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Below Your Means Basics: Getting Your Budget Done


Getting started with a basic budget

If you’ve been keeping up with your Below Your Means Basics series this week, you’ve now thought through your goals and why you’re building a budget.  (If you’re just picking up the thread, you can find the first post here).  You’ve started having sane conversations with your spouse about what you value and how much things are worth to you.  You know you want to take more control of your finances.  What do you actually do about it?

A Note About Tools

We’re not going to get into the mechanics here of how to implement your system on any given piece of software.  You need to be honest with yourself about what will work for you. If you are intimidated by personal financial software, get an printing calculator and a notepad.  I say “printing calculator” and not “calculator” because you’ll REALLY want to have that record of what you entered when the math doesn’t add up.  If you do go low-tech, the envelope method seems to be pretty popular.  All you need to do is get an envelope for each category in your budget and put the cash you have to spend each week or month in there, after paying your bills by check.  You take the cash out of the appropriate envelope when you need to make a purchase.  When you’re out of cash, you stop spending.

If you go the software route, there are lots of options. Computer tools are a terrific way to track your spending and, with a little bit of patience and work, you can pretty easily manage a budget with one.  For fairly simple scenarios without a lot of investments to track, is a great free solution.  If you are nervous about using a cloud resource, we personally use Quicken Deluxe 2011 .  You may also already have a basic spreadsheet program on your home computer, such as Microsoft Excel 2010 .  Additionally, there are free spreadsheet tools such as Google Docs Spreadsheets.

Getting Your Budget Done

Below is a step-by-step description of getting your budget implemented.  Many sites recommend that you have 3 months of tracking information in place before you start drawing up your budget.  We disagree.  If you have thought through what you value and what you are able and willing to control, there is no reason why you can’t start now.  Just remember Principle 3, that your budget is a living, changing document that you will revisit frequently.


Create your list of spending categories.   Don’t edit too much as you draw up the list, just write down the categories of things you spend money on.  Once you have the list done, take a look at the tips below, and review the categories to see if you missed anything.

  • If you’re using a software tracking tool, they have a list you can use to start from but don’t take it as gospel.  Note:  Don’t try to manage your list in your software product just yet. You’ll be making so many changes as you go that it will drive you bonkers to implement them all in the tool.
  • Include savings goals and debt payment goals.  We’ll talk about saving more next week, but for now consider that you want to save for both emergencies and retirement, at a minimum.
  • Do NOT confuse “making a credit card payment” with “spending”.  What you spend each month is what you spend, whether you put it on a credit card, wrote a check, used your debit card, or paid cash. Making a credit card payment is divided into two pieces – paying interest and paying off principal.
  • DO make sure you include a monthly amount for paying down the principal on any credit card debt or other non-auto, non-mortgage consumer debt you may be carrying.  Call this something like “debt reduction.”

Here’s a sample list:

  • Auto – car insurance, car maintenance and gas
  • Babysitting – really any childcare services
  • Charity – charitable donations
  • Clothing – family clothing for the kids.  each adult is responsible for their own clothing
  • Dining and Entertainment – going out and having fun
  • Enrichment – gym memberships, classes (including after school activities for the kids), and the like
  • Groceries, Toiletries & Misc – daily consumables like food, toilet paper, cleaning products, over the counter medicine, etc.
  • Housewares – bedding, glassware, any other purchase for the home
  • Housing – mortgage interest, mortgage fees, utilities, and repairs
  • Medical – medical insurance and medical bills
  • Services – any kind of professional services, from housekeeping to haircuts
  • Vacation – saving up for vacation
  • Savings – paying down credit card balances, building up emergency funds, retirement savings, etc.


Group your categories into areas of control.  Obviously the simpler and more personal you can make this, the better.  There are things you have to pay that are hard to change (fixed expenses), things you have to pay that are easy to change (variable expenses), and things you like to spend money on (discretionary expenses). Those are the 3 easiest groupings to manage, and you may find that your category list changes once you take this approach.  For example, using the list above:

  • Savings Goals
  • Fixed Expenses: Mortgage Principal, Mortgage Interest, Mortgage Fees, Car Principal, Car Interest, Medical Insurance, Auto Insurance
  • Variable Expenses: Groceries & Toiletries, Car Maintenance, Gas, Utilities, Enrichment, Housewares, Services, Medical Bills, Babysitting, Utilities
  • Discretionary Expenses: Dining and Entertainment, Charity, Vacation

Now that you have these organized you can finish up with your budget categories.  Again, group along the lines of what you value and where you can make changes.  Within the “fixed expenses” category, pretty much all of your insurance costs are going to be hard to control on a month-to-month basis.  So group them into a single “Insurance” category, add up your total insurance payments, and you now know your monthly budget for insurance.  Within the “variable expenses” category, you may decide that housewares, groceries and toiletries all belong in the same pile.  You may also not need child care services outside of discretionary expenses, so you can lump that in with “Dining and Entertainment.”

Play around with a few different category groups as you go.  Even if you are handling your budget in software packages, you may want to do some of this on paper while you are settling into a groove.


Once you have a set of categories and they’re organized, it’s time to budget.  Start by taking a look at your existing spending if you have the records for it, and see where your money is going.  Take note of your fixed expenses, as they will be tough to move.  Then, take a look at your savings goals, and set some dollar amounts for the various types of savings.  Once you have those numbers in place, you are ready to tackle your variable and discretionary expenses.

Income – Fixed Expenses – Savings Goals = Total Variable and Discretionary Spending

You can get lost here pretty easily because there is a good chance that you are currently living at or above your means, and fitting all your spending into your income could be painful.  Don’t give up. Remember to think about what you value and what certain conveniences and luxuries are worth to you.  The value equation is all about understanding the true cost and benefits of your spending.  Worth is a bit more esoteric, but it helps to realize that while a purchase might be a great value, it still isn’t worth it to you, right now.

The detail you put into budgeting your variable spending is entirely up to you.  Some people prefer the method of figuring out their fixed expenses and their savings goals, and then letting the chips fall where they may.  Other people want to be more deliberate about it, and make sure they have money set aside for important but not urgent things, like our family’s Enrichment budget.  That reminds us to cut back on things like groceries and housewares where we can in order to make room for positive experiences for ourselves and our children.  But again, it all depends on your personal situation and personal goals.

One thing you must absolutely do within your budget is make room for the unexpected. If at all possible, do this in addition to your savings goals, or you will find that you continue to run up your credit cards as the unexpected strikes.  So, your budget formula should really look like this:

Income – Fixed Expenses – Savings Goals = Total Variable and Discretionary Spending + Slack

After you’ve completed all this, you’re ready for the hard work of cutting back on your spending to fit within your budget.  If you’re not on the verge of financial ruin, be gentle with yourself and take a few months to get into the swing of things.

Software Note: Some software programs will have some extra features that make it a bit more complicated to track, say, a mortgage payment.  The software will want you to enter a value for your home, the size of the mortgage, and break up your mortgage payment into principal, interest, and any fees.  Stick with those features as they will eventually give you good information.  Otherwise, simpler is better.

Special Considerations for Spouses

If you’re in a relationship that involves joint finances, decide how to handle splitting up your money.  We strongly recommend the yours/mine/ours approach, which involves each spouse contributing to a household budget and retaining a portion of the budget for their own spending.  How far you take this has everything to do with how you manage decisions in your relationship.  In our research we’ve found four common methods:

  1. It’s all our money.  We don’t recommend this approach, but sometimes things are tight enough that it’s the only way to go.  But, if you drill into the budgets of people who claim they follow this strategy, often times you’ll find that they actually use method #2.
  2. Each spouse gets an allowance.  In this method, all the money goes into a common pool except an allowance for each spouse to spend on whatever they like.  Allowances are not necessarily equal depending on what expenses are included in the allowance.  If this is just plain ‘fun money’ than equal allowances are the best option.  If each spouse is responsible for their own gas, car maintenance, clothing, etc., then a realistic couple will dispassionately take those differences into consideration (for example, the couple where one partner spends more time driving than the other).
  3. Each spouse contributes equally to a household budget and keeps the rest of their income.  In this method, the household budget is split evenly.  This is a common approach for 2-career couples, especially if their incomes are similar or they are libertarians.
  4. Each spouse contributes to the household budget in proportion with their income.  In this method, the household budget is divided based on the spouse’s ability to contribute.  It has the benefit of feeling more fair and preventing disagreements about spending based on the difference in each partner’s perception of what is affordable.

Talk through these options and experiment to find out what is best for you.

Tomorrow we wrap up our Budget Basics with common pitfalls to avoid.

Photo Credit: Alan Cleaver

Below Your Means Basics: 3 Principles for Budgeting & Tracking, Pt 2

Yesterday we discussed our 3 Principles for Budgeting and Tracking.  To recap:

Principle 1: The purpose of tracking and budgeting is to help you understand if your spending is in line with your goals and values.  Only then can you tell if a purchase is worth the money.
Principle 2: Organize your categories based on how easily they are controlled.
Principle 3: Your budget is a living thing that you will revisit on a regular basis, so don’t stress about making it perfect

Today we’d like to touch on a handful of special circumstances that warrant some additional attention.  Tomorrow we’ll start moving more into the mechanics of building a budget.

Special Circumstances

DetourBudgeting with a Spouse

Remember Principle 1?  That tracking and budgeting are all about measuring your values against your resources?  Here’s why money can be a huge source of friction for couples.  You’re not talking about your spending, either individually or as a family.  You are talking about your values, as individuals and as a family.  That’s difficult.  So go easy on yourselves.  People’s sense of self-worth, upbringing, status, personal reward systems and more are all bound up in discussions about what spending is reasonable.  Take the time to understand the why behind the decisions.

There are as many ways to divide up financial resources and financial responsibilities as there are couples, but one thing that generally correlates with happiness is to have three major budget buckets: your money, my money and our money.  Everybody needs a space to do what they want, even if it’s a small space.  Give yourselves room to breathe and, especially, to not have to agree on everything — even if it’s just $20 a week or a month.

Note that the yours/mine/ours buckets do NOT need to directly match up with income.  How big you decide to make the pots depends on your attitude about money as a couple, and you should tread lightly and carefully while discussing this subject.  More on this subject when we discuss the mechanics.

Budgeting with Kids

We can’t say it enough: include your kids in this process.  Especially if there haven’t been any real spending controls in your household, your kids are going to know something’s afoot.  Either you are going to have to say “no” more, or you’re going to be talking money with your spouse.  There’s a good chance they’ll notice you paying attention and want to know more.  So include them!  Some ideas:

  • Give them a fixed spending amount for a family vacation.
  • Pay them an allowance (either based on completion of chores or just time-based) and, except for birthdays and other holidays, don’t buy them toys
  • Have them help cut coupons or comparison shop at the grocery store with you
  • Have them save up for a more expensive toy and go through a budgeting process themselves.

Budgeting for the Self-Employed

If you’re self employed you have two major issues:

  • You can sometimes wind up with a ‘big check’ that makes everything seem different
  • You can sometimes go without income, especially if a customer doesn’t pay

In other words, your income stream will be highly variable, which creates a difference between your income (how much money you make over time) and your cash flow (when the money actually shows up).  Your mortgage company will not want to hear that you just closed a big deal and you’ll be able to pay them in 45 days.  They will still charge you late fees and hit you with other penalties.

The first thing you need to do is get a decent, realistic projection of your income.  If you’ve been in business for at least a year, you can do this by averaging the past 12 months.  But pay close attention to trends — ask yourself if your income rising or dropping compared to last month, or the same month last year?  If you don’t have that kind of history, you’ll need to make a very conservative estimate.  Remember you can always adjust upwards in the future if you want to, but if you overspend now it will likely turn into long term credit card debt at very high interest rates.

Once you have a realistic projection of your income, start “paying yourself” that amount once per month.  If you have an LLC in place this should be easy, since you probably set up a company bank account for the business.  If you don’t have a separate checking account, now is a good time to set one up (and to set up a budget for the business, too).  Transfer your monthly pay from your business account to your personal account every month, like a paycheck.

Budgeting for Higher Income and Net Worth

If you’ve already achieved the magic income level, or net worth level, where you thought you would effortlessly breeze through your financial life, then you’ve probably realized that it just doesn’t happen that way.  With luck you haven’t been spending too much money keeping up with other people’s lifestyles, but there’s a good chance you’ve found yourself in a car or house that is more than you really want to spend.  You may be spending your money as fast as you are earning it, leaving yourself vulnerable to emergencies and changes in fortune, and unable to seize new opportunities you uncover.  If that’s the case, the same principles apply to you, but you’ll have more flexibility and more challenges.

For one, it will be easier for you to implement your/my/our money if you have a bit more disposable income.  The risk is that you overdo it, but be grateful that you have the chance.  Second, housing and auto payments may not really make sense in terms of your budget.  This is because past a certain income or net worth, you don’t need to finance larger purchases as much as you did in the past.  So the idea that a mortgage or a car payment shouldn’t exceed X% of your income doesn’t make sense – especially if you don’t want the cost of your house or car to rise proportionally to your earnings.  Also, you may find that your earnings are highly variable due to business conditions, and so budgeting based on your monthly take-home pay don’t apply to you.

In these cases it’s important to have a clear idea of what your current goals are, so you can allocate your resources wisely.  We’ve noted in the past that a high income doesn’t necessarily lead to happiness.  Get a good handle on what you think is reasonable to spend, and build your budget from there.

Next week, the mechanics of building a budget.

Helpful Links

Don’t Spend Any Money… Establishing a baseline for spending | Super Frugalette | interesting take on the difference between what you have to spend, and what your budget is

Honey, We Need to Talk … About Money | MintLife | On the value of discussing money in a relationship, with some conversation starters.

Five Budgeting Myths | FiveCentNickel | Budgeting excuses removed

My Self-Employed Monthly Paycheck | BudgetsAre$exy | Dealing with the ups and downs of self-employment


Thumbnail Photo: Blocks 1 by Crissy Alright

Story Photo: Detour by F Delventhal

Principle 1: The purpose of tracking and budgeting is to help you understand if your spending is in line with your goals and values.  Only then can you tell if a purchase is worth the money.









Principle 2: Organize your categories based on how easily they are controlled.

Principle 3: Your budget is a living thing that you will revisit on a regular basis, so don’t stress about making it perfec

Below Your Means Basics

This month we will be presenting a series of Below Your Means (BYM) Basics articles to help those of you who are new to living below your means, and serve as a refresher for those of us who have (or strive to) live the BYM way.

When you live below your means, you shed a huge source of pressure and strain in your life.  Spending beyond your means, in other words – going into debt – means you are trading your future to get something now.  You are agreeing that in the future you will be willing and able to have a certain amount of money.  But none of us can predict the future.  There are lots of ways people get into trouble with debt.  Accidents and health problems lead to massive medical bills and lost wages.  Your ability to earn can be impacted by layoffs, swings in the economy, your own health, and the health of your loved ones.  Those common tragedies are only one reason to worry about spending more than you have.  In fact, bankruptcy laws are in place to protect people specifically from those kinds of ‘unexpected’ crises.

Money CastleThere is a much more insidious price to pay for living beyond your means.  Doing so assumes that you know now what you will want and need in the future.  In reality, most of us aren’t entirely sure what we want and need today, much less the kinds of opportunities and challenges we’ll face tomorrow.  When you take on debt and fail to save, you narrow the possibilities of what the future could hold.  Want to move to a new town?  You’ll need a job with an income sufficient to pay for your debt, and you’ll need to sell your house before you can buy a new one.  Tired of your car?  You can’t sell it because you owe more money on it than it’s worth.  Have a great opportunity to travel to a place you’ve always wanted to visit?  You can’t take the time off, and you don’t have the money saved up to go.  Hate your job, or worse, discover that your career is unsatisfying?  You’re stuck because your monthly payments are too high to switch to something new.

Saving, on the flip side, acknowledges not only that you need to be prepared for the problems of the future, but that you want to have resources at your disposal to seize the opportunities that come your way.  Want to move to a new town?  Sell the stuff you don’t need, get a few leads on some work if you need them, and get going.  Tired of your car?  Sell it and get something else (or go without).  Have a great opportunity to travel?  Plan a leave of absence and head out!  Hate your job, or worse, your career?  Feel free to get started on the next chapter in your life.

In short, money is a tool that you can use to achieve happiness.  It certainly isn’t the only tool, but it’s an important one.  Using it wisely requires that you know yourself and what makes you happy, and you understand that as you grow and change, your wants and needs will grow and change.  While our site isn’t designed to help you live a deliberate, centered life, there are a few resources we recommend to do so.  Franklin Covey’s The 7 Habits of Highly Effective People, while centered a bit too much on an upper-middle class suburban existence, has a great process to follow to think through what is important to you and how to get there.  And David Allen’s Getting Things Done: The Art of Stress-Free Productivity is such a great way to organize your life that he has spawned what Wired magazine referred to as a cult of hyper-efficiency.  Covey’s book especially can take you to additional resources on how to live a successful, meaningful life, but honestly — whatever helps you discover more about yourself, and how to make good choices, go for it.

This month we’ll explore:

  • The Basics of Tracking Your Spending and Building a Budget: This is the single step with which your journey starts.  Sure, you can cut down on your spending, even significantly, without knowing where your spending is going.  But finance is, at it’s most basic, an exercise in math.  If you bring in more money than you spend, you’re living below your means.  If you don’t, you’re not.  Tracking your spending isn’t everything when it comes to living below your means, but it’s hard to be successful without it unless you institute an all-cash system.  Fortunately, there is a whole industry building computer software to help make it simple, and some of it is free.
  • The Basics of Debt and Savings: Debt means giving up opportunities in the future for a lifestyle today.  It is a very dangerous gamble.  You will also see how to use debt as means to manage your cash flow and take risks to increase your wealth.  If you have consumer debt now, you’ll need to first and foremost – stop digging the hole deeper!  Next, you’ll need to pay that debt off as soon as possible and free your future from the tyranny of your past decisions.  Savings, on the other hand, gives you freedom.  It means you have protection from the unexpected and resources that you can use to seize opportunities.
  • The Basics of Spending Wisely: Tips and tricks for spending the least amount possible on things that aren’t critical for happiness and health.
  • The Basics of Living Richly: Spend your money on things that bring you true satisfaction and happiness.  Spending as little as possible for everything else.  Knowing the difference isn’t always easy, and we focus on tools and techniques to help you get there.  To start, realize that most millionaires are ordinary people who live modestly.  And, as this study shows, money doesn’t necessarily bring happiness beyond a certain income.
  • The Basics of the Investing Smartly: Keep tabs on the economy and investing opportunities.  While we aren’t a strict investing site, nor are we financial advisers, we do report on happenings in the economy so you can make educated decisions about where to put your hard-earned savings.  We also believe that, like personal debt, government debt is very risky and the government’s inflationary and spending policies are significant risks to personal well-being and to our country’s future.
  • Common Pitfalls: Identify common pitfalls on your way to financial independence, and share the stories of people who share your commitment to living well by living below their means.


Thumbnail Photo: Blocks 1 by Crissy Alright

Story Photo: Frits Ahlefeldt-Laurvig

Frugal Fail: “Smart” Tea for $1


Money Fail Sweet Tea

Driving today I heard a McDonald’s ad on the radio.  In it, a guy decides that since he’s “smart enough to get a sweet tea for just a dollar” he is also smart enough to build a gazebo.  His female companion points out that he’s building it upside down, and the guy sheepishly agrees to call the “gazebo guy.”

He should have called his 2nd grade math teacher.

Drinks (alcoholic or otherwise) are one of the most overpriced things you can get in a restaurant.  Now, I’m all for going to the bar with friends, or treating the family to a dinner out every now and then, but nobody should be excited about the “deal” they are getting.  For about $16 you can get a bucket of Lipton Iced Tea Sugar Sweetened Iced Tea Mix (Pack of 2) that makes 56 quarts or about 14 gallons of tea, which is enough for 56 large 32-oz servings of McDonald’s tea.  In other words, you can get the same serving for about $0.20 cents at home and the McDonald’s “deal” is 5x the cost.

Amazingly, the $1 tea from MickeyD’s isn’t the biggest rip off in tea … For $6.98 at, you can get a packet of 10 instant tea mix packets.  That’s $.69/glass, IF you make them at home.  But the marketing guys show a bottle of water on the box, which will set you back another $1 – $2 at the convenience store.  That’s somewhere between $1.69 and $2.69 for a glass of tea.

We recommend you get a high quality portable thermos.  Personally, I use a Contigo West Loop Mug that will keep a cup of coffee hot, or a refrigerated drink cold, literally all day.  Using it means I’m NOT spending $1-$4 a day on drinks, depending on what I’m not buying (coffee, soda, or just plain water).  That might not sound like much, but over the course of a month (workdays only) it can add up to $20 – $80.  Let’s call it $50/month or $600/year that I can either invest or spend on things that really matter to me.  I think that’s better than spending $20 a month for 20 glasses of tea.

Just for fun, here is a video of tea being made at McDonald’s:

Ways to get student loan forgiveness

Student loan forgiveness imageYesterday, we did two posts regarding the education bubble and student loans (here and here).  During our research for the article, we came across an excellent article over at The College Investor called Ways to get Student Loan Forgiveness.  Ideally, you will not have to go into debt to get a college education, but if you do (or already have) this article is interesting.


Before taking out student loans through, please consider the following to reduce the debt you take out:

  • Attend junior or community college for as long as possible and transfer after 2 years.
  • Evaluate the college of choice based on the value it will provide, not the size of its library or the head coach they have.  Your goal is to get an education, learn a trade and become successful.  If the college is charging a premium for things unrelated to your goal, take a pass.
  • Go to an in-state university so that you qualify for lower tuition rates.
  • Work part-time while going to school.
  • Take maximum advantage of grants and scholarships.
  • Actually “live like a student” when you are one – This means leaving ultra-freaking-cheap and doing without for 4 years. Having top ramen every night is not just a clichés — many of us did it (or something like it).
  • Compare the costs of boarding at school or off campus, etc.
  • Only use the student loan debt you take out for your education or expenses critical to your education (like books) – if you are using the money to buy a car or pay for a fancy apartment, you are doing it wrong.
  • Make sure the debt you are about to take on will have a measurable, likely and profitable return on investment.  Spending $150k on an education for a $35k a year job is probably not worth it.

However, if you are already in debt with student loans you should consider the following advice from The College Investor:

Student loans can be a great investment in your future, or can be a huge burden if not fully thought out or abused.  If you currently have a student loan or are thinking about getting student loans, you should know that student loans CANNOT discharged in bankruptcy.  This means that they will stick with you for the rest of your life, unless you pay them off, or, if you are lucky enough, qualify for student loan forgiveness.  Before going further, check out my Student Loan Calculator and read my post on Getting Out From Student Loan Debt for some other ideas on student loan debt.

More at the source.

NIA – Video on the Education Bubble

The National Inflation Association has released a very interesting video on the topic of the Education Bubble. The video is available on YouTube and we provide our summary and thoughts below.

The NIA definitely knows how to put together a solid video.  They produced others in the past that are also worth checking outHowever, it is important to take videos like this with a grain of salt. This video doesn’t totally cross the line, but definitely suffers from the same kind of one-sidedness that makes Michael Moore films so infuriating.  The truth of the matter is that nothing is ever as black-and-white or as straightforward as potentially biased documentary-makers portray.  Regardless, the video makes several good points and is worth a watch.

Here is a quick summary of what we found interesting:

  • Student loan debt now stands at $830 Billion in the US
  • The average amount of student loan debt of US students is $24,000 – but there are many students with hundreds of thousands of dollars
  • Colleges spend on average $14B a year in construction and campus expansion, and tens to hundreds of millions on sports teams, staff, etc. – Little of which actually adds to the value of the education.
  • Going to college no longer makes you “special” – of the 2009 graduating high school class, 70.1% enrolled in college.
  • Since, 1992, the US BLS reports that 60% of all college graduates have gotten unskilled jobs, or other jobs that do not require or benefit from a college degree.
  • The video provides a very interesting breakdown of the true cost of a college education which includes:
    • Tuition
    • Supplies and books
    • Lost income
    • Interest on debt
  • Regarding total cost: Their example for a 6 years of school, suggests an average total cost of $460k:
    • 6 years at the average of $27,293 per year, increasing at the rate of 5.15% a year
    • $61,914 in interest on the loan debt
    • Lost income for 6 years at an average salary of $35,400 a year.
  • Law schools use misleading statistics like – 90% of our graduates find employment within one year.  While true, this statistic includes those that got jobs at Walmart and in other non-legal professions.

Where the video gets a little silly:

  • Suggests that a high school student with $30k saved up for college would be better off using it all to buy physical silver than go to college — because the value of that silver will be enough to buy a median priced house in 4 years.
  • Suggests the mainstream media (MSM) is colluding with colleges to spread myths and hoaxes that benefit colleges.
  • One of the people interviewed suggests we may not have running water or other basic services within 4 years.
  • On more than one occasion alludes to or suggests investing a reckless amount of money in  physical metals like silver and gold.

Regardless of where you stand on hyper-inflation and end of the world concerns, we would caution everyone about going crazy buying physical metal.  Personally, I have done a lot of reading on the topic and think it is prudent to own at least some physical metal and by some I would suggest between 2% and 5% of your total net worth.  Commodity prices can be very volatile (as we have seen in recent weeks with the price of silver going from 30 to 50 and back to 30 again). This means that if your net worth is $150k you should consider owning approximately $4,500 in precious metals.  Consider using dollar cost averaging to dampen the effects of price swings.   In this example, I would not buy 3oz of gold tomorrow, instead I would buy one today, one in 6 months and one this time next year.

Two services that I have personally used and recommend include: American Precious Metal Exchange and Bullion Vault.

Disclosure: We are affiliates of both APMEX and

Education, the next bubble to pop?

One of the fundamental premises of Austrian economy theory is that markets must be free to allocate capital quickly and efficiently.  When governments or central banks instead try to control or influence the allocation of money, no matter how noble a pursuit, results in larger, more complex and completely unforeseen problems.  Call it the law of unintended consequences.

The problem with central planning, is that it generally indeed has the most noble of goals.  Some recent examples of the last 50 years include:

This video, while a little dramatic, does a great job of highlighting these unintended consequences:

The general methods for central planning are financial incentives, or regulations.  Focusing on financial methods, the government will either give you money to do something, give you money not to do something or penalize you for doing something. This can be found in the form of rebates, tax deductions, fees, penalties, criminalization, etc.

For this conversation, lets focus on the most common: giving or loaning you money to do something.  One of the most common and obvious side effects of government influencing the public to do something is an increase in prices related to that service.

Here is an example we are all now familiar with: housing.

Over the years, the government did a lot to promote housing.  This was undoubtedly done for both noble reasons (The American Dream, affordable shelter, supporting family structure, etc) and some more shady reasons (help builders, mortgage brokers and banks make a bundle in the process).  Regardless of the reasons, the government did what it does best – it threw money at the problem, either via tax credits or subsidized loans:

  • Mortgage interest tax deduction
  • Property tax deduction
  • Home sale capital gains exception
  • Fannie Mae and Freddie Mac
  • Federal Housing Administration (FHA)
  • US Department of Housing and Urban Developer (HUD)
  • Cheap mortgage rates
  • Tax rebates and credits (these were fortunately short lived)
  • Incentives to banks to lend to home buyers
  • Hyperbole and other rhetoric (Ugh – “The ownership society” is a great example)
  • Countless others…

The result of all these incentives were obvious: as more and more people had more and more access to larger and larger sums of money via loans, etc., the price of homes increased.  This is the basic law of supply and demand.

Education is no different. Just like housing, the government is encouraging and enabling the spending of money on education.  Through various programs such as guaranteed loans through Sally Mae, grants, scholarships and more there are ever-increasing amounts of people who can spend ever-increasing amounts of money on education.  The result is that prices rise.

It’s a vicious cycle:

  • Education is too expensive
  • Government provides loans so people attend school
  • The price of school increases as attendance grows
  • Education becomes too expensive
  • The government offers larger loans
  • The cycle continues…

The result: the cost of education rises faster than wages (people’s ability to pay) — and just about everything else for that matter.  Because the price continues to increase, and the government and society continue to demand (and subsidize) affordability, the government creates an ever-increasing array of payment options.  Including:

  • ESAs / Coverdell Education Savings Accounts – Like an IRA for education.
  • Education tax credits and deductions – If you spend more on education you can spend less on your taxes.
  • 529 Plans – Because you can’t borrow enough, you should also be encouraged to save for college in a tax advantaged account.
  • Various Federal grants and financial aid programs – Loans aren’t enough, we can just give you some money.
  • Pre-paid Tuition and Guaranteed Education Tuition Programs – Lock in today’s prices by pre-paying for tuition.  This is based on the premise that your state will make up the difference in the future.

Each one of these options all seem like a good thing.  After all, who doesn’t want to promote education and helping people achieve their potential? But… take a look at what has happened to the price of education as all of these incentives influence pricing.  The problem with incentives is that they focus only on enabling people to pay the rising prices, instead of asking why prices are rising in the first place.  This madness is one of the reasons, I do not plan on “taking advantage of” my states GET or other 529 plans.

Here is a graph of the cost of a 4-Year college tuition, when compared to median household income and the Consumer Price Index (CPI):

Comparing CPI, Median Income and the cost of education in US

As  you can see, since 1977, the median US household income has increased by almost 3.6x, while the cost of education has increased more than 10X, thus the rate of “education inflation” is several times that of regular inflation.   To enable this: government loans have filled the gap!

I think the fix to rising education costs and unaffordable education is for the government to simply stop “helping”, or at least help less.  The easiest way to do this would be get rid of Sally Mae, or perhaps alter the way it works.  The fact that Sally Mae backed loans (effectively all student loans in the US are Sally Mae backed loans), are 100% guaranteed and can never be defaulted on or discharged in bankruptcy is pure insanity.  Essentially, student loans have zero risk to the agencies and banks that provide them and 100% risk to the students that take them out and the tax payers that fund them. Thus banks have no incentive to give student loans only to credit worthy borrowers, or at least borrowers whose education plan make sense (spending $150k to get a job making $35k for example does not make sense, especially if you could get a job making $30K without the education.  You’ve just spent 150K before interest to earn an extra $5K per year).

Does this sound familiar?  Do mortgage-backed securities, NINJA loans, To Big To Fail and the housing bubble ring any bells?  Without risk, sanity is thrown to the wind.  If risk was slowly and surely re-introduced to the student loan market the supply of new money would decrease, the demand for education would decrease and the prices would decrease, thus allowing more people to afford the education they want without the need for debt.  And without an unlimited supply of applicants, colleges would have to become more competitive to command high education prices.

Much like the housing bubble, the education bubble is also plagued with consumers that have bought into the idea that education is worth the cost, no matter how high.  And like the housing bubble, the risk of default is theoretically solely on the borrow — although waves of defaults would still wind up hurting the taxpayer.  Many who borrow don’t know what it will cost to repay the loan, or even what their monthly payments will be, until the borrowing is already done.  And without requirements to provide Truth In Lending disclosures, it’s incumbent on the borrower to figure it out — the lender doesn’t have to tell you.

On a final note, check out the following infographic that has been making its rounds on various PF blogs.  It tells the history of students loans in the US, and might make you rethink the value of taking one out:

Why student loans suck Infographic