Wednesday, April 29, 2015

How To Evaluate Credit Card Balance Transfer Offers
Last week, I promised you I'd show you how to evaluate those balance transfer offers you get from your credit cards, so let's get into it, shall we?

Here's the situation: You're currently carrying a balance on a somewhat high interest credit card. I know, you broke the cardinal rule of credit cards by not paying off the balance in full each month. I'm not going to judge you for carrying a balance. There is no slut-shaming here. What's important is you realize you are wasting money paying that high interest rate and are ready to take steps to correct the problem.

Your current situation:

Credit Card #1
Balance $4,000
Interest Rate 15.95%
Minimum Payment $120
Actual Payment $150

First off, congrats on making more than the minimum payment! It may not be much more, but it's all your budget can afford and you know every little bit extra helps. You also know that in order to get out of a hole, the first thing you have to do is stop digging, so you've resolved to not charge any more purchases until you get this debt paid off.

Let's see what this is costing you. We'll use the credit card calculator here and plug in values of $4,000, 15.95%, and a $150 payment. That shows it will take 34 months to pay off this debt and you will end up paying $972 in interest.

But today is your lucky day! You got a balance transfer offer in the mail from your other credit card (the one you are NOT carrying a balance on). It gives you two choices:

  1. 0% interest for 18 months, then 11.99% on the remaining balance, with a 3% or $10 balance transfer fee (whichever is more) or
  2. 4.99% for 21 months, then 11.99% on the remaining balance, with no balance transfer fee

Which should you choose? That no fee one sounds better, doesn't it? Maybe that's the one to take? There's only one way to figure this out - we must use the maths! For each offer, we'll figure out how much it will cost us in total interest and then choose whichever one is the lowest. We will assume we will continue to make our $150 monthly payment - after all, that's in our budget and it's all we can afford.

Option #1

This one is the easiest to calculate. First off, let's tackle the fee. Three percent of $4,000 is $120. That is more than the $10 minimum, so that's what our fee will be. Not looking too good so far.

We will be charged no interest for 18 months. This means for those 18 months, 100% of our payment will go towards reducing our balance.  18 * $150 = $2,700, so after 18 months, we'll have a remaining balance of:

$4,000 - $2,700 = $1,300

At this point, the interest kicks in at 11.99%. Going back to our credit card payment calculator, we plug in $1,300 for our balance, 11.99% for the interest rate, and $150 for the payment. It tells us this will be paid off in 10 months and we will have paid $67 in interest.

What's our total cost for Option 1? That is equal to our transfer fee plus our interest charges, or $120 + $67 = $187. The balance will be paid off in 18 + 10 months, or 28 months.

Option #2

This one is a little more complicated to figure out, but we're going to make some assumptions to simplify things. Normally, loans are paid off on an amortization schedule, meaning even though you are making the same payment amount each month, as time goes on, more of that payment gets applied to principle and less to interest (because our outstanding balance is dropping and the interest charged on that amount will therefore also drop). We're going to ignore that and just assume the same amount goes to each portion each month, at least for the initial 21 month period. This means our interest calculation results will be slightly higher than what we would actually be charged, but it will be close enough to the actual value to be able to make a valid comparison to Option #1.

There is no balance transfer fee for this option, so we have no cost there.

For the first 21 months, we're paying 4.99% interest. This is $4,000 * .0499, or $199.60 per year (because interest rates are quoted on a yearly basis). Per month, this works out to $199.60 / 12, or $16.63 per month. So of our $150 monthly payment, $16.63 is going towards interest, leaving $133.37 per month to reducing the outstanding balance. After 21 months, the balance will be reduced by $133.37 * 21 = $2,800.77. So when our promotional interest rate expires, our outstanding balance will be:

$4,000 - $2,800.77, or $1,199.23. Let's call it an even $1,200.

The rest of the calculations are done just like they were for Option #1. We'll go back to our credit card payment calculator and plug in $1,200 for the balance, 11.99% for the interest rate, and $150 for the payment amount. It reports it will take us 9 months to pay off the balance and we will have paid $57 in interest.

What's our total cost for Option 2? That is equal to our transfer fee plus our interest charges, or $0 + ($16.67 * 21) + $57 = $407.07. The balance will be paid off in 21 + 9 months, or 30 months.

The Final Comparison

Let's look at what we figured out:

Total Cost (Interest + Fees) Time To Pay Off
Current Credit Card $972 34 months
Option #1 $187 28 months
Option #2 $407 30 months
It's clear that Option #1 will cost us the least amount of money, even though it comes with a 3% balance transfer fee. That's the option we should choose.

Important! This analysis assumes you are not continuing to charge purchases to the card during this period. If you do, this whole analysis goes out the window. This is because credit card companies will apply any payments you make to your lowest interest rate (i.e. promotional) balances first. If you go with Option #1 and then charge another purchase to that card, none of your payments will go towards paying that purchase off until the promotional balance is paid off. So if your normal credit card rate is 11.99%, you will be charged that in interest on your new purchase for 28 months before you start paying that new purchase off. Odds are, that will wipe out your savings from the balance transfer.

Wednesday, April 22, 2015

How To Use A Credit Card - Part 2
Last week, I went over the basics of using credit cards responsibly. This week, I'll take a look at some of the more advanced things you can do with them and I'll also give a brief overview of what I do.

Advanced Topics


Many credit cards offer some sort of rewards, either airline miles, cash back, hotel points, or something else. The offers change all the time. There are websites dedicated to tracking the best reward cards and there are people who go to extreme lengths of maximize their rewards. Which reward card you get really depends on what you want and what you spend money on. Travel a lot and would like to travel more? Get a card that offers frequent flier miles. Just want cash back on all purchases? There are cards that offer that, with higher cash back rates for purchases at certain stores.

Most reward cards charge an annual fee. As long as the rewards you actually get are worth more than the annual fee, you're coming out ahead.

If you decide to get a card that offers rewards you want, go all out. Charge everything. Buying a pack of gum? Use the credit card! Buying groceries? Use the credit card! Renting a movie? Use the credit card! But always remember the rule: YOU MUST PAY OFF THE CARD IN FULL EACH MONTH!! Never carry a balance. If you do, the interest charges you will pay will negate and even eclipse the value of your rewards and you'll end up losing money. If you cannot pay off the card in full each month, don't use it.

Text / Email Alerts

Most all credit cards offer some sort of text or email alerts. You can set these up to remind you of a coming payment due date or to alert you anytime a charge over a certain dollar amount is made. Two of my favorites are alerts anytime my card is used but not physically present, i.e., phone or internet transactions, and alerts anytime my card is used at a gas station. Credit card thieves like to test out stolen cards at gas stations because they typically are self-service and the initial charge is relatively small. If the card works there, they then move on to larger, more expensive purchases. The gas station alert actually saved me a lot of hassle last year. I used my credit card to make a hotel reservation in Vancouver, Canada. About 2 weeks after I made the reservation, I got an email alert that my card had been used at a gas station in Canada. I was able to call the credit card company immediately and have the card cancelled and a new one sent to me within minutes of the fraudulent charge being made.

Balance Transfers

Many cards offer 0% interest or $0 fee balance transfer offers. Be sure to read the fine print of these to see if they are right for you. If you have a debt you are being charged interest on, it might be worthwhile to transfer it to a credit card with a lower interest rate. You need to do a couple of calculations here to determine this.

First, figure out how long it will take you to pay off the debt at the current interest rate. Determine how much interest you will pay during that time. Now, look at your offers. Zero interest rate offers usually charge a service charge for the balance transfer, typically a percentage of the amount transferred. Is that amount less than the interest you would pay on your current debt? If it is, and you can pay off the loan before the 0% interest rate expires, do the transfer.

Now look at the $0 fee offer. What is the interest rate and how much interest will you be charged before you can pay off the debt? Is that less than what you would pay if you didn't transfer the balance? Is it less than what you would pay under the 0% interest offer? If it is, use this deal for the balance transfer. Be sure to pay off the debt by the time you used in your calculations or you could end up paying more money, not less.

I'll do a more detailed write up about this, using actual numbers, next week.

Playing The Rewards Games

Again, there are tons of websites on how to maximize your credit card rewards. I won't get into all of the methods, but I will point out that getting the most of your rewards program does require some attention to detail. For example, some cards offer increased cash back from certain retailers or store types during certain months of the year. If you are not good at tracking little details, it might be best to go with a simple rewards program that closely mirrors your regular spending patterns anyway.

How I Do It

I have three credit cards, all of which offer some sort of rewards, plus my debit card.

  1. Discover Card - This card I keep because it was one of the very first credit cards I got. I've had the account since 1989. Since 15% of my credit score is based on how long I've had accounts open, I want to keep this card. Back when I got it, Discover was about the only card that offered a cash back program - 1% cash back on all purchases. Now, they have changed with the times and offer 1% cash back on all purchases with 5% cash back from a rotating set of industries that changes each quarter. For example, this quarter, I get 5% cash back on all restaurant charges. There is no annual fee.
  2. Chase Freedom Card (Visa) - The general consensus is this is one of the best general cash back cards out there, so I got it about a year ago to replace an airline mileage card. (I don't travel enough for an airline mile reward cards and mine started charging an annual fee, so I dropped it.) Like my Discover card, the Freedom Card also gives me 1% cash back on all purchases with 5% back on a rotating group of industries that change each quarter. Right now, I get 5% cash back on all grocery purchases. Last October through December, I got 5% back on all purchases at Guess where I bought everyone's Christmas gifts? There is no annual fee. When I signed up, I also got a $100 bonus after charging my first $500 and no interest on charges for the first 15 months.
  3. American Express Starwood Preferred Guest - This card earns me one Starwood point per dollar spent. The Starwood Preferred Guest program is one of the better hotel points programs out there. Not only can you redeem the points at any Starwood hotel (which includes the Sheraton, W, A loft, and Westin hotel chains, among others), but you can also redeem them 1-for-1 for frequent flier miles on just about any airlines. There is a $95 annual fee. I use the points for 2 to 4 free nights at hotels during the year, so I'm still coming out ahead, even with the annual fee.
The cardinal rule of credit cards is to never carry a balance. With rewards cards, you want to charge as much as possible to earn your rewards. Those could be contradictory goals, so you need to manage your expenses carefully. To do this, I use an app on my phone called Expense IQ to track all my spending. This program has replaced my checkbook and it tracks all my credit cards and bank accounts. I enter all my charges into the app and then, each Sunday night, I log into my bank's website and go to the electronic bill pay area. I schedule payments to my credit cards that cover all the charges I made that week. I schedule the payments to be made three weeks in the future, so the money stays in my account earning interest as long as possible without incurring interest charges from the credit card.

Costco only accepts American Express, so I use that card there for groceries and gas. Starting April 1, 2016, American Express is out and Visa is in, so I'll be switching to using my Visa card. Since Costco is the only place I use my Amex card, I'll have to shift my spending somewhere else if I want to continue to earn Starwood Points. I'll be watching to see if it still provides me enough value to overcome the annual fee. I know I'll at least keep the card through December 2016, as we're planning a trip to Germany and I have enough points to get our hotel for free.

The Chase Freedom Card gives me 5% cash back on grocery store purchases for the first three months of this year. I also tend to order a lot of stuff from, so I play the reward maximizing game by buying Amazon gift cards at my grocery store, thus getting 5% cash back on them while getting Amazon credit I would use anyway. Combined with my use of my grocery store's loyalty card, which gives me about a 30% - 40% discount on one tank of gas each month, I'm getting some nice rewards from grocery shopping!

The zero interest rate for the first 15 months also is proving to be a huge benefit. I recently remodeled my master bathroom. When planning this, the original strategy was to use a home equity line of credit to pay for it. Instead, I used the credit card everywhere I could. I got 1% back plus no interest charges. When the 15 month interest-free period ends, I'll pay off the card with my HELOC, which has a much lower (and tax-deductible) interest rate.

As you can see, I don't quite go all out trying to maximize my credit card rewards, but I do make an decent effort. It does require attention to detail, but that's the type of person I am anyway, so I'm comfortable with it.

Wednesday, April 15, 2015

How To Use A Credit Card - Part 1
In today's world, your credit score impacts many aspects of your life, some not even related to finance. In addition to determining what interest rate you'll pay on loans, your credit score can be used to determine your insurance rates and your ability to get a new job or a new cell phone. Many people who advocate living debt free also advocate not having any credit cards at all. Because your credit score is used in so many different ways, and because credit card use makes up a large portion of your credit score, not having credit cards may actually hurt you in the long run. If you cannot show lenders or service providers that you can responsibly manage debt, they will either not lend you money at all or charge you a higher interest rate than you should be paying.

Credit cards are not something to be afraid of or avoided. They are simply a tool. They can be used for good or evil. They can bring you rewards and perks, but they can also drive you to bankruptcy.

The Basics

The Cardinal Rule

The Number One rule when using credit cards is: Don't carry a balance. Pay off the card in full, every month. If you do this, you are getting an interest-free loan from your credit card company, which is a good thing. It means your money sits in the bank earning interest while you spend someone else's money throughout the month. Of course, there's no such thing as a free lunch, so you will have to pay the credit card company back, but if you do this in full each month, they won't charge you interest. If you don't however, they will - usually at an incredibly high interest rate in the 15% to 25% range. Paying interest raises the cost of whatever it was you purchased. You know those killer shoes you found on sale for 50% off? If you charge them and only pay the minimum due amount on your credit card statement, they weren't 50% off. They were probably more like 50% extra.

Always Use Protection

Credit cards give you a certain amount of protection. If you purchase a product or a service from a company and you have problems with it that you can't resolve with the seller, you can many times call the credit card company and file a complaint or a charge back. The credit card company will either remove the charge from your account entirely or place the charge on hold while they contact the seller to resolve the situation on your behalf. While they are doing this, you do not have to pay the charge and they will not charge you interest on the amount in question until the issue is resolved.

You are also protected in case the card or (more likely these days),  the card number, is stolen. Laws governing credit card companies say you are responsible for only up to $50 of fraudulent charges (providing you notify the company within 60 days). If you have the card stolen, you might not be responsible for any amount if you report the loss immediately.

Annual Fee

Look for a card that does not charge an annual fee. Cards that offer rewards usually charge an annual fee (I'll talk about those next week), but there are plenty of cards out there that don't. Get one of those. They may have a slightly higher interest rate than a card with an annual fee, but since you're never going to carry a balance anyway, the interest rate doesn't matter, right?

Debit Versus Credit

Debit cards look and work just like credit cards and some debit cards can also be used as a credit card. However, there are important differences between the two. With a credit card, you are spending someone else's money and, when the bill comes, you pay them back. When using a debit card, it's your money you are spending and the money comes out of your account almost immediately. This can cause some serious issues if your card is stolen or used fraudulently. Yes, the bank will eventually return your money to you, but you'll have to do without that money until the case is settled, which could take weeks.

You also have fewer protections when using a debt card. You remember that $50 liability limit I mentioned before? Doesn't apply to a debit card. Many credit cards also offer perks, such as free flight insurance when buying airline tickets, free auto insurance coverage when renting a car, automatic extended warranties on some items purchased, etc. Debit cards generally don't provide these benefits.

If you have a debit card that can also be used as a credit card, how do you know which it's being used as for a particular transaction? The most sure-fire way to tell is to remember this rule:

PIN = debit
Signature = credit

When you swipe your card at a payment terminal, choose the "Credit" option, not "Debit." You'll be asked to sign your name instead of entering a PIN. But beware! I have seen some terminals that ask you for a PIN even if you choose "Credit"! If you enter a PIN, you are using your card as a debit card, NOT a credit card, no matter what you selected. (Merchants prefer debit cards because they aren't charged as much to process them as credit cards, which is why you see these sneaky attempts to get you to enter a PIN.)

It's important to note that, even if you choose "Credit" and sign your name, if you are using a debit card, the money will still come out of your account almost immediately. You won't get a bill at the end of the month. You will gain the financial protections of a credit card, though - the $50 liability limit, etc.

How Many Cards Do You Need?

Not many. Too many credit cards can hurt your credit score, so you don't want to go crazy. Having 10 to 15 credit cards, even if there are no balances on them, will hurt your score. Thirty percent of your score is based, in part, on your available credit. Many cards = lots of available credit, which means you could go out and max out all those cards in one day and easily get into more debt than you can handle. I think a good limit is 3 or 4 cards. I own three - one Visa, one American Express, and one Discover. You may want to get a MasterCard as well, just so you have one from each issuer and therefore, will likely always have one that is accepted somewhere.

Those are the basics of credit card usage. If you pay attention to these, especially the part about always paying the balance in full each month, you'll never get into any financial problems and you'll be on your way to improving your credit score. Next week, I'll go over some of the more advanced features of credit cards and talk about how I use them.

Wednesday, April 8, 2015

Should You Borrow From Your 401(k)?
Most Americans have little, if any, savings. After hitting a low of 1.5% in 2005, the personal savings rate has rebounded a bit to just under 4%. This is still much lower than the 8% to 10 % it was between 1962 and 1982. These days, most people's savings is in the form of a retirement account, most likely an employer sponsored 401(k). With so little savings outside of retirement accounts, that big chunk of retirement money can be a large temptation for some people. Most 401(k) plans allow the employee to withdraw up to 50% of the total as a loan. This can be a relatively pain-free way to borrow money: there is no qualifying process, so you can't be turned down. The interest you are charged goes back into your own account, so you are paying interest to yourself. It sounds like a great deal, but is this something you should do?

Most financial advisers say no. I agree with them, for reasons I will get into later. But I came across this article on Nerd Wallet a while ago and was quite flabbergasted at it. I generally find the articles on that site to be useful and full of good advice. This article was even written by a professional certified investment advisor and broker. He is not, however, a Certified Financial Planner, which may explain his viewpoint.

In the article, the author argues that now is a good time to borrow from a 401(k). He points out that, for most advisors, the 401(k) is the "third rail" of debt management - meaning that it is a highly controversial topic and most would recommend not touching it. He then spends most of the article explaining why advisors do not recommend borrowing against it. His case in favor of borrowing against a 401(k) is not presented until the last couple of paragraphs and can be summed up as "The stock market is at a 6 year high and therefore, will likely drop soon. Borrow now to avoid the loss."

As he rather quickly glosses over, this is simply another way to say you are timing the market. Timing the market doesn't work. Period. I wrote about this extensively here and there have been countless studies proving the failure of market timing. As a registered broker, i.e., someone whose job it is to buy and sell stocks, it seems to me that the author has a bias towards frequent trading and trying to outsmart the market. As Warren Buffett says, don't ask the barber if you need a haircut.

What really bothered me about this article was the fact that, on a widely-read financial website, he put forth this position and failed to mention any of the possible downsides to borrowing against a 401(k). And, to my mind, there are at least two very signifiicant drawbacks that deserve special scrutiny:

  1. Money you pay back to a 401(k) loan is, in effect, taxed twice.
  2. Any loan you make must be paid back in full shortly after you leave your job - regardless of if you left voluntarily or involuntarily.

Let's look at the first one. The vast majority of people contribute to a 401(k) through payroll deductions made with pre-tax dollars. That money grows in the 401(k) tax-free until you withdraw it at retirement, when it is taxed as regular income. When you take a loan and make payments back to your 401(k), the loan payments are made using after-tax dollars. The Nerd Wallet author sees no problem with this because, as he points out, if you got a loan from any other source, it would also be repaid using after-tax dollars. He goes on to write "...If a person borrows from his or her Roth 401(k), there is no functional difference between the loan interest that is repaid and the participant’s own regular after-tax salary deferral contributions."

Whoa.. wait a minute here! Now we're specifically talking about a Roth 401(k)? The term 401(k) is used 21 times in his article. How many times is Roth 401(k) used? Exactly once. So which 401(k) type do you think most people are going to assume he is talking about? Right. A traditional 401(k).

If we are talking about a Roth 401(k), his statement is correct. However, Roth 401(k)s are still fairly rare, so few people have them and, in any event, his article sure doesn't go out of its way to specify which 401(k) type he is talking about, nor does he mention the fact that there is a difference.

Your average reader is going to assume he is referring to the traditional 401(k). Now, you can make after-tax contributions to a traditional 401(k) plan, however, very few people actually do this. The vast, VAST majority of contributions to a 401(k) are made using pre-tax monies deducted directly from the employee's paycheck. So the author is employing a rather sketchy slight-of-hand here to support his position. 

When you borrow money from your traditional 401(k), what is really happening is you are making your loan payment with after-tax dollars - your take-home pay from your paycheck. That money, which has already been taxed at your current income tax rate, goes back into your 401(k). Then, when you retire and withdraw that money, it's taxed again. Congratulations, you just paid taxes twice on that money. (This won't happen with a Roth 401(k) because distributions from those are tax-free.)

But far more troublesome is the author's lack of mentioning my second point - if you leave your job for any reason, be it voluntary or involuntary, any loans you have against your 401(k) must be repaid, in full, usually within 60 days. Failure to do so will result in the loan being recharacterized as an early distribution and subject to a 10% early distribution penalty tax. This applies to both traditional and Roth 401(k)s. So if you have a 401(k) loan and you are laid off or downsized, not only do you have the financial stress of an unplanned loss of income, you also have the stress of a large loan becoming due right when your income disappears.

To not even mention this in an article on a financial education website is, in my opinion, unconscionable.

I won't say you should never take a loan against your 401(k). I'm sure there are some situations where it is beneficial and perhaps even the best choice to make. However, those cases are rare and a 401(k) loan should be made only after some serious consideration of the ramifications.

Wednesday, April 1, 2015

Goal Update: End Of March 2015

At the end of each month, I post an update of my goals, including a brief discussion of any notable events that might have occurred during the month. The latest month's figures can always be found under the Featured menu in the menu bar at the top of the blog.

Last updated: End of March, 2015
Current value: $13,959
Change from last month: +$1,057
Percent of Goal:  12.84%

Note that the funds in this account are invested in stock, so there will be fluctuations in value that are outside my control. I never withdraw money from this account, so any dips are purely due to stock price changes.

Events Of Note Last Month:

In March, I bought another 11 shares of Realty Income. The stock has gone back up again and is still trading around its 5-year high. This is a bit frustrating, but in a good way: I'm close to unlocking another achievement but the rise in share price is keeping it just out of reach.

I received $342 from sales of my online courses, which is pretty good. Udemy is now running sales more frequently and offering courses at lower prices. It seems to be paying off. I'm picking up several students a week, so the lower income per student is more than being made up for by the increase in quantity. My typical monthly revenue has about doubled since they started these more frequent sales.

I had my taxes done this month and it turns out the money I receive from Udemy is classified as self-employment income, so I have to pay self-employment tax on it. I'll have to adjust the withholding amount on my regular job so I don't get hit with a big tax bill next year.

I also reached something of a milestone for the courses last month - I've now earned over $3,000 in total income from them - almost $3,500 in fact. Not bad, considering my total initial investment was a $149 microphone!

In March, I earned $10.68 in royalties from my first eBook. That actually covers two months. The payment for April came in on March 30.

Yes, I said first ebook. I alluded to this last month and now it is official: I have published a second ebook! This one is quite different from the first - it's a short fiction piece. Approximately 18 years ago, a friend of mine asked me to write her a story. I have no recollection of what led to the request, but I came across the file on my computer a while back and decided to dust it off a bit and publish it. I asked my nephew and his friend to make a few illustrations. The ebook is an Amazon Kindle exclusive and costs just $0.99. If you subscribe to their Kindle Unlimited program, it’s free. If you are an Amazon Prime member, you can borrow the book from the Kindle Owner's Lending Library for free. Check it out!

I will be the first to admit I'm not going to make a lot of money from this one book. For me, this is all about passive income. I want to get as much stuff as possible out there that can earn money for me 24/7. I'm not trying to create one thing that will bring in a ton of cash. I'm more interested in creating lots of things that bring in smaller amounts consistently. It all starts to add up and the diversity gives me some protection against loss of income should any one thing suddenly fail.

I can't overstate the power of passive income. I was on vacation two weeks ago and had 10 students enroll in my courses during that time. It felt great to be making money while relaxing on a beach in Hawaii!