To start this discussion, let’s take a look at some statistics on the distribution of income in the United States. Maybe from this there is something to learn, or perhaps its just interesting data.  First let’s look at some of the 2005-2007 census data. Statistics show that we have 111.6 million households. So what is the relative wealth breakdown of those households?

Income Levels (2005-2007 Census Data)

The median income during this time period is right around $50,000. If you are significantly lower than that, you might be struggling to make ends meet. If you are higher than that, you might have a good income, especially relative to the rest of the country… but even then you might not feel like it is sufficient. And if you are way off the charts, you might be Obama-rich (congratulations if that is the case)!

So how do these numbers differ from the past?  Below is the same data from 1993.  You can see the trend as fewer households are in the under $15k range, and significantly more households are in the greater than $75k range.

Income Levels (1993 Census Data)

In 1993, the median income was $31,553 compared to the $50,000 number for 2005-2007.  During this time period (1993 to 2005) the consumer price index grew from 213.7 to 284.3, an increase of 33%. The median family income grew over 58%. So why are incomes outpacing consumer price index during that time period?  One of my thoughts is that a certain portion of that increase is represented in the increase of dual income families.

At the same time that households appear to have more money relative to the cost of goods, people have felt increasingly more strapped. Take a look at some data from Pew Research (The Median Debt-to-Income Ratio for Households With Debt Holdings) that really highlights what I believe to be a major contributor, if not the largest contributor, to any disparity in wealth and the “fading middle class.”  This graph shows the median debt to income ratio of high, middle and lower income earners in 1992 and 2004:

Median Debt to Income (1992 and 2004)

Notice the tremendous growth in debt compared to income! We can consider what goes into that. For instance, I have no doubts that rising health care costs are a contributor. But I also believe that our excess is a factor as well — our Starbucks, BMWs, and our willingness to take on house we cannot afford.. If you compare the income data, it seems we should feel better about our position not worse. And certainly it is difficult to see the middle class disappearing from the income data. Compared to inflation it seems middle class should be getting richer. But this debt is a tremendous burden. And doesn’t Congress provide a wonderful example of keeping debt within reason?

What are your thoughts on what contributes to this drastic increase in debt?

Uncle Sam?

wealth. The reality though?  Capitalism has merely taken a small portion away of the vast wealth that Capitalism provided in the first place. Sure, it does not seem like a small portion. Times are tough and jobs are scarce. Only jobs aren’t as scarce as they have been in the past. And times aren’t as tough as they have been before.

Will times be as tough as they once were?  Maybe, if we keep trying hard enough. If we continue to get better at spreading the wealth around through taxing wealthy, we can get there. If we socialize health care, that will help. If our government keeps taking companies over that will help too.  We can go all the way to the dark ages and beyond if we want to.

What about the great disparity in wealth in our country? Clearly capitalism has increased the gap between the haves and have-nots, right? No again.  The haves are the have-nots employers! Take away the haves (by taking their money) and all you have are have-nots. Sure it’s just a little bit here and there, the haves won’t miss it. The haves won’t use it to hire someone either then. The government cannot hire everyone. The gap between wealthy and the middle class may be growing, so do we take the money away?  Or do we earn it by providing products they can use. And does the money of the wealthy sit under a mattress providing no value to anyone?  Sometimes, but usually it is invested in something that helps everyone produce goods that people need. If it is invested, what else might it be doing besides earning more money for the investor?  Providing jobs.

Well, take the banks — what an example of unfettered capitalism going wrong. Clearly they demonstrate that there must be regulation, right?  Sure, there must be some regulation – not everything fits into an absolute, capitalism is no different. But did capitalism really result in the mess we are in?  To a point, because with capitalism there will always be fluctuations in the marketplace. That is a good thing. But let’s look at other events that contributed to the mess:

• We, the people, borrowed any money we could get our hands on.  We, the people, bought houses we could not afford.
• We continued to be customers of mega banks that increasingly provided lower interest rates and poor customer service.
• Our U.S. Government decided that everyone deserves life, liberty, happiness, and a home. The Community Reinvestment Act encouraged banks to lend to people who could not afford homes. [This is not the cause, it is a contributor]

Do banks have an obligation to ensure that their customers can repay their loans. Absolutely. If they cannot, what happens?  The bank, its management, its shareholders, and unfortunately its employees move on to better endeavors. Why is this important?  Because this is creative destruction, where companies that fail and cannot produce go away. This is capitalism’s way of handling poor management, poor products, poor service, and corruption.

So after I say all of this, I must not care about others, right?  Me, and others that think like me, must be hoarders without empathy. No, I support capitalism because I care. Capitalism is the only system that allows the level of entrepreneurship we have seen in this country.  It is the only system that produces so many millionaires from the have-nots. Those who believe in the opportunity to create wealth for themselves must believe in capitalism, for without it that opportunity does not exist.

http://www.hulu.com/watch/74840/the-dave-ramsey-show-frid-may-2-2009

Now that I have been able to watch it, I have some thoughts that I want to share on the event.  First and foremost I do recommend that everyone watch the Town Hall for Hope. The message is excellent despite any shortcomings I mention in the rest of this post.  It is important that we continue to work our way out of difficult economic times with as much optimism and hope as possible. Key components of Dave’s message in this event include:

• The fear and hysteria can get to anyone, the media has done an excellent job publicizing it.
• Although 45+% of people believe there job may be at jeopardy, the reality is that unemployment has increased only around 3% (this has gone up slightly since the broadcast; also, 3% is based on the official unemployment number — some believe it is optimistic because it does not include underemployed).
• For those who have lost their jobs, attitude is a critical component to moving on and landing the next job.
• Although it is always difficult starting a new business during an economic downturn, there are advantages and opportunities that exist when compared to times of strong economy.

Dave’s message is extremely consistent with his show, and as he puts it, this is common sense — this is advice your grandmother might give.  That is true to an extent, though not everyone believes that avoiding debt completely is necessary. In fact many believe debt can be a key to financial well being (for example, buy real estate at no money down). If you have listened to Dave’s radio show, watched his television program, or read his book The Total Money Makeover, you will see that much of the content of the Town Hall for Hope has been delivered before. That is acceptable here, because in this event it is delivered to a potentially wider audience.

Dave believes that you cannot separate the spiritual from finances. Maybe more accurately he believes you cannot separate the spiritual from anything in one’s life, financies being a component of life. Although occasionally he will encourage his listeners to seek advice from their pastor or their church, usually he keeps religion out of the discussion unless he knows one’s faith. A big part of his delivery of Financial Peace is through the church community, so clearly his message has tie-ins with religion. Like his traditional shows, this event was mostly finance and economy with a little bit of spiritual mixed in.  This may turn off viewers who do not hold views of any religion, or believe in religions other than Christianity.

Near the end of the event the question / answer session between David Asman and Dave Ramsey added less value to the overall conversation than the initial discussion and the question / answer session with viewers. With the crowd gone and the seats empty, it made me feel as if it were time for me to leave as well.

Dave adds many of his usual quips and expressions to much of the conversation, and if you listen to or watch his show you may be quite familiar with them – to the point where they are overused. But there is something rewarding in Dave’s delivery in general, whether part of this event or his show. To me that reward is a very motivating financial adviser that constantly reminding me of my own financial goals. There are certainly other ways to attain the same motivation, however for those that are looking for the motivation, Dave Ramsey provides it.

In the end, for anyone with uncertainty and concern about our economic climate, the Town Hall for Hope is a must watch. For those who want motivation and want to help spread the message of hope, there is value in the event as well. The only group I might recommend not watch the program are doomsayers, there may be too much hope for even the pessimistic to withstand.

Frozen Credit (Actually Just Water)

that post I also said that freezing your credit was free at TransUnion.  In fact, it was… but today I received a message from the credit bureau that it will no longer be free.  Maybe signs of inflation?

At any rate, here is an excerpt from the e-mail:

“ We have offered the Security Freeze services free of charge through our online self-service channel since its launch in 2008. As mentioned in our online Terms & Conditions, this service was being offered free of charge, but subject to change at any time. Beginning July 14, 2009, TransUnion will assess fees for Security Freeze services through the online channel as permitted by state law…”

TransUnion has provided a fee table that details the fees for each state. The good news is that the fee is no higher than $10 for all states, and still free in many. Well, except Delaware — sorry Delaware!  Appartently in Delaware freezing credit takes lower temperatures, so it is $20.

So despite this fee change, I am a big advocate of freezing your credit. If you do not have any upcoming purchases within the next few years that will require credit, I recommend freezing credit scores on each bureau. This is the best way to protect yourself from credit identity theft. So if you are planning on freezing your credit, be sure to make it to TransUnion before July 14th before the price is increased.

Other Blogosphere Posts on Freezing Credit:

Fine Tuned Finances (How to Freeze Your Credit and Stop Identity Thieves in Their Tracks)

Putting the Plan Together

Our Goals

We would not have a plan without first setting out some goals. While we have long term goals around our childrens college savings and our retirement, the short term goals are the focus for this topic. The short term goals are part of the longer term plan, but the 1-2 year goals really indicate what we need to be doing today.

Two primary factors have led to creation of these goals:

• Birth of our premature son – demonstrating the need for an emergency fund and more stability in our finances
• Upcoming reduction in income – my wife will be reducing her work within the next two years

So here we have a past event that encouraged us to take action. But we also have a future event that we control. Because it is our choice to reduce income in this case, we have set some predefined targets that we must hit before my wife can reduce work. This gives us real incentive to work together and hit the goals. Our two financial goals for the short term are 1) reduce our debt to the point where our home value is greater than our remaining debt, and 2) establish an emergency fund of at least 4 months expenses. When we started the plan last May, we had two 401(k) loans, a home equity loan, a student loan, and a mortgage.  And we had no sizable emergency fund.

Bringing our debt down below the current value of our home is advantageous because we could then sell the house and be completely debt free. With the housing market down, we do have to work harder than we expected when we started the plan!  Nevertheless it is still our target. Establishing the emergency fund is key to providing the stability we craved after the birth of our son.

Crafting the Plan

Our first decision to make was which loans to pay off and in what order. After some thought about each loan the decision was not all that difficult. The type of loan, the size of the loan, and the interest rate were all factors. Here is how we broke it down:

• 401(k) Loans – Generally speaking 401(k) loans are recommended against, which I will cover in a future topic. The only factor for making these loans the top priority was to have more freedom to change jobs (or withstand a layoff) without having to repay the loan immediately or owe interest and a penalty.
• Home Equity Loan – This became our second priority because of the relatively high 8.85% interest rate.
• Student Loan – Our interest rate on this loan is a very fortunate 1.75%. If it were 2 or more percentage points higher, I would be inclined to include it in this debt repayment plan. This became our lowest priority and would only be paid off in a medium to long term plan.
• Mortgage – The interest rate for the mortgage is 5.75%, and it is our largest debt balance. This is our third debt priority, but would have to be addressed after retirement savings and various other needs and wants in our medium to long term plans.

Our intention was to attack this debt with extreme focus. So while we have not followed Dave Ramsey’s Baby Steps exactly, the steps we have taken are not far removed from his approach.

Started a Budget and Reduced Spending

Where we had no formal budget before, we began to track our spending. We tracked our spending for the first month before establishing any budget. We identified areas to cut and began implementing those changes. The key point here is that we communicated what each of our priorities were within the budget, including some available money for non-essentials such as entertainment, eating out, and so on. Instead of eliminating all of the non-essentials, we put together a budget that reduced the number of smaller non-essential items like eating out. Where we really created room in the budget though was by eliminating and putting off the big non-essentials like out of state vacations, recurring monthly expenses, and cosmetic home improvements. Our income situation allowed for this, though if we had more debt or less income we would have had to focus on all discretionary expenses.

Created an Emergency Fund

Getting the budget completed allowed us then to put together a small emergency fund.   As quickly as possible we put in place $2000 for this emergency fund. We chose $2000 because while our expenses we under more control, they were still high enough that an expensive emergency could derail our plan. We keep this money in our ING Savings account in order to be able to access it quickly if an emergency required it.

We Threw Money at the Debt Constantly

All “extra” money we had went directly to the debt.  Well almost   With the 401(k) loans we had to pay them off in full, so we had to save the money first. This gave us extra perceived cushion on our emergency fund as well, but it requires much discipline to avoid dipping into the money that is saved to pay off debt.  All of our excess money went to paying off debt. By the end of 2008 we had our two 401(k) loans paid off. This had a fortunate side effect as well, at least for one of the loans. With the crash in the stock market, if we had all of the money from the loan still in our 401(k), we would have lost much of it in the crash. But instead it was like having a cash investment. We paid one loan off before the crash, so we lost around 40% of it in the downturn. But the other loan was repaid after the crash, coincidentally a great time to be buying into the stock market. This of course was luck, and I would not suggest trying to plan it this way.

Aside from the budget and reduced spending, we also made some other temporary changes:

• Reduced 401(k) contributions – we reduced our 401(k) contributions to just enough to get the company match.  If this plan were going to take more than two years, or if we were going to just incur more debt after we paid these debts off, then this would be a bad move.  All the money that previously went to 401(k) contributions now goes to the debt.
• Any extra income or money such as bonuses, income tax refunds, and reimbursements from Child Care Dependent Care account and our Health Savings Account goes directly to the debt.

Our Current Progress

These changes enabled us to pay off our two 401(k) loans by the end of last year, and cut our home equity loan debt in half. At this rate, we should be able to meet our goal of having less total debt than the value of our home by February of next year. Then within about 6 months of completing that goal, we should have our emergency fund established. So a plan that originally took us through mid 2011 is on track to be accomplished by mid 2010.  We are thrilled about the progress, especially given the current economic conditions. What we have found is that this focused intensity has enabled us to meet these goals much earlier than we imagined. It does not always work out that way for everyone, but my hope is that this provides some motivation for others.

Next Steps

Once we meet our target around mid 2010, our focus will shift slightly to medium range plans.  A major item for that time frame will include saving to buy our next cars.  Our current cars will reach 10 years old around 2013 and we want to be prepared to buy our next cars without incurring new debt. Once we have saved the money, if the cars are still running fine we will wait to buy them though. We own our current cars and are in no rush to replace them — we want them to last as long as possible.

Also during this timeframe we will re-establish fully funding our retirement accounts.  We will plan a vacation.  And my wife will be able to scale back her work.  So with that, I will provide more information on our progress and our medium to long term plans in future posts!