My wife is a public broadcasting fanatic. I recognize its value, but mostly I just tolerate it. (I often joke that NPR is “noise pollution radio” — I can’t think when it’s on.) Usually the television pledge breaks annoy me, but one night last week, the local station employed a clever tactic. They had a financial expert answer viewer questions between pleas for more money.
Jonathan Pond bills himself as “America’s financial planner”. He runs a financial planning firm in Boston, but last Tuesday he was here in Portland, Oregon, fielding questions from the folks who called in to pledge money to public broadcasting. (Pond was also giving away copies of his new book, Safe Money in Tough Times.)
The questions Pond answered were a lot like the questions I’ve been receiving here at Get Rich Slowly. I don’t have time to answer most of the questions readers submit, and some are beyond my ken. (Remember: I’m just an average guy.) When I realized that a financial expert was going to tackle topics of interest to my readers, I grabbed a pad of paper to take notes. I’ve reproduced some of the most interesting responses below.
Does diversification still work? It seems like the rules have changed over the past year.
The biggest risk in investing is taking no risk at all. The diversification rules have not been thrown out the window. The actual problem is that people were not diversified before the crash. Many folks had put all (or most) of their money into stocks. The solution isn’t to now just over-load in the other direction. Diversification and asset allocation are about finding balance.
This seems like a once-in-a-lifetime opportunity to invest in stocks, but my friends think I’m crazy for wanting to do so. They think I should stay away from them. What do you think?
If you’re any sort of contrarian, now’s a great time to get in, a little at a time. Use dollar-cost averaging. Think about 10 years from now. Do you think the market will be lower or higher? Unless you need the money soon, don’t think about where the market will be next year, but where it will be in a decade.
It seems like there’s no safe place for my money now. Is there any safe place to still get a decent return?
There are four relatively safe places to put your money right now and still get an okay return:
- U.S. government money market funds
- Certificates of deposit
- Treasury inflation-protected securities (TIPS)
- Municipal bonds
In fact, Pond believes that this is a once-in-a-lifetime opportunity to pick up high-quality municipal bonds. (I’ve seen similar sentiments in big money magazines lately, too.)
How much should I set aside for emergencies?
In this difficult market, if you’re a retiree, you should have two years worth of money set aside. If you’re young and working, you can get by with less.
I was 100% in stocks, and have lost a lot of money. I still haven’t diversified (am still 100% in stocks). I’ll retire in 5-7 years, and will need the money then. Should I stay in stocks (to maximize possible returns) or should I diversify?
Diversify. Five to seven years is too short a time to be wholly invested in the stock market. If your time horizon were longer, you might be able to do that, but the sooner you need the money, the more important diversification is.
My employer is going to suspend the company match to our 401(k) plan. Should I continue contributing to the 401(k), or should I contribute elsewhere?
Keep contributing to the 401(k) unless you anticipate tough times. Dollar-cost average. Dollar-cost averaging is a good strategy, and now especially is a great time to do it. They key to creating what you need for retirement is to contribute regularly, and to increase contributions when you can. Also, invest in yourself. Get more training. Use your brains. Make yourself more valuable to your company. [J.D.’s note: Pond’s advice is good, but I think he missed the point of the question. I think the person meant, “Should I switch from a 401(k) to a Roth IRA?”]
We’re nearing retirement, but we’re not well-prepared. It was a challenge before the recession, but it’s even worse now. What should we do?
It will probably cost you less to retire than you think. Don’t listen to the talking heads who say that it will cost you 80%, 90%, 100% of your income. You can do it on 60% of pre-retirement income. If you’re really pinched, downsize your house. You might have to relocate to a less expensive region of the country. Also consider delaying retirement, or retire gradually. Delaying retirement by five years can make a huge difference.
My 401(k) is disappearing. What do I need to look for when investing in mutual funds?
Many people unwittingly put all of their money into stock mutual funds. If you lost more than 40% last year, you probably don’t have enough diversification. Don’t give up on your 401(k), but do make sure that your investments are diversified.
Interest rates on CDs and returns on mutual funds are way down. A friend told me about an investment guaranteed to return 14%. Do you think this is legit?
People are attracted to easy money. They want to get rich quick. But there aren’t any legitimate investments that guarantee 10% or 15% a year. If something looks too good to be true, it probably is. One way to check is to show it to some friends that you trust and see what they have to say.
Should I cash out my IRA to pay for a child’s college education?
It’s never a good idea to cash out an IRA for college. It’s never a good idea to stop contributing to them, either. There are other sources of college financing: loans and other financial aid. Save what you can, but don’t mortgage your own future for your child’s college education. [J.D.’s note: Trent just wrote about this last week.]
With the state of the economy, is it better to pay down credit card debt or to build savings?
Right now, it’s probably best to slow down debt repayment to build savings. In this economy, slowing down on credit cards may actually make sense in order increase the amount of emergency savings that you have set aside.
I’m falling behind on my debt. I’m unemployed. I’m having trouble keeping up with my credit card bills. What should I do?
It’s important to be pro-active. If you anticipate falling behind, contact your creditors before they contact you. They can’t work miracles, but many will have programs to help. Go to a legitimate credit counseling organization, not the sort you see on informercials. Use bankruptcy as a last resort, but don’t go to a bankruptcy attorney (because they’re going to think you should choose bankruptcy). Get an objective opinion.
Conclusion
Most of the advice coming out of reputable financial planners nowadays is very similar: Don’t panic, diversify, know your investment time horizon. They emphasize the fundamentals: spend less than you earn, have an emergency fund, etc. None of this is revolutionary, of course, but that’s because there are no magic bullets. I’m surprised at how many people complain about this advice. They think it’s facile because it’s basic; they want something inventive or new. But you know what? The basics are the basics because they work. Most of the time, when you stray from the proven path, you put yourself at risk for financial disaster.
Good info. here. Any chance you’ll do a review of his book?
I like your conclusion. The truth is the truth and it doesn’t change – only our willingness to accept it changes.
I disagree with the not paying off a credit card to build up savings. Your getting charged fees and interest. If you are paying off your credit card and an emergency comes before you build up savings you at least still have room on the card as a last resort but weren’t paying as much in interest.
The rest of it is good.
What’s ‘Dollar-cost averaging’?
“None of this is revolutionary, of course, but that’s because there are no magic bullets.”
Amen to that.
Anything promising to be a magic bullet is just cleverly-disguised snake oil.
@Dee (#4)
If you follow the dollar-cost averaging link in the article, it will take you to a page that explains the concept in more detail.
In short, dollar-cost averaging is an investment method in which you contribute small amounts at regular intervals. You might, for example, contribute $200 every month to your Roth IRA. When you use this method, you ignore the market’s ups and downs.
At a basic level, Dollar-cost Averaging means putting money into the market at regular intervals (like each paycheck, or once a month). The reason that this is a good strategy and can insulate you from danger long-term is two-fold.
Since the stock market goes up over the long-term, your money is going to increase, even if short-term fluctuations seem huge. Sometimes your money will be going in when the stock market is high, sometimes it will be going in when it is low. On average, you’re just getting the benefit of the stock market’s overall rise.
The second benefit is psychological. If you are committed to regular payments as a strategy, you will be protected from the urge to time the market. If it crashes you still make regular investments, and if it booms you still make regular investments, regardless of what fools like Cramer are telling you.
I like to see sensible advice like this. My favourites are the suggestions to consider delaying retirement (time makes a huge difference because of compounding), and to be wary of investments promising huge returns (if it sounds too good to be true, it probably is).
I’m always intrigued by how you should go about withdrawals in retirement – attempting to smooth the peaks and troughs of the market – but I’m too far away for it to be on my radar, the suggestion to increase the amount you have in savings sounds like a very good one.
Aww, I like NPR quite a bit! I do understand the hatred of the pledge breaks though. Luckily our local station does it only a few times a year for a week or two, then they stop. I listen to something else during those weeks :)
I like their Marketplace program about financial news so much that I find myself timing my work commutes to line up with when it airs! (I only listen to the radio in the car.)
I’ve found public radio to be absolutely invaluable. My local station has local programs, most of the daily NPR stuff, and of course Marketplace from American Public Media. I even enjoy Car Talk and their other weekend shows.
The value I get out of it far exceeds the contributions I began making last year (not a lot, but what I can afford), and the pledge drives two or three times a year are nothing at all.
I’ve found that after listening to Fresh Air with Terry Gross, or Diane Rehm, I’ve developed an extreme intolerance for how interviews are conducted on most other shows in TV and Radio. Public radio has become a gold standard for me, and anything else is just annoying.
People tend to get caught up in the news of the day regarding the economy and don’t seem to think long-term. Stocks and real estate go up and down all of the time. It’s hard not to look past the current conditions which are only temporary. I wrote a post about it today in my blog, in fact!
I do not support government health care. I know to many people form other countries with government health care you come here for treatment they cannot get at home.
I also see many of my fellow retirees going back to work. Attempting to make ends meet.
I think a retiree should have double what the think the need to retire, and no debts!
True wealth is not financial it is mental. The actual money is the cushion.
1. The ability to smile at the sun shinning on your face and not worry about money.
2. The knowledge you have a home where you are loved, not the size of the building.
3. The romance you enjoy is the closeness you share holding the hand of the one you love as you walk is a blessing.
4. Dinner out a treat not every day occurrence. Set your table with candles at home, dinner is not rushed that way, even when you use paper plates.
5. The closeness of friends does not equal the number. A true friend is there when you are sick.
6. A great party is one with ten close friends. A party for 100 is impressive, but you do not get to enjoy the individuals.
7. Spread the wealth, ease someones else life by smiling as you walk, sharing laughter and uplifting thoughts. You will be surprised how good you feel when you see someone else feel better.
So enjoy the sun today, smile at your neighbor, great a stranger, and hold the hand of your lover and put an extra dollar towards your debt. So you can be free tomorrow.
@Brad #3: That’s what I thought, so I kept paying down debt and didn’t put anything into savings. Then my credit card companies closed my unused emergency card and cut the limits on the others (citing, ironically, that my debt-to-available-credit ratio was suddenly much worse… thanks to the emergency card being closed!). Now I have no savings AND no available credit, which is not a good place to be.
JD, at some point I’d love to hear what you think of bankruptcy as a viable option. I realized the other day that since I no longer use credit to purchase anything, my high credit score is really just a matter of pride. I live in a big city; I’m planning to stay in my lovely rented apartment for at least the next ten years and have no need or desire to own a car. I have minimal assets, a fairly steady income of about $68k/yr, and $32k in credit card debt plus $8k in informal debt to a friend. Since I’m still employed, my creditors won’t give me any kind of break on the amount I owe. Is there any reason I shouldn’t be seriously considering Chapter 13 as a good way to wipe out some of the credit card debt?
@ Rose,
I know your question was to JD, but I have very strong feelings about bankruptcy as I have some experience with it from the creditor end.
From my perspective debt you take on is a moral obligation. You gave your word to these places that you would pay them back money if they lent it to you. While bankruptcy is legal, I don’t think it’s the RIGHT thing to do in many cases (though not all). From the other direction people who declare bankruptcy are much much more likely to do so again. I don’t know if it’s a situation of the type of person who declares, or if there is something about the financial self confidence hit you take from filing, but studies show that while your short term future may seem better with the relief of bankruptcy your long term future may not look as rosy.
I’m also not sure Chapter 13 will relieve you of any of the debt. I don’t have as much knowledge of Chapter 13, but it is more of a reorganization of debt than forgiveness of it. And you should be able to do that by finding a legitimate credit counselor (see the above article point about credit counseling). They can work with creditors to negotiate lower rates and payments so that you can keep paying but in a way that lets you breathe.
Ultimately, even if you file, you need to look at what got you into the position and take care of it before you get in financial trouble again. I would suggest not only credit counseling but also financial counseling. Live within your means with enough monthly margin to save for the future and take care of any emergencies. If you can’t do that then getting rid of debt via payoff or forgiveness won’t do more than putting a band aid on a broken leg.
Use the same investing principles we should have been using all along – buy stocks when they are low, diversify, invest money that you don’t need in the short-term (next 5 years). Buy good long term investments – things you’ll still want to own in 10 years. And DIVERSIFY (it bears repeating).
I began buying stocks again the other day. I bought long term stocks (GE, MCD, YUM and some indexes) with long term money. I’m also, for the first time, moving into bonds. I’ve learned my lesson.
It breaks my heart to hear that someone retiring in 5-7 years is 100% in stocks – WHY??
We just found out one of our relatives did that – and lost more than half their retirement at age 60. Here’s hoping we learn a few valuable lessons from this mess.
Another good post. That comment from “Retired” has some very wise words, and puts all of this into perspective. They made some lemonaide out of lemons.
This article also reminds me that timing is so important. While exact tops and bottoms are impossible to pick, I do believe that historical values and the big picture should be considered in every investment, including a home purchase. This can just be in the form of asking what has happeneded over the past few years in that asset class, and noticing if everyone currently buying, or if everyone currently selling?
“This seems like a once-in-a-lifetime opportunity to invest in stocks, but my friends think I’m crazy for wanting to do so. They think I should stay away from them. What do you think?
If you’re any sort of contrarian, now’s a great time to get in, a little at a time. Use dollar-cost averaging. Think about 10 years from now. Do you think the market will be lower or higher? Unless you need the money soon, don’t think about where the market will be next year, but where it will be in a decade.”
Pretty bad backup for his point, as we are at 12 year lows.
“With the state of the economy, is it better to pay down credit card debt or to build savings?
Right now, it’s probably best to slow down debt repayment to build savings. In this economy, slowing down on credit cards may actually make sense in order increase the amount of emergency savings that you have set aside.”
J.D., I don’t understand why you keep recommending this. It makes no sense. The emergency fund is there to avoid the need to use high interest debt like credit cards in emergency situations. Why would you avoid paying down high interest debt you already have in order to avoid possibly needing to take out high interest debt in the future?
I agree with others who are against the idea of holding on to credit card debt in order to build an emergency fund. Yes, I understand the basis behind it; you ought to have some cash b/c the creditors could lower your limits, etc.
Actually, the advice of some “experts” gets worse than this. A contributor in the Wall Street Journal yesterday even went so far as to recommend that people who have no credit card debt but also no savings ought to take a cash advance on their credit cards and deposit that into a savings account in order to have an emergency fund. He acknowledged that the 13% you’ll be paying to the credit card is much higher than the 2% you’ll get in savings, but that “it’s important to have some cash on hand” before all the credit limits go away.
All this advice is insane; this whole idea got started because banks convinced us that even if we didn’t have a mortgage, we ought to have a HELOC on standby for emergencies.
Even if there is the slightest bit of merit to the idea of keeping debt until savings are built up, those people who are deciding to follow that advice really should only consider it after they have eliminated their cell phone contracts, cable TV subscriptions, all unnecessary expenditures, all restaurant trips. They should trade down their cars to a 5 year old or older econobox. They should buy no food other than the cheapest basics of beans, rice, cereal and vegetables from Wal-Mart, with milk for children.
In reality though, most people would rather load up their emergency fund with borrowed dollars, because it’s a heck of a lot easier. What an insane idea.
You can’t borrow savings. You save savings.
I’d love to see an article comparing ROTH 401k to traditional 401k (HINT HINT). ;)
If my company stopped matching on the 401k, i would move the same amount of money each month that _i_ am putting in, over to a Roth: I have FAR more control over the investments in a Roth account, then with the VERY limited 401k options I have.
Also, i second the concept of paying off your CC debt FIRST: If you have an emergency, you can use the card again, but you’ve saved ALOT of money in the mean time from those debt payments. Just make sure to use any emergency card you have, every few months. I have an appointment on my calander to go buy gum with mine ever 3 months. :D
Allen,
What about the tax advantage of the 401K now? I find that having the max taken out of my salary (and it is not matched), reduces my taxes.
Hear! Hear! for retired. It’s said that the only thing money is good for is to keep you from worrying about money. Let’s keep in mind that money is a means to an end.
With all the comments about diversification, I wonder how many people here are, and with what? So if I may, who here is invested in something other than stocks, funds, bonds, their home, or their own business? Who invests in:
1) Gold?
2) Collectibles?
3) TIPS?
4) Investment real estate?
5) Anything else???
@Jeremy:
I think a wise investor is invested in gold, but it is quite expensive right now. If it drops to low $800s, I will buy more. TIPS can provide similar safety, but frankly I find it a little odd that people who fear inflation are trusting the Treasury to cover the loss (an oversimplification, I know).
@ryan
Amen. If someone is in a place so desperate that they need to cash advance to have any savings, they should be doing everything else possible to remedy that situation.
We found out yesterday that my in-laws just traded in their recently paid-for sedan for a new SUV. Their excuse? We’re having a baby and we needed the extra space. (This is baby #1, btw). Just a few months ago they asked us to please not spend more than $10 on a Xmas gift for our mother, because that’s all they could afford and they didn’t want to feel awkward. They were also planning on having the mother stay home with the baby, but can’t now because of the new payment.
Their choices are their own, but it makes me crazy when people complain about their situation then do nothing to remedy it.
@des,
If I was in your situation, the moment the family member asked me to limit my x-mas gift FOR SOMEONE ELSE would, for better or worse, be the moment I stopped keeping my mouth shut.
I’ve also seen that same situation with the expected first baby requiring an upgrade to a new $30,000 car. And I have children, so I know the absurdity of it also. It’s maddening, isn’t it?
We have friends who had a nice townhouse close to their jobs and two fairly new cars, both still financed. Getting ready to have a baby they traded up to a 3500 sf house over an hour from their jobs. Then money got really tight, and gas prices skyrocketed so they sold one of the cars, an SUV, to save money and “go green.” Then a few months later, with the baby closer, they realized the mother would not be able to stay home like they had wanted, and they bought a brand new minivan.
I’m curious from an informational perspective(I’m not trying to get into an argument): Those of you who say that it’s a bad idea to build a savings cushion before paying down high-interest debt, how do you feel about Dave Ramsey’s debt snowball?
My guess is that there’s going to be a dividing line here, that you folks don’t like the debt snowball either. I’m ready to be completely wrong on this, but I’m curious how things split…
I hear what you’re saying, and I understand the math, but having been in that position before, and having been one of those who didn’t save first (in other words, I basically followed your advice, although it wasn’t intentional), I can say that I regret not having established a savings buffer first. Whenever something bad happened, I went back to the credit cards, and that had a psychological toll on me. But, on the other hand, I did get out of debt just fine, anyhow, didn’t I? :)
I understand the point that #3 (Brad) and #19 (mwarden) are making, but I think they’re looking at it as black and white, when in reality it is a range of grays.
As #13 (Rose Fox) pointed out, as you pay down CC debt the card companies are lowering limits. I recently had my AMEX dropped to just above the owed amount. A friend of mine paid down two cards for a pending home improvement project, but had the maximums dropped too. This is the best argument against Brad’s point of paying the CC’s down fast – it won’t give you an “emergency fund” on the card – at least not one that’s as guaranteed as cash in the bank.
At the same time, not paying down your CC debt doesn’t work either, but at the very least until you do have a comfortable emergency fund, you can keep paying only the minimums and not adding new debt to the pile.
The gray… In my situation, I’m early in my debt reduction process – I’ve knocked one loan off my snowball, so I split the minimum from that loan between accelerating the next loan in the snowball and building up my too-small-for-the-economy emergency fund. So the net result is decreasing debt and increasing savings at the same time until I find a new balance that suits my risk tolerance and the current economy. And that’s why J.D. keeps recommending this path.
JD – I like Dave Ramsey’s snowball for getting started with debt repayment. I agree that there is a huge psychological change that takes place as a person transitions from a spender to a saver. However, Once those first few small debts are paid off, I think a different strategy is needed to move forward and tackle the larger ones.
For myself, having savings in the bank (especially liquid savings) was too tempting. When an emergency came up, it was easier to overspend on it because “we have the money”. Whereas, when I truly needed to put something on a credit card, I had a visceral reaction and wanted to minimize the setback as much as possible.
For those reasons, I would (until recently) recommend paying down debt before building savings. However, now (as noted before) a person runs the risk of having that card closed by the issuer. I think that makes debt repayment as an emergency fund too risky to rely on as the only form of emergency fund.
Just my 2 cents…
High interest debt first; then a savings account; then low interest debt(mortgage.)
I recommend a phased approach to the emergency fund. Mathematically its setting a dollar value on your risk. Build a small one, then pay off the higher debts, then increase the fund then pay off medium debts and then find a long term balance you want to maintain. Having SOME sort of emergency fund is key. Bad things always seem to happen at the same time.
I have a question slightly related to the savings vs. debt balance.
My boyfriend paid off his cc debt with a HELOC & put a car on it (his last was on its last wheels at 300,000 miles & he intends to keep this one just as long if possible). He had used his cc to work his way through college while supporting a family and ultimately a divorce. He has no cc debt now and has not put anything on credit for a few years.
Would he be better off rigorously paying off the HELOC or building up savings? It is my perception that HELOC debt is not as “bad” as cc debt, but where does that fall on the debt/savings continuum in the current economic climate?
@E:
Your perception is wrong, unfortunately. What you are not considering is that he took credit card debt, which is unsecured (meaning there is no asset backing up the loan) and turned it into secured debt (meaning if you don’t pay it, the credit card companies own your home). He is not debt free; he just changed one form of debt into a less preferred form of debt.
Since he did this, the priority should NOT be paying off the debt, but making absolutely sure you can make every payment.
@ E,
HELOC is worse than credit card debt because he can lose his house if he ever has problems paying it back. Credit card debt is unsecured, so you would just get a bad credit score. However, it looks like he was just using the HELOC as a financial tool to his advantage and seems pretty responsible. In light of this I’m in the camp that says to pay off the HELOC instead of saving and use the HELOC for emergencies ONLY.
JD,
Find some NPR shows you like and listen to them via podcasts.
If you’re not listening to Planet Money, you’re doing a disservice to your readers! npr.org/money
Ryan
“The basics are the basics because they work.” Yes, yes, YES! But the problem is so many people want a magic bullet, or they think something is different/special about their situation. It’s just like losing weight: you have to burn more calories than you consume. Very simple … but not easy.
As someone teetering on the edge of the 1st phase (i.e. still in debt, with a plan, but with a partner who is still in debt without a plan) I don’t contribute to the 401(k) available through my employer, but I am about to buy some stock through profit-sharing funds deposited by my previous employer in my 401(k) with them.
I have nearly a thirty-year horizon because I never expected to retire before 70. When my debt is paid I will be saving every possible penny to buy a home which I don’t expect to live in for probably 10 years – we may choose to rent it in the meantime, or we might use it for weekend getaways. Buying a decent retirement home in the city where we presently work isn’t under consideration, due to still-inflated home prices and undesirable urban conditions.
I am actively pursuing a career change, into a field I will be able to pursue part-time after “retirement” if I choose or if I need to. As long as I need to keep my hourly-wage job, I will; and I will add part-time work in my new field as soon as possible.
If money is tight, first cut expenses, then see about earning more money. It’s basic. It’s simple … but not easy.
@E
I think it depends on the specifics. Ultimately he needs an emergency fund more than he needs to pay off the debt. But how much extra cash does he have every month? Increasing your savings/investments and decreasing your debt are interdependent goals but they mean different things.
After one has an emergency account I think he should do both. You can either decide on a split (like 50% to savings and 50% to debt), or you can set specific goals. For example on one loan I had I had the goal to always pay at least as much extra as I was making in principal payments. Another one I wanted to increase the payment by $50/month every year (when I got a raise I would increase from $350 to $400, then $400 to $450 a year later when the next one came through). Even though they were high balances these left me with a feeling of accomplishment and moving forward.
And that’s ultimately the goal. Once the emergency account is in place it’s up to you to choose: What helps you sleep at night? What inspires you to your next goal? What works for you?
I find two things really interesting about this site: How zealous people are about the plan that worked for them, and how lost people are who are just reaching the payoff of their worst debts. It is easy to lay out a stage 1 plan for people to follow (debt snowball etc), but after that so much is personal. Saving/spending/investing is all about a specific person’s taste and circumstances.
The problem with rebalancing your 401K now if you have money mostly in stocks, is that you will be selling low. It probably is a good idea to diversify future contributions.
@Don:
I’m confused by your comment.
That’s not a valid scenario. If you were balanced before the downturn and have not re-balanced, then you are too heavily into the other asset types. This is the whole point of re-balancing. Re-balancing now will force you to by stocks low and sell your other assets at relatively high (with respect to stock).
Now, if you are saying that people were not balanced before, that might be a problem. However, it would be pretty difficult for them to STILL be too heavy into stock after losing 40% of their stock portfolio’s value. Seems pretty unlikely unless they were 100% stock.
Your recommendation in that case would be to buy heavier into bonds, etc. with future contributions in order to balance your portfolio. That is the opposite of re-balancing. You are buying bonds high when rebalancing would say you should be selling them right now in favor of stock. I guess maybe you don’t have a choice if you really were 100% into stocks, though…
I’m sorry, but if someone is living so close to the margin that their debate is truly between paying down high-interest debt and creating an emergency fund, not only do they need to live below their means, they need to get creative and GET MORE INCOME.
Take a second job, if you can’t find one you want, take a job you may have thought yourself “too good” for (FYI, if you have a ton of debt and no emergency fund, you are in no position to be picky), freelance, sell things, make things, ask family members (kids or non-working spouses) to help out, work extra hard for a promotion/bonus/commission.
These situations do not “work themselves out”, stop making excuses — YOU have to WORK yourself out. I promise the feeling you will get once it is done will be worth it.
mwarden:
My point was simply that buying bonds now with proceeds from the sale of equities would be a mistake. If you are going to rebalance because you are more heavily in to bonds than you want, then it is a good idea to buy equities out of the sale of bonds, because you will be getting a bargain.
I disagree that a bankruptcy lawyer will reflexively recommend bankruptcy. They will know the law better than anyone and lay out your options for you. These guys are plenty busy right now without encouraging anyone to file who shouldn’t.
Shara: “I know your question was to JD, but I have very strong feelings about bankruptcy as I have some experience with it from the creditor end.”
I have had clients go bankrupt and not pay me too, and it is painful. But it is part of the business landscape. We business owners need to protect ourselves where possible and factor in some amount of non-collectables. Brooding over others’ morals isn’t helpful.
I completely agree– the basics are the basics because they work.
Keep the good “basic” advice coming! :)
Thanks for the comments, mwarden, StackingCash, & Shara.
I wasn’t brooding over her morals, but I think our culture has moved away from feeling a debt is a matter of personal honor. I absolutely make judgments based on what I consider moral and right on top of what is legal. I added that caveat of being a creditor for two reasons 1) to let her know where I was coming from (as opposed to a lawyer or fellow debtor) and 2) to remind here that there are people on the other side of the equation.
Our laws are what we all morally agree is right. Owning another person is morally wrong, but it hasn’t always been illegal. It is now because most of us agree. So just because something like bankruptcy is legal doesn’t make it right.
My personal story is from the perspective of a landlord. I went into it knowing that there are multiple avenues for loss and planned accordingly (though since I only have one rental right now it’s hard to distribute the costs to my other customers). Every time I learn how I could have made the situation better for me (eg evicting earlier), and I pity those people. My husband calls them suicide bombers because they manage to take out the debt they owe us but do a lot more damage to their own financial prospects in the mean time.
But my situation or opinion doesn’t change the fact that she agreed to the terms of a contract and she now wants it dissolved. The people I know who have decided to pay their debts rather than file bankruptcy have always been better for it and learned a very valuable life lesson, opposed to people I know who have filed and gone on to make the same mistakes again.
I have compassion and I know there are exceptions and things that happen that you aren’t likely to be able to recover from. But trust me when I say it is not because I have had people dissolve a debt that I say borrowing money is a matter of honor. That is because I am one of those heartless people that believe in personal responsibility and bearing consequences for your decisions.
I think even in bankruptcy you should be on the hook for a number of years to pay back at least a portion of the debt. That isn’t to make sure the creditors get something. The court can keep it for all I care. But being able to make really bad choices and then walk out from under them doesn’t make sense to me. I don’t consider that compassionate or good for anyone. Really what does one learn from that? It’s like when a kid breaks a toy, if you just go buy them another one are they likely to be more responsible with it (even if you do shake your finger at them and give them a stern warning)? Post bankruptcy your credit is shot but what have you learned about fiscal responsibility?
I do understand the rationale behind building up the emergency fund before paying off the cc’s. I, for instance, have a cc @ 0% for 12 months w/a $600 bal. and another @ 3.6%/life of balance w/a $1900 balance (both require a $0 min. payment). I would much rather send any extra $ into an emer. fund and pay off these low-cost balances a little at a time. NOT HAVING THE CASH HANDY WHEN IT’S NEEDED IS WHAT CAUSED THIS DEBT IN THE FIRST PLACE. Keeping the stash of cash acts as a buffer…no more car repairs on a “payment plan” for me. No more indecision about whether or not to take the dog to vet due to the expense.
@Emma Anne: Actually, I was about to comment thanking Shara for reminding me of the moral aspect of this decision; while right now my priority is making ends meet (very difficult with my partner out of work and all this debt to pay off), I agree that there’s a lot to be said for honoring one’s promises and contracts even when it’s difficult.
@ Rose Fox: Shara is right. I make $45K and I have been steadily making payments every month for the past 2 years on my debt of $185,000 (from medical school).
I also owe $8000 in informal debt to my parents from helping me out with expenses during med school, and I make a small payment to them every month as well, with a promise that I will pay them more as soon as my high interest loans are paid off.
I live in Boston so I know city life is more expensive, but I know it must be possible to make ends meet on $68K. It may take a long time, and it may be hard, but I will pay off this debt!
JD,
You asked in #27 “I’m curious from an informational perspective(I’m not trying to get into an argument): Those of you who say that it’s a bad idea to build a savings cushion before paying down high-interest debt, how do you feel about Dave Ramsey’s debt snowball?”
Basically your question and many of our arguments keep going back to the same fundamental debate: mathematics vs. behavior. In most cases the right answer is a combination of both. Dave Ramsey’s method seems to be very successful, so I think that’s great, math be darned. But the reason that I think it’s successful is because his adherents are often devout converts who have recently read a life changing book and maybe attended a seminar. They are attacking debt and their spending mentality has shifted. The difference in this article, however, and even far more aggregiously in the WSJ column I referenced (which advised taking a cash advance on credit cards to build your emergency fund), is that it feeds the mentality that household debt is OK–even savings that are borrowed, the ultimate personal finance oxymoron. So I’m not arguing against the inferior math of the solution, even though I could, my argument is against the debt accomodating mentality.
Dave Ramsey says “all personal debt is bad, get rid of it this way because this way tends to work best.” These other articles say “You really need an emergency fund. If necessary service debt or take more on so that you have one.”
The mentality of personal finance is 99% of the battle. This is now a little off topic, but in my life, when I get talking with people about things we might like to buy I’ll say something like “That’d be nice, but I don’t think I should spend the money since the bank has a lien on our house right now.” They’re instantly taken aback, since by most accounts we’re doing very well. And they’ll ask “Why, what happened?”
I’ll explain very simply “When we bought this house, we didn’t have enough cash to pay for it, so we borrowed the rest from the bank. They only agreed to lend us the money by putting a lien against the house, so if we stop paying them back they’re going to take the house back.”
And the person responds, “You mean you have a mortgage?”
“Yes.”
“Oh. OK.”
For a few moments at least, they think a little differently about their own situations.
It’s an entirely different way of thinking. My grandparents used to say “When we had a mortgage, when never really felt like we owned the house.” My Dad would respond to them with talk of tax deductions and better returns in stocks.
In the old days a “second mortgage” meant you were in the straits. I remember as a kid in my upper middle class neighborhood (1980’s), second mortgages would be whispered about in the same hushed tones as if someone had been committing adultery. Then the banks changed the name and called them “equity lines of credit” that your house had “earned” for you, and how you could tap it. Remember, we’re talking about the EXACT SAME THING. Even many responsible accountants now talk about keeping a HELOC “for emergencies.” And even many responsible people, many of your readers, are terrified that the banks are “slashing their HELOCs!” “What are we going to do in an emergency???”
So now I’ve swung so far back into the other direction, along with my late grandparents, I won’t even call it a mortgage. People are too benign and desensitized to the term “mortgage.” They think of a mortgage like taxes, something you’ll just always have to pay. Get one for your “starter house” (a recently invented term that our grandparents would have found absurd). A soon as you can handle a higher payment, get a bigger one and a bigger house. When you need to send the kids to college, refinance it. If you’re lucky, if you ever finally pay it off; then you can finally enjoy the fruits of your labor in your retirement years. How? You got it–REVERSE MORTGAGE.
So I say “the bank has put a lien on our house.” Even telling myself that sometimes stops me from buying things I don’t need because I consider what the same money can do to shorten my amortization schedule. Double payments bring a 30 down to 10. And I’ll never have another penny of debt after that.
@ ryan:
Our grandparents were very wise… it seems like it’s our baby-boomer parents who sent us in the wrong direction; I do remember my mother saying, “This house is just your ‘starter house’ ” and sure enough, after our 3rd was born, my mother asked, “When are you going to get into a house where the kids can have a little extra room?…this small house affects their quality of life” and “You don’t really LIKE this small house, do you?” And so we have ‘upgraded’ to a much larger house and also have a ‘lien on the house’ of $238,000!! I really do miss my little brick rancher w/the $75,000 mortgage. I’ve talked to my older sister (who always talks about buying a bigger house) and have advised her of all the extra stress that accompanies the ‘upgrade’.
“From my perspective debt you take on is a moral obligation.”
Does a creditor feel any “moral obligation” to the borrower? A loan is usually a business transaction. You have no “moral obligation” to ensure your creditors make money on that transaction.
Part of the cost you pay for any loan is to insure the lender against the risk that you will default. They should have priced that risk into their loan and probably did. If bankruptcy makes sense for you, then go for it without any feelings of guilt toward your creditors.
Of course, a personal loan from family or friends is a different issue. They didn’t loan you the money just to make a buck and you shouldn’t treat it as if they did.
Holly,
I love your story. It’s funny how many kids a generation or two ago never thought much about their “quality of life” living in what would be considered tiny quarters.
Although I don’t live anywhere near there, and work in a field far removed from finance, I’m fascinated by New York City and what my life might have been like if I’d gone into investment banking or another finance field (tough right now, to be sure). And in my head I’ll do calculations about what it would take to have a comfortable life in Manhattan (and by my anti-debt/high savings rate standards, it’s prohibitively astronomical). But I’ll often think of families who are excessively wealthy, with net worths in the neighborhood of $10 million and they’re often living in 2 or 3 bedroom Upper East side apartments that cost about $5 million, that are likely smaller than your old brick rambler. And nobody’s concerned about these kids’ quality of life. They’re doing just fine.
In your situation, I’ll pass on one tip that might help you mentally accelerate your mortgage. I’m sure you know all about extra mortgage payments. But just try this. Go online to your bank and print out your current amortization schedule. With a $238,000 mortgage, your total principal and interest payment is probably something like $1200. Since you’re still early in the schedule, maybe each month you spend about $300 toward principal, and $900 toward interest. But don’t look at this month, look at NEXT month. The amount of next month’s principal is what you can consider the “cost” of eliminating an extra month of the payback period. So if you give them that amount of extra principal with this month’s payment, you’ve just paid off two months for slightly more than one. [there was a GRS post about this not too long ago that said the same thing, but I love it, so it’s worth repeating] Naturally this gets more expensive to do as the balance goes down, but it’s fun to do now.
Sometimes when I get a bonus (or recently my tax refund) I’ll go online for my amortization schedule, look at the principal column, and count down the page as I add up each principal amount in the coming months. When my running sum equals the bonus amount that I’m adding to my mortgage payment, the number of lines I was able to count down equals the number of months that I just shortened my mortgage by.
For me, it’s absolutely addictive.
“I have nearly a thirty-year horizon because I never expected to retire before 70.”
I think this attitude is a huge mistake. At age 40 you have no idea whether you will be able to work until age 70. That may be your plan, but your health and or potential employers may not cooperate.
@ Ryan:
You’re right…my husband grew up 2 blocks over in the exact same style of brick ranch house with a family of 10! He was the one who was ready to move (probably because his parents still live in that house-haha).
Thanks so much for reminding me of that mortgage tip…I will most certainly do that! I, like J.D. and Kris, would like to do it all- pay down debt, add to savings, AND pay extra toward the mortgage. So hard with the kids in private schools @ $15,000+/year (the public schools here are AWFUL, property taxes are low). We do like where we live, and my husband’s job is secure, so we’re pretty certain that we will live here for AT LEAST a decade.
Have a great day and keep up your excellent comments…so many money-savvy people sharing their advice. This site is addicting…
Verbatim from JD,
“I’m surprised at how many people complain about this advice. They think it’s facile because it’s basic; they want something inventive or new.”
….or exciting to get that emotional charge that comes from investing in the stock market.
I’m a big believer that investing should be “boring” and business should be “boring” meaning that both work like a well oil machine – systematic and always producing consistent results.
@Ryan, #53:
And in my head I’ll do calculations about what it would take to have a comfortable life in Manhattan (and by my anti-debt/high savings rate standards, it’s prohibitively astronomical).
A lot depends on your definition of “comfortable life”. Most of my New York friends think my existence is pretty bare-bones because I cook for myself, buy all my clothes at thrift stores and on eBay, almost never buy alcohol in restaurants or bars, don’t have a TV, and live in the cheapest part of Manhattan. Meanwhile, most of my friends outside of New York are shocked by how high my rent is (we pay $1585 for a spacious 2BR in an elevator building, which is well below market rates these days) and how much we pay for groceries. I think I live pretty comfortably, but a lot of that is perspective.
Hi JD,
Excellent blog.
I take issue with your last paragraph (conclusion). Sometimes ‘the basics’ are the basics because no one has yet accepted new ideas. One hundred years ago, no ‘prudent investor’ would own stocks. Today stocks are the primary holding for the prudent investor.
My point is that in today’s world we have a tool that reduces risk and prevents devastating losses. But that tool is just not in ‘the basics’ when it should be.
Stock options are not some high-risk tool for speculators. They are designed to reduce risk and limit losses to small, acceptable levels. And the best part is that protection can be had at no cost if the investor is willing to establish a limit on upside profits.
The COLLAR strategy is easy to learn and implement.
Mark
The Rookie’s Guide to Options.