Saving money: only as frugal as you need to be

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Many of the financial fitness gurus have banged the drum ad nauseum—don’t buy lattes, don’t eat out, buy your clothes second hand, clip coupons. Then there’s the other side of the fence—start your own business, make money by investing in (fill in the blanks), etc. Who’s right?

Well, I say only pinch as many pennies as you need to (unless of course you enjoy it). Do you have an emergency fund equal to at least 3 months income? I like six months to a year better, maybe two if you’re really close to retirement, but you’ll have to assess how secure your job is and what other sources of support you can access—like living with a parent, a partner with secure employment, a good side business. Are you saving at least 10% of your income (if you’re younger than 40) or 20% if you didn’t save much before 40? Are you nearing retirement with savings of 20 times your current income? Then don’t bother—buy anything you crave at the grocery store, indulge in that dinner out without an Entertainment book coupon, park at Starbucks. If your financial picture is already in good shape, you’re probably not the type to go wild anyway.

But let’s take it down a step. If you’re carrying a balance on your credit card(s), aren’t saving, don’t have an adequate retirement fund for your age, it’s time to become a frugalista. And I mean that whether you’re making $50K or $500K. Unfortunately, any financial planner can tell you hair-raising tales that prove income has no relationship to savings. But even being frugal has a hierarchy: tackle the big wins first.

Re-evaluate your big bills first—get some new insurance quotes, see if you really need the super premium cell phone service, and (gasp) calculate whether you really can afford your house or if a sale or refinance makes sense. The afternoon spent doing this can easily pay you back $100 or more per month, and that buys a lot of lattes. People who spend all Sunday afternoon clipping and sorting coupons to save $5 often never take a look at their car insurance or their cable plan. Dumb.

Then what? Calculate how much time you spend to make sure the money saving is worth it. Now, I’m my mother’s daughter so I do clip coupons and probably always will because it’s a fun form of shopping for me, from the comfort of my bed on Sunday mornings. But I only clip coupons for stuff I buy anyway, or might be interested in trying. Since there are rarely coupons for fresh fruit or grass fed beef, I don’t make much on this. However, I can usually find enough coupons to pay for the cost of the Sunday paper, making it worthwhile to me. Also, when I use coupons I generally try to get the value back in cash (just ask) and put that cash in the change jar in the kitchen. I like to see it add up and it turns out to be fun (for me) mad money. Even though I’m awed by people who do it, super couponing is not my style—too much effort for too little per-hour return. But if I were really, really broke or simply enjoyed the gaming aspects of it, I’d do it.

Still short on the silver? Then it’s worth evaluating what IS important to you and what’s not. Brown bagging it is almost always worthwhile not only for cost, but also for taste, identifiable ingredients and weight control. But if you can use lunch to network or accomplish something, then grabbing something to go, or eating in the most plush restaurant will be a worthwhile investment of money. Office coffeemaker or Caribou? Again, is it a satisfying luxury or a reflex. I vote for pleasure, but only if it really is a pleasure. Otherwise, save the dough.

Our strong “Protestant ethic” considers frugality a virtue and an end in itself rather than a means to a goal. Not me, I say enjoy life. I can’t enjoy myself if I’m not paying the bills, and opening up banking statements with a hefty balance is more worthwhile to me than a brand new car. I clip coupons but I like to stop at Starbucks. So, I say adjust not only your spending but also your savings to your needs. Decide if you’re getting a good return on any investment involving money, time, or effort.

 

Diversification—eggs in many baskets

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Put all your eggs in one basket, and watch that basket, a quote variously attributed to Mark Twain and Andrew Carnegie, is really bad advice. While Andrew Carnegie knew what he was doing financially, Mark Twain most certainly did not. So listen to me, not him (I know better than to invest in crazy printing press inventions the way Twain did).

Pinning all your hopes on the success of one thing–one investment, one college admission, one friend—is quite simply playing roulette and you’re probably going to lose. Here’s my rationale for diversification:

• If one basket goes kaput you don’t lose everything

• You can control your choices, but you can’t control external factors. Worry only about what you can control

• Sentiment on various investments can vary greatly. Some part of the time you’ll be in-sync, sometimes not. You have a better chance of success if things are not correlated or all the same.

Quantity is not the same as diversification. If you own Dell, Hewlett-Packard, and Apple, you’re not diversified. If your child applies to Harvard, Yale and Stanford, you’re not diversified. If all your friends are from Civil War re-enacting, you’re going to be pretty lonely in the wintertime. You have to make your investment in things with true differences. In financial terms, this is why I recommend index mutual funds and/or ETFs. Put 90% of your money into funds and you can own Dell, H-P, and Apple as one basket (nicely diversified within that basket but not necessarily one I recommend), but also a fund of small value companies, international bonds, REITs, or just about any other type of investment that might be suitable for you. You develop a suitable mix based on your goals, the amount of money you have to invest, and your tolerance for stomach churning. That’s one of the things a financial advisor can help you sort through.

On the other hand, you probably don’t need 65 different investments. Research has shown that more than about 10-12 core holdings begin to lose the value of diversification. You’re spread out among so many things that you have no chance of “beating the market”—you ARE the market. Plus, keeping up with what’s going on just becomes ridiculously time consuming. 10 or 12 mutual funds you can monitor, 25 individual stocks become your full time job, with no evidence that you’ll actually do better and probably do a lot worse than an index. Ask any big-time money manager. Ask Bernie Madoff.

You know all this already? Are you doing it? Are you in love with a stock? Holding it because it will “come back some day”? You inherited it from your dad who worked for the company forever? Um, were you formerly employed at Enron? Reserve your love for your friends, family, art, music, hobbies. Investments are just money—get professional advice and make rational decisions.

 

 

Paying for college without having a heart attack

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Only a few short months to go and many of us will be filling out those FAFSA and CSS PROFILE forms and thinking about how much we should have saved. But if you’re a little further from judgment day than I am, let me suggest that the way to eat the elephant is one bite at a time. Or divide the elephant up into three large chunks…

Let’s just assume that you won’t qualify for one penny in aid, and Junior hasn’t been offered any scholarship money at all.

Student contributions—the first chunk

Yup, I said the first chunk. If your kid isn’t willing to invest in his education, why should you? Let’s work with some nice round figures here to make it all easier to calculate. Say four years at Ivy U. costs $60,000/year. Yes, I know that colleges aren’t quite up to that yet, but wait a month or two and we will be. So, four years is going to cost at least $240,000—probably more, with college cost inflation at 6%, but let’s just go with the $240K for purposes of illustration.

Now, I firmly believe that any student, even one whose parents have no problem footing the bills, should be paying something. Not only does it tend to cut out some of the late night booze and barf parties, but it also makes the kid a better consumer. No kid who is working hard enough to come up with $20K a year is going to shell it out for classes in Bowling 101, or tolerate a professor who doesn’t show up for class. As an aside, when I was putting myself through college and grad school, I used to calculate how much each individual class session was costing me, and ask myself if I would put that much money in a meter (had there been one outside the classroom)—did I get as much value from the class as it would take me to earn that much money? Sharpens your focus, no?

So, is it possible for little Jason or Jennifer to earn $20K? Let’s see—15 hours per week for 36 weeks at $10/hour equals $5,400. Then, there’s, say, two weeks at Christmas where you could theoretically work full time—35 hours x 2 weeks x $10=$700. That leaves 14 weeks for summer break. Let’s give Junior a two week vacation. 12 weeks x $10/hour x 35 hours=$4,200. Junior now has $10,300. Sure, I know Junior will probably spend some of this, or taxes will grab a chunk, but then again, Junior probably could hold down 20 hours during school (I used to work 32 hours and take 18 hours a semester as an undergrad. But then, I didn’t have any choice—no one else was paying.) With a little attention to skill development and early hustling, he might be able to nail a job paying a little more. Maybe Jason can mow a few lawns in high school?

We’ve got a deficit here of $9,700/year. It’s grant or loan time. $38,800 will need to be borrowed by Jennifer over four years. Maybe that film or speech major isn’t looking so great right about now. But, under my principal of only borrowing up to what you can expect to make your first year out, I think this is doable. The average starting salary for a college grad in 2011 is about $50,000, according to CNNMoney. Round numbers here, don’t forget. And gosh, if you’re forking over $60K a year for Ivy U., you ought to be able to get a job with at least an average salary. Good questions for the admissions and career services officers.

There are worse things than graduating with 4 years of work experience, a cultivated eye for the bottom line, and some consumer smarts. Some people don’t learn that until they’re 40, if then.

Savings—the second chunk

The next $80,000 should come from savings. I’m not going to go through the growth vs. inflation of the four years of college—you’ll need to come see me for that level of specificity. Let’s just say you want $80,000 “in the bank” by the time Jennifer is ready to move into the dorms. Say you didn’t get religion until she was 10 years old, giving you 8 years to come up with the $80,000. Let’s be conservative and assume a 4% rate of return on your investments. You need to save $8,682/year or about $708/month. (Not figuring inflation—round numbers, remember?) Get going earlier, say when Jason was 5, and you can cut that down to about $4,811/year. I don’t think this is unreasonable—if you’re making enough money that you won’t qualify for any aid at all, you’re making enough to stash this amount of cash. Worst case scenario is you’re grossing at least $130,000/year. At more than $10K a month, it’s reasonable to think you could save less than $400 per month (it’s less than 4% of your gross).

Repeat to yourself as often as needed, “I will not skimp on my retirement savings to fund this.” If you get to this point, it’s time to think about a cheaper college.

Payment from current parental income—the third chunk

$20,000 is around $1,667 per month. Okay, you’re already used to saving $400-$800 per month toward the education, right? Now, Junior isn’t going to be eating at home—say $250 per month in savings right there, maybe more. Gassing the car once a week @ $50=$200. No more music lessons, math tutor, SAT test prep course—well, you get the picture. Most parents don’t stop to think that while they’re paying for the kid at college, they don’t have the kid vacuuming out the refrigerator with 20 of their closest hungry friends at home.

These aren’t authoritative figures and they don’t take into account your particular situation—more than one child at home, no savings, child who takes more than 4 years to complete (oh no!). That’s what individual college financial planning is for–you know, that’s the stuff I do. This is just a suggestion of how to think about dividing and conquering, without the feelings of overwhelm and panic that hit parents toward the beginning of senior year.

 

 

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