Just after Christmas, Carl Hendley of The Motley Fool wrote about his cable bill and how much lost investment income that money represented. As an economist, I was intrigued by the notion, and couldn't help but run the numbers. (We economists are strange like that.)
Hendley's calculations assume that the average person cares only about nominal, time-insensitive returns. That is, that a dollar today is worth a dollar tomorrow. But we economists know (from all of our fancy-pants research) that, generally speaking, that's not how people make decisions. Instead, when most folks make personal-finance decisions, they take into account the time value of money.
The Time Value of Money
"The time value of money" is a complex term for a simple concept: Any given amount of money is worth more today than the same amount in the future. Assuming a 5% interest rate, for example, $100 today is worth $105 a year from now. (Or, working backward with the same assumed interest rate, $100 in a year is worth $95.24 today. And what, they're not the same? Nope!)
Two years ago when I bought my People 150cc scooter, I was teased ceaselessly by my car-loving friends. It wasn't so long ago that gas was under two dollars a gallon, and the need for more efficient wheeled transportation wasn't as “in your face” as it is now. Today, when my friends talk about my scooter (or my wife's) it's to ask where I got it, for how much, and how much we save by having them.
J.D. recently mentioned he was thinking of forsaking his dream of a Mini Cooper for a scooter instead, but he had some questions. How much money would he save? Could we quantify with some certainty the impact of a scooter on one's budget? Here's my attempt based on my experience.
First, I'd like to talk about a few misconceptions. Scooters are not necessarily slow-moving vehicles. Your speed depends on your engine size. I'd think of them more generally as small motorcycles. You're exposed to the elements (more so than a car), and you're giving up the “safety” of a steel box, but you are getting a more maneuverable vehicle.
Why did the current financial crisis happen? I don't think a fully comprehensive answer could fit into a few paragraphs, but I can give some brief thoughts.
As of this morning, otherwise sound companies are encountering financial difficulties. If we think of the current financial crisis as being a simmering pot on an oven, the water just boiled over and knocked the cover off. Forces that were either hidden or contained were let loose, and this had a cascading effect. Credit markets dried up further in response to the fall of Fannie Mae, Freddie Mae, and Lehman Brothers. Businesses that otherwise were solid ran into cash flow problems. Essentially, we saw a bank run and lenders pull back their lines of credit and new credit could not be found.
This morning we have news that a neo-Resolution Trust Corporation will be formed to handle the tranches of bad debt currently out in the market. The market rebounded because such a move increases the certainty that at least part of the bad debt will be repaid.
Last month Stephen Popick shared his home-grown budget spreadsheet with GRS readers. He listened to your suggestions and went back to the drawing board. Here is with an updated version.
Growing up, I was taught the importance of having a budget. It wasn't until I finished college that I understood it. I started reading and listening to financial experts such as John Bogle, Clarke Howard, and a lot of folks in between. Their recurring themes were simply to save as much as you could, live below your means, and choose wisely how you spend your money.
Before I started with my Budget Sheet, which has evolved over the years (and which has been greatly enhanced for GRS), I always thought I budgeted well. Making an actual budget showed that, in fact, I did not. It's amazing how far $50 can be stretched when you're aware of it.
Wanting to start a budget? Intimidated by all the choices? Just want something simple to get you going? Stephen P. created his own budget spreadsheet, and he's offered to share it with Get Rich Slowly readers. He writes:
I have something for Money Hacks. It's a simple budget spreadsheet that I made in Excel when I was making $30,000/year and struggling to live paycheck-to-paycheck. It helped me to keep things in perspective. Things you can do:
- The tax table pulls from married filing separate. It is in the first 14 or so rows of the blacked out columns to the right of the sheet. If you want to change the tax table, just change the taxable values.
- My fiancee recommended that I add in a pets row, so I did that, and its now under personal expenses. If needed, this could be changed to be child-related.
- Default value for 401k pretax savings is 5% (Typically, employers match some portion for 5% of gross)
- Health insurance typically comes out pretax, hence why its green. You can also put in FSA money here too.
- The pale yellow cells is of course where the budget information is entered . I tried to put those cells where most people would have the easiest time budgeting.
This is based on a lot of input from financial planners. I think it works really well. Let me know if you like it!