Year: 2009

Money saving tips are something you run across quite frequently if you are browsing in the blogosphere (or talking to my parents).  Whether it’s big savings like negotiation tactics for buying a new car, buying a used baby stroller or small stuff like making your lunch and creative uses for used dryer sheets – everyone has a suggestion for saving money.

Alternative income ideas are also a popular topic on many blogs – starting an online business, filling in surveys for money, freelancing, doing odd jobs around the neighbourhood are some of the suggestions I’ve seen.

The problem with a lot of these ideas for saving money and generating income is that they often involve a fair bit of work for a seemingly small return.  There is no question that you should take a good look at any activities for saving money/generating income with a critical eye and make sure they are worthwhile – you should also try to concentrate on the ones that are likely to be more successful (if you can figure that out).

I wanted to share my ideas on 2 concepts which I think should be utilized when evaluating income or saving opportunities.  These might help motivate you to start doing some of these opportunites if they are more beneficial than initially thought – on the other hand it might get you to reconsider some of the activities you are already doing.

Compare the savings/income with your disposable cash flow – not your gross income

Whenever I hear something like “lowering the temperature of your home by 1 degree in the winter will save you up to $400 per year in heating costs” I always have the same reaction…who cares?  $400 is not a small amount of money but it’s not enough to get me to want to freeze my butt all winter.  Same thing on the income side – if you could spend 20 hours setting up a website that earns 50 cents a day – does that sound like a good deal?  Initially it seems to be a big waste of time.

One of the problems with that reaction is that I’m typically comparing the dollar amount I can save (or earn) with a much larger number like annual family income which might not tell the whole picture.  I think a better approach is to try to estimate your disposable income and compare to that.

If you think about it – gross income is just a theoretical number – once you remove taxes and other contributions you only get paid a portion of your gross income.  Once you then remove all your basic living expenses ie mortgage, insurance, food, gas etc then you might not have much money left over (if any).  For some people the left over money might even be negative (this is not good).

In my opinion you should base your decision on whether to put some effort to save money/earn money on how much impact that money will have on your disposable income because that is the money that you notice.  Someone who has high income and low expenses will have a high level of disposable income and therefore will probably not benefit from spending time on small savings and small income streams.  Many people however, high or low income, often have very little disposable income and any increases will result in a significant improvement in cash flow.

So step 1 is to calculate disposable income – there are different definitions but I’m loosely just trying to calculate how much money you have at the end of the day after all your costs are met.  The amount you save each paycheck plus all completely discretionary expenses (ie nice restaurant dinners) could be assumed to be disposable income because you have a choice about whether it gets spent or not.

Let’s look at an example:

Joe makes $65,000 per year.
Here are some of his costs:

• taxes – $17,500
• mortage – $17,000
• insurance – $2,500
• car payment – $6,000
• bills (heating, phone) – $7600
• property taxes – $3,000
• food  – $4,000
• other  -$5,000

The total expenses for Joe are $62,600 which leaves him with a grand total of $2,400 of disposable income each year.  While this isn’t bad – it sounds a lot less impressive than his $65,000 salary.

So if Joe has the opportunity to save $400 on his heating bill – rather than dismiss the idea because $400 is only a small fraction of his annual salary of $65,000, he should consider that $400 will increase his annual disposable income ($2,400) by almost 17% which might change his thinking on turning down the thermostat.  He might still choose not to change the temperature but at least now he has a better feel for how much effect it will have on his financial situation.

When evaluating the potential savings or income make sure you use the same time periods

In a previous paragraph I mentioned spending 20 hours of effort to build a website which will yield 50 cents per day (after expenses and income tax) without any further effort.  One mistake which I’ve made in the past is to assume that 50 cents is an insignificant amount of money (which it is) and then incorrectly assume that many piles of insignificant sums of money will also add up to an insignificant amount of money.  In some cases that will be true but not always.

In this case the 50 cents per day will add up to $15 per month which sounds a bit better and $180 per year which sounds a lot better.  If we assume this income stream lasts for 5 years the current value of this income stream (assuming 3% inflation) is $824!

So now that we have done that calculation the question is would you put 20 hours effort to earn $824 over the next 5 years?  Depending on your disposable income, available time, your interest in that task and other factors – your answer might be no or it might be yes – but at least now you are analyzing with the right numbers (which look a lot better than the inital numbers).

This also applies to savings – What if Joe has the opportunity to bring his lunch 3 times a week for a saving of $3 per lunch?  $3 isn’t that much when you consider the effort involved in grocery shopping and making the lunch –  but if he calculates an annual saving ($3 each lunch x 3 lunches per week x 50 weeks per year) = $450 per year and compare that to his current disposable income of $2400 – it might not be a bad deal, especially if he combines his lunch making efforts with turning down the heat a bit.  🙂

Alternatively, rather than convert all your alternative income stream and saving amounts to annual figures – you could reduce your annual disposable income figure to monthly, weekly or even daily amounts if that works for you.

Joe might calculate that his disposable income is $6.57 per day so in that context – adding 50 cents per day of income or savings is far more significant than at first glance.

$ per hour – one common approach when evaluating savings or income is to calculate a $ per hour figure for said activity and compare it to your gross hourly wage at your job or some other figure that you deem appropriate.  This isn’t a bad approach but at a minimum you should consider taxes etc ie compare to your net hourly wage in the case of savings.  This is actually the initial approach I use but I combine it with the disposable cash idea.

The way I usually think of the $ per hour analysis is to calculate how much money I can save by doing a task myself (vs hiring someone) divide by the number of hours of my labour which give a dollar amount which I’m basically paying myself.  Since the gross numbers aren’t necessarily all that meaningfull, I find this analysis most useful when comparing to other tasks ie changing my own oil might only pay me $6 per hour whereas replacing a sink faucet might pay me $18 so it’s not hard to see which activity I should do first.

My family loves GICs. As a group we’re pretty risk adverse, with my dad being the “crazy risk taker” for being heavily invested in mutual funds over the years (I think I’ve stolen that mantle from him with my real estate and leveraged dividend ventures however).

Much like mortgages, the posted GIC rates in banks are for suckers. There are some techniques for getting top dollars on your GICs, which I typically assume everyone knows, but figured a post would be useful for those who don’t.

To take a step back, GICs (Guaranteed Investment Certificates) are analogous to CDs (Certificate of Deposit) in the US. You put your money into them for a set period of time (often 3 months – 5 years), it is insured by the government (like a bank account) and you are basically guaranteed to get your principle and the stated interest rate back. Because there’s very little risk, the return is quite meager. However, there are a number of ways to boost that return:

1. Ask. Usually just by asking they’ll increase it by 0.5-0.75%. They’ll be more accommodating if you have more money (sadly, such is life). If you have a wealthier relative and use the same bank / branch as them, often you’ll also get preferential treatment (mention their name)
2. Comparison Shop. Often the newspaper or various internet sites will show the rates, if they’re insured they’re all pretty much equivalent – go with whoever offers the best rate.
3. Haggle – If you want to stick with your home bank, tell them the rate being offered elsewhere and ask them to meet (or beat) it. If they refuse, often when you actually transfer the funds they’ll back down and try to get you to cancel the transfer and reinvest with them (assuming its a sizable amount). Don’t give in:  next time they’ll be more accommodating.

If you put money in a GIC, then need it later, you CAN break it, but there’s a penalty cost involved, and given the low returns this definitely isn’t something you want to do. If you want to have more access to your money (liquidity), you can set up a GIC ladder, which is just breaking a large amount of money into separate GICs maturing at different times. If you need the money, you get access to it sooner, if you don’t you reinvest it.

E.g. say you want to invest $10,000 in a GIC for 5 years. Instead, buy 5 GICs, each for $2,000 maturing at 1 year, 2 years, 3 years, 4 years and 5 years. When the first GIC matures, if you don’t need it reinvest it for 5 years. Now the longest you’ll ever have to wait for money is 365 days (assuming you won’t need more than $2k).

Negatives for GICs include that they’re taxed heavily, and inflation takes a big (hidden) bite out of them.  Personally, I just use a high yield savings account for funds that haven’t been put into a specific investment vehicle yet, which gives me complete liquidity.  But back in the day, before these were available, GICs were a (somewhat) decent alternative.