A Clarification Worth Noting

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Ok, something came to my attention today and I think it merits a blog post. If you already know this, I apologize for boring you.

• Deposit-taking institutions are where you SAVE

• Technically, you INVEST with licensed securities dealers or in a business. Although the term "invest" is used with "alternative investments" and Ponzi schemes, they are completely different from licensed and regulated forms of investments.
  

• Deposit-taking institutions and licensed securities dealers are not the same. If you are unclear about what category a certain entity is, ask them or ask someone you trust

• Deposit-taking institutions have JDIC or FDIC insured deposits. What does that mean? That means that the institutions have paid a premium to the Government to insure your deposits. Deposit Insurance was introduced as a safety net measure - should the institution that has your deposits get into difficulties, the Government will ensure that you get back your deposit up to a certain limit. The FDIC has a limit of US$100,000 per depositor which was temporarily increased until December 31, 2009 to US$250,000 per depositor. The JDIC has a limit of J$600,000.
  

• Investments are risky and have no safety net. Some investments are riskier than others. Higher interest rates generally reflect higher risk premiums. Interest rates are determined by the base rate (determined by the Central Bank) plus a spread. If you notice, deposit-taking institutions have lower rates than all other "investment" entities - licensed or otherwise.

• Licensed securities dealers are licensed and regulated by the Government. That is why they are specifically called "licensed securities dealers"

• Licensed securities dealers do not offer insurance on your investments. Deposit insurance is for deposits in deposit-taking institutions. There are reasons why these terms are used.

• Investments in Government paper - any Government - are not equivalent to deposit insurance. Whether you make those investments through a money market fund, or buy Government paper directly, the fact is that investments operate differently from insurance. I have heard that people are of the view that since the Government has never defaulted - like Jamaica and the US - then that is the same as insurance. And therefore, the argument is that investments in Government paper is the same as saving. That is not true. Some could argue that Government paper is "as safe as saving", but it is technically not saving. Investments are not insured; savings are insured up to a limit. Deposit insurance exists for a certain purpose, and that purpose is specifically to provide a safety net for savings.
  

• Therefore, I urge you to think about your asset allocations. Save FIRST. Maximize the insured portion, even if you are not getting the high interest rates some other institutions are offering. Make sure you distinguish between deposit-taking and licensed securities dealers. When you have sufficient savings (insured), then think about how much you wish to invest, and what your risk/reward tolerance is.
  

FREE Online Personal Finance Courses

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Check out this article in today's Wall Street Journal about the sharp increase in online personal finance courses: A Boost in Online Money Management.

What's the trend? People are arming themselves with knowledge to make informed decisions. Even if you use a financial adviser, it would be prudent to ensure that you have enough of your own knowledge to evaluate if his or her recommendations are appropriate for you, your particular financial situation, your goals, and your risk tolerance which determines not only investing, but also how much money you feel is a comfortable cushion of savings in the current environment.

There are many FREE and paid services you can enjoy from the comfort of your own home!

From the article: "Popular courses included those on reducing spending, and ways of saving and creating a priority spending plan. "

With a little due diligence to ensure the information is credible, do yourself a huge favor and check out some FREE or paid personal finance courses!

What's a small investment of your time if it saves or makes you money for your own financial security?

Guess What Americans Are Doing? Saving More!

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Today's news was interesting. In the last few months, there has been a steady increase in savings rate in the US. At one point in recent years, it had been negative. See an article here in the New York Times: Consumers Increase Savings While Spending Less

So, I'm thinking this is great news!

After the recent financial crisis and given the ongoing uncertainty, people are making sure that they are more conservative with their money, doing the absolute basic minimum of personal finance which is making sure that they have adequate savings, and really making substantial steps to get themselves back on their feet.

However, some economists argue that when people save "too much", the economy takes long to recover because businesses need the revenue to employ people etc. OK, I see the point. But, consider this:

There is nothing wrong with saving. Saving is the absolute basic minimum of personal finance. You don't have to invest (which is to take on risk with the hope or expectation of a return). You don't have to borrow (which is to take on debt). But you do have to have money to spend for the basic necessities of life and that comes from earning and saving.

If you want to get higher returns than what you can get from savings, and are willing to take the risk of losing all your money, then you invest.

Saving is not investing. I repeat, saving is not investing.

Saving is what you do when you place a deposit with a regulated financial institution at a stated interest rate applicable to that deposit and that deposit is insured up to a limit by a Government agency (such as the FDIC in the US and the JDIC in Jamaica)

If you want to buy things that cost more than your income, then you borrow and pay a premium for that money not being yours. That is what debt is - other people's money and you are using it. If you can wait, it is better to save for an item than go into debt to buy it. Why? Because debt costs money. That money is called interest and that debt interest will in most cases - unless it is concessionary debt - exceed your after tax interest on savings dollar for dollar. So after all your time spent saving, you would be effectively losing some of that interest every time you use any form of credit.

Now, back to this debate between savings and economic recovery.

Now, as I understand it, in the US people lost the ability to access credit - many of them through no fault of their own. If you don't have your own money - which is savings - and you don't have credit - either because of the banking crisis, the new lending standards of the bank, the credit rating system, or because you owe too much money - then what are you going to use to consume? You need savings.

Massive borrowing fueled unsustainable levels of consumption. Would some economists prefer that the economy "recover" by people borrowing which they might not be able to do anyway? Would some economists prefer that other people - who are fearing job losses - use up their savings to consume? Because when those savings are depleted, people will have no money to consume, and will have no savings and possibly employment income to qualify for credit to then consume. At some point, the economy will run out of people who have money to consume.

Why, in this time of record job losses, and market uncertainty should people not save more? Now, I love consumption as much as the next person but I have zero interest in unsustainable consumption. Unsustainable consumption, unsustainable debt with limited, zero or negative saving is how we ended up in this global mess.

No matter how you look at it, consumption gets a hit.

In order for an economy to be sustainable, there has to be a balance between consumption and saving.

We cannot continue to live in an interconnected global economy with such great information asymmetry - where so many people do not understand the basics of personal finance:

• that savings are absolutely mandatory;
  
• that savings are NOT investments;
  
• that you have to evaluate investments not just based on hot tips or recommendations but based on your individual risk profile, needs and age in life;
  
• that debt eats away at your hard earned interest and needs to be managed
• that you should only take on debt in accordance with your realistic ability to repay, and fully cognizant of the true cost of debt
  
• that expenses (and hence consumption) must be managed so that they can be paid from earnings without depleting savings, savings goals and ability to save. Remember the "Pay Yourself First" principle, you must save before you do anything else!
  

I could go on.

In order for anyone to prosper, as we have seen, everybody needs to be at a basic minimum level and it is up to education reform, advocacy, and helping each other that this financial literacy will be achieved. It has to start from a very young age.

If you spend money, you must know how to have money to spend - that is, to save.

It is said that those who weathered the Great Depression were the conservative spenders and the aggressive savers. Although we are not in a Depression, we would sure like to avoid one. The only thing we are certain of is that we are living with uncertainty. And if you don't know if and how much money you are likely to earn in the immediate near future, isn't it prudent to adopt some conservative spending and aggressive saving habits?

Plan to Take Action in 2009

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I remember watching the opening bell on the first day of trading. Trading is a speculative activity, involving risk with the hope of reward.

And here was perhaps the most famous personal finance expert/author, Suze Orman - someone who counsels about money management, the virtues of saving, the importance of managing debt, and taking risks only when you have evaluated them, understand them and can do so depending on your age and stage in life - doing the honors.

It was a very interesting note to start the year. And to me it signaled that this should be the year of financial literacy, and greater risk/reward determination, and ultimately responsibility.

About Economy
Read the Article at HuffingtonPost

More Money - The Basics

Image via WikipediaTo get you started, there are 3 basic things you need to remember about money management.

1. SAVE, SAVE, SAVE.

No matter what, you HAVE to save; you MUST save. Saving is not - I repeat not - investing. This is saving - take money and deposit it with a regulated financial institution where your deposits are insured (by the FDIC in the US or the JDIC in Jamaica) up to a limit, and where that regulated financial institution will provide interest at a pre-defined interest rate on that deposit over a period of time.

Why is saving the foundation, the key?

• When you save, your money earns interest for you. Now, other than working to earn more or receiving a gift, how else do you get "new money"?
  
• Save more, earn more interest.
  
• Save longer, earn more interest.
  
• Save your interest and your interest earns interest.

Saving is the absolute basic minimum you must do!

What is the best way to save?

Heard of the "Pay yourself first" principle? Before you do anything else, as you get a paycheck or a payment for services rendered, take a portion and save it - don't invest it, save it. It would be best if you could get into a habit and decide on an amount and do it by salary deduction. That way you don't agonize over "should I' or "shouldn't I". Trust me, after a while you won't even miss it and you'll be happy to watch those savings grow every month. Remember this if you remember nothing else.

2. SPEND LESS.

Easier said than done, right? If you are in Jamaica, this sounds impossible given the cost of basic necessities. Well, here are some suggestions:

• Exercise discipline in consumption. Buy what you need, not what you want. Yesterday's post gave you an idea of how that can work.

• Find out all benefits and discounts available to you and use them. Trust me in 5 minutes what you save by using these discounts and benefits can exceed one year of after-tax interest, dollar for dollar. Come back tomorrow for some specific tips on this one because I discovered big savings and small savings here. Regardless, they all add up.

• Take on reducing spending in your utilities as a special project - phone, electricity and water. I've done experiments with those and I'll share them later in the week.

What's the one thing to remember with spending less: When you spend less, you have more money to save which earns interest.

3. MANAGE YOUR DEBT.

This needs some clarity. Not all debt is bad. Debt that is unsustainable is bad. Debt that you cannot afford to service is bad. If the price you pay for being completely debt free is depleting your savings, I would say that is too high a price. So let's think of debt as something you manage.

• First, dollar for dollar interest charges will exceed the after tax interest earned on savings. This means that you are paying out in interest more than you earn in interest. So, if you have debt, the experts advise you to rank them starting with the highest rate and aggressively pay down that one, then the next highest rate etc. Now important: always service all your debts because not only is it the responsible thing to do, if you don't, then you pay penalties and fees, and it's bad for your credit rating. So, when I say "aggressively" pay down debt, it means pay more than the minimum to eliminate it faster.

• Second, really try to minimize using credit cards. Use cash and ABM cards (fee free preferably). If you can wait, save towards the goal to purchase the item. If you can't wait, remember that you are paying more for the item in finance charges. Would you want that item if it were $150 instead of $100? You may have paid $100, but if the charge sits on your card, then you may end up paying more like $150 (depending on interest rate, time to pay etc.).

What's to remember with managing debt: Less debt, lower rates, shorter time periods means less in interest charges which you could have saved to earn interest. Oh, and pay your debt on time to avoid late fees because those add up!

Those are the absolute basics.

For each category - savings, expenditure and debt - there is much more we can discuss. But we'll get into that later.

Now to get you started on your journey, you need to make an assessment of your current financial picture. What do you earn? What do you save? What do you invest? Did you remember saving and investing are different and do you treat them as such? What are your expenses? Can you track every cent you spend every month? If not, start a log and write it down. How much debt do you have? What interest rates are you paying?

Want to know what I did? I have had an Excel workbook for years, and I have different tabs for different categories and its color coded and everything. I know every single dollar that comes in goes out, and have different scenarios for debt, saving and investing.

• That means I track my accumulation of savings and make conscious decisions about when and where to put my money.
• That means that I have an extremely detailed budget and I know all my regular expenses, and make a provision for contingencies
  
• That means before I even use a credit card I know what it is likely to cost me even for one month in interest.
  
• That means before I decide if I should invest, I know the expected return, I evaluate the risk in terms of the market environment and my own personal finance goals. I know where the funds will come from, and I do not sacrifice my savings goals.
  

My model is very straightforward and I know where to find everything, and change parameters for scenario planning. I have projected at least 5 years into the future. And it's very conservative. It works for me. Some people prefer to use software. Find what works for you.

Now assess the picture, do you like what you see? Are you saving? Are you saving enough? Do you know what enough is? Have you figured that out? Are you meeting your expenses? Do you see anywhere you could cut expenses? Have you looked at your monthly interest charges on debt? Did you realize that if you paid even a little more in debt payments you could reduce your interest charges, and therefore the total cost of the debt?

Now, don't worry. If this is all new to you, we can walk though all of this to make it manageable. But the very first place to start is with that picture. If you don't know what is broken, you cannot fix it.

As I said, come back tomorrow for some big and small savings I've discovered through benefits and discounts.