Wednesday, July 30, 2008

Back up your life with an emergency fund

Life is good.

Maybe you just used the bulk of your savings to buy that cute Audi you've been eying for, oh, the last four years. Or maybe you scrimped, scrounged and recently bought your very own home. But just as you walk over the threshold of your new abode, potted plant (the first of many!) proudly in hand to adorn the all-but-empty living room until your furniture arrives, you get a call from your job, where you're on the verge of a raise -- or so you think. *Poof!* Visions of corner offices and corporate golf games suddenly dissipate with Human Resources on the other end of the line, informing you that, unfortunately, layoffs are in full effect and you won't be needed on Monday ... or ever. Your bottom lip starts to quiver at the frightful thought of the giant mortgage you'll now have to pay off sans current job, along with that overpriced potted plant you just charged.

Hey, it happens.

But before you cry into your Ben and Jerry's and lose yourself in a Mad Men marathon (confession: I'm currently obsessed with the show), sit back and analyze your options. You may have been setting aside bits of your paychecks in a 401(k), but did you also sow the seeds of an emergency fund? If not, chickadee, we need to talk.

An emergency fund should be one of the essential backbones of your life. Seriously. Although it may not always be thought of in the grand scheme of your fabulous future, what with all the chatter of "buying a new home" and "setting aside for early retirement," it's still imperative. Unlike saving in an IRA or mutual funds that you don't intend to cash out till it's time move in with a Dorothy, Blanche, Sophia and Rose of your own, emergency funds prepare you for the present.

And ladies, we watch enough Lifetime (did I just admit that out loud?) to know that the present can hold many surprises. Lost jobs, expensive accidents, divorces -- these kinds of unexpected scenarios can happen at a moment's notice. Would you have enough money right now to pay the rent for a few months while you're between jobs? Are you prepared right now to cough up the cash for a new transmission if your car breaks down? If the thought of these ulcer-inducing scenarios makes you break out into a cold sweat, don't freak out! Just ask yourself one question...

How much do you currently have saved up in an account that you can access at a moment's notice? Sorry, money tied up in stocks or other investments take a few days to clear when transferring accounts, so those don't count for abrupt situations. If you lost everything you had tomorrow, would you be prepared?

If you answered with a sheepish "No ...," don't fret. There are many out there in the same predicament, but all it takes is time and patience to build some solid financial back up. Some marvelous pointers to remember when sculpting your opus of an emergency fund are:
  • In the end, you should have six months worth of your income saved up. Some people think three months, but I say it never hurts to be more prepared. Especially if you don't want to cut back on whatever lifestyle you're leading now. The six month rule is especially crucial if you have kids or other family members that are dependent on your salary.
  • Lock the door and throw away the key. I know you've heard it all before, but your emergency fund should be treated as if it doesn't exist. Don't ever, ever dip into it, unless of course it's for an emergency. Examples that don't fall into the emergency category are new shoes, clothes or front row tickets to see Madonna. You get the picture. I know that in the heat of the moment, those luxurious Michael Kors boots may have "emergency" written all over them, but if you don't have the money in your checking account to buy them, those boots are unfortunately not made for walking.
  • Keep this account separate from all other accounts. Check to see what kind of account is the best for your cash. It may be a savings account, CD or short-term bond, which are all accessible at a moment's notice and considered liquid investments. Just remember that whatever you end up choosing should have no monthly fees, and be returning 4% annually on your money.
  • Set up automatic deposits into your emergency fund. By not doing this you may A.) Forget to make timely deposits, or B.) Conveniently "need" your entire paycheck for other "necessities," such as a bevy of manicures, spontaneous road trips, or that new Dior makeup line you noticed at Saks.
Instead of relying on an emergency fund, many people make the mistake of falling back on credit cards to save the day when disaster strikes and a heating or cell phone bill needs to be paid. But falling back on credit instead of stashed cash puts you at risk of falling even deeper into debt because of burgeoning interest, which can make it harder to pay back in total. Plus, as I've mentioned before, do you really want to spend more on your groceries, rent or even toothpaste in the long run (what with the interest payment tacked onto the price tags), just because you didn't plan in advance?

Didn't think so. And if try as you might, saving just isn't your thing (Brunette on a Budget gawks at her desk at the idea), at the very least create an emergency fund for yourself, before you even think about IRAs or 401(k)s. The latter may be imperative to fund your lavish lifestyle of European villas and the occasional trip to the Cape in retirement, but that's all in the future. Take proactive steps to fund your present!

Monday, July 28, 2008

All you need is love ... and a talk about money

They say when you get married you need something old, something new, something borrowed and something blue. Well, that's cute and all, but what "they" (whoever they are) conveniently forgot to include is you and your better half should also have similar spending styles, or at the very least, be cognizant of what you're getting into.

There comes a point in every relationship where you'll need to have "the talk." No, this has nothing to do with baby names, sketchy in-laws or where you should spend future Christmases every year. It has everything to do with money. This talk should probably occur before you walk down any aisle, even before you spend countless hours choosing just the right shade of periwinkle blue for invitations.

According to a 2005 Harris Interactive survey of about 2,000 people, 29% of respondents ages 25 to 55 in a committed relationship admitted to lying to their partner about their spending habits. Yes, that's right, one-third of people surveyed felt compelled to lie about their finances! But wait, it gets even juicier: 33% of women were more likely than men (at 26%) to be dishonest. Lying in a relationship headed toward wedding bells and Pepsi cans dragging behind toilet-papered limos is obviously not a good sign, so be the savvy money vixen you are and instigate "the talk!"

Hopefully you two have already discussed your childhood, whether you were raised with or without allowances, first jobs, etc. (If you haven't touched on this stuff yet I'm going to go out on a limb here and say maybe you're being a little rash to jump the gun and elope to Vegas just yet.) Once you exchange core financial tenets, telling each other your financial goals is really where the magic starts to happen. Kick off your Christian Louboutins, pop open a bottle of champagne (after all, now is the perfect time to celebrate your union!), set the mood with some Ella Fitzgerald and get comfy -- it's time to make your romance ebb with visions of monetary goals and mutual budgets!

Each of you make a list of 5 to 1o financial goals you hope to accomplish, such as buying a house, buying a Porsche, or saving money for an early retirement. It's all so romantic, isn't it? Now compare and discuss your lists and touch on how you'll meet your combined goals. How much would you need to set aside and invest every year to afford that Porsche? How many years would it take? This gives couples realistic goals to financially strive for, instead of being dumbfounded when your other half comes home with a receding hairline and a Maserati, thanks to an insatiable mid-life crisis. Okay, maybe your financial talk won't cure your husband of any potential baldness, but you get the picture.

While I think that similar budgeting techniques aren't a make-or-break indicator of whether you two lovebirds were meant to be -- many would argue otherwise, though -- it is an important, rational way of prophesying the obvious. If Rock spends each paycheck on fancy martinis and cigars, while Doris saves most of her paychecks for a down payment on their dream house, you can clearly see why the couple's pillow talk would quickly fizzle.

You'll see when discussing finances that one of you will probably be the "spender," while the other more often than not is the "saver." There should be no negative stigma associated with either role, but it's important to see who's who, and how each of you will compensate on your long journeys to the middle. And if you just can't understand your fiance/boyfriend/husband's obsession with Wii video games, don't lose your cool! It's not ladylike, after all. Stay classy and perhaps suggest a "play money" account that either of you can dip into for the occasional shopping spree, facial, or video game purchase. No scrutiny allowed, though! We may get our kicks with a relaxing day at the spa, but that can be just as foreign to our Wii-loving Loves as their video game habits are to us girls. (This "play money" account should of course be added to after you've first saved a portion of your paycheck in a 401(k), an IRA, a gym sock under the mattress, or any other way you're amassing your wealth. There's a reason why it's called "play money.")

Which also brings me to my next point. While it's always fun fantasizing about the future estate you two buy at some point down the road, it's important to talk about how you'll get there, via savings plans you two come up with. These can include IRAs, 401(k)s, mutual funds, savings accounts, stock market investments ... anything, quite frankly. (Maybe not anything -- you may want to hold off on giving any weight to infomercials promising you millions based on pyramid schemes. Trust me.)

After you've covered your pasts and futures, focus on your present, such as credit cards, existing checking accounts and debt. Although I've never believed in separate bank or credit card accounts in my relationship -- hey, if he's going to be married to me, he's got to handle all of me! -- I do know many couples who like their space. If this sounds like you, be sure to let him know and vice versa. Further, do the two of you have a massive amount of combined debt? How are you planning on paying it off without resorting to desperate Bonnie and Clyde tactics? (Hint: More savings, less bank holdups.)

And last but not least, don't forget to discuss bills, the simplest financial matter that many tend to overlook when planning for the big day and beyond. Do you each pay off your bills in a timely fashion? This and other questions surrounding bills (from the big ones such as house payments and rent, down to the smaller ones such as electricity and cell phone payments) are inherently important. It's never fun for one person to be the organized bill payer, and the other to lackadaisically "forget" about being punctual with payments. This usually adds to resentment, anger, and all those other feelings that speed up the horrid frown-line process.

Honesty really is the best policy, especially when discussing your financial future. So relish it just as you would picking out the perfect fondue pot for your wedding registry. It may take time and patience, but in the end it's a melting pot that can last a lifetime!

Friday, July 25, 2008

Learn the lingo: Liquidity

So you wanna invest in the stock market ... but you still can't speak the language. Well, ladies, if you've been reading the past couple months, I've touched on some essential terms you need to know before you depart on your foray into stock market bliss. Key word being "some," though, meaning there's a whole lot more to learn within this realm.

Which brings us to liquidity. I know, just the sound of it makes you shudder,
probably because you're thinking it has some long-winded, snooze-related explanation -- and if you've already gotten this far in life without it, why learn its meaning now? I don't blame you for glazing over these mundane, "liquidity"-related details, but don't hit the snooze button just yet! However dull and boring the terms sound, if you're on the path to becoming financially savvy, you'll need to learn to speak them!

So, back to liquidity, yet another another one of those investment words that sound more complicated than they truly are. Liquidity is basically how quickly you can sell something without taking a loss. Simple, no? To put it in even plainer terms, it's also known as marketability. Say you owned an asset such as a car. How liquid your car (or asset) is depends on how fast you can turn it into cash. So if you buy a car for $8,000 and sell it soon after for the same price or more (if only this happened in reality!), than it would be a liquid asset. If, on the other hand, you had to slash the price to, say, $7,000, and it took longer to sell, it would be considered an illiquid asset.

It's all fine and fabulous when you're talking about personal assets, but how does liquidity come into play in market speak? Easy! To stock market investors, liquidity translates into whether or not a company will experience giant price fluctuations in its stock due to large volumes being traded daily. Stay with me, I promise this gets easier! Let's say you want to invest in a small company who has a low daily volume (or amount of stock bought and sold in the market by investors) of 20,000 shares per day, which is pretty low considering there are many stocks with daily trading volumes of millions!

This smaller, low-volume company (with, for example, five investors buying and selling per day within it) would be considered illiquid and volatile, because any large buy-in by this group of around five could increase its stock price exponentially. This matters to serious investors such as mutual fund managers, who buy millions of stock at a time and don't want their single purchase to artificially inflate a stock's price. This is called market liquidity.

And then there's balance sheet liquidity. (Try dropping that term at your next cocktail party!) A company's balance sheet liquidity is basically any assets a company has (investments, property, bonds, etc.) that can be turned into cash at a moment's notice. Generally a company with high balance sheet liquidity isn't that risky to invest in since they can quicky come up with cash in exchange for their assets if they're ever in a bind. These types of companies usually grow slower than most, though, because assets are kept in storage (so to speak) in case of emergencies, and not outrightly used to generate profits.

Last but not least, liquidity is directly related to a company's overall value (much like the overall value of the car you were going to sell that I mentioned earlier). Take a company that sells scrunchies called Scrunchies, Inc.*

*This is purely for example purposes, it would be highly unprofitable and embarassing in 2008 to A.) sell scrunchies in the first place, and B.) name your company Scrunchies, Inc. Yes, even I used to wear them, but I was an unsuspecting kid in the heyday of the early 90s.

So you're considering investing in Scrunchies, Inc., but you see that it makes most of its profit by, well, selling scrunchies. Being the savvy investor you are, you know that scrunchies may have been popular at one point, but their 15 minutes of fame are up -- they just aren't in demand anymore and people aren't buying them. Would you invest in a company who's products aren't likely to generate that much profit? No, you wouldn't! And that, all you brunettes, redheads, blondes -- or whatever you are -- on a budget, is liquidity. I know, it's a marvelous thing!

Keep it in mind next time you consider investing in a company. Or even if you're just buying a personal item that you hope will hold its value, such as a car or a Louis Vuitton bag. You may think assets such as designer handbags may be good investments, but just how liquid are they? How long would you need to hold on to a bag to sell it used without losing a profit? If you were ever in a pinch and needed to sell it ASAP for cash, would you be able to quickly without losing money? These questions are a good guage of how liquid or illiquid a large purchase will be, and whether or not it fits well within your budget and investment plan.

Thursday, July 17, 2008

Are women more recession-proof than men?

Oh, to go back to the days when $1.75 for a gallon of gas seemed like a fortune, corn cost half of what it does today (curse you, ethanol!), and the general economy was (or at least seemed to be) tight and toned, with an emerald-tinged hue to its lining.

Now that we're entering the current recession du jour, cheaper gas and groceries are a distant memory, and we're left with a nasty subprime mess, a plummeting dollar and a higher national unemployment rate.

But before you kick off your Jimmy Choos, pull the Cynthia Rowley covers over your head and vow to never get out of bed again -- after all, the way the media makes it sound, the apocalypse is naturally upon us -- here's an interesting fact.

According to a study released in April by the Bureau of Labor Statistics (BLS), women are seemingly more recession-proof than men! All right, maybe those weren't the study's exact words, but they might as well have phrased it that way. Why's that? Well, even though hundreds of thousands of U.S. jobs are gone with the wind from the recessionary cold front crawling across the nation, American gals (20 years and up) have surprisingly gained almost 300,000 jobs since November 2007. American men, on the other hand, have lost 700,000 jobs during the same time period.

The huge discrepancy may be just the ego-booster we need to keep strutting our way through the work day, but a closer look at the results shows it isn't so much an "us versus them" scenario in terms of who has the better work ethic, but more so insight into which industries are getting hit the hardest.

No surprise, construction and manufacturing have been the worst bit by the recession bug, what with the slowdown in the housing market and the increased outsourcing for cheaper manufacturing labor overseas. This is all bad news for men, since the construction workforce is 88% male, while the manufacturing industry is home to a 70% male workforce, according to the BLS. Compare that with the budding recession-proof areas of education and health care, which are composed of 77% women, and you can quickly see why more men bear the brunt of the economic burden than women.

Taking it a step further, the BLS also found that Securities jobs (i.e., stock brokers, hedge fund managers, financial advisors, etc.) consist of 60% men, and along with construction and manufacturing are usually the hardest hit with layoffs when financials start heading south. Government jobs, on the other hand, are predominantly held by women (57%), and haven't felt the rising tide of pink slips like other male-dominated professions.

Although the study found women have outpaced men in terms of quantity of jobs held, the same jobs are seemingly lacking in quality. Apparently median weekly earnings for men grew 4.6% within the last year or so, while it only grew 3.1% for females. Translation: Women's jobs tend to offer lower starting salaries, less upward mobility and fewer raises. Even though the salary gap has been narrowing since the 1980s, survey results indicate it has recently widened again.

Nevertheless, keep striving for those raises, ladies! We deserve them since we're doing our part to hold up the economy during these tumultous times.

Monday, July 14, 2008

My Credit Card, My Self

The benefits of saving are enormous, as evidenced by, well, basically every post I write. But I don't think I've stressed enough that the path to a lavish retirement and beyond is not only by way of saving -- it's also by way of paying off existing debt as fast as you can. The longer you are in debt, the longer it will take to pay back all those nasty little bills with their petulant interest rates. There is no point in saving over time if you are in the red and falling deeper into the rose-colored abyss with credit card debt.

If you are indebted to the man, take solace in knowing that you aren't alone:
  • 36% of Americans who owe more than $10,000 on their credit cards have household incomes of under $50,000, according to banking industry group VIP Forum, and 13% of those make under $30,000.
  • Consumer debt has grown almost five times in size from $355 billion in 1980 to $1.7 trillion in 2001, according to the Federal Reserve. Last year consumer debt was a whopping $2.5 trillion. (Put...the credit card....down.....)
  • The average household in 2007 carried nearly $8,500 in debt, the Federal Reserve says.
  • The average adult in 2002 was able to obtain $7,500 in credit, or says a 2002 study by Georgetown University.
  • According to the U.S. Census, there were 164 million credit card-holding Americans in 2003; that number is estimated to be at 176 million this year. Those same card holders own about 1.5 billion credit cards, or an average nine cards per person.
I know, it's enough to make any budgeter's head reel. Hopefully you haven't yet become a statistic, and if you have, don't fret!

The best way to stop from falling deeper into debt is to pay with cash, which includes using a debit card. Personally, I rarely ever use my credit card unless I absolutely have to (like if I'm buying a present for Love and don't want it to show up on our joint bank account statement). The rest of the time I whip out my trusty Bank of America debit card (oh, how I love you so!) for almost every purchase I make. This includes the small purchases, such as $1.50 slurpees or the occasional lunch at Subway, to the larger purchases such as airplane tickets and cell phone bills. I love my debit card because it conciously reminds me, as I fish it out of my wallet, of my spending, whereas tangible cash always seems to go too fast and for me promotes spending a few more impulse dollars here and there.

A rule of thumb when using your debit card is to always remember how much you have in your account at all times. There's no need to obsessively check it on the hour, but take a peek at your balance about every week to get a general idea of how much you're spending and how much you'll need to subtract. I always like to leave a buffer of about $1,500 in my account; make sure to set up a mental buffer of your own and try not to spend under that (sorry, $0 doesn't count).

Why do I condone swiping debit over credit at literally all times? Because whatever you put on your credit card -- even the teensy little purchases like that new Fergie cd or that adorable pair of hoop earrings -- does add up over time, and as they add, so does the interest you have to pay for borrowing the money in the first place. So that "Eat, Pray, Love" book that was only $15 at Target? If you charge it to a credit card with a 19% interest rate, which sadly isn't unheard of, you're really paying another $2.85 on top of the price of the book, for a grand total of $17.85, which still doesn't include tax. That might not seem like a lot, but it all adds up. Take a larger purchase, say a $1,200 airplane ticket to Paris. If you charged this delightful trans-Atlantic flight to the good ole credit card (replete with its pesky 19% interest rate), you'd pay an additional $228, or 19% of what the ticket is worth, and that's if you paid on time. Pay the minimum balance and you'll end up owing more in the long run, all for spending money you didn't have in the first place.

Don't have outright cash for the trip? The 1st commandment in finance, according to moi, is if you can't afford it, maybe you shouldn't be partakething in it.

But what if you have a credit card with a low-interest rate, you ask? Say you and a friend have identical balances of $8,000 on your credit cards. If your friend has a 16% APR, she's paying $1,280 per year on top of her balance (!!!). You, on the other hand, only have a 4.9% APR, and therefore only pay $392 per year in interest, or a total difference of $888 per year!

First off, I applaud you for the taking the time to do your research and find the best card for you. But just because your card may have a 6% APR doesn't mean you're free and clear from being an aforementioned statistic. A low interest rate tends to equate to a lower threshold against impulse purchases -- after all, what's another 6%, right? This problem multiplies if you have more than one credit card with a low APR. If you get suckered into mass credit-card ecstasy with promises of free t-shirts and airline miles, do know that you only need one credit card to build an excellent credit rating, according to Sallie Mae, the largest student loan company in the United States.

Now that the visions of sugar plums and low-interest credit cards have worn off, your best bet would probably be to consolidate all your debt onto a single card. Use that card only for emergencies (remember, no matter how you try to justify it, a weekend cruise for two is not an emergency), and keep it in a place sequestered far, far away from impulse buys. Try storing it in a filing cabinet, deep in a desk drawer, or in a jar of flour...anywhere but in your wallet. Doing so will physically inhibit you from buying that flat-screen TV that you "really need" to watch "My Best Friend's Wedding" on. Only charge what you know you can afford every month on said card, and if it's ever possible, pay your balance as close to full as you can.

Having credit is a privilege, not a right. Credit cards should never be your main source of spending money, or so Sallie Mae opines. It's one thing to use credit as a Plan B, in case you're ever in a tight place and need emergency backup, but this brings me to my next point: only borrow what you can afford.

If you're clueless as to how much you can afford, there is the snazzy debt-to-income ratio to fall back on. All it does is compare what you owe versus what you earn every month. If you apply for more credit, many companies look at this number as a way to measure how good you are for the money you'd be borrowing. To check your number, just divide your total monthly debts (not including rent) with how much you make every month before taxes. Say you make $2,000 per month and have a reoccuring $100 cell phone bill and a $200 car payment, giving you a total $300 in debt. Divide $300 (your debt payments) by $2,000 (your income) and you get a ratio of 15%. But what does that 15% mean, anyway?

Though they say ratios vary between lenders, Sallie Mae has compiled "very general" guidelines as to what "non-housing" debt-to-income ratios mean:
  • 10% or less = Excellent
  • 11% to 20% = Acceptable
  • 21% to 35% = Overextended
  • 36% or higher = Danger!
On a sidenote, when you're ready to buy a house, the "28/36 rule" follows, which are two benchmarks that home lenders use to approve you for loans. The 28/36 rule basically says that 1.) Your housing payments shouldn't be more than 28% of your income, and 2.) Your total debt, including house payments, shouldn't exceed 36% of your total income.

But I digress. The whole point of a debt-to-income ratio is to gauge what you can afford. You may feel cool driving around in your new BMW, but paying rent instead of owning and eating ramen like it's your religion while struggling to pay off a giant car payment every month just isn't that, well, cool. Love and I know people like this and, sadly, everyone can see through the charade.

Bottom line, with or without credit cards, don't borrow money for a lifestyle you don't lead.

Monday, July 7, 2008

A Brief History of the Subprime Mess and Mortgages

I was recently asked what "this whole subprime thing" is all about. It dawned on me as I was telling a truncated version of the debacle that if more people knew just a bit more about mortgages before buying their now-foreclosed homes, this whole credit meltdown might have been avoided. (Blame also goes to the banks, for okaying people who were unqualified to take on such large loans, but that's beside the point.)

And so, before I delve into the mysterious world of mortgages, here's a brief history of the subprime mess, in 30 seconds or less:

It all began in the heyday of the early 2000s, when RAZR flip phones were the latest high tech gadgets, Britney was beginning her descent into the maelstrom and 9/11 reminded many that safety was an illusion. During this time, swarms of Americans took advantage of broker-approved "easy" mortgages that lacked the stringent requirements of mortgages of yore. People banked on the hope that future job raises would occur to cushion monthly mortgage payments and U.S. employment rates would continue to prosper.

But as we all know, when it comes to matters of money, banking on faith and hope alone is never enough! You know how credit card companies try to rope you in with deals screaming "0% APR for 6 months!*" and after closer inspection of the asterisk, you see after six months that your APR balloons up to 19% per month? Well the same kind of thing happened with many mortgages. Lower initial interest rates began to soar while unemployment began to unexpectedly rise. People began to default on their loans, either by losing their jobs or lacking sufficient income, and banks began to repossess homes, which resulted in mass foreclosures across the country.

Say you're paying $1,200 per month on your mortgage, and spending instead of (ahem!) saving on new cars or giant HD flat-screen TVs -- hey, you own a home, you need to buy stuff to go with it, right? Life is good till you realize that you are among a bunch of people who are going to be laid off at work. Now add to that a ballooning mortgage interest rate that you were planning to pay off with some fantasy future raise, and credit cards that you maxed out from overspending. Oh, and guess what? By 2005, house values are in a nosedive and your home is worth drastically less than you bought it for.

This is where a resounding "Crap!" was heard across America. With no savings built up, you've dug yourself into a hole so deep not even Beatrix Kiddo (a la Kill Bill) could climb out of. The debt dominoes fell, leaving a trail of woe across the country, and there you have it -- the 30-second history of the subprime mess. Phew!

Now that you're a subprime guru, your first lesson in Investing 101, or what I like to call "I want to buy a home but I know nothing about the process," is mortgages, or the heart of darkness within the bizarre world of investment banks, credit ratings and foreclosures.

A mortgage is type of loan that is specifically used to buy property (aka a house!). The house you buy with said mortgage is used as a collateral, or guarantee, for the amount you've borrowed against it. Don't have a dime to your name but still have $150,000 left on your mortgage? Then your house will be taken from you to repay off the existing debt on it.

There are a myriad of mortgages out there, but the most common are:
  • Fixed-rate mortgages -- Or loans where the interest rate is fixed for the entire term of the mortgage (usually 15 or 30 years). This is my favorite type of loan, it's steady and less risk-adverse then its brethren.
  • Balloon mortgages -- Loans where the interest rate is set for a given amount of time and then the entire payment of the loan is due at the end of that time.
  • Adjustable-rate mortgages (ARMs) - Loans where the interest rate can change and fluctuate as the prime or standard rate (set by the Federal Reserve) changes. (This is very risky since you can't be 100% sure which way a rate will go.)
  • Interest-only mortgages -- Loans where the interest only (hence the name) has to be paid off in the beginning, resulting in a very low initial monthly payment that hinges on the hope that property values will keep rising. Still with me? By using this loan, many people could buy larger homes they wouldn't have been able to afford otherwise. When home values tanked, they defaulted because their houses were worth much less than their loan price. Home owners couldn't grow equity over the time they invested in the house.
Just by looking at these four common mortgage choices, you can quickly see which ones -- balloon mortgages, ARMs and interest-only -- might have fabulous initial perks, but are the riskiest and were the culprits in "this whole subprime thing." It's marvelously simple, isn't it? And you don't even need a suit and a finance degree to understand it!

You generally get a mortgage by divvying up a down payment, which is usually between 5% to 20% of the loan total. See how this whole "saving" phenomenon I keep raving about comes in handy? Remember, chickadees, the larger the down payment, the more you win because of the decreased amount of interest you have to pay overall. It's just like paying off a credit card bill with much more than just the minimum payments, so you don't get stuck in the endless cycle of paying off interest on the money you borrowed. And the cherry on this ice cream sundae of down payments? If you put down 20% or more on the loan, you're given a "get out of jail free" card of sorts to not have to carry mortgage insurance, which saves you tons of money. (I knew those long games of Monopoly came in handy for something!)

So you see, now, why saving is so very important. When the debt collectors come a-knockin' and you've just gotten notice you're "not needed anymore" at work come Monday ("the company thanks you for your loyal service over the last decade," though), you'll be happy you were insightful enough to sock away savings and plan for all of life's little catastrophes, subprime or not!

Friday, July 4, 2008

How rich are you?

Many of us on a budget are continually aspiring to better our lives by being fiscally responsible. For me, I'm saving now so "magical" things such as investing and compounded interest will sprinkle fairy dust on my early retirement and allow me to live a lush lifestyle, not because I'm some dot-com millionaire, but because I took control of my financial life at an age when many are living hand to mouth, charging fancy cars to credit cards while paying rent instead of saving for a down payment on a home. 

Because I'm saving now, I often feel like I never have enough money. But have you ever contextualized this hopefully similar predicament and asked yourself how poor you really are compared to others in the world? I found a fabulous website,, that ranks you according to how much your annual salary is. 

My salary warrants me as the 103,478,261st RICHEST person in the world, which was surprising considering there are about 6 billion people on earth and I didn't think I made all that much. Apparently, I do! According to the website, that means that I'm in the top 1.72% of wealth worldwide. I'm not really sure to be happy or sad about that number, since it means that there are many people out there who can barely afford to get by, much less have the luxury of saving like the rest of us personal finance writers. Really puts things into perspective.

Anyway, head on over to the site and let me know how rich you are! 

Thursday, July 3, 2008

What does that iTouch or Fendi really cost?

Here's a startling fact for all you Starbucks aficionados: Did you know that if you bought a latte at $3.78 a pop every day for a year, it would cost you $1,332.25? Not bad, especially since many of us -- me included -- rely on a caffeinated kick start at the beginning of every day. But your daily caffeine drip habit starts getting expensive when you consider that if you invested that $1,332.25 in the stock market, it would become about $39,914.11 in 30 years (assuming a yearly realistic return of 12% on your money). 

I know. It sounds so sensationalistic and you're probably rolling your eyes right now, thinking that any purchase in your life could be put into such terms, and so what? You like buying a coffee every morning, and you're entitled to spend your money on whatever makes you happy, right? I don't blame you for having vices; we all do. (One of my many money-spending habits is buying lip gloss. How many tubes of pink strawberry or iced mocha lip gloss does one girl need? Just ask Target, since I can never seem to leave the store without at least one new lip gloss.) 

Anyways, the point is that I know where you're coming from, and I'm in no way trying to curb your spending. I don't condone denying yourself of what you like, and if that includes buying a tube of lip gloss every weekend, then more power to you. But when you're standing in line to buy that latte, don't think of it in terms of how much it individually costs ($3.78), think of it in terms of:
  • What it really costs (in the long term). Think of the returns you could lap up if you denied yourself a Starbucks fix every other day, or a month or two at a time, and invested your latte dollars instead of drank them.
  • What is the total cost of ownership of said latte?
If you're making $50,000 per year, one latte every now and then will not break the bank in terms of your total cost of ownership, or percentage of your overall income. But if you're making $30,000 per year, a year's worth of lattes ($1,332.25) quickly becomes 4.44% of your annual income. Kind of shocking, huh?

Okay, enough with the latte analogy. Total cost of ownership really becomes fabulous when you start using it to decide about a large purchase, such as a designer Gucci or Prada bag, a new Audi, or an iPhone or iTouch. Before you hand that credit card over (or even better, cold hard cash!) do you really know what your new iPhone will cost you?  

Let's say you make $35,000 per year (about $29,000 after taxes). A $200 iPhone would only be 0.69% of your annual income. Not bad, right? But wait till you start considering the big purchases. With that same income:
  •  a pair of Rock and Republic jeans is almost 1%, 
  • a $600 flat screen TV is over 2%,
  • a $1,620 Louis Vuitton bag is about 5.6%,
  • and a used $18,000 Honda s2000 is  62% of your annual salary.
I gave a salary of $35,000 because stats show that it's usually 20-somethings in this income bracket that tend to spend the most money on the excesses: nice cars, designer sunglasses or clothing, the newest tech gadgets and spring break trips to Cabo San Lucas.

But contextualizing costs in terms of a total percentage of your income really puts things in perspective, especially considering that the first 3 of these 4 items are considered "frivolous" and not necessities. (If you need a car, even the 4th can be substituted for an older model, cheaper substitute.) Again, I'm not saying don't spend money on what you like. If you love buying 7 for all Mankind jeans (as I do) or buying a latte with the occasional pastry, then forge ahead with your caffeinated denim endeavors -- don't deny yourself of what you love.

But if you're going to be a gal on a budget, just be conscious of what your purchases are truly costing you because it's never just the number on the price tag. There's a difference between being cheap and being frugal. Cheap people just look at cost; frugal people look at value. No one likes being cheap, so forge ahead frugally!

Tuesday, July 1, 2008

Learn the lingo: Mutual Funds and Diversification

I was recently asked to do a ditty on mutual funds, or what I call the "sultry vixens" of the saving world. Why would I refer to them as sultry? Well, unlike individual stocks, which I consider "femme fatales" because of the immediate risk associated with investing in them, mutual funds are a more demure and unaggressive bird. They stand in the background and make you money without being too risky because of the diversification they bring to your life. But what is a mutual fund? And what in the heck is diversification?

Ask and you shall receive! Before your eyes glaze over with a patina of unadulterated boredom at the mere sight of the words "mutual" and "fund," you should know that a mutual fund is simply a way for you to invest your savings in an account that is operated and run by a professional investment firm or company.

Pretend you're at a casino. (Hopefully a classy Vegas joint such as the Bellagio, and not some seedy Reno dive inhabited by chain-smoking moustached men in faded trucker hats -- but this is all beside the point.) You sit at a slot machine and start funneling in your money, hoping a river of change will pour into your lap. Well, chickadees, the slot machine is like a mutual fund, and has an endless variety of ways (or investments) it can choose from to make you money. Unlike casino gambling, though, there's no random chance with mutual funds. The managers of these funds are highly skilled to invest your money in the best way possible in investments they think will give you the best returns.

These investments can include stocks, bonds, commodities (such as gold, oil, etc.), or other things depending on the fund. The essential idea is that you, the investor, can make one single investment into the fund, where it is then diversified across many different industries or investment categories by people who are well-versed in finance. If you're a newcomer to the market, you may think you should lap up just oil companies, but putting all your eggs into one basket (or one type of stock) is dangerous. Mutual funds will broaden your horizons, by making sure your money is spread evenly across the whole piece of toast, instead of just dumped on one side. Diversification is important because it protects you from the risk of losing all your money on one bad investment.

Many mutual funds are peppered with more costs than standard commission fees, but that's what you get for majoring in English versus Business, and paying Mr. Harvard-MBA to do the dirty finance work for you (or so said the brunette writing the budget blog). Kidding, kidding; I'd take English Lit. over math any day.

When I turned 18, my grandfather revealed he had set up a Vanguard mutual fund account for me (along with my brother and sister), replete with $8,000 for each of us. Although I was of age for instant access to the dough, I was told to forget it was there and treat it as a nest egg, hopefully adding to it every once in a while. Believe me, at the tender age of 18, when all I could think about was fast cars, fashion and boys, $8,000 sounded like an appealing down-payment on a BMW or an extended vacation on the shores of Baja. But I guess the seeds of frugality had already been sewn in the haunches of my late teenage years, and (heeding my parent's advice) it remained essentially untouched. Of course, that all changed in February of this year, when I got bit by the stock market fairy, pulled all of my money out of the account, and decided I could make better returns by aggressive stock trading. I highly advise you only make this kind of move, though, if you feel confident in your knowledge of the stock market or feel like you have enough time on your hands to at least learn the fundamentals (in casino speak, there is a much higher risk of the house winning in this territory).

But why am I even telling this story? Because a mutual fund, like a 401(k) or IRA, is a great way for you to set up a nest egg of your own. As much as we want to write off our parents' advice as superfluous, there's a kernel of wisdom in the "put it away and pretend it's not there" adage. The only way to accumulate is to not spend, and the only way to spend is to, in essence, "pretend it's not there." If you're lucky and never need to dip into your budding fund investment, it can even be a great thing to pass down to your future children as a seed they can continually add to and use if necessary.

So now you know what mutual funds are and why they can help in your quest for an early, lavish retirement. For ideas on which ones to invest in, read this recent top 25 fund list!
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