The Dollar Stretcher Blog

How you look at your situation could make all the difference

The other day I was sitting in the courtyard of a tall hotel building. I happened to notice how small some palm trees appeared against the building. Then it occurred to me that I had similar sized palm trees in my yard. And compared to my split-level home they appeared huge. The difference? It's all a matter of perspective.

Our finances are also often a matter of perspective. Whether $500 is a lot or a little depends on what we compare it to. So let's take a look at some situations where our perceptions could have a big impact on our bank account.

We'll begin with something very familiar, our homes. According to the National Association of Homebuilders, the average home size in the U.S. in 2004 was 2,330 square feet. That was up from 1,400 square feet in 1970. So is your home large or small?

If you have a 1,900 square foot home, you might compare it to your friends and think that you're really quite cramped. In fact, it might be very important to you to find something bigger. Even if it means higher mortgage payments, insurance costs, utility bills and additional upkeep. Moving to a larger home could have a major impact on your budget and your bank account. But, if your friends' homes are the comparison, you'll probably talk yourself into moving.

On the other hand, if you compare your home to the one you grew up in, it probably seems spacious. No need to move to a bigger home. Just a matter of controlling how much stuff you try to cram under your roof. The savings could be significant. Not to mention the peace of mind. It's all just a matter of perspective.

Or let's try car payments. Suppose that you have a car payment of $400 per month. That doesn't seem like much, especially when you compare it to your neighbor's payment of nearly $650. And, it sure is nice having a nearly new car in the driveway for everyone to see. After all, you wouldn't want them to think that you couldn't afford a new car because you can handle those payments with no problem.

Of course, if you should happen to lose your job, that $400 a month payment will suddenly look like a huge mountain. Trying to live on unemployment is hard enough when there's only the mortgage and food to consider, but that car payment is going to make things very difficult. From this vantage point, it looks like a big problem.

Here's another one. Two thirds of college graduates had student loans. And students with loans had an average debt of over $19,000 at graduation (source: National Center for Education Statistics). Depending on the type of loan, the monthly payment will run $200 a month or slightly more. So is that a large debt for a college grad?

Depends on how you look at it. The U.S. Dept. of Commerce estimates that a college grad will earn about $23,000 more per year than someone with a high school diploma. So in those terms, a $19,000 debt doesn't seem so big. In fact, it might even seem cheap.

But, let's take another look. The first thing to note is that the difference in earnings for college grads is an average over their entire career. So they'll probably average less their first job out of college.

What can current grads expect to be paid? That depends a lot on the job. So we'll select something that's fairly typical. The average business administration grad can expect to earn about $38,000 a year (source: National Association of Colleges and Employers). Depending on state taxes and some other deductions, he'll take home about $2,400 per month.

That would mean that 5% of his take home pay is going to repay student loans. Now the debt seems a little bit bigger. Let's further suppose that our graduate wants to replace the beater he drove through school. Add a car payment to the mix and the budget starts getting pretty tight. Once again, we have a different perspective on the same situation.

Why is all this important? Many of us make financial decisions based on how we "feel" about a situation. Those feelings are very much affected by what we're comparing to our potential financial transaction. Unfortunately, sometimes we focus on that first perspective and don't consider any others.

It's important to our financial well-being that we get more than one comparison on any major financial decision. Let's give our feelings and our intellect a chance to see both sides of our potential choices. We'll be much more likely to make a decision that is comfortable in the future.

So how tall is that tree? It all depends on what it's standing next to.

Just last week my wife was going through the mail and noticed an envelope from Bank of America. We have a couple of accounts with them so she opened it up. To her surprise, inside she found a new credit card. The reason that she was surprised is that we do not have a credit card account with Bank of America.

She called to complain and was told by a condescending service agent that she must have applied for the card. No one should be treated like an idiot. But especially my wife. She's been a CPA for 25 years and I suspect that she's more knowledgeable than the service agent!

She asked for someone in a supervisory position. That person, too, insisted that she must have applied for the card even
though she explained that she would remember and did not complete any application.

Finally, she remembered that she had used the drive-through at the bank a few weeks earlier to make a deposit. The teller mentioned that she qualified for a special card, but my wife responded that she did not want the card. Although there's no way to know for sure, it would appear that the teller hit the "yes" instead of the "no" button on her screen. Instant credit card application!

Why is this worth your time? (outside of the fact that I feel better for telling it?) Opening a new credit account would
probably reduce our credit score. Not by much, but we shouldn't be penalized for something that we didn't request or want.

Second, it's a good thing that she didn't toss the mail unopened as junk. I'd hate to think of what could have happened if the wrong person got their hands on the unsigned card. Also, I don't like the thought that we'll probably need to be more careful sorting the junk mail in the future. Like we don't waste enough time doing that already.

Third, I guess we'll all have to be very careful with our conversations with banks. An off-handed reply and you could be signing up for a credit card without even knowing it.

Once again, I guess the bottom line is that you really have to watch out for yourself financially. To do otherwise is to take unnecessary chances.

We have kitchen doors from the 70s or earlier. We would like to change the color but don't know whether we should stop there or go as far as changing cabinets. - John

John's got a lot of company. Kitchen & Bath Business Magazine forecasts that there will be 6 million kitchens remodeled this year at a total cost of $79 billion!

It isn't surprising. Kitchen remodeling projects generally recover nearly all of their costs when you sell your home. MSN House & Home released a report showing that projects costing up to $25,000 returned 90% or so when the home was sold.

So that's a good reason for redoing your kitchen. Another is that it's one of the most used rooms of your home. And, if you listen to the people who study such things, the more time your family spends in the kitchen the healthier and happier your family will be.

OK, so you're thinking about doing something. But, like John, you wonder how much to do. The best place to start is to figure out what you can afford. Kitchen projects can quickly get out of hand. Once started, it's easy to upgrade to a more expensive drawer pull or cabinet door. There's a lot of pressure to go just one step further. And then one more after that. But those decisions can be very expensive. Have a dollar limit in your mind based on what you can afford. Hold on to that boundary. Just about everyone, including your own ego, will want you go spend more.

And, expect some unanticipated expenses. It's prudent to only plan to spend 90% of the money you'll have available. Save the 10% for mid-project surprises.

Next you'll need to decide how extensive your remodel will be. It may be as simple as repainting wood cabinet doors and walls. Perhaps you'll want new countertops and faucets. Or it might be a matter of gutting the entire kitchen and starting from scratch.

Naturally, more extensive means more expensive. This is the stage to get some rough pricing for different aspects of the job. Bounce the costs against your budget. You should have enough information to decide how much you want to take on.

Some people will argue that it's ok to borrow for a kitchen remodel. After all, you're making your home more valuable. That's true. But you'll still end up repaying the loan when you sell. And that means less money in your pocket. If you do borrow, consider repaying the loan while you still live in your home.

If you're going to be making major changes, be sure to consider the three major functions of a kitchen: storage, preparation and clean-up. Think about how your family uses the current kitchen.

Make major decisions before you start construction. Remember making adjustments once work has started will be expensive.

New cabinets are generally the most-pricey part of a fully new kitchen. Choose them carefully. Their style and color will have a major impact on the room and your budget.

In fact, choose all your materials carefully. You'll find that quality varies considerably. The fact that there are a lot of choices means more work for you, but does provide a greater opportunity for savings.

Don't assume that the big home center store is the cheapest or best. Check with specialty kitchen and cabinet shops. Ask if they have any cabinets that they were unable to deliver. You may be able to benefit from another's mistake.

If the job is beyond do-it-yourselfing, ask around for a handyman or contractor. Unless the job is fairly simple (read inexpensive), you'll want to get three bids.

Check out contractors thoroughly. Ask for references and contact them. Ask the contractor about licenses, insurance and bonding. You don't want to make a mistake here. Under normal circumstances a full kitchen remodel will take about two months after planning and materials have been ordered. The wrong contractor could drag that out indefinitely.

Talk with the contractor before starting. Ask a lot of questions. The way they answer will tell you a lot about how they'll perform. For instance, some will encourage you to skip getting required permits. Better you should skip that contractor. Yes, the permits will cost you, but they'll also guarantee that the job is planned and done correctly. The building inspector can be your best insurance against shoddy work.

Finally, expect disruption. Eating all your meals out for two months can get expensive. So some families load up the freezer with meals that can be reheated in the microwave. It's easy to prepare extra portions of the meals that you're already making during the weeks before your kitchen is off limits.

Updating a kitchen can make a big difference in your home. Whether it's just painting cabinet doors or a full blown new kitchen, it takes time, consideration and money. Hopefully, whatever John decides will bring his family together and make many fine memories.

Recently, my husband and I had the displeasure of being ripped off for $400 after eating out at a restaurant. The debit card has now been closed and the bank is supposedly working on the problem of getting our money back to us.

How can one eat out without being concerned that this can happen again. Is there anyway to prevent it? We are very upset and frustrated that someone ripped us off for this money and also cannot afford this big of a loss. My husband is on Social Security and is working part-time. What can we do, if anything, to protect ourselves from this happening? We have discussed buying gift cards to these restaurants, which is a pain but would prevent what happened from happening again. Do you have any other suggestions? -- Cheryl

Cheryl and her husband are not alone. In a recent poll (epaynews.com), three quarters of consumers said that credit card fraud was a major or moderate concern. And, they have good reason to be concerned. The Federal Trade Commission estimates there are $3 billion in fraudulent charges each year.

Guess that shouldn't be surprising. We use our plastic a lot. Visa and MasterCard estimate that we spend near $2 trillion dollars using their cards each year. And, that doesn't include the money we spend using Discover, American Express, store cards, gas cards, etc.

So what happened to Cheryl and her husband? The most likely scenario is that they gave their card to the server to pay for the meal. While out of sight from Cheryl, either the server or the cashier wrote down their card number and the verification code on the back. Later, they used the numbers to make online purchases where a physical credit card isn't required.

How can Cheryl and her husband prevent a reoccurrence? There are things they can do to protect themselves. But, we'll find that security comes with a price. The most effective tools are also the ones that are most inconvenient. So Cheryl will need to decide how much security she wants.

Cheryl is already using a debit card. The advantage is that the crook can only spend what's in the account unlike a credit card that can be used up to its credit limit.

Cheryl probably had the cost of the meal and another $400 in the account that day. One way to limit the loss is to keep less in the account. For instance, if there's only $100 in the account no one can charge more than that using the debit card. Of course, keeping a low balance means adding money to the account every time you intend to use it. If she wants to try this, Cheryl should talk to her bank about using online banking to transfer money. She'll also need to know whether the transferred money is available immediately or if she has to wait overnight.

There are a couple of other ways to make using credit or debit cards safer. One of the most effective is to not let the card out of your sight. That way if someone is going to try to steal your credit card number, they'll have to do it while you're watching them. Chances are, they'll choose someone else who is an easier target to rob.

Use a PIN number. She's probably already aware, but keep your PIN number separate from your card.

Using gift cards probably wouldn't have made Cheryl any safer than taking her debit card up to the cashier herself. You still have someone you don't know handling your card.

One way to make sure no one steals your card number is to use cash. You do run the risk of losing it or being mugged. However, the good news is that you can't lose more than you have in your pocket or purse.

There is, however, one additional risk for cash. Getting cash from an ATM is not completely safe. Some smart criminals put recording devices onto ATMs. They record your account and PIN number for later use. So the safest way to get cash is to visit the bank during normal business hours and deal with an old fashioned, real live teller.

While losing $400 is nasty, it could have been much worse. Cheryl should only be liable for the first $50 in fraudulent charges. So the monetary damage is limited. It becomes a much bigger problem if someone parlays her credit card number into identity theft.

Undoing an identity theft can take hundreds of hours. It's estimated that the time spent by the average ID theft victim to get things straightened out is worth $16,000.

Cheryl is right to worry about safeguarding her credit accounts. Not only are there more ways for crooks to use a stolen credit card number, but also in the age of ID theft, the damage inflicted can be substantial.

We have almost decided to lay "peel and stick" vinyl tiles in our kitchen and dining room. We would like to hear pros/cons on vinyl tiles.

Are they durable? Do they really stick? Do they come loose easily? Should we add more adhesive when applying them? Any help and direction will be greatly appreciated.

We hate to make an investment of money, time, and labor on something that is not going to hold up for the long term.

My sister is a single mom and can't fully provide for her kids. She is receiving housing benefits where the government pays for most of her rent. She purchased a car with no money down. The payment with insurance is about $500 per month. When housing found out, she was told to get rid of that car or she would lose her housing benefits. She asked me to put the car in my name, which means that I would have to put the financing in my name as well so it does not show on her credit. She would still drive the car. I'm afraid to make that kind of commitment. She refuses to give the car back to the dealer because it's going to ruin her credit. My other sister gave her $4,000 to buy a used car when she returns her new car, but she does not want an old car. What should I do? My heart tells me help her, but my head tells me not to help her! I love her dearly, but she's always broke and I am afraid she'd get into an accident and I would be totally liable. -- Confused Sister

Confused Sister must come from a very close and loving family. It's obvious that these three sisters care for each other. But, sometimes you need to do what's best for a person. Even if it's different than what they ask you to do. This is one of those situations.

If your three-year-old takes a sharp knife from the dinner table, you're going to take the knife away from him even if he cries and doesn't want to give it up. You know the danger even if he doesn't.

Broke Sister is going to hurt herself (and her children) with the car loan. That's one reason why the housing authority doesn't want her to keep the car while she's receiving rental assistance. They know that she won't be able to keep up with a car payment and continue to feed her children.

So the best thing that you can do for your sister is to help her get out of the new car and replace it with something she can afford.

Broke Sister has a couple of different possibilities for the new car. If she can find someone to take over payments, she could come out with no bad marks on her credit. The key here is that the lender gets their money on time.

It's also possible that the housing authority could help. Most have laws against "predatory lending" practices. There's a possibility that the lender was taking advantage of Broke Sister. The housing authority might be able to point her to a state agency that could help her get out of the car loan.

A third option would be to contact the dealer and explain the situation. They might be able to put her into an affordable car. The original dealer should be Broke's first stop since they'll get the best price for her now used new car. She will need to finance the loss on the new car, but the money from Third Sister should help keep the payment affordable.

The final method for returning the car is a "voluntary repossession." That's where Broke Sister drives the car to the lender and turns over the keys. They will sell the car. It will bring less than Broke Sister owes on the loan. The lender will expect her to pay the difference. She might have to use the $4,000 that the Third Sister is offering to cover the loss. If she doesn't repay the loss, it will affect her credit rating.

Ok, now that Broke Sister has a few options to put her into an acceptable ride, let's convince Confused Sister why she should avoid Broke's scheme.

First, it's probably illegal. If Broke hides the car from the government, she's lying to get financial aid. That's illegal. Helping Broke to lie is participating in the frau, which is not something that you want to be involved in.

Next, you would be responsible for the financing. If your sister were one day late with a payment, it could trigger penalty rates as high as 30% on any credit card balances you have. Plus, it would affect your ability to get your own car loan or a mortgage.

You would also be responsible for the car. Broke can't insure a car that she doesn't own. So you would need to add it to your insurance policy. You'd also need to let them know that your sister is a regular driver on the car. If Broke Sister had an accident, you would be involved. It's your car and your insurance company. You can guess what will happen to your rates.

This is a case where you need to listen to your head. It would appear that your sister is not grasping financial reality. She can't afford to care for herself and her kids, so the government is helping her. It's time for Broke to realize that paying for food and shelter is more important than driving a new car. You can help lead her to do what's right for her kids.

Confused wants to help her sister. The best way to do that is to tell her the truth. Broke needs to give up the new car and start being a financially responsible parent for her children.

There's an old saying that 'the apple doesn't fall far from the tree'. For those of you too young to have heard that phrase before, it means that children will be a lot like their parents. I was reminded of that the other day when I found my twelve year old reading "The Millionaire Next Door".

Lest you think that I'm some kind of fanatic, I don't give my children homework assignments on money management. The book was just sitting next to my easy chair. But, in fairness, my kids have heard me talk about the value of money on a regular basis. And I do hope that some of the lessons stay with them.

You have the same opportunity to help shape your teen's money perspective. Lessons learned now could save them a lot of grief later. So let's spend a little time talking about what to teach your teens about money.

A cornerstone of building a sound financial future for your teenager is to teach them how to save money. Sounds easy, but even many adults don't know how to do it. And that might be because no one ever taught them.

You can use three strategies to teach a teen to save. First, you can encourage them to reach a goal. Suppose that they want a $100 pair of shoes. Let them save $5 or $10 a week until they have the purchase price. Have them put a reminder of their goal in strategic places. They'll learn patience and persistence. And by the time they save the money, they might also learn that they really don't want the shoes any more.

Another way to encourage savings is to match any money they put into a savings account. Set a minimum length that the money must stay in the account before being withdrawn. Don't want them to put it in with your match and withdraw it a few days later. This won't work for everyone, but some teens will love to watch their savings grow.

The teen years are also a good time to teach your young adult to 'pay themselves first'. That means that they set aside part of their income for savings before spending anything.

It's a perfect time to learn this lesson. Most teens don't have any real financial responsibilities. They don't have items that they're forced to buy each month (like rent, electricity, food). They generally just spend what they have available.

Of course, many adults do the same thing. They spend until they're out of money. Learning to set part of any income aside for savings is a great habit that will pay dividends for their entire lives.

Next a question for you. Do you remember who taught you to balance your checkbook? Most of us don't. And that's a shame. You'd be surprised how many people reach adulthood without knowing how to perform this simple task. And it's important that your teens learn it.

First, they need to know where they stand financially. Even a teenager should know how much money they have. The reason is simple. It's essential to understand that you can run out of money. Balancing a checkbook is a wonderful way of teaching them that there are penalties if you spend money that you don't have.

The alternative is to let them learn to keep spending until they've reached their credit limit. And that lesson will create heartaches later in their life.

PC software makes balancing a checkbook easy. But make sure that they don't just enter numbers and let the software do all the work. They need to understand the basics. You put money in. You write checks to take money out. What's left is the balance.

They also need to learn basic investment information. It's really essential for modern life. Teach them that stocks represent ownership in a company. And bonds are like an IOU. Introduce them to CD's, money market and mutual funds. Perhaps you'll want to subscribe to Money magazine and discuss the articles with them.

Don't forget to teach them how risks and rewards work. They need to know that a big return will include a big risk. It's surprising how many people think that they can get huge returns without taking any risk. That's a good way to lose money.

Also teach your teen about the beauty of compound interest. Let them know that money will double every 7 years if it earns 10%. That means that $1 that they don't spend on a soda today would be worth $128 when they're in their 60's. Compound interest is the secret ingredient of building wealth.

Conversely, they need to learn the risk of compounding debt. They'll learn this lesson before they die. Help them to learn it without pain. Teach them that borrowing money obligates them to pay the loan back with interest. And that credit cards are set up so that they keep making payments each month without ever paying off the debt. In fact, if they pay the minimum due on a charge card each month, it's just like doubling the price of everything they buy. That's a lesson that's less painful if you learn it before the bills come due.

Teach them what things cost. Some families share budget information with their teens. Others prefer to keep that private. If so, send your teen on a pretend 'first apartment' hunt. Have them walk through all the costs of setting up an apartment including rent, utilities and food. It will be a real eye opener for them.

Finally, help them to learn the difference between creative thinking and creative financing. Creative thinking is the ability to have a need and find a way to fill it without spending money. People who don't have money are forced to consider alternative answers. And some of those answers are quite creative.

The flip side is the person who only thinks of creative financing. He can't think of a way to solve his problem without making a purchase. His creative energies are spent trying to figure out who will loan him the money to make the purchase. Not only will he spend a bunch of energy trying to figure that out, but he'll make making payments for quite awhile, too.

Many of these lessons will pay dividends for the rest of their lives. Who knows, if your teen learns them well perhaps the apples will fall close to their tree, too.

A friend just sent me a video clip. It showed an ice fisherman sitting alone on the lake with a pole in his hand. In the background, you could hear the wind whistling over the frozen lake. The pole dipped a few times as the man began to reel in a fish. Suddenly, a huge shark broke the surface and ate the man. Naturally I was caught unawares and surprised by the shark. It was funny.

But sometimes our finances work the same way. We think that we're fishing for something small. Even think that we've got it hooked. Only the truth is that we're about to be swallowed by something much bigger than we are.

I wonder if that's not true with some folks who took out mortgages with low teaser rates that were to be adjusted in a few years. They thought that they were just getting a good low rate on their mortgage and that they had found a way to buy a home that they couldn't really afford. Unfortunately, now that the rate is about to be adjusted, some of them will be swallowed up and lose their home and credit rating.

Some surprises can't be predicted. Our ice fisherman's encounter with the shark for instance. But some, like the mortgages with sharply escalating rates, can be predicted. And, unless you like being eaten, it's probably wise not to go fishing in that pond. It's too late for some people now. Hopefully, others can learn from their mistakes.

I am curious as to whether or not charge-offs can continue to accrue interest. I was always told "no" but today an attorney for one of those "third party collectors" told me "yes." I had already paid $900 into the charged-off debt and then that collector dropped us after I confronted them about some shady practices. They withdrew funds without my authorization and a new law firm picked it up and tacked on another $1500 above what I'd already paid! The first law firm didn't charge interest, but this one is. Any information you can offer would be most appreciated! -- Jennifer

Sounds like Jennifer is in a tough spot. To make the best of the situation, she's going to need to learn a little about what a "charge-off" really is, how collections work and whether the lender can charge interest on the debt.

When Jennifer borrowed money from a company, she created an expectation of future income when the debt was repaid. That's an asset of the corporation.

When a company "charges-off" a loan, they're saying that they don't believe that they'll ever be able to collect the debt. So they "write-off" the asset. It's an accounting entry that reduces their profits and taxes.

They'll also report the charge-off to the credit rating agencies. That makes it more difficult for Jennifer to borrow money later. An overdue debt can be shown on your credit report for 7 years after the account became delinquent.

But, that's just the accounting aspect. What happens to the debt in the "real" world?

Just because a debt has been charged-off does not mean that Jennifer still doesn't owe the money (plus interest and penalties). What she owes depends on the original loan agreement, state law concerning the Statute of Limitations (SoL) and the federal law governing collections.

The original terms from the loan still apply. All that fine print that no one reads becomes important now. Generally, it gives the lender quite a bit of latitude to charge interest and penalties.

Next Jennifer needs to find out the statute of limitations (SoL) on her debt. In most cases, it's between 3 and 6 years. State law and the type of debt will determine the SoL. The SoL says that after a certain period of time that the debtor is no longer legally required to pay a debt.

There are actions that Jennifer could take that would restart the clock on the SoL. Making a payment, signing an agreement to pay or even admitting that the debt is valid could be enough to stop or reset the SoL clock to zero.

She'll need to do a little research to learn the SoL in her state. Her phone book should have a number for the state's information operator. They should be able to point her to the state agency that can explain the law.

Two notes about SoL. Even though the SoL says that a debt doesn't have to be repaid, it's not illegal to attempt to collect it. And, if the lender gets a judgement against the borrower, there's no SoL on the judgement.

Jennifer also needs to know a little bit about collection agencies. Some work for a percentage of any money that they're able to collect. Others buy a group of bad loans for pennies on the dollar. Then they keep everything collected. Since they own the loan, they're also allowed to re-sell it to another collection agency. That could explain why Jennifer has heard from more than one agency. They're also sometimes affiliated with law firms so that they sound more important.

Whoever owns the loan, original lender or collection agency, is allowed to keep charging interest and penalties per the original loan agreement and applicable laws.

Anyone trying to collect the loan is supposed to obey the federal Fair Debt Collection Practices Act. But, as you'd expect, some will bend or even break the collection rules.

It's no surprise that they tapped into Jennifer's bank account. She might have given permission without realizing it. They will also try to garnish her wages or put a lien against any property that she owns. There are, however, laws that keep them from just taking anything they find.

If Jennifer does agree to settle the debt by paying a portion of it, she needs to get a release from the agency saying that the balance of the debt is forgiven. She should look for the words "payment in full."

Once a debt as been reported as written-off, paying it will not wipe away the bad comment in her credit report. It will look better, but only slightly. It's possible that the original lender may agree to remove the item if a partial payment is made. But, only the original lender may do that. Not an outside collection agency.

Hopefully, Jennifer will be able to close this unfortunate episode and never have to revisit the issue again.

Can You Help Out This Reader?

Auto Lease Nightmare

I was not thinking clearly when I signed a three-year auto lease back in October 2006. I knew what I could afford and somehow I was talked into payments that were beyond my budget. Now I'm stuck with a lease and payments that are killing me.

I've talked to the dealership to see what my options are and was pretty much told that there is nothing I or they can do. How can I offload this car and get something more affordable without ruining my credit? -- K .

Do you have any advice for a teenager with a steady job who would like her savings to grow. I have paid for my college education without taking out student loans. I contribute to an RRSP and I carefully keep track of all my income and expenses. I am not sure what to do with my savings. I set aside 10% of my income, but it is currently in a basic savings account because I don't know what to do with it. I was wondering what the best investment strategy would be for someone of my age. Any help you could give me would be great! -- Anita

Wow! Anita sure is off to a good start. Contrary to what a lot of people think, the young adult years are often the easiest time to save money. They often see their income grow faster than their financial responsibilities. That gives them an excellent opportunity to save.

Anita has already started down that path. So what's the best place for her to park the 10% of her salary that's she's saving? The answer to Anita's question has less to do with her age than what she plans on doing with that savings. The decision making process is the same for any age. The first thing Anita needs to do is to decide what she's saving for.

Why is that true? Her use will determine how quickly she might need it. And, that urgency will affect her investment choice.

Let's look at two simple rules of investing. First, you earn a higher return by assuming more risk. For instance, stocks are riskier than savings accounts.

The Journal of Financial Planning cites studies that show the real rate of return for the S&P 500 (stocks) from 1950 to 1999 was 10.3%. At the time this was written, a short term CD (6 months to a year) would pay about 4.0% and a five-year CD closer to 4.5%. An interest bearing checking account earns 1.0% while money market funds are about 2.8%.

So the earnings difference can be significant. To illustrate, suppose that Anita puts away $1,000 each year for the next 50 years (ages 20 to 70). If she earns 2% on the money, at the end of that time, it will be worth $89,000. But, if it earns 10%, it will grow to $1.4 million. Quite a difference!

That means we need to learn about the second rule of investing: risk can be minimized. Either by diversification or through a longer time frame.

Diversification is a fancy word that means owning more than one stock. If all of your money is in one company and the stock goes down 50%, you have a disaster. But, if you spread your money among 10 different stocks and one drops 50%, you've only lost 5% of your investment. Not nearly as bad. In fact, it's possible that one or more of the other stocks could go up and offset the loser.

The longer time frame reduces risk much the same way. The stock market does have bad years. Sometimes even two or three in a row. But, for the last 100 years, if you took any 10-year period, the return was positive. So you might have lost money in one year. But if you could afford to wait awhile to sell, you would have gotten the losses back. Combined, time and diversification allows Anita to get the higher returns without increasing her risk.

Now let's apply all of this to Anita's situation. We'll assume some life events. The first reason that she might need to access her nest egg is for an unexpected bill (think auto repair). For that she needs money that's accessible immediately. Like in a savings or checking account.

Once she's saved more than enough to cover immediate needs, she's ready for a second investment account. Suppose Anita is also planning on buying a new car or making a down payment on a home in two or three years. Savings earmarked for those purposes would earn more if they were put into CDs.

Longer term, Anita will want to save for her retirement. She already has an RRSP account. For our U.S. readers, an RRSP (Registered Retirement Savings Plan) is a Canadian account very similar to an IRA. A mutual fund investing in stocks would be an appropriate selection here.

Anita is off to a fine start. All she needs to do is to decide why she's saving, how much she needs for that purpose, and then select the type of investment that matches her goal. At the rate she's going, in a few short years, she'll be giving others advice on how to accumulate money!

Can You Help This Reader? This is what she writes:

My "Can't Afford" Friend

I have a friend who works full time (I work part time and make half the income that she does) who just doesn't seem to understand that I can't do the things that she does. She is having a holiday from her job soon for two weeks, and when I went to see her a few days ago, she asked me what "we" are doing for her holiday.

I have to work and told her so, but she knows that I work mornings and she wants to do things in the afternoon. Everything that she wants to do involves money, which I simply don't have. I have some bills to pay at the moment, and I am trying very hard to keep on top of my bills and pay off the debts that I have.

I simply don't have the money to travel around and visit places with her. She won't pay for me and I wouldn't ask her to anyway. She wants me to take her places and go on trips with her, but I simply don't have those resources. She lives with family as do I, but she doesn't pay board or have a car. My car is acting up too and I need to save money to get it fixed.

How do I explain to her that I simply can't keep up with her social life and let her know that my expenses are more important than running her around without her getting offended?

Has anyone had a problem with someone like this?

She told me that she doesn't want to sit at home on her holidays and I know that she expects me to run around after her as I have stupidly done in the past. If you or any of your readers have some advice, I would be grateful.

Had an interesting experience last weekend. I was with a friend and he pulled out an old toolbox. In the toolbox was a pretty good-sized screwdriver. The shaft was badly rusted. The toolbox had probably been sitting on a boat for quite some time. My friend is a boater and loves to go out into the gulf.

I looked at the screwdriver for awhile. It was one of those sold by Sears with a clear plastic handle. I noticed that the shaft that was within the handle was also badly rusted. But the handle looked and felt just fine.

It occurred to me that people's finances are similar to that screwdriver. Some people have openly rusty finances. They're struggling and pretty much everyone knows it.

But others had a slick plastic shell. They look good. But, if you can see into their situation, you'd find a rusty shaft. There may be a new, expensive car in the driveway, but the last two payments were late.

If you had a file or a grinder, you could put a nice new head on the screwdriver. But, chances are that it'll just be thrown away and replaced. After all, screwdrivers aren't that expensive.

But it's pretty hard to throw away and replace your finances. Yes, you can go bankrupt, but that's not an easy road.

So my hope is that your finances aren't a rusty shaft. Or, if you have a bit of rust, it's just a little surface rust that can be sanded away before it does any serious damage.

My husband was out of work for two years. We were forced to live off credit cards, so we have five cards that are close to their limits, along with a mortgage and a car payment. Despite our circumstances, only a couple of credit card payments were late over that time, but our rates skyrocketed while our credit score dropped dramatically even though I had had a nearly perfect credit score before. My husband now has a job and our income has increased. What is the best way to get our financial life back on track? Does income count in calculating credit score or in assigning credit card rates? Is there something we can do besides paying off as much as we can as quickly as possible? --Stephanie

Stephanie is smart to want to boost her credit score. That score is quickly becoming a very important number for all your financial affairs.

Let's start by examining her current situation. We'll begin with something called the FICO score. It's named after Fair Isaac, the company that calculates and provides credit scores. The score is a number between 300 and 850. A higher score is better. It attempts to predict how likely you are to be able to pay your debts.

Lenders use the score to determine whether to approve your loan and how much interest to charge you. Others use the score to see how financially responsible you are. Insurance companies, employers and landlords are among those using your credit score in determining whether they want to do business with you.

Stephanie admits that during her husband's unemployment they had a few late bills. And that the interest rates on their credit cards jumped. That's common. In fact, you should expect that a late payment on one will have an effect on all your cards.

According to Fair Isaac, negative information can include "overdue debt from collection agencies, and public record information...including bankruptcies, foreclosures, tax liens, garnishments, legal suits and judgments." Fortunately, for Stephanie, only a couple of payments were late and they stayed current on the mortgage and car payments.

So what's the best way for them to improve their credit score? Fair Isaac will not say how they're calculated. But some general information is known. Stephanie's income is not part of the score. In fact, the scoring company does not know her income.

Some companies claim that say they can raise your score immediately. Don't trust them. Repairing your credit score is not an overnight event. It takes time to improve it.

If information is accurate, you cannot remove it. For instance, a late payment will remain on your report for seven years. That might seem like a long time, but it becomes less significant as you continue to make timely payments. Recent late payments hurt more. The number of late payments counts, too.

Fair Isaac says that about 35% of the score is based on your payment history. So it is important for Stephanie to make all of her payments on time.

If Stephanie is creative, it might occur to her to close the accounts that were late. But, a closed account will still show up on your credit report. You can't "erase" a late payment by closing the account.

Stephanie is right that reducing her loan balances is important. An additional 30% of her credit score is based on the amount of outstanding debt. Ideally, her card balances would be 25% or less of the installment credit available to her.

Do not open up new credit card accounts in hopes of creating new, unused credit to lower the ratio. That would actually work against her by raising the amount of unused credit and by lowering the average time that the accounts have been open.

Stephanie has already limited the number of accounts carrying a balance to five. It is believed that your score will drop if you have an unpaid balance on more than 6 or 8 accounts.

It would probably also be a good idea for Stephanie to check her credit report for errors. Actually, that's a good idea for everyone. At least once or twice a year. Tests show that one in four credit scores have a significant error. Get a free credit report at annualcreditreport.com or call 1-877-322-8228.

Stephanie and her husband are fortunate. They've survived a tough financial situation. Although some damage has been done, their credit score will rebound in time. The key now is to avoid any 'quick fixes' or missed payments that would make things worse. Simply following good money management practices like paying down her credit card balances is the best thing that she can do.

I'm 35 years old and have the option to pay off my mortgage and be totally debt free. After paying off my mortgage, I'd still have approximately $68,000 to invest for retirement. I'm really confused about whether it will be best for me to pay off my mortgage or invest all of the extra money ($98,000) instead. My financial advisor and professor from a Personal Finance class I just completed are telling me it's not in my best interest to pay off my mortgage because I will no longer have the tax benefits. Some financial experts say you should pay off your mortgage as soon as possible. I'd really like to hear your opinion on this subject. -- Julie M.

Good question! And, a common one, too. When you have some extra money, is it wise to pay down the mortgage or is an investment a better choice? Let's begin by understanding the mortgage interest deduction and then work on a framework for comparing options.

Interest paid on a mortgage for your home is generally deductible on your federal income taxes. To use the mortgage deduction, you must file an itemized 1040, be legally liable for the loan, and the debt must be "secured" by the home.

The IRS defines home mortgage interest this way in publication 936: "any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan."

There are some limits to the mortgage deduction. We won't get into the formula here, but in most cases, it won't be a problem as long as the money borrowed was used to buy or improve your home.

The biggest problem with the mortgage deduction is that many people use the standard deduction. In 2004, it was $4,850 if you were single or married filing separately. Filing married on a joint return? You got $9,700.

The rules for what's eligible for deductions are beyond the scope of this article. The safest way to figure out your status is to see what you did on last year's and expect to do on next year's tax returns. The biggest items are typically state/local income taxes, property taxes, medical costs and charitable contributions. Before making any decision, see how your specific tax situation would play out.

One way to look at the mortgage interest deduction is that you're paying someone $1 in interest to get 25 cents back in tax savings. That's what would happen if Julie were in the 25% tax bracket. I suspect that most of us would be willing to give Julie a quarter for every dollar that she gave us. The point is that the interest deduction by itself probably isn't a good reason to have a home mortgage.

Now for Julie's choice. Can she get a better return by putting $30,000 into paying off her mortgage or by investing it for her retirement? We'll need to do a little math so hang on tight! And, we're going to simplify just a little. But, that's ok. This decision doesn't require three decimal places.

What does Julie's mortgage really cost her? If her mortgage were 6% and her tax rate were 25%, she'd pay $1,800 interest during the year (.06 x $30,000). But, that $1,800 in interest would be worth $450 reduction in taxes if she itemized ($1,800 x .25 tax rate). So the true cost of borrowing the money is really $1,350 ($1,800 - $450). That works out to an interest rate of 4.5% ($1,350 / $30,000).

Everybody still with me? Ok, next Julie can calculate what she'd earn by investing the money elsewhere. If Julie were to invest the money, she'd earn the investment return minus the tax rate.

Julie could invest in a lot of different things. And, they have different potential rates of risk and return. We won't get into that today. Let's simply assume that Julie found an investment that she thinks will earn 7%. In the first year, she'd earn 7% minus the amount paid in taxes. So she'd see $2,100 ($30,000 x .07) minus $525 ($2,100 x .25) or $1,575. Or a rate of 5.25% ($1,575 / $30,000).

In this particular case, Julie mentions investing for her retirement. If she's able to use a tax-sheltered account, it's possible that she won't have to pay taxes on the investment earnings for years.

So given these assumptions, the investment looks better. Remember though that predicting future investment returns, tax rates and the ability to use mortgage interest deductibility aren't precise.

Julie also needs to be aware of any biases that her investment advisers have. We're not saying anyone is dishonest, but it is easier for mortgage and investment advisers to see the benefits of taking out a mortgage and investing the money in other places. Julie shouldn't ignore what they say, but she should be aware of the context of the advice.

Finally, there's an emotional side to be considered. Some people feel more comfortable without debt. They sleep well knowing that no one can take their home. Others have a more adventuresome nature and like the thought of picking investments and earning a higher return.

If Julie takes the time to work through her choices and how she feels about them, she's likely to make a decision that she won't regret later.

Wow! Today I get to do something that I've been waiting for years to do. I get to tell you that we have created forums for The Dollar Stretcher site.

I've always wanted a place where it was easier for our readers to contribute and connect. Part of our DNA around here is that everyone is an expert on something. And, that if you take the 100k+ readers of the ezine and add that to the 100k+ visitors to the website each week, you'll find someone who can answer just about any financial question/problem that there is. It's just a matter of getting the question and the answer together.

"Can You Help This Reader" was our first attempt at harnessing our combined wisdom. And, it's been a favorite since our first issue back in 1996. We came close to starting a forum back in 1999, but we didn't have the staffing to do the job properly so we gave up the attempt.

That all just changed recently. Many of you know Pat Veretto. She was responsible for the frugal living pages at about.com.
I always admired her work. Well, to make a long introduction short, about a month ago Pat joined us with her main function
being helping to make The Dollar Stretcher Community a great place for you to ask questions and trade ideas about frugal living and money. We haven't given her a title yet. Perhaps you have a suggestion. If so, you can send it by
mail to pat@stretcher.com. Or maybe you just want to say hello. I'm sure that she'll be glad to hear from you in either case.

I'll admit that we still have some work to do on the forums. The layout isn't exactly what we want. And, we'll need to add sponsors so we can afford to pay for it. But, if you don't mind the fact that we're still moving the furniture around, we'd be happy to have you visit. You'll find The Dollar Stretcher Community at

I rediscovered something the other night. I like just a little taste of something sweet at the end of the day. Sometimes I take a short gulp of soda. Recently I was in the grocery store and saw the big Hershey's milk chocolate bars. I hadn't had one in quite awhile. So I brought one home and tucked it in the fridge. One night, looking for my sweet-fix, I broke off a piece and chewed it. It was just as good as I remembered.

I did that a few more times over the next couple of weeks. When one evening I decided to tuck it inside my cheek like a chipmunk. It must have taken five minutes to gradually dissolve! And, the sweetness! I was amazed at how much flavor could actually be in a small chunk of chocolate. By chewing it, I was missing 3/4 of the sweet taste!

In my rush to get through life, I nearly missed enjoying this simple pleasure. And, I began to wonder how many other times I had purchased something for my enjoyment, but rushed through the experience and missed half of the pleasure. I know that I've purchased electronics and didn't take the time to
thoroughly read the directions or completely program the device. I wonder how much I've given up.

And, that's just the half of it. Because I'm consuming so quickly, I'm looking for a new pleasure experience sooner. Bang! Experienced that! Time to look for something new to entertain me!

Don't know about you, but I keep coming across this same revelation. Maybe one of these days I'll slow down enough to really understand the meaning!

I just found an article you wrote on budgeting. You said to spend no more than 33% of your after-taxed salary on housing. I have to find an apartment and live on my own. I never had to do that before. I am struggling with a budget and not knowing what I can really afford for an apartment. -- Michael

Michael is right to make sure that his apartment expenses don't cripple his efforts to get off to a good financial start. And, he'll find that his choice of an apartment will make a huge difference on whether his budget (and his finances) work.

Before we look at Michael's housing question, let's spend a moment on constructing a budget. They're not nearly as scary as you might think. The purpose isn't to lock your money up where you can't get at it. A good budget simply provides information about your expenses and how they relate to your income. The goal is to help give you data to make good decisions.

Michael asked about after-tax income. There are two ways to do a budget. One includes your taxes and uses your "gross" (before tax) income. The other uses your "net income" (after tax). Generally, it's easier to use the after-tax method. It tends to be a little less complicated.

In an after-tax budget, Michael's take home pay would be his income. And he would not budget for any payroll deductions (i.e. insurance, retirement plans, taxes, etc.).

OK, now let's get back to Michael's main question. How much can he afford to spend on an apartment? It's generally accepted that 30 to 35% is about right for housing expenses. That would include rent, plus utilities, any maintenance and decorating.

Some would argue that Michael could spend up to 40% for housing. The trouble with that is Michael has a limited amount of money. His paycheck needs to cover housing, automobile (or transportation), food, insurance, entertainment, clothing, medical/dental, miscellaneous and debt repayment. So an increase in housing expense means a decrease somewhere else.

Michael didn't share what his income is. So we'll have to keep this somewhat general. But, we'll still be able to illustrate the point.

The three biggest expenses he'll face are housing, transportation and food. Along with 30% for housing, he'll probably need another 15% each for transportation and food. So he's already spent 60% of his money, leaving just 40% for everything else.

The quickest way for a budget to fail is to overspend these "big three" categories. If Michael spends 65 or 70%, it becomes almost impossible to make up the difference in the smaller categories. Even if he cuts back drastically in areas like entertainment and clothing, he just won't find enough savings to offset the additional expense.

Overspending in these big areas is also a problem because we often make commitments for months or even years in advance. It's not like your electric bill. If it was too high last month, you can start turning down the A/C today. But, if you agreed to make forty-eight auto payments, there's not much you can do about it for awhile. Or, if you do make a change, it will significantly disrupt your lifestyle.

Let's suppose that Michael's take home pay was $2,000 per month. He really wanted an apartment that cost $800 (40% of his income). Add his car payment ($225), gasoline ($75), groceries ($150) and restaurant/meals ($150). That totals $1,400 and only leaves him $600 to cover debt repayment, clothing, entertainment, medical, miscellaneous, savings and any unexpected bills. Chances are that he'll quickly be putting some of those expenses on his credit card and adding to the unpaid balance. At some future point, that will come back to haunt him.

If Michael were making a lot more, he'd have more flexibility. If his monthly income were $10,000, it wouldn't make as much difference if he spent 35 or even 40% of his income on housing. He'd have more in other categories to make up the difference.

Most of us live with limited income. It's important for us to get our housing, auto and food expenses under 60% of our take home pay if we're going to keep from getting into financial trouble.

So Michael is smart to pay attention to his housing costs. He's identified the cornerstone to a sound financial future. Let's hope he finds the perfect, affordable apartment!

I requested that my credit card account be closed in June. In November, I received a bill for $110 for automated charges that go through once a year. The credit card company said that it was my responsibility to request that these charges stop going through. The problem is that I can't get through to these companies to have these charges stopped. I had actually requested that one of these companies stop charging my card and they did not. This is a big part of the reason that I requested to cancel the card. Is it legal for the credit card company to continue allowing charges to be made to my account months after I request the account to be closed? If I can't ever get through to these companies because they are always having technical difficulties, am I just doomed to have the credit card account forever? Who can I ask for help? - Kristen

Kristen has discovered that there's a flip side to the convenience that's offered by automatic bill payments. Sometimes, it can be difficult to stop those same automatic payments. Let's take a look at automatic bill paying and see if we can't find a solution to Kristen's problem.

It's easy to see why automatic bill paying is popular. For the consumer, it is very convenient. No need to write and mail checks each month. As long as you have enough money in the account, there's no chance of triggering a late fee. The Electronic Payments Association estimated that consumers saved $4.5 billion in 2002 by using direct payments.

The companies whose bills are being paid automatically love it, too. They spend less when they don't have to sort, post and process checks. They're more likely to be paid on time. And, the consumer is more likely to continue paying for the service even if he doesn't use it. No check writing to remind him he's wasting money.

According to the Automated Clearing House Network in the 3rd quarter of 2005, there were 2.7 billion automated transactions worth more than $6.1 trillion.

It's a great system, except when it goes wrong. And sometimes it seems as if the selling company wants it to go wrong. Because the longer they can pretend not to know that the customer wants the service stopped, the longer they can charge for it. Some companies are notorious for making it difficult to cancel automatically billed products and services. As in Kristen's case, sometimes their phones always seem busy.

She has already discovered that the credit card company will not be responsible for notifying companies that she wants a service/billing stopped. In fact, she can pretty much expect that they will process any bills that are legally presented to them.

But that doesn't mean that Kristen is doomed to pay for these services forever. The Fair Credit Billing Act provides some protection. Kristen needs to notify the billing companies in writing that she wants the service/billing to be stopped. She should send the letter via "certified mail, return receipt requested" so that she has proof that it was received. Check the statement from the company for a heading like "in case of error" or "send inquiries to."

If a statement is not available, Kristen can do a web search for the company. Once on their site, she should find a "contact us" page that will have their mailing address. Be sure to include sufficient information in the letter: account number, how much is being charged, how often and for what goods or services. State clearly that you want it stopped immediately.

At the same time, Kristen should also send a second letter to the credit card company. It, too, should be sent with return receipt. State that you have contacted the billing company in writing and ordered them to stop billing your credit card. Include the company name, the amount being charged and the product/service that has been cancelled. Kristen should keep her copy of both letters and the return receipts when they come back to her.

That should take care of the problem. But, sometimes things don't go according to plan. The next step would be to contact the Attorney General's office in her state. She can find a listing at . Kristen will want to write them a letter explaining what she has done. Include copies of the earlier letters to the billing and credit card companies.

The Federal Trade Commission (FTC) is the final recourse. For information on consumer issues call 1-877-FTC-HELP or go to www.ftc.gov and fill out the complaint form.

As to closing the credit card account, Kristen should be able to do that at any time. That, too, should be done via return receipt mail. And Kristen needs to recognize that even if she closes the account to new charges, she's still responsible for paying any balance on the account.

We were offered a one-year 2.99% interest rate on an existing Visa account that we didn't use very much. We wanted to use the card to make a very large purchase with the intent of paying it off within one year.

Luckily we checked the "fine print." The original purchase will be at 2.99%, but any subsequent purchases on that card will be charged interest at 15.99%. There's a huge red flag! The original "loan" must be paid off before any payments will be credited to the new purchases that are made. So what we pay every month goes toward the 2.99% charge and, for example, the airline tickets I later purchased with this card will continue to accrue 15.99% interest charges until I pay off the original purchase sometime next year.

I said we're lucky because we understand the rules and have put the card away until it's paid off. I shudder to think how many people don't catch this little quirk. -- SB, Virginia

SB is right. Many people are being tripped up by the fine print in credit card agreements. She's fortunate to have caught on before charging up a bunch of stuff at a pretty stiff interest rate.

Credit cards have come a long way. A generation ago, there was a "one size fits all" approach. Today, you can choose cards based on their fee structure, interest rates, cash advance provisions or even the rebate offered. But, with all those choices, comes the responsibility to know what the credit agreement says.

The agreement will specify what the card issuer can do with the account. The language isn't always easy to understand. If you have trouble figuring out what something means, call the card issuer and ask for an explanation. Don't use the card until your question is answered.

All that fine print is actually a blessing in disguise. It will tell you how the card issuer intends to take your money. All you have to do is to read and understand the credit agreement. There's no reason to get caught. Most of the traps can be avoided if you know where they are.

Be careful of zero or low rate offers. Low initial rates typically are only for a limited amount and a short time period. The agreement will explain which purchases or balance transfers are eligible for the low rate. It will also say what you'll be charged for other non-eligible purchases. That's the trap SB uncovered.

You might also find that cash advances and balance transfers carry a different, higher interest rate than other purchases.

You would expect that variable rate accounts would have changing interest rates. But, even so-called 'fixed' rates can be changed. They're only fixed for 15 days.

When you get the card in the mail, don't assume that you're approved "up to $5,000" as advertised and that your credit limit is $5,000. Depending on your credit score, you could be approved for something considerably lower.

Understand what happens when your account goes "over limit." Don't assume that they'll automatically refuse to accept a purchase that puts you over limit. Most will actually let you go over limit, but then penalize you with fees and higher interest rates!

Another trick is to send you a card that's different than the one for which you applied. You could be turned down for the card with the low-rate balance transfer but issued one without that special feature. If you use the card, you will be accepting the terms on the agreement that came with it, even if they're different from the one for which you first applied.

You'll find other little tricks in the fine print. For instance, it's common for the "grace period" to expire early in the morning. You can be pretty sure that the mail delivery will be later in the day. So your payment needs to be there a day early.

Look for something called "universal default." It means that if you're late on another payment, the interest rate on this account will be increased.

Finally, the lender will have a provision in the agreement that allows them to change the agreement. All they have to do is to notify you of the change in writing. That means that you need to read everything that comes from the issuer. Some have been known to send out amendments that look like junk mail. If it comes from your card issuer, you need to open and read it.

SB has learned that you can use credit card rules to your advantage, but if you don't know the rules, you're almost certain to lose the game.

How will my money be given out to me from my 401k when I retire? Will a portion be given monthly or will it be given in a lump sum? I would like to get a big wad as soon as I retire for a new home in a new location. -- Owen

Owen's not the only one asking this question. According to the Wharton School of Business, in the next 10 years, over 10 million people will reach age 65. So quite a few folks will be looking for an answer.

First here's a disclaimer. Before making decisions that could significantly affect your taxes, it's wise to see a qualified tax professional. This is a big decision. Don't risk making a big mistake.

The distribution options on your 401k are governed first by the tax laws and then by the plan's rules. Some plans don't offer every option that's available by law.

If Owen really wants the money, he can get it now, either through a loan or by taking a distribution. You can take money out of your 401k anytime you want. It's just a matter of whether you want to pay the penalty.

If you withdraw money before age 59 1/2, you'll pay a 10% early withdrawal penalty. There's an exception if you leave your company after age 55. Then, a lump sum distribution is not subject to the penalty. But, it will still be taxed.

On the other end of the calendar, you must begin withdrawing part of the account at age 70 1/2. The amount will be determined by life expectancy.

Next, let's look at what choices Owen will have when he retires. The decision will largely be his. The law allows for five different alternatives for a 401k account at retirement. The options include lump-sum distribution, continue the plan, roll the money into an IRA, take periodic distributions, or use the money to purchase an annuity. Owen's particular plan will allow for some or all of them.

The fastest way for Owen to get his "big wad" of money is to take a lump-sum distribution. He'll get the money quickly. But there are two disadvantages. First, he'll pay ordinary income taxes on the entire amount withdrawn. Second, the money will no longer be growing tax-free.

If Owen does take a lump-sum distribution, he'll be subject to 20% withholding. That means the IRS will take 20% of the money distributed now and apply to his tax bill next April. Owen can thank the "Unemployment Compensation Amendments Act of 1992" for that idea.

Owen could decide to leave the money in the account. It will continue to grow tax-free. That can make a big difference in how much is available to him during retirement. Many retirees choose to spend taxable accounts first saving IRA's and 401k's until they need the money or are forced by law to begin distributions.

Another possibility would be to roll the 401k into an IRA. That would give Owen the largest number of investment options. He could still withdraw the money when he wants or choose to let it grow tax-free.

Owen may also choose to take a regular, scheduled distribution from the 401k. Scheduled withdrawals are not subject to the 20% withholding. Most plans allow for a monthly or quarterly distribution. The amount can be adjusted annually if you choose. That can be handy if inflation causes your expenses to increase.

The final option, an annuity, takes the investment work out of the equation. An annuity can be purchased with part or all of the 401k money. It would pay Owen a regular income for the rest of his life.

Owen's goal is to buy a home. Depending on how much he has in his 401k, he has a couple of possibilities. He mentioned the first option. Taking all the money, paying the taxes due and paying cash for his new home.

But he might want to consider withdrawing just enough from his 401k for the down payment. The balance of the account could be set up on regularly scheduled distributions. He could control the investments and distributions. Or Owen could choose to buy an annuity and let them do the investing and checkwriting.

Those regular distributions would cover the mortgage payments. The advantage for Owen is that he won't have a spike in taxable income. Also he might be able to take a tax deduction for the mortgage interest at the same time that he is earning money without taxes within the retirement account.

Owen should speak with his accountant to find our which choice is best for him. Hope he enjoys his retirement and his new home!

Question: I was wondering about a program offered through my local electric company. They offer savings of $5-10 off your monthly bill for allowing them to "cycle" your energy resources. I am not at all familiar with this, and before I signed up, I thought I should learn something about this program. - Heather

Heather has discovered one of the more popular energy saving programs in the country. Not only do consumers like the savings, but also the program also reduces costs for the electric company. So it's a classic win/win situation.

How do the programs work? Actually they're pretty simple. Florida Power & Light (FPL) calls their program "On Call(r)" and claim to have over 700,000 participants. Their program focuses on A/C, central electric heat, the water heater and pool pumps.

FPL adds a small control box to the homeowner's appliance that can be run from a central location. The box allows them to shut off the power to that appliance for short periods of time during peak usage. They claim that the homeowner is unlikely to notice when it is being used since the time is relatively short.

FPL customers have two choices. One is for a 15-minute shutdown. The other is for a four-hour shutoff. The consumer selects how many of the four appliances that they want included in the program.

For instance, if you have your A/C on the 15-minute program, your bill is reduced $21 per year. The four-hour program will pay you $63 for your A/C. With FPL's program, you can save up to $137 per year if you allow them to control all four appliances in the four-hour program.

Why do the electric companies offer these programs? They're in a tough position. We expect them to supply power whenever we request it without fail. That includes the hottest day of the summer when everyone's air conditioner is running continually.

But the capacity that's needed for peak demand isn't needed most of the time. So, if the electric company can reduce peak demand, they won't need as much capacity. That could eliminate the need to build new power plants, which translates into avoiding a major expense for the utility company. FPL claims that their program has eliminated the need to build two additional generating plants.


Consumers generally like these demand response or load management programs. The electric company pays for the installation. Usually the inconvenience is minor, and the savings help reduce a bill that has had a tendency to increase.
In the future, we'll see even more of this type of demand management. It's difficult for utilities to get the approval and financing to build new power plants. So they have a big incentive to reduce peak demand.

Some utilities are beginning to offer variable pricing. The consumer pays more for electricity during peak usage times and pays less for off-peak hours. So far, most of these programs are aimed at large industrial users of electricity, but they're beginning to reach the consumer market.

Technology is allowing the utility companies to go beyond the old tools. The demand management boxes are currently controlled by a radio signal, but future technology will allow for computer control of major appliances. That will mean that consumers will be able to turn an appliance on or off using their cell phone or computer. And the number of appliances that can be controlled will continue to increase. New appliances may be designed with the controlling device built-in.

So not only is it a good idea for Heather to sign up for the "cycling" program, but she should also see what other energy-saving programs are available through her electric company. Some utilities will pay the cost of a duct inspection and will contribute to any repairs needed. Others offer rebates if you update old inefficient appliances or add insulation to your home. The savings could be significant.

Heather has found one of those situations where she can help her checkbook and the environment at the same time. Plus, she'll be reducing the amount of energy she consumes. Pretty much a good deal all around!

We have kitchen doors from the 70s or earlier. We would like to change the color but don't know whether we should stop there or go as far as changing cabinets. - John

John's got a lot of company. Kitchen & Bath Business Magazine forecasts that there will be 6 million kitchens remodeled this year at a total cost of $79 billion!

It isn't surprising. Kitchen remodeling projects generally recover nearly all of their costs when you sell your home. MSN House & Home released a report showing that projects costing up to $25,000 returned 90% or so when the home was sold.

So that's a good reason for redoing your kitchen. Another is that it's one of the most used rooms of your home. And, if you listen to the people who study such things, the more time your family spends in the kitchen the healthier and happier your family will be.

OK, so you're thinking about doing something. But, like John, you wonder how much to do. The best place to start is to figure out what you can afford. Kitchen projects can quickly get out of hand. Once started, it's easy to upgrade to a more expensive drawer pull or cabinet door. There's a lot of pressure to go just one step further. And then one more after that. But those decisions can be very expensive. Have a dollar limit in your mind based on what you can afford. Hold on to that boundary. Just about everyone, including your own ego, will want you go spend more.

And, expect some unanticipated expenses. It's prudent to only plan to spend 90% of the money you'll have available. Save the 10% for mid-project surprises.

Next you'll need to decide how extensive your remodel will be. It may be as simple as repainting wood cabinet doors and walls. Perhaps you'll want new countertops and faucets. Or it might be a matter of gutting the entire kitchen and starting from scratch.

Naturally, more extensive means more expensive. This is the stage to get some rough pricing for different aspects of the job. Bounce the costs against your budget. You should have enough information to decide how much you want to take on.

Some people will argue that it's ok to borrow for a kitchen remodel. After all, you're making your home more valuable. That's true. But you'll still end up repaying the loan when you sell. And that means less money in your pocket. If you do borrow, consider repaying the loan while you still live in your home.

If you're going to be making major changes, be sure to consider the three major functions of a kitchen: storage, preparation and clean-up. Think about how your family uses the current kitchen.

Make major decisions before you start construction. Remember making adjustments once work has started will be expensive.

New cabinets are generally the most-pricey part of a fully new kitchen. Choose them carefully. Their style and color will have a major impact on the room and your budget.

In fact, choose all your materials carefully. You'll find that quality varies considerably. The fact that there are a lot of choices means more work for you, but does provide a greater opportunity for savings.

Don't assume that the big home center store is the cheapest or best. Check with specialty kitchen and cabinet shops. Ask if they have any cabinets that they were unable to deliver. You may be able to benefit from another's mistake.

If the job is beyond do-it-yourselfing, ask around for a handyman or contractor. Unless the job is fairly simple (read inexpensive), you'll want to get three bids.

Check out contractors thoroughly. Ask for references and contact them. Ask the contractor about licenses, insurance and bonding. You don't want to make a mistake here. Under normal circumstances a full kitchen remodel will take about two months after planning and materials have been ordered. The wrong contractor could drag that out indefinitely.

Talk with the contractor before starting. Ask a lot of questions. The way they answer will tell you a lot about how they'll perform. For instance, some will encourage you to skip getting required permits. Better you should skip that contractor. Yes, the permits will cost you, but they'll also guarantee that the job is planned and done correctly. The building inspector can be your best insurance against shoddy work.

Finally, expect disruption. Eating all your meals out for two months can get expensive. So some families load up the freezer with meals that can be reheated in the microwave. It's easy to prepare extra portions of the meals that you're already making during the weeks before your kitchen is off limits.

Updating a kitchen can make a big difference in your home. Whether it's just painting cabinet doors or a full blown new kitchen, it takes time, consideration and money. Hopefully, whatever John decides will bring his family together and make many fine memories.

My family has been trying to work with a budget for the past several months, but the "envelope" system is just not practical with our primarily cashless lifestyle. How can I track our cashless expenditures for gas, groceries, personal items, etc. and still know how much is left in each category as the month goes on?
Lisa

Lisa's right. Some of the old budget tools don't work so well today. Fewer of our purchases are made with cash. So merely controlling cash isn't an effective budget tool.

Before we look specifically at Lisa's question, let's spend a moment to talk about how budgets can be used. A budget is a wonderful way of collecting information about your finances and presenting it in a way that's useful to you. A simple monthly budget can tell you at a glance where your money is going. When compared to previous months, it can tell you what's changing in your spending patterns. That's important. Just knowing that your electric bill is higher could help you identify an air conditioner that needs servicing before it breaks down completely. It's also a good way to find potential savings. If you need to reduce spending by $250 a month, don't look in a category where you only spend $300.

Lisa is attempting to use her budget for its second purpose. A budget can provide discipline and control over-spending.

There are variations, but in the basic envelope system, Lisa would cash her paycheck. She would have a number of envelopes for the different categories of spending, such as rent, food, transportation and so on. Cash from her paycheck would be divided into the various envelopes based on how much she felt she needed in that category.

For instance, if she got paid weekly and expected to spend $40 per week on groceries, $40 would go into the "grocery" envelope. When she went to the store, she'd take the "grocery" envelope with her and pay for her purchases with the money in the envelope. If she got to the checkout and had more than $40 worth of groceries in her cart, she could return some groceries or take some cash from another envelope. Of course, that meant that she'd have less to spend on that category until the next payday.

The envelope system worked well when we used cash for all of our purchases. You immediately knew if you could afford a purchase. Moving money from one envelope to another was a warning sign that you could be getting into trouble.

Unfortunately, very few of us use much cash anymore. We're much more likely to pull out a credit/debit card or write a check. And an envelope system doesn't handle credit cards very well.

One way to modify the envelope system is to add an additional envelope for your checking account. When you charge something, move cash to the "checking account" envelope. If you charge $20 worth of groceries, move $20 from the "grocery" to "checking account" envelope. Then when the credit card bill comes, you'll have the money available to pay the bill.

Or Lisa could use a "pretend envelope" system. She would set it up just as if she were going to use an envelope system. But she wouldn't actually put cash into the envelopes. Instead, on the front of the envelope, she'll list how much money is assigned to it. As she writes checks or makes charges, she'd subtract that money from the balance listed on the front of the envelope. When the running balance on the front of the envelope got to zero, she'd have to quit spending in that category or "move" money from another envelope.

Another way would be to use one or more sheets to keep a running balance for each category. She could have one sheet represent each envelope. Or she could have one sheet per month that contained the balances for all of the envelopes. The sheets, or perhaps a small spiral notebook, could be kept in her pocket or purse.

The danger in any virtual envelope plan is that you'll forget to make the entry and your balance will appear bigger than it is. One way to avoid that is to put any receipt into your pocket or purse. When you get home you can deduct the expense from the proper envelope and place the receipt inside.

There are also products that Lisa can buy that will help. One is available at budgetmap.com. They offer a specialized check register that allows you to keep track of different budget categories. Another is mvelopes.com. They feature an online approach.

Lisa is wise to recognize the limitations of any tool that she uses. But, she's also smart to look for a system to help her keep her finances in line.