Sunday, October 31, 2010

Do You Need A Toy Tractor?

Many suburbanites spend tens of thousands of dollars on toy tractors like this, so they can maintain their mini-estates. However, the allure of playing pretend farmer wears off quickly, and these toy tractors are often not very functional, other than as glorified lawn mowers.

Do you need a toy tractor?  Tractors like the one above can cost well over $20,000 new, some over $30,000.   Even used, like the one above, they sell for $10,000 to $15,000 - a staggering amount for a lawn mower.   This is enough to buy a really nice car, brand new, or two good used ones.  Put in your IRA, it would be worth $100,000 to $200,000 at retirement.  Applied toward your mortgage, it could easily shave 5 years off the repayment terms.

Are these toy tractors are good value?  I think not and let me tell you why.  To begin with, the idea of playing country gentleman farmer with one of these is a pure fantasy.  They are lawnmowers, plain and simple, with scaled down "real tractor" implements.  How much dirt are you going to move with that tiny front-end loader?  You might as well just shovel the dirt.  Similarly, the backhoe attachment, while looking useful, is not going to go through anything but the softest of soils.  One good sized rock and that's the end of your ditch-digging project.  Better off just renting a ditch-witch from the local Taylor rental, if you want to dig a trench.

And once you attach these implements to this lawn mower, mowing the lawn suddenly becomes difficult.  If you mow close to the house, expect to whack something with the front end loader, or hit a tree with the backhoe.  So you end up removing these implements, which sit in your side yard, rusting.  And since they are such a pain in the ass to hook up, well, you end up not using them, anyway.

So the fantasy of "doing yard work" with one of these things remains just that - a fantasy.  And let's face it, what kind of yard work are you going to do that requires a front-end loader and a miniature backhoe?  If you are going to be a farmer, great.  For the 30 grand you blow on a toy tractor, you can go out and buy the real deal, with full-sized attachments.

When we bought the lake house, it came with five acres of lawn.  We thought about buying one of these toy tractors, but after looking at several, we came to the conclusion that (a) they were staggeringly expensive, (b) despite their reputation for quality, these could be staggeringly expensive and complicated to repair, and (c) we could hire a local fellow with a real backhoe for the five occasions we needed one, for about 1/10th the depreciation cost on one of these toy tractor jobs.

And we finally came to conclusion (d) you don't need or want five acres of land to mow, maintain or otherwise care for.

The toy tractor craze really took off in the late 1990's and peaked about 2005.  Since then, it has been harder and harder to find people with that kind of money to squander on what are essentially status toys.  Like the Grand Turbo Gas Grill (the baddest gas grill on the block!) the toy tractor ends up being just the baddest lawn mower on the block, and the thrill of owning the baddest lawn mower wears off quickly.  Actually, past age 40, the thrill of owning anything wears off quickly.

So why do people buy this stuff?  Well, people want toys and they want to look cool and have status.  And the toy tractor can be financed for $299 a month, which seems "affordable" at first, until you look at the overall cost picture over time.

We did buy a tractor - a restored antique 1941 Ford 9N with a 6-foot mower, for about $3000.  Six years later, we sold it for..... $3000.  It held its value with little or no depreciation.  The same cannot be said for these toy tractors, which, like most new equipment, depreciate rapidly, about 50% in value every 5 years or so.  For dirt moving, we simply hired a local fellow, who, for a hundred dollars or so, would bring by his backhoe and move dirt when we needed it.

It was a lot cheaper than buying a $30,000 toy tractor and then selling it for $15,000 after five years.
We also bought a zero-radius lawn mower for about $3000 at the local home improvement store and sold it for $1500, losing only $1500 in the process.  So all in all, we got off cheap.  Had we bought the toy tractor, we'd be crying right now and the loss we would be taking.

But not mowing lawn at all is something I am looking forward to.

Borrowing is not a Privilege!

Borrowing is not a Privilege!  Of course, nor is it a right.

Note:  I will be traveling for the next two weeks, so this is my last entry until mid-November.

One interesting thing reading about other people's financial problems, such as on the Debt Guy Page is that many folks seem to obsess over their credit worthiness, their credit score, and view borrowing money as some sort of privilege.  They take an attitude of subservience, that I think dooms them from the get-go.  Please Mr. Banker!  Lend me more money!  Please Mr. Credit Card Company!  Increase my limit!  Please Mr. Car Dealer!  Let me buy this shiny car!

And it is that sort of attitude that sinks them, financially.  When you start looking at borrowing money as a privilege, as some sort of special treat, then you give up what little power you have in the transaction, right off the bat.  And people who take this sort of attitude often borrow money on the worst sort of terms - high interest rates, toxic ARM loans, payday loans, etc.

In the lending industry, charges of racism have been leveled, as most of these raw loan deals usually end up going to minorities.  This is not necessarily intentional racism, just the background racism, like background radiation, that permeates our society.  The poor often end up accepting crappy loan deals, because they are poor, uneducated, and unsophisticated about finances.  This, in turn, chains them into poverty, which in turn leads to more raw deals.  And since minorities are over-represented among the poor, they get these bad loan deals the most.

What sort of deals am I talking about?

1.  5-year balloon notes:  One lady on the debt site writes that she is refinancing her 5-year balloon note on her house, and wants to know how to pay off the debt before she "has to refinance it again".  This sort of thinking is interesting.  A middle-class or wealthier person would seek out a better deal - 30 year fixed rate at a low rate.  Refinancing every 5 years will result in huge fees being tacked on to the balance, meaning the person never pays it off!  It is like the lender in Thomas Wolf's Look Homeward Angel who, in the 1930's, lends poor southern blacks $20, which they "pay back" at $1 a week, which covers only interest, with the principle never being paid off.

2.  Buy Here, Pay Here:  In poor neighborhoods, really crappy used cars are sold based on weekly payments.  The car dealer is also the lender, and they charge double-digit loan rates on these clapped-out used cars.  Most never survive the term of the loan.

3.  Payday Loans:  Everyone knows the drill on this by now - 30% interest on a loan of a week or more, which rolls over into another loan, ad infinitium, until the poor sucker is paying 300% interest on a loan of a few hundred dollars.

4.  High Interest Credit Cards:  Once a credit card interest rate exceeds 20%, the payback stretches out for decades, and the amount paid in interest dwarfs the principle.  These are not only horribly lousy deals, they are toxic.

5.  The Toxic ARM Mortgage:  Interest-only, payment-optional, and other gimmick mortgages were sold to poor folks right at the height of the market, so that they could "afford" to buy a home they could not afford.  And when the onerous rates kicked in and the housing prices dropped in half, well, there is no way you can refinance that sort of thing, as there is no equity.  They were foreclosure proceedings written into the loan docs.

Why do people accept crappy, often dangerous deals like this?  Each contract is almost a guarantee of eventual bankruptcy.  The big  part of the problem is education - people don't understand how money works and how borrowing works.  But a bigger part, I think, is low self-esteem.  Many folks think they are "lucky" to be able to borrow money, and they accept the worst sort of terms as a way of life.

They don't seek out a 30-year fixed-rate mortgage because they don't think they deserve it, or they think that if they go to a real bank or lending institution, they will be humiliated.  So they go to the "Money Store" to borrow money, at the worst sort of rates.

Or, they get turned down for a conventional loan, and think that the banker who turns them down is being "mean" - and not kind.  So they seek out the legal loan sharks that ply their neighborhoods and borrow money from them - thinking that they are being done a favor in the process.

Here's a hint:  When a banker or other lending institution declines your loan application, that should tell you something.  Banks make money loaning money, plain and simple.  They need customers - they need borrowers.  They do not turn away business on a whim.  YOU are the customer for their business and they need you.  When they turn you down for a loan, it is not because they are being "mean" - it is because they don't think you can pay it back.  And that should be a hint right there that you should not be borrowing in the first place.

Never feel like a supplicant when borrowing money.  They are lucky to have YOU as a customer.  If you start acting deferential to lenders, well, it pretty much is all over for you, financially.  No one is doing you a "favor" by lending you money - you have to pay it back, with interest.  And if your lender says "No" to you, begging for money is the worst thing you can do.  Because there are people out there who will "lend" to you this way, but it will usually turn out horribly bad.

Credit card companies play to this sort of mindset.  "Congratulations!" they chirp, "You've been approved for a credit card!"  But this is not winning the lottery.  There is nothing to congratulate YOU about.  If anything, they should be the ones who feel lucky enough to be selected to earn 2-5% on every purchase you make, plus potential interest on any balance.  And no, you are not "lucky" when they increase your credit limit, either.

And yet most people view the credit card companies as being the ones with the power.  People obsess over their credit-worthiness and their credit score, as if it was some indicia of their overall self-worth.

You are not your debt.  You are not your credit score.  Get out of the mindset that being able to borrow money is a privilege and something that you desperately need or want to do.  You have great worth as a human being, and we were not put on this earth to borrow our way into perpetual debt-slavery.

The debt industry has cultivated this idea that you are "lucky" to borrow money and has successfully instilled the concept of debt into everyone's mind.  It was a slick sales job.  And once you are horribly in debt, like the poor folks on the Debt Guy's website, there is not much you can do, other than declare bankruptcy and start all over again.

And these "predatory lenders" do make money off the poor, in many instances, even though their customers declare bankruptcy or default on the payments.  Since the interest rates are so high, often the borrower ends up paying back more than the principle of the debt, over time, even though, with the high interest rates, the loan is not "paid off".  So someone borrowing at 25% interest ends up "paying back" the debt at an effective interest rate of 15% or more, even if they default.

For example, Payday loan places make huge amounts of money on the poor, getting an effective interest rate of 30% or more on each loan.  But since each loan leaves the borrower that much further under water, the borrower has to take out another loan.  Before long, the borrower has squandered hundreds, if not thousands of dollars in "interest" on a succession of $200 to $300 loans.  So when he finally defaults on the last one, the payday loan place doesn't care at all.  They've made an obscene amount of money off the poor fool.  They sell off that bad debt to a collection company and move on to the next victim.

I have to say, when I was younger, I also fell into the mindset that the bankers had all the power and that being lent money was a "favor".  This sort of mindset is personified in the movie "Catch me if You Can" where the father laments that the bankers "have all the power" and goes from bank to bank trying to borrow yet more money, rather than fold his failing business and moving on with life.

When I was in my early 20's, I thought that getting a car loan or a credit card was some sort of "treat" and not on onerous contractual deal where other people were making a lot of money off my toil and sweat.  Fortunately, I was smart enough to join a Credit Union and learn more about money and started taking action in my life to turn things around.

By the time I was in my 30's, I had made connections with commercial banks and was borrowing money - on my terms - to buy commercial Real Estate.  I recall one conversation with the President of a bank in Alexandria, Virginia, where we dickered over the loan rate.  He wanted 9.5% and I said, "I think 9%" to which he replied, "Well, I'll see what I can do."

You see, I didn't "need" to purchase the property, so it was an entirely optional deal for me (and really, all purchases are that way, even for "necessities").  If he didn't want to play ball, I didn't need to buy the property.  And he needed to make the loan to make the money.  And since the property was worth more than I was  paying, it certainly was a safe loan.  He gave me 9%, which at the time was not a bad rate on a commercial loan.

It started to dawn on me at that point that in terms of power, the customer is really the one who should be calling all the shots.  With the biggest shot of all being who you are going to use to lend you the money.  Bankers do compete - for good loan deals.

But if you have bad credit or are borrowing more than you can pay back, well, no one wants that deal.  So you put yourself in the position of begging for money to borrow.  And that is the worst position to be in.

And yet, most people end up borrowing like that, not for "needs" but for "wants".  They want a new TV, bling rims, a car, or a house.  They don't NEED them, of course.   You can take the bus, rent a house, or whatever.  There are cheaper lifestyle choices, but people don't want to make them, so they convince themselves that they "need" a car to get to work, and by the way, that car is a Lexus.

The old saw is, "In order to borrow money, you first need to prove you don't need it" - and it is true.  Once you get off the bandwagon of perpetual debt and actually start accumulating wealth, well the same "mean" bankers and credit card companies will fall all over each other trying to compete for your business.  They want you, because you don't want them.  And it is a sweet spot to be in.

But the best thing of all is, once you reach that point, you stop borrowing and start living.  Because being debt-free is the best way to be of all.

Saturday, October 30, 2010

Credit Repair Scams

You can't " repair"  a bad credit report or increase your credit score by paying someone to fix it for you.  If there is erroneous data on your report, you can have that corrected, for free, yourself.

People obsess about their credit scores, because the television tells them to.  You are not your credit score, just as you are not your debt.  Get out of the mindset that your credit score is the end-all to humanity and an indicia of your wealth.  Stop borrowing, get out of debt, and your credit score will improve - and you won't care, because you won't need it.

There are a number of scam companies out there they claim they can "repair" your credit score or your credit report by removing items ranging from bad debt, to bankruptcy, to delinquent payments.  Here's a clue - if the reports are accurate and true, it can't be done, period.

They usually take an up-front fee of $150 or so and then do....nothing.  That's the scam - they take $150 from a lot of people and make a lot of money.  Not a real difficult scam to pull off, either!

As I noted in my Really Free Credit Report, you can go to and order all three of your credit reports.  You can't get your "score" this way, but it gives you access to the more important underlying data from which the score is based.  Note:  Use the link and not the one advertised heavily on the TV and internet -the so-called "free" credit report is NOT free!

And yes, inaccurate data can appear on your report.  It happens.  But you don't need to pay someone to fix it.  And in fact, these people who claim to fix credit reports rarely, if ever, do.

For example, as I noted before, I had a mortgage that was sold to Key Bank two decades ago.  I had just signed up for automatic payment deduction from my checking account, and they deducted that month's payment.  But it was not forwarded to the new bank for a month, so they showed me as being delinquent on a mortgage payment by a month.  Ouch!

Late mortgage payments are a number one cause of low credit scores.  How to fix this?  I called the bank in question, talked to a representative on the phone, they reviewed the account, and they agreed the report was in error and agreed to correct it.  Total cost:  ten minutes on the phone.

By the way, another bank has told me that since those days, most banks do not report mortgages as delinquent after purchasing them, for at least the first month or so.  They know that payments can get "lost" between lenders and that reporting a mortgage late is a good way to get sued.

Another example was not as apparent.  I looked at my report and it showed me as "over limit" on a credit card, despite the fact the card was no where near its limit.  The problem, again, was that the credit card company reported my limit as $0, which happens sometimes due to computer error or if no one enters the proper amount.  So any charge was "over the limit" and it dinged my credit report and score.

Again, a simple call to the card company and the problem was solved.  Not only do you not need to pay a "credit repair agency" to do this, they simply would not have caught this, even if they did do something, which they usually don't.

Other small dings on your credit report might be taken off if you call a creditor and make nice.  For example, I had a Sears card that was showing one payment overdue.  Now if you wait long enough, this data "falls off" your report.  But a simple call to the Sears card people was enough for them to take the data off the report, as I had been paying regularly on the card and had a zero balance.  They don't want to be the ones who prevented you from getting a home mortgage - its bad for business.

Miscellaneous Data should also be reviewed, including addresses, spelling of names, and the like.  I found that my name was entered in several different formats, and an address I never lived at was in there as well.  The credit reporting agencies usually have links on their sites to submit such corrections, and when I went back a few months later, the data had been updated.

Big Credit Problems are impossible to take off a credit report, however.  Despite what the "credit repair" agencies, say, you can't just have a bankruptcy wiped off your report, at least for several years.  Ditto for uncollected debts, judgments, and chronic late payments.  The "Credit Repair Agencies" are just doing the oldest gag in the book - telling you what you want to hear - that there is a Santa Claus and you can get something-for-nothing and you can be a deadbeat and have an 800 credit score.

But life doesn't work that way.  If you don't pay your bills, you are a high credit risk, and your credit report reflects that.  And debtors are not going to spontaneously remove negative credit information from your report just because you paid someone some money.

A better approach is to use that $150 to pay down debt and make a plan to get out of debt and get "clean" and stay that way.  It may take years to do this, but it is totally worthwhile.  And by the time you do that, your credit report will be much improved - and you won't need it, as you will have gone to an all-cash lifestyle.

Chasing the credit score is a false religion - one that is taught by the TeeVee.  Get off the debt bandwagon and stop viewing wealth in terms of how much you can borrow.

Should You Start a ROTH IRA? Maybe Not.

At cocktail parties you may hear a friend of yours say something like, "I just started a Roth IRA - it's a good deal, you should get in on it!" or they may say, "You should think about converting your regular IRA to a Roth IRA!  It is a great deal!"

When you press them for details as to what the advantages and disadvantages of the Roth IRA are, well, these same people get awfully vague.  And if you push further, it turns out a financial adviser told them to do this, and they really aren't sure why it is a good deal, only that the financial adviser said so.

Of course, the financial adviser took a 5% commission when the IRA was converted to a Roth IRA, so yes, it was definitely a good deal for the financial adviser!

Should you start a Roth IRA or convert your existing IRA to a Roth IRA?  Tricky question, as it depends on your circumstances.

What is a Roth IRA?  A traditional IRA is something we all know about.  You put in money when you are working, presumably at a high tax rate, and you get that money deducted from your income, saving on your Federal and State taxes.  When you retire, presumably at a lower rate, you pay ordinary income taxes on the amount you take out.  If you move to Florida, this may mean no State taxes at all!

So the regular IRA is a good deal, as is the 401(k), Simple IRA, Thrift Savings Plan, SEP and CSEP plans.

A Roth IRA reverses the process.  You pay taxes when you contribute the money to the plan, and then can take the money out, tax-free, later on.  How is this different from just a regular after-tax investment, like a savings account?

Well, to begin with, in a regular savings account or after-tax stock investment, you pay taxes on the amount contributed, but have to later on pay taxes on the dividends and capital gains.

For example, say you open an E-Trade account and put in $10,000 and buy stocks with it.  You paid taxes on that $10,000 when you earned it, just as you would with a Roth IRA.  But in addition, each year, you have to pay taxes on the dividends earned from those stocks (if any) and when you sell those stocks, you have to pay capital gains tax on the gains.

With a Roth IRA, you can put the money into a similar account, pay the tax on the initial principle and then completely avoid paying any taxes on the dividends and capital gains.  So you get some tax advantages there.

Is this a good deal?  It can be.  For example, suppose you are young and just starting out.  You don't make a lot of money, so you are in a lower tax bracket -  perhaps the 15% bracket, which would save you only a few hundred dollars on taxes.  Contributing to an IRA really doesn't cut your taxes very much.  But the one advantage you do have is TIME.  Putting $5000 into an IRA at age 20 can turn into $50,000 at retirement if it earns 5% return.  If taxed at 25%, means you owe $12,500 in taxes on an initial $5000 investment.  In this situation, a Roth IRA is not a bad deal, as it would save you a lot of money down the road, in terms of taxes when you retire.

And you can withdraw than $5000 at any time, tax-free.  And even some of the "earnings" might be withdrawn, to use as down payment for a house.  Not a bad deal, if you are young, and in a low tax bracket.

But for older Americans, who are in a higher tax bracket, it may not be such a good deal.

For example, if you are 50 and in the 38% bracket, with the savings in both State and Federal taxes, you may save over $2500 in your tax bill, if you contribute $5000 to your IRA.  In the 15 years between then and retirement, this may grow to $10,000 at 5%, which is not a bad rate of return on what was essentially a $2500 investment.  And when you retire, you pay your lower tax rate (probably 25% or less, particularly if you retire to a State with no income tax) on the proceeds - so you might pay $2500 in taxes, or about what you saved when you put the money in.  The same money invested in a Roth IRA, on the other hand, has no tax savings when invested, so the equivalent investment ($2500, after taxes) is only worth about $5000 upon retirement. Or looking at it another way, if you paid the taxes on a $5000 investment at age 50, you'd have to pony up an additional $2500 in taxes at the time.  While you pay no taxes when you withdraw the money, you paid the highest rate when you put the money in, and don't take advantage of the lower taxes when you retire.

But what about conversion?  You can convert a regular IRA into a Roth IRA, which has some advantages.  However, as in any Roth IRA, taxes have to be paid on the money put into the account.

So if you have $10,000 in an IRA and convert it into a Roth IRA, you have to pay ordinary income taxes on that money.  If you are in the $38% bracket, this means nearly $5000, including State taxes, in some cases.    This Roth Conversion Calculator is an interesting link and also discusses the tax implications.

One problem is that a large conversion (say, $100,000) will definitely push you into a higher tax bracket, resulting a staggering bill for that year.  Now, instead of paying taxes when you take money out at a low tax rate (as with a traditional IRA) you are paying in at the highest rates imaginable.  All I can say is, approach this whole idea with caution, as it could knock out a lot of other tax benefits as well.

The Roth conversion calculator is interesting in that is shows that if you plan on retiring in a lower tax bracket (15%) then it may NOT be worthwhile to convert.  But if you plan on retiring at the same rate you are in now, or higher, then it could be worthwhile and earn you more money as a result.

Each person's situation is specific and you should crank the numbers before making such a conversion.

Note also that another advantage of such a conversion is that after the "seasoning" period (currently 5 years) you can then withdraw contribution money from the account, tax free.  This could be a good way to avoid paying the 10% IRA penalty tax, if you see yourself retiring early (before 59-1/2) and want to have access to your IRA money before then.  But that is a dangerous game to play, because if you start spending your retirement money in your 50's, what will you have left over to spend in your 60's and 70's?

Should I convert one of my IRAs to a Roth IRA?  Let's do the math using the Roth Conversion Calculator.  In one of my Vanguard IRAs, I have $20,000.  Now realistically, this might earn 7% rate of return in the next 15 years.  I am presently in the 28% tax bracket, but expect to retire in the 25% bracket, or less.

The Roth Conversion Calculator is illuminating.

According to the calculator, I should make this conversion.  But, if I went to say, $100,000 (another IRA account) things might change.   Paying taxes on that money would be necessary (and where would I get the money?) and moreover, that declared income would definately knock me into the highest bracket imaginable.

Note also that the equation is based on your current tax rate, your expected rate of return, and your projected tax rate when you retire.  We cannot predict the tax rates when we retire with any certainty, or what our rates of return are.

For a small account, like $10,000 or $20,000, it might be a "good" deal in that you come out ahead when you retire, if all your projections come true.  But you do have to pony up that tax money when you do the conversion.  Adding $3000 to $5000 to your tax bill is never a lot of fun, and if you don't have the cash, well, it just isn't an option, is it?

Second of all, if you convert a large amount of money, it will really knock you into the next bracket, meaning you pay more taxes - and have to pony up a staggering amount of cash for the tax bill.  Converting a smaller amount (like $10,000 or $20,000 shown above) may be more palatable, but the "savings" are also pretty pathetic.  In the example above, less than $2000 at retirement - assuming all your projections work out.

Note also that if you assume a higher rate of return, the Roth conversion seems like a better deal.  But I am not sure we can assume such high rates of return anymore, and moreover, at my age, getting into high risk, high yield stocks doesn't seem like such a swell idea.

So why do some people think doing a Roth IRA conversion is the biggest giveaway in the world?  Again, many of these folks are financial advisers, trying to sell you mutual funds and take a "taste" of you retirement account when you do the conversion.  So it is a good deal for them, maybe not such a good deal for you, and you have a hefty tax bill on the year you do your conversion.

Again, each person's situation is fact-specific, so talk to your tax adviser before making such a conversion.  Don't take tax advice from a financial adviser, and don't take investment advice from a tax adviser!  The IRS code is not an investment guide.

The Roth IRA rollover is another example, I'm afraid, of people hoping to make a lot of money at retirement by making investment choices.  The best and hardest choice to make is to save money and put it aside.  Finagling with your money might make you a little more, but by itself is not going to build wealth.

My personal choice is to study this matter further.  I may open a Roth IRA or do a small conversion.  The idea of having to pay taxes on  $500,000 of income in one year is just not in the cards, though, it I was to convert all of my funds all at once.  At best, I might do a conversion on a smaller account, such as the Vanguard account shown above.  But the net savings may be so minimal, that they would be swallowed up by commissions to the mutual fund salesmen, etc.

Frankly, I think I'd rather put that tax money to work for me in a regular IRA.  Once I am retired, I won't have many monthly expenses (no mortgage) so my income can be reduced voluntarily, to reduce my tax bill accordingly.

But do the math for your own situation.  It may be different.

Converting Capital Gains to Ordinary Income

As I noted in my Converting Ordinary Income to Capital Gains posting, one neat trick that you can do, if you are in a high tax bracket, is to use depreciation deductions to reduce your income - offsetting ordinary income by the depreciation deduction allowed on a rental property, for example.

It is a neat trick, as it defers the taxation to a later date (when you sell the property and pay the capital gains tax) and it also may knock you into a lower bracket.  So you might end up taking an effective tax rate of 50% or more (with Federal , State, and self-employment taxes) and knocking it down to a 15% to 25% capital gains rate.

But note that the opposite is also true, and it is true using one of the mechanisms that we have been told is the greatest tax dodge for the middle class - the IRA or tax-deferred retirement account.  In these accounts, you pay in money during your working years, and that money is not taxed when contributed.

When you retire, you withdraw money from your IRA or other tax-deferred account and then pay taxes on the amount withdrawn.  The idea is, your tax rate at that point will be lower than when you were working.

However, all the money is taxed as "ordinary income" - the portion of the IRA money that is your contribution (ordinary income that was not taxed originally), dividends (from stocks in the mutual funds you were invested in) as well as capital gains (increase in value of the stocks you may have been invested in).  So while capital gains might be taxed at 15% at the time of this writing, if you retire in the 25% tax bracket, arguably you may be paying more money in taxes, to some extent, on that portion of your IRA withdrawal.

To some extent this is necessary, as trying to parse which part of your IRA withdrawal is ordinary income and which is capital gains would be an accounting nightmare.  So it is all taxed at your ordinary income rate.  Since most people retire in a lower tax bracket than they earned in, it is not a bad deal - you still save a lot on taxes.

And since the taxes are deferred, you earn much more on your investment than you otherwise would in an after-tax investment.

Perhaps the only time this might not apply is if you retire in a high tax bracket, and make an investment in your IRA right before retirement that has a huge capital gain.  For example, you invest $10,000 in ACME stock at age 50, which doubles in value the next year.  You get $10,000 knocked off your income when you make the contribution.  But that $10,000 gain will be taxed at your ordinary income rate, say 25%, when you withdraw it.  But a similar gain, at ordinary capital gains rate (long-term) would be taxed at 15% if it was not in your IRA.

Granted, this is an extreme and unusual example, and overall the tax savings of contributing to an IRA or other tax-deferred savings account are significant.  Moreover, you should be saving in any regard, as it is the only way to accumulate wealth.

But it does illustrate that you can convert capital gains into ordinary income!

Friday, October 29, 2010

50 MPG? Big deal, we were doing that in the 1980's!

A lot of ink has been spilled lately about " hyper-miler"  cars such as hybrids, that get 40-50 mpg.  But what people forget, is that such cars existed, nearly 30 years go, routinely getting over 50 mpg, at a very low cost.  The simple formula?  Small car, small engine.

50 mpg.  It is a fabled number.  The Prius people bandy it about like it was some impossible goal to reach, that is only attainable with exotic hybrid powerplants using rare-earth mineral battery packs.

Yet during one of our previous gas crises (and there have been, what, like four of them now?) automakers had no trouble selling cars that got 40 or even 50 mpg.  Granted, these were not luxurious or roomy cars, nor were they speedy or comfortable.  But they got you to work and back without a lot of fuss - or a lot of fuel.

1.  Diesel Rabbit

These cars were once so common on American streets that not a day would go by you would not see easily a dozen of them.  Today, they are a rare sight!

The Volkswagen Rabbit (named Golf in Europe) was the front-wheel drive successor to the Beetle and sold like hotcakes in America.  Not many survive today, as these were fairly inexpensive economy cars, and unlike the Beetle, not loved for their styling.  Boxy and plain, they were cars with a mission - Point A to Point B.  The diesel version of these cars offered highway gas mileage of 52 mpg or more.

Slow?  You betcha!  But in an era of dollar-a-gallon gas, it seemed like a trade-off worth having.  Many people kept these cars for years and years (usually being called kooks as a result).  Today, not many soldier on.  But at one time, these little square boxes ruled the road in America.

How did the Rabbit get such high gas mileage?  Simple formula - small, lightweight chassis (2,000 lbs or less), high (tall) gearing, and a small, economical diesel engine.  Not much science to it, it turns out.

These were offered in 2, and 4 door models and also as an ersatz "pickup truck" model.

2.  Geo Metro
A largely throw-away car, the Geo Metro was made from 1989 to 1994.  When the last gas crunch hit in 2008, some folks sold their old Metros for a lot of money!

The Geo Metro was made by Suzuki (the Swift), which was affiliated with GM to some degree.  GM rebadged this car and sold it under the GEO nameplate (a catch-all nameplate for foreign made cars from Suzuki and Izuzu, among others).  The car was cheap and tinny, but its tiny lightweight body, aerodynamic design, and tiny three-cylinder gas engine delivered over 51 mpg in some trim.  Even without resorting to diesel power, the car broke the mythical 50 mpg barrier.

As an inexpensive car, these tended not to hang around for long.  Cheap cars are not collected or saved, merely because often the cost of repairing them exceeds the book value.  And since they are worth nearly nothing, most are driven into the ground.

These were offered in 2 and 4-door models and even a sporty convertible.  But for the most part, driving a Geo marked you as poor, a dork, or both.

3.  Chevette Diesel

The Chevette was a fairly heavy, cramped, antiquated design.  When fitted with the 1.8 liter Isuzu diesel and a 5-speed manual, it could achieve an astounding 55 mpg on the highway.

Chevrolet, using its association with Isuzu, fitted the Chevette with an Isuzu diesel engine to achieve 55 mpg highway mileage.  This sort of vehicle, probably sold at a loss, allowed GM to meet Corporate Average Fuel Economy (CAFE) ratings, allowing them to sell larger "gas guzzler" cars alongside it.

While never a popular car, the Chevette was more solidly built that the predecessor Vega, and they did not tend to rust very much, even in snow country.  Again, like most economy cars, the Chevette tended to die off and be junked, as the repair costs would easily exceed the resale value in short order.  And as they became very cheap secondhand cars, they tended to be driven into the ground.  Again, back in the day, these were as common as dirt, but are rarely sighted today.

The chassis design, originally sold in Brazil, was basically a scaled-down full-sized chevy, complete with dual control arm independent front suspension (with coil springs), and rear-wheel drive with a live axle.  As a result, interior space was cramped, due to the large transmission hump.  Compared to the front wheel drive cars of the era, it was not very roomy.

I had one of these in college, and all I can say it that it made the best pizza delivery vehicle imaginable.  It would burn maybe 2-3 dollars worth of diesel fuel a night - without ever shutting the engine off.  And yes, it would run on fryer oil in a pinch.

* * * * 

So, what happened to the hyper-miler cars of the 1980's?  Why did we see 50 mpg on the showroom floor, only to have it disappear for nearly three decades?  The answer is complex and varied.

Crash requirements were one big cause of the demise of the econo-box.  Air bags, side impact requirments, offset crash tests, and the National Institute for Highway Safety have made crash survival a big selling point - and a legal requirement - for most new vehicles.  1800-pound cars are never going to meet these requirements, and in this age of monster SUVs literally be crushed.  Today, even "small" cars tend to tip the scales at 3,000 lbs or more - 50% more than the tiny hyper-milers of days gone by.

Cheap Gas was another killer.  During the Reagan years and into the Clinton administration, the price of gas dropped steadily, until one day, it was 87 cents a gallon in the 1990's in parts of the South.  Why did gas go so low?  In part because people did buy smaller cars which used less fuel.  Lower demand equals lower prices - basic economics.  But when gas went below a dollar-a-gallon (which would be like 40 cents a gallon in 1980 terms) suddenly getting 50 mpg didn't seem like such a big deal - and having four wheel drive did.  The pickup truck and off-road vehicle booms started, followed by the "SUV" craze that is still with us today, albeit in shrunken form.

Status was another issue.  Back in the day, small cars were sold on price, and if you drove a small car, you were viewed as poor, a kook, or both.  So there was no status in driving a Chevette or a Geo.  A Rabbit GTI might be somewhat sporty, but still viewed as an inexpensive car.  Today, cars like the Prius have solved the status problem by selling small as politically correct (creating a new type of status).  And BMW has had good luck with its Mini line (selling small cars as quality items, not disposable commodities).

Will the econoboxes of yore ever return?  Perhaps not in the form we were used to.  VW has brought back the "Rabbit" name and has a diesel in it which can return 49 mpg on the highway - close to the fabled 50 mpg of the old car (note:  The EPA has revised its testing procedures since the 1980's and many mileage ratings today are lower as a result, which may explain the difference).

I suspect that most manufacturers are playing it safe, and keeping high-mileage versions of existing cars on the drawing boards, in case $5-a-gallon gas comes back, or if the EPA CAFE requirements are raised again.  Dropping smaller engines into cars, reprogramming engine controls, and raising final drive gear ratios can quickly take a car from "average" to "high" gas mileage ranges, at the expense of acceleration.

But, lacking any government mandates or pricey gas, consumers seem to prefer acceleration and roominess over gas mileage.  All that, of course, can change in a hurry, as we learned two years ago.


Renting a Boat - cheaper than owning?

This Grand Banks can be rented for $2000 a week, which sounds like a lot of money until you calculate how much it costs to own it.  See Chitwood Charters for more information.

Boats are a lot of fun.  But unless you live on the water and spend weeks every year ON YOUR BOAT, the cost of owning a boat can be horribly expensive.  And as I noted in my Neighbor's Upside-Down Boat, you can literally hemorrhage cash by owning a boat

We recently sold our boat in Georgia, taking a staggering $35,000 loss in depreciation.  Some people on a boating site chastised me for "selling it so cheap" as they felt it was worth more.  But the boating blue books and local boat brokers indicated that the price I got was about right.  And besides, the people who said I sold "too cheap" only felt the boat was worth $10,000 more, which is not a lot of money.

Not a lot of money?  Yup.  You see, it cost $2400 to store the boat and another $600 to insure it.  So you are looking at $3000 a year just in basic costs.  So keeping the boat another year or two, on the premise that I could "get more money for it" would only result in me spending more in overhead costs.  It was time to pull the plug.

Why?  Because with all that goes on, on our little island, we hardly had time to use it.  Since it was in rack storage, each boat trip was a major project, packing up things and getting ready to go, hauling it all down to the marina, and the loading it on the boat.  When the boat was tied up at our condo, it was a simple matter of just untie and go.

So we ended up using the boat maybe 5-6 times a season, which is not enough to justify the cost - the storage and insurance alone made this about $500 a trip.  Throw in about $5,000 to $10,000 a year in depreciation, and you are looking at $1,000 to $1,500 day trips.  They were fun, but that's a lot of money.

One alternative, if you don't boat very often, is to rent a boat.  Even though boat rentals seem "expensive" the cost per trip and overall cost can be far less than owning.  For example, the 36-foot Grand Banks above, can be rented for $2000 a week, which sounds like a lot, but is less than the storage cost alone on our 28-foot Bayliner.  And it is a heck of a lot more boat.  So we can afford to "vacation" on such a boat for less than half the cost of owning our boat.

Plus, you can rent a boat where you want to vacation.  As we learned the hard way, taking our boat from Georgia to Punta Gorda via the ICW and Okeechobee Waterway, it takes a lot of time to get from point A to point B (about a week, each way) and a lot of gas ($3000 worth) when traveling by boat - and our boat would go 30 mph, which is considered "fast".

Even for smaller excursions, renting can be a good deal.  We rented runabouts in Pompano Beach for a few hundred dollars a day.  Granted, they were pretty run-out boats, but if you want to explore the canals there, it is a lot cheaper than owning a boat, if you are just going out for the day.  There are many places in the area that do boat rentals and charters.  While the daily rates may seem high at first, if you are not going to be renting very often, you may come out ahead.

The company in the previous link also provides a "boat club" for people who want to rent more frequently.  This is a good alternative for someone who wants to boat more, but not pay the high daily rental fees or commit to buying a boat.  There are other schemes like this as well - so-called interval ownership or boating club memberships, that allow you to use a boat for so many days a year.

Another advantage of renting or belonging to an interval membership is that you don't have to wash, wax, maintain, store, or otherwise worry about the boat, once you are done.  Just hand them the keys and walk away.

Chartering a boat is another alternative and can be fun.  For only a few hundred dollars, you can charter a boat, complete with captain and crew, for a half-day or full-day, depending on the area and boat type.  This can be a lot of fun - and cost-effective - if you want to go out with some friends for a day and see the sights or do some fishing.  And since you have an experienced Captain on hand, you don't have to deal with navigating the boat or worry about running aground.

Owning a boat is a lot of fun, and if you live on the water and use it a LOT, it can be a cost-effective way to go boating.  But if you find you are boating less and less, but still want to go occasionally, then sell the boat and rent one - or charter one.  It is a lot less hassle, a lot more fun, and a lot less expensive.

The Key to Saving is .....Saving

Want to make a million dollars in the market?  You may have to invest at least half that first, if not more!  In order to save for retirement, you have to, well, save.

CNN Money is often brilliant at stating the obvious, when it is not merely giving horrible financial advice on how to squander $50,000.  But sometimes the obvious needs to be stated, as we all tend to overlook it.

This recent video report from CNN Money points out one obvious thing about saving for retirement - you have to save.  Seem pretty obvious, no?

And yet, most financial gurus and financial help pages, books, magazines, etc. all tout investment strategies, as if you could make enough to retire on "if only" you'd invest in the right stock, mutual fund, or whatever.

Why do financial gurus tout investment strategies?  It's the same old, same old.  If you want to sell advice, you have to sell something sexy and unorthodox.  You have to sell the sizzle.  And you can't get paid to talk on TV by saying that in order to accumulate wealth, you have to save, just like no one will pay you cash money for a "diet plan" that is a big blank book with two words in it: "Eat Less".

But in essence, those are the solutions to both savings and diet problems.  If you want to save money or lose weight, you have to do the hard things - like spending less and and eating less.

And this is where my two blogs, Living Stingy and Losing Weight Now! are absolutely brilliant, if I may say so myself.  Because in both blogs, I don't try to sell easy answers to complex problems.  That if only you could buy the right stock, you'd be rich.  Or if only you could take the right "fat burner" pill you'd be slim.  No, instead I am finding out that the answers to these problems are rather harsh and difficult and not always easy to swallow.  And that sort of stuff doesn't sell books on Good Morning America.  It does not make for happy reading, most of the time.

Then again, Thermodynamics was a much harder course than Sociology in College.  Which landed me a job?  People who take the easy way out rarely succeed in life.

People want easy answers - that you can get rich without working, create wealth from nothing, and lose weight while eating more.  But those aren't answers - they are lies, nothing more.

Losing weight is hard work!  You have to monitor your calorie intake daily, get some exercise, and weigh yourself daily as well.  It sucks, really.  It's hard and it involves deprivation - denying yourself that cinnamon bun, the nachos, or that slice of pizza.  And the moment you "fall off the wagon" (as has happened to me in the last month) the weight goes right back on!  It sucks, really.

And that sort of blog is not always fun to read.  Because day in, day out, it is pretty much the same thing - harsh advice that is often hard to swallow.  You have to beat yourself up a bit - reprogram your brain, to make sure the new habits "take" and are not just a phase you go through before you fall back into bad habits.

Similarly, saving money isn't fun either.  We'd all rather listen to a great stock tip or some other easy answer.  But the cold, hard, harsh reality is that to make money, you have to save money, as our friend on CNN says.  And that means no Jet Ski, no eating out 4 nights a week, and scrimping and saving and finding ways to make money in the margins.

And that's where profit is found in business as well.  Many employees of companies grumble and complain how "cheap" management is, trying to save a buck here or there.  But if you can cut your costs by 1% in a business with a 10% profit margin, that means a 10% increase in profits.  Do you know what would happen to your company's stock if the profits went up 10%?  Wall Street would go nuts.  And yet Joe Paycheck doesn't get that, thinking that the company is "rich" and that small economies are not necessary.

And the same is true in your personal life. As I have illustrated here before, even if you are making "good money" - like $100,000 a year, chances are, all but $10,000 of that is spoken for, in terms of mortgage payments and other fixed costs in your life.  So saving $1,000 a year through various small economies means your disposable income goes up 10%, which is a heck of a raise - and tax free.

And how do you save $1,000 a year?  Not with the click of a mouse and in all one lump sum.  No, it comes about in dribs and drabs.  You knock $50 off your cell phone plan, or $100 off your car insurance, or $200 off your entertainment budget.  A little here, a little there, and pretty soon it adds up.

That's why this blog has hundreds of entries on everything from grocery shopping to car buying to insurance costs, to.... well, just about everything involving money.  In order to "get ahead" you have to get into a mindset where you meticulously track money - checking your bank and credit card balances DAILY,  checking your spending DAILY, just as you weigh yourself daily.

And once you spend less, you can save more.  That's the easy part, the saving.  It is the cost cutting that is the hard part.

And as the CNN piece illustrates, in order to save up a million bucks for retirement, you have to put aside a lot of money over time.  And the later you wait in life, the more money you have to set aside.

If you can put aside a lot of money when you are younger, then yes, you will benefit greatly from the effects of compound interest over time.  But there's the rub - when you are younger, it is the time in your life you are least likely to make a lot of money, and also the time when you are most likely to spend more.  Try telling a 25-year-old who just got his first "good job" that he shouldn't go out and buy a brand-new Scion.  He thinks he "deserves it" even though he has another decade of student loans to pay off.

And of course, an entire marketing machine is designed to sell things to young people so that they squander most of their income at the time.  Indeed, the Scion brand was developed by Toyota to sell cars to the 18-30 year old set.

We are fortunate in that we put aside a lot of money when we were younger and it has grown to a nest egg of over a half-million dollars (in retirement plans).  That sounds good, but upon retirement, that may mean a retirement income of about $50,000 a year.  Not bad, but if we want to do more, it may be hard.

When you reach 40, and especially 50, you realize that the whole concept of buying and owning things is sort of a false religion.  Moreover, it just loses its allure.  And with retirement seeming more imminent, suddenly, many folks panic and start to think about saving for the first time.  We would like to grow our retirement fund to over a million dollars before we retire.

But at my age, this means setting aside nearly another $500,000 between now and retirement.  We may get some "boosts" along the way, selling our last remaining investment property, perhaps a small inheritance.

The compound interest calculator is an interesting weapon in this battle.  If we set aside an additional $20,000 a year between now and age 65, at 5% compound interest, we could end up with about $1.5 million in the bank.   Since we already have savings, we make out on that compound interest.  If we were trying to start from scratch now, well, ouch.  Fifteen years is still enough time to make money from our good friend, compound interest.  However, it is also the time in your life when you can least afford to risk money on high-yield equities.

So that's the conundrum right there.  Many folks in their 50's in this country are trying to play "catch-up" with their retirement savings, putting it all into high-risk and high-yield investments, with the hope that a big payday will save them.  It is a gamble - and a high-stakes one at that.  If they lose it all, or a big chunk of it, retirement will be a very sad thing for them.

When I read about other people's savings efforts and also the financial trouble they can get into, I realize that we are lucky.  But when I look at all the money we've spend over the years, often to no avail, I realize that we could easily have over a million in the bank right now, well on our way to several million at retirement.

And that's the rub.  Even for someone earning "only" $50,000 a year, if they save even a modest 10% of their income, they could be millionaires in their lifetime.  You don't have to be rich to end up rich.

And yet, so few do.  Most squander their life's work on consumer goods.  This retire-on-your-401(k) thing is going to be interesting, to say the least, in the coming years.

Thursday, October 28, 2010

Buying CRAP - Just Stop Doing It!

Bed, Bath, and Beyond sells this useless Mouthwash Dispenser for $19.95.  That buys a lot of mouthwash.  Many Americans go broke with Credit Cards, buying this sort of trivial bullshit that is utterly unnecessary to living and moreover never works quite as advertised.  It take 20 pumps of the handle to dispense even a 1/8 cup of  mouthwash.  What was the point, again?

Debt!  It is like a cancer that slowly spreads over your life.  And yet many folks in America are heavily in debt, and they are not entirely sure why.  Yes, there are "big ticket" items like cars and toys that take up a lot of your money.  And over-paying for a house is another way to get heavily into debt.  And unexpected medical bills can sink anyone's finances in a hurry.

But many Americans get into debt over junk - small items purchased over time, and charged to a credit card.  $20 here, $50 there, it all adds up.  And restaurant meals and other entertainment purchases add to this debt.  Pretty soon, you are staring at thousands of dollars in credit card debt and you are not entirely sure how you got there.

The useless mouthwash dispenser shown above is a case in point.  My spouse decided to buy one of these - two actually.  The first one, of a different design, didn't quite work right.  It leaked mouthwash all over the place.  So, not taking the hint, he goes back to the well, thinking that if he spends MORE money, this time it will really work out all right.

But of course, the dispenser shown above doesn't work worth shit.  You pump and pump and pump, and tiny amounts of mouthwash come out of it, if any.  So you end up just taking a swig out of the bottle, like always, and this useless piece of counter-top cutter just gathers dust.  Meanwhile, it is $22.50 (with tax) added to your credit card debt and paid off over a period of years, with interest, coming to probably $30 when you're done with it.  And you know what? It will be in the trash before you're done paying for it.

Oh, but wait, you say, there was that $5 Bed, Bath, and Beyond coupon you used!  Nice try.  That sort of gimmick is for chumps.  The item above probably cost about $2 to make in China.  So even when "on sale" and with a $5 off coupon, you end up still paying a lot of money - and they end up making a lot of money.  It was no "bargain".

And even if it was, if it (a) doesn't work and (b) is not necessary to begin with, then was it really a bargain?  Even if it was 10 cents, it was still no bargain, as it was not necessary and it doesn't work!

This is an interesting case study, as it shows how "shopping" can be so damaging to your finances and how "coupons" and other deals which distract you from the real bargain determination, can end up causing you to not think clearly about the purchase.

What is the point of this purchase?  The idea was, in theory, to eliminate the "clutter" of having a mouthwash bottle on the bathroom sink.  Of course, one way to do this is to put it in the cabinet next to the sink.  Problem solved, net cost, zero.  Instead, we spend $20 to fix a "problem" that doesn't exist in the first place and end up with a useless piece of consumer Tchotchke that doesn't work worth shit.

If I sound angry, it is because I am.  We squander away a lifetime of wealth this way - spending, spending, and spending, on "things" that neither enhance our lives or make us happy.  And the only way out of this mess is to just cut it out, entirely.

And in some marriages, this sort of spending can be disastrous.  A spouse likes to "go shopping" looking for "bargains" to put on the credit card.   They are convinced they have gotten "bargains" because things were "on sale" or they "had a coupon" when in reality they are just spending, spending, spending, faster than they are making money.  Some wives spend all day doing this, riding their husband's into the ground like a cheap mule.

And when the husband complains about the bills that result, he is made to feel bad for not being a sufficient "breadwinner".  But maybe the reason they are broke is not that he isn't a sufficient "breadwinner" but that his wife just squandered $89.95 on an electric bread-maker. Marriages like that quickly become a "race to the bottom" as each spouse tries to outspend the other before the credit card is maxed out.

We are moving to a smaller home and downsizing, and it is great.  But part of the process is finding these embarrassing little mistakes, hiding in closets, pantrys, and cupboards.  Small purchases, which alone, are not enough to sink one financially, but taken together, end up costing you thousands and thousands of dollars in purchases, interest, and effort.  And things that were stuffed in boxes and closets, so they are no longer visible as painful reminders of bad purchasing decisions.

Less is more.  The material is mortal error.  Learn to make do with less.  Having the latest and greatest gadget is not going to make you happy - in fact, it will make you miserable in the long run.

I am tempted to throw away this stupid mouth wash dispenser.  But perhaps I should keep it - in some conspicuous and inconvenient place, as a constant reminder that consumer spending can ruin you, a nickle and dime at a time!

And I am only sorry we didn't save the packaging and receipt so we could TAKE IT BACK and get a refund.

If you find your spouse buying crap like this, take action, before your marriage is ruined.  Cut up the credit cards and put them on a budget.  If you see garbage like this being brought home in shopping bags, grab it and take it back the next day for a full refund.  You have to take action to save yourself, your finances, and your marriage.  If you don't, you will end up in a slow-motion form of financial death, bleeding every month in credit card debt, until one day you wake up broke, and wonder why it happened, and what happened to your marriage.

More than half of all marital troubles are related to finances.  Working TOGETHER on financial issues can be very rewarding.  But it requires that both of you confront these issues rather than shirk them.

Shit Happens - Prepare for it.

Medical Bills are the Number One Cause of Bankruptcies and Financial Distress in this Country.  And yet few are prepared for what can be a likely occurrence in their lives.

Shit happens, as they say.  And yet most of us are ill-prepared for it.  In America today, most workers mortgage their futures to the hilt - taking every penny of every paycheck and putting into payments for a house, car, jet ski, cable TV, and credit card payments.  What is left over is spent on take-out pizza, and then even more money than is earned is spent and that added to the credit card debt.

And many folks "survive" this way for days, months, years, and decades, even, until something upsets this carefully balanced apple cart, and it all goes horribly wrong.  You son calls from jail.  Your husband gets a DUI, or most likely, you end up with health problems.

Health problems are the most common cause of bankruptcy, as huge medical bills can swamp even the average household.  And yet, we should all expect health issues in our lives, as our bodies slowly fall apart over time.  Moreover, the stress of living in constant debt, plus the sedentary lifestyle of overeating and over-drinking can lead to these very health problems.

How can you avoid this mess?  And if you are in this mess, how do you get out of it?

Avoiding it is the easier of the two.  Stop spending money you don't have!  Make a plan to get out of debt and stay out of debt.  Sell the Jet Ski, the Camaro, the snowmobile, and any other "toys" that are part of your "lifestyle" - and yea, Cletus, that means your gun collection.   Cut up the credit cards, start a savings plan, contribute to your IRA and 401(k).  Get rid of cable TV and other junk you don't need in your life, that have monthly fees attached to them.

If you can cut your overall monthly cash-flow to a minimum, when the shit hits the fan, you won't need tons of money to make the monthly "nut".  And you can build up real savings, too.

Next, get health insurance.  A surprising number of Americans don't have any, not because they can't afford it, but because they'd rather spend $300 a month on a Jet Ski.  A high-deductible ($10,000) plan like from Blue Cross can be very affordable, provide you with two doctor visits a year (for a $40 copay) and provide you with a prescription plan.  Plus (and this is the big deal) you get the negotiated prices the insurance companies get, for any medical services.  That alone can save you more than 50% on your medical bills.

If you do all that - which is called being a responsible citizen - if bad things happen, chances are you will be able to survive them better.  And if bad things don't happen, well, you can look forward to a happy retirement with a fully-funded 401(k) and money in the bank today to pay cash for that next used car.

But suppose the shit has hit the fan and you are living "paycheck to paycheck" - what now?  Well, I'm sorry to hear it, to be sure.  But there are things you can do.

First, if you have a stack of medical bills and no insurance, call the hospital billing department and talk with them.  As my experience with Blue Cross has shown, medical billing is very elastic.  The difference between the "retail" cost and negotiated price for my colonoscopy, for example, was nearly a 50% discount ($2000 versus $1100).  So hospitals have a lot of "wiggle room" in terms of billing, and moreover, don't want you to default, go into bankruptcy, and end up not paying the debt at all (or paying very little of it).

You may be able to arrange payment terms over time, at no interest, as well.  We had an MRI scan two years ago, at the height of the recession, and I simply didn't have the $1250 laying around at the time.  I called the billing department and they were more than happy to accept $250 a month in payments for five months.  And all I had to do was ask them.

Of course, the next step is to get your own financial house in order.  If you have "toys" in your yard, like boats, cars, and jet skis, it is time to sell them and pay off these debts.  If you have monthly payments like cable TV bills, it is time to pull the plug on that as well.  This could be a wake-up call that you need to change your life for good.

But if the hospital bills are staggering - in the tens of thousands of dollars - or hundreds - and you can't see any way of ever paying them off, then maybe you need to talk to a Bankruptcy Attorney to see what your options are to discharge the debt.

Do you want a Platinum Card?

Status Credit Cards are marketed as being the indicia of wealth and sophistication.  And yet many folks in the trailer park have them!

The other day, I was perusing this "Debt Guy" website and saw this posting, from a lady who is in over her head with a Platinum card.   And not surprisingly, like more than half of all debt issues in this country, it was related to illness.  So this poor lady has gone from being a high-flying "platinum card holder" to having her wages garnished.  It is a very sad story, among many on his site.

As I have noted before in this blog, status sells, and no one knows this like the credit card companies.  So they sell Silver, Gold, and Platinum cards, and having run out of metals, switched to minerals - with diamond cards, etc.  People talk in hushed tones about the fabled "black card".  Ooooooh! To have one of those!

(Amex used to have a gag that their cards didn't have "credit limits".  But this didn't mean you could go out and buy the Queen Mary with your Amex card.   If you tried to charge too much, the card would be declined, of course.  There was a limit, they just didn't tell you what it was.  Their "no limits" campaign was just a gag.  For that and other reasons, as noted below, I no longer have an Amex card).

Does having one of these cards mean you are "special" or wealthy?  Hardly.  One reason for the metals escalation in card types was that just about everyone had a "gold card" and they had to come up with newer levels of status so that people could distinguish themselves (in their minds, anyway) from the hoi polloi.  So now we have Platinum, Diamond, and I guess Uranium will be next (it glows in the dark!).

But like all status-seeking, it is the pursuit of a false religion, and also an excellent opportunity for you to get fleeced.  Many of these cards have high interest rates, and thus are bad bargains.  When you get a letter in the mail that says "Congratulations!  You have been approved for a Visa ZINC card!"  Just toss it in the trash.

One gag being played out in the ad pages of the New Yorker is a new Visa preferred card that supposedly will get you special reserved seats at a concert, or other "perks" that are not related to the basic loan agreement that is a credit card.  Once again, we are encouraged to sign up for a 14% to 25% APR in order to get some sort of ancillary bargain - frequent flyer miles, bonus dollars, or preferred seating at a concert venue.

The problem with all of these "perks" is that you are paying for them in terms of interest rate.  You would not get a car loan at 14% interest because they give you a free toaster, would you?  And yet, in effect, that is what many people do with these "perks" cards.

A loan is a loan, and a credit card is a debt instrument, plain and simple.  You may SAY you are going to pay off the balance every month, but all it takes is one missed payment, and that "free" flight to Duluth (retail value, $99) just cost you $250 in interest payments.

American Express, shown above, bears special mention.  My foreign clients are always amazed that in America, many stores don't take American Express, and moreover that most Americans don't carry the card.  They assume that an American Express card is issued at birth - like a Social Security card.  After all, it has the word "American" in it, right?

And in the olden days, American Express was great - for traveling.  American Express Traveler's Checks - don't leave home without them! as Karl Malden told is.  And when traveling overseas, the American Express travel bureaus could literally be a lifesaver for the American traveler stranded far from home.  When we traveled to Japan, there was an Amex travel office in every major city.

But today, in the USA, Amex is just another credit card.  And for the basic card, there is one kicker - you HAVE to pay off the balance every month.  And if you don't, well, all sorts of fees, etc. kick in, and life gets bad in a hurry.  Amex now offers more traditional revolving-credit style cards, as they realize that this interest game is a lucrative one.  But I dumped my Amex corporate cards a long time ago, when I realized that they were just a temptation to spend, and moreover, just a status item (and more and more stores didn't take them, due to the fees involved).

I had a business line of credit with Amex, and I realized quickly why the credit card companies are not your friends.  To make payroll one month, I used the Amex line of credit - or tried to.  The check I wrote on it bounced at the bank, causing all sorts of havoc.  I called Amex, and they explained that their computer decided to cancel my line of credit - but they failed to tell me about it (the letter was in the mail, they explained).  So I had to spend the afternoon chasing bad checks all over town, which of course was great for my credit rating.  Needless it say, it will be a cold day in hell, before I ever do business with those folks again.

But in a way, they did me a favor.  Minor fiascoes like that were a wake-up call that perhaps the debt model of doing business was not a good one.  Many economists argue that debt is a good thing, which allows businesses to operate.  But when you are reliant on debt to run your business, you have to beg your creditors for money on a daily basis to keep the business afloat.  You pay off one debt, and because of the interest payments, you can't accumulate wealth, so you end up taking on more debt, and the cycle continues.

If a creditor pulls the plug on the debt, the business quickly folds.  And during the recent recession, this happened to many small businesses - businesses that were "making money" and paying their debts obligations, but suddenly found the well dry when the banks cut off their lines of credit.

Debt is debt, and it is not a good thing, as economists claim, but a bad one.  Our entire society is programmed to run on debt, to keep people in debt, and to never get out of debt.  And in some regards, the debtor comes out "ahead" in some cases.  If you are perpetually in debt, no one can sue you, as you have no assets to attach.  And if you are perpetually in debt, you qualify for government relief.  In a way, it is a pretty sick deal.

But I digress, once again.

Real wealth is not found in the kind of credit card you qualify for, or in how high your "credit score" is.  Such things only indicate, roughly, your earning power, not your accumulated wealth.  The truly wealthy don't need credit cards or credit scores.  And if you really want to be truly wealthy, you need to get it out of your head that getting a "platinum card" is an accomplishment or a favor the credit card companies are granting you.

If you have to have a credit card,  get one with the lowest interest rate possible.  I have a Citicard with a 5.8% rate and a Capitol One with a 7% rate.   One of these will go away shortly.  These are reasonable interest rates, so that if I have some unexpected bill to pay (hospital stay, etc.) I at least have a shot at paying off the balance.  Again, a credit card is a debt instrument, so negotiate the best terms on it as possible!

Debt Reduction Scams

One of the heartbreaking aspects of the recent recession has been the rise in debt-reduction scams.

Debt reduction scams - what are they?  It is hard to get good information online.  The FTC website only obliquely talks about their characteristics.  Many other sites are mere cheer-leading sites (spamming, grooming, etc.) for them.  For example, the previous link to a "Hub Page", while informative, implies that "debt reduction" can be a good thing for people "in the right mindset" - and it was responded to with lots of gushing accolades, such as "well, I guess it pays to find the right company for debt reduction!"  And of course, many of the responses are along the lines of "Yea, most of those companies are SCAMS, but click HERE to see one that isn't!"

And people dumb enough to fall for this sort of grooming post are dumb enough to fall for the concept of "debt reduction".

What is the scam and how does it work?  And does it reduce debt?  The answer to the second one is usually "NO" - you end up owing more money than before, and oftentimes end up in Bankruptcy court.  If your debts are that onerous, just cut to the chase and call a real Bankruptcy Attorney. A real one.

The scam works like this:

1.  You call the agency, after seeing an ad on a lamp post, on an online ad, pop-up, or a carefully placed "article" in a blog or newsgroup.

2.  They tell you that they can cut your debt by 60-70% and you will be out of debt in a few years.

3.  They claim they will "negotiate" with the credit card companies on your behalf, to reduce the debt, and for some reason the credit card companies will go along with this (and for some reason, the credit card companies will listen to them, but not you).

4.  They claim that your credit rating will not be harmed, or if it is, the harm will disappear once the "process" has been completed.

5.  They ask for an up-front fee of 3-5% of your debt balance and then ask that you make minimum payments to them to "hold in escrow" for you.

Is this legal?  Not really.  Is this some sort of normal process?  Not really - the idea that you can stop paying your bills and then use this as "leverage" with the credit card companies is really a made-up concept, not some known legal path, such as Bankruptcy.

And therein lies the first problem.  Once you stop paying your bills, the normal legal procedures do kick in.   Unlike real legal processes such as Bankruptcy, these schemes do not halt or suspect collection efforts.  The creditors will report you late on your credit reports, basically killing your credit score.  Next, you will get angry letters, phone calls, etc. from your creditors.  Finally, they will take you to court to get a Judgment for the debt owed, which completely tanks your credit score.  Then, they sell off this bad debt to low-life debt collectors, who will call you constantly and harass you for the money.

If you really wanted to go that route, you could just as well have saved the 3-5% fee and just been a deadbeat for free, then try to negotiate your debts with the debt collectors.

(A minor note on this:  If you do have a legitimate debt that has gone to collection, and a debt collector contacts you, make sure you (a) get a copy of the debt obligation in writing, (b) make sure the debt is legitimate and not made-up, and (c) get a written release from that debt in response to your payment.  Believe it or not, people pay off debts they never incurred, in response to debt-collection calls or letters!  And believe it or not, some folks end up paying off the same debt multiple times, because they don't get a receipt for the debt payment!)

The creditors are not obligated to contact any "debt reduction agency" instead of you, and in fact, they probably can't even talk to them, without some explicit approval from you, under the law.  And in fact, they probably won't talk to them, as they don't have to, under the law.  The fantasy the credit reduction agencies sell is that they are some sort of quasi-legal entity (many have names with "Law" in them, or imply they are attorneys, or have one hapless "sap" attorney on staff) but it simply isn't true in most cases.  And unless you are in Bankruptcy, they are not obligated to talk to your "legal" representative, even if they were one.

And in many cases, the "debt reduction agency" does absolutely nothing on your behalf.  You see, once you gave them the up-front fee, why should they bother doing ANYTHING for you?  Like with the Invention Brokers, once you paid the up-front fee, they are basically done with you.  They need not do much more, as they have already "earned" their fee.  It is another example of one of those "best efforts" contracts, which obligate them to do little or nothing, in return for your money.

And please note, don't fall for the scam that the up front fee is "refundable" if they don't get your debt reduced.   Once you pay that money, you cannot get it back without legal action.  A "money-back guarantee" is only as good as the person making it.  If you have to sue to get your money back, chances are, you won't get it back.  If they really were operating on a commission, they wouldn't ask for the money until it was earned.  And please, don't be so ignorant as to believe their promises of putting the money "in escrow".

And like the Invention Brokers, they close their doors and reopen under a new name, in short order, leaving behind a trail of broken clients in their wake.  So even if you could sue them, chances are, they will be no where to be found.

Why can't anyone stop this?  Well, as the first link above illustrates, the FTC has tried.  But like with the Invention Brokers, they can only stop the more obvious ones.  They get back some money (for 7,000 clients, a drop in the bucket) but even then, only pennies on the dollar.  And often these actions by the FTC only serve to eliminate competition from the marketplace, allowing the more established folks to get more market share.  So in effect, they do worse than nothing, they actually help the con artists.

And the FTC's warnings about these scams are so obliquely worded and hard to find that they are pretty worthless.  The folks who fall for these scams are not very bright people - they don't read much, other than the cardboard sign on the lamp post that says "Get Out Of Debt Now!"  And they call the number and are persuaded by clever telemarketers to get into this scam.  Such folks don't read the FTC website (even if you could navigate it) and such folks likely wouldn't even read this posting.  So they are sheep to the slaughter, basically.

These are the type of people who got into debt through dubious payday loans, rent-to-own furniture, "buy here, pay here" used cars, title pawn loans, rent-to-own bling rims, and of course, the worst sort of credit card offers.  Debt reduction scams are just the next step in a long line of raw deals they are signing up for.  Misery breeding misery.  It is very sad.

And because the clients are all broke, it is a perfect scam - the broke clients don't have the money to hire a lawyer to go after them.  In a way it is sick perfection!

The common thread with this scam, as well as the Invention Brokers, the "Great Wall of Sound" or any number of other scams is simple:  The up-front fee.  These companies promise to do amazing things - make you a millionaire with your Patent, or make you a pop singer with a hit record , or cut your credit card debt in half.  All of this, if you pay them a fee, up front.  Where people get the money, I don't know.  But they get it.  And they pay - and pay, and pay.  And their lives are miserable as a result.

Once you have paid that money, you realistically can't get it back.  As I noted in another posting, any amount of money less than $10,000 is not worth suing over, so if you give someone that kind of dough, and they don't perform, well, it's gone, period.  These are best efforts contracts, where the company is only obligated to use their "best efforts" to do whatever it is they promised to do.  So in many cases, even if you can sue them, guess what?  You don't have a case.

But what about Attorneys?  A genuine bankruptcy attorney will ask for money up-front, too, right?  Yes, this is true, but an Attorney is licensed by the State he practices in.  All it takes to make his life miserable is to file an ethics complaint with the State Bar where he practices.   It costs you nothing.  Just answering the complaint will cost him thousands of dollars and hours of his time.  If he starts getting 10, 20, 100 complaints, well, he is not going to be an Attorney for long!

Similarly, a LICENSED contractor may ask for a down payment on a roofing job, but never for the full amount.  And if he doesn't complete the job, you can file a complaint with the State licensing agency, and he can lose his license.  The unlicensed guy, on the other hand, who blows into town right after the last Hurricane, he'll take your money and then just leave.  He has no credential you can go after.

And that makes all the difference in the world.  If you really are behind the 8-ball on your bills, think about where you want to go with this.  First off, contact your creditors and see if you can work out a payment plan.  Next, contact a legitimate credit counseling agency - one that will help you negotiate a payment plan, not promise to wipe out your debts.  Such agencies may ask for a SMALL fee (less than $100) for counseling, but not a percentage of what is owed.

Finally, talk to a REAL Bankruptcy Attorney.  If you really owe more than you can ever possibly pay back, then Chapter 13 Bankruptcy may be in order.  It may discharge part of your debts (the interest parts, anyway) and work out a payment plan for the principle over time.  Yes, it will ding your credit rating, but it discharges the debt and prevents you from getting angry creditor calls for the rest of your life.  And the damage to your credit rating is probably about the same as just not paying your bills, as the "credit reduction" scam people advise.

If it sounds too good to be true, it probably is.  And if someone says you can make money without work, walk away from debts without paying, or create something-from-nothing, watch out!  Because they probably already have one hand on your wallet.

Wednesday, October 27, 2010

Some Really Sad Stories!

Regardless of your income level, getting into debt is a sport that anyone can do in this country.  Once you spend more than you can pay back, bad things happen in a real hurry.  For the very poor, these bad things are even worse.

This blog is something I wrote for myself, as I struggled to get by on "only" $100,000 a year or so.  I say "struggled" as I saw that many of my peers also felt that although they were making "good money" they were also squandering it as fast as they made it - living "paycheck to paycheck" in expensive homes and driving expensive cars.

The poor and middle class in America are not much different, we just go broke buying better shit.  But broke is broke, make no mistake about it.

But there are some folks out there who are really hurting these days - sad stories that tear your heart out.  Go to this site, if you want to hear some real sob stories.  It will break your heart.

Most of these folks have very low incomes - $20,000 to $50,000 a year.  And their debts, while seeming insurmountable to them, look fairly small to me.  But if you ain't got the money, twenty grand seems like a million bucks.

But what is consistent between their stories and "middle class poverty" is that spending is the problem that gets them into trouble in many cases.  Credit card debt, car payments, and living large are fine and all when you have a job and are "making good money".

But then something happens to upset the apple cart.  Health problems are the biggie, followed by layoffs or job loss.  Suddenly, that monthly minimum payment looks like Mount Everest.

The key is, regardless of income level, to save money and spend less.  If you have some savings, you can endure hardship that much easier.  And if you spend less, you won't have this big nut to crack, in terms of debt payments every months.

The poor guy who runs the site really ends up giving out the same piece of advice to these poor folks - bankruptcy.  But bankruptcy is no panacea these days - oftentimes you have to work out a repayment plan with your creditors.  It ain't pretty.

The secret is, if you are not in debt, don't get into it.  They offer you debt these days, even if they KNOW you can't repay it.  Because once you go into debt for that shiny-shiny, they can hook you and make you pay it off the rest of your life, particularly if you are poor.

Especially if you are poor.

It is very tragic to read these stories - people with so little and making so little, blowing it all on car payments and cable TV bills and then wondering what went wrong.

One fellow said "I don't want to have to make any lifestyle changes" which sort of said it all.  He's thinking of killing himself over his debt (talk about a lifestyle change!) but won't unplug the cable TV to save $100 a month.

It is sad...