Coffee heat rising

Personal Finance

Do you have to be wealthy to be financially independent?

by
Going for home
Going for home

I’m such a bag lady. Not literally…but I suffer acutely from Bag Lady Syndrome. You can tell me till you’re blue in the face that I have plenty to get by, but I won’t believe it until the bills are paid and no one has carted me off to the poor farm.

Matter of fact, this morning after I’d run another Excel spreadsheet that showed, contrary to the present optimistic theory, an average shortfall in 2010’s enforced “retirement” of $740 a month, my financial adviser was on the phone, cooing in soothing tones, “You’ll be f-i-i-n-e.” Even though I don’t have anything like a million bucks in the bank, he says, there’s more than enough to supplement Social Security and cover all my expenses for about 50 years, at a 4 percent drawdown.

The other day Frugal Scholar, the professor with the penchant for thrift-store shopping, reported a delightful revelation: truth to tell, she and Mr. FS could rent their paid-for house and retire to Costa Rica. Today. Gone fishin’. Once and for all… If they so chose.

Ah hah! Financial independence: freedom to do as you please, absent the chains of debt.

Many of us, I think, assume that to enter that blessed state we need to have stashed enough in savings to make us wealthy by most anyone’s definition: a million bucks or more. But I beg to differ. With a reasonable standard of living and a paid-for roof over your head, you don’t have to be a millionaire to achieve financial independence and maintain a middle-class lifestyle. A much more modest stash can support you, given the right conditions.

The Scholars appear to be situated firmly in the financial middle class. With the exception of university presidents, certain deans, and the occasional patent-holding bioengineer, academics don’t earn much. At least, not in the larger scheme of things—compared, say, to the owner of a carpet-cleaning service, to a doctor or a lawyer, to a basketball player, or to a twenty-something kid on Wall Street. It’s unlikely that even between the two of them they’ve stashed a million bucks in their 403(b) plans. Yet they are financially independent. They could, if they wished, retire today with little or no change of lifestyle (other than moving to a tropical paradise…).

The first key to financial independence is to get out of debt.  All debt, including the mortgage. You’ll notice that the Scholars had the initiative and self-discipline to pay off their house. In my own case, I’m especially grateful that I managed to do that a few years ago. Because I don’t have to come up with hundreds of dollars every month to keep a roof over my head, now that I’ve been laid off…hallelujah! I don’t have to get another day job!

And the other key? Come to terms psychologically with living within your means. Though I won’t be enjoying the Queen of Sheba’s lifestyle, neither do I expect to move to the poorhouse. The only real “sacrifice,” if you can call it that, is that I will have to drive my fully functional, very nice nine-year-old Toyota a few more years, rather than trading it in when it reaches the ten-year milepost. I will have to earn a few thousand bucks a year to cover my share of the house M’hijito and I are copurchasing, but that can be done  by taking on a couple of easy, part-time teaching gigs. Pay is low, but work is minimal and mildly entertaining.

Debt, particularly mortgage and automobile loans, racks up the largest part of most Americans’ month-to-month costs. Once you no longer have to pay an outrageous slug of interest to keep a roof over your head and wheels under your feet, your ordinary living costs are surprisingly modest.

Financial independence doesn’t necessarily mean not working. After you’ve attained financial independence—that is, your living expenses are low enough that the proceeds from modest savings and other forms of passive income will support you—you’re free to do as you please. If you want to keep working at your job, you can. Or you can take up a more interesting line of work, try to do something less profitable that you’ve always dreamed of doing, or devote your time, energy and skill to altruistic pursuits.

A friend retired from his medical practice with plenty of zing still left. He and his wife spent a year working pro bono at a hospital in New Zealand. Another friend passes his time working for Habitat for Humanity, as does my step-sister. A third decided to become an organist in her old age, an enterprise that led to a wonderful adventure in Australia. With the possible exception of the anesthesiologist and his wife (who by and large live modestly, by Seattle standards), none of these people are wealthy. They live middle-class lifestyles, dwelling in ordinary homes in decent neighborhoods, driving nice-but-not-gaudy cars, staying out of debt, and generally doing as they please…within their means.

Image by Gargoylepni, public domain, Wikipedia Commons

How much financial help to give a family member?

by

Over at Get Rich Slowly, J.D. has a great post on dealing with a family financial crisis. Responding to a reader’s question asking how to stay out of the red when you’re faced with a job loss and dwindling statements, he brings up a similar problem his brother faced and is still struggling to overcome, and then he lists several points of good, commonsense financial advice. In the series of comments on this post, readers wandered away from coping with job loss to dealing with financially stressed, often dysfunctional family  members.

There’s no question that J.D.’s debt-avoidance strategies are great advice…but what do you do when the family member refuses to listen to any such advice?

For many years, SDXB (Semi-Demi-Ex-Boyfriend) has dispensed exactly that advice (and more) to his profligate daughter. She’s capable of earning a good living (she’s an RN), but she’s even more capable of spending mightily, and she seems unable to recognize the difference between “need” and “want.” A single mother with four children, she rents $2,500/month houses (in a market where you can get a very nice place for $1,000 to $1,200) so that every child has a separate bedroom…and of course, they couldn’t do without a pool! At one point she had five cell phones (until the provider cut her off for nonpayment). Cancel the cable? Unthinkable! The kids have to have it!! She wears expensive clothes, drives an expensive car, and had an (endlessly) expensive divorce. Three landlords have evicted her, and the repo man broke down one landlord’s garage door in his frenzy to repossess her car.

Already on the brink of financial ruin, she suffered a serious accident resulting in head injuries that made it impossible for her to work. She’s now on disability and our state’s half-baked answer to Medicaid. But she still refuses to budget, will not reconcile a bank account, declines to even try to understand anything about personal finance, and continues to try to live up to means that she no longer has.

SDXB has advised her, gone to court with her, helped her apply for welfare, helped her move, given her money he couldn’t afford to part with in retirement.

In some cases, I’m afraid, there’s a point where you have to stop. When you continue to give a person money while that person continues to indulge in irresponsible behavior, you’re not really helping the person. You may actually be making things worse, by underwriting the irresponsibility.

And while you certainly can’t be telling an adult how to behave, neither are you required to support self-destructive and irresponsible habits. No matter how much you love the person and feel responsible for the person’s well-being, you and your family member may be better off if you lay down some ground rules and stick to them.

What might those rules be? Depends on the situation, o’course. But here are a few possibilities:

• The financially strapped family member agrees to get a job, even if it’s part-time and no matter how low-paid and “beneath” his or her status it may be.
• The person develops a realistic budget that fits his or her current means.
• The person moves into affordable housing. If the person can qualify for housing assistance, she or he will apply for it.
• She or he agrees to eat at home, not in restaurants.
• If the person can qualify for food assistance, he or she will apply for it.
• The person disposes of all credit cards but one, and uses that as little as possible.
• The person gets rid of all but one car and may, if possible, dispense with cars altogether and walk, ride bicycles, or use public transportation.
• The person cancels cable or satellite TV.
• She or he restricts phone service to a land line or to a cell phone—whichever is cheaper, but not both.
• If no jobs are available in the person’s field, he or she will go back to school for vocational training in some industry that is hiring.
• She or he agrees to limit the amount of time spent living in someone else’s home.
• If the person has a drinking or substance abuse problem, that issue must be addressed within a specified period or assistance will stop.

Obviously, if a family member is disabled, sick, or mentally ill, it’s reasonable (maybe even a moral obligation) to provide much more support than you would for a person for a person with training, education, and the capacity to hold a job. My point here is that for a healthy, fully abled adult, responsible behavior should play a part in earning family members’ support.

If I Had It to Do Over: 10 money moves I’d do differently

by

Ever think about what you’d do if you could turn back the clock and be 20 again? Though I wouldn’t especially want to live my life over, there are a number of money moves—and decisions that had more influence on lifelong personal finance than I could have guessed at the time—that I’d either not do at all or that, given a peek forward 40 years, I’d do differently.

For example:

• I would have taken advanced degrees in disciplines whose graduates make decent pay.

Can’t say I regret having prepared for an academic career. It has allowed me to earn an adequate (not generous) living after spending way too much time as a lady of leisure. However, I’d never recommend to a young person who wants a life in academe that she or he pursue a doctorate in the humanities. University faculty in business, engineering, and law earn more than those in other disciplines. A Ph.D. in accounting can start at the assistant-professor level with a six-figure salary, and believe you me, that is one hell of a lot more than you earn teaching history or English.

Mind-numbing major? Puh-leeze! What could be more mind-numbing than postmodern theory? Oh yah: postmodern feminist theory! Give me a bag of beans to count, any day!

Knowing what I know today, I’d still want a career in higher education. I would take an undergraduate degree in a humanities discipline that a) interested me, b) would furnish a young mind, and c) would build skills in logical thinking. But at the same time I would take lower- and upper-division courses in statistics and basic college-level math. Then I would get myself an M.B.A. and a Ph.D. in business management, a subject not too taxing for my sketchy math skills. With those credentials—which certainly demand no more work, expense, or skill than the doctorate in English that resulted in a well respected book published through a prestigious press—I’d be earning about twice what I make now.

• I would have started working in higher education early on, even though it entailed having to teach five sections a semester of freshman comp at a community college.

What I didn’t understand, in my callow youth, about that horrifying prospect is that over time community college faculty find ways to evade the most onerous courses and to wangle course release time, just as university professors do. Nor did I have any idea how much more community college faculty here earn, compared to GDU, UofA, and NAU faculty.

Without the fugues into magazine journalism, today I’d be earning a decent income, and I’d probably occupy a layoff-proof job. Or, more likely, I would have retired by now with plenty of savings to support me in the style to which I was accustomed while I was married to the corporate lawyer.

• If I were 25 again, I would insist that my husband include me in the marital finances.

It was easy to tell my women friends to get a grip on their family finances, establish credit in their own names, and know where the money was. But all the time I was dispensing that excellent advice, I wasn’t following it myself! I had no idea where all our money was going, I did not know what my husband was investing our money in or what debt he was obligating us to, and to tell the truth, I never did know exactly how much he earned. Because he deliberately entered false figures in the checkbook, I couldn’t reconcile the bank statements when I tried, and so I had no clue how much we had in our joint account. Nor did I know about the two other bank accounts he’d opened without my name on them.

• I would open my own savings and checking accounts—preferably at an institution other than the one that held our joint account—and set aside part of my paychecks, my freelance income, or (when I wasn’t working) part of the grocery money.

Being my relentlessly frugal father’s child, I was bothered when the husband refused to save for our son’s college education. But he never tried to exercise any serious control over how much I spent. In those days, I paid for everything with checks and often asked grocery-store cashiers for cash back (cash-back policies were more generous then). I could easily have creamed off $100 a month—weekly cash-backs of $25 would’ve gone unnoticed. If I’d started doing that the month my son was born, I would have stashed $21,600 for him by the time he graduated from high school.

My husband also refused to budget; his express reason was that budgeting is for poor people. Consequently I had no control over our spending and no idea whether I was spending more than we had. If I’d put aside money  for myself, I could at least have budgeted independent of his whims and felt more in control of some of our finances.

• I’d use a credit union instead of banks.

Even before banks decided to make a profitable business of fleecing their customers, credit unions were always preferable to commercial banks. Savings rates are higher, checking is free, and service is infinitely better.

• I would have learned about investing early on.

If I’d had a clue about such things as mutual funds (no joke: before I walked from the marriage, I’d never heard of them), I wouldn’t have taken my husband’s private banker’s weird advice to invest a $40,000 inheritance in (hang onto your hats, folks!) one-week CDs! Yes. Forty grand sat in one-week CDs for over a year, until after I ran away, spent three awful months sleeping on the ground in the outback of Alaska and Canada, and finally made my way back to the city.

Yup. I could’ve invested the $21,600 of grocery money in instruments that earned compounding interest, too. Hmmm. Check out this handy-dandy little calculator. Assuming we went ahead and paid for my son’s education out of his father’s capacious salary and so I just kept on investing a hundred bucks a month for him at, say, 8 percent, today he would stand to inherit another $177,395.38.   Ah, coulda shoulda woulda!

Moving on…

• I would have learned and started to use Quicken the minute it came out.

Quicken is the answer to the innumerate English major’s dreams. Not having to add and subtract (something I can’t do reliably even with a calculator) made it possible to reconcile bank statements easily, without dampening sheets of paper with sweat or with tears. Consequently the program allowed me to take firm control of my financial life, in a way that wouldn’t have been possible when every encounter with money involved a daunting episode of math torture.

• I would have learned how to use Excel.

I still don’t know it well enough to free myself from Intuit, which, despite the glories of its Quicken program, rips off customers by issuing ever-more-bloated annual updates that won’t read data in formats more than three or four years old. Excel does everything I need Quicken to do, it doesn’t go out of date, and it functions across platforms.

• I probably would have spent less on my current home’s landscaping.

I’m pleased with the yard and glad to have it, but something acceptable could have been accomplished at lower cost. Specifically, I wouldn’t install such a large front patio (or possibly any front courtyard!), and I would have planted younger, less expensive trees.

• I would have opened a Roth IRA as soon as they became available and maxed out contributions every year.

Though we can add a substantial amount to our 403(b) above and beyond our mandatory retirement contributions, the university matches only 7 percent of our paychecks. IMHO, that makes these highly restrictive investment instruments less desirable than the after-tax Roth IRA, which accrues interest and dividends tax-free and can be passed to your heirs without encumbrance.

My not building Roth savings from the get-go is a function of late-blooming investment knowledge. Which takes us back to item 6: learn about investing early on.

What would you do differently if you could start from financial scratch again?

On this subject, check out Frugal Scholar’s conversation about the most successful things she and Mr. FS did with their finances.

How much was that dollar worth? Interesting money tool

by

In a history article for a client journal, one of our authors mentioned Measuring Worth, a nifty tool that allows you to compare a variety of money-related values over periods stretching back to 1774.  Among other things, it will calculate the relative worth of the dollar. Enter a specific sum and a year, and then ask what it would have been worth in a later  year. The engine disgorges the equivalent according to six different indicators: the consumer price index (CPI), the gross domestic product (GDP) deflator, the consumer bundle, the unskilled wage rate, the GDP per capita, and the GDP.

The first two are ways of measuring average prices. The third (consumer bundle) shows the average value of a household’s annual expenditures; the unskilled wage rate provides a way to compare wages over time. The GDP per capita is another way to compare income over time, and the GDP itself, the market value of all goods a country produces in a year, shows “how much money in the comparable year would be the same percent of all output.”

More on this feature in a minute.

First, though, let’s look at a feature of special interest to personal finance enthusiasts: Measuring Worth also has a tool that shows how much savings would have grown over time. Enter a value and a date, and then ask how much that value would be worth at another date (up to this year), and it will tell you the return on a short-term investment, a long-term investment, and a stock market investment.

So…let’s say your child is 19 years old now, and you’d like to send her to college. When she was born, in 1990, your parents gave you $1,000 to invest toward her education. If you’d put the money in an excruciatingly safe short-term asset, today it would be worth $2,060. Invested in a long-term asset with a term of 20 years, it would have yielded $4,973. And had you put it in a Dow Jones Average portfolio, you would have $4,196, a middling performance.

Well, what if your own parents gave you $1,000—say, when you were born—and now you’re about to retire? If you were 65 today, the gift would have come in 1944 (and it would have been a lot of moola in those days!). Assuming you kept that investment separate and didn’t add more cash other than reinvesting proceeds, how far would it go today toward supporting you in your old age?

• Short-term investment: $16,457.53
• Long-term investment, 30-year term: $32,816.67
• DJA portfolio: $78,449.64

Whoa! Over a really long term, the stock market beats the other two investment modes, hands-down.

I wonder how our college girl would’ve been doing before the Bushies screwed up the economy. How much would her stock portfolio have been worth a couple of years ago, when she was 17?

Ah hah! $4,918. In the stock market, her savings would have fallen off $722 over the the year between 2007 and 2008. In a long-term investment instrument, it would’ve been worth $4,549 in 2007, $424 less than the most recent value. It appears that given competent national leadership that recognized the importance of regulating financial markets and was capable of an intelligent response to 9/11, she might have been better off in stocks and bonds.

Entertaining, isn’t it?

Now for the money story:

At the time my father was born, in 1909, his mother had about $100,000. She’d inherited this small fortune from her father, who had made it freighting buffalo hides out of Oklahoma into Texas. Also at about the time my father arrived, her husband ran off. He eventually was found dead by the side of a rural Texas highway. This left her alone with an infant, a change-of-life baby. My father had two elder brothers, the youngest of whom was 18 years older than he was. By the time he was born, both men were out of the house with families of their own.

She became involved with a Christian church on the fringes of mainline Protestantism, and she also became interested in spiritualism. She donated copious amounts to both causes. By the time my father was about ten years old, these worthies had sheared her of every penny that she had. She was left destitute.

Her home was taken away for taxes. She also lost a commercial property and another house she owned. The two older brothers, who knew nothing of this until they returned home and found her on the street, fell out over the fiasco. Tom, the eldest, was a ranch foreman who, of course, lived out in the sticks. He felt his middle brother, Ed, who lived in Fort Worth where their mother lived, should have been keeping an eye on her finances. The brothers were permanently alienated as a result of the bad feelings that arose in the wake of their mother’s impoverishment.

My father also was permanently affected. He developed a lifelong hatred of organized religion (his skepticism—shall we say—is the reason that to this day I will not donate to a church), and he also conceived a passion about money. He decided that, as his life’s goal, he would earn back the hundred thousand dollars.

And he did.

You understand, he was not a sophisticated man. He dropped out of high school in his junior year, lied about his age, and joined the Navy. He went to sea all his adult life, ultimately became a master mariner, and retired at the age of 53, when he achieved his goal of accruing $100,000 in savings. Details like the relative value of money were largely beyond his ken. Though he understood that a hundred grand didn’t make him a wealthy man in 1962, he had no way of anticipating the double-digit inflation of the 1970s. By the time that was over, the nest egg that would have kept him comfortable wasn’t worth enough to support him through his old age in a fashion other than basic poverty.

Luckily, he was a very frugal man by nature, and so it didn’t much matter: his lifestyle wouldn’t have changed, one way or the other.

I have always wondered what that $100,000 of 1909 would be worth in today’s dollars. Let’s enter it and the date of my father’s birth into the Measuring Worth relative value calculator. Current data, we’re told, are available only up to 2008. According to the various measures, today the dollar value of her inheritance would be…

• CPI: $2,441,007.10
• GDP Deflator: $1,777,507.10
• Value of consumer bundle: $5,009,823.18
• Unskilled wage: $10,307,228.92
• Nominal GDP per capita: $13,314,632.87
• Relative share of GDP: $44,808,290.00

In terms of purchasing power, my grandmother’s hundred grand would have been worth $2,441,077.10 in 2008. LOL! Think of the McMansion I could’ve bought with that as a down payment!

What if she had put her inheritance in the stock market, instead of diddling it away on her religious delusions? Invested in a nice, balanced portfolio, by the end of 2008 it would have been worth $16,595,085.85.

Well. Any way you look at it, if she been a little smarter about money and a little less inclined to woo-woo, today I wouldn’t be worrying about how I’m going to get by in retirement!

My father hugely underestimated the amount he would need to live comfortably into his mid-80s. Of course, without his mother’s crystal ball he couldn’t have anticipated the inflation that ate up his savings…but I think, given the way the government is spending money in the wake of the crash of the Bush economy, we can expect a similar inflationary period in the near future.

How much would I need in savings to have the equivalent of the $100,000 he had managed to earn back by 1962?

• CPI:  $711,510.24
• GDP Deflator: $569,106.07
• Value of consumer bundle: $879,310.34
• Unskilled wage: $809,366.13
• Nominal GDP per capita: $1,510,749.04
• Relative share of GDP: $2,465,665.02
• Purchasing power: $711,510.24

Hm. If the least of these—$569,106.07—is what I’ll need to survive in moderate comfort (or not!), then I’m in deep trouble. Eighteen months ago, my savings were close to that. But today they sure aren’t, thank you very much, George and friends!

Welp, too late now. There’s not a thing I can do about it, so there’s no point in fretting. Tra la!

A little massaging of figures

by

Interestingly, I found a table on the Social Security Administration’s site that calculates how much your “full” retirement age SS benefit is reduced according to the number of months you retire “early.” GDU is closing our office and canning me a year and four months before I reach so-called “full” retirement age.

This has caused many hours of worried number-crunching, because you can’t earn more than $14,160 in a  year without incurring a 50% surtax on the amount you earn above that threshold. If you have the temerity to overstep that boundary by a few dollars, Social Security withholds not just the amount you owe, but an entire month’s benefit! (Or more, depending on how gravely you’ve sinned.) You get it back, minus the amounted owed, the following January! That’s assuming, of course, that you haven’t starved to death by then.

It’s a real problem for me, because my savings, formerly adequate to support me in retirement, have been so dessicated by the crash of the Bush-Cheney economy that today a reasonable 4 percent drawdown plus Social Security plus the allowed $14,160 in part-time earnings will not yield enough to support me.

My financial counselor, however, advises me that my savings probably will outlast my lifetime even at a 6 percent drawdown, though he’s not happy at the prospect. On their own, the net of Social Security plus a 6 percent draw would leave my Ultimate Belt-Tightened Budget $5,544 in the red at the end of 2010.

Obviously, I’ll have to teach, do freelance editing, or some combination thereof as long as I’m splitting the cost of the downtown house with M’hijito. When that obligation goes away, I may just barely get by on Social Security and investment income. And of course…I can’t work forever—sooner or later the day will come when I can’t earn anything.

At the Social Security page above, I discovered that in January 2010 I’ll be “entitled” to 91.1% of my “full” retirement benefit. This comes to $16,026, about $2082 more than I’d been figuring.

Well. Every little bit helps.

It also occurred to me that I don’t have to put the $3,168 that I think I’ll net on the $5,280 GDU will owe me for unused vacation time, come next December, directly into savings. Instead, I could use it to live on in 2010.

In 2011, because I reach 66 that year, I’ll be allowed to earn something over $37,000 between January and my birthday in May (capricious as hell, isn’t it? the rules must have been written by a committee of asylum inmates!). This means that in 2010, I don’t have to worry about limiting earned income.

Taking the new Social Security estimate and adding estimated net vacation pay plus a 6 percent investment drawdown, I come up with a somewhat brighter estimate of 2010 income.

Without teaching at all, apparently I would end up only $2,376 in the hole at the end of the year. Since I will probably net about $1,920 for one community college course, this would mean I would have to teach only two sections a year to break even. That assumes that my estimate of the tax bite is correct, and that, at $39,672, I have not grossly underestimated my annual expenses.

However, if I chose to get off my duff and actually work, taking a 6 percent drawdown and applying the vacation pay to 2010 living expenses would provide a pretty generous income, without drawing any Social Security:

Teaching 5 & 5 (for a total of 4 GDU courses and 6 community college courses over a year), an unholy teaching overload, would give me plenty of money to live on in this first, terrifying year of unemployment. Even teaching a more reasonable load of 4 & 4 would provide an adequate cushion, assuming no really major expenses come up. The middle column in this table would have me teaching three sections a semester at GDU, which I think is disallowed—more than two would make you benefits-eligible, which of course is exactly what universities and colleges are trying to avoid by hiring adjunct faculty.

Advantages: It would free me from a lot of bureaucratic complications, and it would allow me to earn as much as I can.

Disadvantage: The massive workload would allow no time for freelancing, and over a year, I would lose my freelance clients.

A far better course load of 3 & 3 at the community colleges, combined with Social Security, vacation pay, and a 6 percent drawdown, also would keep me comfortably in the black. In fact, the result would be significantly better than working myself into an early grave:

Hot dang! In this scenario (if it’s accurate), I actually could bank the $3,168 vacation pay and still get by just fine.

Advantages: Though I still have to work, I don’t have to kill myself at it. The amount left here suggests I will have no problem covering expenditures, even if a large unexpected expense arises. There should still be time for freelance work, and every $2,400 earned there is one composition course I don’t have to teach!

Disadvantage: I’ll have to draw more than is desirable from savings.

Dropping the drawdown to 5 percent would reduce the total annual net to $45,170, cutting the year-end black ink to $5,500. Even at 4 percent, I stay in the black, but with a much smaller margin: about $1,950 at the end of the year.

What I ultimately do depends on what Social Security actually pays me, which will be different from my guesses. They’re missing two years of income that I can prove I had; though it’s not much, it may increase the benefits a little. More likely, though, benefits will be less than I estimate. That’s just the way my karma goes.

It also depends on the tax load: I’m estimating 20% based on the facts that not all your SS is taxed and that I will deduct everything I can think of from all this contract income. With any luck, the taxes won’t bankrupt me—but again, we’re depending on luck, and the way things have gone over the past year, it looks like the luck well is running a bit dry.

The safest course, it appears, will be to take a 5 percent or a 6 percent drawdown in 2010, start Social Security in January, and sign up for three community college sections in the spring semester. Then, in the fall, reduce the teaching load according to the amount freelancing brings in during the spring and early summer. Then in 2010 I can drop the drawdown to 5 percent or maybe even 4 percent, depending on how much freelance income is happening.

How We Get in Trouble: Sensitivity and nonmonthly expenses

by

This is a post by L. Burke Files, president of Financial Examinations & Evaluations, Inc.

I have seen hundreds of people in financial distress. Often the nonevent problems (as opposed to events such as medical, job, relationship issues) arise from two matters that are more devastating than problems that come up because of a single costly event:

1. Sensitivity
2. Covering nonmonthly expenses with credit cards

Sensitivity, or our sensitivity to financial change, is measured as the percentage difference between our total income and our total expenditures. If I make $100,000 and spend $95,000, my sensitivity is 5 percent, as it will be if I make $20,000 and spend $19,500. If I earn $100,000 and spend $85,000, my sensitivity is 15 percent. On a $20,000 income, I would have to restrict my spending to $17,000 to bring my sensitivity to 15 percent.

Five percent is both shamefully low and higher than the national average. As you can see, the lower your sensitivity rating, the more vulnerable you are to inflation and economic recession, the harder it will be for you to save, and the more you are likely to suffer in the event of a layoff.

Never has the issue of sensitivity been more tested and proven than over the last few years. Real wages have stayed the same while expenses related to oil went up substantially. Oil prices have affected gasoline for cars, energy for running our homes, the cost of food, the cost of medical (think of all the plastic stuff doctors use), and so on, at great length. Because we saw no increase in real wages during this time, while basic costs increased tremendously, in one three-year period we went from several years of saving 5 percent of our income to spending 105 percent. This deficit spending was financed by savings or by credit card. We wiped our savings and ran up our credit cards. We have never been a nation of savers, like Japan, but we had inexpensive housing and food, compared to the rest of the world, now we do not.

Check to see what you sensitivity is—it may surprise you. Take the amount you spend and subtract it from the amount you earn. Now divide the remainder by the amount you earn. The result is your sensitivity, expressed as a decimal:

In 2008, you earned $50,000.
You spent $45,000.

$50,000
–45,000
$ 5,000

$5,000 ÷$50,000 = .10 = 10%

Nonmonthly expenses are those expenses that we have agreed to pay but are not on our monthly budget or cash flow radar screen. These typically are annual or semiannual insurance bills, car repairs, and medical costs not covered by health insurance, but let us not forget school clothes and fees, veterinary bills, or unexpected repairs to our house. Most people manage by using a line of credit, usually in the form of credit cards, to bridge the gap. The balances grow and grow, because the root of the problem, failure to plan for these expenses, is never addressed.

How to address it? One way is to set up a small savings account or money jug at home. Estimate what your nonmonthly expenses will be for a year, and then divide that by 10. Put that amount of money in the account or jug. Yeah, I get there are 12 months in a year. If you estimated correctly, this will leave you have some money for the holidays and for savings. Over time, this practice will increase your sensitivity rating, allow you to avoid increasing debt, and improve your financial health.