February 2011

I (Dawn) was reading the book The Cheapskate Next Door by Jeff Yeager this past week. It’s an interesting book, with quite a few good ideas about how different “cheapskates” across the country save money and live well below their means. Some of the stories are a little extreme (dumpster diving for party appetizers), but there are other, more moderate ideas as well.


One idea in particular stood out, especially with gas prices rising every time you go to the pump. It’s what Yeager calls the “$4 a Gallon Savings Club.” The basic principal is when gas prices rise, you are forced to pay the higher prices to fill up, and you get used to it. It’s hard to part with the money, but you have no choice but to budget for the higher amount. Then, when prices go back down, you still “pay” what you would have before. Put the difference aside into savings (for whatever you want).


So, if gas prices peak and it takes $50 to fill up, $50 is what you budget for gas. Then, when gas prices go back down and you only have to spend $40 at the pump, that’s $10 you can save. The idea is that since you already budgeted for it, you won’t miss it. It’s an easy way to save a few (or more than a few) dollars here and there. Also, if gas prices rise again in the future, you won’t have to worry about where the money will come from because you’ve already budgeted for it.


If you’re interested in some more quirky “cheapskate” ideas, check out Jeff Yeager’s book.


Unlike last month’s book recommendation All Your Worth, Retire Secure! Pay Taxes Later by James Lange is not an easy read. It’s not particularly exciting and it’s filled with complex strategies on investment and estate planning. For this reason, we certainly wouldn’t recommend it for everyone, but that doesn’t mean that Retire Secure! isn’t worth reading. In fact, it’s an excellent resource for anyone planning for retirement and those concerned with the best way to leave their estate to their heirs.


The first part of the book deals with “The Accumulation Years: The Best Way to Save for Retirement.” This section goes into detail about the different types of retirement plans and uses a number of case studies to help show what may be right for your situation.


The next part of the book is about “The Distribution Years: Spend the Right Funds First and Other Critical Decisions You Face in Retirement.” We think this is the most important section of the book. It deals with your retirement income, and goes into detail about what asset should be used for income first, and what you should and shouldn’t do in your situation once you reach retirement.


The third part, “Estate Planning: It Is Never Too Early to Start,” goes into a number of different estate planning methods. This topic is probably the most complex in the book, but it is useful for ideas on what may be the best estate planning strategy for you. Taxes are also discussed in detail, and ways to lessen your tax liability and the tax liability of your heirs.


If you are serious about your retirement planning, and don’t mind some dry, but very informational reading, check out Retire Secure! Pay Taxes Later by James Lange. It most likely has some strategies that you have never considered before that would be useful in your own life.

Last week we talked about saving 6 months worth of your “Must Haves” for emergencies, as recommended in All Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and Amelia Warren Tyagi. In our own practice, 3 – 6 months living expenses is what we would recommend for people to set aside in case of an emergency. But how much is right for you? What factors should you consider while deciding how much to set aside?


3 Months, 6 Months, or More?

There are some important factors that should have consideration while deciding on how much is right for you.


  • Job Situation – How comfortable are you with your job situation? What about your spouse’s? If you or your spouse currently has a job which you feel is less than secure, or if you feel you or your spouse would be unable to easily find a position elsewhere should either of you lose your employment, you should probably look at saving at least 6 months living expenses for emergencies.


  • Housing – Do you own your home, rent, or live with a family member? If you own a home, you have the least amount of leeway in cutting down on your housing expenses, so saving at least 6 months living expenses would be recommended. If you are renting, you would likely have an easier time of finding a cheaper place to live if need be, but moving is also an expense that you may not want to consider. Depending on your other expenses, you could go with 3 months (if you have fewer expenses) or 6 months (if you have more expenses). However, if you live with a family member and you feel that you could rely on cheaper housing (or free depending on your situation), you may feel comfortable with 3 months for emergencies, as long as your other expenses are not too high.


  • Your level of comfort – There are people that we have come across in our business who feel completely comfortable with the idea that 3 months living expenses is enough, and if the situation called for it, they could cut back to the bone to get by. Others would feel uneasy with less than 12 months living expenses close at hand, even though we often see that as excessive. If you are going to feel stressed out about how much you have in the bank and will wonder how you would make it through if an emergency did arise, do what you have to make yourself comfortable. However, we would never recommend keeping more than 12 months in an emergency fund, and our reasoning is explained below.


Where Should You Keep Your Emergency Fund?

The point of an emergency fund is that you have easy access to it when an emergency arises. This should be a savings account or money market account (not the checking account where you keep your spending money). However, if you keep more than 3 months living expenses in an emergency fund, you may consider using a second “tier”. Keep 3 months in a highly liquid account like a savings account, and then put the rest in CDs where you are likely to find a higher interest rate. Just be sure to “tier” the CDs so that they mature at different intervals to avoid early withdrawal penalties and so you always have at least 3 months living expenses easily accessible.


And why do we recommend not keeping more than 12 months living expenses in an emergency fund? With interest rates as they are at the moment, you would be unlikely to make more than 1-2% on your money with it in the bank. Though we normally would not recommend keeping more than 6 months set aside for emergencies, we do know that there are those who need the added security. But beyond 12 months, your money would much better serve you if it was invested elsewhere where the rate of return is higher.


Do you have any additional thoughts on how much should be kept for emergencies?

For the past few weeks, we’ve been spending a lot of time discussing details from the book All Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and Amelia Warren Tyagi. If you’ve been following our series, you know that we love the idea of the “Balanced Money Formula” and think that it can be a useful tool for everyone. This will be the last post of the series, and we’ll discuss Warren and Tyagi’s ideas on how to make adjustments to your “Savings.”

We think the discussion on “Savings” is more complicated than for “Must Haves” and “Wants.” For “Savings,” it’s not a matter of figuring out your percentage and deciding on the best areas to make changes. Once you figure out how much money you should be saving to reach the “Balanced Money Formula’s” goal of 20% of your after-tax income, what should you do with the money? We’ll discuss what Warren and Tyagi suggest, and then we’ll also add our own commentary where our ideas differ from those in All Your Worth.

In their talk about the “Savings” category of the “Balanced Money Formula,” Warren and Tyagi stress that any money that you use toward paying down debt is considered savings. We think this is an important distinction that many people don’t see. Warren and Tyagi call all debt (aside from your mortgage, car loan, and student loans) “Steal-from-Tomorrow debt.” When you have this type of debt (credit cards, back payments, other personal loans, etc.), all you are doing is throwing money away that could be used toward your future by paying on these debts. This problem can be compounded by adding to this debt year over year. As we discussed previously, if you are creating new debt, you are negating any other savings you do.

First, Warren and Tyagi suggest you add up all of your “Steal-from-Tomorrow” debt. However, their ideas on how to pay down that debt are where we differ in our thoughts. Warren and Tyagi suggest first using all the money you have saved anywhere but your retirement accounts and use it against the debt (leaving only $1,000 in the bank for emergencies). Then, if you still have debt left, use all 20% of your “Savings” money to pay off the remaining debt. We think that this can be a very dangerous situation to get into, and we’ll explain why a little bit later. But, Warren and Tyagi do have some great tips on getting out of debt, things you should consider doing and things you should never do.

After your “Steal-from-Tomorrow” debt is completely paid off, Warren and Tyagi suggest you “build a 6-month Security Fund” (6 months of your “Must Have” number). Once you have that saved, the next step is what they call “a lifetime of wealth creation.” Once you are at this stage, they suggest you save 10% of your after-tax income in a retirement fund, and the other 10% should be split between paying off your mortgage (5%) and saving for any other dreams you have, whatever they may be (5%).

Now, let’s go back and explain why we think that Warren and Tyagi’s plan is potentially dangerous. While we completely agree that carrying debt has a big negative impact on your future, and we also agree that you will never be able to really get ahead while carrying debt, there are some major differences in what we believe and what Warren and Tyagi believe. First, if you are trying to straighten out your finances and are carrying a significant debt load, leaving yourself no security fund while paying off your debt can be very dangerous. What if you lose your job or become disabled? What if your car breaks down and you need $2,000 to fix it? You could potentially cut out your “Wants” and use those dollars, but will that be enough?

Warren and Tyagi only recommend keeping $1,000 for emergencies in the bank, and while the last 30 pages or so of All Your Worth is dedicated to what to do when things get tough (and it has some great ideas), we think that using any savings you currently have and dedicating the full 20% of your after-tax income to paying off your debt has the potential to land you right back where you started if something major goes wrong. The temptation to use your credit cards or take out loans may be too much if you lose your job and you have no savings to live on.

Second, we would not recommend suspending all retirement savings while paying off your debt, especially if you are closer to retirement.

We would recommend a plan with slight variations from Warren and Tyagi’s. First, if you already have at least 6 months “Must Haves” in the bank, leave it there. If you have additional dollars that you feel you could put to better use paying down debt, then you can do so, as long as you feel comfortable with what you have for emergencies. If you don’t have any savings currently in the bank, set aside a portion of your 20% into the bank for this purpose until you reach your “Security Fund” goal.

Next, decide on what you should continue saving for retirement. If you have an employer matched retirement plan, you should save at least enough to maximize what your employer will match with no exceptions. The benefit of this free money is too great to miss out on. If you don’t have access to this type of plan, it will be up to your discretion as to whether or not you want to suspend retirement savings while you pay down debt. If you are younger, it may make sense to do so, as long as you are sure to start up again as soon as your debt is paid off. If you are closer to retirement, suspending all retirement savings may be detrimental to your future.

After you decide how much you should set aside for emergencies and retirement, then decide on what your debt repayment plan will look like (see our recommended plan, Debt Rollup). While this modified plan differs from Warren and Tyagi’s recommendation and may take you longer and cost you more money in interest, we feel you will be much more secure. And as long as you stick to your repayment plan and stop creating new debt, you will still get to be debt free.

The rest of Warren and Tyagi’s “Savings” plan, “a lifetime of wealth creation,” we agree with. If you have already paid off your mortgage or don’t own a home, you can add the 5% designated to that category to either retirement or dreams savings however you want. Once you reach this stage of the plan, you will hopefully feel very little stress when thinking about your finances.

Again, we have condensed a lot of pages into a short summary of the ideas in All Your Worth. We hope that you have enjoyed this series and that we have convinced you that this book is worth the read!

Last week we talked about the “Balanced Money Formula” as outlined in All Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and Amelia Warren Tyagi. We discussed how you can figure out your own percentages for each of the categories in the formula: “Must Haves,” “Wants,” and “Savings.”


Once you have gone through your own finances, then what? How do you make the changes you may need to get your money into balance? What if you don’t feel you can ever get to the 50-30-20 split that the formula calls for? Warren and Tyagi discuss in depth how to go about dealing with these questions, but we’re only going to touch on a few points they make that we think are key, starting with your “Must Haves” and “Wants.”


If you’re like many people, once you figure out your own percentages, you’ll probably see clearly where your finances need the most work. Maybe you spend too much on your “Must Haves,” forcing your “Wants” and “Savings” down. Or maybe your “Wants” are too high, and you feel like you’re living frugally elsewhere and still can’t get ahead. Whatever your situation, Warren and Tyagi suggest that the further you are from balance, the more stressed you will become. So, starting out with this exercise, make the commitment to make changes to the way you handle your money. If you can’t get into perfect balance right away, do what you can to move closer, and you’ll be much better off.


“Must Haves”

First, Warren and Tyagi suggest you “Set a Goal.” Figure out, based on your after-tax income what you should be spending on your “Must-Haves” (multiple it by .5). When you subtract your “Must Haves” goal from your current number, it will tell you how many dollars you will need to take away from your “Must Haves” to shift elsewhere (if you are spending too much on your “Must Haves” – if not, move on to the “Wants” discussion).


Next, you need to decide what to cut. According to Warren and Tyagi, you should first “Cut the Easy Stuff,” such as the cost of insurance and getting rid of any long term contract you have making a “Want” a “Must Have.” Next, “Cut Where It Hurts a Little,” such as possibly selling your car or getting a roommate. Last, if you still are far out of balance, you may have to “Consider radical surgery,” like finding a new job or moving. There are many pages in the book dedicated to helping you make these decisions, which we will not get into the detailed help offered, but what we can say is this will require work on your part. You must do some research on where you think you might be able to cut. It won’t be easy and it will take some time, but once you make all the appropriate cuts, you will feel much more comfortable, even if it means some pain along the way.



After looking at your “Must Haves,” you should look at your “Wants.” According Warren and Tyagi, your “Wants” are just as important as your “Must Haves.” You need to have some fun, and to make sure of that, you need to know exactly how much you can afford to spend. First, “Set a Clear Limit—How Much for Fun.” So, using your updated “Must Have” number, and your “Savings” goal (after-tax income multiplied by .2), you can figure out what you could comfortably spend on “Wants” (after-tax income minus “Must Haves” and “Savings”).


Once you have this number, what do you do? “Shift to Cash” is what Warren and Tyagi suggest. We wrote the post “Tracking Your Personal Spending” about using cash instead of a credit or debit card for your personal spending money, and this is basically the same concept. If you have a finite amount of cash which to spend on your “Wants,” you will always know how much you have left and what you can afford to do with it. To decide on how much cash you should have, first subtract out what “Wants” you pay for regularly in your bills (cable/internet, etc.), and whatever is left over, you can pull out in cash and spend how you want.


Hopefully, we covered enough for you to get started. Obviously, we have simplified the ideas in All Your Worth and summarized over 100 pages into a few paragraphs, but hopefully the basic ideas are still there. We can’t stress enough that if you are serious about making changes to how you handle your finances, this book has great ideas. Next week we’ll cover your “Savings” and Warren and Tyagi’s ideas on how to handle that 20%.