Notes

The photo of Dave Ramsey was adapted from the Dave Ramsey website.

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Eating out can be dangerous for your waistline—and your bottom line.

Now I don’t dine out much (sorry about the deceptive title), but many people do. Most people also borrow money to buy a house or condo at some point. And most people, unfortunately, are unaware just how much dining out affects the length of their mortgage.

Spending as little as $200 a month on shoes, gadgets, or eating out is an expensive decision if the alternative is paying down debt. Putting the $200 towards a mortgage would trim 9 years and 5 months off of a $200k mortgage at 7%.

That money would also save $101,014 in interest, eliminating the final 113 payments of $1,330.

Now people generally do not enjoy thinking about their decisions in this way, but closing our eyes will cost us.

Economists have a useful term for counting the costs of our actions. Every time we spend our time or money, we forgo other opportunities. The next best thing we could have done with our time or money is our opportunity cost.

In the example, spending $200 on dining provides us with tasty meals and no dirty dishes—on the other hand that same $200 cannot be spent paying down our mortgage, on entertainment, or perhaps providing our children with music lessons.

Life is about more than money

The best way to mathematically spend our money isn’t always the best for us, so you might prefer dining to owning your house sooner. The decision is up to you. But you should remember to think about the opportunities you’re passing on when you spend your time and money.

note: a $200,000 mortgage at 7% APR will cost $1,330.60 a month for 30 years. Simply putting an extra $200 a month towards principal will trim 9 years and 5 months off the mortgage.

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Have you ever rationalized a purchase by thinking to yourself: I deserve it? I think we all have, or at least those of us who still feel the need to occasionally rationalize purchases.

The belief that I deserve something is very attractive. It sets the stage for a story of injustice. If I do not possess this object or enjoy this experience, I have been wronged.

Although we share a few inalienable rights, we all live under the reality that most things in life are scarce. In a market system, prices convey important information about scarcity. And so, we might very well need something or even deserve it, but someone must pay for it.

Insisting that we deserve things we cannot afford gives birth to a sense of entitlement which begets reckless spending. A belief which pushes us further from reality and ignores the core issue. To acquire something, we must pay the associated costs.

When costs are ignored, years of sacrifice are often required to remedy the situation. If the problem is ignored for too long, occasionally, bankruptcy is inevitable.

The current foreclosure mess is just one example of the spread of I deserve it thinking. The American dream was treated as a right and the true costs and sacrifices of homeownership were not counted. Dreams lie shattered and families are relocating—all because people felt they deserved a house or a piece of the rapidly appreciating housing market. They simply didn’t weigh the costs of homeownership.

Are you focusing today on something you want or need, instead of how to get there? How do you remind yourself to focus on how to accomplish your goals instead of fixating on wants and “needs”?

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Ben Stein’s latest book offers a different, destructive take on one’s personal finances. How to Ruin Your Financial Life contains over fifty popular ways people sabotage their financial lives.

With each lesson taking no more than a couple of minutes, the book is a quick read. It’s also a funny book; Ben’s trademarked dry humor abounds, reaching Saharan levels as he explains why and how you should ruin your financial life.

Each rule is designed to shock readers from their complacency. Although most of the rules might sound like bad ideas, Ben assures us that things will be different for us. So, you see, there really is no reason to be afraid.

Now while we might not spend as much as we want, bravely going into debt (rule 6) and we probably don’t believe that we are not responsible for our financial well-being (rule 16), we still might be making a few of the mistakes described.

If you do see a little of yourself in this book, changing your financial habits should be a little easier after reading about the company you keep.

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Have you heard that advertising campaign about people almost helping their neighbors? It’s a powerful message. Sometimes we think about doing good, but we fail to follow through.

The thought is either pushed aside or we fool ourselves into thinking that it’s the thought that counts. We’ll just do that later.

With investing, like doing good, the thought or intention is not good enough. We can intend to start saving for retirement all we want, but our problem is only going to grow bigger and bigger. It will continue to grow until we actually come up with an investing plan and a written game plan (budget) for setting aside money for our future.

I could list statistics and facts like the amount we must save doubles for every decade we delay, but statistics won’t change most people’s minds. Just as we have to want to do good, we have to want to be responsible in order to be financially successful.

Do you have any plans, dreams, or good intentions lying around gathering dust? Today could be the day to make the leap, plunge, or effort. No one is stopping you, but yourself.

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“I need it” thinking can be dangerous.

Dangerous because it is occasionally true. But more often, we’ve simply confused our wants with our needs, resulting in more money flowing out and new “needs” sprouting up.

Needs usually fall along a scale. Food can be a matter of life or death, but usually the choice is between dining out and preparing food at home. That new tool or gadget might make your job easier, but you could probably make do just as well without it.

Sometimes the truth is dangerous

“I need it” thinking is most dangerous when it’s actually true. Sometimes we really do need something like parts for an unreliable car and the money isn’t there to buy it. Sometimes the solution is to buy it on credit, but that is a dangerous strategy.

More often, the wiser route is to:

• find the money (extra job)
• alleviate the need (borrow it, or find a substitute)
• eliminate the need (sell the unreliable car and take the bus)

Rationalizing a purchase is always dangerous if we’re spending money we don’t have. The real issue is “can I afford this,” not “do I need it.”

Have you ever fallen for “I need it” thinking? I did yesterday. Even though I could afford it, my visit to Half Price Books cost me dearly, falling just shy of three hundred bucks!

If you make a habit of ignoring “I need it” thinking, you’ll make better decisions and end up with your money working for you which is one example of good financial sense.

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Generally, saving money is a great idea.

Most of us would be better off if we were more frugal.

However, there are times when it doesn’t pay to be frugal. Here’s six examples where the costs outweigh the savings.

1. When the savings are minimal

Sometimes the savings are so tiny that it simply doesn’t pay to extend the effort. Most of our expenses can be trimmed here and there, but the savings are too small to make the effort worth while.

It’s also important to distinguish between regular expenses and infrequent purchases. For example, regularly buying soda and snacks from convenience machines is expensive. The premium for the convenience is simply too costly. However, the added cost from an occasional purchase is fairly minor, insignificant enough that it might not be worth depriving yourself.

2. When your time is more valuable

For some people, their time is far more valuable than the average person. For these successful and wealthy people, attempting to trim costs simply isn’t worth the effort. For every hundred dollars trimmed from their budget, they might be missing out on thousands in income.

In a similar way, everyone can point to an experience or activity that is worth every penny. For married couples with children, it might be a date night. Others might prefer to pay someone to maintain their lawn (or not). The key is that the experience enriches your life in a way that saving the money could not.

3. When you have bad financial habits

While almost everyone can benefit from frugal habits, some people have bigger fish to fry. Expecting a spendthrift to be frugal is like asking a student to take calculus before algebra and geometry. The student will fail.

People accustomed to living beyond their means are more likely to embrace reasonable, moderate reforms than deprivation.

4. When you don’t earn much

Of course, some people live beyond their means because they earn too little. When you’re just scraping by, you have to be frugal. However,
focusing your energies on being thrifty is a mistake.

The solution to low income is not lower expenses, but higher income! Focus on getting an education or developing skills that will allow you to earn more.

5. When it costs more in the short run

Some products and stores offer significant savings when you buy a lot up front. For some people, buying in bulk makes a lot of sense. If you have the space and the money up front, there are savings to be had.

The key is to spend your money, not the credit card company’s. If you carry a balance on your credit card, spending more to buy in bulk probably isn’t saving money.

6. When “doing it yourself”

A lot of us enjoy do-it-yourself projects. We often rationalize that we’re saving money which is true if:

1. we can do it safely
2. we can do it well
3. the savings outweigh our time’s value

Otherwise, you’re probably better off paying someone to repair your car, house, etc.

What frugal activities do you find worth your time? Which ones aren’t worth it?

This article was featured in the Festival of Frugality hosted by Mrs Micah.

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Do you know that feeling of anticipation, when you hold a new book, knowing full well it will be a joy to read from start to finish?

Russell Roberts has managed to craft another such a gem. But The Invisible Heart is more than a good story, it’s a love letter about economic freedom.

Roberts has a knack for making economic lessons accessible, even fun to read. In his first book The Choice: A Fable of Free Trade and Protectionism he made the case for trade.

With The Invisible Heart, Roberts pioneers a new genre, the economic romance. The story features an unlikely pair; a couple so unlikely, that the ending remains a surprise up till the end.

Invisible Heart features more plot turns than Roberts’ first book, but still contains plenty of his trademark dialog. In fact, the only way economics instructor Sam and idealist co-worker Laura might have a chance together is through many deep discussions.

Many of their discussions involve Sam defending his profession. Laura sees businesses as greedy and economists, like Sam, as their stooges. Instead, Sam explains that he loves freedom and he has little to no faith that the government can improve life through regulation (restricting freedom).

As their relationship progresses, Sam has the opportunity to dispel many common myths about the dismal science, and the dangers of government intervention.

The Invisible Heart is an exciting story full of rich dialog. Sam’s arguments might not convince everyone about the free market’s advantages. But all readers will better understand the dangers of government intervention and why some people prefer to let the market work.

You can learn more about economics at Russell Roberts’ homepage, or at Cafe Hayek where he blogs. He also hosts a regular “economics podcast for daily life” called EconTalk. The Invisible Heart is available at Amazon.com and sample chapters of his books are available.

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When is a book more than a book? Occasionally a book comes along with an idea so powerful, so simple that it threatens to transform the world.

Russell Roberts’ The Choice: A Fable of Free Trade and Protectionism is more than a book.

Roberts offers us a glimpse of a different America, an America free from foreign competition. A poorer America because it shunned trade. This alternative history is particularly relevant today as members of the media and politicians are all too happy to promote the idea that foreign countries like China are stealing our jobs.

Instead, Roberts shows readers how trade does not affect the number of jobs, instead it affects the types of jobs people work. Fortunately for us, one of the main characters is resistant to the idea.

This resistance to change provides the premise for the story. Ed Johnson, CEO of the Stellar Television Company is facing increased competition from lower priced Japanese televisions. Johnson is a generous man who wants to see his employees protected. His solution is a tariff on Japanese televisions.

In 1960, the tariff passes and employees of the Stellar Television Company continue to prosper. But this tax puts American down a dangerous path and it’s up to nineteenth-century economist David Ricardo to show Ed why (and to earn his heavenly wings in the process).

Their discussions range from outsourcing to tariffs to trade deficits and whether globalization helps the poor.

Roberts view of trade is anything but naive. Sometimes a few people are made worse off when their job moves overseas, but most people’s lives are enriched. The foreign worker now has a job much better than what was available before. Everyone now has access to a more affordable product. And the displaced worker is freed to pursue other opportunities that might pay more or be more rewarding.

Ultimately, the next generation has more money and more choices that were simply unimaginable when the jobs initially moved.

The Choice is a wonderful little book full of powerful examples that will help you better understand the benefits of trade. A clearer understanding is important today as free societies are faced with the choice between allowing people to make mutually beneficial transactions or protecting the incomes of a few at the expense of many.

You can learn more about the benefits of trade at Russell Roberts’ homepage, or at Cafe Hayek where he blogs. He also hosts a regular “economics podcast for daily life” called EconTalk. The Choice is available at Amazon.com and sample chapters of his books are available.

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Last time we talked about stock ownership and how it’s different from gambling, but that risk still remains.

In particular, the risk that your companies may go out of business, leaving you with stock worth little more than used lotto tickets.

This is a very real risk. Fortunately there is a reasonably safe solution. But first, lets push away—once and for all—the dream that you will find the next Microsoft by investing in individual stocks.

Prepare to be disabused

Picking a big winner is highly unlikely. Even the experts have trouble selecting future big earners, at least without also selecting plenty of big losers as well.

Not only do you need to find the right businesses, but you must find them at the right time as well—a near impossible task for the individual investor at home.

You also need to know the best time to sell a winner, so you can buy the next fast grower at the right price. Company growth and stock growth slows over time, so one would need to be extremely flexible, and right. All of the time.

Finally, hidden minefields must be avoided. Stock owners always face the small, but real risk of losing everything when a company suddenly goes bankrupt.

Sound easy? Fortunately, there is an easier way to own successful stocks.

A safer, more reliable way to own stocks

So how does the average investor avoid these pitfalls, while still enjoying any upturns in the stock market? Index funds. Index funds allow investors to own hundreds of stocks, spreading their risk across the entire market.

In fact, a mutual funds’ success can only be measured by comparing it to the relevant stock market index. While some funds manage to beat their indices, few do so consistently. (Indices is simply a fancy financial term for “indexes.”)

Simply investing in an index fund will allow you to beat up to 85% of the actively managed funds out there.

This is possible because:

• Index funds have fewer transaction costs (constantly buying and selling incurs a lot of stock trading fees). Lowered transaction costs translate into lower expense ratios for investors, leaving thousands of dollars where they belong—with you.
• Index funds protect you from incorrectly timing the market. Many of the biggest stock market gains are limited to a short period of time. If you aren’t invested or if you own the wrong stocks you would miss out on huge gains.
• Index funds are protected from management risk. Some managers beat their relevant indices, some of the time. However, there is a risk that they will retire, make a big mistake, or some other surprise will affect your return. With an index fund, you always know where your money is invested.

To learn more about investing with index funds, check out the reliable but accessible book: The Bogleheads’ Guide to Investing (sample chapter available).

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