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Talking about Insurance is Boring! (but Necessary)

September 29, 2008 · Filed Under Insurance, PF Basics · 4 Comments 

In the Personal Finance Basics series I’ve (very slowly) been working through, it is now time to talk about insurance.  So, what is insurance? (it’s boring! – well, ok, that might be true, but that’s not what I mean here).  I mean, what is the definition of insurance?  Actually, I don’t mean that either.  I mean what does insurance accomplish?  I think it makes sense to think of it as a transference of risk.

Insurance is a transference of risk

photo by NIOSH

In exchange for a small amount of money, the insurance company will give you a large amount of money in the rare case that you need it.  You are therefore transferring the risk of having to pay a large amount of money to the insurance company.  I think this definition works well for most types of insurance, but not perfectly.  For instance, it does not apply strictly to most health insurance plans in the US since we want our insurance to cover all office visits and procedures, not just the very expensive and rare ones (though it does do that also)

Do I really need insurance?

Determining whether or not you need a certain type of insurance is a very important first step.  Each person’s individual circumstances will determine which types of insurance are necessary.  You should discuss this with a qualified professional and/or a trusted person (or persons) who can give you good counsel.

The least expensive (at least in the short-term) form of insurance is always self-insurance (I mean no insurance).  Of course, if you end up needing the insurance payment, then self-insurance becomes significantly more expensive.  But if you can afford the payment if the risk is realized, then you don’t need to purchase insurance.  For instance, if you have the money to rebuild your house (and replace everything in it) if it burns down, you don’t need homeowner’s insurance.  If you can afford to lose a lawsuit, you don’t need an umbrella policy.  If your family can afford to continue their current standard of living if you die, then you don’t need life insurance.  If you can’t afford any of these, however, then insurance is a good idea (a very good idea)

Again, each person has reasons for whether or not they need a certain type of insurance  – there is no one size fits all answer to this question.  I’m listing some common insurances that you should consider – it doesn’t mean you should buy them all (I don’t currently own all these types) nor does it mean there aren’t more that you should consider.

Common types of insurance

  • Health – At the very least, you should have a major medical policy that will pay for expenses like surgeries or serious illnesses that can quickly generate enormous bills for you.  Even if you have to pay for office visits ($) out of pocket, the risk of a huge hospital bill ($$$$$) is too much to ignore.
  • Home Owner’s or Renter’s – These policies pay for rebuilding or repairing your house and/or your personal belongings in case of a disaster such as a fire or robbery.  Having such a policy is a very good idea for almost everyone (and most mortgage companies will require one).  Just note that some disasters, such as floods or earthquakes, are not typically covered under home owner’s policies.  Also, look for a policy that provides "replacement cost" for your items.
  • Auto – Auto insurance is mandatory in most places in the US, I believe.  Even if it was not, it is still a good idea for everyone who drives.  Not only do most policies provide payments to cover damage to your car and other cars in an accident, they also cover liability issues that may result.
  • Personal Liability (Umbrella Policy) – If you want to ensure you are very well protected, purchase a personal liability policy.  This policy acts like an "umbrella" to cover your liability over and above that which is provided by your auto and home owner’s insurance.  As Dave Ramsey says, the best way to protect your assets in the case of a liability suit is to put a big, fat, ugly insurance company between you and the other party.
  • Disability Insurance – The greatest asset that most people will have in their lifetime is their ability to earn an income.  Disability insurance is what protects this asset.  If you are unable to work, disability income will replace some or most of your income.  There are two flavors, short and long term.  Long-term is extremely important if you were to suffer some sort of debilitating injury or illness and not be able to work for years.  The best (and most expensive) type is "own occupation" insurance.  It means the insurance company will pay-out as long as you are unable to work in your current occupation.  In other words, if you have a professional job, they are not going to force you to get a job at McDonald’s and stop paying you benefits.  On the other hand, if your job entails sitting in an office in front of a computer (like mine does), if you can’t do that there’s a pretty small chance there would be some other kind of job they could make you do.
  • Long-term care – Long-term care insurance pays for care in the event that you can no longer care for yourself.  Due to the enormous (and ever-rising) costs of long-term care (in a competent facility), LTC is probably a good idea for most people.  Though inexpensive for young people, the recommendations I’ve seen are to wait until between the ages of 50-60 to get a policy.  There are a lot of options and policy types for long-term care – too many to go into any detail in this post.
  • Life – Life insurance is very necessary for some people and quite unnecessary for others.  If you are single and have enough money for a proper funeral, you don’t have much need for life insurance.  Likewise, if you are married with no (or grown) children and a large enough net-worth for your spouse to continue his/her current lifestyle, again you don’t have much need for life insurance.  On the other hand, if you are the sole breadwinner of a family with a few small kids, your needs are enormous.  I’ve heard that the general rule of thumb for life insurance is seven times your annual salary – but personally, I think that the actual need varies greatly by your specific situation.  There are numerous life insurance needs calculators you can find online.  If you need life insurance, my advice to you would be to get a 20 or 30-year term-policy and get a lot of coverage (term policies are very inexpensive, so load up on the coverage).

Of course, there are many other types of insurance out there (but I’m already over 1100 words on this post) but I feel these are the most common that are needed by most people.  Would you suggest any other types for most people to consider?

Photo Credits: NIOSH

My Current Budgeting Technique: The Hybrid Check-Point and Cash Plan

September 10, 2008 · Filed Under Budgeting, PF Basics · 1 Comment 

Yesterday I discussed a few different ideas for following-through on your beautiful budget spending plan . We have personally tried most of them (except for the all cash method) and have not been completely satisfied with anything yet. Not to be deterred, I’ve continued optimizing the plan. Today, I’m going to present our current technique.

The key for us is to automate as much as possible

I use billpay from my checking account to do as many bills as possible. I transfer money to my mother-in-law and even used billpay to send a check to my sister-in-law once. I have automated transfers from one account to another to take care of savings; money is deducted from our paychecks to fund our 401ks and employee stock purchase plan. I have learned that the more I automate, and the easier I make things, the more that gets done. So I do it as much as possible. That is all well and good but the budget is busted by the non-scheduled expenses, as I mentioned yesterday.

The basis of our current plan is the Check-Point technique

The latest approach we have been trying is the check-point technique. I pick a certain date and, on that date each month, I take a look at our checking account balance. I compare the current balance to the reference point to see how well we have done the previous month. If we are above the reference balance, that’s a good thing. If we are significantly below, that is not a good thing. Personally, I take the check-point as the day that our mortgage payment is deducted from our checking account each month.

We have moved the "non-essential" expenses to cash

Our latest variation, hence the "hybrid" moniker, is that we have started to use cash for some purchases.  We continue to use our credit cards for normal expenses like groceries, gas, and other "necessary" things. We now use cash , however, for the "non-essentials" like dining out, buying toys, entertainment, etc. (you have to define your own categories)

To implement this, I withdraw some cash from our checking account at the beginning of each month. We do have a certain amount budgeted for non-essentials each month though I do not take all of it out at once.  About half way through the month, I take out the rest of the allotted amount in cash. That way, if the essentials go over budget, we just take out less for non-essentials at our second withdrawal.  In this manner, the technique is dynamic in that essentials take priority over non-essentials and we still buy groceries and such but maybe don’t each out as much, if necessary.

Don’t forget the "fun money!"

We also use cash for our "fun money" but this is a strictly separate category. My wife and I each get a certain amount of cash (it’s not much, but I haven’t spent it all in a month yet). There is no accountability with this money – we are free to do with it whatever we wish (that’s what I use for hosting this blog). I feel that the fun money is really important – especially for someone who feels overly restricted by the idea of sticking to a budget (especially when that magical trick of calling it a "spending plan" instead doesn’t work!) I would definitely recommend that you incorporate some "fun money" into your plan.

We are still in the process of checking this latest technique out

So far it has worked fairly well. The credit card bills were lower last month even with taking a vacation. And I love not having to write everything down. It is certainly not a strict plan that will force us to "give a name to every dollar" like Dave Ramsey would tell us to – but sometimes theory has to meet reality. As I mentioned yesterday, I’m still looking for the perfect plan.  We’re ever-so-slowly inching towards a cash based method, but we haven’t taken the plunge yet.  So, if you have any suggestions for modifications or other techniques entirely, I am all ears. (or eyes as it were, since I’ll be reading your comments on my computer monitor)

Four Techniques for Executing a Spending Plan

September 9, 2008 · Filed Under Budgeting, PF Basics · 4 Comments 

I am sure that none of you have ever experienced this, but it turns out that It has been very hard for me and my family to stay on a strict budget. Luckily, with an emergency fund in place, we have not suffered any major financial consequences to date.

Creating budgets is not-so-hard, sticking to them seems to be much more so

I have tried a number of times to create a budget. They all look so pretty in my spreadsheet application (some even have different colors!). In my current spending plan spreadsheet, I have exactly nine different budgets. The problem is not in creating the budget but in sticking to it (again, I’m sure I’m all alone on an island here, but I’m just trying to be honest).  In this post, I’ll explain some of the budgeting techniques I’ve tried and hopefully one or more will resonate with you and enable you to execute (as in follow-through on) your spending plan instead of getting frustrating and executing (as in, well, executing) your spending plan!

Those non-scheduled expenses always destroy the budget

Even when I create and actually start using a budget, it is typically busted by the non-scheduled expenses (even the budgets with the fancy colors!). It is easy to account for the monthly bills (especially when you use the equal payment plans). We have never been good, however, at forecasting how much will be spent each month in categories like groceries and restaurants and other miscellaneous expenses. These are the expenses we typically put on our credit cards each month for convenience. Of course, this sometimes leads to bills that are quite large at the end of the month. Over the years we have tried a few different techniques to keep these under control or to at least monitor them and avoid surprises.

I used to write every purchase down

At one point I had a piece of paper on the refrigerator to write down every expense. Believe it or not, some of my friends made fun of me, though I think one actually implemented the exact same technique. Earlier this year I just wrote down every expense on a piece of paper and added all the categories up periodically. This worked fairly well but was annoying and I didn’t like the idea that I would have to write down every expense every month for the rest of my life!

I tried to get in the habit to checking the credit card statements periodically

After getting bored with writing down every expense, I told myself that I would just periodically check our credit card balances to achieve the same goal. The thing is, this didn’t really work for me either. I’m not sure why, it seems like a reasonable technique.

I then created the "Check-Point" budget

Drifting further to the side of convenience, I then created what I call the "check-point" budget (I’m going to call it CP because it is annoying to type). I’m sure I didn’t really invent it as it seems to be common sense, but I had never heard of it before.

The CP works on the theory that if your income is fairly stable and you have done a good job of planning for all your expenses and savings, your checking account balance should be about the same at a certain point each month. For us, I check the value immediately after our mortgage payment is deducted. If the value is at or higher than the "CP" value (the value it was the previous month), then our spending was not out of control the previous month. If the amount of money in the account is significantly lower than expected, then it is time to tighten the reins and get more proactive about our budgeting and spending. I also instituted a sub-CP at the middle of the month to try to catch any deviations earlier in the cycle.

Of course, there is the old standby: Cash

I think the CP technique is pretty good (especially from a convenience standpoint) but I am still looking for the ultimate blend of convenience and effectiveness. The CP is still a bit reactive instead of proactive as you could get yourself in a lot of trouble by the time you check it the next month. As a result, I keep coming back and evaluating the use of cash instead of all these other (and sometimes annoying) techniques.

This doesn’t say much about me, but I had an "aha" moment about using a cash a few months ago: the best thing about using cash is that there is no more writing stuff down! You look in your wallet, if you have money, then you can spend some. If you don’t have any money, then you don’t spend it. Easy. Unfortunately, this doesn’t integrate well with the way my family lives. Yes, I admit that is a cop-out. Of course, If we really wanted to, we could use this system. (Ergo, I guess we don’t really want to)

We’ve tried all of the above except …

So, we’ve tried a number of things. Some have worked fairly well, some are annoying, some are both. The one thing we have not tried is the full cash system (sometimes called the envelopes method). I haven’t decided that we should make the jump to this method and, frankly, I think I would have a hard time convincing the rest of my family to try it. What about you? Do you have any other good budgeting ideas that seem to work?  Have you tried all cash?

A Look in the Mirror: Are You a Borrower, a Consumer, or a Keeper

September 3, 2008 · Filed Under Finances, PF Basics · 3 Comments 

I am (slowly) working through my Personal Finance Basics , going into more details on each step.  It is time for the discussion on #3: Spend less than you earn .  I’m going to focus over the next few days on some techniques for budgeting (I’ve tried a bunch over the years).  Today I want to step back and take a broad look at the topic.  I think the importance of this aspect of your financial plan is illustrated well in the excellent book, The Bogleheads’ Guide to Investing .  This book leads off with a story illustrating three common financial lifestyles lived by three fictitious couples: The Borrowers, The Consumers, and The Keepers.  I think this paints a great picture of the contrast among these common lifestyles.

The Borrowers

image by David Boyle in DC

The Borrowers are living the high life.  They have the best of everything – expensive cars, high-end clothing, a huge McMansion, and so on.  They have numerous credit cards and they are not afraid to use them.  When the balances on the cards become too high, its time for a cash-out refinance or home equity loan to clear the credit cards and start all over.  Leased cars, no money down interest-only adjustable rate mortgages, and minimum monthly payments typify the Borrowers as they lead their life of luxury.

The only problem is that they are nowhere near able to afford their lifestyle.  Forget about retirement, they will be working until the day they die.  They are a job loss or a prolonged illness away from losing everything to the bank and their numerous creditors.  In Texas, the term for this is "big hat, no cattle."  (I find it strange that I’ve read a few different personal finance books that use that term)

The Consumers

The Consumers, in contrast to the Borrowers, do not live life restricted only by the limit of their credit cards.  Instead, they live life restricted only by their take home pay.  The question they ask themselves when investigating a major purchase is, "Can we afford the monthly payments?"  Interest rates and the length of the loan do not matter, if they can wedge the affordable payments into their monthly budget, then what’s the big deal?

Photo by donandcarol

Again, this is an unsustainable lifestyle in the long-term.  If their take home pay drops for whatever reason, the low monthly payments quickly become huge.  Retirement will not be the dream of a huge RV, traveling the country, and golf courses.  Instead, it will be a very restricted one governed by the check received from the government each month (assuming that is still going on by the time they are no longer able to work).

The Keepers

The authors contrast the first two lifestyles with the Keepers.  The Keepers live according to a net worth mindset as opposed to the credit card mentality or paycheck mentality.  They are concerned more with their net worth than their net income.  The first thing they do with their money each month is to save some.  They avoid debt as much as possible (certainly no high credit card rates as they pay off the balance each month) and participate in  tax-advantaged retirement accounts.

While they make no more money than the Borrowers or the Consumers, they are much more likely to achieve their long-term financial goals (partly because they actually have long-term financial goals other than buying the latest and greatest stuff).  While this lifestyle may not sound as exciting as the first two, it certainly sounds a lot less stressful to me.  Plus, I like the idea of being able to stop working 40+ hours a week to devote my energies to other pursuits at some point before I die.

There are numerous other lifestyles

Of course, these are three very broad generalizations.  In real life, there would be more lifestyles too numerous to detail.  I think that we all know people that fall into these three categories though.  Obviously, the book portrays the Keepers as the best lifestyle (the chapter in which this is found is called "Choose a Sound Financial Lifestyle" after all) and I would guess most of us (at least those reading personal finance blogs) would tend to want to live as the Keepers do.

So which type are you?

I do think my lifestyle matches up most with the Keepers.  I track my net worth monthly (oh, time to do another update in a few days).  We do use credit cards but pay them off each month.  I don’t care anything about monthly payments – when I buy a car I negotiate on the price, not the payment.  I should take more advantage of tax deferred investing options, however, as neither my wife nor I max-out our 401ks.

Some people, however, would certainly say that we are not living life to the fullest.  They would claim that we should spend more of our money to enjoy today instead of worrying so much about saving for tomorrow.  That is probably a valid point to some extent, but for me, I think the stress of not feeling like I was being a good steward of my financial blessings would outweigh any short-term benefit.  Though I probably do lean too far towards the "hoarding" side of things and that is something I’m working on.

Well, what do you think?  Do you even agree that the Keepers are the lifestyle to emulate?  If you do, do you hit the mark?

photo credits: David Boyle in DC and donandcarol

Is Giving Really that Important?

August 26, 2008 · Filed Under Giving, PF Basics · 7 Comments 

We’re delving into step 2 on my list of Personal Finance Basics and it is a controversial one – give away some of the money you earned in step 1. Certainly some people would argue with me on this step. "Why would you want to give some of your hard earned money away? You’ve worked so hard to get it. Certainly, you should at least get out of debt before you start giving. You should save your money and invest it – when you have a lot of money to help others, then you can worry about this giving stuff."

Well, I’m going to have to disagree with those who would say that…let me tell you why. (you might be thinking about now, "uh oh, here comes more of that church and Bible stuff," and, if you are thinking that then you are correct. Even if you’re not interested in using Biblical principles to guide your life, please stick around. At the bottom of the post, I’ll provide a few secular reasons to give)

Why should I give before any of the other personal finance stuff?

Quite simply, you should give some of your money away because we are instructed to do so in the Bible. Of course, there are numerous Old Testament passages regarding tithes and offerings. And remember, these passages are directed towards all people – not just the wealthy or the ones who have managed to get out of debt. I think everyone should give what they can no matter what situation they find themselves. If you can only give a little, then give a little. If you can give more, then give more. Remember, God doesn’t ask you to give because he needs the money, so don’t worry about not having much to give. I think God instructs us to give for the following reasons, among others:

  • Giving shifts our focus from the temporal to the eternal – It is quite easy for us to get caught up in our current situations and get distracted from our focus on God and the eternal. Purposefully and periodically giving money (which most of us deem important and find hard to do) shifts our focus from ourselves to God. At the same time, we trade our earthly treasures that are so dear yet so fleeting for heavenly treasures that are eternal.

But store up for yourselves treasures in heaven, where moth and rust do not destroy, and where thieves do not break in and steal. For where your treasure is, there your heart will be also. Matthew 6:20-21

No one can serve two masters. Either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve both God and Money. Matthew 6:24

  • Giving shifts our focus from ourselves to others – As people, we are naturally selfish and self-absorbed. It requires effort to place others before ourselves. Giving causes us to look outside of ourselves and our day to day concerns. As a result, we learn about others and are exposed to the difficulties other people have in their lives. Not only does giving help out other people, but it also helps us as well by enabling us to be content with our current situation. It’s hard to complain about how much it costs to fill up your car with gas when you are giving your money to people who not only don’t have a car but don’t even have enough money for food.
  • Giving typically results in material blessing and increase – This is the quite counterintuitive but it appears to be true. Check out this verse from Proverbs:

One man gives freely, yet gains even more; another withholds unduly, but comes to poverty. A generous man will prosper; he who refreshes others will himself be refreshed. Proverbs 11:24-25

This verse teaches that being generous towards others actually results in our own prosperity. I don’t think this is some guaranteed contract and I do think it only occurs if you have the correct attitude in giving. If you are begrudingly giving some money because you think you’ll get more money in return, I’m going to go out on a limb and say that probably won’t come to fruition.

On the other hand, here are some personal stories from ChristianPF and Capital Couples Finance via Gather Little By Little about how tithing affected their financial situations. My wife and I have regularly given a set percentage of our income since we got married. We continued this even while paying back huge amounts of student loans and somehow (I’m seriously not sure how it all came to pass so quickly) we have paid off all of our student loans decades before they were scheduled to be paid off.

How much should you give?

How much of your income to give is quite controversial as well. I really believe that amount is between you and God – there is no correct answer for all Christ followers. I’ll put some of my thoughts out here as a starting point to the discussion but these are only my opinions.

The most important component is your attitude.

image by Phillie Casablanca

If you are just giving money because you feel you have to, well, that’s alright because at least you are doing it to be obedient to God, but I do feel that you are still missing out on some of the associated benefits and blessings. On the other hand, if you are giving so others will tell you how great you are, then you are really missing out. You’ll get your reward, but it will be from a few people and not from God:

And when you pray, do not be like the hypocrites, for they love to pray standing in the synagogues and on the street corners to be seen by men. I tell you the truth, they have received their reward in full. Matthew 6:5

Shouldn’t I give 10%?

In the Old Testament, God commanded the Israelites to give a tithe, or tenth, of their possessions and income. I personally do think that it directly applies as a command to Christians.

Each man should give what he has decided in his heart to give, not reluctantly or under compulsion, for God loves a cheerful giver. 2 Corinthians 9:7

Though I do not feel bound by the tithe, I do think it is a good starting point for investigating how much of your income you feel led to give.

To whom should I give it?

Some people feel that your minimum tithe amount should be given to your home church and then whatever monies above and beyond that should be given to others in need. Personally, I don’t ascribe to this philosophy either. I believe that the Christ’s church is more than just a building with four walls; rather it is the collection of all Christ followers throughout the world. As such, I think we honor God by giving to wherever God’s work is being done.

For instance, we personally give 10% of our gross income (I don’t think that I should give less money to God when I do a better job of using tax deductions). We give the majority of this to our local church, but we also support a few organizations and directly support some missionaries.

What if you don’t believe in all this church stuff?

If you don’t believe in all this church stuff, I am really impressed that you made it this far into the post (sure, you probably just skipped ahead, but I’ll be optimistic). I still think it is important to give your money to others. Obviously, you won’t have the same reasons for giving as those described above. I do think it can be a worthwhile endeavor for a few reasons:

  • Give to help others – You can make a real difference in a person’s life by giving them a helping hand when they need it.
  • You can make the world a better place – direct your resources to people that need help and you improve their situation and make the world a slightly better place. Repeat this process and who knows how far you can get.
  • It feels good to help others – you generally get great satisfaction from knowing you reached out to a fellow human being and made things a little brighter for them. Don’t believe me? Try it sometime and see what happens.

photo credits: Daquella manera and Phillie Casablanca

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