Debt to Dreams

This is my third post in this series detailing exactly how much my wife and I spend each month financing our family. When I made the list I was surprised by the variety of different ways we spent our hard earned dollars financing the modern banking system.

At this point, I am almost appalled by how large the numbers are getting and we are only 2 months into the year.

Here are the results from February:

A quick summary of the results:

Banking Expenses/Fees For the average American, the banking system has a number of products out there to help you avoid banking fees IF you are willing to jump through a number of hoops. To keep our fees down we use direct deposit and rarely use ATMs. If we are traveling and need cash we just use cash back from our debit card and use credit for everything else.

Credit Card Expenses It is no surprise that we have some charges here. Although we carry a large credit card balance, it is financed through 0% balance transfers. The majority of the $225 we have spent in this category is for annual fee’s on a couple of our Airline Cards and a premium card. I think over the next 12 months we will have to decide if these cards are really worth their yearly fee.

Investment Expenses/fees This is one category that still looks good but I have the feeling that I really need to do some better detective work. Most investment fees are buried in the investment so that it is difficult to discover just how much it is costing you. My contributions to my IRA last month were to an existing no-load fund. In theory there should not be any additional fees other than the yearly operating expenses.

Student Loan Expenses/fees The number that jumps off the table above is the extra $4000 in student loan interest accumulation. I realized last month that I was not accounting for the interest accumulating on my $100,000+ of student loans still in forebearance. Although the total for 2007 was reported last month, it was accumulating at the rate of about $335/month for the past year. Since I only get the bill quarterly at best, I’ll only report the change in balances at that time.

The interest alone on our student loans is greater than all of our monthly expenses except rent and food.

All of a sudden that $100,000 education isn’t looking to cheap.

February is well behind us and the calender is telling me that we are half way through March. I finally managed to drag myself out of the hospital and crunch our numbers for last month.

To state it plainly: Nothing Impressive

The economy is hitting the skids and the Fed dropping rates quicker than I can refresh my account page. This is causing me great angst. The main driver behind my alternative income, our credit card arbitrage, is becoming worth less every day.

When I decided to finally started to maximize my 0% balance transfers last July, I was expecting to earn 5% or more on this balance for months just by placing it in an online savings account. After the Fed’s rapid series of rate cuts, 3% is starting to look like an attractive rate. I am kicking myself for not hedging a portion of this money in CD’s when rates were higher.

Also my Internet derived income PLUNGED from an all time high of $6.36 in January to $0.16 in February. This is more in line with the historical averages of my earnings from my internet related adventures.

February was also a slow month on the farm No harvests right now and if I ever expect to win the lottery I think I am going to have to buy a ticket.

Nothing Impressive BUT, it is extra money in my pocket and yet another stepping stone on the way to financial independence.

A bit late with the results…… mostly because I was afraid to look but we eeked out a slight gain for the month and that is all I could ask.

The realities; read “challenges” of our family becoming a single income household are becoming more evident at this time.

Here is the Damage for February:

Here is our guidance for February:

1. We continue to place the majority of our savings into short term, cash-equivalent savings. I am not a sophisticated investor, but right now I don’t see many bargains out there and most of the major expenses facing a young family (1st home, moving, young children) are looming ominously on the horizon for us.

2. I made a lump sum contribution of $2000 to my IRA for the 2007 tax year. I had already contributed $2000 throughout the year in monthly contributions and my wife an I both decided that this was a good use of a couple of thousand dollars to help decrease our taxes again this year.

3. I also recharacterized my Roth IRA contributions for 2007 to a Traditional IRA contribution. After much reading and deliberation I decided that less taxes this year was better than the promise for less taxes in the future. It is too easy to see congress attaching some form of income/net worth stipulations to the tax-free benefits of the Roth IRA.

4. We also had another 0% balance transfer offer fall into our laps with no fees attached. With the addition of this $5000 balance transfer, we now have over $67,000 in 0% APR balance transfers from various credit card companies. Unfortunately, the Fed is making this a less lucrative proposition each month as they cut the interest rates.

While cutting your family income in half right when the economy is going into a recession isn’t at the top of everyone’s to do list it appears as if we will be OK.

The day is fast approaching when I will finish this stage of residency and proceed to move to the next step of my training. This will bring with it a fresh set of choices once again.

I currently have some old fashioned views on personal finance and I believe that saving as much of your income as possible is a sure fire way to financial independence.

As someone who is currently trying to climb out of debt, saving a larger and larger portion of our income has proved to be the most difficult part of trying to get ahead.

Since how much we can save is such an important part of our family’s financial health I thought I should do a better job of following this information each month.

So, new for 2008 is our Earned Income Savings Percentage!

As you can see, we are not off to a great start in January:

I chose to base the calculation on my Earned Income for a couple reasons:

• First, the majority of Americans only have earned income to contribute to savings
• Second, my alternative income is not very stable or accessible for placing in accounts

For a comparison, I included our finances from the month of December. Here is some insight to those numbers:

December was an abnormal month for us financially.

• Our Salary Income was relatively stable for the month, with a slight bump in our Alternative Income
• Our Monthly Expenses we much higher than normal due to my Private School Loan repayment
• We were able to contribute such a large sum of money to savings due to a 0% balance transfer

In January we saw an increase in our day to day living expense due to increased insurance costs and some travel plans for the spring. This increase in living expenses and my desire to make contributions in lump sums kept us from contributing anything for the month of January

In the past two months we have gone from saving 96% of our income to saving 0% our our income. When it averages out a realistic goal for 2008 will be for us to be saving about 10% of our gross income.

As I progress up the food chain and become fully salaried I hope to push this number to 50% or more but only time will tell. I may be a bit optimistic with those numbers but aiming high never hurt.

For our 2006 tax return we had a CPA file our taxes. First out of laziness and second out of some apprehension on my part of making a mistake with the calculations. Since the CPA filed the taxes, I took a cursory look at the finalized return but didn’t dive into it.

This year, I decided to do my taxes on my own before we have a professional file them. I was hoping to develop a better grasp of the tax implications of my financial decisions while we are still in a learning phase. After this weekend, I’m glad I did.

This weekend I learned the importance of paying attention to the tax implications of your various accounts. I learned this that my wife’s “IRA” account will present us with a capital gains distribution of over $3000. What? Why are we being hit with capital gains? Shouldn’t they be rolled over into the account until retirement? Well, with a quick check, I learned that this account is not a tax-sheltered IRA like the one I opened last year.

This money was post-tax money that should have likely been placed in Roth IRA or the like. Currently it is just a fancy, very volatile savings account. Since it is not a tax sheltered account, we are responsible on paying taxes on the capital gains distribution. The irony of this is that these will likely be “paper gains” if the market continues its jittery fall this spring.

I found a good Morningstar article that does a better job explaining the reasons behind this but here is what I learned that we need to consider doing:

1. We need to consider switching this money to tax-managed funds Apparently these funds make an effort to realize some losses on holdings when they have to realize gains on others. With this tax consideration, these funds can come out ahead.

2. We need to consider switching to EFTs for this account. They apparently don’t have as many strategies available as the tax-managed funds but are a good second choice.

3. When switching out we need to be aware of funds that have had large returns over the past 3 years. These funds will have a huge tax bill regardless of whether we make any money or not because capital gains are based on gains that the fund realized and distributed to all shareholders equally regardless of their cost basis.

So if I go running to emerging markets right now, I could buy close to the top AND get hit with a large tax bill. Note to self, don’t do this.

I made an attempt last year to get this series off the ground. However life got in the way of digging through a years worth of financial statements so I put it on hold for 2008.

The focus of this series is on how much of my hard earned income is being used to Finance my life. I wanted to include everything from credit cards and student loans to how much it is costing me to manage my retirement portfolio.

This is the information that I should have been aware of three years ago and will likely be a real eye opener to anyone who has a significant amount of debt of any type.

Here is the Start of the Year:

Here are my thoughts on the categories:

1. Banking Expenses: Our family has rarely spent a significant amount of money here. We don’t use out of network ATMs, we don’t bounce checks, and there are a ton of free checking options for anyone who willing to use direct deposit. Given the major turmoil rocking the financial industry right now, I wouldn’t be surprised to see the banks looking for some way to squeeze some money out of us here.

2.Credit Card Expenses: We had done very well here until last month, hence the $180 out of our pocket. I missed one of my credit card due dates by a day and was hit with a late payment fee and the ubiquitous finance charge. The majority of this category however is the yearly fee for a couple of our frequent flyer cards.

3. Investment Expenses/fees: I have not made any investments this year and thus have yet to pay a fee. This was the category that killed my attempt at following my borrowing costs for 2007. Most of the companies I use to manage my investments don’t go out of their way to show you how much they are charging you to invest with them. My goal for 2008 is to follow this metric carefully because the only thing I can control with my investments is my allocation, costs and tax burden. Control what you can control and don’t worry about the rest.

4. Student Loan Interest: This category is surprisingly low. Out of my monthly student loan payments, only $66.07/month goes to interest and the rest to principle. This is also due to the fact that this only represents the loans I am actively paying off. The bulk of my consolidated loans accrue the interest lump sum at years end(it accrues all year long but the company only sends out quarterly statements) This category will be much higher come next month when my statement is accounted for.

So, I spent almost $250 of my hard earned post-tax income last month financing my modern miracle lifestyle.

That same $250 invested every month for 30 years at 7% average return would be over $300,000 by the time I was 60. Not a million bucks but a heck of a lot better than giving it to the credit card companies every month.

Since working for your money has become quite passe, I figured this would be an interesting metric for our family to begin to follow.

I cannot take credit for the idea. There are many individuals that have spent the time and energy to develop a well diversified source of income for themselves outside of their day job through activities such as:

• Peer to Peer loans in the form of Prosper and Lending Club.
• Personal Retailing through their Ebay accounts
• Landlording through the development of their own personal real estate empires.
• Blogging!! with the help of Google Adsense.

Looking at that list I find all those options to be very reasonable sources alternative income to consider for just about anyone. There are some pretty amazing success stories of individuals being able to quit their day jobs and making a living with these alternative sources of income.

The catch is that their success was not instantaneous, but was transformed from hours of work by these individuals in developing, researching and refining their alternative income streams.

Most people pursuing these income streams don’t consider these endeavors work for 2 main reasons:

1. It is something that they were doing before as a hobby and would continue to do anyway even if it did not provide them with an income.
2. They are able to do it on their own terms, hours, etc… with no-one to answer to except themselves.

With that as inspiration, here is our start: (Note, all amounts are Pre-tax dollars)

As you can see we don’t have a very diversified source of income and some of the items I listed are very difficult to expand upon or grow in the future without drastic lifestyle changes. I included them more for reasons of personal accounting rather than listing them as something I can build upon.

Currently our only sources of income other than my job as a resident are:

The interest we earn on our savings and 0% balance transfers: My wife and I hope to continue to grow our cash savings even in the mist of falling interest rates.

The occasional dividend check from my wife’s family’s farm: We have absolutely no real control over this unless I were to decide to abandon the practice of medicine and join the agricultural community full time.

The money generated by the advertisements on various websites in various stages of development. Not something I am pursing as actively as others. I do have quite a few interests outside of medicine and I will continue develop them more out of personal satisfaction rather than monetary reward.

Gift money and other forms of windfall income: Something many people don’t consider but something I wanted to follow. Basically I am including things such as the stipend I get for meals on call, book fund money from my department and the $20 my parents still send on my birthday. Also when I win the Lottery, I want somewhere to make a note of this

In my defense, over the past 12 years I chose to focus those hours on learning a highly specialized skill that I hope will one day provide a financial reward to balance the emotional reward it already provides.

To protect myself and my future potential earnings I have disability insurance!!

In 2008 I hope to be able to slowly refine this metric. Over the long term, I will look to expand my sources of alternative income so they can make a more meaningful contribution to our net worth. I am very realistic however that these endeavors will never come close to replacing my day job.

By the numbers we are off to a rocky start in 2008. The $6000+ drop in our net worth is the largest in the past 13 months.

About half of this loss was due to the falling market but the other half was due to the interest from my consolidated student loans for 2007 finally being capitalized.

Fundamentally our household is in good shape and should be in good position to weather a possible recession.

Here are our numbers from January:

Guidance for January:

All of our Credit Card Debt is in the form of 0% balance transfers The banking community has allowed up to borrow this money which I have placed in a FDIC insured online savings account, pocketing the interest earned. This money makes up the bulk of our cash savings. Our true cash savings is only $23,735.25 of the $87,253.25 listed.

Our Investment accounts all fell in step with the market for the month of January. Our project for this year is to take this motley mix of funds and develop a more diversified, lower cost portfolio. If this year does indeed become a recession we will have the opportunity to “buy low” into some new positions.

Once again I am waiting until I do our taxes to decide if it makes sense to invest in a Traditional IRA for 2007. By waiting until tax time last year, I managed to buy into a rather high market which has currently resulted in a slight loss. However, I still need to lose an additional $600 for this to have been the wrong decision.

I have continued to keep our vehicle listed as an asset and will continue to do so until we drive it into the ground. I will not list any additional vehicles or material goods in the future because the true value of these items are difficult to accurately assess.

In my attempt to revalue our vehicle for 2008, the Kelly Blue Book value actually Increased (likely due to low miles) which I find hard to believe. I decided to just keep the value where it is until it shows a definite decline.

I finally received my quarterly statement for my consolidated school loans which capitalized the interest for 2007. I am undecided if it makes financial sense to be paying off this interest to keep it from capitalizing. I haven’t calculated it but in essence that additional $4000 is going to cost me an additional $120/year for the next 30 years. It is too late for 2007 but it will be an option to consider for 2008 once I figure out the present and future values, etc….

I remain undecided about what to do with my Federal school loan. The interest rate remains fixed at 5% which is currently the highest interest rate of all our debt. With interest rates on my savings falling, I will wait to see how much of a tax benefit I can derive from the interest paid on this loan. If there is a minimum benefit and the economy continues to sputter along, we may allocate some capital from our savings to rid ourselves of this debt, similar to what we did last year.

Our day to day finances continue to be a challenge. My wife has decided to remain part time with the birth of our first child which has constrained our monthly cash flow. We are approaching this as a challenge and an opportunity to squeeze the excess out of our spending(due to necessity) so that in the future we will be able to use these gains to increase our savings.

Remember, focus on the process, form good habits and the results will follow!

Although I have been blogging about my finances for a relatively short period of time I have been following my credit card debt since July of 2005.

I have found that an often overlooked key to success is the development of a system that works for you.

How do you keep your money in your wallet and bank accounts?

Everyone starts differently, my system slowly developed from this: a blank index card.

I still use my index card system today to keep a list of all my credit card accounts, how much I owe and when my next payment is due.

When developing your system, the main idea is: simplicity is your friend!

You don’t need an overdeveloped computer program or an online database. If you start with a complex program that takes and hour or more just to download and set everything up you will have to overcome quite a bit of inertia to keep it going.

Just a simple list of all your accounts will enable you to answer the major financial decisions we have to make:
- how much money do I have?
- who do I owe money to?
- what is it costing me to borrow this money?
- who do I have to pay and when?

Once you have been doing this for a few months it becomes second nature and you no longer have to think about it.

The month is still young, it isn’t too late to begin a new habit in 2008 that will improve your finances.

After watching the angst on Wall Street for the first two weeks of this year, I can take some solace in the fact that our family enters 2008 on a much better financial foundation than when we started 2007.

We have eliminated all of our high interest debt on both our credit cards and school loans. We have a reasonable budget for the upcoming year and the insight to know where we need to make improvements.

Unfortunately, that is the extent of the good news. We will have an uphill battle due to 2 major changes in our lifestyle occurring in 2008.

Based on that information, I created 3 somewhat realistic scenarios of what our financial picture could look like at the end of 2008:

Some thoughts on these scenarios:

By the end of 2008 we could end up anywhere from being $20,000 further in debt to finally crossing the zero threshold of our net worth.

In our worst case scenario the major factors would include a 20% decline in the markets, that my wife will not be able to return to work and that our household expenses are slightly increased relative to 2007.

In our Reasonable scenario the major factors would include the markets being flat, that my wife returns to work part time and that we are able to make some reasonable savings in our expenses relative to 2007.

In our Great News scenario the major factors would include a slight increase in the markets, that my wife would return to work full time and that we will be able to make some dramatic savings in our expenses relative to 2007.

Depending on your level of paranoia, I realize that life does throw us curves and that things could be anywhere from drastically worse to drastically better.

This does give us a reasonable target and something to shoot for in the upcoming year. I welcome the challenge and hope you enjoy the journey.

We managed to finish our first year on a positive note posting a $1,817.91 gain in our net worth which brought our total gain for the year to just over $41,000 dollars.

Over the course of the past year we managed to maintain positive growth in 10 out of the 12 months.

The majority of these gains came from our ability to save our day to day income. In years to come as we are able to build our savings we will hopefully see a larger percentage of our yearly gains coming from our investments.

Here is December:

We are closing in on almost $90,000 in cash savings. While that number looks impressive, $64,000 of that is borrowed money in the form of 0% balance transfer offers. Although we started 2007 with the intention to eliminate all credit card debt, the prospect of an extra couple of thousand dollars of interest was too much to turn down.

Currently interest rates falling and balance transfer fees are rising making it a little harder to make worthwhile gains with this strategy. Our current take is that if a good offer comes by and we can make money on it then we will continue to take advantage of these offers.

Our retirement savings were mixed last month. My wife’s accounts posted some slight losses and my accounts posted some slight gains. I also made my last contribution to my Roth IRA for a while in December.

Because of the increased costs of our expanded household in 2008 I will pause my Roth IRA contributions until I am sure that we will be able to cover our living expenses with a diminished 2008 income.

We continue to slowly pay the minimum on our student loans. Our remaining education debt has a maximum interest rate of 5% with the bulk of our loans consolidated at less than 3%.

If interest rates continue to fall over 2008 we will have to reconsider paying off my federal school loan which is at 5%. We are able to write off the interest we are paying on these loans in our taxes so I am not overly anxious to pay these off even if the interest rate is slightly greater than what we are earning in savings.

All in all, 2007 was a great year for our household. We accomplished many non-financial goals and made solid progress on our journey to financial independence.

Thanks for following along during these first slow years. As I finish my training and make the transition into my career as board certified physician I hope to be able prove that pursuing higher education can be financially worthwhile.

Even before running the numbers for our household I can predict that 2008 will not be as financially successful for us as 2007.

In 2007 we were able to take advantage of having two incomes, one household and no children to pay down some debts and accumulate a comfortable cushion of cash for emergencies.

As 2007 draws to a close, those synergies are now history. Over the next 12 months our household is going to have two major changes:

The first change that will affect us the most is that our primary bread winner, my wife, will be down-shifting to part time with the addition of our first child. This is going to affect us in many ways:

• our total family income will decrease by at least 40%
• our family health insurance costs will increase as I add my wife and child to my employer’s plan
• our household costs will rise with more individuals in the household and for a longer period during the day

The next big change is that I will finish my residency on June 30th, 2008 and begin my 1st year of fellowship in July. This is a significant development for us financially because it is going to require a cross-country move… again

• We will need to find the most convenient, cost effective way to move our household back across the country
• we will need to find good housing that is close enough to the hospital to enable us to maintain our single vehicle household

Combined, these two changes will make it a challenge for us to simply balance our inflows and outflows. With that in mind: I look forward to the challenge and lessons that this year will bring.

I know that if we are able to continue to control our spending and make small increases in our net worth on a household income of $60,000, we will be able to make significant gains in the future as I find ways to increase our income.

Although at times the journey to financial freedom appears to be long and hard, I do take some solace in the fact that as a 30 year old, our long run of financial growth is going to come from a series of short runs strung together. Here is to 2008 being another positive short run.

I took a portion of my time off during the holidays to update my accounts in Quicken and analyze where we ended up spending our money over the past 12 months.

I was quite disappointed to find that we were $20,000 over what I had guessed our yearly expenses would be in 2007.

I had forecasted our expenses to be about $40,000 in 2007. I arrived at this number as a random starting point based off the calculation that this is what we could spend with a pre-tax income of approximately $53,000($40,000*1.3265).

$51,000 was my expected salary for 2007. I had hoped that once we were married that we would have been able to live solely off my salary and be able to save my wife’s entire salary, unfortunately we weren’t even close most of the time.

Our biggest surprise was that our biggest expense was our education. A focal point of this blog that I will develop as time goes on is that although pursuing higher education is a very expensive proposition, if you chose the right career this money should be seen as an investment and not as an expense.

That being said, I am counting the money we pay on our student loans as an expense that we incurred years ago, similar to a mortgage.

This year our student loans made up 23.75% of our spending for a total around $15,600. The vast majority of this money went to pay off my sole private loan that I had taken out during the interview process for residency.

With my private loan paid off, we will continue to make our minimal monthly payments on 2 of our remaining loans and I will keep my largest loan in forbearance for at least 6 more months.

We are lucky that housing only makes up about 15% of our spending. Although our rent is as much as a mortgage for most individuals, we are doing our best to minimize the expense by living in a studio apartment in a walkable part of town. Because we rent in a large city where I am finishing my training, this is a pretty fixed cost for us until July.

Ever since I have had to buy my own groceries I have been amazed at how much money I spend on food. This year groceries were our 3rd highest expense and made up 10% of our expenses. This doesn’t sound excessive but when 10% is equal to $130/week, this is a high priority item for our family.

My explanation for our grocery bill is that as a physician, I see on a daily basis what a bad diet and lack of exercise can do to a person, therefore my wife and I are very particular about what we eat. We eat very little processed foods and strive for as “natural” of a diet as possible. We try to buy all of our fruits and vegetables at a local farmer’s market and do eat a fair amount of fresh fish or meat. This diet of nutrient dense foods is much more expensive than the usual low nutrient/high calorie food all around us. That being said, we will find a way to bring this down for next year.

Vacation and Travel was another surprise as our 4th largest expense of 2007, comprising a little over 7% of our expenses. Between flying back home and attending a conference or two we have spent more of our income on airfare and hotels than clothing, utilities, transportation or any other normal “household” expense. I know that this is mostly due to the fact that I have not done the best job of managing our miles programs maximizing our free flights.

This is a category where we could really save some money in a few years at the end of my residency by moving closer to our relatives when we settle down.

The rest of our expenses are all small contributors(about 5% or less) to our yearly total. This is good news in the sense that our expenses are balanced but bad news for 2008 when I am looking for areas of our budget where I could save us money.

With 2007 now behind us I have been taking note of what we have accomplished in a year’s time. .

Last year was a year full of firsts for us:

• It was our first year of marriage
• It was our first year with a combined household of income and expenses
• It was our first year of truly watching what we spent and where we spent it
• It was the first time we needed to buy Life and Disability Insurance.
• It was our first year with only one automobile in the family
• It marked the first time I have been out of Consumption Credit card debt since about 2001
• It was the first time I have had an emergency fund to pay for unexpected expenses.
• It marked the birth of our first child
• And…..it was the first year of this blog!

As I look ahead to 2008 we will continue to have some firsts for our family but with what we were able to accomplish in 2007 I believe that we are on our way to a stable financial foundation.

After catching up on some reading this holiday weekend, I never envisioned that at the ripe old age of 30 that I would be out of touch but I just had to marvel at an article the most recent issue of Money Magazine.

Of course, all kids need stuff, and there’s no reason to completely deprive them of things they’ll enjoy and even show off to their peers

Wow, I am already old fashioned and I haven’t even finished my education. There are lots of “things” children need but I doubt “stuff” is the most important one on the list.

I also wonder about the benefit of showing off to their peers. I remember playing the game of “my dad is …….” but an arms race of who has the most expensive gadget doesn’t teach children anything except that you are measured by your stuff.

If this is everyone’s approach to raising their children, no wonder the average upper middle class family spends $182,000 on each child by the age 17.

I will have to admit that I am tempted to follow what it costs us to raise our children. In a society in which the majority of households don’t budget and don’t know where they spend their money I find it hard to believe that they know how much they spend yearly on their children.

If this data is correct however I am in for a rude awakening.