Beating Broke

Personal Finance from the Broke Perspective

Murphy Strikes Again

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In the midst of spending 5 straight days remodeling our kitchen, our good friend Murphy’s Law decided to show up.  My father came over for the long weekend and helped.  Without him, the remodel would have probably been a disaster.  But, that’s not where Murphy comes into play.  One evening, after we had supper, we made our way to a local park so that the kids could run around and get worn out a bit.

As we were walking back to our car, we noticed a pretty good sized pool of liquid under the car.  Sure enough, it was oil.  It doesn’t take a mechanic to know that a pool of oil under your car is not a good thing.  Not even a little bit.  I got the car home, and parked it until Monday, when I could call the mechanic and have them take a look at it.

Luckily, when they called back with their diagnosis, it wasn’t a hugely serious problem.  A minor seal had broken and needed replacing.  The seal  itself is a $16 part.  The labor to replace it is a bit more.  We had been envisioning a bill in the $1000 range, but instead, got a bill in the $150 range.  Even so, that’s a pretty big unexpected expense for us.  A budget buster on most months.  Luckily again, we have our Murphy thwarting emergency fund and our remaining tax refund, so either case would have been handle-able.

Unfortunately, the extra expense will likely have to come from the remaining tax refund.  It’s good that we still had the money hanging around, but using it for the car repair will mean that we have to wait a few months for the new couch that we had planned on getting.  We do have a fancy new remodeled kitchen though!

Once again, we’ve been reminded how the stress of a Murphy’s Law moment is lessened by having an emergency fund set up.  If the repair on the car had been more expensive, or we had needed a new engine (or a new car), we would have had that $1000 sitting there to help with the costs.  It wouldn’t have covered the whole thing, but would have made a serious dent in the repairs.  Get yourself an emergency fund!  It will pay for itself in peace of mind.

Is CD Laddering Worth the Trouble?

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I’ve been thinking about this for quite some time, but today’s post from DoughRoller with A Dead Simple Alternative to CD Laddering was the icing on the proverbial cake.  And I think that DoughRoller is right.  Or at least, what DR says is in line with what I’ve been thinking too.

Here’s the basics.  A CD Ladder typically is made of several 1 YR  CD’s whose maturity dates has been staggered such that a new one is maturing about every 3 months or so.  Depending on the variation, some may even have one maturing every month.  It’s all in how you stagger the CDs.  Because you have them staggered, your money is never completely locked away and you can always get to some of it every month or three months.  So, any non-emergency expenditure can be planned for and the money from the most recent maturing CD can be used to pay for the expenditure.  At some point, you replace the CD and all is back to where it was.

My problem with all of that is that if you split $10,000 over 4 CDs, you get 4 $2500 CDs.  If you split it over 12, you get 12 $833 CDs.  That’s great, but what if you need to spend more than that?  You have to cash more than one CD.  Or you have to wait even longer until more of the money is freed up.  It’s not a catastrophe.  But it’s inconvenient.  On top of all that, you’ll likely pay a penalty on any extra CDs that you decide to cash out.  Again, not a catastrophe.

The solution, as DR and I see it, is to take that $10,000 and dump it into a long term CD.  Say a 5 year CD.  Yes, if you need the money before that 5 years is up, you will still pay a penalty.  But, the penalty is generally something like 3 months interest.  So, as long as you’ve held the CD for longer than 3 months, the worst you can do is break even.  If you cash it out in less than 3 months, you either didn’t plan well in the first place or you really have an emergency and you probably won’t notice a few months interest.  The main advantage of this method is that all of your money is available to you at all times.  A secondary, but nearly as important advantage, is that the long term CDs generally pay higher interest.  So, if you leave the money for the full 5 years, you will have made significantly more interest than you would have with 4-12 1 YR CDs.

Rate examples (as of March 31, 2010)

  • ING Direct: 1YR CD = 1%, 5 YR CD = 1.25%
  • HSBC Advance: 1 YR CD = 0.40%, 4* YR CD =1.70%
  • Ally: 1 YR CD = 1.54%, 5 YR CD = 2.99%

As you can see, there are some pretty significant differences in rates between a 1 year CD and a 5 year CD.  Ally only has a 60 day early withdrawal penalty.  HSBC only has a 30 day penalty.  ING has, by far, the worst penalties for early withdrawal.  Any CD over 12 months term will incur a 6 month penalty and any CD 12 months and under will incur a 3 month penalty. Looks like Ally is the place to go.

I think the strongest point for this type of CD investing is that I don’t like losing that extra interest because of a “maybe”.  Yes,  “maybe” I’ll need that money before that 5 years is up.  But, I may not need it at all.  And if that’s the case, I’d rather be earning the higher rate.  And if that “maybe” comes around?  Well, hopefully I’ll have had the CD long enough to override any penalty that comes with that.  At worst, with those examples above, I would only need to hold the CD for 6 months before it would be an even transaction.  Sure, I lose that interest.  But, again, that’s only a “maybe”.

Avoiding Reactive Personal Finance

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Just what is reactive personal finance?  It’s the management of your personal finance in reaction to events or situations as opposed to the management of personal finance in anticipation of events or situations.

The best example of this is a budget.  A budget is built and held to in anticipation of events in your financial life.  You know that things like your electric bill and water bill are going to be coming and roughly how much they  will be.  That allows you to budget for them and set aside money to pay for them with.  A budget is a great tool in avoiding reactive personal finance.

Why do we need to avoid reactive personal finance?  Because reactive personal finance is disruptive.  You are managing and spending your money in reaction to the events that are happening.  Doing so can cause you to quickly lose control of your finances and find yourself in a downward spiral of poor management choices and, eventually, it can lead to you being broke.

Some examples of events that can cause you to become reactive.  Medical emergencies, blown tires, unexpected social events, and even bills that are larger than they normally are.  Any thing that is unexpected can cause you to spend in a reactive manner.  And when you have events like that, it can often lead to larger problems, like overspending on luxury items to make you feel better.

How do you avoid reactive personal finance?  No plan is foolproof, so it’s not really completely possible.  However, you can make the odds of it happening be cut drastically.  How?  An emergency fund and a bit of willpower.  The emergency fund will give you the available spending power to cover any emergencies that would normally make you spend in a reactive manner.  Instead of trying to react and borrow from somewhere else to pay for the emergency, you can just pay from the emergency fund and not need to react any further.  The willpower comes in where the spending opportunity isn’t an emergency.  You have to have the willpower to avoid last minute and spontaneous spending that could drain your funds and cause you to become reactive when you no longer have the money to pay bills or buy necessities.

The best laid plans often go askew.  But, building an emergency fund and strengthening your resolve can go miles towards avoiding reactive finance and potential disaster.