• Archives

  • February 2009
  • July 2007
  • June 2007
  • May 2007
  • April 2007

• Categories

  • About
  • Automobiles
  • Basics
  • Behavioral Finance
  • Books
  • Budgeting
  • Career
  • Credit Cards
  • Deals
  • Digital Life
  • Entrepreneurship
  • Health and Wellness
  • Insurance
  • Investing
  • IRAs
  • Mistakes
  • Real Estate
  • Reviews
  • Saving
  • Shopping
  • Steps to Prosperity Series
  • Thrifty Living
  • Tools

• Tags

  frugality inside the meltdown married money obama housing plan paradox of thrift rick santelli taxes theorem of spendthriftism

• Blogroll

  • Consumerism Commentary
  • Get Rich Slowly
  • IWillTeachYoutobeRich
  • LifeHacker
  • MyMoneyBlog
  • The Simple Dollar

Frugality is sometimes mocked and those that practice it have been caricatured as dumpster divers or as real-life Ebenezeer Scrooges of “A Christmas Carol” fame. But frugality is not the same thing as being cheap and it certainly is not the same as being stingy or a miser.

Frugality is about squeezing the maximum value out of a thing.  Sure this can be taken to an extreme, as can any behavior or set of ideals, but on the whole frugality is certainly a good thing.

However, in the face of the worst recession in decades, we sometimes hear otherwise.  Take this New York Times article for instance or this CNBC article.   Both articles discuss an idea that economists call the “paradox of thrift.”

The “paradox of thrift” is the idea that reduced consumer spending worsens the recession in a vicious cycle that works as follows: less consumer spending = less demand; less demand = less corporate profits; less corporate profits = less jobs; less jobs = still less spending which leads to less demand less corporate profits and still less jobs and on ad infinitium.  This all true…

But what is also true is that those households that lived comfortably within or below their means prior to the recession probably have a healthy emergency fund and healthy retirement accounts (despite the market’s ugly drop).  Since these houeholds did the right thing before the rainy day came, they will likely be able to maintain their level of spending despite the tough times.

This is in contrast to those who were already stretching their household budgets to the breaking point.  Households who walked this line are the very households that are now cutting their spending drastically as they come to the realization that their spending is unsustainable in the event of a sudden job loss or even a salary cut.  This is what I like to think of as the “theorem of spendthriftism” - those that spend too much of their income must eventually cut their spending to a more realistic level.

CNBC’s Rick Santelli’s rant has been getting a lot of attention around the web.  In the video below, Santelli rips apart the Obama housing plan:

Santelli’s rant certainly conveys some of the anger people have been feeling about the Obama mortgage plan.  On its face any plan that seeks to use taxpayer money to aid those who got into mortgages they could not afford is tough to swallow.

But upon examining Obama’s plan further, it really does not help too many people. It’s limited to those that had mortgages backed by Fannie Mae or Freddie Mac, meaning that jumbo mortgages over $417,000 won’t be covered.  It allows people to refinance with less than the usual 20% equity, but only affects those whose home values are no more than 105% of their mortgage amount.  It helps to move borrowers’ payment to a more manageable percentage of their gross incomes.

This plan is of no obvious benefit to those living in the areas that experienced the most dramatic price swings, such as California, Nevada, Arizona, or Florida.  The worst kind of speculators and flippers are not being rewarded in any way shape or form.

In my opinion, the Obama plan is laying the ground for shifting more of the responsibility for this mess on those lenders that relaxed their lending standards to the point that anyone with a pulse could get a home - no income, assets, or credit required.

There is a lot of populist rage going in America right now.  People are upset that Wall Street got hand outs after taking this country to the brink of economic collapse.  People want to focus their anger on something and it seems easy enough to pick out a neighbor who bought too much house.  He or she was irresponsible for doing so, but doesn’t the bank who gave them a loan they couldn’t afford bear some of the responsibility as well? I think so.

With the market tanking at historically never before seen levels, it’s certainly tempting to sell all your stocks and park you money into the most conservative vehicle you can find, be it an online savings account or under the mattress.

However, that’s absolutely the wrong move to make.

Over the long run, measured in decades, rather than years, stocks will go up. Stocks go up because businesses take proactive measures to extract the highest return on equity out of their factories, intellectual property, and human capital. The return generated by business as a rule is going to outpace inflation. And as academia has shown, the return on stocks over the really, really long run is just around 7% a year (If that 7% sounds underwhelming to you, just consider this. At an average return of 7% a year, you double your money every 10 years).

It is possible, as Warren Bufett and a few others have demonstrated, that by selecting a few select companies this 7% return can be improved upon. However, for the amateur investor selecting which shares of individual businesses to purchase is a fool’s game.

I’m proud to say I haven’t made a colossal money mistake in a while (you can review some of my past mistakes here), but unfortunately I did make one recently. However, it was a slow developing one.

You see, way back when my wife and I got married (in late 2007), I had worked the entire year and my wife had just finished school and only started her job towards the end of the year. Because of that situation we didn’t owe any extra Federal or State taxes for 2007, and in fact received small refunds.

Fast forward to this tax season and we now owe a nice little chunk of change in Federal taxes. Now, this isn’t going to wipe us out since we do maintain a decently sized emergency fund, but it’s no fun to have to pay up with money that previously was destined for our IRAs.

What happened? Well, unfortunately we didn’t follow form W-4’s instructions closely. If we had, we would have both entered “0″ exemptions and used the IRS’s withholding tables to figure out the extra additional amount we would need to withold. Or, even better, we would have used the IRS’s handy withholding calculator, which is a lot less painful.

Are you a couple who might need to withhold extra taxes? Here’s a valuable tip: if you don’t itemize taxes you probably need to.

Who itemizes? Usually anyone who has a mortgage or owns a business. If you don’t have a mortgaged home or a business, you’re most likely not going to be able to itemize –the percentage of households who get a refund (roughly 66%) corresponds roughly to the percentage of households who own, rather than rent (roughly 66% and dropping).

For those that own a home, and likely receive a refund each year, it makes the most financial sense to increase exemptions in order to take home a bigger paycheck, where the savings can be deployed into an interest bearing account (Uncle Sam doesn’t pay you interest on money he owes you, but does expect interest from you if you owe him).

I’ve always found PBS’s Frontline to be one of the most consistently excellent programs on television.

Their documentaries do a great job of examining some of the most urgent issues of the day. I am particularly looking forward to Tuesday’s program, “Inside the Meltdown,” on the financial crisis the U.S. banking sector is going through.

I’ll definitely be glued to the set for this one…

I’m dusting this blog off and returning to it after a very long hiatus. During the intervening time I had one major life event happen –marriage.

Before my wife and I tied the knot I figured we would have at least some money difficulties I could blog about here. But fortunately it never happened. I think that has everything to do with our pretty stellar communication regarding money.

That dear reader, is what I would count among my strongest piece of advice to newylweds. Make sure you communicate about your money goals. Make sure you are on the same page when it comes to things like how much the student loan payment will be and how much you’re trying to stick into savings each month.

I also urge all young married couples to start off with a budget.

For much of my life I have had what I would call a “poor man’s” view of money. Robert Kiyosakai (whose advice I detest by the way) might call this “poor dad” thinking.

Specifically, I regarded money as an obstacle — money was what prevented me from having what I wanted instead of being the means to have the things and the life that I wanted.

No more.

Because I have learned — and continue to learn — as much I can about every aspect of my financial life, I have a power over my finances (and my life) that is incredibly empowering. My program of saving and investing puts my money to work rather than the other way around. You can get started saving and investing by enrolling in your company’s 401(k), 403(b), or TSP (if you work for the government); or consider starting an IRA.

But investing is not the only reason for my new money attitude. I have also taken control of my career, the source of virtually all of my income; by working hard to create value for the company I work for, I have seen generous raises and bonuses over the last couple years. How can you take control of your career? Read a recent post I wrote on two great career books that will help get you on the way.

You should absolutely not be paying a monthly fee for a checking account.

Banks do pretty well for themselves by loaning out your money to others in return for interest. Don’t you dare line their pockets more by getting dinged by silly fees.

There are tons of banks out there competing for your money and a great many are willing to give you free checks, ATM fee reimbursals, rewards points for debit card puchases — anything to motivate you to keep some of your money with them.

Here in the Washington, DC area I’m rather fond of Wachovia, who is generously offering new customers up to $50 in bonus cash just to bank with them. Find a free checking account in your area now with this handy tool at BankRate.com.

It’s now been four months since I gave the Chase Freedom card a home in my wallet. As an update, I have thus far yielded a pretty healthy 1.6% cash back on my spending, which is a bit off of the 1.8% pace I had observed in my first two months with the card.

I commented in my review of the Freedom card that I thought the card was one of the best deals going in rewards credit cards. I still believe that’s the case.

Update: Since this post was written, Chase no longer offers these terms to new card members. Existing members are for the moment grandfathered in on the 1%/3% terms.

No less an authority on investing than Warren Buffett says that index funds are a great place for inexperienced investors to get started in the market:

In response to a question about why Buffett recommends index funds to investors, he said that for “a know-nothing investor, a low-cost index fund will beat professionally managed money.”

What are index funds? I discussed them in a post on Burton Malkiel’s A Random Walk Down Wall Street, a classic book on indexing strategies. But to recap, indexing is a simple way to buy a basket of stocks. Index mutual funds or index ETFs allow you to buy a diversified group of stocks at an extremely low cost. In a future post I’ll discuss why cost is a very important consideration for individual investors.

Search





• Blogroll

  • Consumerism Commentary
  • Get Rich Slowly
  • IWillTeachYoutobeRich
  • LifeHacker
  • MyMoneyBlog
  • The Simple Dollar