Wealth...Uncomplicated

Where Overdraft Fees Come From and A Better Process to Eliminate Them

The short answer is that overdraft fees come from spending more money than what is available in a checking account, but in an article from USA TODAY, they had a nice graphic that tells us how these overdrafts are transacted.  It should be no surprise that debit cards were number one on the list - generating 41% of all overdraft fees.  Here's the full list of how overdraft fees are created:

Overdraft Source	Percentage
Debit Cards	41.0%
Checks	30.2%
ACH/Electronic Debit	14.2%
ATM	7.8%
Other/Unknown	6.8%

The evolution of the 'free' checking account owes much of its thanks to the rise in debit card overdraft fees estimated at $15.785 billion last year.  Compared to the old model of checking accounts with monthly fees of $5 to $12, the banks have come out well ahead by offering 'free' checking accounts.

These are certainly big numbers, but what's troubling on this list is the 7.8% of overdrafts created at the ATM.  It seems to me that if there's no money in the account, an ATM should simply decline the transaction.  This is exactly what consumers have been saying for years, and it looks like Citibank, Bank of America, and others are finally coming around to giving up their overdraft fees from ATMs (most of it anyway, you can still opt-in to paying these fees).

By the way, if you want to reduce your overdraft fees, the best things to do are:

1. Pay all bills through your bank's online bill pay service - rather than having a check floating out there that you might forget about, the money is debited on the day the payment goes out.  No more sneaky checks coming through for an overdraft fee.
2. Separate your discretionary spending from your bill paying - if you boil down how much goes out in recurring bills versus how much you need as 'walking around money', you'll see that 70 or 80 percent of your money is gone before it ever gets to your wallet.  Setup a single account for recurring bills and a separate one funded with automatic transfers for your day-to-day expenses.  This way, you can manage a much smaller amount of money and eliminate overdrafts coming from checks and electronic withdrawals (44.8% of all overdraft fees).
3. Use cash instead of your debit card - if you're not using your debit card, you can cut your total risk of overdraft by 41%.  Find a bank with convenient ATM locations and go there instead of using the plastic.

My wife and I have been using this system for a long time, and as you can imagine, no overdraft fees.

The Process at Work

As promised at the outset of this year, it's all about principles and processes.  In this post, we're looking at using a better process in managing cash flows in an effort to eliminate overdraft fees.  If you use your bank's web bill pay, separate your bills from your discretionary spending, and use ATMs instead of debit cards, you can take overdraft fees out of your life.

Data Source:  November 2008 FDIC Study of Bank Overdraft Programs

The Three Black Holes of Budgeting - it's not even close to what you think

Somewhat amazingly to me, there are millions of people going about preparing their budgets and millions more complaining that there's too much month left at the end of the money.  There are fights between spouses and couples about buying this or that; disputes arise among roommates about whom should be paying what; and there is generally a whole lot of bickering, fighting, and foolishness surrounding making and living by a budget.  All the while, most are trying to solve this problem by 'spitting on a fire'.

It's NOT the Small Stuff

When it comes to budgeting, a $5 coffee won't break you.  Nor will a $50 mani-pedi.  I don't even think a $100 hair color treatment and styling will bust it.  Usually a budget is doomed before it ever gets to the day-to-day choices because of what financial geeks call fixed financial obligations.

What are these obligations?  Housing, transportation, insurance, utilities, and just about anything else that you have committed your paycheck to and have little ability to substantially reduce or eliminate without a major pain in the backside.  You can't go without a roof over your head.  Certainly we all need transportation of one form or another.  Living without insurance is kind pretty stupid, oh, and we need some of that thing called electricity too.  Like it or not, we've all made our beds and we're laying in them.

Unfortunately, not all beds are as nice as Tempurpedic or Select Comfort beds.  Many are about as comfortable as a gravel road with patches of mud and shards of glass mixed in.  Not good.

So how do we go about making our lives more comfortable through a budget that actually works?  Simple, get yourself a more comfortable bed.

Black Hole #1: Housing

The largest black hole in budgeting is housing.  It controls the largest portion of your after-tax income including (1) mortgage payment, (2) real estate taxes, (3) homeowners insurance, (4) furnishings, (5) repairs and maintenance, (6) electricity, (7) gas and/or heating oil, (8) water, and (9) lawn care.  If you add all of these expenses, many will find that more than half of their take-home pay is committed to housing.  The size of the home you purchase will greatly influence all of these costs.  A bigger home requires a bigger mortgage payment, higher real estate taxes, increased insurance premiums, more and better furnishings, greater maintenance, higher electricity consumption, increased heating costs, more water consumption, and more expensive lawn care.  Can you see the black hole now?

Black Hole #2: Transportation

With the elephant out of the room, it's time to deal with the rhinoceros.  Transportation can take many forms depending on where you live, but for most Americans, it's an automobile of some sort.  To pay for the great privilege of transportation, our budget takes hits from (1) auto loan or fleece...err...lease payments, (2) personal property taxes, (3) auto insurance, (4) registration fees, (5) repairs and maintenance, (6) gasoline, and (7) massive depreciation.  Here, it's not just the size of the vehicle, but also the age that dictates how large the black hole will become in your budget.

 

Black Hole #3: Debt Servicing Payments

Finally, we get to the problem of debt.  Many carry balances on credit cards, take out personal loans, obtain 'special' financing, and the like.  All of it increases your fixed financial obligations.  Of course, I'd argue that this one is simply a result of the aforementioned lifeblood sucking black holes, but I think it merits mention on this topic.  Think about it.  If you don't over-commit on housing and transportation, wouldn't you have plenty of cash to buy all the lattes, mani-pedis, and whatever else gets your rocks off?  Sure you would, and that's the point.

Keeping Black Holes Out of Your Universe

To keep these three massive budget-draining, black holes out of your life, there are some simple rules to follow that admittedly, will make you a weirdo in the mainstream.  Here they are:

1. Live in the Smallest House You Can Manage - If you have a family of three and won't be adding to the family, get a two bedroom home.  What's the third bedroom for anyway?  This is unused capacity that will kill your budget.  Don't forget, that 'extra' bedroom will make you pay extra in eight different ways.
2. Buy Used and Drive It Until It Dies - Think you should only buy new cars?  Wrong.  Buying used dramatically reduces the amount you pay in depreciation and lowers your cost of ownership in a total of five different ways.  Over the course of your working career, buying quality used cars and driving them into the ground will save you hundreds of thousands of dollars compared to buying new.
3. Get and Stay Out of Debt - Once you've made the changes in housing and transportation, it should be easier to get and stay out of debt.  With reduced commitments in 16 areas of your budget, getting out of debt should be a piece of cake.  Shortly thereafter, you'll want to make investing in 'you' your number one fixed financial obligation through saving and investing, education, or both.

Ultimately, a lower proportion of fixed financial obligations is the path to living within a budget and achieving lasting financial security.  Don't be fooled by the myriad budgeting books, articles, and software out there.  The reality of broken budgets has far more to do with your fixed financial obligations than with your day to day spending - so quit bickering over foolish little things.