Friday, February 27, 2009

Rule of 72

Ever wondered how much that music store line of credit is really costing you in interest? Or how much difference it will make to have your money stashed in a 4% Certificate of Deposit, as opposed to a 1% savings account? The Rule of 72 is handy for making quick thumbnail estimates of how interest accumulates.

First, I recommend reviewing my previous blog entry on the subject of compound interest. That can be a real eye opener for many people. Once you have an idea about how compound interest works, you start to understand how important it is to get the maximum return on your investments, and pay the minimum rate on your debt. Even a one or two percent difference can really add up over time.

If you are trying to make a decision or plan based on alternative possible interest rates and you don't have access to a precise compound interest calculator, just remember the following formula:

72 ÷ annual interest rate = number of years it will take for the balance to double

So, for example, if I invest $2000 at a compounded 6% rate of interest:

72 ÷ 6 = 12

In about 12 years, if I don't add or take out any money and the interest rate remains at 6%, my account balance should hit $4000. You can use the same calculation to estimate how long it will take your debt burden to double, or how long it will take for a given rate of inflation to double the cost of living.

I have been running a little experiment for some time now. In 1994, I put $100 in a credit union share account and resolved to make no more deposits or withdrawals until the account doubled in value. Well, it has been 15 years, and the balance currently stands at $168. Not too impressive, eh? That's because the average interest rate on that account over the past 3 years has been a paltry 1.07%. At that rate, it would take over 67 years for my $100 to double! Actually, my interest rate was slightly better in the '90s, so at the current rate, it should only take another 17 years. But that is still a total of 32 years! The lesson to be learned from this experiment: small differences in interest rates make big differences in results!

Friday, February 20, 2009

Getting Out of Debt

Okay, here's a topic that many musicians can relate to! People get into debt for all sorts of reasons, but it's only recently that getting out of debt has become fashionable. If you are currently drowning under an adjustable rate mortgage that's way beyond your means, then I'm afraid I don't have any silver bullet solutions to offer you....perhaps the government will figure out some way to throw you a lifeline.

But if you are simply struggling with garden-variety consumer debt or student loan debt, then there are some proven strategies for getting yourself out of the hole. First of all, as the old saying goes: if you find yourself in a hole, stop digging! Avoid additional debt like the plague. If you continue to allow yourself to think of borrowing as a solution rather than a problem, you will never escape debtor status, regardless of your income level. Most of my blog entries up to this point have been about living frugally and saving money. All of those habits will help you to eliminate debt as well. Since consumer loan interest rates are almost always higher than any reliable rate of available investment return, you should view paying off a loan early as tantamount to earning a high rate of return. Think of paying off your 11% credit card balance as a generous 11% gift to yourself, because that's what it is! That's more enticing than almost anything else you could spend your money on.

Lots of people owe money to multiple creditors, and often don't know how to prioritize their debt payments, so they just make the minimum payment on each bill that comes. Minimum payments are for suckers! The minimum payment option is designed to draw out your debt and earn the creditor maximum interest from you.

The first thing you should do is to make a list of all your credit accounts and find out the interest rate for each one. You can continue making minimum payments on the lower interest rate accounts for now, but target the highest interest rate first, and pay as much as you can on that account each month until it's paid off completely. After that one is paid off, target the second highest interest rate account in the same way, and you should be able to pay this one off even faster, because you now have one less account to service each month.

This strategy requires focused commitment to eliminating debt, because as you pay off your outstanding balances, your available credit limit will probably increase and those old temptations may arise again. Believe me, becoming debt-free is a very liberating feeling. It really is the best gift that you can give to yourself!

Friday, February 13, 2009

Restructuring Your Business

There's been a lot of talk lately about corporate downsizing and "trimming the fat". Perhaps you're in one of the unlucky bands who have already lost a steady gig when management decided to cut back on the entertainment schedule. It seems to be hitting everyone at this point.

Did you realize that you, too, are a business manager with downsizing alternatives? Sure, you are! Even if you operate as a sole proprietor, you may still be able to find ways to lower your costs of doing business and thus offer your clients better value. For example, you can:

1. Resize your act. If you normally perform as a five-piece band and the clubs are balking at your fees, you can offer to go out as a 3 or 4 piece for less money. The ultimate bargain is a solo act, but these gigs are usually limited to players of certain instruments (guitar, piano, etc.).

2. Cut back your hours/barter. Another deal you can strike with management is to play fewer hours for less pay, or agree to accept free food in exchange for giving up some pay. I'm not a huge fan of this option, because it may be hard to get back to the old pay scale once business improves again. Still may be preferable to having no gig at all, though.

3. Lay off middle management. If you have been getting most of your gigs through agencies, try contacting venues directly and booking more shows yourself to save on agency commissions. Of course, when dealing with a venue originally introduced to you by an agent, it would be unethical to later bypass the agent. Similarly, if local teaching studios have been booking most of your students for you, you might make significantly better pay by setting up your own studio and booking students yourself.

4. Renegotiate with suppliers. You should definitely be driving a hard bargain when making any equipment purchases these days. Don't be afraid to ask for a lower price! Most retailers are really desperate now, and they are very willing to negotiate.

Saturday, February 7, 2009

If You Can Handle It Now, Handle It Now

This simple motto has served my very well over the years in a number of contexts. The gist of it is that a good way to avoid the procrastinator's predicament is by dispensing with little tasks as soon as they come up. My rule of thumb is that, if it takes less than 5 minutes to handle something important and be done with it, then I will drop whatever I'm doing at the time to handle that task.

This might seem to contradict the importance of setting time-budgeting priorities. For example, I try to spend an hour every morning practicing piano. Nobody pays me to do it, it only happens because I make it a priority. But if, in the middle of my practice session, it occurs to me that I need to write a check or make a quick phone call, I will give myself a 5 minute break to take care of that. If it's under 5 minutes, then it's really not significantly cutting into my practice time, it's just a healthy, normal break. And handling it as soon as it occurs to me ensures that the task won't be forgotten.

This rule applies to a lot of money management issues. Balancing a checkbook, paying a bill, even transferring balances between accounts are all tasks that can be handled in almost no time, but how many of us let these tasks accumulate to the point of becoming an intimidating mountain of work? Remember, if you're letting too much of your money sit in a low-interest or no-interest account, then you're cheating yourself out of potentially significant annual interest income. It wouldn't take 5 minutes to write a check and transfer that money into your money market account.

Of course, there are many important tasks that cannot be properly handled in under 5 minutes, so time must be scheduled for dealing with bigger issues like devising a retirement plan. But you might be surprised at how many of life's tasks can be dealt with quickly and easily.