What is a Cinderella Loan?   A Cinderella Loan is where the debtor, this means you, agrees to terms that are too good to be true because they either hold out hope the future will be better than the present or in most cases they just don’t understand the terms of the loan.  Like Cinderella must return to her life of toil at the stroke of midnight, the Cinderella Loan promises zero interest for a period of time only to turn into a loan shark equivalent interest rate at a later time.  I have seen many of these loans where they offer zero percent interest for 6 months or 12 or more but if you don’t pay them off in full by the due date, they charge you almost 30% interest.  Once you add late charges and other fees, if you are caught in one of these you may never get out.  Avoid these loans at all cost.

My readers know that I find credit cards to be a modern day convenience but a double edged sword.  I use them and pay them off every month.  The Cinderella Loan is a loan but it often comes disguised in the form of a credit card and typically when you buy depreciating items such as furniture, appliances or expensive discretionary services such as Lasik or cosmetic surgery.  If you sign up for a pay no interest until some “far off date” like Cinderella at the stroke of midnight, you probably have one.  If you sign up for one of these make sure you understand the terms and most importantly when your loan turns from a fairy tale into a nightmare.

One of the leading providers of Cinderella Loans is General Electric.  Their motto is “We bring good things to life.”  However, after midnight, their motto should be altered to “We bring financial devastation to your life.”  I don’t want to pick on General Electric because Cinderella Loans are everywhere.  Go to a department store and you may leave with one of these ticking time bombs.  Go to an appliance store and the same may happen.  These financial land mines are everywhere and you must avoid them or else you may find yourself forever toiling.  There are many perpetrators like them roaming the financial landscape so beware.

Here is an example.  You want to buy a $500 sofa but don’t have $500.  General Electric like a sinister fairy Godmother has a solution.  They will lend you the $500 and you don’t have to pay them anything for 24 months and at the end of the 24 months you can pay the $500.  In essence they are saying—please come to the ball, enjoy your sofa and don’t worry about the consequences because it will end for you like it did for Cinderella.  Trust us we have a magic wand and we are looking out for you.  24 months later you get your statement and it says you owe them more than $800.  How can this be you wonder?  You say to yourself, just last month I only owed them $500?  Welcome to the Cinderella Loan.  Not only do you owe a multiple of your original purchase price but they will charge you interest on this higher number at close to 30% until you pay it off.

Let’s analyze this.  Just 24 months before, you had no sofa and no debt.  You didn’t have the money to buy a sofa but the magic wand made it possible.  Now its 24 months later, you have a used sofa that you can’t resell for even $100 you still don’t have the $500 it would have taken to buy it in the first place and now you owe more than $800.  This is not the type of happy ending you imagined.

What does GE know that you don’t?  They know a certain percentage of the population won’t be able to pay when the ball ends and they will torment you with letters, phone calls and threats until you do.  It is a complete confiscation of wealth from the innocent to the informed. In this case it’s a transfer of your money or Cinderella’s to the sinister fairy Godmother.  A $500 sofa may end up costing you thousands by the time you are through dealing with the General Electric predators.

We live in a capitalist society that has as a mantra “Buyer Beware.”  This means people must assume personal responsibility so I am not railing against GE Credit or the other providers of these loans.  These are high risk loans and GE and companies like them have every right to defend their positions and justify their existence.  However, I find it intellectually dishonest when they hide behind the mantra of capitalism while preying on people weakness of hope and ignorance.  They prey on people’s need for immediate gratification and it’s a shame they must make their money in this way.  Nevertheless they wouldn’t exist if people didn’t have a demand for them and this is America so “Buyer Beware.”

For a way to avoid these pitfalls I urge you to read a few Cautionary Tales at Financial Tales.

How did this happen you might ask?  How is it that what would seem to be a financially savvy financial advisor neglected or refused to pay his bills?  Let me tell you the story and you will see.  You may agree or you may not.

It starts out when I leased a vehicle through Chase Auto Finance.  I had a 36 month lease and every month I paid my monthly payment on time.  At the end of the lease period I turned in my car and settled up with Chase but before I did, I had them sign a letter stating my lease was “Paid in Full” and they had no future claims.  I did this as a precaution because others had told me about “Hidden Charges” that sometimes spring up after a lease is completed.  The situation should have ended right there but it didn’t.  What happened next?

Two and one half years after I had turned in my vehicle I get a funny phone call.  It is from Chase and they are telling me that I owe them $465.  I asked them for what and they say they had to pay a parking ticket I received while in Baltimore.  I ask them to send me a copy of the parking ticket and I would consider it.  I never receive a copy, just a bill.  I don’t pay it of course.  Who ever heard of a $465 dollar parking ticket?  A few weeks later I hear from them again and once again they want me to pay them.  I explain the last call and ask them to once again send me the proof.  Once again they don’t.  This happens for one more cycle before the next bill collector says they can’t locate it but that his notes indicate that it was originally a $15 parking ticket with penalties of $450.  I started to laugh at this point.  These knuckle-heads wanted me to pay for their inefficiency.  They indicated their willingness to settle for less.  When I offered to settle for $15 they refused.

How is it possible you might wonder that Chase could possibly neglect a parking ticket that was obviously getting dinged for penalties every month and either not pay it or bring it to my attention for more than 2 years?  This was pure negligence.  For those that don’t know the mechanics, if you get a parking ticket and someone takes it off your leased car as some are prone to do in cities, the parking ticket goes first to the owner or leasing company—in this case Chase—and they are responsible for bringing it to your attention.  They never did.  They sat on it until the fine was sizable.  Then some genius in their organization decided to pay it.  Is it any wonder that we had to bail out the banks in this country?

What happened after my refusal to pay more than $15?  They referred me to a collection agency.  Soon we settled into the Saturday morning routine of early morning harassing phone call with the usual offer to take half of the balance as settlement in full with my refusal to accept their terms.  After a few months and many Saturday morning harassments, I grew tired and referred them to my attorney.  As I explained to them, I am willing to spend $10,000 on legal fees to make sure I don’t pay more than $15.  As some readers may know, I am of Cuban descent and like many of my kin, not the most rational person when mistreated.  They stopped calling after this.  I asked my attorney what would happen and he said that it would go against my credit rating.  I asked him if I could contest the claim and he said sure, but it’s not worth it.  He said the credit agencies would take the dispute off the report but within a month Chase would report it once again and it was a losing battle.  I had received an education on the power and stupidity of large financial institutions.  I would pay the price on my credit rating.

Why do I write about this you might ask?  Is it to eviscerate Chase?  The answer is no.  I am sure all the large banks have similar processes in these instances.  Is it to explain the inadequacy of credit reporting fairness?  The answer is also no.  They have a good methodology in my opinion and if this were a pattern in my financial behavior it would surely appear.  The reason I write this is to tell the reader one thing and only one thing.  I could make a stand against corporate extortion and stupidity because I don’t care what a credit agency thinks about me.  If you pay your bills on time every month and have money to invest or to buy things that you can afford, your credit rating isn’t a very important component of your life.  When or if you ever feel unfairly treated, you can make a stand.  You don’t have to be a patsy for someone that threatens to “Ruin Your Credit Rating.”  The moral of the story is “Cash is the best credit rating you can have.”

The Joy Dividend article is a great read and if I knew how to link to it and had permission I would have you go there immediately.  It’s that good.  But since I can’t and most of you wouldn’t go there even if I did provide a link let me sum up.  The Joy Dividend provides a blueprint for everyday spending decisions.  It also provides a blueprint for how to live a balanced life in relation to your money.  It’s as good as anything I have ever read and walks people through the human plight which I call the fine line between over-saving and under-living.  It is a very fine line and if you read A Tale of Teamwork on my blog you will see an example of a couple that could not balance their life’s equation.  They over-saved and unfortunately under-lived.  Granted, this is not the case for most of us.  Most of us over-spend and then wonder why we’re broke.  What I most like about The Joy Dividend is that Martha Beck injects an element of individuality to her blueprint. It goes like this,

1)      Every time you make a purchasing decision ask yourself if the item or service is something you need or something you love.

2)      If it isn’t something you need or love; don’t buy it even if it is something that someone else might need or love.  Determine your own destiny.  Follow your own drummer.

She even set up a little matrix to help you with your purchasing decisions.  Her matrix is approximately as follows;

I love her approach especially when I have seen so many clients walk out of my office after overspending only to do it again.  As I’ve always maintained—I am not the spending police but thanks to Martha Beck at least now I have a way to bring things into focus for those that are saving money challenged.  Her matrix puts a personal touch on everyday decisions.  It’s clear that we need to spend money on the things we need because guess what—-we need them.  However, there are certain things such as food that though everyone needs, have different gradations of need.  One person may need to shop at Whole Foods while another may need something less.  The same person that needs to shop at Whole Foods may choose to wear inexpensive clothing.  The point is that you must decide the things that are important to you. What’s important to someone else does not mean it is important to you.  I am sure that everyone can think of examples that fit into their lives. It’s what makes us unique.

So let me close with what I call category 2—something you need but don’t love.  You guessed it—saving for retirement.  Does anyone really love saving for retirement?  I don’t think so.  Does everyone need it?  I think so.  Does anyone think they need it right away, every paycheck, every time they have money in their pocket or savings account?  Again, I don’t think so.  Nevertheless, if you keep putting off this need you will soon learn that the need grows stronger.  Since category 2 is where Martha Beck says we should shop wisely and not spend lavishly, it behooves us to devote time to putting something away every paycheck, becoming a wise investor and making sure we don’t overpay for good advice.  I say good advice because bad advice is costly even when it’s free.

I hope my synopsis of Martha Beck’s Joy Dividend strikes a chord with you.  I say throughout my tales that there is a fine line between over-saving and under-living.  It is a fine line and one that is of increased difficulty for couples since they must work together to blend the spending needs and loves of two people into one future.  Unfortunately, as you can read in A Large Tale, also on my blog, you will meet a couple that over-spent, however, in their case it didn’t translate to over-living.  There are no right answers to maintaining the proper balance between saving and spending, living and under-living.  Martha Beck’s approach is a good starting point.

My previous articles on Cash Flow Sherpas have focused on a small part of the wealth equation; the saving money side of the equation.  There is much more to it than just saving money and investing wisely.  How you plan on spending your money and where will it give you the most pleasure is something everyone should take seriously.  So repeat after me—Do I need it?  Do I love it?  Do we need it?  Do we love it?

This is my first wedding as a dad and the expectations are many. But since this is a site about finance, I will focus on the money side of weddings. In my opinion, there are two central questions surrounding a wedding. The first is how much money is a reasonable amount to spend on a wedding. The second is what alternative use is there for the money spent? There are no right answers to these questions, nor wrong ones, but the answers reveal much about the couple as well as the parents of the couple and their attitude towards money. In a nutshell, weddings aren’t cheap and only last a day. So what drives some couples to elope while others go through the ritual with an elaborate and expensive wedding? Money is certainly a factor. If neither the couple nor the parents have the money, then a small intimate gathering is the only alternative. If you go into debt to pay for a wedding I can virtually guarantee that you are headed for financial disaster. If you do in a few years your vows may gravitate towards “Until Debt Do Us Part.” Don’t go into debt to pay for a wedding.

But what if you have options? What if you are one of the fortunate ones that can afford a wedding from either current income or savings? You’ve got to ask the question. How much to spend for one day? How much are the memories worth? If you ask a wedding planner the answer is that memories are priceless. If you ask the father of the bride, you will get a very different answer. So is there a middle ground? I think not. After thinking about this for a few weeks as the father of the bride and investment manager, all I can say is that a wedding is one of those events that you can’t rationalize. You need to throw logic to the wind because no matter how much or how little is spent, if the money were invested instead, it would have a much higher expected value than a wedding.

On my Financial Tales site I wrote a story called A Twenty Million Dollar Tale. It talks about the cost of college and is also a stealth tale about the power of compound interest. I haven’t written a tale about weddings yet but when I do it will have the following visual. I am happy to share it with Green Sherpa before those that follow my site. The average wedding in this country costs approximately $28,000 and is spent in 1 day. My daughter will be 24 when she gets married and her husband 25. If this $28,000 were instead to be invested for 40 years at a real 7% return it would grow to approximately $420,000. At that time, in the year 2050, my 64 year old daughter and 65 year old husband decide to start receiving income. Mind you, they can only do this if they chose 40 years earlier to get married at the court house instead of throwing an elaborate party. 40 years from now they decide to receive the 7% annually instead of letting it grow. How much can they get per year? They would receive an annual amount of $29,400. They will have more money to spend for an entire year 40 years from now than for 1 day. Let’s repeat that line for emphasis—this is more money to spend for a year than for 1 day. Furthermore, they will get to spend it every year for the rest of their lives. They never have to touch the principal and after they live to the ripe old age of 90 plus, they can leave a legacy to their children, grandchildren, loved ones or favorite charity. The tradeoff is simple. You can spend $28,000 today for 1 day or you can receive a little more every year for the rest of your life after you retire in 40 years. There is much to consider when you think about weddings.

In light of the alternative to a wedding, they are bad investments plain and simple. Good investments are things that appreciate in value and preserve purchasing power, while bad ones are those that lose purchasing power. Weddings depreciate in value immediately. So the answer is that no amount of expenditure is correct. Yet these terrible investments persist and have persisted. Is there a logical answer to the unseen value? Is there a future value to a wedding with all the fixings vs. a Justice of the Peace? I can’t think of any, but I admit to a bit of tunnel vision on this topic. But if readers can enlighten me, please drop me a note at Financial Tales. If you do, please don’t mention the improbability of a 7% real rate of return. The message is still the same. I think expensive parties are bad investments.

What the future holds, what one leaves behind and what one carries with them are just some of the thoughts and realities surrounding graduations. I would like to tie these three together.  It’s not a romantic notion but a way to look at past, present and future in financial terms.  We’ve all heard the saying “Time is money.”   I like to think that choices are money as well.  The choices one makes dictate the way one spends time and the way one spends time dictates the amount of money they accumulate.  The three are intertwined.  Graduations give us pause to reflect on these simple three.

In my financial tales blog I wrote a tale called A Twenty Million Dollar Tale that speaks directly to the topic of college education and tries to answer the question of whether a college education is worth it or not.  If one reads it they will learn that from a purely financial perspective I don’t think college is a worthwhile investment in most cases and what it offers is a non-pecuniary reward.  In fact the tale gets its title from the fact that if instead of spending $25,000 per year for 4 years of college one instead invests it at 12% per year, by the time the student reaches age 65 it will be worth almost $20 million dollars.  College and the ultimate graduation from college is a decision that too many families have taken too lightly for too long.  The common selling point is that college graduates make more money than those that don’t.  However, it does not reflect on the fact that not only is college expensive but the student loses many years of earnings.  In most cases, the higher income for college graduates vs. non-graduates does not compensate for these two factors.

Time and money are complex subjects.  While money is a man-made creation used to facilitate trade.  It is also a measure.  As a measure, money is the most efficient way for societies to monetizing time and choices.  Generally speaking, the more money one has the better choices one has made.  The more money one has means time well spent.  When money is taxed, time and choices are taxed.  Fortunately, the value of money today can be mathematically translated to the value of money tomorrow.  This magic is performed through the process of compound interest.  I suggest the reader also read A Compounding Tale from my blog to fully understand how money today can translate to money tomorrow.  This of course means that time today or choices today are directly linked to money tomorrow.  If we save money today and invest it we will have more money tomorrow.  Learning how to invest wisely is time well spent and a choice one will never regret.

So this month of graduations, I encourage all graduates and attendees to reflect on the hidden meaning of the milestone event.  Those that are furthering their education need to understand that the next few years means time not earning money as well as time spending money.  Use it wisely because the cost is much more than it appears on the surface.  Those launching careers should invest time in understanding money and how it works.  You not only want to work for money but you also want your money to work for you.  Those that will soon be paying or have finished paying for education, should recognize the gift they have given either themselves or a loved one.  You have given the gift of money, the gift of time, the gift of choice.  Cherish it.

The last article I wrote featured my daughter and her first investment account.  This one goes back to the beginning of her first job, her first day.  On her first day, her employer put a form in front of her called a W-4.  They asked her to fill it out and her response determines how much of her salary, what is called gross salary, would go to her every pay period and how much would be set aside to pay taxes on April 15^th.  If she claimed few exemptions, more would be taken out of every paycheck so that effectively she would have less to spend every pay period.  Her net salary would be lower.  If she claimed high exemptions less is taken out every pay period, she would have more to spend every pay period.  Her net salary would be higher.  She called me up and asked me what she should do.  Here is what I told her.

I explained that she should review her W-4 situation once a year and make adjustments accordingly.  I explained that federal taxes are due for everyone in the country on April 15^th and that the question her employer was asking through the W-4 form wasn’t do you want to pay more or less taxes, but do you want to prepay your taxes so that you don’t owe anything on April 15^th and you might even get a refund.  I then explained that the analysis of what she should do isn’t a black and white analysis.  I explained that the W-4 provides financial flexibility.  It lets you determine if you wanted to prepay your taxes, essentially giving the taxing authority and interest free loan until you file your taxes,  or if you wanted to have that money for yourself and pay what you owe on April 15^th.  I suggested that she have very few exemptions and now that tax time is approaching she will see the benefits.  I call this exemption redemption.

Why did I tell her to claim few exemptions?  Why did I recommend she take a lower net salary?  The answer is twofold.  1)  In this interest rate environment with rates being very low, the cost of loaning money to the taxing authority isn’t very much.  She is not giving up a lot of potential interest or what economists call opportunity cost.  2)  In my experience, when people opt for the higher net salary by taking high exemptions they are succumbing to what I call the optimism bias.  They believe they will take the extra money from every paycheck and save it and invest it wisely until tax time rolls around.  It’s one of the things I admire about people.  They are optimists.  Unfortunately, while this is a great plan and it looks good on paper and in theory, it stinks in practice.  Most people spend the money and have to scramble to pay taxes on April 15^th.  It’s ok to be an optimist.  However, optimism without execution doesn’t work.  Until such time as interest rates are higher, lower exemptions seem more appropriate.

My 22 year old daughter graduated with a marketing degree in May of 2009 and started her first professional job in August.  Having grown up around me, she knows that she should save at least 15% of every paycheck.  I am very happy to report that my preaching, or nagging as she would call it, did not fall on deaf ears and in November she asked how she should invest her 15% from every paycheck.  This time I told her something I have never told anyone before. Normally I would have said she should invest in a low cost, no load mutual fund. However, this time I told her to wait until the end of the year and then invest in one of the 8 commission-free Exchange Traded Funds, or ETFs, that Charles Schwab had at that time recently announced would be introduced by year end. I’ll tell you why soon.

She asked me what an ETF was and I explained that ETFs were stocks that owned a collection of assets such as stocks and bonds, but that most importantly, they are what I call the next generation of mutual fund.  The only thing preventing the ETF from going viral on the investment public was the cost to buy and sell them in small quantities.  Once Schwab removed the cost barrier, Fidelity Investments responded by announcing that clients would be able to trade 25 popular ETFs at Fidelity commission free as well.  The dominoes are all in a line and soon I expect the trading of ETFs at no commission will be universal and you will also see them start to populate the fatted calf of investment fees called the 401k.  There is no stopping the ETF now that the veil has been lifted.  In my opinion, the mutual fund had its day in the sun and all but the most competitive both in pricing and performance will be displaced by the ETF.   So for my daughter and for every reader, learn as much as you can about ETFs.  There are hundreds of them and I will write about them at a later date but today I will focus on why I recommended that my daughter wait.  The answer is cost.

Let’s look at cost in the framework of expected returns from investing in stocks.  Suppose a person wants to invest $200 per paycheck in the stock market.  This is called Dollar Cost Averaging.  In the case of the stock market, let’s assume that a 22 year old starts to invest and the stock market averages 10% per year over their lifetime. What happens however, if the cost to invest the $200 every pay period is $20? Simple math will tell you that $20 is 10% of $200.  So in the first year all of the return is eaten up in fees.  With commission-free investing this is no longer the case.  Companies like Schwab and Fidelity and I am sure the others that will soon follow have found a way to eliminate this $20 fee and now the small investor no longer has this problem.

This transformative shift in the cost structure of how small investors can participate in the stock market will go a long way to accumulating wealth in America.  The victor will clearly be the investor and those companies that can deliver the commission-free ETF in a low cost, yet profitable manner.  The clear loser will be the mutual fund industry.

You can read a detailed explanation of Dollar Cost Averaging how it works by reading A Tale of Perspective from my Financial Tales library.