Now Would Be a Good Time to Start Paying Yourself – what to do with that recent raise or bonus

This is the time of year where you may have a debt hangover from spending too much during the holidays (you just didn’t want to listen to my advice in Just Don’t Do It!! did you?). Anyway, you live and learn – it is only a mistake if you fail to learn from it. It is never too late to regain the focus.

This might be a good time to rethink your saving/investment plan since you may have recently received a raise or bonus or expect to in the coming months. This is the easiest time to start or increase your allocation. You are (or should be used to) living within your means at your current pay level. You can allocate all, or a large portion, of your raise/bonus to saving/investing.

Remember, as shown in the sidebar, my fourth lesson to live by is to “Pay yourself -- save 10% of what you make”. In my opinion, this is the bare minimum to be financially prudent. If you have lofty goals such as retiring early you will need to do a whole lot better than that. How do I know? Because my husband and I had such goals and we achieved them! From our mid-30s on we directed probably close to 80% of our raises and bonuses into our investment portfolio. Sounds draconian but it did enable us to retire before we were 40. Saving this much had two important outcomes. First, it has put us into a position of being able to afford anything we want. Second, since we got used to being cautious consumers, we became less materialistic and decided that we really don’t need to have the hottest new car or biggest house – thus making the first goal much easier to achieve!

Life is all about making choices. If you recently received a raise or bonus you have a choice of what to do with it. Reward yourself by keeping it. Your plan might be different depending on your financial position.

1. If you have credit card debt or upside-down loans, use this found money to pay it off.
2. If you haven’t started a saving/investment account start it. You may want to read (or reread) my post Just Do It on how to start saving.
3. If you already are saving a percentage of your income, increase the allocation. My post Chomping at the bit? – how to start an investment portfolio might help you with this.

The best way to make sure you follow through on your intent to save this raise/bonus is to set up an automatic electronic transfer from your checking account for the same day (ok, maybe the next day) that the funds will be coming in. That way you can make sure that the money doesn’t tempt you to do something foolish. If you are not convinced, think about how the government gets its taxes. They don’t give us the “choice” to pay these taxes – the money is taken right out of our paycheck. Most of us soon learn not to even count this as our money (a topic for a whole separate conversation!). If it works for the government, why not let it work for you.

Sure you might want to take some portion of the funds and blow it on a cool new toy or entertainment. Just make sure that you don’t overdo it. My experience is that the “high” I got from watching my savings grow was much better then the temporary buzz I got from spending it on something that I didn’t need and didn’t last. When you think this way, you are well on your way to achieving financial independence.

The View is Lousy from Here -- fixing upside-down car loans

Many of you may have read my November 19, 2006 post, Paying Cash for Your Car and said, “yea right, but what if you already have a vehicle and are upside-down with the loan?”

For those of you lucky enough to have never heard that term, “upside-down loan” is the politically correct term for owing more than what the vehicle is worth. You may not have heard it because you are not in that situation. Congratulations, you can stop reading here. If you are not sure whether you have an upside-down loan, then your first course of action should be to check it out. Compare the balance you owe to the current Kelly Blue Book balance. While you are at it, you might want to take note of the interest rate on the loan because that will be the topic of a later post.

If you are upside-down, you should take no comfort in the fact that you are not alone. The Auto Industry Forum quotes research that indicates that anywhere from 26% to 40% of consumers are upside-down on these loans. You are looking for financial independence and need to do better than the crowd. You should use it as an early warning sign that you need to shore up your finances.

So an upside-down value does make life more difficult – but not impossible. You just need to remember one of the cardinal rules – stopping digging!! The last thing you should do is trade the car/truck in and roll the shortfall into a new loan. There really is no easy way out of this but you can take some comfort in learning an important financial lesson on a relatively inexpensive purchase (read this to mean you can AVOID having the same thing happen to you on your home mortgage).

We are looking to fix the problem here so I won’t talk too much about how to prevent this situation. The easy rules are 1) don’t finance more than 90% of the value and 2) keep the loan shorter than your intended holding period. If you want to read more, I suggest you read the Bankrate article, 9 ways to avoid, correct upside down car loans. One final word. Some might advise you to buy gap insurance to protect you from an upside down situation. As a former insurance executive I will tell you that, in my opinion, this is just a gimmick to raise your payments and take advantage of your need to trade in cars quickly. Holding the car longer than your loan is all you need to do. If this is an issue, then you are not learning what it takes to become financially independent. I would avoid leases for the same reason.

If you are upside-down there are three things you can do to fix it.

1. Keep and maintain the car/truck – The piper must be paid. If you are unhappy with this option, do it anyway. Just funnel your anger positively by reminding yourself that you won’t let it happen again. If you are still mad, look at item three below.
2. Try to refinance – This option, it difficult but worth trying especially if you have a very high interest rate and a relatively new or expensive car. When shopping around for a better deal you need to be careful and avoid too many credit inquires (as it will go against your credit score). You also need to make sure that you understand the terms of the existing loan and the new loan to make sure that you are not making the situation worse. You especially want to make sure that you are not extending the length of the loan.
3. Make extra payments – Use the monthly payment to remind yourself that you are digging out of a hole. Make extra payments whenever you can as these will reduce the outstanding principal and lower the amount going toward interest (more on that later)

Take heart and understand that the problem will be fixed in a relatively short period of time if you stop digging. Whatever you do, DON'T trade it in as you will be compounding the problem. And learn your lesson for your next vehicle purchase. Always plan on a loan that is shorter than the expected holding time of the vehicle!

Free Money!!!! -- finding scholarships

The other day as I was checking news on my stocks I saw an interesting headline for Walmart. “Need Money For College? Wal-Mart and Sam's Club Foundation to Reward Up to $7 Million in Community Scholarships.” The article noted that the deadline for applying for these scholarships is January 12, 2007. More information can be found at http://www.walmartfoundation.org (click on the Education tab at the top)

Besides being proud that Walmart is doing this (Walmart gets far too much negative press in my opinion), the article got me thinking about scholarships in general. If you are in school you are probably on your winter break right now – a good time to find all that free money out there! The CollegeBoard notes that over $134 billion in financial aid is available. There are very few times in life where people give you money – especially for something you were going to do anyway. If you are looking to become financial independent, it is worth the effort to seek out these opportunities. The internet eases the effort. The CollegeBoard has a great article to get you started. http://www.collegeboard.com/student/pay/scholarships-and-aid/8936.html The CollegeBoard identifies seven steps in this process.

1. Start With a Personal Inventory – taking time to identify all of your personal characteristics will expand the potential scholarship opportunities
2. Research Local Scholarships First – your town, county, high school or college may offer scholarships. Chances for these scholarships should be better since there is less competition.
3. Check Membership Organizations and Employers – the Walmart article demonstrates how organizations of all types and sizes sponsor scholarships. Look for opportunities in any organizations that you or your parents are affiliated with.
4. Use a FREE Scholarship Search Service – The CollegeBoard identifies four FREE scholarship search services that can provide you with a list of possible scholarships. I am emphasizing the free aspect of this because you should NEVER pay for scholarship information (see discussion below).
   Scholarship Search Fastweb Scholarship Research Network Express Wiredscholar
5. Contact Your State Department of Higher Education – Most states have scholarships for residents that attend college in-state.
6. Research Institutional Scholarships – You college website and financial aid office should be able to provide information about scholarships that are offered for your school.
7. Employ Scholarship Application Tips when Appling for Scholarships – remember presentation is at least half the battle. Make sure you read the How to Apply for a Scholarship article for advice on creating a winning application. http://www.collegeboard.com/student/pay/scholarships-and-aid/8937.html

So dig in and have fun! If this becomes "found" money make sure that you set some of it aside for your saving/investment portfolio. Also, make sure that you heed that advice of “if it sounds too good to be true it probably isn’t.” There are many scholarship scams out there that you need to avoid. Reading the CollegeBoard article “Can You Spot a College Scholarship Scam?” http://www.collegeboard.com/student/pay/scholarships-and-aid/408.html will help educate you on these scams. In general avoid any situations where they are charging fees or asking you for money. Don’t give out personal information unless you’ve initiated the contact and be wary of “financial aid consultants” as they can be shady and financial aid officers often resent their intervention.

The Tax Man Cometh -- income tax preparation

As unpleasant as it might be, this is a good time to start thinking about your 2006 tax return. I suspect that many of you don’t give much thought to your return. You turn it over to someone else to prepare and are happy if they tell you that you are getting a refund. While you are not alone (more than half of the 130 million returns each year are done by paid preparers), you make two critical errors when taking this course of action. First, having a clear understanding of your tax situation helps move to the path of financial independence – if you are not involved in preparing your taxes you miss a great opportunity to focus your financial goals. Second, getting a refund means that you overpaid – a clear sign that you are not managing your money properly.

So, that is the foundation for my unconventional recommendation that you prepare your own taxes this year. Yes you heard me correctly. I said you should complete your own tax return this year. The entire tax code is complicated but my guess is that your tax return is not. Also, there are several tax programs out there (TaxCut and TurboTax) that are inexpensive and do a great job at walking you through the process. Even if you have someone else prepare your return, I still suggest that you use one of these programs to prepare your return and then compare it with the “pro’s” version. There are great sales on these programs in January and you can usually find a copy for under $30. As an added bonus, you might find this software bundled with financial planning software (e.g., Quicken or Money) that you can use to start your budgeting.

If you are still not yet convinced, I will give you more to think about. Just because you pay someone to prepare your return, doesn’t mean it is correct. Last April, The Washington Post ran an interesting article that reports the results of a GAO study that revealed errors in 19 out of 19 returns brought to them to test the accuracy of work done by large chain tax-preparation firms. I encourage you to read the article yourself. http://www.washingtonpost.com/wp-dyn/content/article/2006/04/04/AR2006040401863.html

Why are there so many mistakes? Have you ever heard the term GIGO – garbage in; garbage out?. No matter how qualified the tax preparer is, if they don’t know your individual tax situation they can’t prepare the return properly. This means you have to provide them with the right information or rely on them to ask the right questions. You owe it to yourself to make sure that you at least understand what information has tax consequences so that you can provide it to the preparer. This is where TaxCut or TurboTax comes in handy. These programs walk you through a questionnaire that asks all the right questions (at least for all but the most complicated tax situations). I will leave these programs (or your preparer) to ask all the questions but I will provide you will the general categories that should be addressed:

• Who needs to file? – Your requirement to file is based on your income level ($8,450 for single filers) but it is important to note that even if you are not required to file you might want to file to recover any tax withholdings you made or receive credits that you may be entitled to (see below).
• What is your filing status? – There are four different filing status (married filing jointly, married filing separately, single and head of household) each of which has a different tax rate. Determining your status may not always be as easy as it seems and mistakes are costly (e.g., filing single when you qualify as a head of household)
• What are your exemptions? – Exemptions reduce your taxable income and are based on your marital status and dependents that you have (or if you are a dependent)
• What is your income? – Determining your income is not always as easy as it seems. For instance did you know that gambling winnings are income but gifts are not? You essentially need to identify any cash that you received during the year and assess whether it is taxable income or not.
• What are your deductions? – Deductions are items that can reduce your taxable income. You can take a standard deduction (a preset amount) or itemized (if you have the proper documentation). Itemized deductions fall under the general categories of i) medical, ii) taxes, iii) interest, iv) charitable contributions and v) other miscellaneous deductions such as casualty and theft losses and some employee expenses. Not all expenditures in these categories qualify as deductions so it is important to maintain good records and assess each expenditure independently.
• Are you eligible for any credits? Credits are very good as they reduce you tax liability dollar for dollar and, for certain lower-income filers, could result in you getting a refund from the government even when you paid no taxes! There are some pretty significant credits related to child care, education and the working poor. This is an area that paid preparers are likely to miss if they don’t know you situation.

There may also be an issue of the expertise of the preparer. The Washington Times article notes that these erroneous returns were prepared by individuals that are not “enrolled” agents. The GAO encourages you to seek out an enrolled agent (essentially a CPA or former IRS agent). While this might help some, it will be more expensive and still doesn’t solve the GIGO issue. You have to take charge by having enough of an understanding of taxes and your situation that you can assess the competency of the preparer. Let me challenge you by stating that if you can’t be bothered to do that, you are unlikely to ever be truly financially literate. It is a dirty deed that must be done!

I hope that I have inspired you to at least attempt to prepare your tax return. Even if you get started and then turn it over to a paid preparer, you will have become more educated on the topic. Gathering the information for your tax return will help you organize your financial paperwork to start a budgeting process. You may identify areas that you did not document and thus have a better understanding of what you need to do for next year. As I said before, budgeting is an iterative process that will improve over time.

As a final step I would ask you to determine what your effective tax rate was. This is determined by dividing your total tax liability (line 63 on Form 1040) by your total income (line 22 on Form 1040). This should be the basis for evaluating whether you think your tax burden is appropriate – NOT whether you get a refund or make a payment on April 15th. You should also use your tax return as a basis for adjusting your withholdings so that any refund or payment next year is as small as possible. Again, the software programs will help you with that.

I will leave discussing a broader issue that is a personal pet peeve of mine. This is a little off track but let me get on my soapbox for a minute. Because so few people actually pay attention to the taxes they pay, we have an uneducated citizenry that allows elected officials far too much discretion in collecting and spending OUR money. The U.S. tax system really is a clever design that serves to minimize discontent. Think about it. First, you have no choice but to pay as your employer withholds it from your paycheck. Then the rules are so complicated that few feel comfortable calculating your tax liability yourself. This leads to the likelihood that you have too much taken out of each paycheck. But when you get your refund you feel good about it! Since you don’t really know how much taxes you are paying, you tune out any discussion of taxes, leaving politicians to freely spend your hard earned money. Clever but totally absurd if you ask me. And yes, I am mad as hell about it and I am going to do something about it. What you ask? Why, I am going to get as many people focused on their own taxes as I possibly can! So go to it and take charge of your life!!

Buy Low - Sell High -- textbook buying and selling

Yes, this is a familiar phase in the investing world. Something easier said than done if you don’t have the proper knowledge and discipline. But today I want to talk about this phrase relative to something that really is a no-brainer – buying and selling textbooks!

If you are in school, I would wager that textbooks are one of your largest expenditures. According to a July 2005 study by the U.S. GAO, “the average estimated cost of books and supplies per first-time, full-time student for academic year 2003-2004 was $898 at 4-year public institutions, or about 26 percent of the cost of tuition and fees. At 2-year public institutions, where low-income students are more likely to pursue a degree program and tuition and fees are lower, the average estimated cost of books and supplies per first-time, full-time student was $886 in academic year 2003-2004, representing almost three-quarters of the cost of tuition and fees.”[1]

These costs are outrageous but you can do something about it. My first rule is – avoid the campus bookstore. Sure the bookstore is convenient but you will be paying out of the nose, even if you buy a used book. You may be able to find a student on campus selling the text book but my advice would be to go online. The explosion in web sites that buy and sell textbooks is a testament to how over priced these books have been at campus bookstores. I would be happy to see a little free market competition challenging this monopoly! Google “textbooks,” “buy” and “sell” and you will get close to 7 million hits! Some of the more well known sites include Amazon, Barnes and Noble, and Half.com.

I just completed a Masters program and bought all of my books on Amazon. More importantly, I sold most of my books there as well. The net outlay for these books ended up being a couple of hundred of dollars – much less than the costs noted above. I am not necessarily endorsing Amazon over any of the other sites, I am just telling you what I used. I used Amazon because I was familiar with it and found it to work for me. You might find another site works better for you.

Buy Low
Buying textbooks online is so much cheaper and easy that I can’t understand why everyone doesn’t do it. I suppose the main drawback is the shipping time. If you wait until the first day of class to find out the required textbooks you may fall behind in the assignments. Please don’t let you grades suffer. The easiest fix to that is to get this information before class starts – either from the instructor or the bookstore website. You might also be able to share a book with a buddy or use the library’s copy while you are waiting for your book. Worse case, you can pay for express shipping – it will probably still be cheaper.

I sense that another reason students don’t comparison shop for books is because they are not paying for them. Your parents or employer might be paying these costs. I think it just makes good sense to spend others money just as prudently as you spend your own but I know that is not the easiest lesson to learn. But you might be able to make this a revenue generating activity. For instance, if you parents are buying the books, you might be able to work out a deal to get a percentage of the saving. This might even give you a jump start to saving (see the November 21, 2006 post “Just Do It!). It might be harder to work out the same kind of deal with your employer but I think they would be impressed knowing that you are spending their money wisely. It could be a career boosting move!

Sell High
Don’t forget the other side. As an undergraduate, I kept most of my textbooks, especially those for my major. I was a nerd – my guess is that most students don’t form such an attachment. For the others nerds out there, I would also tell you that there are probably very few textbooks that you should keep. Especially now as textbooks are changing so frequently, they become out-dated very quickly. Any reference material you need can be readily found on the internet or at local or company libraries. As with selling, avoid the bookstore. I am appalled by how little these bookstores offer While a little more effort is required to sell you books online, you will get far more money for them.

So what effort is required? Not much really. Again, with Amazon, all I needed to do was set up an account and list my book for sale. Amazon only charges a commission if something is sold (usually about 20%). Every two weeks any money due you is credited to your bank account (even if it is a small amount). The shipping is a bit of a pain because it requires a trip to the post office. I usually save the package that the book was mailed in and reuse it when I ship it out. The standard shipping is media mail where the rates are quite low and you do get a shipping credit so I usually find that it doesn’t detract from the amount that I receive. You have two business days to ship but I advertise that I ship within 24 hours of the order (I find that this encourages students to select my book because time is usually a factor. I also frequently offer expedited and international shipping for the same reason.). I suspect that I could have made more by using other sites but I used Amazon because it was pretty painless.

Just a few other points. I find that I need to highlight passages in my textbooks to fully absorb the information. Many students don’t do this because they plan on reselling it afterward. Don’t be penny wise and pound foolish. The emphasis should be on learning the material. If you need to highlight to learn, then that is what you should do. I find that it hasn’t hindered my ability to sell the books. I make sure that I accurately describe how much highlighting there is and price the book accordingly. There is a market for these books. Selling online also helps when you school updates to a new edition. Usually there is still a market for the older editions for a few more semesters for other schools that haven’t already switched to the new edition. Timing is also a factor, you want to make sure that you have your book listed a month or a few weeks before the semester. This will show you the current prices. If it doesn’t sell, try again for the next few semesters. I had a text that came out with a new edition and I thought I would never sell it. I checked a few semesters later and found that I actually got a better price by waiting!

And don’t forget – proceeds from these sales should be found money. Don’t just blow it away. Use it to start that saving account!

[1] http://www.gao.gov/new.items/d05806.pdf

Let's Get this Party Started! -- applying Covey's third habit of highly effective people

A body in rest tends to stay at rest,
and a body in motion tends to stay in motion,
unless the body is compelled to change its state.

Newton’s First Law of Motion

So now you know that I have two speeds, on and off! I am sorry that I have been away so long. We can all learn a lesson from this. If we don’t stay focused on our goals, days turn into weeks, weeks turn into months and before we know it, we are doing what is urgent but not what is important. Stephen Covey cautions us about this in the third habit of highly effective people, put first things first. As he describes it, the four quadrants of activities are:

	Urgent	Not Urgent
Important	I – crises, pressing problems, deadline-driven projects	II – prevention, production capability (PC)[1] activities, relationship building, recognizing new opportunities, planning, recreation
Not Important	III – interruptions, some calls/mail/reports/meetings, proximate, pressing matters, popular activities	IV—trivia, busy work, some mail/calls, time wasters pleasant activities

Source:The Seven Habits of Highly effective People (page 151)

As Covey explains, “Effective people stay out of Quadrants III and IV because, urgent or not, they aren’t important. They also shrink Quadrant I down to size by spending more time in Quadrant II” (page 153). As we start the new year it is good to be reminded of this habit.

I’ve had my wake up call. Why don’t you take a minute or two and estimate what percentage of your time last year was spent in each of these quadrants. Remember, this is for you alone, there is no need to share! I am not even going to tell you what quadrants I’ve been in these last few weeks!Make it a goal to shift your focus this year to more Quadrant II activities.

[1] Abilities or assets that produce the “golden eggs.”