AskDong

Now that Mary Ann has plan on tacking her credit card debt, she can start thinking about what she should be doing next. Personal finances is not about saving money, nor should it be about depriving one from the pleasures in life. If all someone does is save money i.e. Silas Marner, that person hasn’t done a very good job with regard to his or her finances.

Her priorities in terms of spending are as follows:

1. Travel
2. Going out to eat
3. Going out/Entertainment (drinks, concerts, etc.)
4. Groceries
5. Shopping

That priority list looks a lot like mine. The question now is given that those are her priorities, does she live by her priorities? I’m going to ask her to track her expenses for one month in a notebook (old school), or just to purchase everything on her debit card, which will list her expenses. At the end of the month she should categorize her expenses and see if the total spent each category matches us with her priorities.

Her assets are limited currently to her checking account at Bank of America. She primarily uses her debit card for spending. She doesn’t have an IRA or a 401(k) established. Given her situation her next priorities after or concurrent with paying debt should be:

• Establishing an Emergency Fund
• Establishing a Roth IRA
• Opening a 401(k)/403(b)

I’m not going to prioritize each of those, as some people want to maximize tax benefits, and others feel like they can’t live without the safety of a real emergency fund. Though, I would say if Mary Ann’s company matches, she should at least contribute to get the company match - no reason to throw money away. In any case, she should retain her account with Bank of America for the ATMs. In the Boston area, it’s not even funny how Bank of America ATMs dominate the competition. If she’s currently being charged any fees, she should open an online a My Access Checking account which has no fees, and no minimum balance. If she’s already avoiding fees by direct deposit, then she may not have to open a new account. There’s no reason ever to pay bank fees. Once Mary Ann has locked down her bank account, she can go ahead and enroll in the Keep the Change program if she hasn’t done so already. Bank of America will match the “Keep the Change” contributions in the first 9 months. Of course, they force the money into a lousy savings account that only pays .2% and has a minimum balance of $300. She can avoid the minimum balance and the monthly fee by transferring at least $25 a month from her checking account.

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I normally wouldn’t write about how having bad credit might have some perks, but I found this rather amusing. According the to rant from a VC, AT&T will allow you have a prepaid phone plan with the iPhone and therefore no contract.  However if your credit is too good, AT&T forces you onto a 2 year contract with the iPhone.

While I haven’t tried this myself, I imagine one could circumvent the system by putting the iPhone under the name of a minor.  I imagine most minors, given that they don’t have a credit history have poor credit. I could easily imagine someone signing up for the iPhone under his or her child’s name and social security number to avoid the otherwise mandatory 2 year contract.  Or if you want to avoid using your child’s social security number you can follow this guy’s advice. Using a bogus social security number might seem a little morally ambiguous, but given you’re basically guaranteeing AT&T payment, it’s hard to say how exactly other than a bit of dishonesty.

I don’t write much about debt, but handling debt is probably one of the most important parts to personal finance.  The reason I don’t write about debt very much is because I’ve been lucky enough to only have “good” debt, e.g., student loans and mortgage, both of which are at low fixed rates.  I’m one of the lucky few.  Many, if not most Americans struggle with debt.  The other day I was talking with my friend, Mary Ann, about her credit card debt, trying to give her some advice on how to tackle it.  It’s easy to say pay if off, but it’s harder to come up with a concrete plan.  Given that the interest rate on her credit card is at 20%, finding creative ways to pay off that debt quickly can make a huge difference even in a few months.

Before I start examining specific strategies, I also believe it’s critical to make that debt tangible in some way.  I believe many individuals get into credit card trouble because debt itself is an ephemeral beast. Debt has no physical body.  Debt makes no sound but still manages to keep some people up at night.  Trent at The Simple Dollar suggests creating a visual reminder of debt such as progress bar.  This is a fantastic idea, as it serves to remind us of our obligations, and serves as positive reinforcement of good behavior.  I didn’t really start making true progress with my own finances until I started tracking my monthly net worth.  A simple visual reminder can be simply writing down how much debt you have at the beginning and at the end of each month on a 12 month calendar.

Mary Ann doesn’t have an enormous amount of credit card debt, only $5,220. However, even that small amount at 20% interest means she’s paying about $87 in interest a month!

My first suggestion is to apply for a 0% balance transfer. The only caveat is that many of these credit cards require a good-to-excellent credit score. The process of applying for a credit card involves a “hard credit pull” which actually inflicts damage on the credit score.  Also, Mary Ann informed me that she had a little over $700 in unpaid parking tickets that she only recently paid off.  These tickets may be a problem as they are most likely have adversely affected her credit score.  Also, if she can she’s better off applying for credit cards she’s been solicited or offered.  If there aren’t any attractive offers being made to Mary Ann currently, the following are all very attractive balance transfer credit cards with great promotional rates.

• Bank of America Platinum Plus 6 Month 0% APR, No Balance Transfer Fee, 11.24% APR
• Citibank Professional 0% Balance Transfer 12 Month, 11.74 APR, No Balance Transfer Fee (For Initial Offer)
• American Express Blue 4.99% Balance Transfer for Life, 3% Balance Transfer Fee
• Discover More 0% Balance Transfer for 12 Months, 3% Balance Transfer Fee, 10%-18.99 APR

I would also consult creditcards.com for a more comprehensive list of balance transfer offers. Even a credit card that has a balance transfer fee which typically run 3% of the balance transferred are a good deal given that Mary Ann’s paying over 3% every two months.

One of the real benefits of transferring credit card debt to another credit card via a balance transfer offer is that it’s absolutely free of most complications.  The minimum monthly payment should not go up, nor are there penalty rates once you go beyond the promotional period.  Yes, 18% is a penalty rate, but doing nothing at 20% is already a penalty.  Things can only get better except the credit score.

Even if your credit is good enough to qualify, often times the credit card companies do not give you enough credit to transfer the entire balance. Applying for multiple credit cards will hurt the credit score more, but if you’re not applying for a mortgage right now, taking a temporary hit to your credit score is OK. That said, credit scores affect many other things, too, such as insurance premiums.

If the balance transfer route doesn’t work out, there are still alternatives.

• Call your credit card company and try to negotiate a lower rate
• Apply for a loan on prosper.com, and get other people to bid on your loan. I would actually do this first, as you can set up a loan listing with very low interest rate (less than 6%) to get a vague idea of what your credit score is.  Once you know in what vague range your credit score you can better apply for the right credit card.  The alternative to getting graded on prosper.com is to get report from service such as www.freecreditreport.com. However those free credit scores online have many catches, and I generally advise against using them as they try to trap you into a credit monitoring service.

Prosper.com

I’m actually a lender on prosper.com, which, for people who haven’t heard of it, is a peer-to-peer lending website. Basically, I and other individuals collectively lend money to others who have made loan requests on the website. While I’m personally ambivalent about how well prosper.com works for lenders, I do think it can be a good opportunity for borrowers without other recourse to pay off high interest credit card debt. Not knowing exactly what Mary Ann’s credit score is, I’m not sure what kind of rate you can get on prosper.com. If I had to venture to guess, it would be in the 11%-17% range. These are not great rates, but it’s still better than 20%.

Currently, Mary Ann pays between $200-250 to her credit card each month. She’s been good and hasn’t been adding to the debt, but she does occasionally make a few transactions. I’m going to assume that $220 a month goes to servicing debt, i.e. paying interest ($87 a month) and paying down principal. Assuming that Mary Ann continues to apply the same amount to her payments, ideally, by doing a balance transfer or a combination of a balance transfer and a prosper loan, she can take some serious steps towards paying down her debt. After a year she can reduce her total balance owed by as much as $850 (using 0% balance transfer) without changing her monthly payments.

Once Mary Ann has figured out how much of her credit card debt she can transfer to a 0% APR offer or prosper.com, we should look at the bigger picture of both how much more she should be directing towards paying down her debt, and how she can do it if she can. Compared to many other Americans, she’s in pretty good shape.  Her fixed costs, rent and utilities, is on the low side, averaging about $650 a month or so. She has no other debt other than credit card, though beginning next year she will have about $27,000 in graduate school loans to repay.  Tomorrow we will look at next steps.

Tao of Money Making is hosting the Carnival of Personal Finance #118.   There are over 88 entries, and I’m listed under retirement section.   I didn’t make the cut for a Editor’s Choice’s nod - but there’s always next week.  Though I think i may sit out the next carnival as i feel like i’ve been submitting to too many of them recently.  I’ll probably take a bit of break until I come up with a real doozy of post that I can impress the host with.   I haven’t read all the articles, but here are some ones I found interesting which like myself didn’t make the editor choice cut.

• Plonkee talks about how we should be like Richard Dawkins, and do what we love.
• The Happy Rock say don’t forget about the health care reimbursement.  I got my $150 back in March
• Free Money Finance Tells us how to earn 2.6% cash back with combination of American Express Blue Cash and Chase Freedom.   I suggested the same thing last week.
• Jason at Smart Money Daily likens a portfolio to a fantasy football team.   Maybe this year my portfolio can bring home championship.
• Shadox is playing  Chicken Little about the economy, and I agree.
• The Dividend Guy suggests looking at high dividend stocks to weather the recession Shadox is predicting.

It’s been a while since my last economic lesson. Today’s topic, Marginal Cost vs. Average Cost. These costs are typically used in economics as examples of how manufacturing companies should make decisions. However like everything in Economics these are universal concepts that are just as easily applied in personal financial and life decisions.

Average cost is the most easily defined. It’s the total cost of production including all fixed costs and variable costs. An example of a fixed cost is the purchase price of the land used to build a factory. Variable costs are the cost of materials, and labor required for incremental production.  Take the fixed the cost and variable cost and divide it by the output quantity and you have average cost.  Total Cost/Q.  Marginal cost is only what it costs to produce the last incremental unit of product and does not consider fixed costs.  As an example let’s say I had brick factory that cost $10,000 to build, and the first 10,000 bricks cost $1 a piece to produce. The average cost of of 10,000 bricks is ($10,000+$10,000)/10,000 = $2/brick.  The marginal cost of the last brick is $1. The marginal cost of the 1st brick is also only $1, and not $10,001. Marginal costs since it ignores fixed cost only include the the cost that goes into the decision of producing another brick.  A producer should always be willing to produce and sell a product at or above the marginal cost. If I owned a brick factory, I wouldn’t be looking to get $10,001 for my 1st brick to recover cost. As long as I can sell the brick for $1 or more, I’m economically compensated enough for the production of the brick. Producing or not producing a brick to sell does not affect whatever investment I’ve already made into the factory. If I make or don’t make any bricks, the factory still costs me $10,000.

As you can see from the graph above marginal cost can be volatile, changing dramatically with each unit. If you were just to look at average cost, the volatility marginal cost is masked. Also, implicitly as average costs rise marginal cost must be above average cost, and when average cost is decreasing marginal cost is below average cost.So what do marginal cost and average cost imply in our everyday lives?  I think many times we make the mistake of considering average cost when we should really be considering marginal cost.  The average cost of anything easy to calculate - it’s simple division.   More than the fact that average costs include fixed costs, and marginal costs don’t, marginal cost more accurately reflects diminishing marginal returns on productivity.  This nearly universal economic concept implies that increasing the variable inputs into production, material and labor, there is decrease in the rate of output. I imagine we have all seen this in our own work experiences.  For instance I often pick up subs form subway, and one of the shops recently added another 2 workers.  They used to have 3, now they have 5. However the line for subs doesn’t move 66% percent faster. It moves faster but there’s a decrease in productivity of each worker. There is only so much counter space, and still only one register.

The area where we need the put the most consideration of marginal cost is how we use are time. For instance, I like many other personal financial bloggers probably spend too much time on our personal finances. For example I probably benefit on average $75 per hour spent on my finances. I estimate I spend about 50 hours year on my finances not including the work I put into the blog.  I probably save/earn an extra $3750 for an average of $75 per hour spent working on my finances. While it’d be great to think that I earned/saved another $75 for each extra hour, the real calculus is what benefit do I get for the next hour spent? Probably very little.  The marginal cost of my time at my current level of effort is probably closer to something like $5/hour rather than $75. I’ve exhausted all the easy places where I can save and earn money. I’m earning 5% on my savings instead of the .5% I was earning before. Now as I chase interest rates, I’m looking at increasing that rate from 5% to maybe 5.5% percent at best which hardly compare to the 4.5% improvement(actually more like 3% since rates were lower back then) I saw when I first started chasing savings yields.