Planning for Lump Sump Payments

Posted on April 19, 2012 Written by Leave a Comment

One of the most overlooked components of a budget is the lump sum payment.  The lump sum payment comes in many forms, whether it be annual registration for your automobiles, annual membership dues, quarterly tax payments, or anything that you can expect to repeatedly spend on a periodic basis that exceeds a single month.

Since we don’t write that check but once per year for most of these items, we neglect to place them in our monthly calculations and then we fall into a common trap of using credit cards to cover those expenses when they arise simply because we “forgot” about them.

The problem with that practice is that you end up amortizing your lump sum payments, accounting for them monthly with your credit card payments anyway, only with interest, so they end up costing you more than they should after the fact.

Christmas is a perfect example.  I used to find myself nearing Christmas Eve with no idea regarding what I would purchase, for whom it would be, nor how much it would be.  What I knew was that in a pinch, I could easily charge it up and get it out of the way, then worry about it later.

This is a nasty way to spend the first half of each new year, and it sours the taste of giving as you continue to write checks for Christmas gifts that are 5 months old.

A Strategy for Handling Lump Sum Payments

This is so simple you should slap yourself for not doing it.  I’ll re-iterate one particular point…if you aren’t writing a monthly budget, there’s no point in paying attention to the rest of this information.  This strategy is for those who have successfully practiced a few months of budget planning who have suddenly run into a lump sum payment they had forgotten about that they weren’t sure how to handle.

Here’s how to handle it.  I’ll use auto registration as an example.  Every year you’re going to register your car and every year you know that the fee will be less than the prior year.  That’s good news.  To make certain you plan ahead, take the previous year’s registration fee and divide it by 12.  Add that expense to a line on your monthly budget.  That’s it.

See?  I told you it was simple.  Now you know what it costs you per month to register your car.

What about all of the other lump sum payments?  After all, not everything is due at the same time, and dividing by 12 may not work this month because the payment is due in 3 months.

Well, this solution I’ve found works well for me.  I have added up all of my annual fees based on what’s happened in the past and padded it a bit for unexpected annual “gotchas” of the non-emergency type.  I then created a new savings account at my online bank and I called it Annual Dues Account ( most of mine are called annual dues, but you could call it “lump sum account.”)  I took the total amount of the lump sum payment and divided it by 12 to get my “monthly burden” so to speak, then created an auto transfer in that amount from my personal checking account to that lump sum savings account.  Every month my reserve account gets a small supercharge that creates a buffer for those lump sums.  When a payment comes due, I just write a check from that account, and never think twice about it.

Since all of the lump sum payments are due at different times of the year, the first year will require a few extra adjustments.  For instance, if you’re calculating your Christmas budget in August, you have 4 months left before you have your lump sum payment, and 8 months have already passed.  You’ll need to either catch up your deposits by depositing 8 times the monthly amount for the months that you’ve missed, or reduce your budget by 8 times the monthly amount, go cheap this Christmas, and save 4 months worth of your Christmas budget.  Another solution would be to divide the annual budget by the number of months remaining before the payment is due.  Once the lump sum due date has passed, you’ll be on schedule to have the money you need for the following cycle.  Obviously some lump sum payments aren’t so discretionary, so you’ll have to break the cycle as far in advance of the payment due date as possible so when the due date hits, you’ll already have a portion of what you need saved.

Once you’ve identified all of your annual, bi-annual, semi-annual, quarterly, or non-monthly periodic payments that happen in your life, you’ll have a grasp on the corresponding monthly expense and you’ll have a better grasp on your plan.

Tuition for school is not an emergency, and neither are extra curricular activities, or prom, or other expenses that have come to others before you.  If you can investigate the potential cost of something before it comes, you can include it in your lump sum payments.  School supplies, bike tires, annual charitable contributions…you name it, it can be planned.

Don’t let this part of your budget pass you by.  It’s as important as your monthly food budget.  It’s going to take one full cycle to get the system rolling, but once you dial it in, you’ll no longer need to worry about the lump sum.  Don’t forget to adjust if you start something new, but hey, you wouldn’t start something new without planning for it anyway.

Filed Under: Planning and Budgeting Tagged: , , , ,

Tax Refunds Are Bad For The Economy

Posted on February 4, 2012 Written by Leave a Comment

So you say you’re getting a tax refund this year?  Isn’t that delightful.  Now you’ll have “extra” money with which you can do whatever you like.  Most likely you’ll consider it a bonus of sorts and it will be spent on some sort of vacation, gambling binge, or electronic upgrade.  Am I close?  That’s what most people do, right?  So why should you be any different?

If you’re like millions of Americans who over-pay their taxes, you might be getting some of that money back!  Wheeeee!  So what should you do with that “extra” money?

First things first.  Recognize that it’s not extra money.  This is money that you loaned to the government interest free.  It’s hard-earned income that should be in your hands, not the government’s hands.  You do work hard don’t you?  You do want your money to be in your pocket right?  Then stop giving it to the government in advance.

Getting money back at the end of the year is not an indication that you’re winning with money.  It’s not a barometer that measures success.  It’s a tell tale sign that you aren’t doing the right thing with your money and that something needs to change.

If you’re getting a refund, you’re doing something wrong.  And, some companies are helping you continue this trend.

Some tax preparation companies build their entire business models on the fact that you might be entitled to a refund from the government.  They sell you on the fact that they can help you get more, and then they help you think about ways you can spend that money.  Then, you buy into their marketing with some of your refund as a fee to make sure you’re getting as much of a refund as possible.

For the average family living paycheck to paycheck, a $3000.00 refund, for example, might seem like an annual treat.  But if you divide that number by 12, you get $250.00 per month in additional income with which to budget.  When given large refunds, people tend to spend that money in their heads on big, extravagant purchases to satiate their desire for some sort of relief from the monthly grind without realizing that they could have had more wiggle room every month.

Can’t save up that emergency fund?  Need that deductible for unexpected insurance gotchas?  Need a bit extra every month to pay down debt?  You know where to find it.

“But if I don’t pay in, I might owe…”

Yep.  That’s true, you might, but if you plan for it, and save for it, it won’t be a problem, will it?  The optimal plan puts you at zero owed, zero paid back at the end of the year.  It’s hard to nail that right on the nose, but personally, I’d rather owe, have complete control over the money, and not give it to the government.  If it sits in my account, I earn the interest on it.

“It’s like a savings account…”

I hear this from people who don’t have the discipline to save and don’t understand the amazing power of compound interest, which Albert Einstein once declared to be “the most powerful force in the universe.”  Those same people struggle to make their monthly expenses and don’t even realize they could have more breathing room, pay off debt faster, or save for a specific goal.  I’ve heard out of the mouths of people who are getting refunds that they “aren’t able to save $1000.00,” that it’s “just not realistic.”  Oh really?  If you’re okay with your employer automatically sending your “savings” to the government, why not just adjust your W4 so you get more of your paycheck, then setup an automated transfer into a savings account.  Label that savings account “Tax Savings” and leave it alone.

Bottom line?  You are in control of how much money your employer withholds from your paycheck when it comes to Federal and State taxes.  Social Security?  Not so much.  (Man am I fired up about that one!)  If this year you get a big refund, adjust your W2 so that your employer reduces the amount they withhold by the amount of your previous year’s refund.  You should be in much better shape the following year.

 

 

Filed Under: Personal Finances Tagged: , , , ,

Baby Step 2: Check!

Posted on December 1, 2010 Written by 1 Comment

My son, if you have become surety for your neighbor, Have given a pledge for a stranger, if you have been snared with the words of your mouth, Have been caught with the words of your mouth, do this then, my son, and deliver yourself; Since you have come into the hand of your neighbor, go, humble yourself, and importune your neighbor.  Give no sleep to your eyes, Nor slumber to your eyelids;  Deliver yourself like a gazelle rom the hunter’s hand and like a bird from the hand of the fowler.

-Proverbs 6:1-6

December 1, 2010 marks the actual day that I eliminated all consumer debt.

You may recall a recent article entitled Big Secrets in which I confessed:

But there’s one more card that I have lingering around that needs to be paid down.  I have the money to pay for it, but I also feel like I’m in a constant income crisis.

Well, today I actually pulled the trigger on the payment and became debt free except for the house.  If you know me well enough, you probably know that I am all about technicalities.  The statement, “you know what I meant” isn’t one of my favorites.  There’s probably a better word to describe what you meant, technically.  So, when I say I’m debt free but the house, I cringe a bit inside, because I’m still in debt, technically.  And no, I don’t believe it’s good debt.  That’s another argument for another time.

So, the remainder of my servitude is going to be paid to two separate financial institutions.  1) Bank of America (I loath you…) and 2) MidFirst Bank (…likewise…)

I don’t like big banks.  That’s no secret, and it’s for good reason.  Anyway, I digress.  The whole point is that I finally did it.  I finally took that last payment which was sitting in my account, and let go of it so it could reach the credit card company (which happens to be my banking institution…[Wells.])

Now, I can feel completely free to declare “I’m debt free!” without having that little monster inside of me gnaw away at my conscience as I lie through my teeth.

Here’s the proof:

Yeah, I don’t care if you know how much money is in my account.  Not only am I about technicalities, but I’m also about transparency.  Try it, it will be a liberating experience.

The False Insurance Policy

Consequently, as a result of my reluctance to let go of that last $2929.20, I was being billed monthly:

(thanks Mint.com, you make it so easy to manage finances)

The way I see it, I was paying roughly $35.00/month insurance premium to protect $2929.20 in my checking account, thereby reducing the value of the supposed savings every month.  You see, I should have paid this off long ago, saving myself approximately $245.00, yet another stupid tax that I have paid AFTER adopting Dave Ramsey as my financial advisor.

Either way, it’s done now, and I have reduced my debt burden to zero, and eliminated a $35/month expense.  Hurray for me!

Filed Under: Baby Step 2 Tagged: , , , ,

It’s Fun to Watch Money Grow, Even If It’s Only $1000

Posted on November 18, 2010 Written by 2 Comments

The fuel that fires the burners in the financial fiasco is that wonderful concept called compound interest.  If you don’t know what that is, here’s a simple explanation.

When you borrow $100.00 from someone and they expect a payment of $110.00 by a certain date, you’re paying a total of 10% interest on the money you borrow.  If you don’t pay them, aside from late fees, the next time they calculate interest on your balance, they’ll use $110.00 as the basis, not $100.00.  So, for the first month, 10% of $100.00 is $10.00, but the second month, 10% of $110.00 is $11.00.  On the third month, 10% of $121.00 is $12.10.

(keep in mind, we’re charging 10% per month in this example, which is an insane rate [sorta like a title loan company or check cashing company] just to show the sheer awesomness of compound interest.)

My Emergency Fund

Putting $1000.00 in the bank, in an easy-to-access, fee-free account is exactly what you need to do to manage Murphy’s Laws of Diminishing Returns.  In other words, emergencies.  Before you start making plans to get rich, or get out of debt, or whatever, you need to set aside at least $1000.00 to handle possible problems, which I might add, will happen. It’s not a matter of if.  It’s a matter of when.

  • Tire blows out
  • Alternator fails
  • Air conditioner dies
  • Water heater dies
  • Son breaks arm (deductible)
  • you name it, it will happen…

In July of 2009, I transferred enough money into my ING Savings Account to equal exactly $1000.00.  At the time, the interest rate on the account was a measly 1.3%.  Let’s be clear about savings accounts designed for emergency funds:  They’re not meant to make you money.  They’re meant to handle emergencies, so the interest rate isn’t important.  However, thankfully, there is actually a rate on this one, which means I get to watch it work for me, even if it’s only a few bucks.

It’s now November 18th of 2010 and I have been paid interest every month on the balance of the account for 16 months.  Below is a graph of my account, which shows positive growth with no effort from me whatsoever.  Watching money work for you is exciting!  It’s measurable progress, and that’s what we’re looking for in our finances.  We want to be earning interest, not paying it.  We want the fundamentals of compound interest to work in our favor.

The orange line represents the balance of the account, and the blue line is the amount of interest paid each month.  The blue line fluctuates because the interest rate fluctuates.  The orange line increases steadily over time because nothing is taken out of the account.  The is the direction your money should be going.  If you’re spending less than you make, then you’ll see this trend on your net worth.  What you don’t see here, is that the orange line is actually a curve that gains momentum as time passes.

The goal, in your financial life, is to reach a point where the interest paid on your nest egg covers all of your basic living expenses.  But, before you can get there, you need to remove the dead weight of compound interest being charged to you, instead of paid to you.  Get that $1000.00 socked away as fast as possible.

Filed Under: Financial Basics Tagged: , , ,

How I Turned $370 into $21,000

Posted on September 3, 2010 Written by Leave a Comment

Economies of Scale

Economies of Scale is a term in micro-economics that is used to describe the decreasing cost to produce something as the scale of the operation increases.  Home brewing, for example, requires a basic set of tools and ingredients and time to produce a single batch of beer, which equates to approximately 2.2 cases.  Therefore, producing one batch is relatively expensive.  But, if the manufacturing process was ramped up to hundreds of thousands of gallons of beer, the cost per gallon, or the cost per batch goes down as the quantity produced goes up.

I thought about this the other day when I purchase 4 light bulbs at the grocery store for $1.00.  I know, you get what you pay for, but it reminded me of how efficient the manufacturer must be in order to keep the costs low enough to make a profit on each light bulb at that price.

The Rich Get Richer

Another example of economies of scale is the common phrase “you have to have money to make money.” The more you invest, the more you have working for you, and therefore, the more you’ll return on your investment.  The factor then becomes a question of risk tolerance.  If you put 5 coins in the slot machine, you will earn more if you win, but you’ll also lose more, and slot machines are very high risk, etc.

Cut Costs Using Economies of Scale

Any wholesale goods provider knows that the more they can purchase, the less it will cost them per unit.  The problem with many goods is that they have a shelf life, and they need to be moved, so they can’t just sit around doing nothing.  But what happens when it comes to services?  What happens when you purchase services in bulk, in advance, utilizing a bulk discount?

How I Saved over $600.00

Yesterday I analyzed one single category on my budget, website maintenance. For those of you who aren’t aware, owning a domain name is very inexpensive.  Utilizing that domain name is also very inexpensive, but it is a required cost.  How much should it cost though?

Stupid Tax

For the past few years, I have been tricked into thinking that I’m not spending much on my web hosting needs because of the ridiculously low costs of each website that I have online:

  • centerpoint.cc = $2.95/month.
  • chateaudeviesix.com = $2.77/month.
  • jongriffith.com = $16.55/month.
  • realscottsdaleliving.com = $7.23/month.
  • showseason.com = $2.14/month.

Total expense every month = $31.64/month, or $379.68 per year.  Whoops.  That’s too much money.  I know that I can do better, but here’s the catch.  Had I not looked into it, I wouldn’t know that it was happening.

A New Direction

It took me about 2 hours to do some research on the topic of hosting websites, and I ended up chatting online with a sales representative from HostGator.com.  The service was excellent.  Through the course of the conversation, it became clear to me that I was spending way too much for my current hosting plan, not to mention the frustrations that go along with the particular hosting provider I am currently with.

With HostGator.com, I will be spending a total of $12.95/month for ALL of my websites.  That’s a monthly savings of $18.69, which equates to an annual savings of $224.28.  That’s a 59.1% reduction in cost.  Not only that, but because I’m a first time customer, I’m getting an additional 20% off the bill, so the total monthly cost is $10.33.  That increases my savings to 67.3%.  That means that over the next 3 years, I’ll be saving $767.00 if I make the change.  What’s the catch?

The Catch

I must pay for 3 years in advance.  My standard monthly budget for website hosting has been $40.00.  My one time payment in the upper $300.00 mark will take me WAY over budget, but in order to take advantage of the bulk discount that is being offered, I have to be willing to give them my money now.  It’s a brilliant marketing plan for HostGator.com, because they’ll bank the money now, and it helps them scale up quickly to reduce their costs, making my discounted monthly cost even more profitable.  It’s a great deal for me because I can invest $18.69/month (my savings) more than I was before.

$18.69 saved for 30 years is $6,700.00 but invested at 8% over the same time period in the right type of account could yield an additional $21,300 in free money.

So, to change website hosting providers or not to change?  I think this is a $21,000 decision that’s going to cost me only $370.00.

Filed Under: Hey! Wake Up!, Personal Finances Tagged: , ,
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