Personal Finance 

Define Class with Financial Planning Time Horizons

Grandfather & GrandsonI was talking to reader Mike Cannon, who lives a frugal lifestyle and runs a small business called Ascent Solutions Group in Maryland, about Aldi (more on them when I get a chance to check one out) when the conversation shifted off to an idea one of his professors at Maryland once told him about class (as in middle class, upper middle class, etc). I think it’s a very different and helpful way to look at class and how it should be defined, rather than how it is defined today (i.e. poorly).

His professor said, and I’m paraphrasing, that it’s far better to define class by looking at their financial planning time horizons than anything else. The higher you go in the class spectrum, the farther out the time horizon is.

At the low end of the extreme, the extremely poor are thinking only as far as their next meal. As you move up the spectrum, those living from paycheck to paycheck have a time horizon of two weeks (or their paycheck frequency). In both classes, the concept of saving is difficult because income is less than or barely meeting their expenses.

The middle and upper middle class are looking a few years to forty years into the future. They’re contributing to their retirement plans, contributing to their kid’s 529 plans, saving for their first/next home, or saving for their first/next car. Saving is possible here because income has exceeded expenses to the point where you can save for the future.

As you get even farther up the class spectrum to the upper class (and whatever is past that), you begin seeing people planning for their grandchildren and their grandchildren’s education. Once you have met your needs, you begin thinking about your future and your children’s children.

I think that’s a far better way of defining class than any income ranges or net worth figures. It’s about mentality, rather than income and I believe it’s a far healthier approach towards class than talking income. What does it matter being upper class if your expenses force you to spend the vast majority of your income? One stretch of bad luck and you could lose it all (just think about any number of bankrupt celebrities) and then you’re no “better” off than someone in a “lower” class. In fact, I would say that the stress of living on the edge of disaster is far worse than the enjoyment you get out of living in a huge house or driving half a dozen fancy cars. I’d much rather be happy living the simple life within my means than feeling the pressure to produce to sustain an expensive lifestyle. I suppose that’s why they say money can’t buy happiness.

What do you think about this definition of class?

(Photo: indieink)


Tax Exempt Money Market Funds: VMSXX

When I compiled a list of high yield savings accounts rates, a reader mentioned that tax exempt money market funds blow all those returns out of the water. He was totally right. In fact, I have a portion of our savings invested (I say invested because your principal is not protected by FDIC insurance in a money market fund) in Vanguard’s Tax Exempt Money Market Fund (VMSXX [Google Finance: VMSXX]).

About Tax Exempt Money Market Funds

The Vanguard’s Tax Exempt Money Market, and in general all tax exempt money market funds, seeks to maintain the $1 share price while generating a return using very safe assets. Specifically, they invest in “short-term, high-quality municipal securities issued by state and local governments across the United States.” That’s how they can guarantee that the earnings are exempt from federal personal income tax. With VMSXX, they invest in securities that are a year or shorter and a dollar weighted average of 37 days (as of this writing). You’ll find that most funds are structured this way regardless of the company. I am using Vanguard as an example because I have my money there.

Calculate Taxable Equivalent Yields

Since the yield is exempt from taxes, it’s not fair to compare them to other investments without some additional math to account for the tax exempt status. The easiest way is to find out which marginal tax bracket you’re in and divide the yield by (1 – marginal tax bracket).

If I’m in the 25% tax bracket and I want to find the taxable equivalent yield of an asset with a yield of 4%, I divide 4.0 by 0.75 = 5.33%. A tax exempt security yielding 4.0% is the equivalent of a taxable security yielding 5.33%. That 25% tax really takes a big chunk out of that return, huh? That’s why tax exempt securities are so attractive.

You can use this simple tax equivalent yield calculator to help you do the math.

Not FDIC Insured, Other Points

Some things to keep in mind about money market funds:

  • They are not FDIC insured, so they are investments. However, I believe that tax exempt funds are safer because they are investing in munis; rather than corporate bonds. When those money market funds broke the buck a few weeks ago, it was because they were invested in Lehman corporate bonds. While those were considered safe too, a company is far different from a state or local government. That being said, state and local governments can also go bankrupt, it’s just less likely.
  • Much like savings accounts, these fund yields aren’t guaranteed. With an dollar averaged holding period of 37 days, the yields can fluctuate very rapidly and much more so than the yield on a savings account.
  • Don’t invest in tax exempt securities in tax-advantaged accounts like a Roth IRA. Since the earnings in a Roth IRA are already tax free, it makes no sense to put it in a tax exempt investment. You take the teeth out of what makes the investment attractive in the first place.

If you want to get another opinion, Nickel also put some money in VMSXX and wrote about his experiences with the tax exempt money market funds.


How to be the Family CFO by Kim Snider

How to be the Family CFO by Kim SniderHow to be the Family CFO by Kim Snider is a book that teaches you how to manage your household like a business from the financial side, hence the term Family CFO. It’s written in simple terms and for people who want to learn the whole personal finance picture from the very beginning. If you’re a veteran of personal finance, this book might be useful to borrow to see if you need any blanks filled in. If you’re a beginner, this is a very quick and easy way to get that whole picture without wading through complicated terms and ridiculously complex explanations that try to prove how smart the author is.

(Click to continue reading…)

 Personal Finance 

Roundup: Nixing 401(k) Tax Deduction, Free Tools & More!

Jeremy at GenXFinance wrote about one of the most horrible proposals I’ve heard in a very long while, House Democrats are contemplating abolishing 401(k) tax deductions. Yep, House Democrats are actually thinking about removing one of the last incentives people have to save money. Oh, and to make matters more exciting, workers would instead get a $600 subsidy, be required to contribute 5%, and, get this, it would be administered by the Social Security administration.

My buddy Fred at One Project Closer has been giving away tools on his site. This month, he’s giving away a ceiling fan from Home Depot (it’s really a $175 gift card from Home Depot) and all it takes to enter is a comment. You can get more entries by subscribing to his Feedburner email distribution or writing about it, like I’ve done here. If you’re a home improvement junkie, just a few posts will get you hooked (just ask my friend Dave, who clicked over once from BFP and has been hooked every since!). If I won the gift card I think I’d get myself some tiling supplies for one of our bedrooms or a fancy power tool. One second though, I’d definitely get a power tool.

I don’t normally toot my own horn in these roundups but I recently had reason to revisit a post I wrote last August (2007), about how you should be comparing salaries. It was written back before the bulk of the financial turmoil and when some of the financial talk was on salaries of college graduates. I still think, over a year later, it’s a healthy way to approach the idea of looking at salaries and I still feel the same way about it. I’m curious to hear what you all have to say on the subject though.

Seems like the bottled water known as Sam’s Choice of Wal-Mart and Acadia of Giant Food didn’t quite meet the standards of California. They tested more than those two brands and in that larger group, they found “Coliform bacteria, caffeine, the pain reliever acetaminophen, fertilizer, solvents, plastic-making chemicals and the radioactive element strontium.” Those two brands had quality so poor that the study had to release their names. Not all bottled water is created equal!

This is the best “F U I Quit” letter ever, written by a hedge fund manager who raked in huge profits betting that subprime would blow up.

Finally, there are six reasons why the current economic turmoil can be good for you. I totally agree, stop freaking out and look for some sales! Stimulate my economy! 🙂

 Your Take 

Your Take: How Do You Evaluate Job Offers?

Working Man with a BriefcaseI was reading’s 2008 Employee Job Satisfaction & Retention Survey and saw that, not surprisingly that the number one reason people leave their jobs is because of inadequate compensation (i.e. they’re underpaid). What also interested me were the four other reasons (of the top five) that people left for – lack of career advancement, insufficient recognition, boredom and inadequate development opportunities. So here’s a tip that I have, from when left one company for another, remember to consider all the other factors when making your decision of whether or not to leave.

One factor that isn’t listed is stress. 🙂

Another useful stat, 50% of employers believe an offer of 8-15% is enough to lure away an employee but 38% of employees would only leave for 16-30%… use that to your advantage!

So, how do you evaluate a job offer if money isn’t the only metric?

(Photo: manuelvdw)


McCain & Obama Propose IRA & 401(k) Rule Changes

With the recent cratering of the stock market, both Presidential nominees have proposed changes to IRA and 401(k)s that would allow for both early withdrawals, up to certain limits, and suspension of the required minimum distribution rules. Jeremy at GenXFinance hated the idea but I think offering the option, especially since we are headed towards certain stagflation (inflation for the trailing 12 months before August 2008 was a staggering 5.9% and unemployment was rising). People are going to be strapped. Offering the option of the lesser of two evils is better than forcing people to take drastic measures.

Here are the proposals:

McCain: “Temporarily suspend mandatory annual withdrawals. Current rules require investors to start selling stocks at age 70½. Allow savers who are younger than 59½ to withdraw up to $50,000 at the lowest tax rate of 10 percent in 2008 and 2009.”

Obama: “Temporarily suspend mandatory annual withdrawals from Individual Retirement Accounts and 401(k)s. Current rules require investors to start selling stocks at age 70½. Exempt withdrawals made up to the required minimum amount from taxation. Allow savers to withdraw 15 percent, up to a maximum of $10,000, without paying a penalty as the law currently requires for withdrawals before age 59½. These withdrawals are subject to normal taxes.”

(You can read all of their economic & tax proposals at the New York Times)

I think the suspension of required minimum distributions is crucial and I’m glad the candidates both agree on that. It’ll be the biggest help to those nearing retirement because they won’t be forced to liquidate those stocks that have lost value.

As for the second piece, of the two, I prefer Obama’s proposal because it offers 15%/$10,000 (rather than $50,000) and it is subject to normal taxes as opposed to 10%. McCain’s proposal of dropping the tax rate on withdrawals to 10% is too attractive. All of my 401(k) contributions were done in the 25% tax bracket, I’d have a huge incentive to withdraw my money because I’d immediately see gains because I would only pay 10%, not 25%. (should either proposal ever become law, I wouldn’t withdraw money unless I absolutely needed it though)

Don’t get me wrong, I still think withdrawing funds from your retirement account is a huge mistake. But people will be in trouble and they will either turn towards credit cards and dangerous loans, or they will withdraw the money anyway and simply be left with less of it. It’s truly the lesser of two evils.

 Personal Finance 

Teaching Kids About Money: Tessy & Tab Money Manager Kit

Tessy & Tab Money Manager KitThe topic of financial literacy and personal finance education has gotten a lot of attention the last few years because our society’s economic woes, which in part stem from our individual woes, have smacked us right in the face. One of my wife’s friends visited us a few weekends ago and she explained that the most surprising aspect about life in Europe was that it lacked the “in your face” consumerism that is prevalent here. When you take such a money-driven capitalist system, as we have here, and couple it with practically zero financial education… it’s no wonder we have difficulty managing money! It’s like putting a bunny in with a bear and expecting the bunny to “figure out” how she’s supposed to survive.

The one thing we do accomplish fairly well is literacy (we are in a multi-way tie for 18th with a 99% literacy rate according to Wikipedia), so when I saw a childhood literacy education company offer a financial literacy kit, I had to ask them for a copy to review. (Disclaimer: We don’t have kids, but I am a kid at heart)

The Tessy & Tab Money Manager Kit is a standalone program that builds on the lessons learned in creating and tweaking their literacy product. It’s designed for children ages three through six and lots of fun interaction between the parents and the child. Tessy & Tab have been featured in numerous websites and publications, including Parenting.

Tessy & Tab Money Manager Kit Contents
The contents of the money manager kit are:

  • An instruction manual that explains the three concepts to teach your child about money – where money comes from, what money is used for, and managing money is fun.
  • Three “magazines” that are used to teach those concepts – Yard Sale, “Save, Spend & Share,” and Earn Allowance.
  • Half a dozen worksheets that help reinforce the concepts (one is a savings plan, how the child plans to save $___ by the time they are ___ years old, with individual milestones, etc),
  • Finally, and I think this is a great piece, there are three “Moonjar Moneyboxes,” labeled Save, Spend & Share with a “passbook.” Moonjar Moneyboxes are parallelogram shaped boxes that fit together to form a hexagon like “piggy bank.” The “passbook” is just a way to record deposits and looks like a check register.

Why I Really Like The Kit

I think the money manager kit is a great way to teach kids about money because it lets children act like adults. When I was a kid, my favorite day in gym class was when they turned the gym into a faux city and we all pretended we were grown ups. We drove around the city, we went to work, we earned Monopoly money, and we could spend the money on things we wanted (like car washes!) or save it at the bank. Children are naturally inquisitive and eager to grow up and the Tessy & Tab Money Manager Kit leverages that to teach them about money.

The Books: You begin each module by reading a short book (here is a sample book). In the “Yard Sale” book, you and your child can read about how Tessy and Tab prepare for and run a yard sale and what they do with the proceeds. At the end of the book, there are questions that engage your child. They have to find certain objects, find two words, and answer story questions (one of the questions in the Yard Sale book is “Why do Tessy and Tab need money?”). There is also a featured letter and number and more literacy-type questions that relate to those.

The Moonjar MoneyBox: The Moonjar MoneyBox is one step up from a piggybank because it takes the one-jar catchall and separates them for one of three excellent purposes – save, spend and share. It’s like graduating from just a checking account to a checking, savings, and online savings account. While the kit recommends that you put 20% to savings, 70% to spending, and 10% to sharing – though there’s no reason why you can’t adjust that based on your needs (and they have instructions on that).

Learning By Doing: Finally, on the allowance guide worksheet, there are several rules that parents must follow to really maximize learning. Don’t buy discretionary items for your children, let them pay for their own items and truly learn the value of money (that’s why they think 70% isn’t unreasonably high when kids have to buy all their candy and whatnot). The second rule is to let them spend their money on whatever they want. If they want to make bad decisions, obviously talk to them about it but if they are insistent, let them! Finally, stick with the program and eventually kids will internalize the concepts.

Overall, I was very impressed with the program and if you have kids 3 – 6 and want a framework to help teach them about money, you won’t go wrong with the Tessy & Tab Money Manager Kit.


We Need UK’s Individual Savings Accounts

The UK just joined us i experiencing a phenomenon known as a “negative real interest rates,” where the rate of their central bank is less than the rate of inflation. The Bank of England’s base rate stands at 4.5% and their recent calculation of inflation puts it at 5.2%, meaning savers are seeing their savings erode at 0.7% a year. The Federal Reserve, the United States’ central bank, current set its target interest rate to 1.5% with inflation, especially if you don’t use the bogus sans food/fuel measure, being much much higher.

The economic climate has made it wrong, financially, to save money!

Individual Savings Accounts

One of the ways UK citizens can combat this is to use what’s known as an individual savings account, a type of account unavailable to us here in the United States. Individual savings accounts can get pretty complicated but the part that I find intriguing is that it incentivizes saving, something we Americans have a difficult time doing.

The ISA has two components, a cash component and a stocks and shares component. Without getting too deep into its inner workings, especially since I have no hands on experience with it, the part that I like and feel we need is the cash component. Each year, eligible persons can contribute up to ÂŁ3,600 into the cash component and the interest earned is tax free. (The stocks and shares portion has a higher limit but all the income derived from that component are also tax free). I admit that I might not know all the details about ISAs, but at first glance they are very appealing.

We have nothing like this here.

We Need That Cash Component

Given the availability of Traditional and Roth IRAs, I don’t think introducing the stock and shares component of the ISA would add much (though brokers would probably love it!) but the cash component is something we should think about.

Imagine if some of those high yield savings accounts offered tax free savings accounts, like these ISAs. The prevailing rate of 3.50% APY at FNBO Direct would be the equivalent of 4.67% APY for someone in the 25% tax bracket.

We need to start incentivizing people to save, rather than incentivizing people to spend. The economy may be hurt in the short term but will be greatly strengthened in the long term.

What do you all think?

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