I’m a dog person myself, though I’m not an anti-cat person… I just happen to be allergic to cats.

I’ve always liked dogs because you can play with dogs. You can throw toys with them, you can chase them around, they can chase you around, and they’re a lot of fun. You can’t really “play” with a cat outside of flicking around stuff for them to try to scratch.

Are you a cat person or a dog person? Or perhaps you are a hamster, rabbit, or hedgehog person?

(Puppy photo: klash, Cat photo: dougwoods)

It’s a well known advertising and marketing fact that human beings make decisions based on emotion and then confirm it with facts. It’s why salespeople are taught to sell benefits (how something helps you, what problems of yours it solves) rather than features (this thing can do this or that). Some sales tips say that rather than straight up selling benefits, get your prospect worked up and emotional about their problems… then hit them with benefits or solutions to those problems.

Emotions sell and facts confirm.

Want a prime money example of this idea at work? Consider Dave Ramsey’s snowball approach to paying off debt, it’s mathematically sub-optimal. By sub-optimal, I mean his approach does not result in the least amount of interest being paid and the shortest payback period. His approach states that you pay the smallest balance first, then take that payment and add it to the next smallest, etc. The optimal approach is to pay the highest interest rate balance first, and then moving to the next, the next.

His snowball approach has a huge number of supporters because it appeals to emotion (and the psychology of motivation). You feel the happiness of progress, of paying off your mountain of debt, of not feeling like you’ll be in debt forever. Those feelings are very real and they are exceptionally motivational. The approach is backed up with facts too. While not mathematically the best, it works. You might pay more in interest but the end result is that you will be debt free and thousands have achieved this with this approach.

Another great example is whenever you buy a car. Car salespeople want you to get into the car and drive it, to make a connection with the vehicle and for you to picture yourself driving it. They want you to imagine yourself strapping your kids into the back, packing the trunk with your golf clubs or your vacation gear, and driving it down the street with the top down. Once you’ve imagined that, they take you into the showroom and give you the facts. You find out how much trunk space it has, how many cup holders, its horsepower, the fuel efficiency, and finally the price. If you can afford it, and sometimes if you can’t, the facts merely confirm whether or not you want the car. If you don’t like how it handles or can’t see yourself driving it around, the MPG and horsepower won’t matter. The facts just confirm your decision, a decision made on emotion.

Is it wrong to be swayed by emotion? No, unless you begin bending facts to justify a decision. Think about the political party affiliation on your voter registration card – mine says Democratic Party. Does that mean you blindly justify everything your candidate says? My emotion says that Barack Obama wants to bring change to Washington. I firmly believe he does want to bring change, however he, and his advisors, carefully planned his actions over the last two years such that he’d be at his political peak right now. He might be new to Washington but he’s not new to the same old Washington politics. I could easily take that idea and say that Obama is new to politics but his advisors aren’t, but I think that’d be naive of me to believe. He might be new, but he picked up on it real quick.

Just be aware that you decide on emotion and confirm with facts, that alone will protect you in many ways.

This Devil’s Advocate comes straight at you and assails the one last bastion of hope for a prosperous retirement – 401(k)s and IRAs. While it probably doesn’t feel that way with the volatility in the market, conventional wisdom says that the best way to save for retirement is tax-advantaged accounts like 401(k)’s and IRAs. The power of having that money grow tax free trumps all other options.

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Reader Jeff is switching jobs and wondering, given the market’s drop the last few months, if he should roll over his 401(k) to a Rollover IRA. His concern is that he’d be “selling low and buying high” in that situation and didn’t know what he should be doing.

I’m not a retirement nor an investing expert but I can say that your biggest concern shouldn’t be the performance of the market, it’s the volatility. With the various indicies gaining and losing large single-digit percentage points on a daily basis, it’s the volatility that is the big concern. A rollover takes time. Depending on how quickly or slowly you, your 401(k) administrator or your Rollover IRA administrator is, you could be left waiting for many days on the sideline as your 401(k) assets as liquidated, transfered to you, then transfered to the Rollover IRA. In that time, the market could go down big, go up big, or go sideways pretty erratically. My point is that the volatility is unpredictable, so on that basis alone, without any other compelling reason, I’d stand pat for now.

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My wife works in a management position at a local biotech startup and in that role she’s granted non-qualified stock options from time to time. I wrote about pre-IPO stock options over two years ago but since then she’s received “post-IPO” non-qualified stock options. Since it’s getting to be the end of the year, I’m doing some research as to how the capital gains works and it turns out that stock options are pretty easy to understand.

First, there are incentive stock options and non-qualified stock options. There are several differences but the one that really matters is how they are taxed. This article will focus on non-qualified stock options, non-qualified referring to how they are not qualified for special treatment (incentive stock options are treated differently).

How my wife’s stock options work is that she’s awarded X shares, say 1000 shares, at a grant price, say $10.00, on a certain day. The shares vest over a number of years, say 4 years. So next year she gets 250 shares at $10, the year after she gets another 250 shares at $10, etc. She currently has the options but she can’t exercise them until they vest. That’s the basic vocabulary.

How are these taxed? When you exercise the option, 250 shares at $10, you are immediately taxed on the difference between the market price and your exercise price ($10). If the market price is $12 when you exercise, then you will immediately be taxed on $500 ($2 x 250 shares) of capital gains. You can hold the shares, you can sell them, but you are already on the hook for $500 of capital gains. From there on for tax purposes, it’s as if you bought the shares at $12.

When Should You Exercise Your Options?

So I had this chat with my wife and the first thing she thought of was to exercise the stock options when the stock is at its lowest value. On the face of it, it seems to make sense. The smaller the difference between your grant price and the market price, the less you are taxed. However, you earn less too. It doesn’t matter which tax bracket you are in, you are taxed less than what you earn. In the highest tax bracket of 35%, you keep 65 cents on the dollar; you want the price to be as high as possible before you exercise. The key is to maximize income, not minimize tax.

In reality, you balance your need for the money with the market price of the stock. You always want to exercise at the highest price possible but you have to balance that with whether you need the money or when the options expire. When you exercise, you want to sell immediately. There is no benefit to holding onto the shares. If you wanted the shares in the first place, you could’ve bought them on the open market. By keeping your shares, you run the risk of being taxed on income you will never realize.

This is all based on my own web research, I’m not a tax professional so please consult with a tax accountant or attorney before making any decisions.

One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.

Here’s a real life example in case that general one was unclear. Here are your three debts and minimum payments:

• $10,000 @ 20% APY, $500 minimum monthly payment
• $4,000 @ 10%, $200 minimum monthly payment
• $1,500 @ 12.5%, $75 minimum monthly payment

The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:

• $10,000 @ 20% APY, $500 minimum monthly payment
• $4,000 @ 10%, $200 minimum monthly payment + $75
• $1,500 @ 12.5%, $75 minimum monthly payment

Why is that brilliant? From a strictly mathematical point of view, it’s a bad plan. It’s bad because you’re paying off a 12.5% APY interest debt when you have a 20% APY interest debt staring you in the face. You save more in interest payments if you pay towards the 20% APY debt first.

However, that ignores human psychology. Big mistake.

It’s well known that children aged up to about 7 (the end of Piaget’s pre-operational stage) believe that taller, skinnier objects are “bigger” than shorter, fatter objects (they lack Piaget’s concept of conservation). Ask them to tell you which glass is bigger, a tall skinny glass or a short fat glass, and the taller skinnier one looks larger. It’s not much of a stretch that on an unconscious level this may still apply. The debt snowball method plays on that psychology by making your debt seem shorter and fatter. Two debts may seem less than three, though the two debts are “fatter.”

It also affects your motivation and feelings of success. Drawing a line through one of your debts is a very powerful motivator. It inherently builds on that success by rolling your now unnecessary minimum payment into your next debt. You knock out a few early quicker wins (smaller debts) and that enables you to push onward towards the larger, harder ones. Progress is crucial in motivation, everyone is cognitively aware of that.

Dave Ramsey might not be giving you the mathematically correct plan but he also knows that personal finance is as much about psychology as it is about math.

And if you’re not Dave Ramsey’d out, my friend Pinyo has a very descriptive post about Dave Ramsey’s Baby Steps.

(Photo: redjar)

When I wrote about Vanguard’s Tax Exempt Money Market Fund VMSXX, I explained how you calculated tax equivalent yield. Rather than have you struggle through my poor explanation skills, I built this calculator to calculate the tax equivalent yield for you.

Tax Equivalent Yield Calculator

Anything I should add?

With the Fed dropping the federal funds rate like it’s going out of style, the interest rates of many online banks have begun dropping as well. If you’ve been watching, you’ve probably seen many 5%+ fall to the mid 4%’s and many of the banks that once offered in the 4%’s now offering in the 3%’s. So, with all these falling rates, does one’s criteria for selecting the “best” high yield savings account change? Nope.

You might be tempted to swap because of rates alone but the difference of half a percent of interest reduced even further by taxes and fund transfer time. Let’s say you have $10,000 of savings, half a percent on that for an entire year is $50. Cut that down by 25% if you’re in the 25% tax bracket and now you’re talking $37.50 for the entire year. If you consider that the transfer time between accounts is about a week, that’s another 2% off. You’re not talking about a lot of money for the hassle.

So, what criteria do I use for picking the best online savings accounts?

Must Be FDIC Insured – I had to throw this one in there even though it sounds obvious, but always confirm the bank you’re looking at is FDIC insured through the FDIC’s Bank Find tool. I’ve never written about (or used) a US bank that isn’t FDIC insured (or credit union that was NCUA insured), but I suppose there may be some out there. If it’s not FDIC insured, skip it no matter what.

Now, onto the other criteria…

Interest Rate

While it may not be worth it to move funds from one account to another, it’s certainly worth it to keep up with the best rates when you’re moving funds out of your 0% APY checking account. The number one criteria for evaluating the best online savings account for you has to be the interest rate. It’s not the only factor, simply the first. It’s not the only factor for a variety of reasons but one big reason is that the rate could change the very next day. High yield savings accounts aren’t like certificates of deposit, there are no guarantees that the rate will remain the same.

Convenience

Convenience is the next thing I look for in an online bank. Banks that offer both a savings and a checking account, most of them do, win out because I can get nearly instant access to my funds. If a bank only has an online savings account, then to access the funds I’m forced to first transfer them out (takes about five business days for most), and then I can access them. If a bank offers both a savings and checking, I can instantly transfer from savings to checking and then access the funds via the checking account.

If you have a savings and checking account combo, you can start evaluating the bank with the criteria you reserve for regular banks. ATM access, branch access, branch services, etc.

Brand Name

Let’s be honest, brand name banks confer a sense of trust and permanency. It’s like the white coats doctors wear. Despite the recent bank failures and acquisitions, I still think that brand name confers a sense of trust if you recognize it. While your deposits are always protected up to $100,000 by the FDIC ($250,000 through December 2009), if all other things are equal, you want to go with the brand name.

The big names are the same as the big brick and mortar banks (such as Citi, E*Trade) but you have to add in a few of the big online players (such as FNBO Direct and ING Direct, both of which are big banks but not banks that were nationally recognized before their online versions appeared). I irrationally feel more comfortable with a brand name online bank like FNBO Direct and ING Direct than I do with higher interest offerings from WT Direct and UFB Direct, though all are FDIC insured.

Online Interface

While most banks won’t let you “test drive” their online interface, some will offer tours. If there is no tour, read reviews of the banks and pay close attention to what the reviewer says about the interface. Is it quick and responsive? Is it easy to open additional accounts or sub-accounts? Is it easy to transfer money? Is it easy to set up a recurring deposit and cancel a recurring deposit? Is it easy to link external accounts? Does the site load quickly or has it been historically slow? This interface will be one of your own touch points with the bank, you don’t want to be stuck with an antiquated system that’s difficult to navigate.

I have an example of online interfacing trumping interest rate. I have accounts at both ING Direct (2.75% APY) and FNBO Direct (3.25% APY). My emergency fund is with ING Direct because they offered a convenient one-page CD laddering form that helped me setup a CD ladder for my emergency fund. The funds were in there to begin with because ING Direct was the first to offer a high yield savings account, they remain there because of the online interface.

Offline Interface

What’s better about a Citi or an HSBC high yield online savings account is that if things go sour online, you can always try to find a branch in your area. Some online banks have extremely robust customer service systems because the phone is your only interface outside of the web, but some do not. Some online banks have better phone systems than brick and mortar banks because they know that the phone is the only other point of contact. Read reviews though if you’re concerned (I’ve never called an online bank, other than to unlock my account) because they are trying to keep their services lean and overhead low so that they can offer the higher interest rate.

What criteria do you use to help pick the best online savings account?

My friend once asked me why anyone would put their money in a 60-month certificate of deposit. In our age of instant gratification and blockbuster returns, the thought of putting a sum of money, even if it’s just $100, locked away for 5 years with a pittance of a return seems preposterous. Why put it in a 5 year CD when a high yield savings account can give similar returns? Thirty year Treasury bonds? Forget about it, they’re not even on the radar.

The Fed Will Lower Rates

However, recent market events have really knocked those ideas on their head as people are looking for a safe place to put their money. The economy is looking shaky and many are anticipating that the Federal Reserve will lower the target federal funds rate. Investors typically use options on federal funds futures as a way of predicting how the Fed will move rates in their next meeting. You can review the summary of those futures on the Cleveland Federal Reserve Bank’s website. The futures are absolutely certain the rate will be lowered, it’s just a matter of how much (50 basis points to 1.00% is the most probable). As the federal funds rate drops, so will high yield savings accounts interest rates and any incentive for Americans to save.

When they lower interest rates, it’s almost certain that high yield savings account rates will move down with them (it’s just a matter of when). In an environment of declining interest rates, remember certificates of deposit. It’s a bit disheartening to think that I wrote that post as a post script to what I, and many, thought was the start of a period of increasing interest rates. The economy wasn’t stellar, there was still talk of a recession, but the Fed was more fearful of inflation than recession. Now, its the fear of an economic slowdown that has the Fed acting.

Mitigate Risk

Another good reason to go with a CD is that it helps mitigate risks. If you put some of your savings into a CD, you won’t be tempted to withdraw it and chase after an investment. You earn a little return for your funds but you also lower your investment risk. It’s a bit of a stretch to say it but it’s a point that shouldn’t be overlooked. With the tumultuous market and low prices, you might be tempted to put a lot of money into an investment that you otherwise wouldn’t have. By having some of your funds already locked into a CD, you preclude that from happening.

Early Redemption

Locking in a so-so rate of return into a CD doesn’t look so bad right now. And to those who are concerned about having their money “stuck” in a CD, you are usually allowed to withdraw your funds after a penalty. For example, ING Direct will deduct 3 months of interest on CD’s with maturity periods of 12 months or less and 6 months of interest on CD’s with maturity periods of greater than 12 months (the penalty could be more than the interest earned to date).

I keep a list of the best CD rates available for CDs of 12-18 months or less, with links to the CD rates pages so you can see how the longer term rates are.

While I’m not saying long term CDs are the best option, I don’t know what is (feel free to chime in with your vote), but in our current economic environment, long term CDs may be cool once again.

(Photo: baronbrian)

Frontline is a part of PBS and an example of phenomenal investigative journalism. If you haven’t seen any of their shows before, you should check them out when you have a chance. I’ve seen numerous shows and the recent ones that really stand out are (you could spend days watching their stuff):

• Bush’s War: A discussion about the decision to go into Iraq following the attacks on September 11th, 2001. It offers a tremendous amount of insight into the decision making process and is actually quite scary. [March 24th, 2008]
• Affluenza: “Affluenza is a one-hour television special that explores the high social and environmental costs of materialism and overconsumption.”
• CARRIER: This is a great series that explores life aboard the USS Nimitz, one of our nation’s amazing aircraft carriers.

Frontline: The Choice 2008

However, today I wanted to highlight one particular episode: The Choice 2008, aired Oct 14th, 2008. It follows the political growth of both candidates from the very beginning and gives a very balanced perspective on both. It’s non-partisan, takes no sides, and merely presents the facts as they’ve learned them. I recommend watching the full program, rather than the individual pieces on either candidate, because it tracks both men chronologically; showing what each did during the same time period.

Some things I took away from the show were how much planning and politicking goes on. Barack Obama had a two year plan to position himself such that his political peak would occur for this election. Barack Obama leveraged his opposition to the war, which was aided by the fact that he wasn’t in Congress when it was voted on, as much as possible. John McCain absolutely hated President Bush following the 2000 election in which Karl Rove, spreading lies about McCain possibly fathering a half-black baby out of wed-lock, absolutely destroyed him in the Republican Presidential primaries. McCain, who had then alienated the Republican’s conservative base, decided he had to align himself with Bush, despite hating him, to regain that base. That’s part of the reason why he now faces charges that he’s just like President Bush (voting with him 90% of the time).

It’s good stuff, definitely something you should watch before November 4th.