triviageek

I linked to this a long time ago but just discovered that the link is not always working correctly (apparently since she has moved her blog since then). And the information it contains is more relevant than ever. From http://www.janegalt.net/blog/archives/005614.html

So here's the collected Jane Galt wisdom for people who are living on a tight budget. If you've ever read a financial advice book, you'll recognize a lot of it since there simply isn't much new in the world of financial planning. But you're getting this advice absolutely free. It's probably worth a little more than you're paying for it:

1) Pay yourself first. What does that mean? It means you divert money into savings automatically, before the money hits your bank account. You divert an automatic percentage of your salary into your 401(k), and you set up your direct deposit so that money is automatically put into a special savings account unconnected to your ordinary checking and savings, that serves as your rainy day fund. The rainy day fund should hold at least six months, and preferably a year's, worth of expenses. Retirement savings should 15-20% of your income.

Yes, I said 20%.

"20%!!!!!" I hear you screech. "I can't afford it!" Well, then you'd better start developing a taste for cat food. Home equity is going to be a bad way to save for retirement in a country with a stagnating population, as the US will have when I get around to retiring. And Social Security benefits may be slashed, means tested, or otherwise legislated out of your pockets. If you're putting 3% of your salary into your 401(k) every year and hoping that will cover you you're in big trouble.

The reason you pay yourself first is that for most people, budgeting just doesn't work. Most people simply don't have the discipline. The answer is to keep the money out of your bank account. If you don't see it, you won't spend it.

What if you don't have enough savings? You probably feel like your budget is pretty tight, but--trust me!--it can get tighter. (When I graduated from business school, I made about $40,000 a year, and had $1,000 a month in loan payments to make.) Start right now and set up your 401(k) to take 5% of your salary out of every paycheck, and set up a separate bank account with your bank that is your rainy day account, and arrange with HR to have a chunk of money deposited in there every month automatically. If you're poor, start with $100, or even $50 or $25, but put something in there, even if you have to cancel the phone and sit on your stoop to read by the streetlights. You must have savings.

2) Avoid credit card balances Credit card debt will kill you. If you just make the minimum payments, you will pay for whatever you purchased many, many times over. If you can't afford it, don't do it, no matter how important it is. Credit card debt can turn a bad situation, like a job loss or a medical emergency, into a financial disaster. Don't take on credit cards unless you genuinely have no choice, like an emergency repair on the car you need to get to work. And if you put your money into a rainy day fund now, hopefully you won't need it.

3) Use tax advantaged savings vehicles Unless you are making minimum wage, every time you save money in a 401(k), it's like getting a 30% match from Uncle Sam. You should max out your 401(k), and put money into an IRA.

Some financial pundits like Suze Orman are now telling people that they shouldn't bother to use a 401(k), because today's deficits will just mean that tomorrow's governments will have to raise taxes. That's probably true. But in your retirement, you will probably be in a lower tax bracket than you are now, so even if taxes go up, the net result may not be that big an increase. And the effects of letting your money accumulate for thirty years or so with no capital gains taxes are huge.

Should you use a Roth IRA (which doesn't give you a tax deduction now, but pays out the money tax free on retirement) or a regular IRA (which gives you a tax deduction now, but taxes the money at ordinary income tax rates when you take it out)? Depends on whether you're in a low tax bracket now, or a high one. If you're currently in a low tax bracket, then a Roth IRA makes more sense. If you're in a high one, go with a traditional IRA.

4) Wait a couple of years to buy a house The market is probably at or near its peak. The general rule is that troughs in the housing market tend to come about three years behind the peak, meaning that if you wait a couple of years, you will probably end up buying near the bottom of the market, and you will have markedly less risk of ending up "upside down" on your mortgage--meaning that you have negative equity, so if you have to sell, you owe the bank money. I know that you have a voice screaming at you that you want to build equity for yourself instead of a landlord--but the likelihood is that if you buy now, particularly on the coasts, you will not build much equity. And the bank, unlike the landlord, will not let you break your agreement without destroying your credit rating.

5) Use index funds, not actively managed mutual funds An index fund is one that mimics a broad market index such as the S&P. Study after study shows that actively managed mutual funds do not beat the market. I know, you think your fund does, but the research says that that's just luck . . . and that luck could easily turn next year. All actively managed funds do is cost you money in management fees.

6) Saving is more important than lattes People who say they can't afford to save can surprisingly often afford Starbucks, new cars, and alchohol. These are not things you need in the same way that you need to be able to eat if you get sick and can't work.

The easiest things to cut out are food. You *can* cook at home, no matter how tired you are; breaded chicken breasts and steamed vegetables take ten to fifteen minutes to prepare from scratch. Cutting out restaurant meals and buying your own lunch are the single easiest way to save money. Oh, I know, it's not as pleasurable to pull a turkey sandwich out of a plastic bag as it is to go down to the deli and get exactly what you want this minute. But the markup on those sandwiches is generally between 400-800%, and a daily starbucks will cost you over $1000 a year. As a side bonus, the more you have to cook it yourself, the less you'll be tempted to overindulge in goodies. And if you want to hang out with friends, I can generally prepare a very nice dinner for four for less than it would cost me to pay for my own meal at a New York City restaurant. And no waiter badgering you to free up the table.

7) Put yourself on a cash budget. Figure out how much you can afford to spend each week, and take that money out at the beginning of the week in cash. Once you've spent it, no more until the next week. It's surprising how easy it is to develop spending discipline when you have to watch each purchase steadily diminishing your purchasing power.

The corollary to this is to leave some of that money at home at the beginning of the week. You can't spend what's not in your pocket, and it saves the painful denouement at the end of the month.

8) Pay down your debt unless the interest rate is ridiculously low. Credit card debt should be your first priority, but it's also nice to get a headstart on student loans and mortgages. Oh, some of my business school classmates would be horrified. But real returns on investments are pretty low right now; by paying down a 7% non-deductible loan, you get a guaranteed 4.5% real return.

Your mortgage, of course, is deductible. But you are not a corporation; you are a real person who will suffer if you go bankrupt and lose your house. It is only sensible to shorten the time until you own your abode outright.

The easiest way to do this is to split your mortgage payment in two, and set up your bank account to automatically pay one of the half payments every two weeks. This will result in your paying 26 half-payments a year, or an extra payment per annum, and will shorten the life of a thirty year loan by about eight years. Because it is pegged to your paycheck, this is practically painless, and depending on the interest rate and the size of the loan, can result in material savings on interest just because the steady payments slow the interest from compounding. This works especially well for credit card debt.

9) Don't take on debt unless you absolutely have to Absolutely have to means: you need a car for work; your boiler broke down in the middle of winter; you are buying a house. It does not mean: your friend is getting married in Gstaad, your old couch is showing its age, you want to buy a nicer car than you can afford to pay cash for. If you want a treat, save for it. You'll enjoy it more when you have it.

10) Do not default on your loans A shocking number of students default on their student loans. This is a terrible idea. For one thing, those loans aren't dischargeable in bankruptcy, meaning you'll have to pay them eventually--if nothing else, they'll garnish your social security benefits. For another, it screws up your credit rating for years and years. And for a third thing, student loan lenders will almost always work with you if you genuinely can't pay--they'd rather get something than nothing, and they don't want to piss off the government by leaning on students too hard.

11) Do not take on adjustable rate debt There's nothing wrong with adjustable-rate debt, but most people who take on ARMs are doing so because they can't afford the payments on a fixed-rate loan. When interest rates rise--and there's practically nothing else they can do now--those people will end up defaulting. You really, really do not want a mortgage default on your credit report.

12) Buy used There's a genuine debate over whether it's a good idea to buy used cars; it is for me, because I have mechanics in the family, but most people don't. But there are loads of other things you can buy used, through Craigslist or the local classifieds. Furniture (although I don't recommend buying mattresses or anything upholstered), lamps, computers, china. You need plates and something to sit on, but you only want shiny new ones.

13) Buy generic Some brands are worth paying for, but half the time that private-label (aka "store brand") sitting next to the brand name on the shelf was turned out in exactly the same factory; the only difference is the name. Drugstore makeup is generally pretty much the same as the stuff sold in department stores. Vitamins, organic ingredients, and things that you eat make absolutely no improvement to bath and skin products, all of which rely on the same basic chemistry for breaking apart the fat molecules in dirt, and then putting new fat molecules back onto your skin.

14) Buy in bulk. Don't tell me you don't have space; I live in 450 square feet. You can find room for six boxes of pasta and sixteen rolls of toilet paper and you'll save a ton of money. If you don't want to pay for a Costco membership, ask around and find out which one of your friends already have one. They'll be happy to take you with them; warehouse club shopping is much more fun as a social experience.

15) Don't bet on home equity gains Buying a house is a fine way to make sure you have somewhere to live. But historically, it has not been a particularly stellar investment; your retirement plans should not count on enormous returns on your investment in housing. Nor should you take out a mortgage with a tiny down-payment; if you have to move, you can get screwed. And if you are buying a house, buy it because you want to live there, not because you're counting on flipping it for twice the price in three years.

16) Invest in stocks when you are young, and then transition an increasing portion to bonds in your fifties and sixties. When you have an investment horizon of twenty or thirty years, you can afford to ride out the ups and downs of the stock market, and in the long run, it should give you a better return than bonds. As you get closer to needing the cash, you should start transitioning your funds into fixed-income securities, which have a lower return, but guarantee that you won't have to sell in a down market.

That's it. Unfortunately, no surefire way to get rich quick; if I had one, I'd be using it, not telling you. But if you follow my advice, it should keep you out of the poorhouse.

Hope she doesn't mind that I copied the info rather than risk it being lost again.