Spend Less Than You Earn

Today’s post starts off the “Family Financial Guidelines” series. Whether you’re going through a financial turnaround or are just wanting to stay on top of things, this series will give you the tools to get and keep your family’s finances on track.

A lot of people look for shortcuts and easy ways to turn their financial situation around. It sure would be great to find one small, easy fix that would completely transform your situation, and if I found such a fix I would be sure to write a book about it and make a bunch of money from it. But what if I told you that there is such a fix, and that it has been around as long as money itself?

The Basic Principle of Family Finances
There is a common denominator in virtually every situation where a major financial turnaround is necessary. Like I mentioned yesterday, a lot of these turnarounds start when you reach a point where you’re tired of the collection agencies calling, the constant juggling of bills, the paycheck-to-paycheck lifestyle, the stress of knowing that the next unexpected bill (car repair, appliance replacement, medical bill, etc.) will put you over the edge and you want to make it all stop. The fix for this is to spend less than you earn.

This simple concept is the cornerstone of successful personal finance. Spending less than you earn results in a number of positive benefits:

You can eliminate debt: Every month that you spend less than you earn, you can take that difference and pay down your high-interest debt.
You can build savings: Just like paying down debt, you can take a portion of the difference and put it in a savings account for future emergencies.
You can lower your general stress level: This is a big one. When you know that your monthly spending is consistently lower than your monthly income, you can sleep a lot better at night knowing that you’re financial situation is improving each and every month.

Two Sides of the Coin
There are two parts to this concept, both of which are important. You can work to both spend less and to earn more.

Spend Less: The fastest way to start spending less than you earn is to find things you regularly spend money on that you can cut back on. This does not mean you necessarily have to cut out all non-essential spending. What it means is that you need to review everything you regularly spend money on and decide what things you can cut back on, what things you can find a less expensive alternative for, and what things you can cut out altogether.

– Shop around for lower auto and homeowners insurance rates.
– Eat out one less meal per week.
– Switch to a basic cable or satellite package, or cut it out altogether and sign up for Netflix streaming.
– Cut out a few coupons from the Sunday newspaper.
– Install a programmable thermostat and CFL light bulbs in your house.

Earn More: Typically the “earn more” approach takes longer than the “spend less approach”, but it is definitely worth working toward. Ideally, you can find ways to both spend less and earn more. And as an important note, “earn more” doesn’t only relate to your job.

– Go through the clutter in your home or apartment and sell unused items on Ebay, Craigslist, or have a yard sale.
– Do your best while at work. Go the extra mile to master complicated tasks and responsibilities.
– Take on a part-time job, or start a small side business to earn some supplemental income.
– Learn a new skill or further your education

The Bottom Line
There is no magic fix to turn around your financial situation. However, spending less than you earn is the closest thing.

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The Mini-Max Rule

I remember back in my college sociology class, the professor mentioned something called the “Mini-Max Rule”. It’s practically universal and works something like this: when people are faced with a choice, they tend to make the decision that they believe will minimize their cost and maximize their benefit. This principle is one of the primary drivers of every choice that people make. It’s surprisingly simple, but it was kind of an eye opener at the time. Even though a lot of times people end up making bad decisions, their thought process at the time of the decision was such that they believed the benefit would outweigh the cost.

One of the biggest challenges I face (and I’m assuming many others face as well) in managing the family finances is finding the right balance between saving money and saving time. I strive to “minimize” the amount of time spent and “maximize” the amount of money saved. I know that I could potentially save more money on things by spending more time on them. But time is at such a premium that I feel like I should really protect it. Last time I checked, there are still only 24 hours in a day, and I don’t want to shortchange my wife and baby to save a few bucks here and there. These decisions will be different for everyone as we all have varying thresholds of what we consider “worth it”, but here are some examples of our decision-making.

Insurance
Last year I shopped around for new homeowners and auto insurance. I had been happy with my insurance with Allstate. I had used them for my auto insurance since high school, and I really liked my agent. I didn’t think my rates were bad. I know there are those out there that swear by shopping around every year to make sure you’re getting the lowest rate, but I was happy with what I had. To me, I didn’t think it was worth it to spend a few hours online getting rate quotes at a bunch of websites to find a somewhat lower rate. (Time required greater than savings generated)

But last year my Allstate agent retired and sold his practice, and my policies were being moved to another office. At this point, my reason for staying was gone (my agent), and I did think it was worth it to shop around for insurance. I ended up saving around $200 a year on my homeowner’s insurance and about $50 a year on my auto insurance. But even with this, my strategy was to call an independent insurance agency and have them do the hunting. (Time required less than savings generated)

Coupons
I know there are people out there that go “coupon crazy” and to some it’s worth it. Personally, that’s not for us. We do use coupons, but we don’t spend a lot of time collecting them. To spend multiple hours a week finding coupons (both in the newspaper and online), organizing and sorting through them, and checking through the grocery list to make sure we buy the items with coupons, all to save $10 a week or so isn’t worth it to us. (Time required greater than savings generated)

I’d rather just buy the generic brands at the store and save a similar amount. (Time required less than savings generated)

One-Time Household Tasks
The things I love are the one-time tasks that continually generate cost savings.

Almost every light bulb in our house is a CFL bulb. These do have a higher upfront cost, but they last far longer than regular incandescent bulbs and use far less electricity. Some don’t like the lighting put out by these bulbs. For us, we’re so used to them that it doesn’t bother us. (Upfront cost and time required far less than savings generated over the life of the bulb)

One of our bathrooms has a low-flow shower head, and our kitchen sink has a low-flow aerator on it. As a result, they use less water than standard ones do. Since we are on municipal water, this has a direct effect on our monthly water bill. I should replace our other sinks and our other shower head with similar fixtures. The upfront cost is a bit high, but the installation time isn’t too bad. And over the years, the cost savings really add up. (Upfront cost and time required less than savings generated)

Your Stories
What are some of the choices you make between time spent and money saved? Share your story in the comments below…

Being Happy With What You Have

Trent at The Simple Dollar had a very nice post this morning about contentment.

Life is full of unlimited wants and desires that we cannot possibly fulfill. We can sit back and feel sorry for ourselves that we can’t have everything we want or we can choose to be happy with what we have.

Now, this doesn’t mean we shouldn’t strive for those things that we don’t have right now. On the contrary, if something is really important to you, then you should work hard to achieve it. The point is not to dwell on every little thing that you want to do or have but can’t. Contentment (happiness) is achieved when you find a good middle ground. You’re working hard to achieve your important goals, but you don’t worry about not having everything you want (or having everything someone else has).

Is It Still Possible To Raise A Family On One Income?

In today’s economy it has become increasingly difficult to raise a family on a single income. The costs of raising a baby are quite high, and when you add those on top of your normal monthly expenses it can be too much for one parent to support on his or her income alone. But it is not impossible. If having a household with a stay-at-home parent is a high priority for you, it can be done. And you don’t need a six-figure income to do it (depending on where the cost of living is for your location).

Our Decision
Before my wife and I started trying for a baby, we already knew that she wanted to be a stay-at-home mom until our child starts school (at which point she would re-enter the workforce). We didn’t want to send our child off to a day-care all day while we were at work. However, we knew that it would take preparation and some lifestyle changes to be able to do this.

My Wife’s Job
One of our deciding factors was the fact that my wife’s job as an entry-level dental assistant did not pay enough (in our opinion) to make it worth working and paying for daycare. The average pay for a dental assistant with between 0 to 2 years of experience in our area is between $11 and $13 dollars per hour (or roughly $22,000 to $25,000 annually). But even looking at the high end of that range ($25,000) her true earnings would be a lot less than that. There are a lot of costs associated with her working while we had a baby:

– Federal, state, and local taxes ($5,000). This is calculated at 15% federal plus 5% state and local.
– Social Security & Medicare ($1,912.50). This is calculated at 6.2 for social security and 1.45% for Medicare.
– Gas for the trip to work and back ($468.00). This is calculated at today’s gas price of $3.79 a gallon, gas mileage of 20 mpg in city driving in my wife’s vehicle for 10 miles per day for 48 weeks.
– Depreciation and maintenance on her vehicle ($120). This is calculated at $0.05 per mile for general vehicle depreciation, oil changes, wear on tires, etc.
– Clothing and shoes for work ($200). This includes scrubs and good shoes.
– My wife typically brought her own lunch, but if you ate out with co-workers every day this would easily add up ($1,200). This is calculated at $5 per meal per day for 48 weeks.
– We would most likely eat out more meals, since there would certainly be days where neither my wife nor I felt like preparing a meal after working all day and then taking care of a baby in the evening ($2,080). This is calculated at $20 a meal two nights a week for 52 weeks.
– Daycare for the baby ($5,250). This would cost around $6,000, but $5,000 is tax deductible and reduces the total cost.

After subtracting these expenses, you’re only taking home $8,770 from that $25,000 job. This is roughly equivalent to $4.57 per hour. To us, having my wife stay at home and raise our little boy was worth more than the $4.57 per hour she could be bringing home by working.

Making it Work
There are a number of conditions that have to be met in order to raise a family on one income.

Have Money Saved: One thing we did before trying to have a baby was to save up enough money to cover all the expenses related with having a baby, plus some of the money associated with the first year costs of raising a baby. This really helped us avoid feeling financially strapped right away from having a baby.

Monthly Income: The parent that does work needs to make a decent income. This will obviously vary depending on what part of the country you live, and this is one of the advantages of living in the Midwest. Our cost of living is fairly low, and if one parent earns close (say, within $5,000) to the median household income of around $50,000, you could be able to make this work. However, there are a lot of other points to factor in as well, as you could get by with earning less if your monthly expenses are low.

Debt Payments: This is probably the most important point. The more debt you have, the more of your monthly income has to be allocated to those payments. If you have two new cars with payments, a huge mortgage, and a pile of credit card debt, you will need a much larger income to get by with only one parent working. When we had our baby, we had our mortgage payment and a small student loan payment. We had no vehicle loans and no credit card debt. In the year since then we have needed to replace one vehicle, but we purchased a nice used vehicle with a very manageable payment. This is one of those lifestyle changes I mentioned above. Having my wife stay at home with Tyler is more important to us than the status of having a fancy new vehicle.

Recurring Monthly Payments: Besides debt payments, you need to really take a look at all of your regular monthly payments. Are you spending $200 to $300 a month eating out? How much are you spending on satellite/cable, and can you scale back to a more basic package? Living on one income means you will need to find ways to cut back on these expenses. But it does NOT mean that life has to be boring. That little baby gives us more enjoyment than going shopping for the latest fashions or tech gadgets. And there are a lot of things you can do that don’t cost a thing. You can get books from the library (even to download to your Kindle), go for walks in the park, have friends over for dinner and games, etc.

Priorities: Like I mention above, living on one income has a lot to with changing your spending priorities. My wife and I decided that it was more important to us for her to stay home with the baby than it was for us to have new vehicles, go out to eat, or spend money on new “things”.

The Bottom Line
If it is a high priority for your family to have a stay-at-home parent, know that it is possible. Try to plan ahead and pay down those debts early to alleviate your monthly cash flow. Review all your monthly expenses and see where you can cut back. I hear a lot of people say they wish they could stay at home with their babies, and I think some of them could do just that if the really made it a priority.

What To Do With A Tax Refund

I’m going to assume that most of you have already filed your taxes. But if you haven’t, this is a reminder that tomorrow is the deadline. Did you know that according to the IRS, the average tax refund is right around $3,000? That is a pretty nice chunk of change, which leads me to today’s post. What are some of the most useful things you can do with a tax refund? Here are six ideas…

1. Start (or add to) an emergency fund
If you don’t have an emergency fund, your tax refund is the perfect opportunity to get started. Put $1,000 in a savings account and then work to gradually build it higher. Look into an online bank such as ING Direct or Ally for the best interest rates.

2. Pay off (or pay down) consumer debt
If your refund is more than $1,000, then complete item #1 first. Then if you have credit card debt or other consumer debt (a car loan, etc.) put your refund towards paying off those debts. If your credit card charges 18% interest (about average) then paying $2,000 towards the balance will save you $360 a year in interest.

3. Get current on household and/or vehicle maintenance
It’s easy to put off routine vehicle and household maintenance when your budget is tight. Getting your oil changed, tires rotated, or other important things may end up falling off your priority list during the year. The same applies with household maintenance. It can be easy to put off putting on a new coat of paint, replacing worn carpet, or having your heater serviced. Use your tax refund to get caught up this year, and then plan for how to stay up-to-date on all your maintenance in the future.
(See ‘How to handle irregular but expected expenses’ for tips on how to better plan for these items’).

4. Improve the energy efficiency of your home
Along the same lines as maintenance, there are a number of little things you can do to improve the energy efficiency of your home to save money year-round. You could replace your regular light bulbs with CFL bulbs, switch to low-flow shower and faucet heads, add insulation to your attic, air seal your home, and replace old windows. Start out with getting an energy audit (most utility companies offer this service at a very reasonable cost) to see what areas of your home can be improved.

5. Open an IRA
Sometimes it can be difficult to save enough money to open an IRA. Most investment companies (Vanguard, Fidelity, etc.) have minimum investment amounts to open an account. If you receive an average-sized tax refund, you probably meet those minimums. As an added bonus, contributions to a traditional IRA reduce your taxable income. Or if you open a Roth IRA, future investment earnings are tax-free.

6. Have a little fun
Take a small portion of your refund (say 5%) and do something fun. If you get an average-sized refund of $3,000, this would be around $150. Take your spouse out for a nice dinner. Take your family (including kids) out to the movies. Spend it on something you enjoy, and do it without feeling guilty about it. Just be careful not to spend too much of your refund on “fun” stuff.

How much was your refund and what did you do with it? Share your story in the comments below…

What Does Being Frugal Mean?

Much like the word “budget,” the word “frugal” and all its forms seems to have a negative connotation for many people. Much like using a budget, being frugal forces people into making choices with their time and money that they’d rather not have to make. Being frugal means you think twice about it before eating out, buying that newest gadget, or buying that new car. However, it doesn’t necessarily mean that you can’t do any of those things. If your finances are in order and those are things you really value and truly bring happiness to your life, then go for it. Being frugal is more about the thought process behind your purchases.

I looked up “frugality” on Wikipedia, and it defines it as:
The tendency to acquire goods and services in a restrained manner, and resourceful use of already owned economic goods and services, to achieve a longer term goal.

The part of that definition I like most is that the purpose of being frugal is to achieve a longer term goal. It’s about doing what is really important to you. I’ve read quite a few posts about something called “intentional spending” that is very similar.

Our spending paints a picture of what our life’s priorities are. For example, in our family the largest monthly expense is for housing, which is obviously very important. Following that, the next two things are groceries and baby, also very important. And number three is savings for retirement, very important to us as well. For us, entertainment and eating out are probably close to the bottom of our list. Spending on our dog is a lot higher. Cell phone and Internet use is somewhere in the middle.

It’s a neat exercise to go through, and It doesn’t take very long if you’re already keeping track of your expenses. If you’re spending more on your monthly cable bill than you’re putting away for retirement, one way of looking at it is that your daily television watching is more important than your future living conditions. That may be a bitter pill to swallow, but it makes sense.

I understand that those just starting their financial journey will see some scary things with this exercise. Your largest expense could very well be interest on your debt. Now I’m not saying that interest is the most important thing to you, though the education/vehicle/purchasing that created the debt was obviously pretty important to you. But whatever the amount of interest is, paying off those debts is pretty important. Once those are gone you can put your money to work on other things; things you may not be able to spend much on now.

The point is to really think about your spending choices because they reflect what is most important to you. I’m not saying to stop and think over every item at the grocery store before putting it in your cart (that would be major overkill and take hours). Just be conscious of where your money is going.

Managing Irregular But Expected Expenses

Yesterday’s post talked about an emergency fund and how important it us to have one. But what about those irregular expenses that while you vaguely know about them, they always seem to come as a surprise? This includes things such as the annual registration on your vehicle, vehicle insurance typically due every six months, annual life insurance premiums, property taxes, homeowners insurance, etc.

These expenses really should not be paid out of your emergency fund. Instead, you should be including these expenses in your normal monthly budget on a monthly-average basis. For example, you know your car insurance gets paid every six months and that your bill is $240. Instead of waiting until the month it is due and scrambling to find an extra $240 in your budget, you should just pull out $40 each month and set it aside for car insurance. Then at the end of six months when your bill comes in the mail, you will have the $240 ready. No scrambling around to find a way to pay it; you’ve already got the money set aside.

You can do the same thing with any irregular expense. Personally, we do this with insurance (both life and auto), vehicle maintenance costs, and gifts. I simply take the average monthly cost of these things over the past year and then transfer that amount each month to a designated account. When birthdays or Christmas rolls around, I don’t have to rack up credit card debt because I’ve already been putting money aside throughout the year. Our homeowners insurance and property taxes are included with our mortgage payment as escrow, but you could use a similar technique if you pay these yourself.

What’s The Big Deal?
The point is that these expenses are things you know you have to pay, so you should take them into consideration when making your monthly spending decisions. You may be thinking that you can’t afford to set that money aside each month. On the contrary, since you have to pay those irregular bills at some point anyway it is much better to take the money out each month to cover the bill than to put the bill on a credit card when it comes due and pay interest on it. You may need to adjust your monthly spending to fit these expenses in, but it ends up costing less in the long run.

The Benefits
There are certainly benefits to planning ahead for these irregular expenses.

– You avoid having to put these expenses on a credit card and paying interest on them
– You don’t have to worry about being able to pay these bills when they come due. It’s a bad feeling when you know a bill will be coming in the mail any day now that you really don’t have the money to pay.
– By moving money to a savings account each month for these expenses, you’re actually earning interest. In today’s low rate environment it certainly isn’t much, but even if it’s a nickel or a dime, that’s better than nothing. And it means that you’re making your money work for you rather than the other way around.

How Do I Set This Up?
The easiest way to get this system started is by using an online savings account such as ING Direct. This is what I use, and it works well. You can set up unlimited sub-accounts for each savings target. So, I have a different sub-account for vehicle maintenance, gifts, and insurance (along with one for my emergency fund).

However, you can achieve the same result with any savings account. Just keep track of how much is for each expense on a sheet of paper or an excel worksheet on the computer.

Also, make sure to set the transfers up to be pulled automatically each payday. This makes it easier on you, with one less manual transfer to make. The easier it is, the more likely we are to keep doing it.