Tuesday, April 29, 2008

Credit Cards or Cash: A Costly Tradeoff

Where do you stand in the tradeoff between cash and credit cards?


There’s an ongoing debate on the preferred and recommended method of payment for routine, everyday expenses and purchases. Is paying cash better, and more financially sound, than paying with credit cards? Maybe it should be the other way around with credit cards being a more convenient method of payment?

The trade off between cash and credit cards – It doesn’t end with convenience

Many people recommend handling a monthly expense budget on a cash-basis. This recommendation is sound as it essentially contains two important principles:

1. Increasing the tangibility of money – Cash spending is the most tangible form of spending. When we pay cash we see the money literally leaving our wallet and hand and watch it slowly moving away from us and into the seller’s register making harder to spend.

2. Following budget constraints – Cash just runs out. Credit doesn’t. When the cash we allowed for this month is over it’s over (forcing us to carefully reconsider expenses).

However, the problem arises when we try to account and budget for these expenses. Keeping track of the cash that leaves our wallet is hard and requires constant bookkeeping (either by hand or by an electronic wallet of some sort).

Unless we know exactly what we paid cash for we would have a very hard time keeping a monthly budget of our expenses and of their dispersion and behavior (more information on why we need to do that is detailed in this post “How to better analyze your budget”). This information is crucial to correct financial planning.

If we choose to pay with credit cards monthly statements will provide us with every detail we need to know about our purchases and expenses in a specific month. However, we would have an easier time both spending money and exceeding the budget we set ourselves.

Which means of payment is better: Cash or credit card?

I believe the answer, as many others, is not a definitive one. It depends greatly on the sort of person you are. The more disciplined you are the more I’d recommend using credit cards more often in order to have the best data available for budgetary planning and review.

Unfortunately, the less disciplined have a hard time here as well. Obviously using cash as the preferred payment method is recommended. Unfortunately, it carries a price. The data about expenses and purchases would most likely be unavailable as discipline is also required to keep manual track on all that cash.

I personally prefer credit cards as they are more convenient and provide us with the data we need. I believe that with small behavioral adjustments we can actually create a sort of tangibility to credit card payments as well. More on increasing the tangibility of credit card payments later this week.

Image by: Joe Shlabotnik

Monday, April 28, 2008

How to Break the Vicious Circle of Negative Cash Flow and Growing Debt

Understanding the vicious circle is the first step out of it

Chronic overdraft and debt is a widely spread illness. Chances are many of the household who suffer from it are caught in a vicious circle of negative cash flow and debt. Even more likely is the fact that they are unaware of their situation and of the behavioral pattern responsible for it.


The vicious circle


A vicious circle is comprised of an interlinked series of events or behaviors which constantly reinforce themselves through feedback towards greater instability. In household finances the classic vicious circle would like this:

The total negative cash flow of the household keeps getting bigger and bigger. The end is obviously and painfully clear.

Getting caught in such a vicious circle is terribly easy. Express loans, credit and other magical solutions are handy and available to everyone. These magical solutions obviously carry some of the highest interest rates known to man (other than loan sharks I guess) which bury us further in the circle. Financial awareness and education is unfortunately a lot less available and so many people find themselves stuck in such circles.

Getting out of a vicious circle is the tricky part. It will require painful concessions and, without a doubt, a sudden drop in your standards of living.


How to break the vicious circle and stop negative cash flow and growing debt


The strategy required to break a vicious circle should be clear. Attack one, or more preferably all, of its links. In the case of household debt and negative cash flow action should be taken on the following:

#1 Know where you stand - Awarness and acceptance

Find out how sizeable is your debt and how serious your negative cash flow is. By budgeting and concentrating all your financial data together with some hard work and the help of endless helpful posts from personal finance blogs around you will be able to draw these numbers. Getting professional financial assistance is always recommended but will cost additional money (I believe it’s worth it if it’s good counseling).

#2 Consolidate your debt - Immediate Action

Getting caught in a vicious circle usually means having multiple loans and credit lines. Consolidating your debt and setting a fixed monthly payment with a known period is very important to planning your way out of debt. Your monthly payment should be within your new budget (Step 2,3 have a lot in common).

#3 Adjust your standard of living to your income (don’t forget to include your debt payments) - Balance

The most important and maybe hardest step of all is to create a new, balanced, budget which will ensure you live what you earn. This is difficult in a world where consumption is the new god but you will also discover, as many of us have, that there is a lot more to life then consuming.

This post is about the bigger picture.More detailed guides, advice and how-to’s are available here, at The Personal Financier, and also at leading personal finance blogs which can be found in my blogroll and links section.

I especially recommend this guide by Trent Hamm from The Simple Dollar titled “31 days to fix your finances”.

Saturday, April 26, 2008

Overspending, Sleeping, Eating (healthy) and Equal pay @ The Round Up

It’s been a good week for me at The Personal Financier. I’ve had some spare time and I think I’ve put it to good use writing a few posts that I’ve planning on for some time now. I hope I’ll be able to keep up this pace in the future though I doubt it. My goal is to publish a new, quality, post at least every other day. If I can keep that up I’ll be glad.

I’ve received a lot of visits from fellow bloggers hosting the better known personal finance carnivals lately and would like to return the favors by choosing my own picks, as customary.
On another note the investment basics carnival I was planning on didn’t turn up as well as I’d expected with most content barely useable. I’ve decided on expanding this round-up instead with some better article from around the personal finance blogosphere.

I’ll start with the carnival of personal finance (#149 – Chasing dreams edition) hosted by The Happy Rock. The carnival hosts over 100 articles each week with the best of personal finance blogging. Here are my top picks from this edition:

  • Equal Pay Day @ Feminist Finance
    My small part in promoting this important issue.

  • Early Excitement in New Investments @ Quest for Four Pillars
    A good post demonstrating the fallacy of investment success. We’re always so sure our investment will turn out well. We sometimes call that success oriented planning. Sometimes it’s just wishful thinking…

From the Carnival of Money Stories hosted by Can I get rich on a salary I chose the following post: Financial Health is More Than Numbers, It Is Also About Motivation @ I’ve paid for this twice already… A personal story about the motivation behind financial decisions and how we make them.

The following are some of the better posts from fellow personal finance blogger I’ve read this week:

More carnivals around the web I took part in:

Friday, April 25, 2008

Investing in Your Pantry and Bargain Antiques @ CNN Money and Yahoo! Finance

At a great timing Brett Arends wrote a great article for the Wall Street Journal which was featured on Yahoo! Finance titled "Load Up the Pantry".

She argues that as flour, rice, milk, eggs and more basic food prices sore investing your money in a stocked pantry is wiser than just letting it rot in a bank account maxing at 4%.

The article provides additional background and some future predictions (in continuance to my post on the commodity and food prices) and makes for a very interesting and recommended read in my opinion.

Another article with real added value was published at CNN Money and reveals "The best kept secrets of antique shoppers". This is a great post on a tightly closed, less familiar market. Apparently there are real bargains out there.

This weekend The Personal Financier will feature the "Carnival of Investment Basics" and a weekly round-up as usual. Next week I'm planning on posting two great posts about fortifying our careers and on breaking the vicious circles of debt.

I'm always glad to receive questions, comments, ideas and thoughts and will gladly discuss them on the blog should they be interesting enough for everyone.

Thursday, April 24, 2008

Maybe Money Does Buy Happiness After All @ The New York Times

New research points to high correlation between wealth and satisfaction

We like to think money doesn’t really make that much of a difference. The intuitive truth is that it does, but we must be careful not to jump to early conclusions.

In an article by David Leonhardt for the NY times titled “Maybe Money Does Buy Happiness After All” a new research by two economists from the University of Pensilvenya is discussed. I urge you to take the time and read the complete article but for the ones of you who are more pressed here are the main points of the research:
  • The contrast between wealth and low satisfaction (demonstrated in post war Japan) was research by Richard Easterlin in 1974 and became known as the Easterlin Paradox.
  • Mr. Easterlin also claimed relative income mattered far more than absolute income.
  • The paradox became a social science classic for obvious reasons. We all like to believe we all have the same chance at happiness (I believe we do).
  • In a new research, economists Betsey Stevenson and Justin Wolfers argue that money indeed brings happiness even if it doesn’t guarantee it.
  • Furthermore, they argue absolute income is more important than relative income with a distinct correlation between income and happiness.
  • The research was conducted at country level.

Some very interesting questions are left unanswered and will hopefully be followed through in future research. One significant question brought up by Mr. Easterlin himself is: Did satisfaction rise in individual countries as they grew richer? His answer for China and the US is: no. The researchers claim 8 out of 10 European nations indeed showed a rise in satisfaction.

I believe it’s still a matter of relative income for some very basic reasons. Think about yourself. Your goals, ambitions and hopes are mostly relative. Many of them stem from what is considered an achievement in your society and the accepted standard of living.

Naturally, global or country level satisfaction would also be relative leaving poor counties wanting for more as globalization opens their eyes to the wealthy western world.

Still, while absolute income makes you absolutely happier, we must not confuse this with more consumption. Higher incomes mean better healthcare, better education and better child care. Not necessarily the ability to purchase that 63” Plasma TV screen you saw yesterday.

Wednesday, April 23, 2008

Spontaneous Observations on Commodity Prices - Will Prices Remain so High?

A multitude of reasons suggest commodity prices might not remain this high for long (oil just might)


My post on “The financials of 2008 – What will we talk about” has proven itself so far (to my great surprise). True, I didn’t think the credit crisis would prove to be so deep but my thoughts on inflation, commodity prices and the Chinese market were pretty accurate. In this post I’ll be sharing my observations on commodity prices. Naturally, this is my personal opinion and should not be used to make investment decisions.

Commodity prices have continued their unprecedented rise. Corn, wheat, rice, oil and many other commodity prices have all skyrocketed. The rise in basic food products’ prices have caused riots to erupt in developing countries such as Egypt, Cameroon and Burkina Faso. Other countries such as Vietnam, India and Pakistan have banned grain export as farmers and traders hold on to stock and await more price increases.

The whole word is anxiously watching food prices rise like they never did before.

Is there a just and sensible reason to the rise in food prices?

Yes and no. Confused? So am I. As developing countries developed so did the demand for food and other commodities. Economists list many reasons for the rise in commodity prices. Among these are the following:

Increased consumption and standard of living especially in south-east Asia causing a rise in demand for both foods and other commodities such as oil and metals.
The price increase of raw materials caused manufacturing and growing costs to rise as well.
Global warming which has caused a shortage in wheat crops.
Ethanol and bio-fuels competing for corn crops.

It seems, however, that commodity prices are also a target for highly speculative investments causing greater fluctuations and a sort of overshooting in prices.

Will Prices Remain High?

Prices will remain high for sometime. As I’ve written before it takes time to fulfill growing demand for commodities as more fields need to be planted and agricultural and genetic developments need to be introduced to farmers in developing countries. This will happen eventually and faster than we think. We all know what good motivator money is and with food prices so high the motivation is bigger than ever.

It also seems the current slump in crop yields is just that: a slump. Should a couple of years of better crops ensue prices will react pretty sharply. If you believe global warming is responsible and things will only get worse than you better stock up. I personally believe a process such as global warming takes more time to impact. I hope I’m not wrong.

Furthermore, if indeed commodity prices are the subject of heavy speculative investments hedge funds and their likes will eventually turn to other assets, after maximizing their potential profit in commodities. Such a change would lead to a drop in prices.

Hopefully oil prices will remain just high enough to keep alternative fuels economically worthwhile thus reducing pollution and also reducing the world’s dependency on oil producing countries, which aside from Canada and a few selected others have been corrupted by this natural resource and are not model countries to say the least.

One more aspect to consider is the monetary side. Another interest rate cut is expected in the US but Bernanke’s running out of interest rate to cut. The ECB (European Central Bank) has chosen to combat inflation and has left interest rates untouched through out this crisis. In England interest rates were cut by a mere 0.25% if I’m not mistaken and that was due to a housing problem developing there as well.

Interest rates will not remain at such a low level for a long time. A rise in interest rates will affect commodity prices and lower them as higher interest rates both reduce the demand for storable commodities and increase their supply. Higher interest rates provide a higher incentive to “extract” today rather than tomorrow, decrease the economic incentive to carry inventories and most importantly might draw speculative money out of commodities and back to treasury bills.

Image by bernt

Tuesday, April 22, 2008

Do you understand investment risk?

Talk of investment risk is abundant but what is investment risk really?


Stock investments are risky; Investing in corporate bonds is less risky but still carries some risk; Investing in government bonds is risk free; we each have our own risk preferences and should invest accordingly, and so on and so forth.

We all know and recite these market truths by heart. But do we understand investment risk for what it is?

Investment risk is often defined as “The volatility of returns. Generally, the higher the potential return over time, the higher the level of risk involved” (BT financial group).

Essentially, a riskier asset means the asset’s returns are more variable. The economic risks which are responsible for this volatility make good subjects for a series of different posts. Suffice to mention the following as sources for varying volatility of returns in different financial assets: Operational risk, financial risk, credit risk, market risks, geographical risks and more (endlessly more). Whatever the source, the result is volatility in the returns of a certain financial asset.

Alright, volatility in returns is still not clear enough: what does that translate into?

In finance volatility of returns of a certain financial asset is measured by the statistical tool of standard deviation. Before you run away to the sound of statistics let me explain how easy and intuitive this is. Standard deviation measures statistical dispersion or how widely the values, in this case, returns are spread. By calculating an average return for a certain stock and calculating the differences between this average and the actual returns over time we learn how volatile or how widely spread the results actually are. If results are close to the mean or average then the volatility is low. If they are widely spread then volatility is high. Here’s a short example of how standard deviation is calculated (notice we take the square of the spread from the average. That is done so negative and positive results will add up instead of cancel):


In this example 6 out of 12 returns fall within 1 unit of standard deviation from the average (+10%, - 10%). Another financial asset might display higher or lower volatility, or distance from the mean. The higher the volatility of a financial asset the higher the risk we attribute to it.

Government bonds will display lower volatility as the interest rates is government assured. These financial assets will be less influenced by the economic environment and will guarantee return if you hold on to the asset until payment. A stock will display higher volatility as it is more sensitive to the economy and all those risks we discussed earlier. Each influence will be translated to price shifts which increase the overall volatility of the stock.

Why is higher volatility associated with higher investment risk?

An obvious yet often overlooked question. The basic premise in this case is that as individuals we require a certain level of certainty for our future wealth which is translated to utility. Higher volatility implies a higher level of uncertainty and lower utility from a specific investment. Therefore higher volatility is translated into higher risks and in turn we demand a higher compensation for the risk taken in the form of higher returns.

How to we determine the level of return we require for the risk taken is a whole other story. If you find this subject matter interesting please let me know.

Image by dziner

Sunday, April 20, 2008

Why Bulls and Bears?

Stock market etymology for the curios


The famous New York Stock Exchange Bull sculpture is a beautiful work of art. The bull, seemingly moving, is radiating raw, yet restrained power, with surprisingly gentle grace as it prepares to storm up Manhattan.

The statue, created by artist Arturo Di Modica in 1989, was apparently placed illegally in front of the NYSE. It was created by Modica to symbolize the strength and power of the American people after the market crash “Black Monday” in October 1987. Public protest was strong enough to keep it in place after it was seized by police.

For those of us who are less familiar with stock market lingo a Bull market is a market characterized by an uptrend in stock prices and increased investor confidence while a Bear market is characterized by pessimism and downtrend in stock prices.

But why bulls and bears?

Etymology can be very surprising sometimes. I enjoy learning about the origin of words and phrases we use daily with little knowledge of where they originated from. As bulls and bears go there seems to be on single explanation.

According to Wikipedia (“Market trends”) the most reasonable origin is London bearskin brokers (“jobbers”) who would sell the skin before they had caught the bear (Selling short!). It seems these brokers in did sold short expecting a downtrend in bear skin prices hoping to make a profit by selling high and buying skins lower at a later date. Other possible explanations seem to have been made to fit already existing proverbs. Among these are the animals’ form of attack (while bears strike paw down bulls swings horns up), their speed (which is wholly inaccurate as bears can move at speeds of up to 40 mph easily) and more.

Further explanations (phrases.co.uk quoting Merriam-Webster) suggest the term bull was originally used to describe a speculative purchase in expectation that prices will rise. Its’ earliest use is thought to be 1714 and it was apparently chosen to counter “Bear”.

I’d love to hear other explanations you’ve come by.

Image by babblingdweeb

Excess Frugality, Practical Tips and Gas Prices @ The Round-Up

The American Economics Blog Carnival hosted my article “Is Present Value - Value in the Present? The Economic sense behind Net Present Value" and featured some interesting posts. I especially liked:
  • Fuels Costs, High Gas Prices and the Real Estate Investor @ BiggerPockets
    This article discusses some interesting effects high gas prices might have on real estate investors. An interesting point made is that increased fuel costs will also affect the selection process of the average home buyer as longer commutes to work become more costly. I believe low gas prices have created an inherent inefficiency in real estate and urban planning. I find suburbs to be one of the main problems created by this inefficiency resulting in commuters jamming highways and roads, pollution and waste of resources an time.

    I personally believe that with increased gas costs and environmental awareness the suburbs will cease to exist as we know them now and will slowly transform to more densely populated, self serviced metropolitan areas. That will take a while though.

The Festival of Frugality @ Rather-Be-Shopping hosted my article on “How to Successfully Navigate Your Way through Home Renovations: 10 Practical Tips”. I recommend the following posts featured in this addition of the carnival:

  • The Frugal Lifestyle: Are We Missing Out on Life? @ Consumerism Commentary
    My thoughts on the issue should be pretty clear by now and are very close to the author’s. I believe a delicate balance exists in being frugal, one that is too easy to cross. I believe real money is saved by being smart, educated and aware and not by saving a nickel a day while denying trivial and basic needs. I recently wrote how being over ascetic just might end in the exact opposite with an explosion of denied passions (or in the words of Lloyd Brown from Seinfeld “Serenity now … Insanity later”.

  • Frugal Tips: How To Make 10 Ordinary Things Last Longer @ The Digerati Life
    The Digerati Life is one of my favorite blogs for articles such as this. Writing everyday handy and practical tips is pretty hard. Some of these are really useful, the others, to me, are more entertaining (chilling candles, how brilliantly simple is that?)

The Carnival of Personal Finance @ Gather Little by Little hosted my article on “How to Successfully Navigate Your Way through Home Renovations: 10 Practical Tips”. This carnival edition featured the beautiful photos of North Carolina’s Landscape and good posts as well. Here are my picks:

  • Spend $10. It’s Worth It! @ Cash Money Life
    This article offers a refreshing break from excess frugality. This is an excellent example of what I mean when I write about fulfilling the more basic needs which will later help us postpone the bigger ones.

  • Riding a Bicycle to work @ Pinching Copper
    A classic win-win choice which speaks for itself. The obvious obstacle is distance but then you can always ride a motorcycle (I do).

More recommended readings from fellow personal finance bloggers:

Friday, April 18, 2008

How to Save Money by Analyzing Your Budget: 4 Basic Tools

Can’t see the forest for the trees?

Budgeting is an essential part of managing our personal finances. The story doesn’t end there though. We can and should learn to leverage our budget and the historical and future data it holds. By analyzing this data we can spot trends, problems and opportunities and increase our financial efficiency.

Basic budgeting will help you keep a positive or zero cash flow, as opposed to a negative cash flow which leads to never ending debt. The next step would be analyzing a budget using basic statistical and analytical tools and trying to identify which expenditures are problematic, abnormal and hold the greatest potential for increasing savings.

#1 “I spend how much on eating out!?” or Average

The most basic tool in budgeting is arithmetical average. Since our lives are cyclical and routine by nature using average costs will work 80% of the time. Averages can be put to good use in one of two ways:

a. Analyzing average historical expenditures – Averaging historical expenditures generates the most basic from of budget data: How much, on average, do we spend on various expenditures such as groceries, restaurants, health, clothing and more. There are over 50 different monthly expenditures to include in a budget.By adding a simple average column to your budget spreadsheet you can easily get another look at how your monthly expenditures and income behaves. You’d be surprised by what you’ll find. Using averages should be limited to those cases where the expenditure is cyclical and averaging it is a good proxy. Expenditures which should not be averaged include significant one time expenses for example.

b. Using past averages to forecast future expenditures - Relying on historical averages for planning a future budget is a good way to start. Usually, cyclical expenditures will not deviate a lot from the average and would normally only need to be adjusted to inflation and increasing family size. The historical data your budget holds is priceless in planning the future.

#2 “Our grocery bill seems a bit high, doesn’t it?” or Trend

Averages are a good start but there’s more. We often use historical data to observe trends in every aspect of our lives. Why not in budgeting? Many expenditures and incomes are correlated with seasons, holidays and certain months.

Furthermore, certain expenditures evolve and show a trend. Examples are the constantly increasing telecom costs with growing internet and cellular services or growing cost of healthcare with age. There are more mundane examples such as growing food prices and more. Identifying the trend is possible by analyzing the historical data available to us in our budget spreadsheets. Isolating each expense and studying the way it behaves is easy and informative.

If changes are minor then average would be a good representative of that expense. If there is a change we can certainly characterize it as either: growth, decline or seasonal for example. This information is very useful in planning and understating our cost structures.

#3 “Holidays again!?” or Expecting the expected

Don’t you hate it when all of a sudden Christmas is here we’re tight on gift’s budget? Holidays came early this year didn’t they? Well, the expected is often very easy to forget. Another birthday, another anniversary and life goes on. Analyzing historical budget data is very useful in identifying these expenses and marking them on next year’s budget.

There is really no need to be surprised by the expected. Browse through the different months, mark the dates and the average costs each occasion generated and plan for these next year at the same time.

This goes for bigger and less frequent events as well such as weddings, college tuition and more.

#4 “I had no idea we spend 25% of our salary on groceries” or Visualization

Visualization is a very powerful tool. I wrote a post about using visualization to motivate your self to save once and I’ll press the matter a bit more.

A picture is worth a hundred words, they say. I strongly believe that. Simply taking that average expense column and generating a pie chart to display the percent each expense takes will show amazing things. 25% of our income on food is a phenomenal number and yet is very true to many families. Each expense can be controlled, some more than others, but awareness plays a very crucial part and is a pre-requisite.

Using graphs to demonstrate trends is another powerful visualization tool. An up or down trend is easily noticeable in a graph. “Unexpected” expected costs will appear as small bumps on certain months allowing you to easily identify and plan for them.

In short, our historical budget data is a goldmine for the future. Identifying opportunities and problems can be easily done if we control the right tools and put them to work properly.

Don’t be afraid to experiment with customizing your own. Playing with your budget spreadsheet will, in itself, motivate you to make the bottom line look better.

Image by Brapke

Wednesday, April 16, 2008

How to Make Saving More Rewarding and Tangible: 5 Practical Tips

Increasing the tangibility of your savings and rewarding yourself for achievements is crucial for success in this long term effort.

Saving money consistently is hard. The temptations and needs are numerous. There will always be just one more thing to buy to make everything perfect. How do we resist the urge and how do we discipline ourselves to save?

Having the required self-discipline is a good start but is by no means enough. Making the process of saving more rewarding and more tangible is a must in order to succeed in this long term effort.

The sense of tangibility of money has been greatly decreased since the invention of credit cards and online bank accounts. Bills and coins have become number on a screen and these are easier to spend (in most cases we just hand out a credit card). We have no real since of how much money we’re spending and on what unless we budget carefully and regularly. Increasing the tangibility of money and saving would allow us to save more easily and to be more motivated and geared towards saving.

Rewards are always a good motivator if they are applied correctly. Adding small rewards to the process is crucial for success. One can not deny his own wishes always. Satisfying smaller wants and wishes will make delaying the bigger ones easier.

Taking these two concepts of reward and tangibility and applying them to the saving process will help us achieve our goals. Here are my practical tips on how to do that:

#1 Budget and plan

A budget has another significant advantage beyond keeping track and planning. It serves to make income and expense, loans and savings much more tangible. By budgeting we have a constant reminder on how we’re doing, how much we’ve spent and on what items, how big is our debt or our savings account and more.

#2 Make your budget more visually attractive and revisit often

This sound trivial but is very important. Draw pie charts, graphs, use averages and reports and build as many statistics as possible into your charts. Revisit your charts often and constantly examine them. You’ll soon discover how keeping a positive balance becomes increasingly important to you, how you enjoy watching your net worth grow each month and how sorry you are you haven’t done this before.

The explanation is simple. Through behavior and repetition we change believes and rational. There is a concept in behavioral sciences called “cognitive dissonance”. This concept deals with gaps between behavior and belief and, in short, describes how a contradiction between the two would be settled psychologically either by changing behavior or changing believes. Changing behavior is considered harder. This is where self-discipline comes into play.

#3 Don’t be overly ascetic

Much like a diet denying everything from your self will end up in nightly raids on the fridge. This never works. Instead, allow fulfilling small yet important needs while postponing bigger ones.

#4 Set goals and mile-stones and complete with matching rewards

Ambitious yet attainable goals serve as powerful drivers. However, with out properly acknowledging their completion they quickly lose their affect. Set goals and mile-stones such as reaching a 20,000$ portfolio and reward yourself accordingly (for example, setting aside that month’s savings for a nice restaurant, for example).

#5 Learn to understand and enjoy the process itself

It takes time to turn small savings to a formidable portfolio. This process may seem to take forever. A watched pot never boils they say but I believe taking occasional peeks at your bank account does you good and motivates you to save more hoping to see the dollars and cents pile up. I discourage acting often but keeping track in expectation helps (please do not confuse this with waiting for stock investments to generate returns. It’s a whole other issue).

Image by distinguish

Sunday, April 13, 2008

The Little Savings That Could

The heap paradox as a powerful metaphor with surprising results.

Making the long and tedious process of saving small sums of money more rewarding and more tangible is a formidable effort. We all lose hope when we only manage to save 100$ each month, thinking desperately we will never get to see them amount to anything significant.

Sure enough, becoming wealthy is easier when you’re able to save significant sums of money on a timely basis. However, we shouldn’t neglect the smaller sums saved as they also have a key role is creating wealth.

I’ve recently re-read a very interesting paradox named the Sorites paradox (Greek for heap paradox). The paradox is attributed to Eubulides of Miletos who lived in 4th century BC and goes as follows: Consider a heap of sand of which grains are removed one at a turn. With each grain removed the heap gets microscopically smaller but is still a heap. However, is it still a heap should one grain remain? Or ten grains for that matter? When was it that the heap ceased being one?

The paradox can also be considered the other way around. One grain of sand is definitely not a heap, yet continuously adding individual grains will eventually result in a heap of sand. I assume you can already see where this is going.

The philosophical question is very interesting in itself and has to do with concepts that lack boundaries. However, the day to day application of this metaphor is even more powerful. A heap will eventually gather. We won’t necessarily get to see the moment it transforms from grains to a heap but we will get to see the heap at he end of the process.

Saving even the smallest amounts of money in a timely and consistent manner will eventually results in decent savings in the long term. The power of compounding interest mixed together with time and discipline will eventually work for you as well. You won’t notice the exact moment your monthly deposits became a worthy sum. But it will eventually become one.

Saving is a long term and tedious effort. Making it tangible and rewarding is very important for consistent success.

Image by Steffen M. Boelaars

Money Stories, Pets and More @ The Carnivals

The Carnival of Personal Finance #147: Q1 Financial Advice Edition was hosted @ Moneyning. I found the Following posts particularly interesting:

  • The Cost Of A Bigger House @ Frugal Babe
    I bring you this story which demonstrates, quite successfully, what I always talk about. Firstly, You should buy a home which lasts you at least 10 years (if not more). Secondly, frugality only gets you so far. The real money is in the big ticket items. Although a frugal state of mind is always necessary.

  • Four Ways I Upgraded Out Of My Raises @ Free From Broke
    Another story which discusses another painful issue I intend to deal with in one of my upcoming posts. The hedonistic fallacy or why more consumption won’t make us any happier.

  • Hey, You Invest Like a Girl! @ Dividends4Life
    This short post uncovers a little known truth. Women are better investors than men. Understanding why is yet another step in the right direction towards smart investing.

  • The Annual Cost of Pet Ownership: Can You Afford a Furry Friend? @ Money under Thirty
    A good niche article is always in demand. This post deals with costs of pet ownership and is straight and to the point.

The Consumer Focused Carnival of Real Estate was hosted @ Searchlight Crusade. I recommend The Difference Between Note Rate (APY) and APR by Dan Melson.

The Money Hacks Carnival #7 Real People Named Hacker Edition was hosted @ Mommy Gets Paid. I chose the mention the following posts:

Saturday, April 12, 2008

How I Saved Over 3,000$ In One Hour

I admit the headline is a bit catchy but the amazing thing is that it’s absolutely true. I was literally amazed at how easy it was. I was even more astounded to discover that had I not been aware and acted promptly no one would have bothered telling me anything.

Yesterday, by leaving work for one hour, I managed to save 3,000$ in interest payments and a year and a half (!) of mortgage payments.

How was this miracle performed? Simply by being aware to falling interest levels and by snooping around at current interest rates offered on mortgages. The loan officer knew exactly what I came for the minute I sat down and was suddenly very eager to match and best any offer I had received elsewhere.

A simple discount of 0.5% on my mortgage rate was enough to save me 3,000$ on interest payments and a whole year and half of payments while leaving my monthly payments the same as it was.

The source of this financial miracle is obviously a combination of two powerful financial tools:
1. Compound interest
2. Long term

There have been so many words written on these two but nothing compares to watching them do their magic for you.

Still a troubling thought crosses my mind. What would have happened had I not been aware of the economy and of current financial developments? What would have happened had I not been financially literate and had the understanding and opportunity to refinance my mortgage as I just had?

The obvious answer is that many of us are probably throwing money away daily. I’m not a “frugal” person, as I often bother to mention. For me the everyday effort of saving pennies is just not worth it. I strongly believe saving real money lies elsewhere. It lies in loans, interest rates and smart saving and investing. It’s how we buy our homes, how we save for mid and long term and how we manage our home economics that matters. That is also why “The Personal Financier” is more about these subject matters.

With interest rates dropping sharply I believe every one of us who carries a mortgage should very diligently look into the possibility of refinancing it and saving big.

The thumb rules regarding mortgage refinancing are usually lower interest rates compared to the costs of originating a new mortgage. I’m not very proficient when it comes to mortgages and I suggest, as always, you consult with a mortgage consultant. Bankrate.com offers this calculator.

Thursday, April 10, 2008

Is the Chinese Stock Market Bubble Bursting?

If you’ve been following my posts for a while you’ve probably read my thoughts on the Chinese stock market (two quick reminders for the ones that haven’t are attached at the end of this post).

One of the topics I constantly wrote about come 2008 was the Chinese stock market and the high price levels it had attained.

High inflation and interest levels combined with a less than perfect stock market (mildly put) brought me, as it did many others, to believe the 2008 will prove to be a turning point for the Chinese market.

High hopes were placed on the Olympics to stabilize the system but as every novice game theorist knows when a premise like that is common knowledge than each individual always has a dominant strategy to go and sell a bit early to avoid the mass sales to follow. I’m guessing that’s what’s happing, amongst other things.

Meanwhile, the Chinese stock market plunged by approximately 45% compared to October 2007’s record (Chinese CSI 300 chart by Bloomberg.com):


I wrote before, and I think it is still obvious, the Chinese market has every reason to become a great invest in the long term. But what we’ve seen so far has been a serious overshooting in stock prices compared to potential growth.

Related Posts:

1. The Financials of 2008 – What Will We Talk About?
2. 5 Spontaneous observations on what's going on

Tuesday, April 8, 2008

How to Successfully Navigate Your Way through Home Renovations: 10 Practical Tips

For a while now I’ve been writing about my recent experience with purchasing and renovating my home, a small apartment in bustling city center.

One of the more difficult steps in this process was renovating our home. Home renovations have some characteristics which make them extra difficult to plan and execute:


1. Uncertainty is high
2. The professional knowledge at our disposal is scarce
3. Our experience is very limited while the contractor is well versed
4. The costs of a single mistake can be relatively high
5. The work takes place at our home thus creating more pressure on us

Understanding these crucial elements is essential to a managing a successful renovation. While the following advice I provide from my own recent experience won’t assure surprises won’t happen they will greatly reduce the risk associated with them.

This is my list of 15 practical tips for successfully navigating your way through home renovations:

#1 Get professional help

My readers probably recognize by now how strongly I feel about this particular advice. Architects and interior designers get paid because they have added value. Professional help is crucial in any field which requires a level of expertise and experience which is unavailable to us.

Our architect saved us from many mistakes and helped us greatly in deciding which of our plans is feasible and within out budget limits and which plans will never leave the drawing board.

As in all aspects of life pricy designers and architects are abundant and pretend to offer greater value in various forms: from feng-shui interior designs to spiritually designed homes. If that’s your cup of tea it’s ok, just be aware of the price you’re paying for this. A good proficient architect and interior designer will save you 80% of the headache with significantly lowers costs (as always, it’s all about marketing).

#2 Have an agreed bill of material and work

I was surprised when I heard how many people get into home renovations without a proper summation of the scope of the work. This is absurd and is the worst thing you can do when renovating. This is obviously a clear and sure way into early arguments with the contractor on what is included and what was left out in the initial agreement which will usually end in you constantly paying more and more (remember the pressure part?).

Another aspect is properly pricing your renovation. You have no way of comparing two offers if you don’t have one defined and finite scope of work and bill of materials. Each contractor will make an offer based on his assumptions and understandings which will eventually change after the work begins.

A bill of material and work should be a tabled document providing information in very high resolution which will enable the pricing of each work and material unit.

#3 Shop around and let them know you do

Use your bill of material to shop around. The high resolution pricing will enable you to negotiate better with each contractor as you’ll know exactly how much each material and work unit should cost.

The most beautiful part of this process is that the contractors themselves will provide you with that information.

#4 Don’t hire the cheapest contractor or a rouge contractor

I personally never buy the cheapest available. It ensures getting lower quality 99.9% of the times. I agree expansive doesn’t mean better but the correlation exists without a doubt.

A cheap contractor might prove to be very costly. Remember, no one works for free. If the offer is cheap something is paying the price: work quality, material quality or he might have future plans of sticking in some ‘unexpected’ costs.

Make sure your contractor is a professional with the required certifications. Cheap is costly! Just imagine getting stuck midway into the renovation. You’re at his mercy.

#5 Sign a contract

Contracts sound scary. Who needs all that legal lingo? A handshake is as good as a contract. Right? Wrong! You definitely need to sign a contract with your contractor. This binding and legally anchored document is your assurance if things go wrong. Better yet, it’s an excellent measure towards making sure things don’t go wrong. A contract is your leverage on the contractor. Remember, we are the weak party here and we need all the help we can get.

If a contractor doesn’t want to sign a contract or tries to convince you it is unnecessary, take that as a bright red flag and think three times before you hire him.

Make sure your contract includes all the following:

a. Agreed dead line and penalties or rewards – No renovation ends in time. You will get a more realistic time estimate if the proper motivators are set in the contract. This, in turn, will help you plan better for things to come.
b. Agreed price per bill of work and material – Naturally your contract should include the agreed upon work and the agreed upon price.
c. Agreed payment milestones – Payment milestones are a very important aspect of planning a project. Don’t agree to pay too much too early. Payments are the main motivator for the contractor to keep on working.


#6 Plan to overspend by at least 20% and don’t be surprised by surprises

Even if you’ve agreed on a price you should plan for surprises. The initial d├ęcor you thought would work seems plausible. You suddenly discover some bad wiring, etc.

We’ve already noted the level of uncertainty renovations hold. Plan in advance to spend 20% over your agreed price for the work (this might mean lowering the work down a bit if you’ve planned on your entire budget).

#7 Coordinate your expectations

Are you a perfectionist? Let your contractor know. In such negotiations and price offers people plan and price considering reasonable circumstances. Do you simply must have each tile spaced exactly 2.1 mm apart? Let him know in order to price accordingly and remove future arguments and conflicts.

Remember each expectation comes with a price. The more you communicate your wishful thinking and expectations to your contractor the better the chance you’ll make them happen with a lot less conflict but with higher costs.

#8 Perfectionism should be leveled

I believe there is little room for perfectionism in construction unless you’re willing to pay a very high price for the best workmanship and materials. Don’t expect to get something you didn’t pay for. If a 2 degree deviation in the bath tub prevents you from sleeping consider renovating very carefully.

#9 Be there

You can’t replace good overseeing and inspection. Your presence will greatly increase the chances of better workmanship and schedule. Don’t hesitate to ask and comment, probe and touch. Most of it isn’t rocket science.

Make sure you drop by often and sometimes unexpectedly. There is no other way to make sure you’re getting what you want.

#10 Have boundaries

The contractor is a person too. Keep your demands at a reasonable level. I’ve heard from many contractors (that didn’t have a contract and a bill of materials and work by the way) how frustrated they were by unreasonable and pricy demands from their customers. Guess it works both ways.

Reader Green Pastures suggested hiring a local contractor which has a reputation to maintain. I strongly support his advice. They hold all the cards and we must strive to maximize our bargaining power which way we can.

Images by eye of einstein, Wolfcreeker

Sunday, April 6, 2008

Outsourcing, Skills and Investing – Weekly Round Up

It’s time for more excellent posts from fellow bloggers. Naturally these are handpicked. I genuinely hope we agree on their added value:

The Carnival of Personal Finance #146 - Online Broker Tips Edition was hosted on Stock Trading to go. I was especially fond of the following posts:

Thursday, April 3, 2008

Where Should Your Next Spare Dollar Go?

My wife and I have finally been able to save some money. After buying a home, remodeling it and getting married all in one year our financial resources have been greatly depleted. A couple of months with relatively smaller expenses passed and we’ve been able to save a small yet significant amount of money.

Suddenly we’re faced with a question: Where should we put this money? What should we do with our next saved dollar?

I believe the answer lies in the truths of basic financial planning theory. In my opinion when we consider where our next dollar should go we have to examine the following hierarchy of financial “needs” (assuming your debt repayments are within your monthly budget):


Repaying expansive debt

Not all debts are bad debts, just the more expansive ones are. For example, just yesterday I wrote about the advantages a mortgage has in making us more disciplined savers (with relatively cheap interest rates).

If your outstanding loans are pricey you should definitely work towards repaying them or recycling them soon. If you’re debt repayments are already in order and within your monthly budget it is advisable to consider direct your next dollar elsewhere (while still maintaining liquidity should anything go unexpectedly).

Securing a liquid emergency fund

I recommend keeping a liquid emergency fund whole-heartedly. An emergency fund, in my opinion, should hold sufficient funding for at least 3 months with no income. Your emergency fund can also be used to reduce pricey debts gradually while using the money saved on interest to re-establish it.

Contributing more towards a secured retirement

Save early and often is the best tip in retirement planning. If you have an extra dollar better check how are you meeting your retirement goals. Postponing instant gratifications and increasing contribution to retirement plans will be well worth in the long run.

By no means am I recommending all your savings should be directed to retirement. We still need to lead a life. My recommendation is to raise our awareness towards securing our retirements.

Establishing a foundation of solid investments

Congratulations. You’ve made it past the basic foundations of your financial planning and financial living. The next step, in my opinion, is substantiating another level of solid investments. This next level should be planned in order to help us meet our goals: an apartment, education and more. The risk level and liquidity of these investments should correspond to our goals and term of investment and should definitely be on the solid side.

Building an investment portfolio

It’s the big league. Depending on your preferences you are now able to take more risks (or less) and really start enjoying your money working for you. Investing is never detached from your goals and personal status and should always reflect them. However, if you’re extra dollars are going in here you’re doing quite well. Good luck.

Wednesday, April 2, 2008

Why Buying a Home is More Important than You Think

Rent vs. buy comparisons are abundant. I’ve wrote quite a bit on the matter trying to illuminate the less obvious parts of it. In this post I’ll concentrate on a few fundamental financial advantages of home ownership which are too often painfully overlooked.

Buying a home is indeed a great undertaking which requires maturity and an ability to commit (not to mention available funds). However, it also presents several significant financial advantages to the home owner.

#1 Your home is a solid long term investment

In financial planning a portfolio consists of the household’s entire asset allocation, including real estate investments. Buying a home is, in essence, investing in a relatively solid asset for the long term.

Furthermore, as your home is usually your primary asset it automatically creates a significant allocation of solid investments.

#2 Your home hedges your financial risk

As a result your home helps you hedge your financial risk. Even if your investment portfolio is invested in very risky financial assets your entire financial portfolio gets its risk balanced whether you like it or not.

This kind of hedging will prove very useful in difficult times when risky investments tend to drop sharply together. In financial theory (and practice) there is no way to diversify the market risk which might hit all the financial markets (we got a pretty good demonstration lately).

#3 Your home is a great tool for disciplined saving

Being able to save money while renting takes strong character and self discipline. I’ve tried and failed. When you rent you automatically live in a higher standard of living than the one you can actually afford.

Taking on a mortgage is forcing yourself to save. Economically, renting a home can sometimes prove more profitable. But the question remains. Can you rent and save enough to buy the property at the end? (as a good financial comparison of rent vs. buy should be).

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