Friday, November 30, 2007

The Plan: Debt Reduction

The Problem

I have always been a math and science person. In elementary school, I participated in a special program for math and science that exposed us to lessons two to three grade levels beyond our class. In high school, I participated in every extra-curricular activity geared towards math and science, including robotics competitions, math clubs, engineering clubs -- ok, I was a geek. My degree is in Biomedical Engineering with a concentration in mechanics and a minor in Psychology, with a huge number of complicated sounding math and science courses under my belt.

With all of that math and science background, and what tends to be a very analytical mind, why, then, would I dig myself in to debt like I did, knowing fully the extent of the debt versus my income and the effects of compounding interest?

I started with my first credit card my freshman year of college. I did well with the card for the first year or so, before I carried my first balance. It got worse from there, and through the next three years or so I consistently carried a balance. Some time later, I got serious about the debt and paid it down. Then I ran it up again. Then I paid it down. Then up. Then I opened a second credit card account, and ran that up too. Eventually, I ran the debt up to where I felt uncomfortable, so I took out a personal line of credit to consolidate both cards under a more structured payment plan. Then I ran the credit cards up again.

Hindsight being what it is, I think I had a problem with impuse buying. Two or three years ago, I realized that I was stuck in a cycle that I had to break before I dug myself deeper. I can attribute most of that epiphany to meeting my wife, growing up a little, and looking forward in my life's timeline at the bleak picture of my financial future that I was painting.

The Solution

Spend Less Than We Earn

The first step in the resolution of my credit card problem is to stop making more debt. I mentioned in a previous post that we have been doing much better for the last year - our overall income exceeds our overall expenses and we've made some progress towards the debt. Even so, there were many times where we underestimate our expenses between paychecks and had to resort to the plastic to hold us over. We've been good about using the credit cards only for "needs," but typically the only reason we had to resort to the card was because we spent too much on "wants. I still consider it an unnecesary use of the credit card.

Avoid Temptation

To counter the temptation to break out the plastic in the face of every "irrestible" deal, special, sale, or bargain, I destroyed my two high-balance cards and froze my low-balance card in the freezer. My wife still has her card in her wallet, but I'm trying to convince her to freeze hers too. For those unfamiliar with the strategy of freezing the card in a block of ice, I still have access to the card in case of an emergency, but in order to use it I have to anticipate it, take it out of the freezer, and set it out to thaw. If I am about to make an impulse purchase, the hope is that by the time the card thaws, the impulse will have passed.

Reduce The Debt

Putting the breaks on adding to the debt is half the battle to reducing it. The second weapon in the war on debt is to make payments. There are many schools of thought on how to pay off credit card debt. Mathematically, to spend the least on interest while reducing the balance the fastest, the best strategy is to pay the minimum payment on all debts and maximize the payment on the highest interest card first. Psychologically, making the same payment to the card with the smallest balance is more noticable and satisfying. I decided on a plan somewhere in the middle.

The Plan

I think I have a touch of OCD when it comes to the card payments, and I like to make payments that leave the balance as a nice round number. For example, if the balance is $10,502.03, and the minimum payment is $180, I will pay $202.03. That being said, the plan is to pay higher interest rates any excess funds, and pay the "minimum" payment as described above. I won't be able to work out how much I will be paying every month, though, until I figure out what impact the 401(k) contributions, automatic savings, and changing health insurance will have on my take-home pay.

So, once I work it out, I'll post more details of the plan.
Until then,
Jonathan

Thursday, November 29, 2007

The Plan: Savings

Overview

I've mentioned in previous posts that I am still developing a plan, working out the budget, finding the right balance between repaying debt, building savings, and still having enough left over for here-and-now spending. I have spent a good deal of time in the past year evaluating my own behaviors, and I know that without some intervention, any money left over after paying the bills will go to here-and-now spending at the expense of any savings whatsoever.

I never realized the impact our lack of savings had until recently when I started looking back on the last 12 months of Quicken records. I found a pattern that repeats itself many times - paycheck comes in, bills go out, and I'm getting good at sending most of the balance towards the debt and holding back a small amount for us. What keeps happening, though, as the next paycheck draws nearer, something comes up that exceeds my cash on hand and we put it on the credit card with the good intent to "pay it off as soon as we get paid." The problem, though, is that my next credit card payment goes mostly towards the recent expense and does nothing for reducing the overall debt.

To counteract this pattern, build a larger emergency fund, and lay the framework for goal-oriented savings fund, I developed the first version of our Savings Plan. I established four basic savings categories:

- Short-term "float to the next paycheck" funds, to cover the small unexpected expenses that used to crowd my credit card statement.

- Short-term and Long-term goal funds, to save for future big-ticket items such as vacations, furniture, or "other." A not so short-term goal is the downpayment for a house, also in this category.

- Long-term Emergency Fund, should the worst happen, to cover three to six months of living expenses in the event of catastrophe.

- Financial Future fund, i.e. Retirement.

Short-term "Float to the next Paycheck" Funds

Over the last year, our overall spending has been less than our overall income, and our overall debt balance has gone down. About once a month, though, we're charging expenses that we shouldn't be, and this fund is designed to limit that.

I have a low-yield savings account with the same bank as my checking account, USAA, which offers the convenience of same-day transfers between them. I want to minimally fund this account to cover those unexpected expenses that I know I can cover out of the next paycheck, while not leaving too much cash at a low interest rate. I also know if the money is there than so is the temptation to spend it, so I don't want too much on hand.

Short Term Funds - Goal: $500.00
Short Term Funds - Current: $247.01
Short Term Funds - Method: Initial funding will be $50 per paycheck until the target balance is reached. After that, funding will be the maximum "residual" from each paycheck as needed to maintain the target balance.

Short-term and Long-term Goal Funds

The sad truth about our financial situation, to this point, is our tendency to be impulse oriented on big-ticket items are concerned. We decide on a big purchase, research the best price, and buy it on credit. Although we have always stayed within our means, technically, on the payments - i.e. we have never missed a payment in the three years we've been handling our finances together, it doesn't do much to research the best price only to pay more in interest.

For the Short and Long Term Goal Savings, I setup the Automatic Savings feature at ING Direct to transfer money from the Billpay account biweekly. That transfer is small right now, since debt-repayment is our biggest savings priority. Different portions of those deposits will fall into different sub-categories, depending on our savings priorities.

I also have an investment account that is automatically funded every month for the long-term goal funds. It tends to have a higher return rate over the long-term but it fluctuates more. Our plan to purchase a house is dependent upon eliminating our consumer debt, which will likely take at least five years. Once the consumer debt is eliminated, we can evaluate the state of the funds and, if necessary, wait for a shift in the returns. Although there is still some risk that the return will take a turn for the worse, the flexibility in timing will hopefully counter that.

Short-term and Long-term Goal Funds - Goal: TBD
Short-term and Long-term Goal Funds - Current (ING): $150.02
Short-term and Long-term Goal Funds - Current (Inv.): $1,659.60
Short-term and Long-term Goal Funds - Method: ING is setup to take $20 biweekly. The investment account is setup to take $50 per month. I make seven payments every month towards our debt, and as each debt is paid, the payments will be increased on the remaining debts. However, I think after every other payment is eliminated, I will split the balance of that payment between goal savings and the remaining payment.

Long-term Emergency Fund

I don't usually like to think about worst-case scenarios, but should the worst happen, we need to be prepared. Most personal finance authors seem to be in agreement that having three to six months of living expenses in the emergency fund is reasonable. Since predicting catastrophe is quite difficult, the risk that our investments will dive right before catastrophe strikes is a great concern, so ING Direct wins this one. A second ING account will eventually be the Emergency Fund.

As far as the rate of building the emergency fund, I've decided to hold off on building this rapidly for now, and focus the money instead on reducing our living expenses through debt-reduction, since debt payments are our biggest expense right now. There are two reasons behind this decision: First, we work in an industry that is always short-staffed, and should either of us lose our current employment, I already know of several employers where we have a standing offer. Second, in the event of accident or illness, our disability insurance will cover the same three to six months of income that the fund will. Eventually, the fund will take the place of the accident and illness disability, thus eliminating the monthly premiums, but for now the interest on the debts exceeds the premium amount, so our greatest payoff is reducing the debt.

Long-term Emergency Fund - Goal: $10,000.00
Long-term Emergency Fund - Current: $0.00
Long-term Emergency Fund - Method: Eventually, automatic transfers will fund the account biweekly, but not until a few of the debt payments are eliminated. The plan now is after three debt payments are eliminated, a portion of those payments will be directed here.

Financial Future Fund

Also known as retirement, the finanical future fund is in its earliest stages of development. I submitted the paperwork to enroll in my company's 401(k) plan this month, so starting January 1 it starts to grow. My company matches 50% of my contributions, up to a total employer contribution of $1000, so for the first year I am going to maximize their contribution.

Financial Future Fund - Goal: Maximize
Financial Future Fund - Current: $0.00
Financial Future Fund - Method: Automatic pre-tax contributions at $77.00 biweekly, with the employer match at 50%, for a total of $115.46 biweekly or $3002.00 annually. As with the rest of the savings plan, I want to push this contribution up as the debt payments go down.

The Principles of the Savings Plan

1) Save the money before we miss the money - By transferring money to savings before it even figures into the account balances, we are less likely even to realize that the money is gone.

2) Redistribute the money before we miss the money - As debts are paid off, that payment will be immediately added to the remaining debt payments, and periodically added to the savings transfers, and never added to our here-and-now spending budget.

3) Frequently evaluate the balance of the plan - Finding the right balance between debt payments, savings, and here-and how spending will take a while. For the first couple of months, we will most likely be reviewing our contributions biweekly to make sure we are still moving towards our goals.

Until next time,
Jonathan

Tuesday, November 27, 2007

Our feelings on spending, debt, and budgets.

Our Financial Childhood

My wife and I butt heads occasionally on money matters. They are usually small, inevitable differences in opinion about how much of our income should go to savings, debt-repayment, and here-and-now spending. I tend to pull towards debt-repayment and savings, while she wants to enjoy the fruits of her labor now.

There is a middle ground, where we can continue to make progress on the debt, stash some extra money away in savings, and still have some money left over for entertainment and other material luxuries. Since our wedding last year, we have swung back and forth around that happy medium. Some months we do very well with savings and debt-repayment, but do nothing for fun, while other months we spend a little more than we should.

Our Finances: An Update

I've been picking away slowly at debt for a long time. Getting married last year was a wakeup call of sorts, and its time to get organized, get a plan, and get into a more comfortable position with our money. For our plan to be successful, it needs to satisfy three key elements: it must be flexible, it must be achievable, and it must meet both of our needs. Here are the major steps in our plan, and I'll write more about each step in future installments.

The Plan

1) Establish savings - in the last year, for every month we make substantial progress on debt and savings, we have another month that sets us back with an unexpected (and sometimes expected but not anticipated) expense.

2) Pay off Debt - ok, that goes without saying. With better planning, I want to figure out how much we can reasonably afford to pay towards debt every month, decide on an order for the payments, and snowball and snowflake until its gone. With the bolstered savings plan, we won't have to resort to credit in the face of unplanned expenses.

3) Live Frugally - This one is somewhat vague, and this is where the balance really comes into play. If I invest hours each week researching the best price for groceries and nit-picking at every little expense, I have accomplished nothing. However, I am always looking for ways to trim expenses.

4) Get Real About the Future - I am 27, have no savings and no retirement. I should have, could have, and wish I had started earlier. It makes no sense to cry about it now, but it is time to start planning.

The Progress

I setup some automatic transfers to start moving money into our long-term savings and investment accounts before we even realize it is there. Starting in December, each month I will put $100 into low and moderate risk investments and $40 into Long-term savings. Eventually, I want to increase those amounts, but I want to clear up a couple of credit accounts first.

December is Open Enrollment at work, and I have all of the paperwork for the 401(k) and Flexible Spending Account. Our company matches 50% of 401(k) contributions up to $1000. I plan to maximize their contributions by investing $2000/year ($77/paycheck) for this year. I figure on about $2200 in medical expenses annually, including glasses and contacts, co-pays, and OTC products, so there's another $85/paycheck.

With the automatic savings, 401(k), and FSA setup, I just cut our bi-weekly income by about $200, once you consider the decrease in withholding. Now, I need to sit down with the wife and review our expenses, look at our debts, and get our budget on paper for the first of the year.

Until next time,
Jonathan

Monday, November 26, 2007

Getting started on the quest

I have not made any specific "get out of debt" goals yet -- I am still trying to find the balance of debt repayment versus living comfortably and enjoying life. While I try to find that balance, here is the lay of the land to get the quest started - this should be current as of December 1, 2007:

About Us
We are recently married, September 2006, and still feeling out our financial values. I ran up quite a bit of debt during college, and she has some debt from old medical bills she incurred while uninsured. We both work for an Ambulance Service, so we spend a great deal of time every day on the road, yielding some rather essential "extra" expenses - dining on the road and cell phones are at the top of that list.

We are both hourly employees, paid biweekly, myself a manager and my wife a "blue collar" employee. I am also a reservist, which generates some handy extra income. Since I make about twice as much annually, I usually figure on one-third/two-thirds when paying the monthly bills and each of our "fair" contributions to the joint expenses.

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Our financial summary as of December 1, 2007

My Checking (USAA Bank) - $190.08
Her Checking (KeyBank) - $43.84
Billpay Checking (USAA Bank) - $713.82

Primary Savings (USAA Bank) - $247.01
Long-Term Savings (ING) - $150.02

Universal Card - $8,496.52 (4.0% until paid) - Cards destroyed.
Capital One Card - $435.00 (15.4%)
Citi Card - $3,185.98 (10.24%) - Card frozen in large block of ice.
US Card - $10,502.03 (11.65%) - Cards destroyed.

Investment Account - $1,628.04

Car Loan - $15,855.47 (7.4%) - Asset valued at approximately the same.
School Loan - $4,499.81 (6.97%)

Misc Debt - $5,755.13 (0% until 12/2008)

Current Net Worth = -$29,842.99
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So, the picture is not a bright one. The credit cards are a problem, the lack of savings is not good, and the interest is rediculous. Luckily, I never have a problem meeting the monthly payments - just in hammering down the principle.

Over the next week, I will outline my current plans and goals for each category. I hope to post once every couple of days, to include progress reports, new ideas that I'm trying, and other personal finance tidbits that I pickup along the way.

Until next time,
Jonathan

Sunday, November 25, 2007

Changing Directions

Trying to earn money doing surveys does work - I have a $30 check coming from InboxDollars for many nights of surveys and following advertising links. However, the payoff really isn't worth the time spent trying to hit that $30 threshhold. It is, however, $30 more than I had and will make a nice snowflake for my credit card debt.

So, the making money on the internet idea really isn't paying off for me - too much time, not enough return. I'm far better off spending that extra time at night with my wife.

I am shifting the direction of the blog and using it to log our progress towards becomming debt free. A few words on my debt-reduction philosophy - everything is about balance. Yes, I could live uber-frugally and pay off the debt faster, but at what cost. Instead, I plan to reduce the debt at the fastest pace possible while still enjoying a comfortable life. Through smart decisions, I think I can reduce the debt at a reasonable pace but still enjoy some luxury.

I need to review my budget and accounts this month anyway so I can setup my 401(k) and FSA, so my first post about My Debt Quest should be ready in the next week or so.

Things to look forward to with this blog:
- Frugal ideas that don't sacrifice personal comfort.
- My personal thoughts on money and debt.
- Links to other personal finance blogs that share my ideas and values.

Until then,
Jonathan

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