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Personal Finance

Income Streams/Savings Streams

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People talk about establishing several income streams to increase net household income, pay off debt, and build a safety net for hard times. I certainly have advocated that more than once, because I’ve done it and it’s worked well for me. A small, unsteady income from freelance editing combined with taking on a few courses at the Great Desert University and then at a community college earned enough to pay off the second mortgage on my house, leaving my house free and clear before I was laid off, and helped establish a $14,500 emergency fund, which, in a pinch, would cover a year’s worth of living expenses.

So…how did I manage to cobble that much together, when I certainly didn’t net $35,900 ($21,400 went to pay off the loan) in those two semesters of part-time teaching?

Well, you’ve heard of snowflaking, whereby we put every little windfall and every extra few pennies toward debt? I think of this as snowmelt into savings streams. For some years before I was laid off, I had several savings streams:

• One was a regular credit-union share savings account, into which I put a base amount of $200 a month. In addition, I also deposited any windfalls in here: the annual American Express card rebate, manufacturers’ rebates, gifts, whatever. In palmier days, come to think of it, I usually  put the AMEX rebate into a Roth IRA, but that’s another story.

• Another was a money market savings account, into which I put everything I netted off sidestream jobs—teaching and freelancing—plus any other windfalls that came my way. This was the primary savings for the loan payoff.

• A third was a money market checking account. Each month as paychecks came in I moved $1,500 here, to cover the $1,500 a month I budgeted for credit-card spending. This represented discretionary spending, as opposed to monthly bills that have to be paid come hell or high water. Usually, I spent significantly less than this. Any money that was left over stayed in money market checking.

• A fourth was another share savings account at the credit union. It held a monthly $325 self-escrow to pay annual property taxes, homeowner’s insurance, and auto insurance.

• And a fifth savings stream was a Vanguard Prime Money Market Fund, into which I put 30% of all freelance income—a set-aside to pay income taxes and my tax preparer.

Three of the five monthly “snowmelts” happened as automatic transfers: on the first of the month, $1,500 was moved to money market checking to cover discretionary expenses; on the last, $200 went to monthly savings and $325 went to tax & insurance savings. Instead of “paying myself first,” I kept that $525 in my primary checking account until the last of the month to ensure that no checks would bounce. They never did. But in Quicken I deducted the amount from the bottom line, so I would always know what was left in the account with those savings streams flowing out.

In other words, what I left in checking from each month’s pay was only enough to cover monthly nondiscretionary expenses. Funds for costs over which I had some real, credible control were paid from the credit card budget, which flowed into an account specifically to pay off the card in full each month.

Because the discretionary budget is based on summer expenses, which are about $300 higher than late fall, winter, and early spring costs, over time quite a bit of leftover money quietly accumulated in regular checking, just as it was quietly accumulating in the discretionary spending account (because I rarely used all my discretionary budget).

It’s surprising how much money accrues—and how painlessly it accrues—when you make savings streams a part of your financial life. When I was finally laid off last December, I was pleased to find something over $28,000 lurking in the credit union. That was after the second mortgage was paid.

Admittedly, a credit union or bank account is not the best place to stash 28 grand. I simply hadn’t registered how much had accrued in the various accounts that I wasn’t deliberately using as savings accounts. When you added the serendipitous savings that resulted from living within my means to the deliberate savings, it came to quite a lot. I moved $14,000 to investments and kept $14,500 as this year’s “cushion,” knowing that with Social Security’s stringent earned-income limit, 2010 would be tight.

Although 2010 is tight, I still haven’t lost the savings-stream habit. In semiretirement, I no longer feel the need to save as much—largely because I no longer live in fear of layoffs. And restructuring The Copyeditor’s Desk from a sole proprietorship to an S-corporation changed its tax structure, so I don’t have to set aside a chunk of dough to cover taxes on freelance enterprises.

• I’m now keeping all budgeted spending money—discretionary as well as nondiscretionary—in my primary checking account. Because I’ve undershot both budgets all winter…uhm, well…ahem…until the great Shopping Spree Episode…about $2,100 extra has accrued in there. So it’s a de facto savings account, although I expect to spend that money over the summer, when teaching income dries up.

• Regular monthly savings still gets its $200/month deposit, plus all other small windfalls. As a matter of fact, this is where the $700 to cover the clothing frenzy will come from. With over 14 grand sitting in checking as a gigantic emergency fund, the regular monthly savings account, which I used to regard as “emergency” savings, is now a diddle-it-away fund.

• Another $325 still goes into the self-escrow account each month. Taxes and insurance being unavoidable, that one’s not an option. Starting this month, I’ll add another $90/month to that, to cover the annual cost of Medigap insurance.

• The corporate account now collects all freelance and blogging income. With an S-corporation, you pay yourself a salary, which can be fairly modest as long as it recompenses you reasonably for the work you do as the corporation’s director (which ain’t much). The money that remains in the corporation can be used to cover your incorporated enterprise’s operating expenses (such as computer equipment, office supplies, server space). Money that you draw out after you’ve been paid your salary is treated as dividend income. To date, I haven’t needed any of that money to live on. So, the corporate account also functions as a de facto savings account.

Even though I’m now unemployed (or, we might say, “underemployed”…in a big way), with a total gross income of about 58% of what I earned at the Great Desert University, money is still flowing through four income streams (teaching, Social Security, a small pension drawdown, and the incorporated freelance enterprise) into three formal savings streams (tax & insurance, regular monthly savings, and the corporate account) plus an informal savings stream in the form of unspent cash in regular checking.

Savings streams ensure that there’ll always be enough to cover those ugly recurring tax and insurance bills, plus something to pay for the occasional indulgence. Consequently, my lifestyle has really not changed much, despite the 42 percent cut in income. Thanks to a few small income streams and savings streams.

Every little bit helps...

Bye-bye, Bag Lady Syndrome

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So I’m sitting in my counting-house entering Friday’s paycheck in an Excel account, when suddenly—ever so belatedly—it registers with me:

One of these diddly little semimonthly community college paychecks is almost as much as my entire month’s nondiscretionary budget.

Yeah. I could cover all of the monthly recurring can’t-get-out-of-it bills with a single net paycheck. Not only that, but my discretionary budget—all other costs except those that are required to keep the power and water running and creditors away from the doorstep—is about the same. Which is to say that when I’m teaching three sections, my measly community college pay alone would cover all my regular costs.

Naaaahhhh….couldn’t be! Out comes the calculator: tap tap tap tap…

Sure could be: the net pay from two paychecks comes to $35 short of my total month’s budgeted expenses. That means that Social Security—almost a thousand bucks!—is mostly gravy.

How did this come about? Three months ago I figured I would be living out of a grocery cart under the Seventh Avenue underpass. How could I have so radically misestimated my cost-to-income ratio?

Well, in the first place, when I started at the community college, I had no way of knowing for sure what my net pay would be. Tax rules are a total mystery to me. Extrapolated from what I’d earned in the fall from two courses, my guess at the net for three sections was significantly less than the actual amount.

Then there’s COBRA. From what I can tell, there’s no way to know what that will cost in any given month, at least here in the State of Arizona, where the Beast has effectively been killed. Since last January, I’ve had four bills for COBRA, no two of which have been the same. COBRA is the largest single item in the expenses list, and it’s impossible to predict. When you don’t know what the bill is going to be, all you can do is budget for the highest amount you can imagine and pray for the best.

And there’s Social Security, whose rules are almost as bizarre as the IRS’s. When you “start” SS in January, you don’t get your first check until February. No, you can’t “start” it in December so you’ll have an income during your first month of unemployment; try that and they’ll count your soon-to-be defunct 2009 salary against you and take the SS money away from you for having committed the crime of earning too much. Because I was forced to take Social Security a year early, thanks to GDU’s layoff activities, in 2010 I come under the government’s earning limitation: every penny more than $14,160 is taxed at a 50% rate—to extract the amount owed, the government withholds an entire month’s SS check, the unused remainder of which you will see (if you’re lucky) the following January.

Well, 14 grand is well under the poverty level. The gross for the two—$14,000 for the part-time teaching and $15,000 for the “unearned” Social Security—also comes to a figure that IMHO qualifies as “poverty.” Because my investment advisor wanted me to forestall taking a drawdown from savings for a year in hopes that during 2010 my investments would recover from the rape of the economic crash, that left me trying to live on 44 percent of my former pay. Significantly less than that—more like 34 percent—if you counted last year’s freelance income and noonlighting income.

So I started out feeling mighty poor. And not knowing what the 2010 take-home from the various sources of cobbled-together income would amount to, it wasn’t evident in January that enough would come in to cover $1,600 worth of expenses. Nor, since in the old regime the discretionary budget was $1,500 a month, was it evident that I could actually buy groceries and live comfortably on about half that.

What to do with these new-found riches?

Before we make an appointment with the style adviser Neiman-Marcus, let’s consider that the freelance teaching income stops in May, just as utility bills climb toward the stratosphere. It doesn’t restart until the end of August. If the only revenue that arrives during the summer is net Social security, each of the three summer months will see a $475 shortfall. So, I’ll need $475 x 3, or $1,425, stashed in savings to see me through the summer.

But that’s only a month and a half of thousand-dollar surpluses. [ahem.] But what we have here is three months of thousand-dollar surpluses. Come summer of 2011, we’ll have nine months of thousand-dollar surpluses.

Gosh.

One way or another, even in 2010, the Year of Penury, I’m looking at about $1,500 that could be saved or spent. Just during the spring semester.

My inclination? Spend. Well, at least spend part of it.

Every time I think of myself sliding into my dotage on the cusp of poverty, I think of My Bartleby, the eccentric woman of my own age I stupidly hired as a secretary. It was hard for me to go in for the kill with Bartleby, because I empathized too much with her. Crazy old ladies have a lot in common. So I think “there but for the grace of God” and contemplate ways to avoid going down her path.

To wit:

• I would like not to live so cheap that my hair looks scruffy and I go around in scroungey-looking second-hand clothes that are out of date, saggy, and baggy.

• I would like not to get so far behind the times that there’s no hope of catch-up, simply because I refuse to update my hardware and software, refuse to plug in to pop culture, pay no attention to what’s going on around me, especially if paying attention costs more than about a buck and a half.

• I would like not to let minor health issues go until they become middling- to major health issues because I’m too cheap to cough up the copay to see a doctor.

• I would like not to be so afraid of spending a few bucks here and there that I bring personal growth (and life) to an end.

So. First off, the hair: last time I went to the $30 hairdresser, he gave me a tuft sticking out of the back of my head and a half-spiked “cap” on top of too-short sides and back, which can be made presentable only by dint of 20 minutes worth of primping in front of a mirror with a hair dryer. Every. single. time I walk into that guy’s salon, I tell him I hate bangs falling down in my face. Every. single. time I walk out, I walk out with bangs falling down in my face.

The $75 hair stylist knew how to cut short hair without bangs, and he knew how to make a style that could be fingered into curls and waves without benefit of hair dryers and strand-scorching curling irons. Today I’m going to a new stylist, closer in than the old guy, about the same price. By the time I’ve added the tip to her $65 charge, it’ll be right up around $75. But it may be worth it. We shall see.

Next: I have got to get some clothes! Day after tomorrow, when I’ll have a free day, it’s off to B’Gauze and Talbot’s in search of something that will fit. Don’t hold out much hope, but at least the search can begin.

Then: entertainment. Ticket purchased for a concert downtown May 1. Then, it’s off to the Botanical Garden for a membership and tickets to Jazz in the Garden, if they have any left.

Alors, it’s a start, anyway. With any luck the clothing stores will have something on sale.

Image: Gypsy woman with her dog. Public domain.

How Middle-Class Are You?

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This is a guest post from Crystal of Budgeting in the Fun Stuff: A Personal Financial Blog about the Next Financial Step. It’s an open fiscal diary and a personal finance blog rolled into one that is looking to get as many people involved as possible.

This article at Yahoo Finance, How to Gauge Your Middle-Class Status, made my inner-financial competitor salivate. It’s chocked full of ways to compare yourself to others. I know that is a bad thing, but I want to spread the naughty.

According to the article, the typical two-parent, two-kid household:

  • Makes $51,000 to $123,000 with both parents working a total of 3747 hours per year.
  • Owns a home worth $231,000 that is about 2300 square feet.
  • Spends about $5100 a year on health insurance and non-covered expenses if their employer provides their insurance.
  • Spends $12,400 a year on two medium-sized sedans that were bought for $45,000.
  • Puts $4100 aside for college expenses for two kids (it seems to mean total…that’s a little low if you really want to help, right?)
  • Spends $3000 on an annual one-week vacation.
  • Doesn’t save at least 3.2% a year for retirement.
  • Spends about $14,200 a year on clothes, food, entertainment, and living expenses.
  • Has a typical head of household that has about 2 years of college under his/her belt.
  • Wants free time more than they want healthy kids, a strong marriage, or to be wealthy.
  • Has a net worth of about $84,000.
  • Spends about 18% a month towards debt.

Okay, so my husband and I seem to be doing very well comparably, but we don’t have two kids to contend with either. Here’s how we fall; we:

  • Make $78,000 with both of us working about 4000 hours total.
  • Own a home worth $130,000 that is about 1750 square feet.
  • Spend about $1500 a year on health insurance and non-covered expenses – my company provides insurance and hubby pays $75 a paycheck.
  • Spend $7000 a year (including his car payments) on two medium-sized sedans that were bought for $12,000 and $21,000.
  • Put $0 aside for college expenses (I know, unfair comparison, we suck)
  • Spend $1500 on an annual one-week vacation.
  • Save at least 15% a year for retirement.
  • Spend about $12,000 a year on clothes, food, entertainment, and living expenses.
  • Have two college graduates and one person in graduate school.
  • Want health and a strong marriage way more than free time or to be wealthy…although I want it all.
  • Have a net worth of about $125,000.
  • Spend about 19% a month towards debt (since we overpay our mortgage).

What do you think of the typical amounts?

Check out these other posts from Budgeting in the Fun Stuff:

The BFS Way To Diagnose Your Financial Health
Want a Raise? Got These Traits?
Determining Our “Allowances”

The Queen Is in Her Counting House…

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So now that the Dow is closing on 11,000 again, I spent part of yesterday evening counting up my shekels.

Some time back, I figured the crash of the Bush economy (oh, how i luv bugging my rightie friends with that one! 😉 ) had drained my retirement savings of about $180,000.

Things are looking somewhat better today. Thanks to ten nontaxable grand available from a whole life policy, I contrived to set things up so I could pay my share of the downtown house’s mortgage without drawing down from the big, professionally managed IRA. Landing a temporary loan modification helped, too: the reduction in monthly payments will draw out the number of months the $10,000 lasts.

Despite partially drawing down the cash in that policy, total retirement savings are now down “only” $95,400 from the all-time high in October 2007.

We know, of course, that stocks were hugely overvalued in October of 2007. And some say they’re overvalued now. Seeking a more realistic measure, I compared total savings today with the figure that appeared in January 2001, when I first started tracking the various accounts in Excel. In that scenario, over 9.4 years my savings have grown by $18,211.

Looks like a pretty poor return on investment, eh?

However, it must be remembered that I used some of my savings to pay off the loan on my house. I also used about 30 grand to copurchase the downtown house with my son. So, it could be said that some of the funds were simply reinvested elsewhere

That notwithstanding, there’s no question the crash did some serious damage. If we look at the amount that was in savings in December 2006, before the run-up had built any momentum, we see that today’s bottom line is down $55,716 off what might be regarded as a reasonable figure.

Well, it’s better than a $180,000 loss, anyway. Just depends on how you look at it, eh?

Checking net worth: Respectable, though down about $400,000 from the 2007 estimate. Net worth sustained a huge loss when the mortgage on the downtown house went upside-down. Equity in that property is now negative…to the tune of about –$60,000. However, my own house, the one that’s paid for, retained its value and may even have crept up a little. So, even though M’hijito and I took a bath in real estate, it could have been worse. A lot worse.

My net worth is still significantly stronger than most Americans’. A calculator at CNN Money suggests the median net worth for Americans my age is $232,000; mine is about three times that. For 65-year-olds in my post-canning income bracket, median net worth is $34,375; mine is about twenty times that. For those in my pre-canning income bracket, median net worth would be $301,475; mine is 2.2 times that.

Despite the fact that I moved a fair amount of cash from equities into real estate, I’m still none too thrilled at the piddling $18,000 ten-year growth in liquid holdings.

But on reflection, my sense is that a free-and-clear house may be more valuable than smoke-and-mirrors money in stocks and bonds. While the sale price of a house may rise and fall, the value of a roof over your head is pretty immutable. It’s hard to evict a person from a house that has no mortgage.

To rent my house would cost between $800 and $1,200 a month. At 4.8 percent, principal and interest for a traditional 20 percent-down mortgage on this house would cost about $995. So I figure owning the house outright represents a return on investment of about $1,000 a month. Though that’s only a 5% annual return on the house’s present sale value, the fact is that if I had to pay $1,000 a month out of my much-reduced “retirement” income, I could not afford to stay in my home! And since my home is nothing very extravagant, that would mean that when I was laid off I would have had to move into some pretty downscale digs.

Another benefit to owning the house: when I shuffle off this mortal coil, the house will pass directly to my son, giving him a pleasant place to live with very little overhead. He then can rent the downtown house for the amount of the mortgage (or, if things are better, sell it) and end up with a solid basis to build his own retirement savings.

Both of these advantages, IMHO, are huge.

How are things in your money bin? Are you seeing any improvement?

Taxpayer confusion

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Damn, but I wish Congress and the IRS wouldn’t let corporate lobbyists make hash out of the tax code so the rich folks can get out of paying. If you have several different kinds of income, it is just flicking impossible to understand tax forms and what you’re supposed to do to pay fairly. What excuse is there for this mess?

This spring, for the first time since I started paying my own taxes (as opposed to the ex-husband doing it), I owe money: $770 to the IRS! This happened because, when ASU started jacking us around with furloughs, I added two allowances to my W-4 so as to minimize damage from the $480/month cut in pay. After six months, the furloughs went away but I didn’t change the withholding.

Meanwhile, I taught two classes in the fall, hustled a lot of freelance business, began to make money on FaM, and also withdrew $800 a month from an IRA to cover my share of the mortgage on the downtown house, yielding a pretty plump gross income. As a result, not enough was withheld to cover federal taxes. On the other hand, the state of Arizona owes me $1004.

It remains to be seen whether the state will issue refunds. Tax Lawyer says her understanding is that they will, but others have heard that we’ll be getting refunds in the form of useless IOUs. Meanwhile, TL charged me $476 to do my personal return and $442 for the corporate return.

Holy mackerel! She’s never charged more than about $350 before. I realize lawyers have to eat, too, but still… The state refund will not cover the federal income tax bill plus TL’s bills.

I can’t even begin to do my personal returns. With income from investments, freelance sources, jobs, Social Security, and limited partnerships offset by itemizing and mortgage interest deductions, the job is just too complicated, because the law is just too complex for me to follow. But I’m pretty sure I can manage the corporate return using Turbotax’s business edition. It’s $150, an amount that has to be ponied up every flickin’ year, but that’s a far cry from $442.

This year my income will drop to about $33,000. TL tells me I should be able to figure out what percentage I’ll owe at the IRS website. Problem is, although Social Security is taxed, it’s not considered earned income. If you add it in to the “earned income” line, the tool calculates an incorrect figure. But it’s not dividend income. It’s taxed in a bizarre way that’s linked to how much you make elsewhere. The complexity of that transaction renders the tool at the IRS site useless.

I think that if I teach only five classes this year (rather than the previously planned six), I may not owe any taxes on Social Security. The clinker is, though, that the RASL payments (sick-leave payout), even though they’re not considered 2010 income (they were earned while I was working at ASU), may push me above the threshhold. I just don’t know, and I don’t know how to prove to the IRS and Social Security that RASL is not 2010 earned or dividend income.

Meanwhile, I still have two allowances on my community college W-4, something I installed at TL’s advice last fall. So…is the District withholding enough? Who knows? It’s impossible to make an accurate guess.

There’s a tool at Money Chimp that sort of explains tax brackets (as best as one can: your tax is xx% but it’s really not; it’s really probably yy%… Yeah! makes sense).

So, if my teaching income is $12,000 and Social Security is $15,084 and the enforced drawdown from the 403(b) is $6,000, and I can keep the “salary” from The Copyeditor’s Desk down to $500 or $1,000 and I don’t withdraw dividends from CE Desk this year, then my total 2010 gross should come to something between $33,584 and $34,084. That will put me in the 15 percent bracket, with an actual tax of 13.73 percent. If I have to draw $1,000 from CE Desk (an S-corporation), then I’ll be in the 25 percent bracket, BUT my actual tax as percentage of income will still be only 13.8 percent.

Huh?

But then, if only half my Social Security is taxed (that’s one possible scenario), do I enter $26,042 into the calculator? If I’m lucky and none of it is taxed, then should I enter $18,500? And what about the RASL? How do I know? How do I find out?

See what I mean? It just doesn’t make any sense at all. And you can NOT arrive at a credible answer without hiring a tax professional (to the tune of $400+) to figure it out.

At any rate, I need the cash flow from my paychecks and am loath to get rid of the allowances. The fact is, with two allowances the community college district is withholding 15 percent. The feds are withholding 20 percent from Social Security. And Fidelity is withholding 23 percent from the $500 distribution the state is forcing me to take.

If the Money Chimp tool is correct, then I shouldn’t have to change my withholding, even though the college is not extracting enough to cover both federal and state taxes. If the calculator is wrong, I do have some money to pay taxes. Really, I’d prefer not to overpay, partly because of the need to buy groceries, but partly because, if the state is going to start issuing IOUs, I certainly don’t want those SOBs getting any more of my money in advance than I can avoid.

Social Security doesn’t issue anything that looks like a pay statement, so you can’t tell whether they’re sending money to the state. At 20 percent, they probably are, since I asked to have 15 percent withheld. The state gloms a percentage of your federal tax.

I’m thinking I should drop or maybe even eliminate the drawdown from Fidelity. Now that the General Accounting Office has approved my RASL payout, I may not need to keep taking that drawdown. However, RASL is paid out over three years. I don’t know whether the RASL Czar checks each year to be sure you’re still drawing down a so-called “pension” or whether once she’s approved it she just cuts a new check for each year. What would make sense would be to roll the ASU drawdown into my big IRA, which just now is cranking money. If I had, say, $250 paid out to me and then rolled the rest, I’d still have a little pocket change, my taxable income would drop by $3,000, and that would put me solidly in the 15 percent bracket.

The question is…can I get by on $3,000 less?

Financial Freedom: Building the bankroll, part 1

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In the quest for financial freedom—the search for a way off the day-job treadmill—it’s important to build the habit of living not just within your means but below your means.

When you live within your means, you spend no more than you earn. In living below your means, however, you spend less than you earn. This allows you to put money aside for future use; to wit, early retirement. The scheme is pretty simple:

• Live below your means;
• Save a specific amount each month;
• Also set aside whatever else you don’t spend;
• Stash your savings in investments and leave it there.

Saving is a strategy you can start at quite a young age, from the moment you begin to earn. My first full-time job paid a grandiose $300 a month. After paying the rent, I had $200 to live on. From that I budgeted $15 to buy myself some clothes or shoes and $20 to put into savings. Following the old adage, I always paid myself first. We didn’t have automatic electronic funds transfers in those days; I had to physically go into the bank to deposit my paycheck, and while I was there I had a share of it deposited to a savings account. If I hadn’t spent the previous month’s clothing budget, I transferred that or the amount remaining from it to savings, too. I still do the same today, only instead of $20 I put aside $200 plus anything else that doesn’t get spent.

It doesn’t sound like much, but over time it adds up. And when you’re young, your greatest financial asset is time. Twenty dollars a month invested at 8 percent starting in, say, 1967, when I began working, today would amount to $89,498.86. If you began investing $200 a month today and worked for twenty years, in 2030 you’d have $117,804. That’s a respectable amount, especially if you’re saving from after-tax income so that this is on top of your 401(k) or 403(b).

Yes. That’s what I’m talking about here: not only investing before-tax income in whatever savings plan your employer offers, but also setting aside something from take-home pay.

For most people, $200 a month is minimal. In fact, while I was still working I was setting aside about $370 a month, plus whatever was left over from my general operating expenses. Over 20 years at 8 percent, $370 a month would add up to $217,937.55—about as much as my 403(b) accrued in 15 years with matching contributions from my employer. In other words, the habit of saving and investing on your own can double your retirement savings…and at least some of it will be in instruments that you can access before age 59½, a crucial factor for those of us who do not intend to stay in the traces until we drop.

Even if your earnings are modest, it’s surprising how many ways you can find to unearth cash for savings and investment.

If you’ve recently succeeded in paying off debt, then you know that you can break loose a certain number of dollars from your income for purposes other than mere survival and indulgence. If that’s your case, instead of diddling away the newly freed-up income that you were having to use to service debt, put it into savings.

If you’re using the “snowball” approach to debt payoff, once you’re out from under the debt, put the snowballs into savings. If you’ve “snowflaked” debt away, keep on putting every little windfall aside, only put it into savings and investments.

Similarly, when you get a raise or move to a better-paying job, don’t change your standard of living. Put the increase into savings.

More proactively, start a side income stream and invest all the after-tax proceeds for the future. My freelance endeavors, for example, have earned around $8,000 to $10,000 a year. Eight grand amounts to about $666 a month; invested at 8 percent over our 20-year period, it would add up to $392,288.

Living below your means entails downsizing before you upsize. Instead of buying the biggest, most grandiose house you can afford, for example, buy a more modest but comfortable house. Or rent instead of buying and save the difference between the rent payment and mortgage payments for comparable digs. Refrain from buying the largest, fanciest vehicle your paycheck will support; get a car you can pay off quickly and use the amount you’d have to put into payments to build your Bumhood stash. Find better ways to entertain yourself than sitting in front of the boob tube, and then ditch the cable TV. Get rid of the land line. Learn to cook, and eat better for less by eating in instead of haunting restaurants.

If you never develop the habit of buying more than you need, you’ll never miss what you don’t have. Obviously you don’t have to live like an anchorite. But too many apparently middle-class Americans fail to distinguish between indulging their wants and providing for their needs. As a result, they’re really not in the financial middle class: they’re actually poor folks who are in way over their heads.

By April of 2009, the average household saving rate was only about 4 percent of disposable income. Let’s say you have $48,000 left after taxes from a $60,000 household  income: that would give you an annual savings rate of $1,920—significantly less than the rather modest $200/month we started with in this discussion. If your 4 percent includes your required contribution to an employer’s deferred saving plan, then you’re not even putting $160 a month ($1,920 ÷ 12) aside from take-home pay.

Meanwhile, economists at the Federal Reserve estimated (also in 2009) that despite the slight increase in U.S. households’ savings rate, most savings were going to pay off debt, which had accrued at a staggering rate during the recent boom, when consumption far exceeded income. To eliminate this household debt, the Fed observes,

Assuming an effective nominal interest rate on existing household debt of 7%, a future nominal growth rate of disposable income of 5%, and that 80% of future saving is used for debt repayment, the household saving rate would need to rise from around 4% currently to 10% by the end of 2018.

Clearly, if you start out with little or no debt and never accumulate debt, instead of pouring your savings into some already spectacularly wealthy banker’s pockets you can put your money to work for you. Living below your means is, then, the first stage of building your Bumhood bankroll.

The Financial Freedom Series

• An Overview
• Education
• Work
• Debt
• The Health Insurance Hurdle
• Own Your Roof
Building the Bankroll, Part 1
Building the Bankroll, Part 2