AskDong

I often preach about having a financial plan, a budget, and goals.  However, I realize having a plan is much easier said than done, and while many of us have goals, knowing what we want isn’t always enough.  Most of us struggle with debt, or have hard time putting money toward our savings.  It’s easy for me to get on my high horse and tell others to spend less than they earn, but in truth it’s much harder said than done.  While I’ve never had issues with credit card debt, I did for years after college spend pretty much everything I earned.  I would often think about coming up with a financial plan, but I never did.

I didn’t really have much of plan until a few years ago at which point I was actually in pretty good shape.  Being able to sit down and formulate a plan is great, but if paralysis by analysis prevents you from doing anything then it’s better to move forward without any kind of set plan.  That’s what I did.  I didn’t set any goals or ask myself what I wanted to do with my financial life. I just turned the screws. I increased my contributions to my 401k from 10% to 15%, and I opened an ING Savings account and started diverting an additional 10% a month in sync with the direct deposit from my paycheck towards that ING account.  Those two items took me about a half hour to do.  5 minutes to change my 401k contribution rate, and 25 minutes to open and set up an automatic savings plan for the ING account.  I diverted 15% (or closer 13% of after tax income), but that number will vary for everyone.  Whatever that number is, it should be doable.  There is nothing worse than being overly ambitious and failing.  As a quick rule of thumb, I would divert 20% of your gross income left over after housing and debt.  So for example let’s say you paid 30% towards housing and another 20% towards student loans, that would leave you with an “excess” income of 50%.  I would suggest diverting an additional 10% towards automatic savings. Just make sure whatever that number is passes your gut check and is more than few coffees.  Take that money and do one of the following.

Increase contributions or open up a 401k

• Set up a savings account and make automatic deposits. I use HSBC and ING.  There are banks with better rates but those two have been around the longest, and offer a stable platform to launch your savings empire.  You can always chase rates later.  If you want a referral to ING which will net you $25 if you make a deposit of more than $250, email me at dong AT askdong.com.

• Open Mutual Fund, and start making automatic investments
• If you have credit card debt, cut up the card, and setup automatic payments in excess of what you would normally pay
• Change your student loan plan to make increased payments
• Make extra payments on the mortgage

There are many other financial actions to be taken such as opening Roth IRA account which many would argue should be a top priority. What distinguishes the actions above is that they all force your hand by automatically pulling money from your pocket or in the case of cutting up the credit cards prevent you from spending money that you might not have.  By nature I’m a procrastinator. I don’t do anything until I have to do it. So when I was daydreaming about having a plan that’s all I did - daydream. However once I actually found that I had much less money to spend in my bank account, I started thinking not only about how I could better spend my money, but what I really wanted to do with that money.  Sometimes it takes a good kick in the pants to get the financial engine started.

I got email from HSBC the other day about the “Dash Sweepstake” promotion they are running between 10/6/07 and 11/30/07. The prizes are as follows:

• One $20,000 Grand Prize
• One $10,000 1st Place Prize
• Four $5,000 2nd Place Prizes

Each customer gets an entry for each $250 increase in funds (not attributed to interest), and for each week of maintaining the balance increase. I realize it’s probably a bit foolish, but I’ve decided to maximize my chances. I had some money in another savings account (Citibank) that I had once considered transferring over to HSBC. Now, I’m going to go ahead and transfer that money in $250 increments daily until 11/30/07. There are basically 36 Business days left on which I can transfer money. The total of 9600 I transfer will give me approximately 40 additional chances to win. 1 for each transfer for 36 and 1 for each week for another 4 chances I keep my balance up.

So what are my chances? Depends on the number of customers of HSBC has. My best guess is that the company has about 500k direct customers. According to this article they had about about 350k in January of 2007.  I’m sure they’ve grown since they, so 500k I believe is a reasonable estimate. My approximate chance of winning  is .008% (40 out of 500,000) - not very good odds.  My expected value if $4.20.  For those unfamiliar with expected value, it’s basically the probability of an event multiplied by the value of the event. If there were only 1 grand prize winner, my expected value would simply .008% X 20,0000 = $1.60. However because there are other prizes, I can add up the expected value of those other outcomes which totals $2.20.  $4.20 is not all that great.

HSBC is making out running a promotion like this instead of offering higher rates if all customers behave like me (both by keeping my money in and adding to it).  The truth is I’m actually losing out in interest. At Citibank I get 5% vs 4.5% at HSBC.   I get 5% via Citibank’s Ultimate Money Market Account when I make two bill pays with the linked checking account which I regularly do.  I’ve been expecting them to lower the rate ever since the Fed lowered rates, but they haven’t.  As a result of transferring over $9000 to HSBC, I’ll be out about $3.75 in interest.  Effectively, my potential winnings pays for my lost interest.

This week one of the next steps I had for Mary Ann in her MoneyMakover was to establish an Emergency fund. Most experts including personal finance bloggers think they’re a good idea. I do as well

• JD Tells us how and why we should start an emergency fund.
• All Financial Matters tells us how an emergency fund can save us thousands a year

However just because it’s a good idea, doesn’t mean an emergency fund is without controversy as well. For instance Free Money Finances asks if establishing an emergency fund has priority over paying debt?. And even if the firm decision to establish or grow the fund, there’s question of how much you need. Lifehacker.com tells us how to calculate what someone needs given their expenditures.

Now that you know what you need, how do you save for it?

• Amanda at Young and Broke gives us creative ways to start an emergency fund.
• Frugal for Life gives 10 Ways to Save for An Emergency Fund

If you already have enough saved in your emergency fund, compare yourself with others who’ve taken MyMoneyBlogs’s poll. Is it too much as The Tao Of Money Making might think? Still have questions about emergency funds? Money Smart Life let us in on everything you wanted to know, (but were afraid to ask).

My personal feeling is that a large emergency fund is critical for younger people with fewer asset categories. Someone who is 40 with a house, brokerage accounts, 401ks, IRAs, and other assets still needs an emergency fund, but can also be more creative with funding a longer term emergency horizon with both sales of assets, a home equity line, or as Advanced Personal Finances suggest the Roth IRA. Someone in their early 20s usually doesn’t have those options. Having an emergency fund is what allows the younger person avoid using a credit card for emergencies and therefore establish a better financial footing.

p.s. Some of the articles linked are older, but emergency funds are a classic concept.

Dear Dong,

Is there any financial reason (I know there are psychological ones) to have
money in a savings account when you are paying a significantly higher rate on
your HELOC? For example, if the savings account is paying 5% and the HELOC is
costing you Prime (now 8.25%), wouldn’t it make sense to pay down as much of
the HELOC as possible and then borrow from it (with no transaction costs) when
you needed to dip into your “savings?”

Sincerely,

CFO

Simple Answer: No.

There’s absolutely no reason not to pay down a HELOC from savings if you have it. As you said, you can always dip into the HELOC if the need arises. However that is not to say that you shouldn’t have extra savings once you’ve paid off the HELOC. While I think it’s okay to “fund” some of you emergency fund via a HELOC, it’s better to fund it with actual savings.

I just finished my taxes recently.  Haven’t filed yet as I’m still waiting on TurboTax to obtain some forms.  I am getting a refund, mostly because I don’t have enough exemptions on my W-4 to account for my mortgage.  I know I’m giving the Government a free loan, and professionals will advise that it’s best to get no refund or even better to pay the Government come tax time.  If you’re disciplined enough to that then by all means do that.  Even though I think I’m fairly disciplined, I’m also aware of the limits of my discipline.  I’m disciplined enough to save and invest my refund (instead of putting it towards a TV for instance), but I’m not disciplined enough not be swayed by the wealth effect of having a slightly bigger pay check.   One of the more important things in saving, and life in general is to know thyself.  When it comes to saving sometimes, it’s best not to be too ambitious.  Someone who attempts to lose 40 pounds in 6 months will most likely fail and give up on dieting.  Another person who sets a goal of losing 10 pounds in 6 months is more likely to succeed and continue dieting (losing 40 pounds over a longer period of time).  I rather be the latter.  Next week I’ll post my State of Dong - a personal financial snapshot of 2005.