What to do when you win the lottery

…or get your tax refund.

Suddenly you have a ton of money! Yeah! But what do you do with it? You are my wise and clever reader, so you know it is not smart financial planning to blow it all on a sports car. But this new money isn’t in your budget, so how do you fit it into your spending and your goals?

First, you celebrate! It’s exciting, you have a little spare cash! Go buy that jacket you have been dying for. Try that new restaurant. Replace your ratty old gym clothes with something that makes you excited to exercise. Make the celebration reasonable- it should be about 10-20% of your new ca$h money. Spending $500 on a new tv when you got a $1000 tax refund might be going overboard, but maybe getting HBO might be a nice splurge.

Next- look at your debts and your savings goals.

  • Can you pay off a credit card with this cash? Won’t that feel awesome, to not pay interest anymore?
  • Is it enough to make yourself an emergency fund? Then you won’t have to worry about unexpected expenses, and the amount you were saving already towards your emergency fund can go to feed the general pot.
  • Can you invest it in your 401k or your Roth IRA? Earn some crazy compound interest on this free money to make even more free money?!!
  • Should you use it to pay off some student loan debt?

If I were you, I would do a mix of the things above with my newfound cash- but you have to be wise about it (consider your interest rates, my friend). If you can pay all of your debt off- do it! But paying just some of your debt off all in one big chunk may not actually be the best choice.

What if the cash you just received is big for you, but it is just a fraction of your overall debt?

Suppose you are the newly graduated Dr. John Doe. Medical school sure was fun, but the average cost of med school is $170,000. Your monthly payments are almost $2,000. Yikes.

But wait! An unknown- yet extremely wealthy- elderly relative just died peacefully in his sleep. He was so proud of his great-great-nephew the doctor that he left Dr. Doe $20,000.

If Dr. Doe immediately puts that $20,000 into the balance of his student loans, he will now owe $150,000. His monthly payments will be a little over $1,700. Is that much better for Dr. Doe, who may be struggling to make his rent while working those crazy shifts as a resident at his new hospital?

Depending on Dr. Doe’s income, it might be better to save the $20,000 and to use it to make the monthly payments. He can make 10 months worth of payments with the $20,000. The total interest he will pay will be slightly more than if he had paid a lump sum off at once- but not by much (an $8,000 difference). I suspect that early in his career, Dr. Doe would value 10 months of being able to pay his bills worry free more than he will value $8,000 after he is an established doctor.

 

Moral of the story: when you suddenly come into some money, think about your overall financial picture. Paying off part of your debts all at once might not make sense if you are struggling to make monthly payments- but if it lowers them enough to ease some of the burden, then go for it! Look at the parts of your budget that are difficult for you (maybe you just can’t quite squeeze enough cash into your emergency fund) and use the newfound money to help with those areas that are challenging.

Congrats on that lottery win, by the way!

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Car shopping

I don’t know anything about cars except that you shouldn’t put diesel into a car that doesn’t take diesel and also something about sugar in a gas tank will wreck the car?

Understanding cars is a monster subject. I don’t even own a car, so this is the first installment of a few guest posts by Darius about our most loved appliance.

You are ready to buy a car, you say?!  You have followed Kate’s budgeting advice and you want to hit the road.  Great!!  What do you think the first step is?!  Color?  Brand?  NO!  The first step should be listing the criteria you want your new car to meet.  Only one of those criteria should be price.  Here is a sample list:- How many people do you want to carry?  Seems simple but it is a valid question. Why buy a four door pickup that can seat six when it’s just you?! (a tip for the boys…size really doesn’t matter). Do you and your friends take turns being sober drivers? You might want more seats for more safety.  For the ‘about to have kids’ readers, the smaller the person, the more junk they need. ‘Lower lift height’ is a parent’s new best friend.  Plan accordingly.
– How much cargo do you need to carry/tow? Cargo capacity is not just the weight a vehicle can haul.  An SUV with a racy and slick curved rear roofline looks nice but you can’t fit nearly as much into the back as you can with an SUV that has a more squared off look.  It’s just geometry (<—this is the moment your math teacher told you about). *Note from Kate: my mom has a Honda Fit and one time we fit a shelf, two dressers, a nightstand, a mirror and two people in there without even breaking a sweat! That car is a miracle clown car!*
– What kind of mileage do you want?  Automakers want you to focus on the highway mileage of their cars.  Unless you are commuting 50 miles over a traffic-free highway per day, you want to disregard this number. The EPA has implemented it’s ‘combined’ fuel economy rating and it is the BIG number on the car sticker.  This is calculated using a mix of driving 55% in the city and 45% on the highway and should give you a better idea of what mileage the average user can expect (and should help you estimate gas costs)
– Do you live in an area that requires four or all wheel drive?  Four wheel drive (in most cases) weighs more and lowers fuel economy.  It also costs more (except on Subarus) and requires that much more maintenance.  Does it make the car safer to drive?! On snow, ice, hurricane level rains, mud, and loose dirt: yes. Otherwise…no. If you don’t live in an area where you need the extra safety, save yourself some cash and stick with two wheel drive.
– How much do you want to spend? There are a few options to get your hands on a car. You can:
  • Pay cash. This means no interest and therefore will save you money in the long run. Cash price=sticker price.
  • Finance. Remember this simple rule…on average for every $1000 you finance (fees and interest rates included) with a bank, it will cost you $16.67 per month in payments for a five year car note (60 months) (depending on your loan rates).  $17,000 financed = ~$283 per month. The total amount would be lower if you paid cash up front.
  • Lease. Leasing means that you can pay less to get a nicer car (overall), and you don’t have worry about maintenance because the car is under warrantee. However, this is not a good financial option because you end up with no physical asset at the end of your lease- you have been making monthly payments and when your lease is up, you have no car. For most twentysomething readers, this is a bad financial decision.
  • If you have bad credit, do NOT sign up for a high interest loan. Horror story from the front page of the LA Times here. (Summary: Ms. Lee paid $3000 down and signed a loan with 20% interest for a $7500 car. Over the next year and a half, she paid $6,966 more on the loan ($9966 total for a $7500 car). According to the terms of her loan, she still owed $11,610. When she fell behind in the payments her car was repossessed and she was left with nothing (even though she had already paid more than what the car was worth. This is not an unusual story. If you have $3000, buy a less nice car with cash and then save up for a nicer car.)
  • Don’t forget to budget in your insurance costs.
– Do you live in an urban or rural area?  Buying a 4X4 Heavy Duty pickup when you live in a city will mean that you will be very frustrated driving to (and parking!) any event in the city.  Parking spaces are tight and parking garages have an average clearance of 6′ 6″.  Consider where you live…trust me…you will do your future self a lot of favors.
Next time:  Resources for Car Knowledge.

Budgeting when you use ca$h

I am not a big ca$h user. I like to use Mint to track my spending, so I put almost everything on my credit card and then I pay it off in full every month. I watch Mint like a hawk, so I’m never surprised when my bill comes in because I have been watching my spending and not blindly swiping my credit card.
You might not be like me. You might LOVE carrying ca$h around and you might hate using your credit card. You might have tons of ca$h lying around from that time you robbed a bank, so obviously you should spend that instead of using your credit card. That’s totally smart! But you still need to follow a budget, even if you are a cash user.

Here is one method I have heard suggested for budgeting using cash.

You start each month by taking the amount of money in your budget out in cash. Is your budget $800? Take out exactly $800. Then, divide it up based on your budget categories. I have heard this called “the envelope method” because one way to keep it organized is to carry around a pile of envelopes full of cash with each budget category written on them. You can also buy one of those coupon sorters. Or, you can use paperclips and post-its. Whatever. You pick how to keep it sorted! The point is- if you have spent all of the money in your envelope for groceries, that’s it. You can either borrow from another envelope, or you can put some groceries back on the shelf. You’re breaking the rules if you  use your credit card or take out any more cash (and you’re kind of breaking the rules if you move money from one envelope category to another, but whatever. You are your own boss, here).

I have also heard that this is very effective if you find that you go overboard Christmas shopping. Decide before you shop how much money you are going to spend on Christmas, total, and then how much you are going to spend on each person, and then use the envelope method. This is especially useful at Christmas time because gifts for other people (that you have to pay for all at the same time) are a budget abnormality, and even a budgeting rock star can lose track. This way you have planned ahead, and you won’t have any fiscal regrets in the New Year!

This is also very effective because when you pay with ca$h, you are more aware of how much actual money is leaving your account. When you break a $50, that $50 is never coming back to you. If you have a problem with overspending in general, it is often advised that you switch from swiping credit cards to a ca$h only scheme.

Convinced that budgeting is for everyone, yet?

Budget like a Rock Star

So you are convinced that it is a good idea to make a budget, right? Right!

But how do you start?

Let’s start with the easy part- income. Most people have a fairly steady income and should know how much money is coming in. If you have a variable income, you need to treat it like you treat your spending- use your best guess based on history/upcoming income that you know about, and be conservative. Update it as you learn more.

After you know how much money hits your bank each month, start by getting an idea of where your money is going now. A baseline, if you will. It will probably take a few months for you to get a full picture of your expenses, but don’t let perfection get in the way of planning. Estimate now and then you can adjust as you go. When I got my first job out of grad school, for the first four months my clothes spending was triple what it is now because I needed a full professional wardrobe. Now that I have the staples, I’ve adjusted my budget to reflect my lowered spending and my lowered need for clothes (did I really just say that?! There is no such thing as a lowered need for clothes!)

There are a few ways to go about tracking your spending. While working on this part of your finances, I would recommend relying on debit or credit cards (but don’t use this as an excuse to overspend!) just so that you don’t make yourself crazy trying to figure out where your cash went (or, if you are a diehard cash user….save those receipts!) When it comes to actually following a budget once the amounts have been set there are ways to use cash only and still stay on track- I’ll cover that later.

Method 1: The Worksheet Method

Make your own spreadsheet and fill in your expenses. Pros: You can adjust it to fit your lifestyle. This is good if you have complicated finances or if you mainly use cash, because you will have to manually enter your expenses anyway. Also, you can keep it supersecure by saving it only to your computer. Cons: Pain in the butt. High maintenance, and you really have to be committed. If you suspect this will be too much work for you, don’t do it. Make it easy on yourself to stick to a budget!

Method 2: The Automated Method

Use a personal finance tracking software. I use Mint.com, which is very secure (and pretty awesome), but there are other options out there. Mint works by linking all of your accounts into one website so you can look at your spending, your budgets, your savings goals and your investments all in one place. NICE. Mint automatically uploads your spending and files each purchase into your budget tracker, so you can see how you are doing for each category. Mint also tracks long term trends in spending. It’s pretty great. And there’s an app.

Worried about security? Mint is just as secure as online banking. But more awesome because everything you need is in one place.

Ok, now you know where your money is going. Next, set your budget!

First you need to make a list of the main expenses that come up regularly in your life. Here are examples from my own budget:

  • Rent
  • Utilities
  • Cable/Internet
  • Phone
  • Public Transportation
  • Taxis
  • Emergency fund
  • Restaurants
  • Savings
  • Gym/Fitness
  • Alcohol/Bars
  • Retirement investments
  • Groceries
  • Clothes
  • Charities
  • Haircuts
  • Travel

Next, set target amounts of what you want to spend in each category based on how much you normally spend. Be realistic-  don’t worry about “trimming the fat” just yet. If you usually spend $250 on groceries, don’t suddenly expect your spending to drop to $100 just because you wrote it in the budget. Some items won’t come up every month- I don’t travel every month, but I plan to fly every three to four months, and that is in my budget.

Now, add it up. Is your budget less than your income? Awesome! Book your flight to Vegas, baby! (Or, keep reading this blog so you can learn about some good long term plans for that spare ca$h).

Is your budget more than your income? Still awesome, because now you know where your money is going, and you can make a plan to tweak your spending so that you are living within your means. You are becoming empowered to take charge of your financial life, and that is something to be proud of.

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