Gold Investment

Zion, IL
By A.B. Dada
—
I received quite a few emails regarding my post from a few days ago, titled Preparing for the Worsening Credit Crunch. I forgot to enable comments, oops.

One of the emails was added as a comment because I had asked her to. A regular reader, Lane Petersen, emailed me the following question:

this advice goes against everything ive ever read from ramsey and other financial gurus. id love to see you prove them wrong tho, because we are in big debt and following ramsey’s advice and each month we have nothing left over and it is depressing. i read it twice and it does sound like it makes more sense in a harder economy. can i email you my financials and have you tell me how to go over payments?

I emailed her back last night, and she emailed me her family’s financial situation, which is precarious but not over the cliff. From the few people I’ve emailed about my theory, which goes against every financial expert’s view, I think it will work, and it will lessen the burden of a possible recession.

To recap, I have always been a “Pay off debt before investing” financial advisor for friends and family. Why invest at 10% if you’re paying 20% on your debt? It generally makes more sense to knock out debt before saving for the future, because you’ll pay less in interest sooner, compounding your long term investment gains. In the past 3 months, I have changed from that view significantly. I believe that savings is more important than debt reduction, but with a few standard caveats thrown in. I’ll try to explain my advice by using Mrs. Petersen’s example below. As I said, and others confirmed, there are not a lot of financial advisors who recommend this system. I am not a professional, I have no financial degree, and I am just theorizing this based on what I consider common sense, coupled with what I have seen as a massive amount of questions from people I respect who are now in financial trouble.

Here is the information that Mrs. Petersen sent me about her financial situation. She has given me approval to post it:

Income
Husband - $53,000 per year
Wife - $48,000 per year

Expenses
Mortgage - $1100 per month ($13,200 per year)
Property Taxes - $2100 per year
Insurances - $3600 per year
Credit Card #1 - 17%, $13,000 balance (Min is $260/month)
Credit Card #2 - 12%, $18,000 balance (Min is $360/month)
Credit Card #3 - 6%, $5,000 balance (Min is $100/month)
Auto Loan - 4%, $11,000 balance (36 months remaining, $325/month)
Groceries Monthly, $960 (budgeted)
Utilities Monthly, $840 (Electricity, Gas, Cable, 2 Cell Phones)
Auto Gas, $180 per month (they rideshare to work with others)

I totalled everything up, and their annual budget is $55,000, making just minimum payments. Lane told me that after taxes and budgeted payments, they have approximately $18,000 left over, or about $1500 per month. They’re putting all of this toward retiring the credit card debt, but they have absolutely nothing saved except for a small 401K. She told me that even though their bills are paid every month, they are depressed with their financial outlook for the future. I figured that if they continued to put all their extras towards debt payments, they’d be debt free in 25 months. If they paid the minimum, they’d be paid off in approximately 86 months. The difference is huge: 2 years versus 7 years.

The problem with the situation is that they have NO emergency capacity, other than credit on their cards. This is very scary. If either should lose their job, they would immediately be underwater. Thankfully, they did NOT HELOC a lot recently, and have paid that off. Their equity in their home is reasonable enough even in this popping bubble market, but taking a HELOC to overcome a job loss is not a good idea.

I looked over various options based on my “save now, pay debt later” theory, and I came to the following conclusions:

1. They’re overpaying for insurance. Because they have at least $20,000 left in credit lines, are very healthy, and don’t use their insurance often, they should raise their deductibles immediately. Putting a yearly deductible payment in an emergency on a credit card is actually a reasonable option, until you’ve saved enough in cash to pay for the deductible. By raising their low deductible from $500 to the maximum allowed (by law or policy), they can shave almost 30% off their health insurance and car insurance bills. This savings alone adds $1200 a year more to their extra.

2. Their utility bills are too high for the area they live (relatively warm winters). Yes, energy costs are up, but there are many ways to save. Wear sweaters before turning the heat above 66. Dress lighter rather than run the A/C. Turn off the lights (of course), and unplug appliances that aren’t in use (especially the TV which isn’t turned off but put on standby). They can shave another $300 a year with some basic changes. I highly recommend a family gathering each week to note your electrical, gas and water usage at the meter. Write this down into a spreadsheet. Look at week-over-week and month-over-month uses. You can even calculate what your bill will be (within 10%) by using the information from your past bills. I guarantee you’ll see at least a $30 savings the first month when you see what minor changes can do. Some households can see a $100+ saving in 2 months by learning what effects each utility.

3. There is no reason why they can’t be “saving” around $2000 per month. Their monthly minimum payment for all expenses comes to $4190. To have 18 months of security, they’d need $75,000 in the bank. Because they are a two job household, I believe that having 9 months of security in savings makes good sense, since the chance of both workers losing their jobs (in two different non-related industries) is slim. It can happen, but it is unlikely. I told her that they should try to get to $36,000 in the bank as fast as possible. This would take 18 months. It would means that all their credit, other than mortgage, could be paid off in 4 years instead of 2.

We examined both of my analyses this morning: how long they can live safely if one person lost their job, but they were paying down debt fast versus house long they can live safely if they paid the minimum and saved the maximum. The difference was 3 months versus 26 months, based on the idea of cutting off all unnecessary items and living VERY frugally if one person lost their job. We then made the same analyses together based on if one person lost their job, but quickly went to work for a very low wage at a restaurant, retail store, or other “lower income” type work. The difference was 8 months versus 44 months.

Mrs. Petersen and her family will be trying this theory. I have guaranteed her 6 months of interest if she doesn’t like it (I will pay the difference in interest). Already she says her and her husband are relieved, because she remembers when they had money in the bank, and the comfort it gave her when she knew she would be OK if life through a rock at her. Yes, it is counter to almost every financial expert, but the experts sometimes forget the depression you can enter when you’re paying your bills, but your subconscious mind makes you concerned about life’s speedbumps.

Note that my theoretical idea is not for everyone. I told Mrs. Petersen that their spending MUST be kept at the current level: zero. They have NO budget for some typical needs (new clothes, travel, household goods, etc) beyond what is listed above. They have NO gas budget right now either, as they both rideshare with others. I mentioned the idea of selling one car, but they’re unable to do so currently. One of their cars is paid off, and has a KBB value of approximately $7500 wholesale. This would get them to the 9 month safety level 4 months earlier, at which point they could consider buying an older but in good shape used car.

While this is a typical family in some ways, I have a great deal of respect for them to look at future problems before they occur. Most of my friends who are concerned about finances are already over the edge, and I have a very difficult time in helping them without resorting to bankruptcy or other legal, but immoral, means. This theory is for others like the Petersen family: those who feel “comfortable,” but have a nagging sense of depression or fear in the background.

Paying debt off quickly makes sense, but not if you can’t weather the short term before you catch up with the long term. Even if the dollar falls in value, your debt is based on the previous dollar’s value. Eventually, money inflation can lead to wage increases (without value increases), which does help pay down your debt easier, but other expenses are costlier as a percentage of your income.