One of the most frequent questions I see popping up these days is whether or not we should continue to invest in stocks, or pay off our mortgages early? There are many factors driving the urgency behind this question. The down economy, and endless talks of deficit spending, national debt, etc, seem to have awakened people from their personal debt slumber. Folks are finally making serious dents in their personal debt, and I think that is a good thing.

Photo by sacks08

But what about mortgages? Real estate has been a pretty touchy subject as of late. Many people now find themselves underwater – owing more on their mortgage balance than their home is worth. Those not currently in a home have taken a much more cautious approach to home buying than just a couple years ago, when anyone who could scrape up closing costs and had a half-decent FICO score were jumping into jumbo mortgages they could ill-afford.

Now that we have seen real estate is not a sure thing when it comes to appreciation, and that the market can basically go nowhere in an entire decade, we are questioning some long-held assumptions about the world of finance. Maybe it doesn’t make since to keep a mortgage. Maybe paying off a mortgage early, and living debt free, is the ultimate hedge against what the future might hold. Maybe renting isn’t such a bad deal after all.

Using Investment Money to Pay Off Mortgage

I was recently asked by a friend if they should pay off their mortgage using $120k in taxable investment accounts. I asked him the opposite of that question. “If you owned your home free and clear would you take out a mortgage to put $120k in the stock market?” Naturally, he replied, “Of course not!” Same thing.

That question gets right to the heart of the matter: risk. Our society seems to be going through a pull back thanks in large part to the pains we’ve experienced after watching each other go on a credit binge. It goes beyond being frugal. People are downright scared. And for good reason.

Unemployment is still hovering around double digits (real unemployment is much higher). I read a new article every day about the coming bust in commercial real estate. The student loan program appears to be under strain (and might get overhauled along with the healthcare system). And will there be a double dip to this recession? There is a lot of uncertainty out there.

I often advise people to make paying off their mortgage a priority, once other financial goals such as retirement investing and saving for college are in place.  However, I’m going to go a step further. I believe, over the next decade, we are going to see some unprecedented shifts in the way our economy operates – some good, some bad.

I think those who are completely debt free will be the most insulated from the negative effects of the changes, and have the most opportunity to be successful. That doesn’t mean you’re doomed if you have a mortgage (at least I hope not, considering I still have one myself), but it does mean that finding a way to pay off your mortgage should be near the top of your financial priorities.

What About the Opportunity Costs Lost By Not Investing in the Market?

Well, assuming market values appreciate in the coming decade, there is a cost to paying off your mortgage rather than investing in stocks. However, if I asked you if you’d rather owe nothing on your home or have $150,000 in savings in ten years, which would you pick?

Not having a mortgage could mean living comfortably on $1,000 a month less (or more, depending on your home loan). With $150,000 in stocks, you are doing pretty good, but certainly no where near financial independence. And you’d still have that big mortgage payment to contend with.

In a perfect world we could do both: pay off the mortgage early and invest in the stock market. Unfortunately, most of us don’t have that many dollars to play with. So, the ideal compromise may be to save for retirement, save for college for your children, and then pay off the mortgage early, rather than invest in taxable investments outside of retirement accounts.

This is the plan I will adopt, with the exception of adding to my dividend stock portfolio over time in an effort to boost passive income.

It’s that time of year again. That time when Uncle Sam returns some of your hard-earned tax dollars that he’s been borrowing at zero-percent interest. Tax refunds are sort of a forced savings account for many people. And while I personally aim to avoid receiving a tax refund, there are some smart things to do with one once you receive it.

Kimberly Lankford, contributing editor at Kiplinger’s Personal Finance magazine, put together five smart uses for your tax refund. I’ve expanded on her ideas, and added eleven of my own to the list below.

Smart Things to Do With a Tax Refund

1. Pay off high-interest credit-card debt. Kimberly listed this one first, and for good reason. Eliminating credit card debt is one of the smartest ways to spend any windfall. The higher the interest rate on your debt, the bigger the payoff. Think about it; where else can you get a guaranteed return of 22% on your money?
2. Rebuild your emergency fund. Thanks to unemployment, underwater mortgages, and a general economic funk, many households have had to turn to emergency funds to weather the storm. It makes sense to allocate some or all of your tax refund towards covering future emergencies.
3. Boost your retirement savings. If your debts are paid, and you have plenty of money saved for emergencies, the next biggest bang for your refund buck is to invest in your retirement. Maybe that means funding a Roth IRA, if you are eligible. If not, drop the money in a savings account, increase contributions from your paycheck to your 401k plan, and use the savings to offset the difference.
4. Build your college savings. It’s tough to carve out retirement savings, college savings, and put a roof over your family’s head and food on the table. After all, there are only so many dollars to go around. Boost your kids’ college savings by opening a 529 college savings plan (here’s a look at the best 529 plans).
5. Help your kid save for the future. If you are the parent of a teenager that earns an income, did you know you can help them open a Roth IRA? No kidding. The only requirement is that your teen files a tax return. He or she can invest in a Roth IRA up to their earnings, or the maximum yearly contribution, whichever is smaller. So, if your daughter earned $1,800 last year babysitting, kept meticulous records and files a return, you could gift her $1,800 to invest in a Roth IRA. She’ll be well on her way to becoming a millionaire.
6. Start a side hustle. Ah, the infamous side hustle. Many of the world’s most successful entrepreneurial efforts were started on less than $1,000 (I started Frugal Dad on less than $50!). Use your tax refund to seed a business you’ve always dreamed of running.
7. Invest in a home improvement project. Lean towards projects that improve your home’s efficiency long term. For instance, installing a programmable thermostat and planting a few trees around your property will go a long way towards reducing your future monthly energy costs.
8. Open a “Car Replacement Fund.” Let’s face it; the car you are driving now will eventually die. Why not divert a little tax refund money to start a car replacement fund. If your current car is paid for, save what amounts to be a car payment in this account and when the time comes you can pay cash for your next car.
9. Build a square foot garden. Use a couple hundred dollars of your tax refund to purchase gardening supplies, soil, and seeds. Now’s a great time to plant, and soon you’ll be enjoying tomatoes right off the vine, instead of those shipped across the country in your grocer’s produce section.
10. Give it away. If you’ve been considering giving money to a charity, now is a great time. Donating your tax refund to a worthy cause can even help on next year’s taxes, as most charitable contributions are tax deductible.
11. Pay extra on your mortgage balance. We personally plan to pay off our mortgage early. Why? Because we value the freedom a debt-free lifestyle affords. Sure, we’ll miss a tax break or two, but I’d gladly end sending $14k to my mortgage company each year to save $3k on my taxes.
12. Get your will done. My wife and I recently updated our wills after a death in the family. Identifying guardians for your children, and disposition of your stuff in the event of your death is not fun, but it is absolutely necessary. If you have kids and do not have a will, stop everything, financially, until you have enough saved to visit an attorney and have one drawn up. It is that important.
13. Purchase a gym membership. Many gyms offer significant breaks for those that opt to pay one year in advance. My gym offered two free months and waived the registration fee if I agreed to pay for the full year, effectively shaving $90 off my annual gym costs. Be sure to check out the gym’s refund/cancellation policy before agreeing to such a long commitment.
14. Take a class. It doesn’t have to be an academic class, but it could be. Maybe you’d like to learn more about cooking, or self-defense, or real estate. Investing a little tax refund money in yourself can go a long way.
15. Go on a “paid-for” vacation. My family recently enjoyed our first cash vacation, and it was awesome! I didn’t have any bills to dread on the ride back home.
16. Create your own “car insurance savings account.” If you currently have a $250 or $500 deductible on your car insurance policy, consider raising it to $1,000 and parking $1,000 of your tax refund in a dedicated savings account. You’ll enjoy a permanent way to save money on car insurance premiums, and earn a little interest on your savings account.

If you’d like to avoid getting a large tax refund next spring, and instead get a boost to your take home pay now, check out the withholding tool at Kiplinger.com.

As parents hoping to raise financially savvy kids, one of the best things we can do is expose them to banking concepts at an early age. Savings accounts for children offer many great personal finance lessons such as the importance of saving money, the magic of compound interest, and the basic mechanics of banking.

Photo by theritters

When I was in high school I took a class called “Citizenship.” The coursework was divided logically between a number of “civic” topics such as taxes, politics, law, and even a very brief introduction to personal finances.

Since I began working the day after I turned 16, I was very familiar with basic checking and savings (well, I had a savings account, but save the $0.03 interest accumulations each month, I wasn’t very good at adding to it).

Back to Citizenship 101. The time came for students to balance our own checking register, write out our own checks and complete a deposit slip. My classmates were stumped, and I even made a little fun of a friend of mine for not knowing how to fill out a check.

He innocently responded that he had never even seen his folks write a check, and he joked that the only bank he knew of was his piggy bank. I suppose that is probably the average level of exposure kids are given to the world of personal finance. That is, until they are on their own and must learn on the fly. I distinctly remember thinking my kids would know how to navigate banking well before they had to know how.

Opening Savings Accounts for Children

It’s funny how fast 20 years seem to fly by. Fast forward a couple decades and here I am with kids who have been introduced to the concept saving and investing, but have not yet learned the mechanics of banking. Shame on me. My 16 year-old self would kick my butt for not teaching this before now. Better late than never, I suppose.

Last Saturday, my daughter and I strolled into our local bank to open a savings account for her. Until now, she saved at home, and I deposited larger amounts into an account for her online. While the interest rate was a little better for her online savings account, investing there caused us to bypass the act of allowing her to make a deposit herself – something I believe is important, psychologically.

With my guidance, she walked up to the teller with some of her hard-earned allowance money and completed deposit slip. In return, she received an updated account notice reflecting the amount of her deposit and increase in her balance. She updated the balance in her savings account register.

In a few weeks, we’ll receive her first savings account statement. I’ll point out the interest that has accumulated since the last statement (her first introduction to passive income), and we’ll update the register to reflect the new statement balance. At some point, I know she’ll want to withdraw a bit of this money for a purchase, and I’m fine with that. In fact, I’ll encourage it (and use it as another teaching opportunity)!

Witnessing the reverse of the deposit process is just as powerful. She’ll fill out a withdrawal slip, receive some cash from the teller and spend it. She’ll then have to reduce her savings balance in her register, and she’ll notice the balance reduction on her statement (and a smaller interest accumulation next month).

By then, she will have probably have forgotten what it is she took the money out for in the first place, and it’s my hope that the next time she considers withdrawing money, she remembers the disappointment she felt watching her balance dwindle.

A few years down the road, we’ll also add a student checking account for our children. We’ll practice completing checks, balancing her checkbook, and I’ll probably include something like “Lunch Money” in her allowance and let her write the check to her school to fund her account.

In the mean time, I’ll let the kids help me pay a few bills by check (I think I’m down to only one or two bills that I still write checks for). This way, they’ll get a lesson in how to write checks, and how much it costs each month to have water come out of the faucet!

Have you introduced your kids to banking concepts? Share your experience in the comments below.

I have been thinking a lot about our financial future and where we are headed. When your looking that far ahead though, you’re assuming that you are going to continue to generate an income. Well, what if that income stops from a disability? Wouldn’t that ruin your financial plans in you didn’t have an income? It sure would!

Over the last few days, I have been checking around about disability insurance. What is disability insurance you ask? Disability insurance helps replace a portion of your income when you cannot work because of illness or injury. If you have an emergency fund built up, you really only need long-term disability insurance. Long-term disability insurance usually only kicks in after you have been disable for at least a few weeks.

Many people argue that having disability insurance is more important than life insurance. The main reason for this argument is that for a 30 year old male, you are 4 times more likely to become disabled than die. It was that staggering statistic that got my attention. I already have life insurance, but not disability insurance. So, I guess it’s time to buy. During my research, I came across a few things that everyone needs to know when purchasing a disability policy. Here they are:

Waiting Period

The waiting period is from the time you become disability to the time the policy starts paying. Most policies have a 30, 60, or 90 day waiting period. In other words, the insurance company wants to make sure it’s a long-term disability before they start paying. Like I mentioned before, it’s crucial to have an emergency fund to cover the waiting period.

Also, the longer your waiting period, the cheaper the policy. It’s been said before that a 1 year disability with a 7 day waiting period costs more yearly than a 30 year policy with a 90 day waiting period. Weird huh?

Benefit Period

The benefit period is the maximum time that benefits will be paid. Obviously, the insurance company will only pay while you are disabled. So, if you recover 6 months after, the benefits will stop. But what if you are permanently disabled with no chance of recovery? That’s were the benefit period is crucial.  You can get almost any term policy but the most popular is probably the “to age 65″ policy. As you can guess, it will continue to pay until you are age 65 so long as you are still disabled.

Type of Disability

This is an area where you need to read the fine print. There are basically two ways a disability policy can be written. It can be written as an “own-occupation” or “any occupation” policy.

An own-occupation policy states that it will pay benefits if you can no longer perform the occupation you were doing when you were disabled. So, if you were a fireman and were disabled on the job, the policy will pay so long as you can’t perform your old duties.

An any occupation policy states that it will pay benefits only when you cannot perform any occupation. So for the same fireman example, if you can still sit in a wheelchair behind a desk, the policy will not pay.

As you can see, it’s more beneficial to get an “own-occupation” policy as it will cover you a lot better. It does come with a price though!

Riders

There are a couple riders out there that are important. The first rider is the cost-of-living (COL) rider. The COL rider will increase your benefit each year to keep up with inflation. It’s important because obviously $1 today isn’t going to buy the same stuff 30 years from now.

The other rider to think about is the Social Security rider. A social security rider will allow you to increase your benefit should you be turned down for Social Security disability (as 70% of people are). When most people think about their needs for disability insurance, they assume they will get something from Social Security. This rider protects you just in case you are denied!

OK, Now How Much Does It Cost?

Disability insurance is just like any other insurance. The company rates you on the amount of risk they take. So, if you have a higher chance of a claim, the policy will cost more. For example, if you work around heavy machinery every day, you are more likely to become injured than say someone like myself who sits at a desk. That’s just the way the cookie crumbles.

For me, a policy with a 90 day elimination period that would pay until I am 65 (I’m 26 now) costs $375 a year. I was really surprised at that number and I thought it would be WAY higher. I also only looked in once place (Zander Insurance) so I could possibly find it cheaper somewhere else.

Where Can I Buy It?

Well, the first place to look is your employer. Many places offer long-term disability through work and it’s cheaper due to group rates.

If your work doesn’t have a policy (like my work), you need to find yourself a good independent insurance agent. These are the people that don’t just work for one company. They can shop around and get you the best rate.

So, what are you waiting on? You shouldn’t be going another day without disability insurance!

Bank of America recently announced they plan to stop charging customers overdraft fees for exceeding their checking account balance with debit cards. They go on to say they will no longer allow charges to go through if the amount exceeds the available funds in customers’ checking accounts. I say, it’s about time!

I’ve never liked the idea of a bank allowing a charge to go through for more than is available, and then tacking on a $30+ fee for the privilege. I’d much rather know at the checkout that I don’t have the $6.87 for a fast food meal, rather than discovering it cost me another $35 when I get my statement.

I hope credit cards will follow the lead, because overdraft fees are another ridiculous bank fee. Sure, the onus is really on cardholders to keep up with their available credit, but a $35 fee for going a few dollars over doesn’t add up – the punishment doesn’t fit the crime.

The Frugal Roundup

Lessons in Frugality From a Lady Named Grace. Here is a great story about a woman who lived below her means and gave away about $7 million on a secretary’s salary. (@The Money Jar)

How to Make Money On Facebook. Next time, don’t rave about a house you want to buy until you close the deal. (@brip blap)

Unautomate Your Finances. Our good friend Baker just released a new eBook. He was gracious enough to send me a copy and I can easily say that it is a great read. Check it out as there are plenty bonus items that come with it. (@Man vs Debt)

10 Benefits of Raised Garden Beds. I’ve talked about square foot gardening before and Lynnae gives some great tips on the benefits. (@Being Frugal)

Best of the Rest

• Preparing for the Canadian Income Tax Deadline
• The Pain of Ordering Online
• 28 Tips to Save Money on Car Expenses
• Why Our Search for Perfection Fails Us
• Should You Automate Your Finances?
• How to Save Money on a Wedding
• Know When to Shop to Save Money
• Simply Being Nice Will Help You With Your Business
• Parenting Teens = STRESSFUL!
• Financial Planning to Age 100

Wrap Up

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Don’t forget to spring forward an hour Saturday night/Sunday morning. I use the occasion as an opportunity to test our home smoke alarm and carbon monoxide detector, something that should be done at least a couple times a year.

On Monday Jason wrote a great overview about dividend investing . Since you now know what dividends are all about, I figured it would be a good opportunity to do a guest post on the subject. I write about the stock market and personal finance at my blog Stock investing 101.

Photo by gfpeck

Dividend investing is the best way to generate passive income and become wealthy, period. It is the perfect example of making your money work for you.

AT&T pays out a 6.7% dividend yield. This means for every 100 dollars of the stock you own you will be given $6.70 a year from the company as a bonus for just being a shareholder of the company. Compare 6.7% to the interest you could get from a standard checking account or a CD. You are getting at least 3 times the return from owning AT&T versus investing in a CD, and that is not factoring in any potential increase in AT&T’s share price.

Most dividend paying companies also offer a DRIP program, DRIP stands for Dividend reinvestment program. If you opt for the DRIP program the money you receive each quarter from owning stock will be used to buy more of the stock instead of being given to you in cash. This is a great way to take advantage of compound interest.

Jason mentioned he purchased 80 shares of AT&T. If he opted for the dividend reinvestment plan those 80 shares would grow to 85.4 shares after just one year. After 5 years his purchase of 80 shares of the company would now have ballooned to almost 110 shares of the company. After those 5 years, assuming AT&T kept its dividend rate steady [which is very conservative when you consider that AT&T has a long track record of consistently raising its dividend] Jason would then be actually getting a 9.3% yield on his original investment. 110 X 1.68= 184.8/ [25.25[share price]X 80= 2020].

The numbers only get more and more impressive and mind boggling over time. In ten years AT&T could go from paying his Netflix membership to making his car payments, in thirty years AT&T could pay his mortgage.

The best thing about this is that there is almost no work involved. After you make your initial investment everything is on autopilot.

Here is a short overview of 5 different dividend paying companies in 3 different sectors to get you started. Remember that this list is not comprehensive in the least bit and it is far from fool proof:

• AT&T: Jason and I have mentioned this company countless times for a reason. It pays out a whopping 6.7% yield, it is in a stable sector that all of us understand, and I don’t see people getting rid of their cell phones or their Internet connection anytime soon.

• Coke: Coke is another great dividend paying company. Its yield of 3.2% is not as impressive as AT&T’s but it is still a great value. Coke raises its dividend religiously so I expect even more from it in the future.

• Pfizer: Pfizer is a huge health care conglomerate. It pays out a very impressive 4.1% dividend yield at the moment and it is a very solid company. It presents a great value to investors.

You will not get 30% yearly returns from investing in dividend paying companies but you will get the best possible return in the long run along with the most stable investment with the least amount of work involved.

If you are interested in learning more about dividend investing, I highly recommend the book The Ultimate Dividend Playbook from Morningstar (written by Josh Peters).

Note from Frugal Dad: After giving it some thought, and investigating the plan with my online brokerage, I have decided to sign up for their dividend reinvestment program. Dividends will be reinvested in eligible securities held in our portfolio, allowing us to build our positions more quickly without an added fee.

Last week, Sen. Jim Bunning of Kentucky created quite a stir when holding out his vote for extending unemployment benefits. His contention was that it violated the self-imposed PAYGO (pay-as-you-go) rules that Congress and the President reinstated just a month earlier. Bunning eventually caved and the benefits were extended, but just because the government can’t operate under PAYGO doesn’t mean we the people can’t.

Photo by robson2313

PAYGO requires new federal spending to be offset by budgetary cuts or tax hikes. Makes sense; without paying as you go you will surely wind up deep in debt, which is exactly how we find our country. As most things political go, PAYGO seems to be more for show, as politicians on both sides have ignored their own rules, or taken advantage of lapses in PAYGO, to spend like maniacs.

Since the idea of debt first came along, people have opted to borrow versus saving for a variety of reasons. Farmers often needed to borrow money for seeds and tools to produce their first crop. Many business were started with loans, because they had significant upfront costs that owners were unwilling or unable to cough up. Homeowners cannot usually afford to buy a house for cash, so we choose to take out a mortgage.

These examples all seem relatively easy to justify, but then a little tool came along called the credit card, which made it much easier for households to borrow money for everyday items. With credit cards, the idea of paying as you go became nearly obsolete.

Every now and then I hear stories of someone who built their own home. They often saved up to buy some land, then the materials, then completed as much as they could on their own while saving to pay someone to finish up those things they lacked the expertise or physical ability to do themselves. I’ve always admired these types; not only for their self-reliance, but because they understood the pay as you go way of managing your money.

My wife and have implemented PAYGO in our own household, on a smaller scale. A few months ago we agreed not to sign up for any new subscriptions, or add to our recurring monthly expenses, without canceling something equivalent.

For instance, after living for more than a year without cable television to speed up our get out of debt plan, we decided to sign back up for basic programming. Doing so would add about $30 to our monthly budget. To pay for it, we scaled back our Netflix membership (a $10 savings), canceled a weekend newspaper subscription (I can read it online – $10 saved), and I canceled a forums membership I no longer participated in (at $9.99/month).

In our example, we eliminated two things that were no longer useful to us, or that we no longer enjoyed, so it wasn’t too big a deal. However, we have had times where we wanted to add a new service or subscription, and couldn’t identify we were willing to eliminate. Enter the other side of the PAYGO equation: Increasing income.

The government can increase income by raising taxes. Fortunately, we don’t have the ability to levy a tax on others and collect their money, so we have to raise the funds ourselves through work. If you receive a raise at work, you may want to allocate a small percentage of your new income to adding something to your household that would add value.

Perhaps you’d like to listen to audio books on the road to increase knowledge on a particular subject. Or maybe there is a cooking class you’d like to attend, or a gym membership could help relieve stress. Whatever it is, use a small percentage of your new, monthly income to reward yourself. Notice I said “small percentage.” There is a risk here of lifestyle creep – inflating your lifestyle to meet or exceed your new income. Tread carefully.

By implementing a pay-as-you-go system in your personal finances, you will not only avoid debt, but you will be able to take pride in the things you own because you really own them, they don’t own you. And yes, that’s right out of Tyler Durden’s Guide to Personal Finances.

*This article appeared in the Carnival of Personal Finance – Tour of Ireland edition