Wednesday, December 9, 2009

Budgeting: Part 11: Quid Pro Quo

"When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck."

- James Whitcomb Riley


Another source of budgeting errors is the failure to recognize a quid pro quo in your expenses. I will give simple two examples.

Christmas gift exchanges. I get a chuckle out of a number of financial bloggers who claim that they don't spend any money on clothing. "I receive a number of shirts and pants for Christmas each year," they maintain, "and I just wear those items and never have to purchase any clothes." However, I doubt that is the complete picture.

Kids birthday parties. Sometimes I talk to parents who brag that since they invite 15 or 20 kids to their child's birthday parties, they receive lots of gifts and don't have to spend much on toys. But I have kids, and I know how this works. If you invite 20 kids to your child's birthday party, then your child will usually receive 20 gifts. However, your child will now also receive 20 invitations to other birthday parties throughout the year. Your child will surely want to go to these parties and bring a gift to each one of them. At the end of the year, it will cost you the same as buying 20 toys for your own child.

So do I have a problem with gift exchanges? Not at all. Our immediate and extended family exchange gifts at Christmas and my children go to their fair share of birthday parties. But there are some subtle dangers here for your budget. Let's take the two examples from above.

First, I think it's good to recognize that in fact money is being spent on clothes and toys. Yes, the initial spending is a gift to someone else, but there is a quid pro quo involved. This has implications for how you categorize things in your budget. The spending that you may be calling "Birthday Gifts For Friends" is in a round about way being funnelled to "Toys", and what you classify as "Christmas Gifts" is actually coming back as "Clothing". So do you really need to match up these transactions and classify your $20 Applebees gift card to Uncle Albert as spending on clothing since he gave you a polo shirt in return? I wouldn't. That's way too much work. But if you rely on gifts for a substantial portion of what you would otherwise spend on a given category, I think you should make a mental note of it.

Second, it's possible that the reciprocation arrangement may end at some point and cause budget confusion. Since you will be spending less as well as receiving less, there is no real issue, but only if you recognize both sides of the ledger. In the first example above, suppose your family decided to eliminate the yearly Christmas gift exchange because economic times are tough. Financially, you are no worse that before just because the gift exchange ended. If you spend less on gifts, and receive less gifts, it will equal out. But it's possible that you will look at your budget and think that since you aren't going to be spending $300 on Christmas gifts, then you can spend that $300 on something new and maintain your overall budget. The problem here, of course, is that if you are used to receiving $300 in clothes each year, then spending that $300 on something new will actually change your overall spending.

Lastly, it is human nature to think more highly of ourselves than we ought, and perhaps nowhere is this more pronounced than our ability to overestimate our generosity toward others. It's easy to categorize all these sorts of arrangements as "gifts" and then feel very smug about how generous we are when we see how much we spend on such "gifts". So it's good to remember that soft dollar agreements are not a substitute for charity.

Monday, December 7, 2009

Budgeting: Part 10: Work Benefits

"Write your injuries in dust, your benefits in marble."

- Benjamin Franklin


Most people don't formally factor each work benefit into their budget, and that seems like a reasonable approach to me. However, if these benefits are essential to you, then it's important to know how much they're worth.

Insurance

The biggest work benefits are typically health insurance and other medical benefits such as dental insurance and prescription drug coverage. The time when people typically try to measure these benefits is when they are looking for another job. For example, if Company A is offering a higher salary than Company B, but Company A pays only 50% of health insurance costs while Company B pays 80% of a similar insurance policy, then the cost of the insurance most be known to make a fair comparison.

But there are at least two other times when attention should be paid to the cost of these benefits: when planning for a possible job layoff, and when planning for retirement. People mainly tend to look at their cash costs when figuring their budget. If cash costs are $3,000 month, then it is often (incorrectly) assumed that an $18,000 emergency fund will last 6 months, and a $36,000 income stream will be sufficient for retirement. It can be a rude awakening to discover that your emergency fund will not last nearly so long when you start having to pay cash for a number of different insurance premiums (health, dental, life, etc). Worse yet, in some cases your replacement cost may be significantly higher than the current cost to your employer. For example, if you have a serious medical issue, you may not be able to obtain private life insurance at reasonable rates, even though you were able to obtain reasonable rates through your employer.

Other Payroll Deductions

One simple error that is surprisingly easy to make is to omit spending that occurs through paycheck deductions. In the United States, it is very common for out-of-pocket medical expenses and childcare expenses to be paid for through paycheck deductions, because they are associated with tax-advantaged health care and dependent care "flexible spending accounts". Often these deductions can be paid directly to healthcare and childcare providers up front without a payback step. But remember that $1,000 deducted throughout the year and paid to doctors and pharmacies is still $1,000 of spending even though you never handle the money.

In some cases, certain job-related expenses such as union dues, cafeteria meals, or uniforms are also deducted from paychecks. Sometimes these expenses are relevant to your budget, while other times they are not. For example, if you are planning for retirement or for a job layoff, then the cost of the union dues may not be relevant. But what about the uniforms and the cafeteria meals? Even though you won't wear a uniform and eat at a workplace cafeteria during retirement or unemployment, you will need substitutes for these expenses because you'll need other clothes to wear and other food to eat. Hence, these expenses need to be recognized as real spending.

Discounts

Lastly, many employers provide significant discounts for certain services, such as childcare centers, fitness centers, downtown parking facilities, and even cellphone and Internet service. If you intend to continue using these services during unemployment or retirement, then you should be aware of their potential increased cost to you.

Summary

The bottom line is that most employer provided benefits should generally be considered spending. Failure to recognize this fact in your budgeting will tend to understate your real spending level. While it's not necessary to create and track a separate line item for each benefit, it is a good idea to calculate the value of your work benefits and factor that into your emergency planning and retirement planning.