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Achieving Financial Freedom & Early RetirementOver my lifetime there has been one quote that my Dad has mentioned at least 1,000 different times.

“You have two choices!  You can work for your money, or you can have your money work for you!”.

For most this is easier said then done.  I created this site to help others with their path to financial freedom.  I hope to do this by proving useful tools, resources, and personal experiences.  Click Here To Continue Reading...

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How Overdraft Protection Works With a Debit Card

Why Does Overdraft Protection Work a Little Bit Differently for Checks and Debit Cards?

It’s important to understand that there are important differences in paying for something with a check vs. a debit card as far as overdraft protection is concerned.  Think about it.  As a purchaser, when you pay with a check you get what you want right away, but the seller has to wait for a period of time in order for your check to clear.  On the other hand, when you pay for something with a debit card the transaction goes differently.  First your debit card is run through a payment processor and then, after a little bit of a wait, your purchase is either approved or denied.  And it’s that difference –the speed at which checks (slower) and a debit cards (faster) can be validated – which is the reason overdraft protection is just a little bit different for check and debit card transactions.

Savings Account and Credit Card Overdraft Protection Works the Same for Check and Debit Cards

Before explaining the differences in how overdraft protection works for checks and debit cards let me first explain how they are the same.  If you overdraw your account on a debit card purchase and you DO have savings or checking account overdraft protection then you should generally be able to make your purchase without too much hassle; the necessary money will be transferred to your checking account to cover the shortfall in the same manner as if you had overdrawn the account by writing a check.  Read about How to Use a Credit Card Effectively.

Something Different: Automatic Debit Card Overdraft Protection

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Prior to August 15, 2010 if you overdrew your account as a result of a debit card transaction then your bank could automatically charge you a substantial overdraft fee of approximately $27 per transaction.[1]  For example, if for whatever reason you didn’t realize that you had no money left in your checking account and you made 3 separate purchases of $5 apiece using a debit card then your errands could end up costing you a whopping $96 (3 purchases at $5 apiece plus 3 bank fees at $27 apiece)!  But now, based on the new regulations, your bank can no longer automatically hit you for overdraft charges related to debit card purchases unless you affirmatively sign up for the program.

To illustrate how this works, let’s say that you did NOT have savings account, credit card, OR the automatic debit card overdraft protection.  What would happen if you attempted to buy something with a debit card for more money that you had in your account?  The seller would run your card through a payment processor and, after a brief wait, your card would be denied.  Perhaps you might find that a little embarrassing if you were making the purchase in person rather than online, but at least you would be spared a far more expensive alternative.

And what is that expensive alternative?  If you had signed up for automatic debit card overdraft protection (or whatever your bank might call it) and you had made the purchase described above then the good news is that it would be approved even though you didn’t have enough money in your account to cover it, but the bad news is that you would be subject to the $27 overdraft fee.  That’s enough money to hurt any regular person!  As a result, I recommend that you cancel, resist, turn down, or otherwise opt out of automatic overdraft protection and instead utilize the much less expensive alternatives of saving account or credit card overdraft protection.

How Do You Cancel Automatic Debit Card Overdraft Protection if You Already Have it?

If you have any question in your mind about whether or not you have automatic debit card overdraft protection (as opposed to savings account or credit card overdraft protection) then contact a customer service representative from your bank to find out for sure.  Now if you do indeed have automatic debit card overdraft protection then, again, I recommend that you opt out of it.  If the bank’s customer service representative cannot help you do that, or they are not giving you information that’s sufficiently clear enough to enable you to make informed financial decisions, then consider taking your business to a competing bank that will.

A Reminder on How all of This Relates to Overdrawing an Account by Bouncing a Check?

I want to again emphasize that the August 15thregulations relate to automatic debit card overdraft protection.  In other words, while banks can no longer automatically charge you fees for overdrawing your account as a result of debit card transactions, they can still automatically charge you for bouncing checks.  As a result, regardless of whether you generally use a debit card or checks to make purchases and pay bills, I highly encourage you to get savings or credit card overdraft protection.

 

How to Use a Credit Card Effectively

Understanding How to Use a Credit Card Responsibly Can Increase Your Credit Score!

The Ideal: Pay Your Credit Card Balance Each Month in Full and On Time

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At its core a credit card is simply a means of borrowing money.[1]  It’s also important to understand that a credit card is an exceptionally lousy means of borrowing money if you carry a balance.

Thus any credit card strategy in that doesn’t also involve paying off your balance in full and on time each month is, at best, of limited value and, at worst, downright stupid.  In short, how to use a credit card effectively entails you pay off your credit card balance each month then you can reap significant benefits from making purchases with a credit card.  However, if you consistently carry a balance from month to month then your credit card issuer is the one reaping the benefits (at your expense!).

For example, let’s say that you need to buy a plane ticket that costs $1,000.  You have both a credit card and $1,000 in the bank that you could use to make the purchase.  Should you pay in cash or use your credit card?[2]  If you use the cash then you can purchase the ticket outright without incurring any credit card debt.  Of course that’s good, but if you purchase the same $1,000 ticket with a credit card then you could automatically receive accidental death and dismemberment (“AD&D”) insurance for the flight as well as 1,000 bonus points or flight miles.[3]  Further, when your credit card statement comes the next month you can use the $1,000 you have in the bank to pay it off in full.  So either way you’ll end up with no credit card debt, but if you pay in cash you’ll get no special benefits whereas if you pay with a credit card you’ll get valuable insurance for the flight with credit card bonus points to boot.

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Second Prize: Make Purchases With a Credit Card as Long as You are Able to Steadily Reduce Your Debt

While it would of course be great to have your credit card fully paid off, what if you’re not in a position to do that right now?  Does that mean that you should lock your credit card away and only pay for things in cash until it’s fully paid off?  Not necessarily, because you can still benefit from making purchases with a credit card as long as you’re disciplined enough to continue to make meaningful progress towards paying down your credit card debt.  Understanding how to use a credit card effectively may vary from situation to situation.

Danger: How To Use A Credit Card Negatively By Using Rewards & Points as an Excuse to Pile on Unsustainable Debt

While it’s true that paying by credit card offers some unique advantages that paying with a check, a debit card or cash does not, I want to again emphasize that you should never use the benefits you receive from paying with a credit card as a means to rationalize making purchases you can’t afford.  For example, don’t talk yourself into buying a $1,000 plane ticket you can’t afford just because you’re going to get a few credit card bonus points or flight miles. If you choose to go down that road then it won’t take long before the deadly math behind credit card interest threatens to make financial bondage your destination.[4]  The Fidelity credit card has one of my favorite reward programs.

Summary: Credit Cards are Great Financial Tools if Used Correctly

There’s a myth among some that only those who are irresponsible, addicted to spending, or deeply in debt use credit cards on a regular basis.  While there are some who do indeed fall into one or more of those categories, it’s also true that those who understand the benefits of making purchases with credit cards and pay off their balances each month use credit cards to make practically every purchase they can.


[1]  See the article, “How Do Credit Cards Work”.

[2]  Note that “paying in cash” means paying with cash, a check or a debit card.

[3]  These are just examples of the types of benefits you could receive; individual credit card terms vary.

[4]  At 22% the interest on $1,000 of credit card debt for 1 month is about $18.33 (22% divided by 12 months x $1,000) whereas 1,000 bonus points can typically be redeemed for something valued at about $10 (equal to about 1 cent per bonus point).

Personal Money Management

Why Personal Money Management Is Important

In order to understand why personal money management is so important consider the following questions.

  1. Do you ever worry about money?

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  2. Does it ever seem like your money just disappears and you have no idea where it all went?
  3. Are you now on your own (or soon will be) and you have no idea how money really works?
  4. If you’re married, do you and your spouse ever have tense conversations (or flat-out argue) about money?
  5. Would you like to know how much money you can safely spend before your next paycheck and still be okay financially?
  6. Do you have hopes and dreams that are bigger than your bank account and you wonder if you will ever be able to achieve them?
  7. Do you have a tendency to spend money on things that you can’t afford?
  8. Despite big plans, do you always have trouble coming up extra money to save or invest?  Would you like to know what it will take to make that happen?
  9. Does it seem like you never make any headway paying off your debts (or worse, they continue to grow)?
  10. Have you ever felt overwhelmed by the thought of what it would take to get your finances organized?
  11. Does it seem like you’re never getting ahead despite the passage of time and all of your hard work?
  12. Do you sometimes feel tossed about as external events crash upon you, feeling that they are in control of your financial destiny rather than you?

If the answer to any of these questions is “yes” then I would suggest that personal money management is very important to you.  Then you’ve come to the right website.  Keep reading!

Related Articles and Information on Personal Money Management

If you have not already done so, reading the following articles will enhance your understanding of the concepts presented in this one.

Budget Planner Template

Using A Budget Planner Template

I recently received an email from John about using a budget planner template.  He wrote:

“Hello, I’m feeling a little lost and have some questions in regards to budgeting and saving.  1. Which budget planner template should I use?  2. From the total salary what percentage is ideal to spend for various needs, and how much to be saved for future?  Any insight would be greatly appreciated.”

It’s a question that we all must answer. Even if some of us would prefer to ignore it! Because, with rare exceptions, we all have to deal with having just so much money to cover all our expenses. And, if we spend more than we take in for very long we get into trouble.

Let’s look at a “typical” budget planner template. Then we’ll discuss it.

Category% of Income
Housing35%
Food15%
Auto15%
Insurance5%
Entertainment5%
Clothing5%
Medical5%
Everything Else5%
Savings10%

Understanding The Budget Planner Template

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The first thing you’ll notice is that I didn’t include any taxes (either income or Social Security). You can choose to do that if you like (in fact, it’s a real eye opener). But for our purposes it’s easier just to deal with your ‘take home’ pay.  The second thing to notice is that this is a guideline, not a straight jacket. The truth is that very few of us will fit into this exact framework.  So if your spending doesn’t match, don’t despair! Analyze the situation before you panic!  Try our free excel budget template!

Customize the Budget Planner Template To Fit Your Wants & Needs

For instance maybe your entertainment spending is closer to 10%. Is that a problem? Maybe not, if you’re young, single and sharing an apartment with three friends. In that case what you save on housing is going for entertainment. So overall you’re not spending more than you’re making.  Or you may be a city-dweller where housing is very expensive (think NYC). But because of public transportation you don’t own a car. So the extra you spend on housing is offset by the reduced spending on transportation.  You get the idea. Tailor your spending plan to your needs. And, adjust it as you go through life and your needs change.  One other thing to notice is that housing, food and auto make up the lion’s share of the expenses. That’s true for almost everyone.  It’s in those three areas that most families get into trouble. Most often by buying a home or vehicle that they cannot afford. But once the commitment is made it’s very hard to undo.

Categorizing Your Expenses

You might wonder where a certain expense goes. For instance, household cleaning supplies. Many people buy them at the grocery store. So are they a housing or food expense? The answer is: it doesn’t much matter. Put them wherever it seems best to you. The key is always putting them in the same place, so you can compare results from month to month.

Another common question is what should I do with charitable contributions. You can either take it off the top (like taxes) or create a separate category for it. If you believe that contributions should come before your expenses you’ll want to take it off the top. If you think that it’s part of your regular spending then include it as another expense category.  For a budget planner template to be effective you must continuously follow your progress.

How Much Should You Save?

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Finally, let’s look at John’s question about saving. There probably isn’t any single right answer, because saving isn’t really an expense. It’s an investment for a better future.  So I prefer to think of savings in terms of priorities. Before I can put money aside for savings I need food and a reasonable shelter. Probably also need dependable transportation to get to my job.  But after those basic needs are met, it’s time to begin saving some money. Not necessarily the 10% in our guidelines, but 2, 3 or 4%. Enough so that there’s some money set aside for the so-called unexpected expenses that happen to us all (dead appliances, home and auto repairs, unexpected sickness, temporary lack of work).

One other comment about savings. Paying off debt (especially credit card debt) is a little like savings. Consider payments used to reduce the amount owed as if they were savings or a Bank CD.  Finally, for those of you who don’t want to bother with any of this. I know what you’re thinking: I’m fine and don’t need any help monitoring my money. Just remember that most people who are in trouble today said the same thing when everything looked good to them.

 

Stock Valuation – How To Value A Company

Stock Valuation – The Relationship Between A Company’s Stock Price and Cash

In another article titled Companies To Invest In, I made the point that, at its core, a well-run company is simply a money making machine.  That concept – that the value of a company is ultimately tied to cash – is one of the keys to understanding how to value a company and it’s relationship stock price.  Stock valuation are great to get quick snapshot of a company’s value.  I’ll illustrate this point with a simple example, and then build on it in ensuing articles.

How To Value A Company – Cash Per Share Example 1

If there were a company that had $1,000 in cash with 100 shares of stock outstanding then you could calculate the value of each share of stock as follows.

Stock Valuation Cash Per Share Example

How To Value A Company – Acquiring 20% Ownership Example 2

If that were the case and you wanted to own 20% of the company then how much stock would you have to buy, and how much would it cost?  The answer is that you would have to pay a total of $200 for 20 shares of stock, which can be calculated as follows.

Stock Valuation Ownership Example

How To Value A Company – 10:1 Stock Split Example 3

What if the company did a 10 for 1 stock split, meaning instead of having 100 shares outstanding, it had 1,000 shares outstanding?  Would that change the value of the company?  The answer is no.  The company’s only asset is $1,000 of cash, and no amount of stock splitting (or combining) can change that.  However, by doing a 10 for 1 stock split the value of each individual share is diluted, going from $10 to $1 per share.  So in summary, a stock split affects the value of each share of stock, not the value of the company itself, which can be illustrated as follows.

 

Stock Valuation Stock Split Example

 

Now, what if our little company went public and was traded on the New York Stock Exchange?  Wow, that’s big time!  Wouldn’t that would boost its stock price above the $1 it’s now trading at after the stock split?  Not at all!  The stock could be traded on the moon, and that still wouldn’t alter the fact that the total assets of the company are worth $1,000, making the value of each of those 1,000 shares equal to $1.

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How To Value A Company Using The Terminal Valuation Method

But wait, isn’t just focusing on a company’s cash overly simplistic?  After all, there’s no company of any size or consequence whose only asset is cash.  While that may be true, at the end of the day, determining how to value a company is ultimately measured in money (or cash) – nothing else.  This is known as the terminal value of a company.

The application of this concept is known as the Terminal Valuation Method.  To illustrate how it works, say a company’s stock price is trading at a value that suggests the total worth of the company is $10,000,000.[1]  How can you tell if this stock valuation is reasonable?  One way to go about it is by to pretending that the company sold everything off: its inventory, furniture and fixtures, real property, and so on, until it converted all of its assets to cash.  After going through exercise you estimate that upon liquidating all of its assets and settling all of its outstanding debts (or “liabilities”) that the company would end up with $4,000,000.

“It’s Important To Note Stock Valuation Can Vary Greatly Depending On A Number Of Factors Such As: Industry, Maturity Level of Company, Ect.”

What…$4,000,000?  Didn’t we say that the value of the company’s stock suggested that it was worth $10,000,000?  Does this mean that the company’s stock price is vastly over inflated relative to its true worth? Perhaps, but not necessarily.  For example, aside from tangible assets (assets that you can touch) that could be converted into cash, an established company might have valuable intangible assets that would substantially contribute to its ability to make money: established business relationships, a highly skilled workforce, an efficient supply chain, secret formulas and patents, widely recognized brands and trademarks, etc.  In short, there can be a lot more to the value of a company than just its “hard assets” such as cash, inventory, property, etc.

However (and this is a BIG however), if a company is being valued at $10,000,000 and yet it would only be worth $4,000,000 upon liquidation, there still has to be a financial explanation for where that remaining $6,000,000 of value is coming from.  In other words, what is it about the company that makes it worth more than sum of its tangible assets?  If there is a compelling story there – a story that explains how the company’s business prospects, activities and operations are worth an extra $6,000,000 – then the stock valuation of the company can be justified.  If not then the company’s stock price is being pumped up by hype and hot air.

Summary

While it’s true that you cannot you cannot fully measure the value of a company based on its hard assets (cash, inventory, buildings, etc.), it’s also true that a company’s value is ultimately measured in dollars.  That means when it comes to a company’s stock valuation, cash is king!

 


[1] This would be the case if, for example, a company’s stock was trading at $50 a share and there were 200,000 total shares outstanding ($50 x 200,000 shares = $10,000,000).