Wise Bread (Personal Finance posts)

Best of personal finance: Wall Street Rollercoaster

Andrea Dickson — Wed, 15 Oct 2008 23:23:23 +0000

Welcome to Wise Bread's Best of Personal Finance roundup!

Rules to live by when the economy heads south. Boston.com and FIRE Finance

Smarter than the average bear market. "Yet with these terrifying headlines every day, it’s like people have become blind, yet highly literate zombies who wander aimlessly from one newspaper to another. Being dumb is not just focusing on the wrong things, it’s making poor financial decisions and then throwing up your hands and wondering why you don’t have enough money a few years later. If you own only one stock — especially if it’s your employer’s stock — then you are a fool." I Will Teach You To Be Rich

Avoiding bankrupcty when you're sick. Queercents

Comfort foods are all the rage during economic hard times. A grilled cheese sandwich is the height of frugality. Here's a recipe. Cheap Eats

Tips for jet-setting, worldly types. "Most tickets are changeable, no matter what is written on them. If you run into trouble, don’t give up – the airlines can make exceptions under the right circumstances. It doesn’t always work, but good things often come to those who are persistent." Zen Habits

Throw the bums out. AIG is rightly still getting hammered by the government for acting like a bunch of jerkwads. NY Times

What if there were no Joneses to keep up with? The Simple Dollar

Free grub in your birthday suit! Lots of restaurants give you free food on your birthday. Dean provides a list for all of you who love a free-ish lunch. Mr. Cheap Stuff

Less time, less spendy. Reducing your time at the supermarket will help you spend less. "[L]ast weekend at the grocery store I was unnerved by displays of snack foods, ice cream, Halloween candy, and ready-made items like deli entrees and rotisserie chickens. Seeing them was like hearing fragments of a language I used to speak. What was all this stuff?" MSN Smart Spending

Giving when you're not really getting? Is your charitable giving going to change as the economy worsens? Free Money Finance

And it begins. Credit card companies are cracking down on consumers because they are panicking as much as everyone else. Walletpop

When time IS money. Small ways to work smarter on your PC. Dumb Little Man

Why total meltdown is unlikely. "I continue to think that global governments will get this figured out and credit markets will start to ease before truly awful consequences take hold. We're in for a recession, not anarchy." Motley Fool

Richy McRichpants. What does it really mean to be "rich"? Can you be rich without realizing it? Get Rich Slowly

Why your credit card debt is partly to blame for this financial mess. "By 2006, though, consumers were not only spending more on everyday goods -- remember, spending 89% of income -- but also spending more to pay debt. They were spending 13% of their incomes to cover debt, Church notes. So households were spending everything they made -- and borrowing some more money on top of that -- just to get through the average year." Freep

When being cool as a cucumber matters. Why staying calm in an economic crisis is better for everyone involved. Five Cent Nickel

Goodbye, schadenfreude. "Until last week, Europe had witnessed the type of anti-American gloating usually seen only during the soccer World Cup, the quadrennial event in which the American team is routed in the early rounds." Slate

Tips and tricks for budgeting. Some of the best (free) tools you can use to save money and reduce debt. No Credit Needed

Iceland almost goes bankrupt. Who knew that countries could even do that? "Iceland's dramatically transformed stock exchange offers a clear indication of the massive blow dealt to the country's economy, recently based almost entirely on a financial sector that represented between eight and 10 times its gross domestic product." AFP

Hard times call for simple soutions. Why simplicity offers a fairly easy path to saving money. Mighty Bargain Hunter

HAHA! It can be fun to see what people wrote about a few months ago, when the economic collapse was becoming a reality and lots of people said it wouldn't happen anyway. Reuters

Is tax season here already? Oh, it never ended. If you filed for an extension, you have to actually file your taxes by today. Consumerism Commentary

California is selling itself to the American consumer. Want a piece of the action? Bloomberg

Talk about lemons into lemonade. So what if your 401K is down 40%? Stocks are going to be cheap. All Financial Matters

Oooh la la. Does this mean that sales of cheese and cigarettes will decrease? Europeans react to the economic crisis. Xinhua News

Slippery slope. If the cost of oil keeps falling, will we keep pushing to drill? CNN

Safe bet. Everyone is buying safes for their home because it's frowned upon to keep your money under your mattress. LA Times

It's the little things that count. There are plenty of ways to pinch pennies - here are 101 pinching techniques. Our Four Pence Worth

Discount on discount chain membership. Sam's Club memberships can be had for $10 for the rest of the year. Bargain Hunter

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Surviving a financial panic -- lessons from the past

Philip Brewer — Mon, 13 Oct 2008 13:44:45 +0000

By Philip Brewer

Financial panics used to be quite ordinary. In the century or two prior to the great depression, there was a panic every 15 or 20 years. Since the great depression we haven't had a classic financial panic, until now. There's a thing or two that we can learn from panics past to help us survive the current one.

To begin with, there's a reason why we haven't had financial panics for the past 75 years--fiat currency.

Panics and gold

Panics used to begin when people decided to get their hands on actual, physical gold. That could happen for a lot of different reasons. Often it was because there had been inflation--banks issuing bank notes far in excess of the gold they had on deposit--and people decided that they didn't trust their bank. Sometimes, though, it happened without any particular malpractice by the banks, simply because there was a demand for gold someplace else--an economic boom in Europe or South America could drain gold from the United States or vice versa.

Since issuing banknotes was literally printing money, the temptation to go overboard was immense, and individual banks that did so used to collapse all the time. A prudent bank, though, could be modestly profitable and a great boon to its community, but in a panic, even prudent banks would fail. (You could, in theory, create a panic-proof bank that held enough gold to pay off every banknote, but it would be a money-losing institution. Holding all its gold in its vaults, it would be practically unable to make loans, but would still having to pay for a building, tellers, security, and so on.)

Prior to 1933, it was very hard to address a panic, because there wasn't enough gold. Sometimes, if a panic started small, it could be headed off by large banks (or even wealthy individuals) lending gold to the banks that were under pressure. The banks could then redeem enough banknotes to satisfy worried note holders. When the panic subsided, gold would flow back to the banks, they could pay off the loan, and things would return to normal.

In the case of a large panic, though, the banking system as a whole didn't have enough gold to redeem enough of the banknotes. Banks would pay out gold for a while, hoping that they could thereby demonstrate their soundness. Once it became clear that the gold on hand wouldn't satisfy the demands of note holders, the bank would suspend note redemption. Note that, even when that happened, depositors and note holders didn't necessarily lose everything. In many cases, the bank was actually solvent. As their customers went on paying their debts, gold would gradually flow back to the bank, allowing it (at some point) to resume redeeming its notes.

Since 1933, there hasn't been any gold backing the banknotes anyway, a condition that had seemed to have eliminated the possibility of a classic panic.

And yet, here we are. So, what were the keys to surviving a panic in those days, and how do they apply today?

Liquidity

The first way a panic works its harm is by destroying liquidity.

Once a panic started, the first things to go was the payments system. In normal times, people could spend banknotes as easily as they spent gold and could pay their bills with checks. In a panic that isn't true. Every transaction becomes its own negotiation. Payment in gold is fine (although you have to be sure it's real gold). Payment in the notes of a sound bank is okay, but opinions differ regarding which banks are sound and which aren't, leading to confusion and disagreement--the result is a whole sliding scale from the sound banks to the iffy banks to the banks that have suspended redemption of their notes but are still open to the banks that have closed. Checks have the same issue of bank soundness, only it's layered on top of the question of whether or not you've got money in your account.

Adding that sort of negotiation on top of every transaction was obviously a nightmare. So, if you want to understand why central bankers, finance ministers, and politicians are in such a tizzy, imagine layering those issues on top of the complex payment systems that we use now.

Today, checks are clearing, credit and debit cards work fine, the ATM machines have money, direct deposits are going through on schedule, automated clearing house payments for bill payments and bank transfers are all working smoothly. This is a huge win for the economy. Just imagine what happens if those systems start to break down--if your transfer from your internet bank doesn't show up in your local bank, if your credit or debit card starts being declined, if your landlord and the power company stop taking checks and start wanting you to show up in person with cash in hand.

If it was just liquidity, though, the problems would be manageable. Cumbersome, but manageable.

Solvency

The second way a panic works its harm is by destroying solvency.

As a panic began to set in, a business with merely adequate capital could suddenly find itself on the ropes. Its customers would start paying at the last possible moment, and then start paying late (and, in many cases, going bust and not paying at all). At the same time, its suppliers would start cutting credit limits, pressing for early payment, and then demanding payment in cash. On top of that, its bank would refuse to lend. If you had the cash to bridge the gap--paying your bills on time, even though people were paying you late--then you were fine.

It wasn't that simple, of course. If your bank failed it didn't make much difference how much money you had. The wealthy could take measures--dividing their money among several banks and holding some amount of physical gold for example--but those strategies were largely closed to the poor (who couldn't scrap together enough for one bank account, let alone two, and who didn't have a safe place to store gold even if they could put their hands on some). They were also largely closed to businesses, who had their money invested in the business, not sitting around just in case their customers started paying late the very same week their suppliers started demanding payment in cash.

The key, then, to surviving a nineteenth or early twentieth century panic was to have ample cash, to choose your bank carefully, and to have some actual physical gold on hand. In particular, being one of the first people to panic--showing up to turn your banknotes into gold while the bank was still paying in gold--was the winning strategy. The result was bank runs that could bring down even sound banks.

Since there's deposit insurance to protect small and medium-sized depositors--and since there's no gold at the bank to be gotten anyway--we do seem to have largely eliminated bank runs, and largely eliminated the need for ordinary people to participate even when there is one.

Still, the solvency issues remain--if customers can't pay, even a well-capitalized business can't continue to operate for very long. And, as businesses cease operations--or simply shrink to the point where they're sized to service the fraction of their customers who can pay--employees find themselves out on the street, facing their own solvency issues.

And solvency issues are why, even though they're not obliged to back deposits with gold, the banks are failing.

Our new panic

Even sound banks can fail in a panic, if they're obliged to pay out gold, simply because there isn't enough gold in the system to pay off all the banknotes at once. Since our banks aren't obliged to pay out gold, sound banks aren't really at risk--even if they don't have cash on hand to pay off all their depositors, as long as they have assets (generally, loans that are being paid back), they can get unlimited cash from the central bank. In this situation, what would have been a panic is merely a credit squeeze.

So, how come banks are failing in our current panic? Basically, a lot of the banks aren't sound. Their assets, instead of being mortgages on local homes and loans to local businesses, are instead huge amounts of the sort of "securitized" debt that you've no doubt heard about--groups of mortgages, auto loans, credit card debts, and so on, all packaged up and divided into slices that were supposed to have predictable risk characteristics (but that turned out not to).

Presumably, not all the banks are in trouble. So, a second problem is that nobody knows which banks are solid, which banks are iffy, and which banks are just waiting for the coroner to sign the death certificate.

(That's why the Treasury's plan was to buy up a large amount of this securitized debt. The idea was, if you could put a price on those iffy securities, the sound banks could resume normal operation. If the price was high enough--higher than the assets are really worth--many of the iffy banks would be okay as well.)

The result has been a situation a lot like a classic financial panic, even without the issue of a shortage of physical gold.

A few words about gold

In panics past, the key winning strategy was to move to gold before banknotes lost all their value. I don't think that's a useful strategy this time. Gold may be a winning investment, but it lacks the key attribute that made it a winner in the past: it isn't cash.

Until 1933, contracts were often written in terms of gold dollars. If your banknote wasn't backed by gold--if your bank had closed or suspended payment--you couldn't use it to pay your bills. That's no longer true. The value of the dollar may soar or crash in terms of its international value and it may lose its value slowly or quickly to inflation (or even gain value due to deflation). But you can be reasonably sure a dollar will continue to be worth a dollar when it comes to paying your bills. That's something that people didn't have going for them in the panics of the nineteenth and early twentieth centuries.

Gold may (or may not) be a great investment, but it's a crappy way to pay your bills. For that, you need money--regular old bank deposits and currency.

The hard money folks like to say that gold is the one financial asset that isn't someone else's liability. In a world where many liabilities are not being honored, that's a big deal. But as long as your liabilities are in dollars (or euros or pounds or krona), you want to have cash on hand to pay your bills. For example, I'm just three months into a one-year lease. I know exactly how many dollars I need to pay to keep my apartment for the next nine months. I have no clue how much gold I'd need.

As an aside, it seems that there actually is a shortage of physical gold. Perhaps in part because a rather new fund (SPDR Gold Shares) has been buying huge amounts of gold and storing it in vault--enough that its gold reserves recently passed those of Japan. Fabricators of gold coins are having trouble getting their hands on enough to meet demand. That's a situation that can't last for long--people will bid up the price of physical gold high enough to draw those large gold bars out of the vaults. That makes gold sound pretty good as an investment--but it doesn't turn it into cash.

Strategies for survival

Knowing that the keys are liquidity and solvency, there are some obvious strategies to begin with.

Don't depend on credit. Arrange your finances so that you can fund everything with cash. If you're a business, this will inevitably make you less profitable, but less profitable is better than being out of business.

Keep your assets safe. Even if you avoid debt, you still have obligations that need to be met--rent, taxes, utility bills, etc. If your income is uncertain (and it is), then you want to have cash on hand to meet those obligations. Things like bank deposits (under the insurance limits), money market funds (now also insured), and Treasury securities are very safe and very liquid.

Cut expenses and diversify your income. Having liquidity is key in the short term, but over the medium to longer term the key is to make sure that your expenses don't exceed your income.

Later, buy valuable stuff cheap. As the panic winds down, large amounts of valuable stuff will be on sale cheap, because those who were not liquid enough will be forced to sell. If you've got cash at that point, you're in a position to make some outstanding investments.

These were the strategies for surviving panics in the past. They're still the strategies today. The one good thing about a financial panic is that it (unlike, say, a war) doesn't destroy the actual productive capacity of the economy. The factories are still there, workers are still there, the land is still there. Staying liquid, and making sure that your expenses don't outstrip your income, will get you through to where that underlying productive capacity can come to the fore once again.

Permalink | 9 comments | Philip Brewer's blog | Channel: Personal Finance

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Please Pass the October Surprise

Catherine Shaffer — Sat, 11 Oct 2008 13:49:49 +0000

By Catherine Shaffer

I've always believed that mastery of vocabulary is at least halfway to mastery of the subject. Words are power--the kind of power commonly wielded by eggheads with pocket protectors, but power nonetheless. In the past weeks and months, I've seen a lot of new vocabulary thrown around in the media, and most of us are too busy ducking and diving out of the way to ask what all these crazy words mean. So let's demystify the language of the new economics, right here, right now. Here's a list of common terms you might encounter in your newspaper, on television, or even in a blog.

Commercial paper: This is an IOU, good for maybe a month or two. Unlike a regular IOU, it's written for very large amounts, and companies accept them from each other pretty much without question. Apparently, commercial paper is the way that many companies meet payroll and buy inventory. I always thought they used money. Who knew?

Credit default swap: Halfway between an insurance policy and a racetrack wager, this is a way that mortgage lenders made themselves feel safe giving loans to people about whom they otherwise knew nothing. No job? No documentation? No problem. We have a credit default swap.

Subprime debacle: The inevitable outcome of widespread use of credit default swaps to back sketchy loans. The word 'debacle' has somewhat of a Victorian ring to my ear. It sounds like something that might happen in “The Importance of Being Earnest.” This is how the whole mess was described earlier this year, when we were all in an enviable state of denial. Notably, a 'debacle' is nothing that ever happens to oneself. It always happens to other people. Like the time our neighbors, a husband and wife, met each other driving separate cars in opposite directions on our street, and proceeded to have a very loud argument between the two cars. Boy, was that ever a debacle. So glad I wasn't involved!

Liquidity crisis: Until recently, I would have told you that a liquidity crisis is what happened when my sixty-pound puppy wasn't put outside often enough. But apparently, 'liquidity crisis' is actually what happens when you can't borrow enough money to keep going. Next time your buddy asks you for $100, just until next payday, you'll know he's having a liquidity crisis. Let's just hope that his employer is not relying on commercial paper to make payroll, or his liquidity crisis will become yours. Which, when I think about it, is the essential circular nature of this whole mess.

Tranch: This is a silly, made-up word that big investor types use to explain why they can't look closely at the history of individual mortgages bought and sold by their companies. See, it's in a “tranch.” It's meant to evoke bundles, or “bunches,” which are sort of shrink-wrapped so you can't open them up and look in side. Someone once suggested calling them “faggots,” but that idea was quickly shouted down.

Toxic assets: Imagine that pirates Larry and Lunt from Jonah, the Veggie Tales movie, had successfully invested their prize money from the Mr. Twisty's Twisted Cheese Curls Sweepstakes in cheese curls, as they wished to do. And suppose that after they bought those cheese curls, but before they had a chance to resell them at a profit, they learned that the cheese curls had been manufactured in China (not Nineveh), and that they had high levels of melamine...

Mortgage meltdown: This is the same as subprime debacle, but a bit later in history, when everyone is feeling that it is not so funny anymore. It's like those neighbors shouting in the street are suddenly in your living room, and their car is parked in your driveway, and their trunk is full of those toxic cheese curls, and it turns out they are radioactive, not toxic, and they are going into nuclear meltdown!

Irrational despair: This is one half of a very small set of emotions which Wall Street stock traders are capable of (the other being irrational exuberance). Their severely limited emotional range literally controls our economy, while regulators feebly scold them from afar.

Economic collapse: In physics, there is conservation of matter and energy. Sadly, there is no law of conservation of money in economics. Money can simply disappear, and if enough of it does so, you have economic collapse.

Iceland: A small country in the extreme north populated by the descendants of Vikings which has recently experienced economic collapse (see above). If not rescued by other nations of the world, Iceland will have no choice but to replenish its coffers by raiding the coastlines of Europe and America. Guys with names like Sven and Eric Ericson, with Swedish Chef accents, will be burning our houses and raping our women. Also, they will be sending millions of emails that read, “Dear Friend, We would like to offer you a unique business opportunity...” (with Swedish Chef accents).

October surprise: As if having toilet paper in your trees and rotten pumpkins smashed in your driveway were not enough of a surprise, the October surprise is lore believed by stockbrokers and other Wall Street types (see 'Irrational despair,' above). Apparently, people who work in the New York Stock Exchange are among the most superstitious people on Earth. To a man, they take vacations each year in Ireland to hunt leprechauns, and can be found any time clutching rabbits feet, voodoo charms, saints medallions, and all manner of good luck items. Apparently, these denizens of the trading floor believe bad things happen in October, and in the way of many such prophecies, it happens to frequently be self-fulfilling.

So that, in a nutshell, is the lingo. Know it, understand it, use it wisely. And yet, one thing is still missing. We still don't have a comprehensive phrase to describe the whole phenomenon. I submitted my entry, “The Great Economic Shitstorm of 2008,” to Ben Bernanke, but I haven't received a response from him yet.

Permalink | 9 comments | Catherine Shaffer's blog | Channel: Personal Finance, Consumer Affairs

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Why young investors should "Stay the Course" and continue to invest

Xin Lu — Fri, 10 Oct 2008 06:25:13 +0000

By Xin Lu

With the recent upheaval in the financial markets, many individual investors are feeling the pain of shrinking investment accounts. In fact, retirement accounts have lost over $2 trillion dollars in value in the past 15 months. One of my friends says that it seems that every bit of money he contributes into his 401k is gone by the next statement. I understand how he feels, but I believe that young investors should try not to panic in these turbulent times and "stay the course" with their investments.

Right now, no matter what you have invested in in the past few years probably lost value, but if you have an investment plan where you regularly contribute money you would be buying in at a low point right now. It is true that the market could fall further, but your regular investments would buy at those lower points, too. This is basically dollar cost averaging and it is a strategy that has been shown to work even during The Great Depression . If you believe that the stock market would recover some day then buying in at a low point is a good thing.

Another point is that noone knows when we will hit bottom and market recoveries happen just as fast as market crashes. If young investors like me are too spooked to put in any money now or just hold too much cash for a long time then we might miss the recovery and receive returns below the market. Cash is a safe bet, but it is eroded by inflation so holding a disproportionate amount of cash is not the most profitable investment in the long term.

Also, what many people are doing now is to cash out their stock holdings in fear of further drops. I think this makes sense if the cash is needed for immediate use and if you believe the investments you bought will become worthless. However, if you are a long term investor with a balanced portfolio of stock mutual funds then there may not be much to worry about. It has been shown that individual investors in mutual funds tend to have less returns than that of the funds they invest in because they tend to pull out their investments at low points and buy in later at a higher point as an emotional response. So if there is no need for the money and you believe that in the long term stocks will recover then it may be best to leave it alone even though it is stressful to see your nest egg shrink.

In addition to staying the course and continuing to invest, this could be a great time to diversify your investments since nearly every asset class has fallen in value. If you are heavy in stocks then you could look into some real estate, commodities, or bonds. The goal is to have a well balanced portfolio that you understand, and eventually the current bear market would seem like just a bump in the road.

Permalink | 12 comments | Xin Lu's blog | Channel: Personal Finance, Investment

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What Makes You the Expert?

Linsey Knerl — Fri, 10 Oct 2008 03:10:28 +0000

By Linsey Knerl

Bloggers get flack sometimes. Even here at Wise Bread, we get the occasional, “Who died and made you the King of Frugality?” rant that leads us to continually examine the quality of posts we offer our readers. But perhaps the most enlightening part of writing for such a richly diverse audience is the genuine sharing of knowledge – one that allows for us to learn as much as we teach.

With every claim to a financial expertise, there are some important things to consider:

We are all human. Textbooks cover economics in a theoretical sense, and for the most part, these theories hold true. What the textbooks don’t take into account is the element of humanity, personal decisions, and the feeling and emotion that make up most decisions of a material kind. Love, in particular (or the desire for it) can cloud the judgment of even the most educated economist. Why am I saying this? Because I have known and respected many self-proclaimed financial “experts” who were successful in their finances, until a sticky personal situation came along (like lending money to a relative, divorce, etc.) They were no more able to handle it than most financially-illiterate people.

You can’t sell it ‘til you’ve lived it. A good friend of mine and her family were recently featured on a national talk show in order to get tips from a frugality expert. The expert studied her lifestyle, and suggested some hacks to help stretch her grocery budget a bit further. The entire scenario played out on TV, and I was able to watch my friend’s smile fade as she listened to the “expert” and her tips. Many of the tips were atrocious, and sounded great in theory, but I could tell that this woman had never actually tried most of them (or attempted to make children go along with it.)

I’ll admit that tough times do call for tough measures, but my friend was far from destitute. Instead of getting tips for using coupons, hitting sales, or making her stuff last longer, she got one-size-fits-all cheats for the very, very poor. (And the “expert” seemed far removed from the advice she was dishing out.)

Economy is relative. One thing that I have learned from writing here at Wise Bread is that my economy is not my neighbor’s. Assuming that my rural, farming family can follow the same tips as my fast-driving city friends, it doesn’t mean it will always be. We’ve seen commenters from all over the world that see U.S. values as something to be desired (or in some cases, something to be avoided.) This will affect how our “expertise” is received, and we must always be sensitive to others in this manner.

A good track record speaks volumes. Some of my favorite financial experts have years of experience behind them. They have not only maintained a successful financial picture, but often times they have come from nothing, only to rise above it. They have grown. They have met the challenges. They have been encouraging in their message. Mary Hunt, Suze Orman, the late Larry Burkett, and Dave Ramsey (among others) are popular, not because they have fantastic PR reps (although that helps), but because they have proven themselves. And their message will stick around as a result.

Nothing says it like a testimony. I see more and more “experts” popping up on talk shows, newspapers, and blogs. I am always on the lookout for something that gives credibility to their message. Many of them have really slick websites, have been featured on talk radio, and even speak at sold-out events, but have they ever really helped anyone? Those experts that can provide me with a testimony (or twenty) are the ones I will trust the most. To know their techniques are proven is a must!

Experts are everywhere. Believe it or not, most of us are an expert in something. If you’ve overcome incredible debt, raised a large family on a limited income, put yourself through college, or started a successful home business, you ARE an expert in finances. Regardless of how many talk shows you’ve done, you do have something positive to offer the world. If you heart is in it, and you have a desire to help others, I encourage you to share it!

The world can’t have enough of these kinds of experts.

Permalink | 9 comments | Linsey Knerl's blog | Channel: Personal Finance, Frugal Living

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How to Financially Educate Your Children

Nora Dunn — Thu, 09 Oct 2008 01:42:49 +0000

By Nora Dunn

You have the power to create and mold your child’s financial imprint. It is through your own actions, discussions, and attitudes towards money that your children will develop habits – both good and bad – that will carry them through and last a lifetime. They won’t learn it from anybody else; finances are not taught (at least not thoroughly enough if at all) in schools, and nobody else is going to show them how to succeed in life and avoid the huge financial pitfalls that lurk around every corner.

So do your child a favor and give them a huge helping hand! Here are a few ways you can help them create a healthy relationship with money:

Don’t Bribe Them with Money

By offering money as a reward for good behavior, your kids will learn that money is an end, instead of a means to an end. Try rewarding them with tangible life-enhancing experiences which the money would buy, like taking them to the movies, or out for a family lunch. Better yet, you can reward good behavior with things that don’t require money like having a sleepover with friends.

Go With the Flow

If your child wants to count the coins in your purse, let them. Use the opportunity to help them understand what each coin is worth and their relative value. You may even help them identify what each coin can buy (if anything). If they receive birthday money, then talk about the benefits of opening a bank account. As money works its way into your child’s life (and it will), use the opportunity to talk to them about it.

Allowances: Stick to the Plan

If you give your child an allowance, be exact and consistent with the amount and timing of each payment. This will get them used to timing and managing their income stream, as they will need to do when they later have jobs and careers.

Allowances and Pocket Money: Pay Yourself First

The best way to get your kids into the habit of paying themselves first is by doing it right from the beginning. Discuss long-term and short-term savings, and encourage them to put at least 10% of their allowance either in a bank account or even a piggy bank. The piggy bank option will require additional discipline (on their part) not to delve into it for candy, and could go two ways. On one hand, irresponsibly accessing their long term savings (maybe they are saving up for a video game) may affect their ability to reach their goals; a great lesson to learn - the hard way - early on in life. Then again, using a bank account instead may take just enough of the impulse urges out of their hands to help them achieve their goals and feel the satisfaction of getting that video game after saving up for it.

Put a Positive Spin on it

Even if you don’t have a positive attitude towards your own money matters, don’t allow your children to inherit this unhealthy disposition. Don’t let them associate money with anxiety or stress. Instead, teach them practically how money can help achieve their goals and get the most out of life through avenues like creating financial independence, creating a better world with charitable contributions, and even giving it to loved ones. Again try to stay away from the idea that money is an end or is happiness in and of itself; instead show how money can be a conduit to positive things.

Talk About it, Lots!

Money is not a taboo subject, even though we may have been raised to believe it is. If you aren’t comfortable telling them how much money you personally have in the bank (either because you believe you are not a shining example or because you simply don’t want to), then that’s okay. But when your child asks why you can’t go to Disney World, this is an opportunity to discuss the household’s budget, the cost of living, vacations, and entertainment. Involve them in the family finances, and they will learn to take ownership naturally – a skill that will take them through life.

Money Milestones

Involving your kids in the family budget when they are only three years old may be a bit of a stretch. (!) Instead, consider these money milestones as a way of incorporating finance education seamlessly into their lives.

Coins

When your kids start to become curious about pretty coins and money in general, educate them as to the value of coins and what they can buy. It also makes a great lesson in math: start with pennies as building blocks, then introduce higher value coins as their numerical repertoire increases.

Bank Account

As soon as pocket money and birthday gifts start adding up, take them into the bank to open an account. There are lots of child-friendly accounts out there, so make sure you actively involve them in the process. They will derive great pride from having their own account. This is when you start to discuss the concept of earning interest on savings.

Budgeting

Now that they have a bank account and the ability to save up for things, it is time to start budgeting. If they receive an allowance, hopefully they are already paying themselves first and putting away at least 10%, as with money received as gifts.

They are also probably talking about toys they want (like video games). So help them budget for it! With pen and paper in hand, help them construct a budget by determining how much their toy costs, figuring out how much they currently have, and calculating how long it will take them to save up for it. Seeing the plan on paper may encourage them to save more than just 10% towards their goals, depending on how motivated they are. Again, this is a great exercise in applicable math.

Extra Income

Let’s say your child is now motivated by their budgeting goals, and eager to reach them sooner. You could consider paying them extra pocket money for additional chores performed (they call this “overtime” in the working world, and it is outsourcing for you!), or help them if they want to earn money entrepreneurially. Teach them good business principles if they come to you wanting to open a lemonade stand, and help them to launch their enterprise successfully, starting with a solid business plan.

Investing

As your child continues to understand and appreciate the delayed gratification of saving and budgeting, and has a good handle on the interest their bank account earns, they may be ready for something more. Talking about various investments is the next step. A small lesson in big business and stock investments could turn into a game, as they follow the share price of companies they are familiar with, like Coca-Cola, or Disney. Although having them invest their hard-earned pennies in the stock market is not recommended just yet, you could set up a mock investment account, and get them to follow the value of their money along with the stock (again, a great lesson in applicable math). Even if they forget about it for a while, a reminder a year or so down the road that they had “money” invested and what it is now worth may lead to a pleasant surprise about market growth; or conversely a rude awakening about market downturns.

Family Finance

As your child gets a good grasp on the above financial matters (they will likely be in their teenage years by now), it is time to involve them actively in the family budgeting and finances. Help them to understand what their own short term and long term goals are, such as the cost of higher education (even if you plan to pay for it), and eventually getting a car (or conversely what their alternative transportation options and costs would be), housing, and the cost of getting set up comfortably to live on their own (and hopefully, before the age of 35)!

When it comes to family vacations, involve them actively in the process, by working out with them the cost of various vacation options and funds available, and then decide together what the family would most enjoy doing. Budget together for excursions and souvenirs, and your kids will take ownership of the trip and learn to appreciate the experience so much more. Not only that, but they will be much less likely to try to guilt you into unreasonable expenditures since they already know what the budget is; they may even help other family members to stay on track!

You may not see yourself as the world’s best financial example. But this is no reason to sit back on your haunches and do nothing; in fact this will only increase the chances exponentially that your kids will follow suit! Instead, be prepared to come clean with your own mistakes, and celebrate your victories, in order to help your kids learn from you and start their own financial lives on the right foot.

Permalink | 9 comments | Nora Dunn's blog | Channel: Personal Finance, Life Hacks

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Inflation is going away for a while

Philip Brewer — Wed, 08 Oct 2008 15:14:20 +0000

By Philip Brewer

For a decade, starting in the mid-1990s, the Federal Reserve kept interest rates too low and expanded the money supply too quickly. Their theory was that, as long as consumer prices were stable, they must not be creating too much money. We now know that they were wrong.

Confused by the way globalization held down consumer prices, the Fed printed us up a metric truckload of inflation. It showed up in house prices, stock prices, oil prices, grain prices--pretty much all prices except the prices of stuff made in low-wage countries and imported into the United States. Unfortunately, those prices are a major component of the CPI--and particularly of the "core" CPI (consumer prices excluding food and energy).

Starting in late 2006 and accelerating in late 2007, though, that inflation started spilling into consumer prices as well.

The US (both the government and individuals) had borrowed huge amounts of money. Between that and the rising inflation, holders of dollars were beginning to think that maybe they didn't want all their cash in dollars. That put downward pressure on the value of the dollar, which pushed up the prices of just about everything (because the US imports just about everything). Prices soared--oil, wheat, milk, corn, anything traded globally got more expensive: This was a decade of excessive money creation by the Fed finally showing up in prices.

Just as this was happening, though, the Federal Reserve seemed to lose its mind. Instead of raising interest rates to curb inflation, it started cutting rates. Pointing to the "core" rate of inflation, which barely budged, the Fed suggested that deflation was a bigger worry than inflation.

The verdict is still out on that, but there's some new evidence that the Fed is right.

First, prices of global commodities are falling. In just the past few months:

So, what's going on? There are several forces at work, and they're currently feeding back into one another.

US as a safe haven

The same people who had decided that, in view of the US trade deficit and budget deficit, they didn't want to hold so many dollars have changed their tune. If the economy is going to melt down, maybe the US isn't such a bad place to have some wealth. The US has a strong tradition of sound banks and other financial institutions. In addition, it has seemed much more willing these past few weeks to take aggressive action to protect its financial system than some other countries.

With more demand for the dollar, it has been rising against foreign currencies. A stronger dollar means lower dollar prices for global commodities.

Leverage

During the huge spike in commodities, many investors piled on, trying to make money on what was obviously a long-term upward trend. Many of them did so with borrowed money--and many thought that the dollar would be the cheapest currency to borrow, because dollar interest rates were low and the dollar was falling.

Now, with the dollar rising, many of those investors are moving to unwind those transactions--selling their commodities so they can pay off their dollar debts now, before the dollar moves even higher. That pushes commodities down and the dollar up.

Economic slowdown

Less business activity means less demand for basic commodities, leading directly to lower prices.

Producers of basic commodities will obviously see lower profits. Other businesses are facing lower profits as well, even though some of their inputs are shaping up to be cheaper, simply because of falling demand due to the general economic slowdown.

Notice that these forces emphasize one another--any sort of economic stress makes the safe-haven aspect of the US look more attractive, anything that makes the US look more attractive raises the value of the dollar, and a higher dollar pushes down the price of commodities, producing more economic stress, and so on.

What about inflation?

Just as higher commodity prices looked like inflation, lower commodity prices look like deflation.

I think there's a long-term trend toward higher commodity prices, simply because rising demand inevitably runs up against limited resources--oil, fresh water, arable land, etc. Because of that, I think declines in commodity prices are going to be temporary. Even so, prices might stay down for a considerable period, if the economy remains stressed for a considerable period.

I was one of those who, a few months ago, thought the Fed had lost its mind. Cutting interest rates just as inflation was spiking up to generational highs seemed like exactly the wrong policy. I've changed my mind. I certainly don't know if the Fed's policy is the right one, but I no longer think it's an insane one.

Vast amounts of "money" have simply disappeared: the illusory wealth of the housing bubble, the mortgage-backed securities based on it, and the paper assets based on those. The destruction of that "money" is hugely deflationary. The Fed is trying to create enough money to offset that destruction. The problem is that they have no way to know how much money to create. They're walking a tightrope, with a deflationary depression on one side and hyperinflation on the other.

The Fed is clearly inclined to err on the side of inflation, simply because they know how to cure inflation. Only incredible luck would produce a soft landing at this point. The Fed is aiming to produce a modest amount of inflation--confident that, if it manages that, it can bring the inflation back down once the economy is out of danger. In the short term, though, I think the risk of inflation has fallen quite a bit, simply because so many people want to hold dollars.

Since the Fed is trying to create some inflation, I don't expect this situation to persist for long--I wouldn't get rid of your inflation hedges--but don't enter into transactions expecting inflation to bail you out, and don't be surprised if we see some of the price hikes of the past few months suddenly reversed.

It's a scary situation, and it's not very comforting to realize that the central bankers are just as scared as we are.

Permalink | 14 comments | Philip Brewer's blog | Channel: Personal Finance

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9 Signs You Need to Fire Your Financial Planner

Nora Dunn — Mon, 06 Oct 2008 10:56:50 +0000

By Nora Dunn

In tough economic times, financial planners are on the front lines. They are the gateway to investment returns when the markets are good, and are the buffer against financial disaster when the markets are bad.

When I was in the financial planning business and markets experienced corrections of sorts, my colleagues and I would brace ourselves for something called “statement shock”. Clients would receive and open their quarterly or monthly statements, and regardless of whether they were keeping up with the news of market performance and understood the circumstances, they would experience a certain degree of shock when they realized how their own dollars and cents were affected.

There were three possible outcomes from this onset of statement shock:

They would realize that it is a function of the markets and not the planner and stay the course
The would call their financial planner for some reassuring words of encouragement and possibly ask for a meeting to devise a new action plan
They would look for a new financial planner

I was lucky. Most of my clients fell into categories one and two. I worked hard to educate them, work within their tolerances for risk, and was there to hold their hands when they needed it. This also usually put me on the receiving end of new clients who were in category three and displeased with their old financial planners.

But in times like these, when terms like “Meltdown Monday” and (sshhh…the “r” word) are being tossed around, financial planners around the world are waking up in the middle of the night in cold sweats. Try as they may to buffer their clients against market downturns, statements will look bad. And they will be sure to hear about it. And ultimately through no fault of their own, they will lose clients.

Some planners though, will lose clients, and arguably deserve to. They will not have performed the proper amount of due diligence with their clients by assessing their investment personalities and time frames, and instead of facing the music when their clients call, they may instead choose to hide under their desks as a way to weather the storm. They will not have addressed their clients’ larger financial situation and dealt with issues like taxation, short and long term savings, and estate planning, and will instead have simply focused on returns – something which can never be promised and will never be predictable (unless you are invested solely in term deposits, in which case again I would suggest the advisor’s incompetence).

If you are experiencing statement shock, or are wondering if your financial planner is up to snuff, here are nine signs you may need to fire your financial planner:

They never asked you about your personal goals and time frames before recommending investments.

There is no such thing as a one-size-fits-all investment plan. Although having a standard set of investment recommendations according to your stated time frame and tolerance for risk is acceptable, they must do the initial groundwork to determine who you are and what you want from your money.

Only one company’s products are recommended.

As good as that company’s products are, true diversification includes not only a range of asset classes, but also a range of investment managers. Recommending only one type of or company-labeled product indicates that the advisor is not providing truly unbiased advice.

You received no written financial plan, prospectus, or documentation.

Every investment product should be accompanied by a detailed written description of the investment, including its composition, historical performance, and inherent risks and rewards. This is generally covered in the prospectus, which is a bare minimum of what you should receive. Better yet though – you should also be given a written financial plan, which addresses your personal financial situation and outlines a financial road map to reaching your goals – both short and long term.

You are pressured into making investments.

Although sitting on the fence forever is an advisor’s nightmare and sometimes clients need a little extra push, undue pressure into doing something you are uncomfortable with is not right. Even if the recommendations are sound, if you get bad vibes from high-pressure sales tactics, your ability to communicate with this advisor and for them to listen to your needs is going to be problematic going forward.

Your planner’s recommendations don’t match your financial goals.

You say you want to save up to buy a house, and your advisor recommends high-risk long-term investments. Something is not jiving here, and it is likely that they are either not listening to your needs, or are not acting in your best interest.

You can never reach your advisor when you want to, and they don’t return your phone calls.

With an onset of statement shock, you need to talk to somebody. Often big problems and feelings of discomfort can be alleviated with a simple phone call and a reassurance that staying the course is the best thing to do. But if you can never reach your advisor, if they pawn you off on an assistant, or if they don’t return your phone calls promptly, they are not doing their job.

They constantly change your investments.

Seeing a regular list of transactions coming through may lead you to believe your portfolio is being actively managed. However a true financial planner (and not a broker, who is transaction-oriented) should be focused more on the game plan and less on making money by moving it around. It’s a “slow and steady wins the race” approach. Too many transactions may also mean that they are making commissions on each move – a sign that they are not truly working for you.

The plan given to you seems too good to be true.

If it seems to good to be true, it probably is. If that tax strategy seems a little lofty, or you are introduced to a strategy that you’ve never heard of that goes in the face of everything you know to be true and legal, then you may find eventually yourself in hot water. Although the advisor may be liable, you are ultimately the one who will have to clean up the mess if your financial actions were unruly.

They tell you they can time the market.

I don’t care who your financial planner is – they can’t time the market. If they call you wanting to make drastic changes based on what they think the market is going to do, run. What they should really be focused on is you, your goals, and a plan (and portfolio) that will weather the good times and the bad. Sure – small adjustments here and there may be prudent, but moving everything in and out of different asset classes is a losing game. They may get it right a few times, but all it takes is one bad calculation to lose everything you have gained.

If it is indeed time to fire your Financial Planner:

Please do them a favour and give them a call. Sometimes things are lost in translation, or a breakdown in communication is accidental. In my experience, people can be short-sighted, focusing on returns and setting unrealistic expectations based on short term performance. When the markets are booming, people expect consistent double-digit returns and forget not-so-distant times when that wasn’t the case. And vice versa: after a stretch of poor performance, the same person may be convinced that the bad times will never end and want to stash all their money under the bed, forgetting to take the bad times with the good to achieve an overall rate of return that will help them attain their goals.

By calling your financial planner and giving them a chance to explain their actions, you may be able to save the hassle of moving your accounts and starting from scratch with a new planner.

Then again, don’t stick with a planner because it is the easy thing to do. If your financial planner is the culprit of any combination of the above mentioned blunders, it is a problem that needs to be addressed and fixed – either by finding another planner, or by tuning your existing planner in.

Statement shock sucks, through and through. But don’t take your eye off the ball because of the initial shock of seeing your investments lose value. If the markets are down overall, don’t blame your financial planner; they don’t have a crystal ball. And if they pass the acid test above, then keep communicating with them and together you will weather this market downturn, as with every other downturn. The media will sensationalize every market correction and somehow identify that this is the worst, the most dramatic, or the hardest whatever since whenever. But time and time again, slow and steady is what wins the race.

Permalink | 10 comments | Nora Dunn's blog | Channel: Personal Finance

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How a $700 billion bailout became a $800 billion "rescue plan"

Andrea Dickson — Fri, 03 Oct 2008 22:07:02 +0000

By Andrea Dickson

You know how, when the bailout package was first proposed by Henry Paulson and Ben Bernanke, Congress and the public were generally outraged that the Fed Chairman and the Secretary of the Treasury would ask for so much money to bailout large corporations and Wall Street? Seriously, Congress was all "OMGWTF, $700 billion!?!?!? That's, like, nearly a trillion dollars! FAIL."

Joe Public probably thought that Congressional outrage was along the same lines of the outrage felt by most tax-payers. Something like "Shucks, that's a heckuva lot of money."

Turns out what Congressional leaders meant was: that wasn't nearly enough. That's why the Senate and the House both passed a bail-out bill that now includes 100 billion dollars in pork, for a grand total of $800 billion.

How on earth did Congress manage to pack so many earmarks into such a bill. Here are some of the tax benefit recipients, as listed by the San Francisco Chronicle:

$2 million tax benefit for makers of wooden arrows for children
$100 million tax break to benefit auto racetrack owners
$192 million in rebates on excise taxes for the Puerto Rican and Virgin Islands rum industry
$148 million in tax relief for U.S. wool fabric producers
$49 million tax benefit for fishermen and other plaintiffs who sued over the 1989 tanker Exxon Valdez spill

How ridiculous are these (with the exception of the rum benefit, of course) tax benefits?

But wait, there's more - for instance, Washington residents (as well as residents of Texas, Nevada, Florida, and Wyoming) can continue deducting their sales tax from the their federal taxes, something I've never taken advantage of because I am too lazy to save my receipts.

The bill passed the house by a vote of 263-171, meaning that 58 more Representatives voted for the bill today than on Monday, when the bill was defeated by a few dozen votes just before Congress all pretended to be Jewish so they could take Rosh Hashana off and go drink some of that subsidized rum and shoot wooden arrows at each other.

I'm not one who thinks that earmarks are all bad, not by a long shot. But I find it interesting the lawmakers who were completely obsessed with government waste and disturbed by government intervention and special interests were happy to pass along over $100 billion in pork.

Anyone else bothered? Does this seem hypocritical? Especially considering that there are no actual revisions or reforms to the laws that govern the mortgage industry to begin with?

Other fun things to consider:

The money being used to finance the bailout doesn't technically exist. Yet.
The result of creating the funds necessary to fund the bailout can crush the American dollar in a landslide of inflation.
Some former members of Congress would like to further deregulate industry accounting practices by repealing part of the Sarbanes-Oxley Act of 2002. You know, the part that dictated that companies "must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately".

Permalink | 27 comments | Andrea Dickson's blog | Channel: Consumer Affairs, Taxes

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