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Problem 3: Not Looking at All Sides of a Problem

This problem is usually having a point of view on an investment situation where you may have taken someone else’s word on it or never really given the question serious thought. One common financial example of this the use of a financial advisor to assist you in buying and selling stocks, mutual funds, or other investments. Whenever I consider that advice from this kind of source, I ask several questions about the source of the advice. Some basic ones may include the following:

- Does this advisor have anything to gain or lose by my decision?

- Is this advice based on the advisors own expertise or on someone else’s?

- Is this person following their on advice on that issue?

- Is the advice based on a fair analysis or a biased analysis?

- Is it to my advantage to even consider taking this advice?

- If the advisor makes any performance claim, can the claim be backed up?

- Does the advice make sense?

- After further investigation and research on my part, does the advice still make sense?

- Does not following the advice make better sense?

The current rash of mortgage problems in the US, issues like short sales because of underwater mortgages and foreclosures, is one example of this kind of decision problem in action. Many people got into this situation because they didn’t think about the consequences of taking out a home equity loan to buy expensive toys, or the possible negative consequences of an adjustable rate loan.

There are many more questions that one can ask, but the basic point is that every decision can be looked at in more than one way. It is to your advantage to ask a few questions and do at least a little work to understand what may be behind a piece of advice.

Next Lesson: Being Overconfident In Your Predictions

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Money Decision Problem 2: Solving the Wrong Problem

You can have the greatest system in the world for analyzing and solving your personal or business money problems, but you would be wasting your time if you were solving the wrong problem. This usually happens if you do not think through a problem before you start to solve it. To understand how to approach a particular problem you should understand at least these things about the problem:

1. What are the limits to problem at hand?
2. How do you define a good or a bad outcome to the decision?
3. How should you measure the outcomes?
4. What do you bring mentally and psychologically to the decision table?
5. What are other ways to look at the problem?

A Mutual Fund Example
One example of solving the wrong problem is to pursue a high rate of return from a mutual fund investments without first deciding what kind of comparison or benchmark you should use to determine if the return is high enough. For example, index mutual funds that are designed to mirror the results of the Standard and Poor’s 500 index consistently outperform rough 80% of all mutual funds. The original problem may have been how to choose mutual funds with high returns. A better problem to solve would be how choose mutual funds which consistently perform better than the S&P 500.

Final Thoughts
Remember that most problems involving money usually involve something else besides money or mathematics. If you focus on the parts of the problem that are objective and that can be measured or solved with common with equations and spreadsheets, you may miss the most important part of the problem.

Next Lesson: Not Looking at All Sides of a Problem

Money Decision Problem 1: Not Taking the Time to Think About the Problem

Money Decision Problem 1: Not Taking the Time to Think About the Problem and the Decisions that Must Be Made

Before you make a financial decision, you have to know something about your needs, the effect your decision may have, and how you go about making a decision. Some common money decisions that often happens too quickly is what credit card you should have, whether to buy or sell a stock, or whether to go into debt to replace your boring old (and paid off) car for a shiny new one. Taking the time to make a proper decision can save you a lot of frustration and regret, especially if you do it consistently.

A Credit Card Example
Let’s look at the credit card situation more closely. There could be dozens of reasons why you suddenly decide that you need a new credit card. You might not have one at all, but one day you decide to rent a car and find out that you need a credit card. You might have a card already, but you find a way to transfer balances and reduce your interest rate for the first six months. Even if you think you need to take action right now, it always makes sense to think it through to see if it is the right decision for you. The following are just some of the questions you should ask yourself before you sign on the dotted line:

1. What do you want to accomplish when making the decision? - At the very least, figure out if it is a short term or long term goal.
2. Who will be making the decision? - Typically anyone who will be responsible for paying the bill and whoever will be allowed to make charges on the card.
3. How should the decision be made? - Figure out things like whether you need to decide after comparing other options, or if any one person will have veto power.
4. Does the decision significantly affect other decisions?
5. Does the decision have to be made at all? - Think about what would happen if you took no action.
6. Does the decision have to be made by some kind of deadline?
7. What’s the worst that will happen if you don’t make a decision?
8. How much time do you need to make a decision?
9. What kind of options do you have?
10. Do you have any experience making this kind of decision, and if so what did you learn?

Once the background questions are settled and you have a good understanding of your overall situation, you have to start dealing with the decision making process. You should finish gathering any information that you need to make a decision. For credit cards, this would be things like late fees or other penalties, how much interest you will be charged, and what kind of no-interest grace period you have. These kinds of details should be spelled out in the agreement. If you don’t understand it, don’t sign it. If you don’t see it in the agreement, then it’s not part of the deal.

The next big steps are making the decision and carrying it out. If you decide to do something, then follow through. If you decide to do nothing, then take no action, no matter how tempting it may be. If you decide to change your mind, go through the same decision process. Don’t make the mistake of being logical and systematic the first time through and then being very informal the second time you wrestle with the same decision. Every decision is a combination of your analysis and your judgment. If you have a consistent process, you’ll likely improve the quality of both your analysis and your judgment.

Final Thoughts
Keep in mind that a credit card can turn out to be a long-term relationship. If you pay your bills in full every month, it can be a very happy and harmonious relationship. If you fall behind, it can turn real ugly real quick.

Next Lesson: Solving the Wrong Problem

Making Money Decisions

Do you every wonder about your ability to make good decisions about money? Do you think you need to know something special to be better than average? Before you got that seminar, buy that book, or sign up for that MBA program, you should take some time to look at how you make money decisions. Success in investing, or choosing the best mortgage, or picking a sensible credit card all starts with using your mind to figure out your options and to make decisions.

The Making Money Decisions posts will take you through a few basics of decision making and take some of the stress out of making decisions about your money.

The ability to make good decisions is as skill that can be improved through practice and the use of the proper techniques. None of these techniques are based on any sophisticated mathematical or psychological concepts. If anything, the basic techniques of decision making are about figuring out what information you need for a decision, making a clear decision, and checking up on the results afterward. It is about finding the proper balance between intuition and analysis and recognizing that you can develop all the decision making skills that you need to become a better investor.

Next Lesson: Taking the time to think about your money problem

Quick Budget

If you’ve never had to budget before it can sometimes seem like an overwhelming task. There are all kinds of elaborate methods to create very exact budgets that track everything. For most of us, this is probably overkill and prevents us from getting to the task of actually saving money. To get started today you can do something very simple. Take all of your absolute necessary expenses. We’ll call these our fixed expenses. These are the things that we can’t stop paying without making some major life changes.

Examples, include

Mortgage $1,000
Babysitting $500
Utilities $250

The next step is to list out your monthly income

Salary $3,000
Spouse Salary $2,000

Next you will need to think about how much you would like to save. You’ll need a cash buffer and to save for retirement. You may want to think about other goals such as your next car and whether or not you will save for your kids college education. This is the whole idea of pay yourself first. It represents a way to make sure you put your savings goal first.

The difference is then the amount you can spend on all the other things.
Obviously, you need to think about groceries, gas and everything else that you need day to day. I purposefully lump all of these items into one big general fund. Because they involve a large range of trade offs that you will need to think about. This is the opportunity to get creative.

You can think about what you truly value and use to make your life fulfilling. Personally, there is no way I could actually live without Internet access, but I could live without my NetFlix account. To save on gas I started carpooling and got a special fuel perks card. If I really want some purchase that I can’t afford perhaps I’ll find some coupons or cut back in other spots.

A great one we have started is cooking with our kids. We save money by not going out and our kids really enjoy it. I’m sure you can think of similar examples to help you cut back spending, but still enjoy life.

A Case for Cash

I’ve heard financial planning experts talk about cutting up credit cards and telling people to use a cash based system to manage their finances. I’ve typically thought didn’t apply to me. I always paid off my balance every month and had an excellent credit score. Recently, I wanted to tighten down how much my family spends on various purchases. We’ve always used credit cards for every day purchases, but the credit card bill tended to fluctuate every month based on the families desires. I’ve tried various mechanisms for tracking. I’ve said that we’re only going to spend X dollars a day etc. It seems there was always some special 1 time event or purchase that ended up on the card.

The problem is that the mental accounting the family had to do to stay on track just wasn’t working. Instead we switched to a complete cash based system. Each family member was given an envelope with a certain amount of cash for everything. If my wife finds bargains at the grocery store she can have a little extra the next time she goes to the beauty salon. If she decides she has to have that certain something at the grocery store and doesn’t have enough money for the salon then she will just have to live with a few of the grey hairs a little longer before her next color treatment.

After using the system for a month it has worked well for us and allowed us to stay on budget.

What if You Can’t Pay Taxes Owed?

It is close to the due date
for taxes and you just prepared your return and realize that you owe
more money than you can pay. This year, more than ever, taxpayers
are coming up short on the taxes they owe. Since this is such a common
problem, you can be assured there are many options available for you.

The first thing you need to
do, even if you know you can’t
pay your taxes owed,
is to send in your completed tax return. The penalty for not filing
is more than the penalty for not paying. Once you have your taxes
filed then you can figure out what you are going to do about payment.
Below are some of the most common solutions for paying for taxes when
you cannot afford to pay. The right option for each person varies
depending upon their unique financial situation.

Find the Money Elsewhere

Many times you could easily
get together enough money to pay off taxes by thinking outside of the
box a little. Some options to pay in full when you don’t have
the money are the following:

• Credit Cards
• Home equity loan
• Friends and Family
• Pay advance from
  employer
• Sell old items on
  E-bay

Some of these options should
be used wisely. Even if you can borrow money, sometimes there could
be a better option. Consider some of the below options before borrowing
money.

IRS Installment Agreement

This is a very common mechanism
to pay back IRS taxes owed. The IRS will allow individuals to pay taxes
off in monthly increments (including interest) if they can pay off the
tax amount owed in 3 years or less. To apply for an installment
agreement you will need to fill out IRS form 9465 with the IRS. This
agreement will allow you to have money taken right out of your bank
account that will go towards the taxes you owe. This is a better
method to use than using a credit card because the interest rates are
typically lower.

Financial Hardship/Uncollectible
Status

If you cannot qualify for an
installment agreement, you may be able to get determined uncollectible
by the IRS. This will temporarily put you back on good terms with
the IRS and prevent the IRS from taking any actions against you.
They will check back every so often to see if your financial situation
has improved enough for you to pay back the taxes you owe.

Offer in Compromise

This is typically a last resort
option. The IRS will only consider this option if they think it
is very unlikely they will ever collect the taxes you owe. Under
this method you will pay a lump sum offer to the IRS for taxes owed.
The amount paid is typically much lower than the actual amount owed.
To apply for this you will be required to fill out a personal financial
statement and submit IRS form 656 to the IRS to be considered.
Very few of these filings are actually accepted and it is highly recommended
to consult a tax professional before attempting to make this type of
filing.

Picking the right method to pay back taxes is important. If the problem goes
ignored, penalties and interest on unpaid amounts will add up very quickly.
If you need help
with taxes and
help with picking the best resolution method, you should consult with
a tax resolution firm.

30 Year Fixed Hovers around 5%

If you don’t currently own your the place you live in you may be missing out on one of the greatest opportunities in your life. Most of us are well aware that it is a buyers market and that homes are being sold dirt cheap. The other opportunity is the incredibly low prices on 30 year fixed mortgages. The last time they were even close was March of 2004 at 5.45%. If you look at the charts since 1971 this has rarely happenned and could truly be a once in a lifetime opportunity to have a low monthly payment on a loan. Even if you already have a home loan your payback period to refinance could be less than 2 years. The reason for that is you typically have to pay some fees to refinance your home. Let’s say you save $100 a month in mortgage payments by refinancing, but the fee is $2,400. Even with the lower payment it will take you 2 years to make up for the difference. If you plan on staying in your current home for more than 2 years it should certainly be considered. Over the next 30 years you would save $36,000.

$100 Homes

Last night 20/20 featured an interesting segment on homes in foreclosure. They interviewed some urban pioneers in Michigan who are rebuilding an entire neighborhood one house at a time. The homes sold for $100-$500. They were in terrible shape. Most of them were either burned and partially destroyed. While it will probably take 10’s of thousands to repair them and the area is awful the pioneers were doing something very interesting. They were building a community. Instead of trying to go it alone they found other people that wanted to renovate this area. One by one they began attracting friends and family to come join them in their quest to rebuild this area.

I have no doubt that in ten years this will be some cool, hip part of Detroit that everyone wants to visit. An interesting example of creativity during a tough patch in our economy.

VA or Military Home Loans

The LA Times recently featured a story on VA Loan Benefits. For military members coming home and looking to purchase a home there are some tremendous benefits. Without putting up any of their own money veterans can borrow up to 417k with a GI loan. The limits increase in other areas such as California and Colorado where home prices are higher than the rest of the nation. There are some pretty specific items you need in order to qualify

You Are Eligible For A VA Home Loan If:

• You have had 90 days or more of active duty service during wartime
• You have had 181 days or more of active duty service during peacetime
• You were discharged for circumstances that were not dishonorable
• You are currently active duty personnel and you meet the above service requirements
• You are the surviving spouse of a Veteran who died during service or because of service-related injuries and you have not remarried.

You will also need to show work history and ability to make payments for the loan you are applying for. Lastly, there are three other reasons these loans are good for veterans.

No PMI Insurance is required.

VA Loans require no money down and you will see no penalty rates

VA Loans have lower rates than conventional loans.

Given the current economic environment this is a great option for those who have dutifully served our country.

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