Angela writes in with the following situation:

I didn’t see any archives where you unexpectedly come into money. My husband is re-enlisting for a big chunk of change (in the end we will get about 37k after taxes). Here is where we are now:
Credit Card 1 - 10k @ 14.25%
Credit Card 2 - 1k @ 16.99%
Debt consolidation loan - 11.5k @ 14%
Truck loan - 12K @ 12%

So you can see that we can pretty much wipe the slate clean there. Here is my real question. Will all that debt just gone, we will have a little over $2,000 a month left over. How do we make sure that we are not just going to blow it? We have four kids to put through college and a neglected retirement fund to look at. But it seems like it is just too much money to really handle. Help!

According to my math, that debt is about $34K, and you’re getting about $37K. With interest rates like those, you’re definitely in the right to pay all of them off as soon as you get the money. Step one is to get that debt completely gone - any time you’re paying out double-digit interest, you’re never going to get ahead.

This leaves you with about $2,000 a month in excess on your monthly budget, which is great. I also understand that, without a plan, you’re going to be prone to spending all of it, which is not great.

What I would do is start automatically putting that money in various places. Set up automatic deductions from the paycheck into a 401(k) and into 529 college savings accounts for each of your kids - $500 a month into the 401(k) and $100 a month into the 529s will eat up $900 of it.

What about the rest? First of all, I’d build up a nice emergency fund to protect yourself from things like a car breakdown - if your car dies and you suddenly have a large bill at the auto repair place, you don’t want to dip into credit to cover it. I would set a goal of having an emergency fund equal to six months’ worth of your monthly budget - with four kids at home, lots of things can happen when you least expect them. This will siphon off that extra $1,100 each month for a while, but when the time comes, you are going to be incredibly happy that you have that money.

What about when the emergency fund is full? Between now and then, spend some time with your husband figuring out what your most important goals are. Do you want a bigger house? A better retirement? Do you want to really fund your children’s education? Some amazing family vacations in the future? Paying cash for automobiles so you never go into debt again? Each of those goals points to different things to be doing with that money. By putting cash into an emergency fund now, you’re not only building security, you’re also giving yourself plenty of time to think about what you really want to do with your money after the emergency fund is completely funded.

My wife and I dream heavily of a country estate, for example, so we’re focusing on paying down all of our debts with some seriously large overpayments right now, then saving rapidly for this home.

The real key, though, is making it automatic - just set up automatic deductions into appropriate accounts. That means that you’ll never touch that $2,000 a month and never be tempted to spend it. Good luck!

In the aftermath of yesterday’s discussion about how to manage several funds in one account, several people mentioned actually opening multiple savings accounts at ING Direct under one general account, enabling people to sort their money (I happen to be a big fan of ING Direct, but you may also want to read the note at the bottom). This, of course, intrigued others, who asked how this could be done, so here’s a description.

Step 1: Log in to your ING account Enter your information and go view your overall account information.

Step 2: In the upper left, click on the “Open Account” option You can see it clearly in the picture above.

Step 3: Choose to open a new savings account on the next screen The “Open Now” link in the image above is where you should go.

From there, the process is really straightforward - you can call each account you create whatever nickname you like to identify it as a distinct fund: an emergency fund, a “house maintenance fund,” a “vehicle replacement” fund, and so on. From there, you really should set up automatic deposits into each of these funds so that you can always be building up these funds.

Why not do this instead of using Excel? In fact, I did do this for quite a while. I moved my primary savings out of ING Direct not too long ago, not because of the service, but because having all my savings accounts so easily available made them tempting. (note: I later moved everything back to ING because of HSBC troubles). I moved the savings accounts to a single HSBC Direct account, and I manage the distinct layers in Excel. I’ve actually left all of my old accounts in place in ING and when I’m ready to get money from HSBC into a particular fund, I withdraw it from HSBC directly into the matching ING account, so I can quickly see when that money’s there and ready to go.

Over the past several months, I’ve suggested that people break up their savings into several smaller funds for various purposes: a home maintenance fund, an emergency fund, an automobile fund, and so on. Some readers have asked whether or not I use several accounts to manage this cash - the truth is that I use just one savings account to manage all of my funds.

Why? The biggest reasons for doing it this way all revolve around privacy. With only one account to manage, there’s less threat from identity theft and fewer passwords to remember (and potentially spill the beans about).

How do you do it? Each week, I make a standard deposit into the account, a percentage of which is intended for each of several different funds (two auto funds, a home improvement fund, an emergency fund, and a splurge fund).

In Excel, I have a six-tabbed spreadsheet that keeps track of these funds separately. There’s one “master” tab that keeps a running total of the account, and five separate tabs, one for each fund. I make sure that the summed total of all five funds match the balance in the account. Then, when I make a withdrawal from any of the funds, I just mark it on the balance sheet for that fund - the total for that fund is lowered and then the sum of all five fund balances again matches the total in the account.

What about interest? Each month, interest is deposited into the account. I usually “give” that interest to whichever fund can use it the most. Lately, it’s been going primarily into one of the auto funds.

An example Let’s say each week I want to contribute $200 to be split up evenly among five funds.

Weekly deposit I set up an automatic deposit into my savings account of $200 each week. In Excel, I mark that as a contribution of $40 to each fund every week. So, after four weeks, each of the funds has $160 in it, and the total account has $800 in it.

Monthly interest At the end of the month, the account earns $1.23 in interest. I decide to include that in fund #1. So, I go into Excel and add $1.23 to fund #1, leaving it with a balance of $161.23 and the other funds with $160. The total account balance is $801.23, which is the sum total of $161.23 plus four separate amounts of $160 each.

Withdrawals I then decide to take $50 out of fund #2 to buy a new Wii game. That brings the account balance down to $751.23, with fund #1 having a balance of $161.23, fund #2 with a balance of $110, and funds #3-#5 having a balance of $160.

Isn’t this confusing? Not really. If you’re diligent in keeping track of things with Excel, it’s actually very easy - and also rather fluid, because you can effortlessly “borrow” money from one fund for another fund if you need to. I find it very, very convenient, actually.

An old friend of mine discovered this site and asked to have lunch with me because she had a few questions she wanted to ask me about her financial situation. She was actually in good financial shape, but rather than having any sort of filing system, she would mostly just glance at old statements, toss them in a box, and forget about them. She didn’t keep track of anything that could be tax deductible or anything like that, merely relying on end of year statements for any of those. The end result? A huge trash bin in her closet full of eight years’ worth of financial statements.

The good news is that she now sees the purpose of organizing one’s financial statements: they provide a great record of where you’ve been and where you’re going, plus detailed records can be huge at tax time if you choose to itemize your income taxes. I personally look at old statements regularly to track my progress in various ways; I often use them to build various models of my spending and I’m building a huge one now to estimate some payoff dates of my student loans, my home, and our next automobiles.

The only problem is that she can’t motivate herself to even get started making sense out of this huge pile of statements. It seems so overwhelming to her that she just can’t get started with that huge pile of paper.

My solution? Declare paperwork bankruptcy (sort of) and start over from scratch. Similar to email bankruptcy, it’s an acknowledgement that the pressure of the stuff you haven’t dealt with is enough that it’s keeping you from moving forward, so you simply just leave all of the old stuff behind. Don’t worry about filing anything that’s in that bin, but don’t throw it away yet, either. Here’s the plan I proposed to her, one that might be useful if you’re feeling nervous about getting started in a filing system of your own.

First, verify all of your most current statements so that you know they’re correct. If something doesn’t jibe, dig back until you can find the source of it and get it straightened out. Don’t declare paperwork bankruptcy until you’re sure everything is fine.

Next, figure out the essential documents that should be in your filing cabinet. I made an extensive list of the basics for your home filing cabinet in the past. Most of the stuff to include is pretty basic: tax returns, pay stubs, and so on.

Then start filing all of your receipts, statements, etc. I recommend having a section for each year and then folders within that section that break down the groupings, like electric bills, pay stubs, etc. Some of the documents (like a will, etc.) are timeless and should be in their own section. I find it very easy to do this once a week and let things pile up in a “to be filed” basket until that point. I just toss everything in there - receipts, statements, etc. - and then file them all at once.

What about all of that old stuff? If it’s in your “trash bin of doom,” don’t worry about retrieving it unless it’s a lazy Sunday and you feel like pulling all of that old stuff into your system. Instead, just start filing the new stuff and leave the old stuff alone wherever you have it. Let it sit for seven years (just in case you ever need to retrieve something out of it), then burn the whole thing in a raging inferno. A couple of boxes clearly marked “old papers” in the back of your closet or in a storage space is the best place for it.

My wife and I use a simple mathematical construct called a moving average in order to help us budget and estimate upcoming bills.

What’s a moving average? Let’s say our telephone bills over the last twelve months were as follows:

May 2006 - $55
June 2006 - $55
July 2006 - $58
August 2006 - $55
September 2006 - $80
October 2006 - $55
November 2006 - $55
December 2006 - $55
January 2007 - $85
February 2007 - $55
March 2007 - $55
April 2007 - $57

Our basic cost is $55, but on occasion we use our phones outside of our calling area and incur some hefty bills. This happens roughly at random.

If we average the costs of these twelve bills, we come up with an average of exactly $60, which is what we estimate our next cell phone bill to be. Most of the time, it’s slightly under this, so we take that extra $5 and leave it in our checking account, where it earns interest. Then, when we get a higher bill, we can pay it off easily with the money we’ve been holding onto.

Easy, right? Here’s where it gets interesting. Let’s say our next bill, for May 2007, is $75. When we recalculate, we don’t just add on the new number, we drop the oldest one. Why? It reflects our situation far enough in the past that it doesn’t really reflect the actual use right now. So, when we re-average the numbers, dropping the oldest one and adding the new one, we get a new average of $61.67, which is how much we budget for for the June bill.

It’s really easy to keep track of all of this in Excel. We just have twelve rows (one for each month), and we just overwrite the bill from a year ago with the newest bill and Excel recalculates our budget for us. Over time, as we become more careful with our cell phone minutes, this moving average slowly drops and frees up more space in our budget. We can actually see frugality at work.

What about when the bill varies quite a bit? Let’s say our electric bills over the last year were as follows:

May 2006 - $50
June 2006 - $60
July 2006 - $65
August 2006 - $70
September 2006 - $45
October 2006 - $40
November 2006 - $50
December 2006 - $80
January 2007 - $85
February 2007 - $95
March 2007 - $70
April 2007 - $60

This is roughly typical for the Midwest, as fall and spring electricity usage is always much lower than summer (when you need air conditioning) and winter (when you need heating).

If we average the cost of these twelve electric bills, it comes out to $64.17, which we use as an estimate for the upcoming electricity bill. However, we do know that in the winter and summer it’s going to be more than that, and in the spring and fall, it’s going to be less than that. So, we budget in $64.17 for electricity for May, knowing that almost assuredly our bill will be less than that, and we leave the excess in our interest-bearing checking account. Then, in August, we use that money we left in checking to pay the inevitably higher bill, and we’ve earned a bit of interest in the process.

Much like the cell phone example, when we initiate cost-saving measures (like installing CFLs), it causes all of the bills to drop, and over time we begin to see more breathing room in our budget (which usually means more money in the bank). Excel makes this all automatic, thankfully.

What happens when you move and all of the numbers change? First thing, we take the utilities estimates from the previous owner and add 20% (to give us plenty of leeway). Then, we enter this number in for all twelve months, so the moving average is actually just equal to the estimate plus 20%. When we start receiving bills, then we start entering real numbers - almost assuredly, the real bills will be lower than our padded estimates, so over time our budget will gain breathing room rather than losing it.

Several readers have asked me how a person’s primary residence should be used when calculating net worth. As we’re on the verge of buying our first home, this becomes a very relevant question to us for the first time, so I spent some time looking at the options:

Include the debt, but don’t include the house at all. The argument here is that if it’s your primary residence, then you’re not going to be liquidating it ever, thus it’s not an asset. For many people, this would push their net worth far, far into the hole and if you’re making interest-only payments, it’s a hole you’ll not be climbing out of.

Include the debt, but only include the equity in the house. In other words, only include the portion of the house that you could draw equity from through something like a home equity line of credit. This means that any payment directly to the principal actually counts double towards your net worth, as it decreases the debt and increases the equity in the house.

Include the debt and also include the purchase price of the house. This means that the house itself has no direct effect on your net worth upon purchase and it slowly goes up as you reduce the principal of the debt. Many people seem to follow this path because it somewhat disguises the debt.

So what are we going to do? We’re going to actually follow a fourth path, which is an interesting one.

Include the debt, but only include the assessed value of the house. This means that right after purchase, our net worth takes a small hit, but as time goes on it climbs back as we make debt payments. Plus, each time the house is reassessed, the value of that asset changes - and given the location and the quality of the house, it will likely go up. In essence, this route means we are not counting the appliances as assets in any way, nor are we considering some of the more aesthetic appeal of the house that isn’t directly affected by the tax assessment.

What this means is that in the short term, my monthly net worth calculations will look disastrous, with some big losses, particularly in the month where we sign all the papers and take possession of the house. After that, however, our net worth will begin to climb again, albeit at a slower rate than before because our housing payments are going up. Then, whenever our home is reassessed, our net worth will likely see a bump (even though that also means that we’ll be paying more in taxes, which is a downer).

I would recommend that others follow the same path as well for including the primary residence in calculations. It is an asset and can be liquidated, but the aesthetics of the house and the appliances within and so forth will often make some difference in the actual purchase price that may only be of value to you.

My wife and I have a monthly financial review meeting where we sit down with all of our bills, credit card statements, and so forth. We go through everything together, item by item, and try to figure out where we can trim our spending. Most of the time, we’re in pretty clear agreement on things, but once in a while we disagree on the necessity of an item. What this entire discussion comes down to is a clear definition of our wants and our needs.

What are wants and needs? In a nutshell, needs are the things that you absolutely have to pay in order to live and avoid bankruptcy: housing payments, taxes, groceries, commuting costs, and so on. Wants are the things that you spend money on that you don’t explicitly need, like dining out or music.

As a rule of thumb, my wife and I allow each other a certain amount of wants in a given month, because life isn’t fun if you can’t have anything that you want. My wants are usually books, food, and occasionally music; hers are much more varied. By capping our wants at a reasonable level each month (and also with the peer review process on such spending), we often find ourselves saving quite a bit of money each month.

The tricky part is determining whether some of your spending is a have or a want. For example, let’s say we have beef burgundy for supper and in order to make it, we have to buy a new bottle of cooking wine (we generally buy pretty cheap wines for cooking wines, like “two buck Chuck”). It’s not explicitly a need, as you can prepare food at home without it, but it also really stretches the definition of want as well, as things like cooking wine enable us to prepare delicious meals at home that encourage us to eat at home instead of getting takeout or eating out, so in the long run buying a bottle of cooking wine is a money saver for us.

Here’s the process we go through to determine if something is a need or a want:

First, we list all of our spending that isn’t strictly essential in a month. Things that are essential are housing bills, most gas costs, staple foods, medical bills, insurance, and so on. These are things that we have to pay no matter what.

After we’ve made that list, we list everything that’s clearly a want. Entertainment and hobby expenses, dining out, and so on go under this category and immediately go on the want list.

This leaves us usually with a handful of things that we talk about - things like the cooking wine and so on. This process is more organic, but it usually comes down to the following question: would we have spent more money than this had we not purchased the item? With a bottle of inexpensive cooking wine, the answer is usually “yes,” because we likely would have eaten out more often without tools like that in the kitchen, thus costing us more in the long run. We use a similar philosophy to mark things such as CFLs as needs.

After this process, reviewing the list of wants helps us keep our eye on the financial ball each month. We usually strive to keep ourselves within our self-imposed allowance - and thankfully, we’re both usually way under the limit.

Yesterday, I spent several hours setting up an electronic system to maintain most of my records instead of using a filing cabinet system as I described a while back.

What is an electronic financial document system?

Basically, it just means that instead of saving paper copies of your financial records, you save them all electronically, saving only paper copies of the most vital documents. This can save a tremendous amount of space, plus make it much easier than before to find and search through your documents.

Here’s an example: let’s say you wanted to find all of your credit card charges for gas in the last year. With paper records, you’d be going through the filing cabinet for an hour: with an electronic financial document system, you just click a few times and search through a handful of PDF files, retrieving the info you want in just a few minutes.

The benefits of such a system include:

It saves space Having all of your financial documents in electronic form is a lot more space-efficient than having a filing cabinet.

It’s easier to search Finding the specific information you need in an electronic system is much quicker than in a system of file folders, especially if your question is rather esoteric. This is especially true come tax time. To me, this is the true benefit of electronic financial documents.

It’s easier to back up Backing up an electronic system basically involves a blank DVD and a DVD burner (or even a CD and a CD burner for a small archive). That’s a lot easier than a filing cabinet full of photocopies.

On the other hand, the drawbacks of such a system include:

It takes longer to file things away When you get a new document, you have to scan it and add it to the system. This can take substantially longer than merely putting it in the appropriate folder in a filing cabinet. This can be mediated, though, by having an efficient system as described below.

It’s slightly less reliable. Filing cabinets typically don’t have disk errors. The best thing you can do is to make sure you have a paper copy of everything truly vital and also be sure to have plenty of backups.

It’s slightly less secure. You will probably want to have some security on the drive, such as having it attached to your desk with a steel cable or something to that effect, as well as data security software like TrueCrypt. A hard drive is much easier for someone to take than a locked filing cabinet.

What do I need?

Here are the components of the system I’ve set up.

A home computer Yep, that’s the basic piece. A few free USB ports and a CD or DVD burner are also needed peripherals.

An external hard drive Over time, this data will really add up. Plus, you’ll want the ability to easily move this archive to another computer. Thus, I recommend an external USB hard drive for storing this data.

A scanner / printer These may or may not be two separate devices. You’ll obviously also need the software for both.

Adobe Acrobat Standard (not Reader) This is my preferred format for storing the documents. Acrobat does a great job of handling character recognition from your scans, making it possible to do text searches of all of the stuff you scan in. Plus, Acrobat files are quite portable.

Blank DVDs These will be used for backups. I highly recommend monthly backups for all of your data, but especially for this type of data.

How do I do it?

This is a step-by-step example of how I set up my filing system. Your filing system may differ - the important part is that it makes sense to you.

First, I devoted an entire external hard drive to financial storage. This meant that everything on this external hard drive was nothing but financial documents. It connects via USB and is hidden in a locked desk drawer. I get it out when I need it.

On that drive, I created a series of top level folders for each entity I conduct financial business with. I have an IRS folder for my taxes, a Vanguard folder for my investments, an Alliant Energy folder for my electric bill, and so on.

Within each folder, I have a folder for each month. “December 2006″ and so on. Within each of those folders, I store the actual scanned documents with a filename that includes the date I received it as well as a brief explanation of what it is. So, in Alliant Energy / March 2007, I have a scanned copy of the bill I received during that month as well as a copy of my receipt for the online bill pay.

I also have a series of “shortcut” folders based on year. At the top level of the drive, I have a 2007 folder, and under that folders for each month. Inside of each of those folders is a direct alias to all of the folders on the drive for that month. This saves time in searching for documents.

Actually getting the documents in there is simple. I just scan them directly into Adobe Acrobat, save them appropriately, then shred the document. Once it’s shredded, I save the shreddings for campfire kindling (seriously, shredded documents makes for great kindling). I only save documents of vital importance.

Once you are used to the routine of scanning and shredding, it becomes very simple to archive all pieces of financial information that come your way. I am now actually archiving grocery receipts and so forth to make it easy to analyze my shopping habits.

In short, even though it takes a bit of work, it’s well worth the extra effort because of the constant convenience of having your financial information at your fingertips.