The other night, I watched a couple episodes of the A&E documentary series Hoarders. For those of you who haven’t seen it, Hoarders is a documentary series that focuses on the struggles of people who suffer from compulsive hoarding.

One thing that struck me over and over again was that people were saying things along the lines of, “I can’t get rid of this stuff because I might have a use for it some day.” Of course, they were making this statement in a home that was so full of stuff that they had difficulty even walking through their home.

Frugal people live on an interesting spectrum between minimalism and hoarding. While on the one hand frugal people often move towards minimalism, with fewer possessions and the like, at the same time, two of the most powerful tools for saving money are reusing things and buying in bulk. Both of those tactics result in the pure accumulation of stuff.

Nearly everything we throw away has some sort of value to it. I could save old newspapers for campfire starters. I could save old magazines for children’s art projects and collages. I could save worn-out clothes for our rag bag. A broken piece of furniture could provide pieces of wood and cloth for other projects. Old electronics can often be refurbished and repurposed.

Given that a frugal person often focuses on the maximization of value, sometimes it’s easy to fall into the trap of keeping more stuff than we actually need. We do this all the time – you wouldn’t want to look at our garage, for example. I have a really bad penchant for saving cables and electronic components because I’m so sure that someday, this adapter will have a valuable use or someday, I’ll need this cable.

Add on top of that the value that can be found in bulk buying and you soon see the problem: frugality can easily lead to the accumulation of excess stuff.

Where’s the line between frugality and hoarding? My feeling is this: once you have a small reserve of any one item, it crosses the line into hoarding if you continue to accumulate more of that type of item at a faster rate than you’re using it.

So, for example, after I go camping, it might be a good idea to save a few newspapers for the next camping trip. However, once I reach that point, it crosses the line into hoarding to continue to accumulate. The only purpose I have for saving old papers is for campfire starters. Saving beyond that, just because the papers have the potential to be useful someday, is hoarding.

You can take a similar approach to anything. If I have plenty of shower soap in the closet, why am I buying more of it? If I have plenty of toothpaste, why am I acquiring more of it? Even if it’s free.

The real story to all of this is that every possession you have has a cost. To own all of these possessions, you have to live in a larger home than you otherwise would. You also have to deal with the cleaning and organizing of all of your possessions. If you’re saving hundreds of newspapers, you’re going to either have to have a lot of room or a lot of organization.

Lately, my wife and I have started to adopt a completely different approach than we used to have towards the accumulation of possessions. In short, if we can’t say that this item won’t have a use in the next two months, we won’t bring it into our home. Even if it’s free.

Why? Even free stuff has a cost, and it’s a cost that we don’t feel the need to pay.

Katie writes in:

The article on budgets was *great.* I’ve long felt guilty for not doing the whole formal budget thing, especially since I always liked and did well at math. (Like you, however, spreadsheets cause my eyes
to roll back in my head.)

But here’s a question/comment on one bit. You said: “First, this doesn´t work if you´re already spending more than you make. That type of behavior is not sustainable. If your credit card balance is going up each month, no amount of budgeting or planning matters until you´ve reached a point where that credit card bill goes down each month.”

We don’t have ANY credit cards, so that’s not a problem. To be honest, I doubt if any credit card company would give us the time of day. (I do want to get a secured card at some point, with the goal of rebuilding a bit of credit.)

But we’re currently at a stage that’s a variation of what you described. Since we can’t use a credit card, we often wind up playing a sort of “musical-bills” game with such things as our electric, water, gas, trash, phone and so on. By this I mean that we will either skip a month of paying one of them, or make a short payment on one or more. The next month, we try to catch those up, but sometimes then need to repeat the process with another bill going short.

Occasionally we get a small windfall: selling something, or a gift of cash for a birthday, or the like. This usually goes into making sure *everything* is 100% current… which is a wonderful feeling! But then comes a month (such as this one) where the power bill is extra-high, or gasoline prices spike just as I need to make several trips into the city for doctors’ visits. When that happens, all too often the following month begins the cycle once again.

Beyond the standard advice on cutting back as much as possible, or earning more, do you have any particular suggestions to help get us off the merry-go-round? I know the best solution is to have more coming in, and I am hoping (now that my medical issues are being dealt with properly!) I can get back to writing and actually SELL something again. But meanwhile, treading water has gotten rather old.

Many people find themselves at this “treading water” stage and are unsure how to get past it. Basically, it amounts to spending almost exactly what you earn, with the irregularities from month to month causing trouble.

The solution here is usually just a few pebbles on one side of the balance or the other, just enough to cause the tipping to begin.

Where can you get those pebbles from?

A bit of extra income This is the perfect type of situation for some small-scale earnings online doing things like Mechanical Turk (see my notes about it) while you’re watching television or relaxing in the evenings. You’re not really looking for a job per se, but something that can earn a little bit whenever you have a few spare minutes to work.

A bit of extra diligence You don’t need to make radical cuts. You just need to be a little bit extra diligent when it comes to your spending. When you’re standing at the checkout line, make the conscious choice not to buy a pack of gum or a People magazine, for example. Get just a sandwich and a water cup without the value meal – you don’t need the fries anyway. Then feel good about the little choices you made – and watch as they slowly add up to a better balance at the end of the month.

A bit of sharing Go in with a friend or three and get a membership at a bulk-buying warehouse. Go there to buy your toiletries and split the cost on jumbo packs. Buy a four pack of deodorant, each of you take one of them, and reduce your deodorant cost by about 30%. Do the same for paper towels, toilet paper, milk, garbage bags, and countless other things. Go beyond that and share larger things with your friends – you don’t both need a toolkit. Just put tools in one kit and pass it around as needed, for example.

A bit of self-improvement Spend your evenings learning about the things you’ve always been curious about. Check out books from the library on it, or surf through Wikipedia on the topic. Try doing the things you learn about. Learn about a topic – and learn how to learn, as well. You’ll come out of it with more knowledge and perhaps more skill – and it won’t cost you a thing for entertainment.

A bit of mutual support Support your partner when he does things that are financially smart. Reinforce the idea that spending less is the good thing to do. You’ll find that with people around you supporting this kind of behavior, particularly the people you spend the most time with, it becomes more natural to spend less money.

A bit of friendship This attitude spreads to your closest friends as well. Don’t be afraid to admit that you’re having financial challenges. Be willing to talk about money with them and encourage each other to make better choices. Engage in non-expensive activities together – most activities are made fun by the people you do them with anyway.

Many situations are made a lot better by doing just a little bit of a lot of different things.

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. 401(k) profit sharing
2. Online job application tips
3. Illness and challenges
4. College freshman advice
5. Mortgage decisions
6. Annuities for retirement?
7. Refinancing questions
8. Universal life policies
9. Using self-help advice
10. Getting started with credit

Two readers this past week wrote to me asking if I would detail what I would like to have in our dream house. I’d like a five bedroom house (one for the parents, one for each child, one for guests) – we currently have four. I would like a larger kitchen than we have now, but most of the other rooms are fine. I would like to have an office/library (right now, I’m using one of the bedrooms in our house for this) but this isn’t vital. I estimate we’d add about 500-600 square feet to our current house.

The biggest change would be the land. I’d like to live in a place that had forested land nearby and was not positioned close to a major road. I’d also like a barn and the possibility of raising chickens.

That’s really my dream – and it’s very pastoral.

My husband and I have $30,000 in credit card debt. My dilemna is that I was laid off and am now making 2/3 less than I was, and my husband’s employment in the construction industry right now is spotty at best. I have $60,000 in a 401K/Profit Sharing Plan at my old company, and I’m wondering if I should take that money and pay off the credit cards, even though I know I will pay prepayment penalties on that amount. The pressure of the debt right now is killing us, and it’s a matter of the worse of two evils, leave the retirement funds alone and risk losing the house, or pay off the cards and be able to make our mortgage payments . . . what would you do?
- Laurie

The number one thing you need to do is adopt some new spending patterns. If you racked up $30,000 in credit card debt when you were making three times as much and your husband was fully employed, you’ve got to be in the hurt locker now. Burn the credit cards. Do not use them.

The next step is to call your creditors right now. Call those credit card companies and explain your employment situation and money situation. Offer to prove your situation with pay stubs if they’re interested. Ask for special help in resolving this. Don’t get enraged at what they say – after all, you borrowed their money.

When you’re talking, make sure the person you’re talking to has the power to change your rates or terms. If they do not, politely ask to speak to someone who has that ability.

Remember, it’s not beneficial for them to enter into a situation where they have to chase you for the money and eventually have to sell your debt at a loss. Take action.

I am finishing up my college education this summer, and am simultaneously applying for jobs. I need any job I can get because my parents aren’t exactly chomping at the bit to let me come home. My question is, I’ve been applying mostly online for all these jobs and I haven’t received any responses at all. Since they’re sent online, I receive confirmations that my application has been received, but I can’t help the feeling that I should be calling and checking in on the stores/companies to see if they’ve received my application. Is this rude, considering I get email confirmations? Also, my very nicely formatted resume’s and cover letters get ruined when I have to copy and paste them into online resume builders and text boxes.

any suggestions or good resources for how to apply to jobs with online application services? Is everything I learned about paper resumes moot?
- Michelle

Many online employment applications are utterly deluged with entries from people out there just spamming everything. People will see thousands of applicants for a particular job, and 90% of them aren’t even qualified for it or have submitted junk.

So how do they do this? They usually do some harsh filtering on the applications, looking for people in certain age ranges, certain locations, and so on. Most of the time, this filtering eliminates quite a few good applicants, but because of the huge numbers involved, they don’t have the time or resources to look at each one.

Your best bet is to try to apply for jobs that are close to where you’re at and ones you’re qualified for. This won’t guarantee a thing, of course, but it does improve your chances of getting some sort of response. Calling the place you applied to for follow-up certainly doesn’t hurt, either.

I. Have a disease. And I wish not to disclose what it is; but to say the least, I work at Wal*Mart and sift through financial issues and debt because I can’t afford medical insurance. My boyfriend can’t find a job because we’re 15 miles out from any real place to work. We live in the middle of nowhere. I need treatment, and I need to get my life on track. I’ve had jobs where I’ve had to walk five miles there and five miles back- and trust me, I don’t mind, because I feel like it empowers me to do something for myself.

This is basically my issue. If you can take the time, can you heed any advice?
- Sara

I think you’re in a bad location with bad influences all around you. My honest suggestion would be for you and your boyfriend to move to a different area for a while, preferably a place with lots of opportunities. I would suggest a city with a low cost of living, like Des Moines, IA or Omaha, NE.

Go there. Find some work. Use mass transit to get there. Use every service you can get for low income people in the city. If you feel the need, send some money back to your parents.

Look for opportunities in the city to share your artistic skills. Volunteer to produce art for community groups so that you’re seen in a popualted area. Share your talents so that people see what you’re capable of.

I know that you feel strong family ties and responsibilities, but the longer you stay there, the less likely it will be that you’ll ever actually do the things you dream about.

I’ve read your blog for a little while now, your posts are very helpful and make for an enjoyable read. But what further advice would you give to a college freshman? For instance, I just turned 18 and set up my own Checking and Savings accounts apart from the savings account previously held under my parents’ account. What specifically can I do right now to set myself up for financial success? Because of college bills, I won’t have much money to use but I’d like to get some kind of “head start” on my future finances. I’m trying to read a few financial blogs to at least get informed on personal finance but I’m still unfamiliar with many terms and processes. I’m going to a private school with about 1/3 paid for by scholarship, and the rest to be covered by myself and my parents — without loans. What would you advise?
- Christian

Your best move is to educate yourself. Pick up a few well-rounded books on personal finance, read them slowly, and absorb what they’re saying. Use the internet to look up terms that you’re having a hard time understanding.

I’d suggest starting with two books (and these are linked to my reviews of them): Your Money or Your Life (puts personal finance in a whole life context) and The Bogleheads’ Guide to Investing (drier, but more information-based). From there, you’ll know enough to figure out what directions you should go in next.

The best solution for your problem is education, pure and simple.

My husband and I purchased our first loan last year. Since my husband had been self-employed for roughly 8 months at the time, we only qualified for an in-house 5/5 arm loan at a local bank at 5.7 %. The adjustable rate loan is very reasonable (tied to prime, can not adjust up or down more than 2 percent, etc), but we are looking at refinancing now that rates have dropped and my husband’s work history would let us qualify for a 30-year in a few months. Our bank will do a refinance for $1200.

I love the security of a 30-year mortgage, but the reality is that I have four more years in my PhD program, so the longest I could see us staying in this town is 4-6 years (if I took time off for some reason). Should we just get the 7/1 arm?
- Amanda

I almost never think an ARM is a good idea. It will often look like a good idea at a certain point in time, but it looks like a good idea because it locks in well with what your plans happen to be at this given moment.

If there’s anything that’s certain right now, though, it’s change. Your plans today will likely not match what you’ll be doing in five years, and if you’re in a situation where your mortgage is about to adjust and you’re made to either refinance at a higher rate or suck up the adjustment (because rates are going to go up).

If I were you, I’d get the lowest rate with the PMI – the 30 year mortgage. Focus on getting that debt paid down to the point where you don’t owe the PMI. That way, you’re not stuck in an adjustment or refinancing choice if your plans don’t go exactly as you think they will.

I’m trying to help my fiance sort out her retirement benefits at a new job, which offers two plans. The first is a pension-type account they make the entire contribution for, but the second is a 403(b) Tax Sheltered Annuity Plan, either traditional or Roth, offered through one of three companies. I’m completely adverse to the idea of investing in annuities; everything I’ve read indicates they’re much more expensive than general mutual funds, and since we’re only 25 I think the extra growth potential in index funds makes more sense. Her company does not match her contribution to the annuity account, so I don’t see much benefit to it.

Should I be giving more consideration to the annuity plan?
- Jeff

It really depends on the specifics of the plans. What kind of fees are involved? Are the companies stable? Are the annuities insured?

As a very general rule of thumb, you’re probably right in saying that your current investing plan is superior to the annuities because annuities often have heavy fees with them. However, if you’ve got that much money to sock away, it helps to do some research.

I’m willing to bet that her best move is to just fully fund her Roth, because it’s probably a stronger investment. If there’s still money left, upping your 401(k) is an option, but she may balk at that because it leaves her funding your retirement, which would be a raw deal if you ever got divorced.

I owe 530,000 on my mortgage.I’m currently paying back at 5.125 %.If I refinance, which is a better choice?A 5 year fixed at 4.25% from ING or a 30 year fixed from another company at 4.875%?
- Phil

I’m going to guess that you meant a 15 year fixed.

If that’s the case, the 15 year fixed is the better deal. You’ll pay a lot less interest over the life of the loan. The drawback is that your monthly payments will be a bit higher, but you’ll also be done paying them 15 years earlier than you would be with the 30 year.

If you can afford the monthly payments easily, take the 15 year loan.

A friend sold us a universal life insurance policy for each of us. We have 3 children and the premium per month is about $1500 for the 5 of us. My husband is the only breadwinner of our family. the friend who sold us the policy showed us some complicated math about all the money we will receive if we wait so many years, how it is a great gift to give our kids when they are 21 etc. I have been paying $1500 t for 8 months now.My question is ,is this a good investment as he says it to be or is a term life insurance better? My husband is about 40 years old. Kids are around 12,7 and 5 yrs old.
- Penny

Whole life insurance is way better… for the person who sold it. They earn a lot more commission on whole life insurance than they do on a term policy and thus salesmen often become true believers in the greatness of whole life policies.

To put it simply, whole life policies don’t earn well enough to make up for the fees and expenses tied to them. Yes, over the long run, you will see some returns from it. However, it’s not as good as simply buying a term policy and then putting the money you save away in an investment account elsewhere, like a Roth IRA.

Doubt me? Dave Ramsey says the same thing.

I regularly read a lot of self-help stuff, from books and online resources. I subscribe to many blogs, including yours, that talk about how to live a better life and self-growth. And, since I´ve been doing that, I feel I know more about me, my problems and what must be done to solve them. But the thing is that I have a hard time making the transition between theory and the actual application of all I´ve learned, I can´t seem to make it work. It´s like I can´t effectively “internalize” all the information to make it useful. For example, recently I finished reading this great book, Mastery, by George Leonard. It talks about a lot of things that make so much sense to me (I had a lot of “A-ha!” moments during the reading), and is full of practical tips that are key to improve many things that I´ve been struggling with. At the time I finished it I felt really energized with all the wise words and so, and managed to apply that through the whole day. But as the days went on, I apparently forgot all that, and got back to the normal state from before the reading, feeling only an itch of the amazing sense of flow that I had experienced. I wish I could really retain all this good stuff and make it a part of myself, going beyond the knowledge by making it functional.

I know you are an avid reader, so I would like to know how do you go about this. How do you take the wisdom you come across and turn into positive changes in your life? What´s the best way to do that?
- Liana

Many self-help books have hundreds of suggestions for behavioral changes. They talk about many, many things you can do to improve your life, and they’re often inspiring.

The problem comes when you try to apply lots of changes at once to your life. The more changes you try to execute at once, the easier it is to utterly fail and wind up making no changes at all. It’s like going on a “diet” and eating nothing but lettuce for a week. That will fail, almost always.

The best solution is to take a self-help book and try to apply one specific principle at a time to your life. I can’t comment on the book you mentioned, but if you read Getting Things Done, you can get started by simply having a “collection” weekend or carrying a notebook in your pocket and jotting down everything in your mind. If you try to do the whole system all at once, it’ll be tough.

Take life changes one step at a time, especially changes that are easy to backslide on.

I have a couple of questions concerning credit and the need for it. Just for some background I am currently engaged and will be getting married next month. I have been out of college for almost 6 years and have a well paying job and have a mortgage on a duplex. I have no other debt than my mortgage and have a nice credit score. I have had a credit card for the past 10 years and I have never carried a balance. My fiancé on the other hand has never had a credit card and has always used a debt card since he didn’t trust himself when he was younger. He feels now that he can handle using a credit card wisely. He has tried to look into get a credit card but is having difficulty with the way credit card companies are being picky on who they lend to now and he doesn’t have a credit history. This wouldn’t be an issue but we are worried that in the few years after he completes a program to become a physician’s assistant that we will start having kids (and I will stay home) and want to move into a single family home and keep the duplex. At that time he will probably be the only income besides rental income. I am hearing that they are now taking the lowest credit score of the couple into account vs. they used to take the higher one. This could create an issue with my husband’s lack of a credit score if it is true. If it is true how would you recommend him getting started with a credit score? He has checked his bank but even though he has had accounts with them (a national bank) for awhile they won’t even give him one since of the lack of credit history. How does one get a credit card if they are past college age and have no credit history? Does applying for any and every credit card in hopes of getting one hurt you in the long run? We are trying to get one that will not have an annual fee so there will be no financial impact on our end. We own both of our cars and do not plan on replacing them in the near future. Thank you so much for you help.
- Alison

There are a lot of benefits to establishing credit for your husband and you outlined some of them above.

The simplest way to get started is to co-apply or co-sign for a new card for your husband. Don’t worry if it has a low credit limit or other such drawbacks – the purpose of the card is to raise your husband’s credit.

Use the card for some very routine purchases, like gas, and pay off the balance of that card in full each month. Over time, try raising the credit limit of that card – call and ask for a credit limit increase.

You may also inquire about adding him to the mortgage you have on your home. Call your bank and ask. This can do nothing but help his credit if you’re diligently making payments.

In short, use your credit to prop his up in the short term.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

In my recent post about cultivating your own knowledge for fun and profit, I mentioned that you should hit yard sales, consignment shops, estate sales, and so forth as a way to put your knowledge to work for you and take advantage of underpriced items. A few commenters thought that this was unethical, so I thought I’d look at that particular point a bit more deeply.

I’ll start off by giving you a specific example of a situation where I did this in the past. As a teenager, I collected Magic: the Gathering cards (I still play with my wife using a handful of remaining cards). I had a very good idea of what some of the valuable ones were, including a few that sold for hundreds of dollars and a good number that could net $20 or more apiece.

In 2002 or 2003 (I’m not entirely sure which – I was out of college, but it was definitely before children and possibly before marriage), I visited a yard sale that was just a block away from the apartment I was renting. The couple that was running the yard sale was selling off a lot of stuff that obviously was previously owned by a teenage boy with a bit of a nerdy streak. One item was a large box full of trading cards, mostly Magic. The sticker on the box said $5. Within thirty seconds of looking through the box, I found one card I knew I could resell on eBay for $20 and a couple more that I thought could net me at least $5 each – and I had suspicions of finding some of the real valuable ones in the box.

I asked the couple if the box was really available for $5. They said it was and that much of the stuff was items their son had said he didn’t want when he went away to college. I immediately paid $5 and walked away.

I netted a nice profit from selling some of the cards, but I also kept many of the cards and some of them make up the handful of cards I still have.

Here’s the question: was I ethically obligated to tell the people running the sale that their items were potentially worth much more than $5?

My opinion is that the buyer never needs to say such a thing. The seller has the responsibility of setting the price for the item. If they want to set an accurate price, they should investigate the item they’re selling.

This is particularly true today, in the age of the internet, where you can find the value of almost any item you have. An eBay search for those cards would have quickly revealed, even after searching for just a handful of them, that the individual cards had significant value. Even just searching for “Magic: the Gathering” on eBay would have shown that such cards often have value.

To me, the question really comes down to this: should knowledge of the value of an item be the responsibility of the seller? I absolutely think so.

When I’m trying to figure out if I’m doing the right thing in such a situation, the first thing I do is put myself in the seller’s shoes. If I were the seller in this situation, would I consider it ethical and fair for the buyer to tell me that I had grossly mis-priced an item?

In a word, no. If I were the seller, accurate pricing is my responsibility, not the buyer’s. If I put something on a table at a yard sale with a sticker on it, that means I’m agreeing to sell the item for that price. If a buyer thinks that’s a good deal – and in this case, the buyer certainly did – then the buyer has every right to pay that price and attempt to turn a profit on it.

I did a similar thing with Nintendo Wiis back in 2006. During that Christmas year, you could easily resell new Nintendo Wiis in the box for $350-400 online after buying them in the store for $250. When Target or Wal-Mart put a Wii out on a shelf for $250, should I have grabbed one and ran for the checkout or should I have informed the manager that they were worth $350 before buying them?

Now, here’s a separate but connected issue: should a buyer tell a seller if they think an item is radically mispriced? I think it’s a kind thing to do, but I don’t think it’s a required thing to do.

If I had it to do over again, I would probably walk up to the seller and say something like, “This box seems like a really good deal. I think there are some cards in there that I could sell to the right buyer for more than what you’re asking.” Then, I would probably offer them more for the box than the sticker price, but I wouldn’t offer them the hypothetical resale value of the cards, either – probably $10 or $15.

Now, if I were a seller and someone did this to me, I’d refuse to take more than the $5 stated on the sticker. After all, I view the sticker price as the seller’s responsibility, not the buyer’s.

That’s my full take on the issue.

After the universal positive response to my idea of doing a chapter-by-chapter discussion of David Allen’s Making It All Work, I’ve decided to go ahead with it. Expect it to begin in a few weeks (I usually like to have several posts already in the bag for series like that before I start posting them).

Meanwhile, here are some interesting articles I’ve read from around the web this week.

Professionals, Amateurs, and the Great Unwashed Which are you? And which one would you be most likely to hire? I think it depends on the job, but I agree that enthusiasm and passion make up for a lot. (@ seth godin)

How To Get Hired & Get The Job You Want By Volunteering The people that do this kind of thing are the people that stand out from the crowd and get hired. At the same time, the people who do this kind of thing are people who have enough financial stability in their life to pull it off. (@ the digerati life)

Can’t stand the heat? Get into the kitchen — but only long enough to make iced tea. My wife and I are enormous fans of tea. We almost constantly have a sun tea jar sitting out on our deck during the summer. It’s incredibly inexpensive and tasty. It’s just our beverage of choice, hands down, and it has a lot of health benefits, too. (@ surviving and thriving)

Preparing for a Baby – What Do You Really Need? I’m linking to this because it’s a great example of how two frugal people think differently. She thinks that a changing table “is the single most important piece of furniture in the nursery.” I thought it was basically useless – we just have a “portable changing table” with a towel and the stuff we needed in a bag, meaning you can change the baby pretty much anywhere. (@ cool to be frugal)

Big Difference Between Average and Median Net Worths “Average” means you add up all of the net worth in America and divide it by the number of people. “Median” means you line everybody up in order of their net worth and ask the person in the middle what their net worth is. The two numbers are vastly different. (@ free money finance)

Advice from Financial Planners for Members of Generation Y I’ve never been quite able to determine whether I’m part of Generation X or Generation Y – or why it really matters. (@ gen y wealth)

If you’ve read the reader mailbags for a while, you’ve noticed that I often get messages from people who have worked their way into a good financial place and now have some money to invest, often for the first time in their life.

They look around, watch CNBC, read investment advice online and in books, and still aren’t sure exactly what to do. Should they keep the money in cash, or buy a CD from the bank? Should they invest in stocks, and if so, should they buy individual stocks or put money in a mutual fund? What about bonds? What about real estate?

The options seem overwhelming, as do the potential risks and rewards. I’m going to offer a few ideas that I’ve learned over the years that will help anyone that’s just starting to invest.

First of all, there is nothing that will guarantee you a great return. If anyone is guaranteeing you a large return – and by large, I mean more than a couple percentage points higher than what you’re getting in a savings account – be very, very wary. Such investments usually have some sort of giant drawback, like losing all access to your balance for a very long period, hidden and/or extensive costs, or hidden risks that aren’t being directly revealed. Leave such “too good to be true” investments for people who are actually skilled investors – and they probably won’t be investing either.

Instead, most investments beyond a savings account or a CD offer potentially strong gains coupled with risk. That’s just part of the equation. What usually happens is that the better the estimated returns on an investment, the greater the risk.

Let me spell it out for you in detail using a specific example. The Vanguard 500 is a long-established index fund that essentially invests in 500 of the largest publicly traded companies in the United States. If you look at the returns on this fund, you’ll see that (for the quarter ending June 30, 2010) money invested in the fund has earned 14.33% over the previous year. That’s a very nice return.

At the same time, though, money invested in the fund has earned an average of -9.84% the last three years. Yes, each year (on average), an investor has lost almost 10% over the past three. Even over ten years, the average is -1.67%. Over the lifetime of the fund, though (since the mid-1970s), money in the fund has returned an average of 10.10% per year.

So what does that mean for you? It means that over the course of some years, you’ll have a 15% positive return. Other years will have a -30% return. Over some decades, it’ll average out to a nice positive – 10% or so. Over other decades, like the ’00s that had two economic downturns, it’ll average out to a very low positive or even a negative.

Sometimes you can afford that kind of risk. If you’re many, many years from your goal, that kind of risk is fine. If you’re 25 and investing for retirement, you’re going to get enough great years between now and retirement that you’re pretty likely to make up for the losses of the bad years. The key is to just ignore the year-to-year losses and gains and just be patient.

However, if you’re closer to your goal, you can’t afford that kind of risk. If you’re saving for a goal that’s going to happen in five years and you need to have the balance you’ve already saved up, you’re making a big mistake to put it at this kind of risk. You need to keep it safe, even if you’re losing the potential to have a big year.

You also have to look at your debts in comparison. Right now is a great time to pay down debt. Why? The “return” you get from debt repayments is equal to the interest on that debt. So, if you have a debt that’s costing you 8% interest, an early payment on that debt essentially earns a guaranteed 8% return. Why? If your balance is lower (and that’s what an early payment does), the lower balance will generate that much less interest that you’ll have to pay. It’s important to note, of course, that actually acquiring new debt is really, really bad – I’m looking at debts here as water under the bridge and merely a problem to be solved.

Also, you can never, ever have too much money put away for retirement. It is never bad to over-save for retirement, because you can always use that money during the early years of your retirement for whatever things are most important to you knowing that you’re secure for life.

Thus, here would be my very general suggestions for someone with a chunk of money to invest.

The first thing I would do is aim for debt freedom. Why? Paying ahead on debts is probably the best stable investment that people have right now. Get rid of your debts – all of them.

If you’re debt free, I’d sit down and look at my life goals. Are there any big goals that I want to achieve in my life? Am I going to buy a house? Do I want to start a business, or launch a new career? Maybe you’re really happy with how things are right now. If you have a strong overriding goal, keep the money in savings and have it help you reach that goal a lot sooner. Most likely, the goal will be short term enough that you shouldn’t put it into stocks or other risky investments, for the reasons discussed above.

If you don’t have an obvious overriding goal, open up a Roth IRA and put the money in there. A Roth IRA is a simple retirement account that anyone can open – you just sign up for one with an investment house like Vanguard, much like signing up for a savings account at a bank. You put money in the account from your checking account, then tell the investment house how you want the money in the account to be invested. The best option for most investors is a Target Retirement fund that matches your estimated retirement date. You can contribute $5,000 a year to a Roth IRA – if you have more than that, put it in a savings account and make contributions each year.

There are two things that people virtually never regret: freedom from debt and plenty of money saved for retirement. If you have money just sitting around, you’ve got two good things to do with it, right there.

A final tip: read. Pick up a well-regarded book on investing (here’s my pick) and read it at your own pace. Go slow and make sure you understand every sentence. Use Wikipedia and Google to help you understand terms. This is perhaps the best thing you can possibly do with your time as a beginning investor.

One of the biggest things that’s changed in my life since my financial turnaround and subsequent career changes is that I’m constantly involved in a lot more self-evaluation than I used to be. I’m constantly looking at how I do things, looking for ways to improve the quality and value of how I spend my time and energy and money.

Something I’ve noticed quite a lot lately is how much of my life seems to move along with a particular rhythm. I don’t necessarily mean that things are the same day-in and day-out, because they’re not. What I mean is that I go through periods of heightened efficiency and mindfulness. I get ahead on my work. I write lots of posts. I find lots of quality time to spend with my family and for my other hobbies.

How do I fall out of these periods? Usually, it’s a series of unexpected events that triggers a change. One of our kids is sick during the night. I go on a lengthy trip of some kind (more than a few days). Something breaks in our home and I have to repair it. There’s a serious illness or death to someone close to me.

And, boom, the rhythm is interrupted. I feel tired and my mind is cloudy. I have a harder time working. I’m not as mindful of my spending and I make a few awful spending decisions. I get upset with myself – and with others – much easier than before. I’m less productive and less energetic – and it shows in every aspect of my life.

I have a lot of techniques for finding my rhythm again. Usually, it involves spending a couple of days resetting everything. I get my organizing system back in order. I go to bed early a few nights and don’t set the alarm, allowing my body to wake up naturally when it’s rested. I play with my kids a lot. I clean the house. I spend some time with my friends. I directly address any things that are causing ongoing stress, like a relationship that’s not as strong as I’d like it to be.

And, gradually, I get back into the rhythm of things. My productivity and energy go back up. I begin to feel more fulfilled about everything in my life. My spending discipline is stronger than ever. I feel like I’m doing better work in every aspect of my life.

Over the past few weeks, I’ve had some conversations with a lot of people in my own life and several readers about this phenomenon – and I’ve found that most people feel the same way, although they don’t articulate it as well. They have a “rhythm” in their life that they’re sometimes in touch with and sometimes out of touch with. The amount of “rhythm” seems to vary from person to person quite a lot, though – some people seem to find it a bit of a rarity, while others seem to rarely find it.

I will say this much: one universal thing that everyone has said is that the times in their life when they’ve found their rhythm are much richer than times where they’re off of their rhythm.

Obviously, I’d like to move in a direction where I’m in touch with my rhythm more than I used to be. I’ve found several techniques for doing this that really seem to work.

Know some sure signs that your rhythm is out of whack. For me, the biggest signs are that my office is messy, my GTD inbox has a buildup of stuff in it, my “article buffer” (articles I have written in advance) is low or depleted, and that I feel tired in the middle of the day. When I see two of these things, I usually take it as a sign that my rhythm is out of whack.

If you see any sign of falling out of your rhythm, stop and recharge as soon as you can. You might not be able to do it immediately, but you should do it as soon as you can. I find that when I force myself to do things when I’m out of sync, I make many more mistakes and am much slower about things than when I’m in a good rhythm. In other words, the time I spend keeping myself in sync pays great dividends over time.

If you don’t feel that you’ve had your rhythm, or have severe difficulty reclaiming it, get a medical checkup. There are a lot of little things that can hold us back from feeling great and knocking it out of the park. Many of them are very simple – a vitamin deficiency or something like that. I have an underactive (bordering on inactive) thyroid and if I miss out on my daily thyroid medication, I can quickly get out of rhythm.

Certain routine activities help me maintain my rhythm. For me, a daily walk of about three miles, a daily 20 minute meditation session (where I try to empty my mind for a while in the quietest room in the house), and a daily gaming session help me keep in my rhythm. I try really hard to accomplish these things every day. A piano practice session seems to be creeping into the picture here, as well.

If you’re out of rhythm, put off buying decisions. I find that, time and time again, my judgment when it comes to purchasing decisions is out of whack when I’m out of rhythm. If I put the decision off until I’m in a better frame of mind, not only do I end up making a better decision over the long haul, I usually have created some additional incentive to focus on what I need to do to get back in the swing of things.

Good luck!

Naomi is trying to get a good picture of her actual spending and is using a very good process to get there. She’s run into a bit of a snag, though.

I have reached a month of collecting receipts and preparing to organise it all in an Excel spreadsheet. Categorising by what type of expense will not be the difficult part for me, however deciding weather it was a ‘necessary’ spend is. I’m finding too many grey areas. For example; it was necessary to eat lunch but instead of having an at home sandwhich, i grabbed one on the go. Or, i needed some new clothes for work and brought a nicer dress than was necessary. Maybe I am overthinking such a simple exercise a little too much, but I would appreciate any direction you could provide.

This is a classic problem that people run into when they’re first getting a grip on their finances. What exactly constitutes a necessary expense? If you don’t buy the low-end garbage bags and instead buy the ones that Consumer Reports calls a “best buy,” is the difference in cost a necessary expense? If you’re caught in traffic and can’t stop at home for dinner before an evening meeting, so you stop at a fast food restaurant, is that a necessary expense?

I can certainly give you my opinion on a lot of such buying situations, but the truth of the matter is that it’s my opinion. I’d call the garbage bags a necessary expense. I’d call the fast food an unnecessary expense, a cost that results from poor planning. And on and on and on…

Here’s the truth. Every single one of us is going to spend money on something that we view as necessary and that others view as unnecessary. Almost all of us are going to spend at least some money on things that we view as unnecessary upon later reflection.

What matters isn’t that we eliminate all unnecessary spending from our budget. That’s impossible. It’s the equivalent of eating nothing but lettuce for a diet – eventually, you’ll either wither or fail.

What matters is that we get a grip on our unnecessary spending, however we define it.

I usually encourage people to be pretty tight with their definition of what a necessary expense is, because the real value in budgeting is to figure out where all of your unnecessary expenses are going. What areas are you dumping money into that, with some forethought and changes in routines, you could improve?

Here’s an example of what I mean. Let’s say you’ve decided to count lunches eaten out as an unnecessary expense. You make a category in your accounting of your spending called “lunches eaten out.” At the end of a month’s worth of receipts, you look at that total. $250? What?

You can reclaim that $250 (or at least most of it) by simply changing one behavior. Stock your desk with the materials for some lunches on the fly, for one, and then get in the routine of brown-bagging it. If things don’t work out with the brown bagging for a day, you have some food in your desk as a backup. Boom! Suddenly, you’re not dumping that money into eating out all the time.

That’s how budgeting is supposed to work. You group all of your expenses into categories and look for ways to sharply cut some of the areas of unnecessary spending (like the lunches) while also looking for ways to reduce the costs in necessary areas (energy efficiency, for example). It is much easier to identify ways to cut your spending if you’re looking at the exact dollar amounts you’re spending in a specific area and are focused on that specific area.

In other words, don’t focus so much on what’s necessary and what’s unnecessary, at least not at first. Just try to group things into piles that make sense to you. Budgeting books often offer suggestions of categories, but don’t be afraid to go beyond them and have categories like “lunches eaten out” or “comic books” or “makeup” or “video games.”

Then, when you’ve got those specific categories and how much you spent in each of them each month, focus on those categories one at a time and ask yourself, “How much of this is necessary? How much can I trim from this?” Different people will come up with different answers here, but the more you cut without significantly altering your standard of living, the easier it will be to find financial freedom.