Thursday, February 19, 2009

Opportunity Cost

Last night I heard a story about a young man who decided that he wanted to buy a certain Mercedes model. He actually set the money aside for the car (Novel idea, actually paying cash instead of financing). He promised himself that the first year he made 100k he would buy the car.

Well he soon made the 100k and headed down to the Mercedes dealer in his old diesel VW Rabbit. The salesman looked down his nose at the still young man who drove there in a "beater" car and asked him how he expected to pay for the Mercedes with a price tag of 40k? The young man replied, "I'm going to write a check". The salesman changed his tune and off they went for a test drive. The young man was pleased with the car, it truly was everything he wanted right down to the leather seats!

Ultimately, the young man decided not to part with his hard earned 40k. Instead, he put it in a mutual fund and left it there. One day 12 years later the was driving his Rolls Royce and pulled up alongside the very model of the Mercedes that he had so dearly coveted. He rolled down his window and said to the man driving it, "I don't wish to be rude but can you tell me about your car?" The man told him that he had just purchased the car and it was in mint condition. He went on to say that he was able to buy it at book value for $4,000! The young man smiled and said thank you and they parted ways.

The young man learned a valuable lesson about "Opportunity Cost" that day. You see, 12 years ago he could have bought the Mercedes for $40k and today it would be worth 4k. Instead, he left the money in a mutual fund and 12 years later it was worth over $300,000!

12 years ago he could only use that money for one purpose and he chose to reward himself by saving for his future rather than spending it in the present!

What a great lesson to learn. I am fortunate to have all of my needs met everyday. May I be wise with my extra income and not waste it by failing to understand the opportunity cost.

Monday, February 16, 2009

Credit Cards

We received a letter from our credit card company about a "change in relationship". There is a lot to "unpack" here so I appreciate your indulgence. First, credit cards can be a slippery slope to debt. I have suggested to my sons that they avoid using them, telling them, "you don't need a credit card" if you have a debit card. This is admittedly a bit hypocritical since I have carried a credit card for lo these many years. A slippery slope comes into play when you charge something without having the means to pay for it when the bill arrives...

There are some good reasons for carrying a credit card:

1) There is a good amount of buyer protection.
2) You don't have to carry a lot of cash.
3) There can be some good "rewards".
4) Often a credit card will cover rental car insurance requirements.

There are also some down sides to carrying a credit card:

1) Studies show that you spend a lot more money using a credit card versus cash.
2) The rewards can be hard to redeem.
3) Fees are steep and interest rates are ridiculously high if you carry a balance.
4) Financing a $5 hamburger can cost you more than a gourmet meal!

The specific reason we carry our current card is that "points" earned can be used to pay down our mortgage. We have used the points to pay $650 off our mortgage balance in the past year. Here is where the "change in relationship" comes into play. The agreement between our mortgage holder and the credit card company will be ending next month. So now we are being courted with a new "cash back" card.

We will likely continue to carry a credit card because it is convenient, we pay off our balance each month, and we actively redeem the rewards rather than let them languish or expire.

The other thing is we have made a paradigm shift in our spending and our credit card use is greatly diminished and will stay that way because we are saving by not charging. We now budget and use cash for most of our expenses and the result is more intentional spending. For example, if we budget $250 for groceries then we stick to our list more closely and don't overspend because there is a fixed amount of cash in the envelope set aside for groceries.

We have been at this cash thing for just over a month and we're adjusting to it but we are spending a lot less because we are using cash and there is a direct emotional and painful correlation when you use those dead presidents (cash) versus the old credit card!

I like the change we have made and I love taking more control of my spending.

PS It really helps that my wife is on board with this whole process.

Tuesday, February 3, 2009

Learning to "Live on a Budget"

Everyone makes some New Year's resolutions, we are no different and our resolutions included the typical lose weight and get in shape along with getting our financial house cleaned up.

We moved the elliptical machine into the den where we have been working out three days a week for twenty minutes. This is in addition to our Yoga class that meets twice a week.

Denise, my wife challenged me to feed our family of three for the month of January on $200. Actually, she challenged me to spend only $150 but we agreed on $200 and ended up close to that goal with total expenditures of $240! How we did this was two fold; first we only used cash so I was much more aware of what I was spending and I stuck to my grocery list. Second, we made several meals from foods in the freezer & pantry. We never went hungry and enjoyed being creative with the things we had available to us.

Beyond our food budget we decided to live on a budget and now we tell our money where to go before the month begins! February will be our first full month on a written budget and we'll see how it goes.

We have curtailed using our credit card and are paying cash for so much more which is a paradigm shift for us. Using cash has an immediate psychological impact versus using a credit card where the only emotion comes with the arrival of the statement and the sum of all those charges!

In summary, we now have a plan and we're trying to live into the plan. I'll let you know how it is going along the way.