Tuesday, August 19, 2008


Copyright 1989-2005 Harold Melnick


My Dear Children...

Quite a few years ago I promised myself (and you) that I would not give you unasked-for advice. But, because I care very much about you, I am going to break that rule now. I am going to talk about money and the future -- your money, your future.

Though mothers and fathers give us life,
it is money alone which preserves it.
...Ihara Saikaku.

Money was never a big issue in our family when you were growing up. (At least, I don't think it was.) We didn't have a lot of it, but we didn't lack for what we needed. And you didn't grow up needing a lot of money, or being impressed by it. (Again, I think that's so.)

But I fear there was also not much in the way of money management for you to observe, either. Your Mother and I didn't really know much about managing our personal finances. She tended to be conservative -- don't buy what you don't need, put what you have in a safe place. I tended to spend, sometimes almost as fast as I made it, feeling that I could always make more.

But we didn't "manage" our money. We usually made enough to take care of what we needed and have some left over. But there was no idea of a budget, no disciplined savings, no plan for the future.

Managing Your Money

O money, money, I'm not necessarily one of those
who think thee holy,
But I often stop to wonder how thou canst go out
so fast when thou comest in so slowly.
...Ogden Nash.

During the past few years I finally organized our finances, prepared something of a budget -- or, at least know where the money's going -- and have learned something about financial planning.

So I hope you'll forgive me for intruding into your lives now to try to tell you about some things I wish I had known when I was younger. If you listen, then chose to disregard what I say, my feelings won't be hurt -- I probably wouldn't have listened either. And, anyway, free advice is usually worth only what you pay for it.

I'm going to tell you, in simple, general terms, how to evaluate where you are financially, and how to do better in the future. If you decide you want to know more or ask questions, I'll be glad to tell you what I can, and direct you to where you can get additional information.

How Much Are You Worth?

Money won't buy happiness; but it makes being unhappy
more comfortable.

How are you doing -- financially, that is? Here's a quick way to tell: How much money did you have 10 years ago? Five years ago? Today? If you're worth more now than then, you're going in the right direction. That was easy, wasn't it? The fact is, given the inflation we've had over the past ten years, you would need about $150 now for every $100 you had ten years ago just to keep your real buying power the same. I am going to tell you how you can improve your chances to keep your finances growing, maybe even do a better job of it.

But what if you're worth less now? Wait -- I know there were reasons. I don't plan to chide you about it. I just want to tell you how to get control of things and reverse the trend.

When you have money in your pocket you are handsome,
you are wise -- and you sing well, too.
...Jewish proverb.

Like it or not, how much money you have affects how you will live, and how most people view you and treat you. Not your friends and family, of course. We love you for what you really are. But life isn't fair. When you're sick or old or weak or in trouble -- well, how much money you have could determine how well you'll be treated, how much you'll suffer, how soon you'll get well, maybe whether you'll live or die.

You're not well-connected with rich friends, you won't get any insider tips for investing, your family isn't wealthy, you're not likely to inherit a great deal of money. You're going to have to make it on your own. What follows are some simple steps toward setting your financial house in order, and a simple plan for keeping it that way and improving your financial situation. It's not dependent on how much you make -- though the more you make, the easier it should be. And it won't necessarily be easy or painless. But whatever pain there is now may save you from much grief later.

For without money, George,
A man is but a beast:
But bringing money, thou shalt be
Always my welcome guest.
...The History of George Barnwell, 1731.

How much are you worth? Financially, that is. Because how much you have in the bank determines how you're going to live, how well you'll live, how much cushion there is between you and financial disaster. And changes in how much you're worth, as I said earlier, tell you how you're doing in the financial race. It's not hard to figure your financial worth, though it might take a bit of doing if you haven't been keeping records. You'll have to write it all down -- this isn't something you can do in your head -- and you'll need to refer to it in the future.

First, list everything you own, grouping similar items together for neatness of organization: Cash, checking and savings accounts, CDs, money owed you (that you can expect to collect), any other money instruments; and the present value (if you had to sell them today) of houses, cars, furnishings, jewelry, etc. Put down the value of each item, then add it all up. The sum is your Total Assets.

Now do the same for everything you owe: Mortgages, car loans, any other loans, charge account balances -- everything you're going to have to pay out. The sum is your Total Liabilities.

Now, subtract your Total Liabilities from your Total Assets. The result is your Net Worth. With any luck at all, it's positive; that is, if you sold everything and paid off all your debts, you would still have some money left. You should check this figure every six months or year. The idea, of course, is to have it increase each time.

But if your net worth is negative, it means you owe more than you have -- you're broke. This is not uncommon for banks and airlines nowadays. But little people in this situation don't fare too well. If you're in this hole, you should do some serious planning to change things as quickly as possible.

In either case, you have work to do. You need...

A Budget

Annual income twenty pounds, annual expenditure
nineteen nineteen six, result -- happiness.
Annual income twenty pounds, annual expenditure
twenty pounds ought and six, result -- misery.
...Charles Dickens

Mr. Micawber was right. Never mind the examples of airlines and government -- spending more than you earn is deadly for ordinary folk. Not only does it lead you toward financial disaster, it also increases the cost of everything you buy or do. But to get your expenditures in balance with your income, you need a budget. This isn't easy, the first time. It may take you several hours.

You'll need a budget for each month. First, list your income from all sources -- wages, interest on savings, dividends from the stock your aunt left you, etc. That's usually pretty easy. The hard part is figuring your expenditures. Some items will be easy: rent, loan and mortgage payments, utilities, medical insurance, car insurance, gasoline.... Other items may not be as obvious: restaurant meals, groceries, cosmetics, car repairs, tuition, taxes.... You'll probably have to look at old checks or bills for much of this information. Don't make too many categories -- lump similar items together. "Miscellaneous" usually gets a lot of entries.

Your objective is to have expenditures average less over the year than income. The excess of income over spending goes to savings. Each time you receive money and pay bills, you should record the amounts in the appropriate budget categories. Then, each month you can compare your actual expenditures with what you anticipated, and make adjustments if necessary.

This doesn't sound like much fun, does it? It's not. The fun comes when you have your financial life organized and in order, and know that you're doing better. Watching that net worth grow can be very entertaining and satisfying. Being free of debt and having a cushion can do wonders for your peace of mind.

Having a budget makes it possible to see where you may be able to reduce expenses, and to control which way your situation is going. It'll be pretty crude the first year, but you'll still see where the money is going, and you'll be accumulating information you'll need to make a more accurate budget for the following year. (Using a computer and a program like Managing Your Money or Quicken can make this task easier -- but not easy.)

Money is the seed of money, and the first guinea is
sometimes more difficult to acquire than the second million.
...Jean Jaques Rousseau.

Let's say you have some savings -- your assets and net worth are more than zero. How to handle it, keep track of it, invest it? These are the questions you face.

First, you should have a checking account for your current needs, to pay your living expenses each month. Keep a sufficient minimum balance in this account (usually $1000 or $2500) so that the account doesn't incur service charges.

Next, you need enough ready cash to cover four to six months of living expenses. This is your emergency reserve in case you become ill, lose your job, suffer a disabling injury, or for any reason lose your source of income. Put this money where it's safe, accessible, and will earn a higher rate of interest. Good choices are: Money Market Funds (there are hundreds of these); or short-term bank certificates of deposit. Money market accounts usually require a minimum balance, often have a minimum amount for each withdrawal, and sometimes limit the number of withdrawals per month -- which is OK since you're not planning to use it anyway. As you accumulate additional savings, add them to this account. Your objective is to have this account always increasing.

Once your emergency reserve account is safely above your minimum needs you can think about other investments. There is much to be said for diversifying. No one knows the future; diversifying is a way to hedge against what you don't know. The more money you have, the more investment options there are for you. But take it slowly, don't leap into higher risk investments without knowing where you're treading. If you don't understand it, don't do it. Invest in nothing you're not comfortable with. Resist the temptation to get into something you don't understand. Listen to friends and others, but don t assume they know more than you. Trust no one who is selling you something until you have good reason to do so. Run from strangers selling investments over the phone. (If it's such a good deal, why are they calling you, a complete stranger?)

You might want to get a copy of Andrew Tobias' book The Only Investment Guide You'll Ever Need from the library. It's easy, fun reading. It covers many things you need to know about the world you and your money are in. It tells you about things you can invest in and, more important, what some of the dangers are. I urge you to read it and other books on investing and personal finance before you start diversifying your investments.

Are You Broke?

Let us all be happy and live within our means,
even if we have to borrow the money to do it with.
...Artemus Ward.

I've been assuming you have income, maybe some money in the bank, and have your spending under control. But what if you don't have money? What if your net worth is negative, you've been spending more than is coming in? What if you're "balancing the budget" month to month by leaving bills unpaid, riding credit cards, borrowing from friends, relatives, savings?

You've been kidding yourself. It's time to take serious stock of the situation. How will you stop the out-flow of your financial life's blood, put yourself back in the black? This is when a budget is most needed. Use it to find where you can cut expenses. Face reality. If your expenses hopelessly exceed your income, radical surgery may be needed. If the problem is serious enough, the choices may be very unpleasant, even embarrassing. But if you don't deal with the situation yourself, now, you can be sure that you will be forced by others to take the same -- or even more unpleasant -- steps later. Get advice; you may need to counsel with someone who can help you decide what to do -- a banker or debt counseling service.


Enter upon your inheritance, accept your responsibilities.

Lucky you! That rich uncle died and left you some money. But wait. Because it was acquired without effort, there is a temptation to spend it on something you've really been wanting. This is a mistake, unless you're already well-fixed. Money you earn comes in more or less regularly, and you know how to get more. But windfall money comes only once and, when it's gone, you can't get more from the same source.

The best course with unexpected money is to pretend it's not there. Resist the temptation to use it to buy that new car or boat or whatever it is you've been yearning for. Don't touch it except possibly for urgent medical or educational needs. Don't even use it to pay off loans or bills -- that was supposed to come from your regular income. Instead, stash it safely away where it will continue to grow. (If the temptation is just too great, use a little of it to buy yourself something, so you can feel you've had some immediate benefit. Then stash the bulk of it away and forget it.)

Don't Borrow

By no means run in debt; take thine own measure.
Who cannot live on twenty pound a year, cannot on forty.
...George Herbert.

If you borrow at all, borrow only for real necessities, preferably something which will increase your savings or earnings and thus justify the borrowing. Borrow for a car you have to have to get to work; to expand a successful business; to buy a home. But be sure you can handle the payments; if you're not sure, don't borrow. Don't borrow for vacations, clothes, a stereo or TV.

Don't borrow from your credit card. Such debt usually carries a 15%-25% interest rate. Imagine -- paying $120 for a $100 item just so you can pay it out over time. Pay the $100 in cash and put the $20 in your own pocket, not someone else's. If you don't have the $100, that's a message to you that you probably shouldn't buy it right now.

It's OK to Say "NO"

If you are successful in accumulating some savings, someday a friend is going to figure out that you have money, ask you to lend a hundred or a thousand dollars. The friend says the need is urgent, the bank won't lend the money, and the friend will pay a good rate of interest. Don't do it. That's what banks are for. Banks make their money by assessing risk and lending money. If the bank said no, why should you take the risk? You're not equipped to do so. If you think you'll hurt or lose the friend, keep in mind that you'll almost certainly lose the friend if he or she can't pay you back. If you do lend, be prepared to lose the money. Then, if you aren't paid back, you won't be hurt or disappointed; if you are, you'll be pleasantly surprised.

So, When Can I Spend Some of This Money?

Most people can't count on earning more than about 3-5% above inflation on their investments. Taxes take a cut, too. So what your investment earns isn't as much as it might seem. But if you reach the point that investment income, after allowing for inflation, taxes and potential future needs, exceeds what you need to live on, you might start spending the excess. But before then, you might want to ...

Become Your Own Banker

Would you like to earn a sure 15-25% on your money, tax-free, with almost no risk? Too good to be true? No, it's easy and safe. Just pay off credit card debt. Then, when your savings are sufficient, borrow from yourself instead of from the bank or credit cards. You spot a great buy or need a vacation? Fine, borrow from your savings. Only, be sure to pay it back. In regular monthly payments. With interest. Just like the bank or credit card company would have required. Only now the interest is yours, not the credit card company's or the bank's. (But don't empty your savings; you don't want to destroy your emergency cash cushion. Unlike banks and huge corporations, the government won't bail you out if you dissipate your assets.) Do this awhile and watch how banks, businesses and credit card companies start begging you to open accounts and borrow money.

The Miracle of Compound Interest

One is never too thin or too rich.
...The Duchess of Windsor.

If in 1 A.D. some wise ancestor had invested one penny for you in a savings account at 3% annual interest, today you would have $331,438,000,000,000,000,000,000. This didn't happen, of course, which is why you're reading this now.

But here's something you can do. $1,000 invested today at 7%, compounded quarterly, will be worth $4,006 in twenty years, $8,019 in 30 years. More interesting, put just $100 every month into an account earning 7% interest. After 20 years, there will be $52,092 in the account. After 30 years, $121,096. (These examples don't deduct the taxes you'll have to pay on the interest earned; but in an IRA or similar tax-deferred plan, taxes don't apply until withdrawal.)

Thirty years is a long way off when you're 30; there may seem to be more urgent needs now for that $100. $100 can buy a few concert tickets or restaurant meals -- or a financially secure future. That money will look really good thirty years down the road.

Think About It

There's a lot more which could be said about managing and investing your money. But this will get you started in the right direction, and could be all you'll need for some time to come.

Good luck.
Copyright 1989-2005. Permission granted for non-commercial reproduction and distribution only, in full, without alteration or editing, and including acknowledgment of the author and this copyright notice.