The Debit Card Dilemma

Posted on October 11th, 2011 in Financial Abundance, Newsletter Articles by wayne

There has been a lot of recent press and political punditry about Bank of America charging $5/ month for the “privilege” of using their debit cards.  Arguments can be made over whether this fee is justified, after the Dodd-Frank bill lowered the allowed maximum debit card transactions fees, or whether Bank of America customers should find a new bank.  However, assuming that one is able to get a credit card, the correct question should be:  “Why would you ever want a debit card?”

Let’s explore some of the reasons for which debit cards are used and see if any of these are required.

1) Debit cards are a replacement for writing checks.  While debit cards were initially designed as a replacement for checks, modern technology has made checks almost obsolete.   Monthly bills can be paid by credit card or by direct payments from a bank account. No physical checks are required.  Any product that can be purchase with a debit card can also be purchased with a credit card.  If checks are required, the vendor requiring a check will typically accept neither debit or credit cards.  Thus, debit cards no longer serve exclusively as a replacement for checks.

2) Debit cards prohibit their users from spending more cash than they have. Debit cards (theoretically) do not allow for spending more than is in a bank account.  While debit cards usually limit spending to a bank account’s cash balance, there are other methods of achieving this same goal.  With a laptop or smart phone, bank balances can be accessed 24 hours a day.

If it is critical to your budgeting process that expenditures never exceed the cash on hand, consider the following approach.   Always have a small amount of cash for incidental purchases.  For all other purchases, keep track of credit card purchases so that you know to stop using the credit card when bank account limits are reached.  When the next pay check arrives, pay off the credit card balance and repeat this process.  This approach provides the same cash management function as a debit card, while eliminating any possibility of debit card overdraft fees.

3) Debit cards are a budgeting tool, helping assure that one does not spend more than they earn.  With the proliferation of free, online budgeting tools, such as mint.com, debit cards are one of the least effective budgeting tools available.  As with 2) above, using cash for small purchases and keeping track of the larger purchases that are made with a credit card provides considerably more budgetary control than a debit card.  The only “downside” of this approach is that it requires discipline to keep track of purchases and to stop spending when you cash is depleted.

To successfully eliminate debit cards and their associated fees, it is important that the credit card balance be paid in full every month.  Without discipline, credit cards can easily become an easy method of “budget busting.”   While quick and easy to use technology makes it possible to keep track of all credit card purchases as well as the remaining cash available in a bank account, implementing this technique requires both desire and determination for it to succeed.

The small amount of work required to enter each credit card purchase as it is made, coupled with the determination and desire to maintain a budget can break the debit card habit forever.

The Key to Successful Investing

Posted on October 11th, 2011 in Investments, Newsletter Articles by wayne

A question that is commonly asked in times of market volatility is “should I invest or keep my savings in safe Certificates of Deposit?”  Even if the questioner is stuffing their cash in a mattress, they are “investing.”   Thus, the question that should be asked is “how will I invest my funds?”

For many investors, the stock and bond markets are just too risky.  These investors are often choosing such investments as one year CDs.  One year CDs yield approximately 0.6%.  At the end of August, the US inflation rate for the past 12 months was 3.8%.  When we consider the real rate of return (total return less inflation rate) for one year CDs, they currently provide a -3.2% real rate of return.

On the opposite extreme is an investor that is 100% invested in the US stock market.  From the beginning of 2007 through the end of Q2 2011, the annualized investment rate of return for the S&P 500 (with dividends reinvested), was 0.4%.  With the recent volatility the S&P 500 annualized return declined to -2.6% by the end of Q3.

Is a guaranteed -3.2% real rate of return better or worse than a volatile rate of return created by investing in the markets?  Investment studies have shown that the most critical requirement for investment success is to develop an investment plan and stick with it through both good and bad markets.

Studies show that investors consistently underperform stock market benchmarks.  This performance is not related to an investor picking the wrong stocks or mutual funds.  Most of the long term investment underperformance occurs because investors often buy when markets are high and sell when markets are low. Whether the investment approach is conservative or aggressive, these studies show that long term investment results are consistently higher when the investment approach is maintained throughout a full market cycle.

A conservative investor will typically significantly outperform an aggressive investor in down markets.  Unfortunately, in frothy up markets, conservative investors are often tempted by the significant gains that their more aggressive investor friends are receiving.  At the worst possible time (when stocks are overpriced) these conservative investors often decide to become more aggressive investors.  By changing their investment approach, their funds are often decimated by the next market downturn.

Aggressive investors will typically significantly underperform their conservative counterparts during a down market.  In desperation, aggressive investors often sell much of their stock market investments at the worst possible time (when stocks are underpriced).  By changing their investment approach, aggressive investors will not be fully  invested in the stock market when the markets stages its next recovery.

Financial Abundance, LLC, uses a diversified investment approach that includes US and international stocks and stock funds, US and global bonds and bond funds as well as some exposure to “alternatives” such as REITs, gold, commodities and currency funds.  We seek out value oriented investments that typically provide better than average dividend payouts.  This approach helps decrease a portfolio’s volatility and increase the total return.  From the beginning of 2007 through Q3 of 2011, our consistent investment approach has provided for average client return that exceeds the S&P 500 (with dividends reinvested) by over 6% annually.

Whether your investment approach is conservative, aggressive or somewhere in between, the key to long term investment success is maintaining a consistent approach through up and down markets.  Fear and greed are two of our most common investment nemeses.  If you are susceptible to one or both of these, find a fee only investment advisor to help manage your investments.  At Financial Abundance, LLC  our primary added value is our ability to remain consistent with our investment approach, through up and down markets.

After reading many investment studies, a consistent conclusion is that investors can be successful as aggressive investors, conservative investors or anywhere in between.  Regardless of investment approach, the two primary components of successful investing are portfolio diversification and consistency.