Ask Liz Weston

The authors of a new personal finance book make a perfectly accurate, and perfectly ironic, observation about money advice today—which is that most of it seems geared to people with steady paychecks, ignoring freelancers and the self-employed.

Joseph D’Agnese and Denise Kiernan have written a terrific new guide, “The Money Book for Freelancers, Part-Timers and the Self-Employed,” to address that gap. More on that in a minute.

The reason most advice assumes traditional employment is that most workers (about 75%) are, in fact, traditionally employed, working for a company that pays them at regular intervals. But that leaves quite a few who don’t have traditional jobs, including (here comes the irony) a lot of the people writing that personal finance advice.

I’m self-employed. So is Kathy Kristof of MarketWatch. So is Ilyce Glink of ThinkGlink.com. All the big guns—Suze, Dave, David, Robert—are self-employed. So are many of the best personal finance bloggers who, even if they haven’t yet left their day jobs, are typically earning money on the side.

So we all know the pain of paying for all our own benefits, saving for retirement without a match, irregular incomes, estimated tax payments and clients who don’t pay or pay late. Yet too often that experience isn’t reflected in what we write.

Of course, the best advice is universal. Live below your means. Track your spending. Save for the future. Know your goals and have a plan to get there. But how you get there is going to be a little different when you’re on your own.

Once they cover the basics of organizing your finances, estimating your future income and figuring out where your money is going, The Money Book’s authors have some great suggestions. One of them is to save a percentage of each check you receive for taxes, retirement and emergencies, rather than saving a set dollar amount each month for those goals. With irregular incomes, your dollar amount may be too big one month and too little the next. (Ideally, you’ll be saving 25% to 30% to cover taxes, 10% to 15% for retirement and maybe 5% for your emergency fund. That may seem like a lot, but the tax portion at least is about what an employer would slice out of a regular paycheck.)

That’s just the start of their good advice. If you’re self-employed or your income is irregular, I’d strongly encourage you to pick up this book.

Dear Liz: My wife and I are working to get out of debt, and I am interested in comparing the amounts we spend on mortgage, food, diapers and so on with what would be considered ideal or at least average for homeowners living in areas with a high cost of living. Do you have recommended percentages for various items? I am always looking for places where we can cut our expenses so we can pay off debt faster.

Answer: You can find averages in the U.S. Census Bureau’s annual Consumer Expenditure Survey, which you’ll find at www.census.gov. The categories are fairly broad — you won’t find a line item for diapers, for example — but the bureau provides averages for housing, food, transportation, clothing and insurance, among other categories. The bureau also slices the data various ways: by income, by metropolitan area, by child.

You may find the information more interesting than helpful, however, because every family’s situation is different. A couple with little debt and no children, for example, can comfortably afford a bigger mortgage payment than a family that has both kids and debt.

A better way to manage your spending is to use Harvard bankruptcy professor Elizabeth Warren’s 50/30/20 plan. Warren, who outlined the budget in her book “All Your Worth,” recommends limiting your “must have” expenses to 50% of your after-tax income. Must-haves include shelter, food, transportation, utilities, child care, insurance and minimum loan payments.

That leaves 30% for wants, including clothing, entertainment, gifts and vacations, and 20% for savings and debt payments.

Many families in high-cost areas find it extremely tough to keep must-haves to 50% of their after-tax pay. Some spend that much, or more, on their housing. But the 50/30/20 plan underscores how important it is to contain your basic overhead if you want to have money left over to pay down debt from the past, save for the future and enjoy your life in the present.

photo credit: Russ Beinder

I’m hearing from lots of people who plan to only spend cash this holiday season to stay within their budgets.

A recent USAA survey found more than half of respondents planned not to use credit cards at all, and 85% planned to pay cash for at least some purchases. Two-thirds planned to use more cash than last year.

I’m all for restraining spending and avoiding debt, but cash has quite a few disadvantages, such as:

Cash is easily lost or stolen. So are credit and debit cards, of course, but plastic comes with zero-liability protection. With credit cards, particularly, loss or theft is almost a non-issue; your card is quickly replaced and you move on.

There’s no “court of appeals.” Credit card issuers serve as middlemen when you have a dispute, a function I’ve had to use a few times. Unless you absolutely, positively trust the merchant to do right by you, you’re better off with that extra layer of protection.

There’s no purchase protection. Most gold and platinum cards will pay to replace your purchases if they’re lost, stolen or damage. Coverage varies by card, but you typically can get reimbursed for incidents that happen within 60 to 90 days of purchase.

Debit cards and prepaid cards aren’t really a good substitute for cash. Not only do they lack credit cards’ protections, but they have their own disadvantages: ridiculous fees in the case of prepaid cards, and the possibility of overdrafts in the case of debit cards.

If you really can’t control your spending without cash, then by all means, use cash. If you want to avoid debt without giving up credit cards’ advantages, though, here’s another approach to try:

Draw up your holiday budget. Include your list of gift recipients and how much you plan to spend on each. Also include travel, decorating and entertaining costs. Adjust as needed until you have a spending plan that doesn’t require you to add to your debt.

Set aside that money. You can transfer the whole amount to savings before you start shopping, or transfer as you go: as soon as you get back from shopping, log on to your bank and shift the amounts on your receipts from checking to savings. When the bills come, transfer the money back into your checking account and pay it off in full. Or you can make payments to your credit card as you go; most credit card issuers allow you to make payments weekly, if not more often.

Dear Liz: My wife and I are planning to have a child in the next couple of years, and I realize that I have no idea how to go about preparing for that financially. How much cash should new parents try to have available? What else should we be considering?

Answer: Congratulations in advance on your entry into the great adventure of parenthood. The most important thing to know is that you can’t predict what’s ahead, financially or otherwise.

The U.S. Agriculture Department estimates that it will cost middle-income parents nearly $300,000 to raise a child to age 18. But your costs could be a lot less if you’re particularly frugal, or a lot more, particularly if you have a high income, plan to pay for private school or have a child with special needs.

You can get some idea of what to expect by using the Agriculture Department’s new calculator at www.cnpp.usda.gov/calculatorintro.htm.

Your annual food, clothing and healthcare bills typically rise $3,000 or more with each child. You also may opt for a bigger home or car, which can add to the bill. Child care and education are other considerable expenses.

Then there are the set-up costs. The authors of “Baby Bargains,” one of my favorite books about preparing for a child, say you easily can spend more than $6,000 just on equipment such as strollers, car seats, maternity clothes and nursery care. If you’re smart, however, you’ll try to spend a lot less, buying or borrowing used furniture and selecting well-reviewed, midrange brands of strollers and car seats rather than status brands.

You’d be smart to start trimming other expenses now and saving the difference, so that you have a fund to pay these start-up costs and so that the added expenses of a child don’t push you into debt.

If one of you is planning to stay home with the baby for an extended time, consider starting to live on one income now and banking the other.

Dear Liz: Your recent advice about investing an inheritance prudently is all good. However, I think most people waste unexpected money, spending it in dribs and drabs with not much to show for it. So, to your advice, I would add this:

Take a minor portion of the inheritance and spend it on some indulgence you would never have done otherwise. About 15 years ago, I used about 20% of a sizable inheritance to take my family, including kids, spouses and grandkids, on a three-week African safari. The result? We all have wonderful memories of a trip in which family members bonded closely with one another, and of once-in-a-lifetime sights and experiences.

The rest I invested, spent on college tuition and used for retirement. I can’t account for it all, but I have no regrets about that Africa vacation.

Answer: Your advice is terrific. It’s important to enjoy our windfalls and even more important to invest in experiences and memories that last. Your family is lucky to have you.

photo credit: Qiao-Da-Ye賽門譙大爺

If you’ve got variable rate debt, now is the time to look into fixing your rate.

I wrote this week about the risks of inflation and how prices and interest rates could soar as the economy picks up.

Of course, interest rates are already soaring for many credit card holders. The average credit card rate rose to over 15%, hitting a two-year high, according to IndexCreditCards.com. Even people with good credit scores and on-time payment histories are getting slapped with higher rates, as issuers try to beat the February deadline for the implementation of the credit card reform act.

Here’s what to do:

Mortgages. If you have an adjustable-rate mortgage and don’t plan to move before the rate resets, look into refinancing to a fixed rate if you have some equity in the home. If you don’t have equity, you may be eligible for refinancing under the government’s Making Home Affordable Plan. GET HELP if you go this route–talk to a HUD-approved housing counselor. You can find one HERE.

Credit cards. If you have credit card debt, consider it variable-rate debt, since there’s no such thing as truly fixed rates in the credit card world. Consider getting a three-year, fixed-rate credit union loan to pay off your balances. Interest rates for people with good credit currently average just under 10% for these loans, according to the Credit Union National Association. (If you don’t belong to a credit union, you can find one HERE.) Other options for 3-year, fixed-rate loans are social lending sites such as Prosper and Lending Club. Rates vary according to your credit scores and investor bids but loan rates currently range from 7% to 26%. (Can’t pay off your debt in three years? Then you may be in more trouble than you think. Consider talking to a legitimate credit counselor and a bankruptcy attorney to get a more complete idea of your options.)

HELOCs. Home equity lines of credit are a tougher call. The rates on this type of debt are typically very low and not as subject to the whims of lenders as credit card debt. If you have a home equity line of credit and you’re concerned about being able to pay it when rates rise, however, you could consider a fixed-rate home equity loan or even refinancing your primary mortgage to incorporate the debt and fix the rate.

You also should have a plan for paying off your debt. Read “A debt payoff plan that works” for more.

Dear Liz: My husband and I are having a rough time making it from paycheck to paycheck. We make pretty good money. We have four children and end up helping them every month. We cannot seem to make it without going in the hole in our checking account. Could you please help me with what we should do?

Answer: As writer Erica Jong once said, advice is what we ask for when we already know the answer but wish we didn’t.

You know what you need to do: Cut off your children (assuming they aren’t minors, of course). If you can’t make it from one paycheck to the next, you’re in no position to help anyone else. Your children may not know the financial straits you’re in, or they may not care; either way, it’s up to you to close the Bank of Mom and Dad.

Once that financial spigot is shut off, you’ll need to look for the other leaks in your financial system. Track where your money is going using personal finance software such as Quicken, online tools such as Quicken Online, Yodlee or Mint, or a notebook and a pen.

If you’re still spending more than you make, you’ll need to find ways to cut back so that you not only don’t go in the hole but are putting aside money each month. You need to save for retirement and for an emergency fund, among other goals.

To do all this, you’ll need to use a word that apparently hasn’t been given enough of a workout around your home: “no.” “No, we can’t help you.” “No, we’re not going to buy that.” “No, I’m not going let my finances be in chaos because I can’t say ‘no.’ “

photo credit: allancaplan

Back-to-school sales are already in full swing, although the National Retail Federation says the typically K-12 family will spend 7.7% less this year, or an average of $548.72.

That’s still a significant chunk of change, particularly for families coping with financial setbacks such as a job loss or cut in hours.

There are plenty of smart ways to cut the tab. Among them:

Sort through what you have. Go through closets, drawers and shoe bins to see what’s still wearable and what basics you might need to add. The same is true for school supplies–you may have enough pens, notebooks and other items squirreled away to avoid another materials run. Even if you don’t, inventorying what you have will prevent you from buying duplicates.

Solicit donations. I’m not talking about panhandling strangers. I’m saying let your network of friends, neighbors and relatives know that you’re interested in gently-used hand-me-downs. You might even organize a swap party so your circle can get together, socialize and trade no-longer-needed clothes for stuff they can use. Or check out clothes-swap sites or Freecycle.org.

Set a budget–and let your kids help make choices. After all, making choices is at the core of smart money management. If you start this dicussion far enough in advance, your kids may even have time to supplement what you can spend with money they earn and save on their own.

Widen your search. Yard sales, consignment shops and thrift stores abound in most areas and can be a great source of clothes, accessories and supplies. So can eBay, Craigslist and deal-hunting sites like DealNews. Dollar stores and teacher supply catalogs are other places to check.

Shop early and late, but not the weekend before school starts. Yes, retailers will be slashing prices then and some states waive sales taxes for those days, but any savings may be offset by the hassles of dealing with big crowds and the temptation to buy more “because it’s on sale!” Delaying at least some purchases until a few weeks into school also has its advantages: your kids will be able to see what’s really in style (and yes, that’s important to all the but the youngest and least socially-conscious children) and you’ll find out how much of that long school supply list is really necessary.

photo credit: Andres Rueda

I’m a fan of having access to plenty of low-cost credit—as a proxy for an emergency fund while you’re building one, and to supplement your cash once you’ve got several months’ worth of expenses set aside. The future is uncertain, after all, and you can never tell when a cascade of events will wipe out your reserve.

What’s worrisome is that so many people never get beyond relying on their plastic as their only source of funds for unexpected emergencies—or even relatively predictable events like car and home repairs.

The national research center Demos recently published its second survey examining credit card debt among low- and middle-income households, which it defined as households whose incomes fell between 50% and 120% of the local median income.

“The Plastic Safety Net: How Households are Coping in a Fragile Economy” blows it in one sense by citing an “average” debt of $9,827 for these households. If you’ve been reading me awhile, you know how deceptive these “averages” are, since they’re skewed by big balances owed by a relatively small number of households.

A better measure of household debt uses medians, which describe the halfway point—half of the surveyed population owes less, half more.

The latest figures available from the Federal Reserve show that only 25.7% of the lowest-income households, 39.4% of lower middle income and 54.9% of middle income households have any credit card debt. Of those who have credit card debt, the median balances are $1,000, $1,800 and $2,400, respectively.

The other data Demos cited, though, was revealing. Particularly:

•    3 out of 4 low- and middle-income households reported using their credit cards as a safety net–relying on credit to pay for car repairs, house repairs, layoff or job loss, money given or loaned to relatives, college expenses or starting or running a business.

•    More than 1 out of 3 households reported using credit cards to cover basic living expenses, on average for 5 out of the last 12 months.

•    The most important predictor of higher “debt-stress” levels was whether a household relied on credit cards to cover basic living expenses such as rent, mortgage payment, groceries, utilities or insurance.

•    For 1 in 2 households out-of-pocket medical expenses contributed to a families’ credit card debt, with an average of $2,194 dollars related to out-of-pocket medical expenses.

•    The average interest rate paid on a families’ card with the highest balance was 14.8% with close to 1 in 4 indebted households paying more than 20% interest on their card.

•    In the past five years credit card indebted homeowners used an average of $14,344 in home equity to pay down credit card debt.

•    The majority of credit card indebted households used tax refunds toward debt reduction and nearly half of respondents worked extra hours or took on an extra job in order to get out of debt.

That last finding shows most households realize they have a serious problem and are trying to do something about it.

Demos’ recommendations to reduce dependence on high cost debt include:
1.    Promote increased savings, not increased debt, to help families meet unexpected financial emergencies.
2.    Modernize the unemployment insurance system and expand coverage and benefit levels.
3.    Strengthen the position of low-wage workers in the labor market.
4.    Address rising health care costs and the growing number of uninsured.
5.    Establish a new agency focused on consumer financial protection.

I think numbers 2 and 3 are longshots, particularly in this economy, but 4 and 5 are in process and the first suggestion–promoting savings rather than plastic–has always been a good idea.

If you want to break your own dependence on plastic, read the following:

• How to plan your ‘emergencies’
• How much should you spend on…
• Why you need budget buckets
• The $0 emergency fund
• Want to sleep better? Save $500

photo credit: nicely85

The September issue of ShopSmart recommends sites and software that can make tracking your budget easier. (ShopSmart is published by the same folks who bring us Consumer Reports, and manages to combine CR’s great research with a Real Simple-style clean design.)

Here are ShopSmart’s picks, with my comments in italics:

For people who “just need a quick look at my spending,” ShopSmart likes:

Mint, saying “You’ll get an easy-to-read snapshot of what’s in your bank account and what you’ve spent so far on your credit card. Mint also searches the Web for appealing deposit accounts, loans, and other deals.” My take: Mint’s the leader so far in this space, and has an active community of users.

Quicken Online, saying “Quicken Online lets you input checks that haven’t cleared, so you know how much cash is left. It can also project what you’ll have in your bank account in the next several weeks, based on info you provide on regular expenditures.” Quicken’s been at this transaction-tracking game the longest and has a solid reputation for support and security. Being able to add transactions that haven’t cleared is a great way to avoid bounced check fees, but either of these sites would be helpful to get a grip on your money.

For people who “want something more comprehensive,” ShopSmart recommends:

Microsoft Money plus Deluxe. Oops. Clearly, the magazine went to press before Microsoft announced it was pulling the plug on its downloadable personal finance software. You can no longer purchase Money and support will be going away as well. So the better choices would be:

Quicken Deluxe 2009. ShopSmart says, “Quicken might intimidate novices with its spreadsheet-like graphics and overwhelming options, but the program has endless ways to analyze data. You can set up Quicken to do automatic bill paying, write checks, and export your financial information to tax software.” My take: All this information lives on your computer, rather than on a third-party Web site, which is often a big selling feature for its users. If you’re comfortable online, though, check out:

Yodlee Money Center. ShopSmart says, “Yodlee, which is fully online, displays a complete list of expenses and lets you remove what you don’t want to track, which is a real plus. It lets you customize charts and graphs in ways the other free Web sites don’t. You also can input checks that haven’t cleared so you know what cash is still on hand. Yodlee is the only online service ShopSmart looked at that lets you set up automatic bill paying.” My take: Yodlee provides account aggregation for banks, and it’s the most robust expense-tracking site for those who are comfortable doing their finances “in the cloud.”

For people who want community support to reach their goals, ShopSmart liked:

Geezeo, noting that the site “lets you set up particular goals—say, paying off your credit-card debt or saving for a vacation—and share your experiences with other Geezeo participants.”  ShopSmart wasn’t fond of the busy layout or the fact that Geezeo doesn’t include check numbers in the account statements it downloads from your bank, but notes “it’s the only one of the four free online sites ShopSmart tried that doesn’t require you to store your passwords and account numbers on its server, which might be important to you.”

Finally, for those who “just can’t be bothered setting up another online account,” ShopSmart suggested:

Your own bank or credit card company. “Bank of America, Wells Fargo, Discover Card, and other financial-services companies offer their own versions of budgeting software for online customers. Usually they don’t allow you to add info from other accounts, but if most of your transactions reside in one place, you might prefer this system. Check with your financial institution to see if it offers such a service.”