashioned methods and have unlimited filing space, paper accounting is an option. Download this ledger paper and print a few pages. Use a separate page for each account, and keep track of your transactions just like you would with software. If you don’t like my ledger paper, try these templates, available for free.

Tips for accurate accounting

• Collect receipts for all transactions, including the purchases using cash. “Cash” should be an account in your software or on paper. Your starting balance is amount of money you have in your wallet on the day you begin tracking.
• If possible, keep notes about your expenses while you’re away from your computer or desk. Carry a small pad or use mobile software like those listed above.
• Every month, or more often if you have online access or automatic transaction downloads, compare what you record with the activity your bank has recorded in their systems. This “reconciliation” ensures you have accurate records for your bank accounts, investments, and credit cards.
• The web software listed above usually download your bank activity automatically. In some cases, the application will try to categorize your spending based on the vendor name or similar transactions by other users of the software. This “artificial intelligence” will make errors, so review every transaction to categorize the expenses and income properly.
• ATM withdrawals should be recorded as a transfer between your savings account and your cash account, not an expense. Cash deposits should be transfers as well.

As time goes on and you become more familiar with your finances, you can afford to be less aggressive about recording every cent. I suggest following the above suggestions and keeping track of everything for at least several months to get an informative view of your money.

If you have any additional tips for tracking your money accurately, please share.

Image credit: Refracted Moments

After viewing yesterday’s income and expense report for an imaginary person, Dan observed astutely:

... The one area that I don’t see is for a persons IRA, 401K, or ESPP. When is that money taken out or where/how is it assigned? It isn’t like you can say that you had a net income so you placed the net income in these funds because those IRA, 401K, or ESPP plans are taken out as if it was money flowing out.

Let’s call the imaginary person “Roger.” Here is a view of Roger’s income and expense report again.

After paying all non-discretionary (required) expenses, only $175 of the income remains. Roger could take this excess money and save it, invest ir, or spend it. Beneath the non-discretionary expenses, Roger also has discretionary expenses. This second category of expenses adds up to $350. Before Roger can think about saving and investing, Roger spends more than the $175 he has left.

Rather than having an extra $175 at the end of each month, Roger has a $175 deficit. In order to cover all his expenses, Roger has to come up with an additional $175. This will come from savings or a form of debt, like a credit card or a loan. Either way, Roger is cash flow negative and his financial health will get worse every month until expenses decrease or income increases.

If this month is typical for Roger, he will reduce his savings or increase his debt by $1,500 each year. And this is a conservative estimate, because he may need a new car someday or he may want move to a new house. Most likely, he will have large expenses not covered by his income. If Roger has savings to cover the monthly shortfall, eventually they will be depleted. He is not able to save or invest for retirement or any other future goals. Roger will be required to work to afford to survive until he can live no longer.

This should be a wake-up call. In this first part of this series, I wrote about financial enlightenment, the moment when you realize where you stand and your future outlook. I described how to take an inventory of your finances to determine your current position and how to use your income and expenses to predict your improvement or deterioration over time.

In many cases, people don’t reach a turning point in their financial lives until they hit “rock bottom.” That is something that people should avoid as much as possible. It’s not uncommon to just ignore a problem until it gets in the way of normal human functioning. You can live with a broken heater until winter, and you can continue to accumulate debt for a long time. Eventually, you’re going to want to be warm when the temperature drops and you’re going to want to keep your house when you start receiving foreclosure notices.

Now that he has reviewed his finances, Roger should have a good understanding of his condition. So far, I’ve written about self-evaluation, but now it is time for people whose situation is similar to Roger’s to take action. Starting with Part 2, I will share some ideas for moving in the right direction.

Image source: crowt59

Now that you’ve taken an inventory of your finances and determined your net worth, I can tell you that the number is meaningless. Well, there is a point to your net worth, but it’s not the most important number to your finances. Your net worth tells a very small part of the story that defines who you are.

Let’s say my net worth is $100,000. Am I in good financial shape, poised well for the future? It’s impossible to say because we don’t have enough information. $100,000 means different things to different people. For example, starting retirement with $100,000 in the middle of Kentucky will go farther if you relocate to Kentucky or Argentina than if you move to New York City or London.

But more importantly, your net worth is nothing more than a snapshot at some particular time. If you’ve recently climbed out of credit card debt, $100,000 is good. If you have hospital bills to pay without insurance, $100,000 might not be enough to last the next year. When you view your net worth in combination with your income and expenses, you will be able to better define your finances. You’ll have an idea of where your money is going.

Income

In today’s society, almost everyone needs income. Most people acquire money by trading their time and effort. I give eight hours of my day, five days each week, as well as a portion of my brain power during that period, to an employer. The employer is (usually) grateful and provides me with money in return. It’s kind of a strange system, but it works. Chances are you do something similar, but perhaps you receive income from investments or a pension.

With one source, it’s easy to calculate income. On a monthly basis, how much money do you receive? Some incomes are steadier than others. I receive a predictable paycheck from my employer each week. But I also earn money from a side business. The side business is highly unpredictable, so I don’t rely on counting that income each month.

Expenses

The reason we trade of time and effort for money is often because we need to use money to trade for items that allow us to survive, like food, water, and shelter. If we’re lucky, we’ll have some money left over after paying for necessities to spend on luxuries like furniture, internet access, and hot air balloon rides, or to save for the future.

Your expenses should be less than your income. Put another way, spend less than you earn, or live within your means. If you do, your financial situation will gradually improve. If you do not; that is, if you spend more money than you have each month, then you will dig yourself a hole that gets more treacherous each month.

Determine about how much you spend each month in a number of categories to determine whether you’re sinking, treading water, or winning a gold medal in breast stroke. For now, until you actually track every financial transaction you make, these numbers can be estimates.

Non-discretionary expenses

These are expenses you have to pay, the necessities for living. I use these categories but you may have some others you’d like to include. Like the net worth calculation, create a two-column list. The first column contains the category and the second column contains the monthly amount you spend in each category.

1. Automobile/Transportation: This includes parking, tolls, and train tickets.
2. Food and Groceries: If you have a family to feed, this could be very high.
3. Healthcare: How much do you pay each month for doctor’s visits and prescription drugs?
4. Household: Some household expenses are non-discretionary. I include clothing in this category.
5. Interest and Fees: If you have loans, credit cards, or any service that charges a fee, then include the amount you spend in this category.
6. Insurance: Health, car, and life insurance should be placed in this category.
7. Rent: I rent an apartment, but you may not.
8. Utilities: You pay for power to your home. Perhaps you would include cable television here, but I would consider that discretionary.
9. Tax: It’s almost impossible to avoid paying tax.
10. Debt payments: Each month you must make at least the minimum payments on all your debt.

Discretionary expenses

Everything else is a discretionary expense. You don’t have to spend this money every month. Dining out, gifts, charity, and your vacation are discretionary expenses.

The goal is to be able to start with your monthly income, subtract your non-discretionary and discretionary expenses, and still have some money left over. This calculation is your “net income” if it is positive; if the number is negative, you can call it a “net loss.” Net income can be saved, invested, or used to pay off your debt faster. Here’s what your income and expense report might look like. Note that income is positive while expenses are negative.

This person is in bad shape. With a monthly income of $2,000, he has only $175 after non-discretionary expenses. During this time period, including all expenses, he spent a total of $2,175 while earning only $2,000. If this is a pattern, he is probably increasing his debt load every month, and the non-discretionary debt payments expense will grow.

If this is you, this should be the first sign that it may be time to change your behavior. This individual has some flexibility, but everyone’s situation is different. Assuming that the month observed here is typical of other months, we can predict fairly accurately that net worth, if not buoyed by investments, will decrease every month.

This is the opposite of anyone’s financial goal. It’s time to take action.

Image source: specialkrb