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Nothing Left For Extras

by Gary Foreman
The Dollar Stretcher

Dear Dollar Stretcher,

I have a common problem. I have been married for three years. Both my husband and I work full time. We have no children. Between the mortgage on our condo, one auto loan and credit cards we find a lot of times we don't have extras. We are managing but I want to start saving and investing. Any suggestions?
Tina M.

The good news for Tina is that she's identified a problem early enough to solve it. The bad news is that she really shouldn't have the problem.

Tina is like many Americans who just don't save a lot. According to the Bureau of Economic Analysis personal savings as a percentage of disposable personal income has slid from 4.5% in 1997 to 2.4% in 1999. What makes it especially bad for Tina is that the easiest time to save money is when a couple has two incomes and no children.

So how does she start to gain control? The first thing is to take their finances off auto-pilot. Just working hard and paying the bills won't get it done. "We're too busy" isn't a good excuse. Tina and her husband need to know where they stand today and where they'd like to go in the future.

To find out where they are today they'll need some way to measure how much they're making, how much they're spending and what is the value of their assets after any debts are subtracted. That means they'll need a system to keep track of their finances. They can do it with pencil and paper, but if Tina has access to a computer it will be better to use software like Quicken.

Knowing their income and expenses is important. First, because they must make sure that their income is greater than their expenses. Many people fall into the trap of thinking that they can't live on what they make. That's a very dangerous idea. We all must spend less than we make. Sure, you can borrow money. But that means agreeing to pay interest on the money you borrow. If you can't afford to pay cash for the item, paying for it later with interest added is going to be even harder.

Knowing where they spend money is also important because it will help them find potential savings. The best place to reduce expenses is where they're spending the most money. If Tina spends $1 each day for lunch, there's not much to save. But if lunches average $6 a day, then she's uncovered a source of potential savings.

Next, Tina needs to evaluate their 'net worth'. That's a business concept that can be very informative for individuals. Just list all your assets and then all your debts. Subtract your debts from your assets. The amount left over is your net worth.

It's a great way to see if you're making progress. Until you reach retirement, your net worth should go up each year. In fact, if Tina wants to have a $40,000 annual retirement income, she will need to build their net worth to $600,000 or more.

Net worth is also a good way to take your financial temperature. More debts than assets? That's a sign of sickness. And if that number approaches your annual income you're a candidate for the emergency room!

Next Tina should take a step back and analyze how her family uses money. Tina mentions that the credit cards are a major expense for them. They need to find out why that's true. There are two possible reasons for high credit card bills.

  • The first, and obvious one, is that they use the cards too much. Only use the cards for planned expenses. If they're making unplanned purchases, it's time to put the cards away. Studies show that people spend 30% more when using credit cards.

    The solution is to resolve not to use the cards for unplanned purchases. If that doesn't work, stop carrying the cards. In extreme cases it's best to destroy them to eliminate any temptation.

  • The second cause of high credit card bills is a balance from past purchases. The rule here is simple. When you're in a hole, stop digging!
Tina also needs to remember that the check she writes to the credit card company is not a monthly expense. You've incurred an expense when you put a $40 dinner tab on your credit card. The interest on an account balance is also an expense. That's important because you want to remember to think twice when you use the credit card. Not when you sit down to pay the bill at the end of the month. It's too late then.

Once Tina's income is greater than her expenses, it's time to think of savings. An important part of any savings program are retirement accounts. A 401k plan is an excellent choice. Currently there's over $1 trillion invested in 401k plans. The money grows without taxes until you withdraw it. Many companies match a portion of your savings. The money is withdrawn before you get a paycheck so there's no temptation to spend it. If their employers don't offer a 401k, then an IRA is the next best option. No employer matching funds, but you can get the other benefits especially if you routinely add money to the account each month.

Paying off a credit card balance can also be a form of savings. For instance, if charges plus interest expense total $200 this month and you send a check for $300, then the extra $100 reduces your balance. That increases your net worth.

Finally, a philosophical note. Tina mentions 'extras'. Not to pick on her, but extras are the things that you can afford after paying for necessities. Extras are not guaranteed. It's never a good idea to use credit for something that's not essential. And even then, you should have a clear plan of how you'll repay the debt. It's important because most of the people who are struggling with debt today started by buying a few extras with a credit card. And once started, they never stopped.

Hopefully, Tina and her husband will find that a little homework and planning will put them on the path to a long and successful financial future.

�2000 by Gary Foreman. All rights reserved.

Gary Foreman is a former purchasing manager who currently edits The Dollar Stretcher website and newsletters.

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