Month: August 2016

Mental Money Mistake #1: Forgetting to Plan for Unexpected Expenses

A few years ago, we met with a young man who we’ll call Sam.  He asked us a very simple question: “Why can’t I ever seem to get ahead financially?”

We asked Sam to tell us a bit more about himself.  He continued: “I’m a college graduate.  I have a good job.  I pay my bills on time and don’t use credit cards.  I don’t spend money on frivolous things.  So why can’t I ever get ahead?”

Fortunately, after a deep dive into the state of his finances, we were able to help him find the answer: he made too many of what we like to call, “mental money mistakes.”

What are mental money mistakes?  They’re subtle errors in judgement.  Basic oversights and miscalculations.  As a rule, they tend to be subtle and easy to miss.  We’re not talking about big mistakes like taking on a bunch of debt, spending more than you can afford, or being too risky with your investments.  No, these are the kinds of mistakes just about anyone can make, even if they’re intelligent, hard-working types like Sam.

To help you identify mental money mistakes, we have decided to write a new series of articles.  Each one will discuss a different mistake and how to avoid it.  So without further ado, let’s dive into:

Mental Money Mistake #1: Forgetting to Plan for Unexpected Expenses

We all know the line, “Expect the unexpected.”  But how often do we actually do it?

The fact of the matter is that many people do a good job planning for expected expenses, like mortgage payments, health insurance, gas, and groceries.  But when it comes to saving for the future—whether for your retirement or just that trip you’ve always wanted to go on—we tend to forget about all the unexpected expenses life tends to throw our way.  And that’s a mistake, because a plan that assumes nothing will ever go wrong isn’t really a plan at all.  It’s more of a prayer.

With that in mind, here are five very common but usually unexpected expenses that many people fail to plan for:

1. Unemployment. Sure, no one wants to think about losing their job.  But what if the economy goes south?  What if the company you work for gets bought out?  What if you or a family member gets sick and it becomes hard to work your normal hours?  You have to admit, none of these events are exactly unheard of.  So ask yourself: do you have a plan for what to do if you lose your job?  Do you have any fallback options lined up?  Do you have enough money saved up to help you stay afloat until you get back on your feet?
2. Long-term or life-changing illness. If there’s anything unpredictable in life, it’s our health.  But even if you have health insurance, an extended illness can drain your savings in a hurry.
3. Car repairs. You know it will happen one day: the strange clunk-clunk sound you start hearing from your engine ends up being a problem that will cost hundreds, maybe even thousands, to fix. And if it happens more than once …
4. Your bills keep going up. What goes up does not necessarily go down. Anyone who has ever paid for an internet connection or satellite TV knows that prices tend to rise over the years.  Your basic utilities are prone to price fluctuation as well.  A really cold winter means your gas bill will go up.  If you have children in the house who keep leaving the lights on, your electricity bill will go up.  You get the picture.
5. Household repairs. When the toilet clogs or the faucet leaks; when a window breaks or the roof starts to degrade; when wood-boring beetles infest the tree in the backyard; unless you really like to DIY, that means paying for a professional … who usually aren’t cheap.

The point of all this, is to show that unexpected expenses can come at any time, in many different forms.  What’s more, they can really pile up.  In Sam’s case, even though he was being prudent with his money, he still had trouble getting ahead because he was always having to allocate more money than he expected to dealing with expenses.  And he’s not alone: according to a study by Pew Charitable Trusts, “more than 70% of Americans find it hard to save because of expenses they didn’t plan for.”¹

So what’s the solution?  Start a rainy day fund!  When most people save, they tend to just throw everything into one savings account and withdraw money whenever they either need or want to.  Instead, we suggest creating a separate type of savings account: one that can only be touched whenever the unexpected happens.  Every month, devote a set percentage of your income to the rainy day fund in addition to your regular savings.  Then, when your car inevitably breaks down, you won’t have to worry about it interfering with that vacation you’ve been saving for, because you’ve already set aside the funds to deal with it.

By making a list of possible expenses in addition to the regular expenses you’ve already planned for, you can make real progress in regards to getting ahead financially.

Stay tuned for next month’s article, where we’ll discuss Mental Money Mistake #2 … and learn why not all $20 bills are created equal.

¹ Ann Carrns, “Unexpected, but Not Unusual Expenses Thwart Efforts to Save,” New York Times, January 8, 2016.  http://www.nytimes.com/2016/01/09/your-money/unexpected-but-not-unusual-expenses-thwart-efforts-to-save.html?_r=0

Check out other articles

Negative Interest Rates

For most people, it starts when they take out their first loan.  Others don’t really think about it until they buy a house.  But whoever you are and whatever you do, at some point you’ll have to start paying attention to it.

We are referring, of course, to interest rates.

Interest rates are one of the many mile markers that separate adulthood from childhood.  (You always know someone’s growing up when they start having to worry about interest rates.)  But here’s a term even some adults haven’t heard of: negative interest rates.

While you probably haven’t seen the term in the headlines of your local paper, it’s become a common topic in global financial circles.  That’s why it’s a good idea to familiarize yourself with the concept, because there’s a chance you’ll see it much more often in the future.

First, the basics.  What exactly are negative interest rates?

Investopedia has a good definition:

A negative interest rate means [a nation’s] central bank and perhaps private banks will charge negative interest: instead of receiving money on deposits, depositors must pay regularly to keep their money with the bank.  This is intended to incentivize banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe.¹

Since the Great Recession of 2008, many countries have done almost everything in their power to help their respective economies grow.  One way to do that is to keep interest rates low.  Lower interest rates make borrowing less costly, which means businesses and individuals can borrow and spend more, thereby pumping more money into the economy as a whole.  This, of course, equals growth.

The United States has been no stranger to this tactic.  Our own central bank (the Federal Reserve) kept interest rates low for years.  Only in late 2015 did the Fed finally raise rates, and the increase was very small, going from 0–0.25% to 0.25–0.5%.²

But what happens if a central bank takes interest rates all the way down to zero, and it still isn’t enough to kick start the economy?

That’s when negative interest rates come into play.  It’s like hanging a carrot from the end of a stick, then telling the rabbit it has to either eat the carrot or lose a percentage of the food it already has.

What are the consequences of negative interest rates?  It depends.  For consumers, negative interest rates can mean that taking out a loan to start a business or buy a home becomes much more attractive.  Existing loans or mortgages with negative interest rates also become much easier to pay off.  On the other hand, simply keeping your money in a savings account becomes less attractive, since you will probably have to pay interest rather than earn it.

For banks, negative interest rates can be harmful.  After all, most banks rely on high interest rates to make money.  The less money they earn, the less money they have to lend—meaning less business overall.  That puts banks in danger of failing, which as we know from our own national experience, can plunge a country into recession.

Fortunately, most banks are aware of the risk and take steps to reduce it.  For instance, they may apply negative interest rates only to certain types of accounts and transactions.  Above all, though, central banks rely on negative interest rates to increase borrowing and spending, thereby boosting the economy and making long-term growth more likely.

As of this writing, several countries have dipped into negative interest rate territory.  For example, Japan went to -0.1% in February.³  The European Central Bank followed in March.  Nations like Denmark and Sweden have already instituted negative interest rates.  What about here in the United States?  Back in November of 2015, Janet Yellen, the Chairwoman of the Federal Reserve, acknowledged that negative interest rates are a potential tool for stimulating the economy, but seemed to dismiss any current need for them, saying, “I don’t at the moment see a need for negative interest rates.”⁴  In short, it’s possible the U.S. might see negative interest rates in the future, but not very likely.  It’s more likely that the Fed will continue raising rates, albeit at an extremely slow pace.

What does all this mean for investors?  Well, the global economy still remains fragile, which can lead to market volatility here at home.  So the fact that more central banks are taking steps to jumpstart their economies is probably a good thing.  On the other hand, negative interest rates are also proof that our planet is still a long ways away from economic stability.  As a result, we need to remain vigilant and educated so we can continue making the best decisions for your financial future.

Vigilant and educated—that’s why I make it a point to send you letters like this.  In the meantime, we’ll keep monitoring the global markets like we always do.  But if you ever have questions, about negative interest rates or anything else, don’t hesitate to let us know.  We are always happy to hear from you!

¹ “Negative Interest Rate Policy,” Investopedia.com, http://www.investopedia.com/terms/n/negative-interest-rate-policy-nirp.asp. 

² Patrick Gillespie, “Finally! Fed raises interest rates,” CNN Money, December 16, 2015.  http://money.cnn.com/2015/12/16/news/economy/federal-reserve-interest-rate-hike/?iid=EL

³ Paul Diggle, “Negative interest rates’ positive side,” CNBC, March 10, 2016.  http://www.cnbc.com/2016/03/10/negative-interest-rates-positive-side-commentary.html

⁴ Craig Torres, “Yellen Signals Solid Economy…” Bloomberg, November 4, 2015.  http://www.bloomberg.com/news/articles/2015-11-04/yellen-signals-solid-economy-would-lead-to-december-rate-hike