A number of people have asked me how I’m saving for retirement now that I’m self-employed, and several more asked yesterday when I mentioned that I was signing up for a SEP-IRA. In order to clarify everything, here’s exactly how I’m saving for retirement as a self-employed writer.

For comparison’s sake, my previous retirement savings were exclusively in 403(b) and 401(k) plans. Even though I planned to open a Roth IRA in 2007 (and even went so far as to fill out the paperwork), I eventually elected not to do it, primarily because of the costs associated with purchasing a house in 2007 and the fact that I was already rolling about 20% into my retirement plan. In fact, my savings in there is quite a bit above what’s considered “normal” for a 29 year old – I have substantially more than a year’s worth of my old salary in there, and it’ll just do nothing but grow over the next 30 years.

My current self-employement retirement planning is handled exclusively through Vanguard. I’ve invested with them in the past, I feel wholly comfortable with the way they do business, I agree strongly with their company’s investing philosophy, and I want to put all of my retirement into index funds, which is what Vanguard specializes in.

So what did I do? Almost as soon as I moved to self-employment, I opened up a Vanguard Roth IRA. A Roth IRA is a retirement account that almost anyone can set up (well, anyone with a Modified Adjusted Gross Income below $114,000 for an individual or $166,000 in a married couple). Each year, you can contribute up to $5,000 to the Roth IRA out of your after-tax money – it isn’t pulled straight out of your paycheck like a 401(k) is. However, once it’s in the account, it’s sweet – as long as you follow the very simple withdrawal rules (basically, no withdrawing until the account is more than 5 years old or you’re over 59 1/2 years of age), you can withdraw the earnings tax free – you don’t have to pay income tax on any earnings in the account (you can also withdraw your contributions at any time without penalty). For a lot more detail, read up on Roth IRAs at Wikipedia.

So, basically, each month I put a few hundred dollars into my Roth IRA at Vanguard – just enough so that after the year’s up, I’ll have contributed my total $5,000 (my wife is considering opening one as well, so that will make our combined contribution $10,000 for the year if she does that). Ideally, then, I’ll contribute $5,000 each year over the next thirty years into this account, taking me right up to retirement age. If I do that, and it earns even just 6% per year, that’s $395,290 I have access to at age 59 1/2, all of it tax free. If I get an 8% return on it, that’s $566,416 – tax free. That’ll certainly help with retirement.

What about the SEP-IRA? So, as I mentioned yesterday, I’m setting up a SEP-IRA through Vanguard as well, mostly because I wanted to contribute more towards retirement than the $5,000 a Roth IRA allows for me. A SEP-IRA allows a self-employed individual to contribute up to 20% of their profits to the SEP-IRA. I’m allowed to invest up to (approximately) 20% of my self-employment income into this plan (though I’m not going to be putting in quite that much). This plan is tax-deferred, meaning that I put in money before paying taxes on it and then pay income tax on everything I take out later on. For the purposes of most people, it’s like a 401(k) for the self-employed, except that you don’t get employer matches.

Right now, I’m contributing roughly 5% of my income each month to this plan – that’s in addition to the Roth IRA, but way under my contribution limits for the year.

How did I invest? In both cases, I set up a regular investing schedule and bought into the Vanguard STAR fund because I didn’t want to put in the $3,000 minimum for other funds. I’ll sell the STAR shares when it reaches $3,000 and move it to another fund. Eventually, I plan on having all of it split among a few funds just to ensure diversity – I want some international stocks, some domestic stocks, etc.

For most self-employed people, particularly those under the cap for a Roth IRA, this is a solid path to follow.

This morning, in a fit of self-disgust and angst, I made a long list of all of the stuff I’ve intended to do over the last few weeks and simply failed to accomplish:

I intended to finish two chapters of my book by now – only one is done.
I intended to clean out the garage – it’s still a mess.
I intended to add compost and topsoil to the garden and till it in – it’s still in “winter” mode.
I intended to wash the windows – still covered with two-year-old fingerprints.
I intended to finish up a really cool homemade Mother’s Day gift for my wife and for our mothers – still undone.
I intended to set up a SEP-IRA – the paperwork is still sitting on my computer desktop.
I intended to make some loaves of sourdough bread – the barm is still in the refrigerator.
I intended to deal with a big pile of correspondence – but it’s still left untouched.
I intended to do some serious number-crunching concerning what to do with our excess tax savings – it’s still sitting in a savings account.

What did I do instead?

I spent about three hours more than I intended to at the library doing research for my book.
I took my kids to the park for two hours, long enough that my son was actually getting tired of the park.
I took a two hour nap one afternoon after our children had been awakened in the middle of the night because of a thunderstorm.
I played some online games.
I bottled a batch of homemade beer – and brewed another one.
I spent way too long on the phone talking to my mother one afternoon.
I resorted my book collection and put away several volumes to take to a community book sale.
I did some volunteer work for a community project.
I spent about two hours designing logos and other things in Photoshop.

Obviously, some of these things were worthwhile things to do, but they leave a big problem in their wake: failure to accomplish. And that’s a real problem worth looking at.

A Task List is a Big First Step
One of the biggest steps a person can take towards becoming a more productive person is to maintain a to-do list in some fashion, whether it be simply a sheet of paper listing tasks to be accomplished, a text list on your computer, or an “inbox” in the Getting Things Done methodology. I’ve used such methods for years to keep the tasks I need to do out of my mind but stored somewhere safe so that I can focus on the task at hand instead of wandering mentally to the things I need to do in the future.

For the most part, this works really well. Whenever I have an idea or think of something I need to do, I just jot it down immediately without thinking about it. Then, when I get done with a task, I just go on to the next one on the list without thinking about it all too much. This keeps me moving all the time and it’s really empowering.

Failing to Follow Through Undermines the Value
The problem for me, though, is that it’s often too empowering. To put it simply, I often add more to the pile than I have time to ever accomplish. Right now, my task list has about sixty items on it and even if I worked like a madman on these items over the next week, I’d still end up with thirty or so items left on it.

Here, the problem isn’t the organizational structure – that’s good. The problem is that there’s simply not enough time in the day to do all of the things I want to do and thus things start falling through the cracks.

This is a problem that many people run into no matter how well organized they are. Our interests are so diverse and our ambitions are so large that we end up piling more and more on ourselves. Eventually, it doesn’t matter what kind of system you’re using – there simply aren’t enough hours in the day to get it all done.

That’s where I’m at right now.

Solutions to the Problems
So what can I learn from this?

Delegate One of the first productivity books I ever discussed on this site was The Four Hour Workweek by Tim Ferriss. In it, Ferriss strongly argues on behalf of delegating simple tasks to others so you can focus on the more complex things or the things you most enjoy.

Let’s look at this from my perspective. Professionally, I enjoy writing and talking to readers but I don’t enjoy some of the professional correspondence associated with it. I can’t tell you how many emails I get a day that are basically from PR firms, from people requesting interviews, or people who are just shilling for a product of some sort. Reading through this correspondence and figuring out what’s worthwhile and what isn’t is a very dull task that consumes probably an hour of my time each day. Hiring someone to do this boring (for me) task would be a way to free up an extra hour each day and, since the job is simple, I could pay a relatively low wage to do it. Is that extra hour worth $8 or $10 to me? You bet! I can transform that hour into something that’ll earn $20 or more over the long haul – and I’ll enjoy it more, too.

A similar logic applies to housework. It’s largely impossible to get any serious cleaning done when the children are around, so I usually burn 2 to 4 hours during the week cleaning when people aren’t around, doing things like dishes, straightening up the kitchen, and so on. If I were to hire someone to handle this task – again, at a relatively low wage – that time would be freed up for more creative work.

Eliminate Another useful option is to simply eliminate some of the areas that I want to follow up on. In essence, this means to de-involve myself from something so that I have time to adequately follow up on other ones.

For example, lately I’ve been making quite a bit of homemade goods – homemade beer, homemade laundry detergent, homemade sourdough bread, homemade wine, and so on. These have been fun things to do and they’ve saved a bit of money, but they’re not entirely high on my priority list. Perhaps it’s time to think about putting that stuff into storage for a bit until I clear out other aspects of my life.

I’ve also been wringing my hands a fair amount about financial decisions, even though I know what the best options are. Instead of sweating about it, why not just sit down and fill out those SEP-IRA forms and invest some of our extra tax money in there? In fact, I’ll do that right now.

Break It Down One of the major themes of Getting Things Done is the idea that most of our life consists of “open loops” – things that are just hanging out there, awaiting the next step. From page 128:

This is the biggie. If there’s something that needs to be done about the item in “in,” then you need to decide exactly what that next action is. “Next Actions” again, means the next physical, visible activity that would be required to move the situation toward closure.

This is both easier and more difficult than it sounds.

In other words, if there are some big things you need to do that you’ve been avoiding, look at them and figure out very specifically the next action that needs to be done. So, if my task is to clean out the garage, the first action I need to do is figure out what to do with all of the folded-up cardboard boxes still in there from our move last summer and also with the old torn-up junk loveseat that’s still sitting in the garage – it’s in such bad shape that Goodwill rejected it. That action’s easy – I just called our trash pickup service and they’ll take all of it next week for $8, recycling the cardboard for us if we bundle them all together. That means that my task is set – next Wednesday morning, I get out there nice and early, move the cardboard boxes and the love seat out by the curb with our normal trash, and then get to work on the rest of the mess.

Applying the Solutions
Let’s look at the tasks I wanted to get done but didn’t.

Finish two chapters of my book by now
Clean out the garage
Add compost and topsoil to the garden and till it in
Wash the windows
Finish up a really cool homemade Mother’s Day gift
Set up a SEP-IRA
Make some loaves of sourdough bread
Deal with a mountain of correspondence
Do some serious number-crunching concerning what to do with our excess tax savings

Delegation lets me eliminate washing the windows and dealing with the correspondence.

Elimination removes the sourdough bread – it’s simply too much of a task for the benefit. I’ll just add the barm to our composter. It also removes the SEP-IRA task and the number-crunching – I’ll just contribute that tax money to the SEP-IRA.

That leaves the following list:

Finish two chapters of my book by now
Clean out the garage
Add compost and topsoil to the garden and till it in
Finish up a really cool homemade Mother’s Day gift
Send in the SEP-IRA paperwork

Defining the next action for each task is similarly easy.

Outline the next chapter I need to write down to individual paragraphs
Put the cardboard boxes and the old loveseat out by the curb next Wednesday
Get some topsoil at the hardware store and plug in the tiller to charge
Finish that Mother’s Day gift
Send in the SEP-IRA paperwork

That’s my new to-do list. Instead of looking like an impenetrable wall of stuff, it now looks quite doable. In fact much of it can be done this afternoon, leaving me with a sense of actually accomplishing something instead of a sense of feeling overwhelmed.

At my house, we use a lot of AA batteries. Not only do several of our son’s toys use the batteries, but so do both of our baby monitors, our Wii remotes, our television remotes, and several wall clocks. Not only that, my wife’s breast pump runs on AA batteries as well, enabling her to pump in places where an outlet isn’t available (like on a long car ride when our children are asleep).

I did a count recently around our house and found that there are 36 AA batteries in use around our home (plus ten more in the breast pump, but I won’t count these for this purpose). Some of these are replaced frequently (even as often as monthly), like those in the Wii remotes and in my son’s self-propelled school bus toy – others are replaced rarely (less than annually), like the ones in the wall clocks. My estimate is that in an average month, we replace 10 AA batteries.

Because of our heavy battery usage – 120 AAs on average in a year – we were interested in finding an alternative to this expense, and we found that an investment in good rechargeable batteries up front will save significant money over the long run.

Let’s walk through this step by step. In order to do a fair cost comparison, I’m going to use prices from Amazon.com – a bargain shopper will be able to find better prices on specific items, but by using the same source, we can do a fair and valid price comparison.

Annual Cost of Non-Rechargeable AA Batteries
Since in a given year we burn through 120 AA batteries in our house, we obviously buy them in bulk in the largest packages we can. We’ve also tried many, many different brands of AA batteries and we’ve found that for our use, we almost always get the best bang for the buck from e2 Titanium batteries. They don’t have the longest life among the ones we’ve tried, but my wife and I have both observed that they have a very long life for the dollar.

So what do these batteries cost? You can get a twelve pack of e2 Titanium batteries on Amazon.com for $7.77. Since we use 120 per year, these batteries cost us $77.70 per year.

Startup Cost of Rechargeable AA Batteries
In order to effectively use rechargeables for our AA battery usage, we need to replace all 32 batteries with rechargeables, with four batteries to spare so that we can swap in fresh ones immediately and then put the empty ones on the charger. We’ll also need to invest in a charger.

After researching rechargeables, I found that almost every source recommended using eneloop rechargeable batteries because they don’t become weaker after many recharges and, more importantly, they hold their charge very well while just sitting there. I’m also investing in a quality battery charger that will last forever. Since I want these batteries to be a seamless replacement for our old AAs, I’m willing to buy the best.

As a result, I selected GE/SANYO eneloop AA batteries, which are available for $11.20 for a set of four on Amazon. Since I need 36 batteries, this is a startup cost of $100.80 for the batteries.

For the charger, I followed recommendations and selected a La Crosse BC-900, which not only charges batteries, but actually completely discharges them before beginning a charge, extending the number of recharges that you can get out of a battery significantly. Unfortunately, there’s another big cost here – $47.94.

Thus, the startup cost for our rechargeable battery use is $148.74. I recognize that I could cut some corners here and reduce the cost by buying other rechargeables or a lower-end charger, but the goal is to make the transition from disposable AAs as seamless as possible.

Maintenance Cost of Rechargeable AA Batteries
I put the charger on my handy Kill-A-Watt to see how much electricity is actually used in a recharge – and I was surprised. The battery recharger ate up 0.02 kilowatt-hours per AA battery recharged. Since I would be recharging 120 AA batteries in a given year, the recharger would eat up 2.4 kilowatt-hours per year. With electricity costing $0.10 per kilowatt hour these days, that means the charging cost per year for the rechargeables is $0.24.

Comparing the Two
Let’s look at this year by year.

In the first year, we would spend $77.70 on non-rechargeables. Simultaneously, we’d spend $148.74 on startup costs for our rechargeable batteries, plus $0.24 for recharging, giving a total cost of $148.98 for the rechargeables. Ouch – after one year, the non-rechargeables are way ahead, being $71.28 cheaper.

In the second year, though, the rechargeables get their revenge. The non-rechargeables cost $77.70 again, giving us a total cost over the two years of $155.40. The rechargeables just add another $0.24 onto the pile, making for a total cost over the two years of $149.22. Thus, after two years, the rechargeables are $6.18 cheaper, even after that huge initial investment.

Each year after that, the cost investment in the rechargeables is $0.24, while the non-rechargeables cost $77.70 – an annual savings of $77.44.

For us over the long haul, the rechargeables are clearly a good investment over the long term.

Let’s look at it another way. In the examples I used above, the rechargeable batteries cost $2.80 each and the non-rechargeables cost $0.65 each. Beyond that, there was also the startup cost of the charger itself – I used a very high-end charger in the example. The best way to spread out that cost fairly is to divide the cost of the charger by the number of rechargeable batteries you purchase. So, for that $47.94 charger above, my cost per battery for my 36 batteries was $1.33, giving me a total cost per battery of $4.13 per battery. At that rate, I have to charge up those batteries 7 times to match the cost of the disposable batteries. For me, that will take just about two years on average (some will be charged more often, some less, but that’s the average) – after that, this will turn into a great investment.

What’s Better For Me?
Let’s look at the numbers in general.

The more AAs you use in your home in total, the higher your rechargeable startup cost will be. This is because you’ll need to buy more high-quality rechargeables to rotate into the mix as the old ones wear out. You might want to just get rechargeables for the items you use often in order to reduce this number, but it’s really worthwhile to just get rechargeables into all of the places in your home where you use AAs.

On the other hand, the more batteries you use up each month, the quicker the startup cost will be recouped and you’ll be profiting from the investment. If you have a lot of heavy-use items that go through batteries like a child goes through candy on Halloween night, then this number is rather high and it’s worthwhile to dive into rechargeables.

The best way to determine if this is worthwhile for you is to keep track of how many AA batteries you replace over a long period – say, six months – and how many AA batteries you have in your home. The easiest way to count batteries is to buy a giant jumbo pack of the AAs and write the date of purchase on the back, then note the day you use up the last of the batteries – this will give you a good idea of how many AAs you use in an average month.

Here’s a thumbnail calculation: divide the number of batteries you waste in a given year by the number of batteries total in your home (plus a few for backup purposes). For us, that would be 120 divided by 36, or 3.3. That’s how many times you’ll recharge (or replace) an average battery in a year, and the higher it is, the more you’ll get out of a battery charger. My suggestion is that if your number is over 2, look seriously at getting high quality rechargeables into rotation. If it’s more than 4, you should definitely get good rechargeables in rotation.

I’m personally convinced that any household that has even a single device that uses a high quantity of batteries should look seriously into rechargeables. It takes some time to overcome that initial investment, but after that the savings is quite nice – it’s basically batteries for free.

This is the eleventh discussion in a “book club” series on Born to Buy by Juliet Schor, which focuses on consumerism issues and young children. You can jump back to the first discussion if you’d like. This discussion covers the first half of the seventh chapter, “Habit Formation,” starting on page 119 and ending after page 129 at the subheading “Who’s Responsible: Parents or Advertisers?”.

When Sunny Delight first came on the market in our area in about 1989, my best friend at the time became borderline obsessed with the stuff. I personally thought it was awful – it tasted like a mix of stale orange juice and pure Karo syrup, but my pal would regularly choose it over orange juice, even bringing a jug of it with him when he came over to our house because it was so much “better” than orange juice.

At the time, I just sort of nodded my head and would occasionally drink some of it, at one point even convincing my mother that I liked the stuff, resulting in her buying it a few times when it was on sale. Eventually, though, she got the hint: I simply didn’t drink the stuff unless my friends were around.

Was it marketing, or did my friend really like Sunny D? When I read through this part of Born to Buy, I couldn’t help but wonder.

Kids Versus Adults

From page 122:

Themes of kid empowerment and antiadultism are used to sell ostensibly mundane items such as snacks and cereal. [Food advertiser Amanda] Carlson described the agency’s approach for one sugary snack: “It’s empowering because it’s a snack that’s really very kid-proprietary, it’s not for adults … sometimes it’s licensed so it has shapes that only kids would like. There’s also an element of separation in there because it separates me from you: This is my snack. It’s a little irreverent. It’s something your mom might not want you eating, so that gives you power.”

When I first read this book, shortly after the birth of my first child, this section didn’t really make much sense to me. Sure, I had memories of childhood where I did things with my cousins and with my friends that were very much kid-oriented – we played with toys, had an old beat-up shed as a “clubhouse,” and so on. What I didn’t really remember was how that extended to food.

Already, with my son just two years old, I see it. Just last night, we had homemade pizza, and as it was being assembled, I realized that at least part of the ingredient selection for the pizza was due to my son’s preferences. He loves black olives, far more than his mother does, so I moved the black olives around so that a little more than half the pizza was coated in them (I like them, too). On the other hand, he doesn’t like mushrooms, so I moved the mushrooms around to only cover part of the pizza (I like them, so they covered part of the “black olive” section). In effect, it wound up almost being three pizzas in one – one piece with light black olives, one piece with heavy black olives, and another piece with heavy black olives and mushrooms.

My son was immediately able to identify which portion of the pizza was his – lots of “tires” (as he calls black olives) and no “mushy rooms” (as he calls mushrooms). It was a distinct portion just for him – different than what mom and dad were eating. I think this distinctiveness was part of the appeal – it’s a sign of independence and freedom.

Right now, the bridge hasn’t been made to food marketing, but it’s easy to see how it would be. “This is a pizza for kids!” it would say, and it would show off his favorite ingredients and probably come with a toy car and a premium price. It offers that same sense of independence and distinctiveness – natural things that growing children strive for.

No wonder kids want junk food that’s marketed to them. It tugs on their natural developmental tendencies.

Food as Addiction
On page 125, Schor makes a great case that the marketing of junk food to kids often uses adult behavior as a model, but transforms it into something palatable for kids:

If the idea of food as drugs sounds far-fetched, consider the findings of Wynne Tyree, director of research at JustKid, Inc.: “Kids say they use sugar like adults use coffee – to give them a boost. Since coffee isn’t allowed, and they have no other means to ‘get them going’ or ‘give them energy,’ they use soda, chocolate, candy, and sugary fruit drinks. It gives them the jolts they say they need throughout the day.”

In other words, some of the marketing relies on another natural aspect of childhood development – emulative play. Kids often pretend to be adults – think of a little girl taking care of her doll. Now, imagine a kid observing their zombie-like parent stumbling into the kitchen in the morning, eager to get their fix of coffee to help them get started.

It’s a behavior that kids are going to emulate – when they feel a natural energy lag, they’ll do what their parents do. They’ll find something that will pep them up, and marketers are quite happy to provide them with a boost in the form of a really sugary soda or an energy drink. Why do you think many soda ads and energy drink ads depict people burning a lot of energy in a very loud fashion?

I’m not condemning adults drinking coffee – I don’t drink any, but my wife often does. I am saying, though, that it makes sense that children would want to emulate it and, from there, marketers would take advantage of this natural emulation that children perform.

These examples have one thing in common: they take advantage of natural child development. Almost all children exhibit a certain set of natural behaviors – it’s part of the development of their mind as they grow. Sure enough, marketers are on board each step of the way.

What can you do to help? Be a model parent. Eat healthy foods so that when your kids emulate you, they eat healthy, too. Don’t exhibit substance addictions unless you’re fine with your children emulating it. They look to you for many of their cues – don’t give them bad ones.

The next discussion, coming in three days, will cover the latter half of the seventh chapter, “Habit Formation,” starting on page 130 at the subheading “Who’s Responsible: Parents or Advertisers?” and finishing out the rest of the chapter.

After posting my budgeting 101 article yesterday, I almost immediately got a response from a reader who had a very good follow-up question:

You talk all the time about setting goals and measuring progress. Without a budget, how do you set personal finance goals for yourself and measure progress?

My wife and I use only one metric to measure our financial progress – net worth. No other single metric says so much about our financial state.

Defining Net Worth
To put it as simply as possible, net worth is the value of your assets minus the value of your debts. In other words, if you sold everything you owned, emptied out every account, and paid every debt, how much cash would you have on hand (or, possibly, how much debt would you still have)?

Over time, a household with their financial hat on straight will see an increase in their net worth. They’ll spend less than they earn and invest the difference in some fashion. On the other hand, if there are financial difficulties, a family’s net worth might decrease over time, meaning their debt is increasing at a rate faster than their earnings – a very bad sign.

If you’re interested in trying it out yourself, here’s how to build your own net worth calculator.

Using Net Worth to Track Positive Financial Progress
Using your net worth to keep track of your financial progress is easy. Just calculate your net worth each and every month and track it over time. You might not necessarily see a jump every single month, but over the long haul, if the general trend is upwards, you’re in fine shape.

This long-term approach is much better, actually, than a monthly budget in terms of seeing the benefits of lifestyle changes and smart financial moves over the long haul – it constantly forces you to see the big picture, not just the picture of that specific month. You might not think a change that saves you $10 a month is a big deal from just the view of a monthly budget, but that $10 saved every month over ten years creates quite a different picture – used properly with an 8% annual return compounded monthly, that $10 a month becomes $1,802.12.

Because of that, things like buying in bulk and investing in quality stuff with a long lifetime show up as beneficial on a net worth progress chart, but don’t look nearly as good on a monthly budget sheet.

Using Net Worth to Set Short-Term Goals
My net worth calculator is a constant supplier of short term goals. Each month, I look at the sum total of assets and of debts and use that data to set small goals for the coming month – an asset increase of 1%, for example, or a debt reduction of 1%. These short term goals force me to keep my eye on the ball – talking myself out of buying VMWare Fusion, for a recent example – and keep myself constantly motivated.

These little goals are achievable, but by themselves they don’t seem like a whole lot. But look at it this way – if I target a debt reduction of 1% each and every month for a year, 11.3% of my total debt goes away. If I then keep pushing myself – moving that goal up to a 1.25% reduction every month, for instance, and then to a 1.5% reduction and then to a 2% reduction – I can push all of that debt out the door in just a few years.

Not only that, achieving those little goals over and over again enable big goals.

Using Net Worth to Define Long-Term Goals
Let’s say I want to achieve debt freedom in five years without reducing my current assets – that’s a big, audacious goal for most people. If my total debt is $100,000, that means that my true goal is to increase my net worth by $100,000 in five years.

How can I do that? $100,000 divided by 60 is $1,333 – that’s how much my net worth has to increase on average each month over the next sixty to achieve debt freedom.

I then set that as my small goal each month – my net worth needs to go up $1,333 that month. How can I do that? I can pay down extra debt. I can invest smartly. I can buy in bulk, effectively investing now for the future. I can work hard for extra income.

All of these little goals spring from a big goal, and that big goal is all about the net worth.

The Net Worth Mentality
The idea of net worth as a primary method of figuring financial success is a concept explained very well in the wonderful book The Bogleheads’ Guide to Investing by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf – I reviewed this one a while back and loved it.

Here’s what they had to say about the net worth mentality on page 7 of the paperback edition of the book:

From the time we are old enough to understand, society conditions us to confuse income with wealth. We believe that doctors, CEOs, professional athletes, and movie actors are rich because they earn high incomes. We judge the economic success of our friends, relatives, and colleagues at work by how much money they earn. Six- and seven-figure salaries are regarded as status symbols of wealth. Although there is a definite relationship between the income and wealth, they are very separate and distinct economic measures.

Income is how much money you earn in a given period of time. If you earn a million in a year and spend it all, you ad nothing to your wealth. You’re just living lavishly. Those who focus only on net income as a measure of economic success are ignoring the most important measuring stick of financial independence. It’s not how much you make, it’s how much you keep.

It’s not how much you make, it’s how much you keep. That’s a very strong assertion, and one that a lot of big spenders would argue vehemently with. But it’s true. The money you keep is the money that will allow you to be truly financially free. The one true path to a future where you can do whatever you want is to have a high net worth – without it, you’re guaranteeing yourself a lifetime of work and limited choices. With it, though, you can walk away from your old career anytime you want and chase your dreams – that’s what I did.

Earlier this week in the reader mailbag, I mentioned offhand that I built a strict budget for the first several months of my financial turnaround, but now I am much looser about my budgeting. At the same time, I stated that this strict budget was vital in my financial turnaround.

This spurred several readers to write in and ask how exactly I built this budget – starting from scratch and having no real idea how to do it – and how I eventually loosened the reins on it as well.

So, here’s my guide on how to build a budget. This isn’t just a rehash of the budgeting guides that appear in countless personal finance books – this instead is exactly what I did. It’s the plan that I personally found very effective in helping me right my ship.

Let’s get started.

Save Your Receipts and Statements
Sitting down and immediately writing out a budget in the way most personal finance books describe is a giant waste of time. They often instruct you to write down how much you should spend in a bunch of categories that may or may not apply to your life and then stick to those amounts. That’s completely useless for the average person.

If you want to budget, the only way to start is to get a very firm grip on exactly how you’re spending your money right now.

Step 1: Starting today, save every single bill statement, receipt, or check that crosses your desk for at least one month, preferably three months.

You should be building two piles: money coming in (paychecks, etc.) and money going out (bills, receipts, checks, etc.). If you spend money in any way, record it in some fashion by saving the bill statement, a copy of the check, a receipt from the shopping trip, or even by simply writing it down on a sheet of paper. Every single penny should be accounted for.

The longer you do this, the better, but you need to do it for at least one month at the absolute minimum so you can scoop in all of your monthly bills. For most families, you’re better off scooping in three months’ worth of receipts so you can get a good “average” of what you’re spending.

I found it convenient to keep a “spending notebook” in my pocket. Whenever I spent a dime, I’d either make a note of it directly in the notebook or stuff the receipt in there. If I made an ATM withdrawal, I’d write on the back of that receipt what I did with all of the cash.

Sort Your Receipts and Statements
Once you’ve saved all of your receipts and statements up over a few months, it’s time to sort them into some sensible groups.

Most personal finance books provide a big list of groups for you to sort your stuff into, but the problem is that these lists try to be all things for all people. Very few people have financial lives so complicated that they actually cover all of those categories.

Instead, try this.

Step 2: Take all of the receipts/statements/notes/etc. you saved up and start making piles on the floor in a way that makes sense to you.

Just define your own categories. When I first did this, I basically had the following categories, which really didn’t match up very well with any personal finance book:

Required utilities (electric, gas, water, sewer, etc.); non-required utilities (cable, internet, etc.); gas; other car expenses; good food; junk food and eating out; household supplies; books; magazines; golf; video games; Magic: the Gathering; other entertainment; insurance; bank fees; finance charges; student loans; baby supplies; and miscellaneous

I still have that ancient budget, actually, and those were the categories listed on it, and they all started by piling papers and receipts and statements on the floor in various groupings.

Some receipts I came across actually fell into multiple groups, like receipts from Super Target. What I did then is go through the receipt, figure out which items went into which group, and then wrote a note for each pile with that total (including sales tax, which I divided up proportionately).

You’ll probably find yourself shifting piles around and making new piles throughout this process, as you should. The goal is to find ways to group your spending that’s natural to you. Don’t try to force it to match someone else’s groupings – if a group of receipts or statements feel like a natural group to you, that’s how they should be sorted.

Tally Them Up
Once you have all of your piles figured out, it’s time to tally up each pile.

Step 3: Add up the totals on all of the receipts and statements in each pile, then divide these totals by the number of months you’ve been accumulating data.

So, if you saved all data for three months, you’ll want to divide each total by three (remember, the more months’ worth of data you have, the better).

As you calculate the tally for each of your piles, start writing these totals down, making a list of the category names and how much you spent in that category for an average month. When you’re finished, you’ll have a picture of what you are really spending each month in each category.

When that’s done, total ‘em up and you’ll see how much you’re spending. Do the same for your income over an average month – see how much you’re earning. Those two numbers really make up the reality of your financial situation – are you spending less than you earn?

Find the Fat
If you’re like many people, the total amount you earn in a month and the total amount you spend in a month are going to be pretty close to each other – and that’s what you’re trying to correct. Spend less than you earn is the mantra, and it’s a good one – the bigger the gap between the two, the better off you are.

Step 4: Go through each category and find ways you could reduce your spending in each one.

Some categories won’t have much room to breathe, while others will be loaded with fat.

The key here is to be realistic. Look for ways to trim spending that you can easily maintain. For example, you can often trim your electric bill a bit by installing a programmable thermostat, or you might be able to cut some entertainment expenses by finding a different route home from work that doesn’t take you near your most tempting places. Maybe you could challenge yourself to cook one more meal at home each week, cutting down on food expenses a bit. If you’re a book or a movie lover, you can probably cut some fat there by digging into what’s available at the library. The next time you go grocery shopping, maybe you can make a list first or, even better, make a meal plan using the flyer before you even walk in the door.

Going overboard, though, is a bad thing. Just focus in on the baby steps – the easy things you can do to reduce some spending. If you go hardcore, it’ll fail just like most diets do. You’re developing a basis for the long term here, and by trying to force yourself into a bunch of activities that don’t come naturally, you’re asking for failure. Focus on things that are wholly automatic, like a programmable thermostat or a CFL (or a more fuel-efficient car in the future), and on just a small handful of changes you need to make to your behavior.

In a nutshell, go through all the categories and identify automatic ways to save money as well as five other ways you could trim the fat a bit. Estimate how much these will save, then subtract them from the total in that category. You now have your target numbers for next month (don’t worry about extras, we’ll deal with that later).

One more thing: add one additional category called “Flexible” and put in a dollar amount next to it equal to about 5% of your monthly take-home. This will help you during the month if a crisis comes up – just take the money from this piece to help with those unexpected. If there’s anything left over at the end of the month from this category, put it into savings.

Try It Out
Over the next month, just do things as normal except with the changes you thought up based on how you spend money – and one other little change.

Step 5: Work hard to stay within your target numbers in each category for the next month.

Remember, these numbers are completely realistic and based on how you’re really spending money minus just a few little lifestyle changes, so these are goals you should be able to meet. Even better, at the end of the month, you’ll find that you’ve spent a little less money overall.

You’ll likely stay under those numbers in most categories and go a little over in others – that’s fine, just as long as you know the reasons you went over and your total across all categories doesn’t exceed the total of all of your targets.

Even better, you’ll have a little left over, so do something productive with it. Use it to make an extra debt payment or sock it away in a savings account for a big emergency.

But even more important than that…

Rinse and Repeat
Budgeting doesn’t work unless it’s repeated, so just get in the habit of doing it at the end of each month.

Step 6: At the end of each month, refresh your budget.

This simply means go through all of your receipts and statements for the month and verify that you did indeed hit your targets overall. If you did, that’s a good thing – it means you’ve added real change to your life.

So, if you did make your targets, take that total amount that you have left over and add another line to your budget – debt repayment (or savings, if you have no debt) – and write that dollar amount in next to it. Each month, you’ll use that money to follow a basic financial security plan – first, build up a small emergency fund with it in a savings account, then start making extra payments on your debts.

Then repeat the whole process of making target numbers. If you feel confident, try adding in some additional cost-cutting tactics. If last month didn’t go so well, don’t be afraid to revise some numbers upward (and thus reduce the amount going into debt repayment or savings).

Training Wheels
The goal of budgeting is to keep in tune with your spending and don’t overdo it. Instead, treat it like an exercise plan or a diet – you gradually become more and more fit as time goes on and the budget begins to feel more normal in your life. Eventually, the little changes will become natural and you can take the training wheels off.

It took me almost a year to reach that point. I became so confident with my budget that I simply set up most of my bills to be paid automatically with online bill pay at my bank and I set up a bunch of automatic savings, too.

All of those little cost-saving tactics that I developed had become so natural that I was simply no longer spending money at an outrageous pace. Going to the library had become natural. Cooking meals at home had become natural. We were buying groceries in bulk as a matter of course now, saving money over time. We stopped shopping just for social reasons, as well.

Combining the automatic nature of my savings and bill paying with the natural reduced costs of my life was the very goal of budgeting, and thus the next natural step was to take those training wheels off and ride that bicycle of financial stability.

Big news: I have a book deal.

I signed the papers last Friday and shipped them off to my publisher. The book project itself is just about perfect for what I want to do right now, particularly as a first book – very nice price point (it will have a price a bit lower than you might expect to make it accessible to all), a focus and a style that I’m very comfortable and happy with, and a publisher that’s really involved with the process and very interested in a follow-up book if this one gets finished well.

Right now, I have a chapter written and a very detailed (10-15 pages) outline of the remainder of the book, which is due in a strong first draft format on July 1. We’re both hoping to have the book on bookshelves well before Christmas, likely in October or November.

This means two things when it comes to The Simple Dollar. First, my cooking blog will have to be postponed a bit. I was basically ready to launch it on May 1, but this book deal (and another writing opportunity I hope to announce soon) means I have a pretty sharp deadline and I need to focus my writing energy on that.

Second, and perhaps more interesting, is that I’m seeding this site with “supplemental” articles that relate to the book itself (I’ve actually been doing this for a while). Basically, they’re expansions on particular ideas from the book – sort of like sidebars for specific ideas that deserve more depth but would derail the rather tight focus of the book. When the book nears publication, I’ll collect all of these into one giant collection of links so that readers can visit one URL and see all of the supplemental material.

Intrigued? I hope so. My plan is to announce the book in great detail at about the time it pops up for preorder on Amazon, and I’ll make a fairly big splash with it – it’ll be in conjunction with a slight redesign so that the book will be noticed by anyone who visits The Simple Dollar. I’ll also be making available some opportunities for signed copies, though I’ve not figured out quite how I’ll do that yet – I may work out an arrangement with a local bookstore to handle that mess.

If you’re curious… just be patient. The book, by all accounts, should be out by the end of the year.

Now, for some personal finance articles.

Is It Smart to Trade Time for Money? Only when you’re certain about the value of your time. Most people have little grasp on what the true value of their time is, something I talk about regularly on The Simple Dollar. (@ dumb little man)

Money Lessons Learned Through Square Foot Gardening We have a large garden ourselves and I often find myself deep in introspection while out in the garden. (@ frugal dad)

Teenager on a Budget This is a really interesting series about a mother attempting to teach her teenage son about budgeting, particularly food budgeting. The entry I’ve linked to is rather amusing. (@ debt free revolution)

You Paid $9.60 a Gallon for What? The embedded video is a bit over the top, but the point is right – bottled water is drastically overpriced for what you get compared to what you get out of the tap. (@ poorer than you)

Recession and the State of Our Economy: A Visual Primer This is an excellent visual guide on basic economics and the meaning of a recession. (@ the digerati life)

50 Tips to Help Establish Your Emergency Fund Excellent tips all around. (@ consumerism commentary)

This is the tenth discussion in a “book club” series on Born to Buy by Juliet Schor, which focuses on consumerism issues and young children. You can jump back to the first discussion if you’d like. This discussion covers the the latter part of the sixth chapter, “Dissecting the Child Consumer,” starting on page 109 at the subheading “Inside the Child Brain” and continuing through the rest of the chapter.

Most of this section covers the nuts and bolts of how companies engage in research when it comes to children and, quite frankly, most of it comes down to money. Many of the more intense research programs pay the children (or parents of the children) when they “volunteer” to participate in a focus group or another marketing research program.

I found two quite interesting pieces in this section.

Is Marketing Research Child Labor?
On page 115, Schor mentions:

Watching the bedraggled crowd at one focus group site as the evening (a school night) wore on, I wondered why this phenomenon has stayed out of public view. We don’t let eleven year olds staff fast food joints at 8:30 on weeknights. Why hasn’t there been any discussion of their work at the local focus group facility?

I think I can actually answer that question. It’s because information work – white collar work – is perceived differently than labor. In other words, work in a focus group is seen as existing under different rules than work in a fast food restaurant.

You can see it quite often in the adult world, where IT workers are required to have their cell phones on at all times. On the other hand, factory workers clock out and completely forget about their workplace. Businessmen are chained to their Blackberries, but waitresses go off duty and forget about the restaurant. Construction workers leave their cranes behind at the end of the day – but other workers come home with a briefcase or a laptop in hand.

Unfair labor laws exist all over the place for blue collar jobs, but not for white collar jobs. Why is this? In the past, blue collar jobs were the ones that could be exploited for profit, as white collar jobs merely existed to manage the work of blue collar jobs.

In the information economy, though, white collar workers are now doing much of the actual productive work, but the perception that white collar jobs don’t demand any labor protections still exists.

It’s this same perception that allows children to be at the focus group until very late, earning their pay for being in the marketing program, but they’re not allowed to flip burgers at the restaurant.

An interesting double standard, isn’t it?

Childhood Friendships for Fun and Profit!
Another interesting aspect of all of this pops up on page 116:

I encountered other troubling aspects of the research process, such as the use of one child to recruit others. In these cases, full disclosure to both children and parents is much harder to ensure. The research cannot be certain about how a situation is being described and the preconceptions friends are coming with. The recruiting child also has a financial incentive to get others to participate, which raises the potential for exploitation.

This sounds an awful lot like multi-level marketing to me – Amway/Quixtar for kids, in other words, where people make income at least in part by recruiting others into the system. The only catch here is that it’s kids effectively doing it to other kids – they’re convincing playground chums to sign up in order to make profit for themselves.

It’s hard enough for adults to distinguish social marketing techniques – have you ever been seduced by a salesman into buying a product, for example, or witnessed it happening? It’s even worse when you introduce such factors to kids who are at least as prone to social acceptance and don’t have the years of life experience needed to build up a good filter against such marketing.

There are times when I genuinely feel uncomfortable about the issues I face raising my kids today.

The next discussion, coming in two days, will cover the first half of the seventh chapter, “Habit Formation,” starting on page 119 and ending after page 129 at the subheading “Who’s Responsible: Parents or Advertisers?”.