Monthly Archives: August 2009

Keep Your Cash, I Want My Clunker

Posted on by  at  6:00 am
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The following guest post is from one of my favorite writers, Neal Frankle of Wealth Pilgrim. After reading the post, head over to Neal’s site and check out his free subscription options.

Let the Government go bail out somebody else.  It’s too expensive for you.

I’ll admit that I haven’t followed all the ins and outs of this program but I have two good reasons for not doing so:

  1. I have a 1995 Camry that I love.  My two eldest daughters used it to get to and from high-school. I still have a ten-year old at home and my ultimate goal is for her to use it to get to high-school 6 years from now.
  2. As long as I have a pulse, I will do everything I can to stop anyone I know from buying a new car.  It’s a complete waste of money in most cases.

So why am I bothering to write about this? Well, the subject came up over the weekend.  My daughter is thinking about getting a new car and “taking advantage” of the “Cash for Clunkers” program (with my beloved Camry no less!).  I’m dead set against it.

This program stinks worse than the junk you find when you clean out your trunk for one major reason:

It forces you to get rid of a very inexpensive mode of transportation and burdens you with a very expensive form of transportation.

An automobile is a device we use to move around.  That’s it.  It’s not a social statement or a tool to increase your self-esteem.  It’s a hunk of metal that moves you.

That being said, the question is, how do you get from point A to point B in the safest manner with the least cost. Right?  Am I missing something?

Let’s look at my Camry to illustrate the “virtues” of this program.  You tell me where I’m wrong.

Let’s take the first scenario where you trade in your clunker, receive $4500 and buy a new car.  What does it cost you to own that new car over the next 7 years?

A 2009 Camry (SE) costs a hair over $23,000 if you buy a new one.  Assume you buy it after turning in an old clunker, drive it for 7 years and sell it.  In this case, here’s how your numbers add up:

cashforclunkers1

So, if you buy the new car, it will cost you about $1700 per year to own.  This is without the high cost of insurance you must buy when you own a new car.  It also excludes the jacked up price you paid for the new car because everyone wants one right now and it excludes the maintenance cost.  (I could not find good data on what it costs to maintain a used car.)

Now, lets assume you pass on the cash and drive your clunker.  Here’s what it costs you to own it per year:

cashforclunkers2

This means you could spend up to $1400 per year on repairs and still save money vs owning a new car.  This assumes the car is safe and reliable for your particular needs.  In my case, my 1995 gem is perfect.

By the way, this analysis ignores the low cost for insurance for the used car.  No question about it, the clunker is better than the cash.

Will the clunker last another 7 years? Maybe not.  So let’s consider another alternative.

If and when my good old 1995 Camry dies, I’ll replace it with a 2 or 3 year old car.  It’s still going to be much cheaper than using this program.  Take a look:

cashforclunkers3

I used the Toyota site to determine the new car prices.  I used the Kelly Blue Book site to get residual values. Again, this excludes the higher cost for insuring the new car but the lower maintenance expense. Buying used saves you $600 every year.

The bottom line is even with the clunker cash, it doesn’t make sense to buy a new car.  So just remember this, friends don’t let friends buy new cars.

Additional Reading:

Rent vs Mortgage: Calculating Tangible and Intangible Costs

Posted on by  at  6:00 am
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We are still in the midst of what most would consider a great time to buy a house. Benefits are plenty for first time home buyers and those looking to trade up alike, including sizable tax credits and low interest rates. I personally know a number of people currently renting a house that are finally considering buying a new home.

One argument used to convert renters to homeowners is a side-by-side comparison of mortgage payments to monthly rent. Realtors often like to tell potential buyers that renting is like “throwing money away.” I happen to disagree with that logic, and think renting makes a lot of sense in certain scenarios. Considering the lessons we’ve all learned from the 2008 real estate bubble, building equity is no longer a sure thing either.

Comparing rent to mortgages and declaring mortgages a cheaper option is to compare apples and oranges. Let’s assume a potential home buyer is considering two houses of equivalent square footage. One home rents for $1,000 a month. The other home could be financed with a principal payment of $1,000. Based on these two costs alone the deals look equal, however there are a number of other factors to consider.

Property taxes. One of the benefits of renting is that you are not responsible for paying property taxes on the home. The bill still comes to your landlord. Of course, if you own a home you get a tax deduction on mortgage interest, but depending on your income this may or may not be a wash.

Insurance. Homeowners insurance is practically a requirement when buying a home (in fact, most mortgages require it to underwrite the loan, and even if they didn’t it is still a good idea). Renters should investigate renters insurance as it is typically very cheap relative to the contents of your rented home. Since renter’s insurance is usually cheaper than home owner’s insurance, renters have a slight advantage here.

Maintenance/Repairs. This is the big one. Hot water heater bursts in the middle of the night and floods your utility room. Who pays for the repairs and cost to replace the water heater? If you own the home it will come from your emergency fund (hopefully). If you rent, a quick call to the landlord is all that’s required and they are on the hook for repairs.

Same for ongoing maintenance of the property. Landlords are responsible for things like painting or replacing siding on the exterior of the home, putting on a new roof, and any other updates required over the years. Renters are typically responsible for things like lawn care and keeping the interior in good shape (walls, carpet, etc.).

For this reason, it is important to have a solid emergency fund before taking the plunge into home ownership. Take it from me, if you buy a home without much in savings, something expensive will break within the first 90 days. It’s a sure bet. If it can happen, it will.

Freedom. Even though freedom is not a tangible cost of renting or home ownership, it is still a very important factor when choosing where to live. Renters typically sign a lease or rental agreement for a specified time (usually one year). Most people who buy a home sign a 30-year mortgage, and unless they pay off the mortgage early, they will be stuck with the debt for decades to come.

Guess who can pick up and move easier if the local economy sours? Guess who can move to a different part of the country if they decide the heat/cold no longer agrees with them? Yep, it is the renters. Buying a house is a big commitment, and if you are still unsure about planting roots in your community, job, etc. then it might make sense to rent a little longer.

It is a great time to buy a home with plenty of inventory, motivated sellers, tax incentives and low rates. But none of those things matter if you are not in an position to buy. Resist taking on the added responsibility, and the debt, if you are not ready.

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Where To Park Car Savings?

Posted on by  at  2:00 pm
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John writes in with a question about parking medium to long-term savings for a car replacement fund.

Here’s my situation: my car is 7 years-old with only 60,000 miles on it. It’s in good condition and definitely dependable; I plan on using it for another 5-10 years (five being the least). I figure that after 7 years of saving I would have about $8,400 plus the trade in value  for my car  – we’ll say that’s $1,000 for a total of $9,400.

My question is what do to with those savings? I don’t want to just let them sit there in my savings account, although it does have a decent APY of 1.40%. Should I put a sizable chuck into a 5 year CD and then continue to ladder it in CDs of decreasing term lengths until I need  the money to buy my car? Or should I just put it in a money market account, or higher yield savings account?

I want to maximize the money earned on that fund with out totally sacrificing my ability to withdraw it should an emergency come up, or I need to buy a new car sooner. What would you recommend?

John also shared with me that he is nearly debt free and will begin this car replacement fund after building a small emergency fund. Normally, I would recommend investing money that is to be used greater than five years out in a mix of fairly conservative mutual funds, such as a broad index fund with a low-fee brokerage like Vanguard.

However, this case is a little different because John is dedicating these funds as a car replacement fund. As such, the need to use these funds could arise any time between now and the six or seven years he plans to save. My own experience with Murphy’s Law leads me to believe John’s car will die the exact moment there is a market downturn, causing John to pull out savings at precisely the wrong time.

Instead of dabbling in a risky market, I would suggest parking the savings in an online savings account or money market account, and possibly a CD. I’m hesitant to fully recommend a CD because John mentions the possibility of tapping the funds in an emergency. To do so, he’d have to pay a penalty for cashing out the CD before the term expires.

Sometimes we have to sacrifice a little earnings for peace of mind, and I think this is the case with John’s car replacement fund. I’ve taken the same approach with my own set of sinking funds and targeted savings accounts. For now, they are stashed away in an online savings account at ING Direct.

Funds I don’t plan to use for a number of years will soon be laddered in CDs to increase the rate of return slightly. I’m comfortable reserving market investments for long-term saving goals.

Do you have any additional advice for John? Where are you currently parking savings for large purchases?

Passive Income Idea With A Spin

Posted on by  at  6:00 am
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Most would agree that diversification plays a big role in the success of one’s personal finances. Spreading out risk is helpful in any environment, but is especially important when times are tough. It is just as important to diversify income as it is investments, because until we achieve financial independence it is income that covers basic life-sustaining expenses such as food and shelter. That brings us to the idea of creating passive income.

I’ve always been a big proponent of developing a side hustle – an additional income-producing endeavor you cultivate along with your full-time job. A side hustle might be related to your full-time job, or it could be something completely separate. In my case, I do very little writing at my full-time gig, and nothing related to personal finances. But past experiences, an interest in writing, and a passion for frugal living came together to form this blog and my side hustle.

What if we took this active-active income model to the next level? What if we used this side hustle to invest and create a third, passive income stream? This would be the ultimate in income diversification, and provide maximum coverage in an income emergency, such as  a job layoff or a huge stock market tumble.

I first read about the three-way income model at Money Hacker and thought it was a great concept. I immediately thought about how I could apply it in my own financial life. Keep in mind the difference in active and passive income for these purposes is active income requires me to work actively to generate an income. Passive income continues to grow whether I continue to do work or not. Here are my three current layers of income:

  • Active Income #1. My first, and primary, source of income is my full-time job. Until two years ago this was my only source of income. My wife and I recognized that to meet our financial goals of becoming debt free and building a sizable savings fund, we would need to increase our income. After I struck out trying to find part-time employment, and spent a summer mowing lawns in 100-degree temperatures, I came to the conclusion it was time to try something else. Enter the side hustle.
  • Active Income #2. In addition to my full-time job, I spend about 20 hours a week working on my blog, and related freelancing opportunities. This makes for some long days, but the per-hour earnings rate is much higher than traditional forms of part time work, such as retail or manual labor. Of course, this wasn’t true in the beginning. I made about $3 per hour the first few months of blogging when time invested yielded very little return.
  • Passive Income #1. Creating a passive income stream is the area of this three-way income plan that I need to work on the most. As it is now, we have very little in the way of passive income, save the little bit of interest that accumulates in our online savings account, and the minimal stock dividends that accumulate on the couple stocks and mutual funds we own. Once completely debt free, we’ll be able to afford diverting more of our income to investments, and boost passive income.

Specifically, we plan to use the majority of active income #2 (side hustles) to build a portfolio of income-producing investments. Why? Because I recognize that earnings from active income pursuits are never a sure thing. In my personal example, I could be laid off from my full-time job tomorrow. Advertisers could decide to slash budgets, or some regulatory change could seriously affect my online earnings. I could get sick, or injured, and no longer be able to continue working at a 60-hour per week pace.

For these reasons it makes sense to develop a passive income stream over time to further diversify our sources of income. Early on, the passive income portfolio won’t pay for an extra value meal at McDonalds, but over time our goal will be to grow passive income to the point where it covers all of our required expenses each month.

Passive Income Portfolio Possibilities

What types of investments might make up our passive income portfolio? There are a couple requirements. To be truly passive, the investment has to be a “set it and forget it” type of investment. The simplest form of passive income investment may be a simple savings account. You deposit money, forget about it, and it earns a little bit (very little bit) of interest each month.

As you have higher sums of money to invest you can typically move up in rate of return over a simple savings account. Sticking with deposit accounts for a moment, higher investments in products like money market accounts and CDs will yield higher returns and build our passive income more quickly. A diversified mix of bonds, treasuries and dividend-growth stocks have even higher rates of return (traditionally), but must be spread across a variety of sectors for ultimate diversification.

In addition to financial investments, there are other ways to build a passive income portfolio. Authors of books often earn royalties on copies sold, though the argument could be made that books don’t promote themselves, so the marketing effort required might eliminate the “passive” feature of this investment. In this case, the work is done up front and the residual income that follows could be included in a passive income portfolio.

Over time, we may also use active income to invest in paid-for real estate, and consider rental income and real estate appreciation as passive income. Again, unclogging a toilet at 3:00 in the morning is far from passive, so if you want a totally hands-off real estate investment you will probably need to hire a property manager.

For me, the main benefit of building a passive income from active earnings #2 is that it extends the life of those earnings. If I simply spent them each month on a bigger mortgage, or a car payment, they would be forever gone. Eventually, when my side hustle dwindled away I would have nothing to show for the years of work. This way, passive income will continue to flow long after I quit working for money, guaranteeing financial independence in the years to come.

Introducing The Frugal Dad Giving Project

Posted on by  at  6:00 am
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I love it when inspiration meets opportunity. For a long time I have been trying to come up a plan to incorporate more giving, both in my personal life and through my fledgling business here at Frugal Dad. I write a ton of posts about paying off debt, building savings, and a variety of other money topics, but I rarely post my thoughts on giving.

That was until two sources of inspiration smacked me in the face and encouraged me to get moving. The first was a comment left on last week’s post, The Proper Rate of Savings.  ”Philip” commented, “I’d like to see a post on the proper giving rate.” The makings of a new post were now in development.

Just this morning I read a post at No Debt Plan about DonorsChoose.org – Use Donors Choose to Support Your Local Schools.  The post introduced me to Donors Choose, and specifically to the author’s wife’s classroom project. His wife, a music teacher, is trying to raise money for two drums. Faced with a limited budget (even more limited for arts and music, I suspect), she is turning to community support to fund the purchase of these drums for her students.

It was at this point that I was inspired to take action. I have managed to build a large community here at Frugal Dad, and I like to think I’ve helped a few people along the way with money issues. But honestly, I don’t feel like that’s enough. Quite often I write about the need for improved financial education for kids, and education in general, and unfortunately many kids do not get that education because of limited resources available to teachers.

Not only are teachers grossly underpaid, in my opinion, but they are expected to cover many classroom expenses out of their own pockets. Considering we live in a world where six-figure salaried businessmen expect to be reimbursed for $10 cab fares, I think asking teachers to foot the bill for supplies is ridiculous.

My reluctance to donate to charities in the past was in part due to the fact it is hard to see where your contributions make an impact. Even if most of the money is put to good use it isn’t easy to see the direct impact of your support. That’s why the model at Donors Choose intrigues me.

Teachers and administrators list needed equipment for their classrooms. The requests and associated costs are vetted by Donors Choose representatives and the projects are made public. When fully funded, Donors Choose orders the materials, ships them directly to the school and notifies the school’s principal – reducing the chances of fraudulent requests. The requests also often include class pictures, thank-you letters from the class, etc. It’s really a heart-warming way to make a difference.

While I don’t have all the details down just yet, I plan to incorporate support for these projects into my work here at Frugal Dad. For now, I’ve included a link in the navigation menu above to my “Giving Page” at DonorsChoose.org. Here, I have hand-selected a few classroom projects that are meaningful to me, such as those that support financial literacy, autism and sensory disorders, writing, and other topics.

Other than this initial post, I won’t bombard you with messages about the giving project. If you can help with financial support, great. If you can’t, that’s fine, too. Perhaps you could mention the project on Twitter, or email it to friends. There are plenty of ways to support the cause without giving money.

I know this is a bad time, economically speaking, to be mentioning a giving project. We’re in the middle of our own budget crunch trying to pay off remaining debt, rebuild our emergency fund, and put a little away for a vacation in the next several months. Still, I should be able to carve out a little for this project.

Putting My Money Where My Mouth Is

To kick things off, I’ve donated all ad revenues from today towards the project featured at No Debt Plan, since it was his post and his wife’s idea that inspired me to get going on this project. (Update: That project is now fully funded, so I’ve decided to support a local project in my kid’s school district).

In the coming weeks I’ll donate a percentage of ad revenues to go towards the projects featured on my giving page. In addition to those projects, I’d encourage you to browse requests in your own community. You’d be surprised how many things are needed at your neighborhood schools.

Finally, to Philip’s original comment, giving is a personal decision. There is no proper giving rate, as it is a decision to be made with your family. Apart from examples such as tithing, there is no set amount a family should give. My recommendation is to give as much as you can without straining your own budget, and just enough to fill your spirit with the joys of being a giver.