Accounting For Different Kinds of Accounts

savings_bank

Different kinds of accounts where you can keep your money … and how to use them.  This is the way I do it.

Checking account (for day-to-day expenses).  Even if it’s only used to fund ATM withdraws, de

bit-card purchases, and online bill paying, everyone should have a “checking account” — despite the fact that many people don’t even have blank checks these days, and the last time I purchased blank checks I probably got enough to last the rest of my life.  A checking account is for your usual day-to-day bills.  It should have enough money to cover transfers to your savings account (pay yourself first) as well as your regular monthly expenses, such as the rent or mortgage payment, and bills for utilities, groceries, transportation, and other things that you pay for every month.  Whatever spending comes out of your checking account should be replenished by income coming in.  (Did you see the post about how money is like a tank of water?)

In addition to your checking account for expenses that come due every month or more frequently, you should also have separate accounts for expenses that come less often.  The first three, like the checking account, should be at a bank or credit union.  The last one should be with a mutual fund company so the money can be invested in stocks.

Short-term savings (once-per-year expenses).  Money set aside for foreseeable and predictable expenses that come once per year, such as birthdays, holidays, and vacations.   

Medium-term savings (once every-several-years or just a few times per lifetime).  Money for foreseeable, but perhaps not predictable, expenses that come less often than yearly, such as an automobile, refrigerator, heating and air conditioning systems, washer and dryer, or a new roof.  Other medium-term goals might include buying a house, college education for your children, or starting a business.   

Emergency savings (unexpected expenses).  For unforeseeable expenses: accidents, medical problems, periods of unemployment, and special opportunities.

Long-term savings (once in a life).  For foreseeable expenses that come just once in your life, such as buying your dream house and retirement.

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Homeowners: Pay Property Taxes and Insurance Yourself

Generally, home mortgage payments consist of 4 parts:

  • principal (a partial payment toward the amount that was initially borrowed)
  • interest (the cost of “renting” the remaining loan balance)
  • property taxes
  • insurance

mortgageWhen someone borrows money to buy a house, the lender has a good reason to want to make sure that the property is insured and the taxes are paid.  (If the house were destroyed in a fire or other accident, the lender would have no way to collect the debt if the borrower walked away.  If the taxes aren’t paid, the local government could seize the house and sell it to pay the unpaid taxes.)  Because lenders prefer to make sure that insurance and tax bills are paid, and paid on time, they include those costs in the monthly payments and pass the money along to the insurance company and local government as needed.  The money is kept in a separate “escrow” account in the mean time.  Federal Housing Administration (FHA) loans always come with an escrow account and include insurance and taxes in the payments.

Many homeowners like escrow accounts just fine.  It’s convenient.  Not making insurance and tax payments means two fewer things to worry about.  Someone lacking in financial discipline might not be able to put enough money aside for the tax and insurance payments, and that could lead to trouble.  Simply forgetting to make the payments can lead to late fees, or worse.

However, someone who is able to manage their money and wants to spend a little extra time doing so might want to consider a no-escrow loan.  While this does not reduce your taxes and insurance costs, it does let you keep your money in your own account until you need to make the payments.  This might allow you to earn some interest from the bank (or credit union!) where you keep your checking and savings accounts.  Additionally, you might more easily meet some minimum balance requirement that eliminates monthly service charges.

It’s usually easier to avoid escrow on a new loan and harder or impossible to remove an escrow requirement from an existing loan.  Even if you can avoid escrow, watch out: banks might charge a higher interest rate on a no-escrow loan.  As always, shop around and negotiate.

Spending is Like a Faucet

An old song says “Love is like a faucet … it turns off and on”.*  Spending is like a faucet too.  It can be turned off and on.  Or it can be set to any spending level between the off and on extremes.

We can extend the imagery a bit.  Let’s say the spending faucet is attached to a storage tank.  Income is like water flowing thru a pipe into the tank.  Spending (in other words, buying things that are sure to decrease in value, such as automobiles, clothes, food, furniture, etc.) is water flowing out of the tank through the spending faucet.  The amount of water in the tank is accumulated wealth.

Spending = Income

spending_equals_income

Is your situation like the first image?  Money is flowing into the tank (as income), but it’s flowing out (as spending) just as quickly. The tank will never be filled.  There will never be any accumulation of wealth.  This will be true as long as spending = income.

Note that as long as spending = income is true, the tank will never be filled — no matter the amount of income.  This first image could represent a person with an income of $20,000 per year and spending of $20,000 per year.  Or it could just as well represent someone with an income of $20,000 per day and spending of $20,000 per day.  No matter how high the income, people who spend all they earn — people who are unable to live below their means — will never have wealth.

Sadly, this is how many people live their whole lives.  They wonder, like Senator Hoar, why they can never get ahead.  In some cases, I believe, the people are doomed to financial failure because they can’t even imagine, or they’ve never been taught, that there is any other way to handle their money.

Spending < Income

saving_and_spending

The second picture is clearly different.  The tank is filled, representing an accumulation of wealth.  Look at the picture for a moment and you’ll see why the tank is filled, and will stay filled:  The spending faucet has been adjusted so that spending has been reduced.  Spending is now less than income (spending < income).

Also notice that the tank has another pipe.  The new pipe leads to saving and investing.  We can think of the tank as a checking and savings account at a bank.  The saving and investing pipe leads to retirement savings accounts, stocks, bonds, IRAs, 401-Ks, and other investments.  Buying shares of stocks or mutual funds might be thought of as “spending” but there’s an important difference: it’s buying things that have a good chance of increasing in value.

If your personal financial situation is like the second picture, then you have learned the lesson of living below your means and allocating part of your earnings for savings and investment.  If your situation isn’t like the second picture, then there’s an important lesson you need to learn.  Start today.

saving_and_spending

Here’s another image, which is the best way to think about the financial plumbing.  It’s basically the same as the second picture.  You can see that spending < income because the tank is full.  But, by using the pipe at the bottom to represent saving and investment, and the pipe at the top to represent spending, the third picture represents the application of another important principle, which is, “Do not save what is left after spending, but spend what is left after saving” (Warren Buffet).


*

Online Mistake Costs $70 (Which I Got Refunded)

I sorta like opening checking accounts (and setting up direct deposits and e-bill paying, maybe opening a savings account so as to avoid any monthly fee) just to get bonus of $150 or more.  One of the banks I’ve done this with offered me a credit card charging 0% interest for the first 12 months and paying me a $350 bonus if I charged $500 per month for the first 3 months.  I took the offer and earned the bonus.  All was going well until a few days ago.

I was online, making a payment, and I accidentally clicked the wrong button!  Instead of selecting to make a payment from the credit union where I keep most of my money, I accidentally selected the checking account at the same bank that issued the credit card.  I was paying off nearly the entire card balance (I guess it’s okay to carry a balance when the interest rate is 0%), which was a little over $1,000.  But I didn’t have that much in the checking account at that bank.  No matter!  Without any warning, the payment was made and the checking account had a negative balance.  I looked in vain for a way to un-do the transaction.  I was so flustered that I immediately made another mistake when I tried to transfer some money from the savings account at the same bank into the checking account, so as to partially offset the negative balance.  I accidentally did the transaction backwards, resulting in an even larger negative balance!  Finally, I transferred money from the credit union to the checking account at the bank (the money which I intended to use for the credit card payment in the first place) and I waited.
reverseJust as I feared, the next day there were two $35 service charges for insufficient funds.  Despite the fact that these accounts exist solely for the purpose of obtaining the bonuses for opening them, I felt pretty strongly about being charged $70 for just clicking the wrong button.  Especially when the bank’s online system didn’t give me any error message (“hey, you’re trying to make a payment of $1,000 from an account that only has a balance of $500”) or any way to un-do the transaction.

I did an online chat with one of the bank’s customer service people and, with sufficient amounts of politeness and contrition, along with the fact that I actually did transfer the $1,000 from my credit union account to the checking account at the bank, was able to get both fees reversed.

Moral of the story: Be careful not to click the wrong button. And, as is often the case with customer service, it often pays to ask.

O Fortuna

FortunaI’m sure it could be explained away as the workings of my subjective mind.  Just my imagination.  But it sure seems like my luck is better when I have money in the bank, ready money, cash on hand — as opposed to living paycheck to paycheck.  I don’t just mean that having ready cash allows me to take advantage of opportunities that present themselves (“luck is what happens when preparation meets opportunity”, as Seneca the Younger tells us).  I mean that I seem to be unlucky in the sense that bad things happen when I don’t have much money, but someone those bad things seem less likely when I do.

Take, for instance, a car repair (that I can’t do myself).

At times when I haven’t had any money in my savings account and was spending everything that was coming in for rent, food, gas, and the other essentials … that’s when my car wouldn’t start one day and after getting it towed to the garage I’d hear that it needed over 1,000 dollar’s worth of repairs to make it go again.

But, if I’ve got plenty of money in my savings account (I mean, at the same credit union where I keep my checking account — not my retirement savings) and I find money left over each month after I pay all the bills … if the car won’t start then … the news from the garage is that the car only needs some $100 part and it will be good as new.  And that’s when I’m glad that I have all the money for any repair that might be needed.

It’s as if Fortuna smiles on me if I’ve saved money for those emergencies, but she punishes me when I have nothing saved.

At other times when I’m working on some DIY project, some lucky thing happens and the whole things ends up costing less than I had expected.  Like going to the store and getting something for free for filling out a credit card application.  Or, after seeing you working around your house, your neighbor offers you something for free.

Again, Fortuna smiles on me when I work for myself (and pay myself, instead of paying someone else).

Well, it sure seems that’s the way it works.

The song:

Start Your Savings with MyRA

A couple years ago the U.S. Treasury Department started a program called MyRA (My RA,
sounds like “IRA”).  It’s a savings account that allows anyone to save small amounts of money in a retirement account that pays interest similar to U.S. Treasury bonds.  (It’s basically the government securities fund that’s part of the TSP retirement savings program for government employees.)

myra
Learn more at myra.com

The MyRA account is much like a Roth IRA: you can deposit only after-tax earnings into the MyRA, so there are limited tax benefits for putting money in; however, all accumulated earnings can be taken out free of taxes (if the withdrawals are made under certain conditions, such as the account owner being over a certain age — this is a retirement account, after all).

Several news articles have criticized the MyRA program on the grounds that it can’t completely solve the nation’s retirement savings problem.  One criticism is that there are no investment options to allow accounts to be invested in stocks or corporate bonds.  The interest rates on U.S. government bonds are only slightly higher than what is available on passbook savings accounts at banks.  Another criticism is the maximum account value, above which you are not allowed to make additional deposits.  This maximum is so low ($15,000) that the MyRA by itself won’t make much of a difference in a retired person’s financial affairs.

However, I think those criticisms are more than offset by the MyRA program’s advantages. First, the minimum amount required to open an account or make a deposit is very low.  Like, $2, I think.  That’s obviously lower than the required minimums at commercial banks and much lower than what’s needed to open an account at mutual fund companies.  Similarly, there are no fees charged to open or maintain an account.  What bank is going to open a savings account for someone with an initial deposit of $10 and then allow that person to make $20 monthly deposits — and without charging any fees?

If you have the minimum amount required to open an account at a mutual fund company (which is $1,000 at the very lowest and more likely $2,000 or $3,000) then I highly recommend you go directly to the Vanguard website and open an account right now.

For everyone who can’t easily gather up $3,000 to start their retirement savings accounts (e.g., most people who earn less than our country’s average earnings, a group that includes many young people), MyRA is an easy and safe way to get started.  $50 a month,  maybe a bit more now and then, will grow to over $2,000 in 4 years.  That balance can then be transferred to a private Roth IRA at Vanguard or any other investment company.  This is the real purpose of the MyRA — to help people get started and allow them to save a sum that can be transitioned to “real” investments.  Once there, of course, it can be invested in stock or bond mutual funds where it will earn returns that will make a real difference in retirement.

That’s the beauty of the MyRA.  It gives everyone the opportunity to start saving and investing.

To learn more, go to myra.gov.

 

Please Don’t Get A Car-Title Loan

car_title

It makes me sad and angry to read, “Back in 2007, the couple took a $500 car-title loan that mushroomed into a $3,000 headache”, in a news story about car-title loans.  Clearly, there’s something morally wrong here. Lenders just shouldn’t lend money to people who can’t pay it back.  These lenders not only lend money, they count on profiting when the borrowers are unable to repay.  That’s when the lenders pile on the fees and the loan gets rolled over into a new loan.  The story of a $500 loan growing into a $3,000 debt is only one of thousands of such stories.  Many of these loans grow much larger.

We could discuss what the couple should have done (work more, spend less, beg or borrow from family and friends instead of going to the car-title loan place).  Or we could discuss what kind of laws might help protect people from this sort of lending (limits on interest rates or fees? mandate that all loans must allow repayment in some large number of monthly payments?).

But what I want to say most is simply this: Debt can be an awful, evil, horrible thing and must be used with extreme care and caution and avoided as much as possible.

If you aren’t able to borrow a small amount like $500 by just filling out a couple forms and signing on the dotted line (without putting up your car or any other valuable property as collateral), then you shouldn’t be borrowing money at all.  The system is telling you that you are not a good borrower.  You are not a good risk.  If you proceed you will be treated accordingly.

The rich rule over the poor, and the borrower is slave to the lender.
— Proverbs 22:7