The Basics of Personal Finance
Lisa Laprade from Women’s Personal Finance has a great article we wanted to share:
Back in the day when I was growing up, my mom taught me all of those little things that any young lady should know: How to sew a button on a shirt, knit a scarf, clean a house from top to bottom, and so on. I thought she had covered everything, but she left out two things that ended up being of great importance- cooking and money.
As I approach 40, I still can’t make my way around a kitchen, but I did teach myself to make a mean macaroni and cheese, as well as quite a bit about money and finance. Personal finance can sometimes seem maddeningly complex, but it doesn’t have to be; knowledge of some basic principles will make your life much, much easier.
The Very Basics
- Spend Less than You Earn. This may seem like a bit of common sense to many, but it really is an issue when it comes to trying to save money. The term “Champagne Taste on a Beer Budget” comes from this area of finance, as there are hundreds of thousands of folks that just spend way more money than they bring in, with the help of credit cards, car payments and other personal loans from financial institutions that see you as nothing more than a dollar sign. Cutting spending habits and/or aiming for a large pay increase are the only two options available to help you.
- Pay Yourself First. Financial expert David Bach, author of Start Late, Finish Rich tells everyone to throw out the dreaded “family budget” for this simple reason: It doesn’t work–if it did we’d all be doing it and we’d all be rich. According to Bach, as long as we all save a percentage of our pay each month, what the rest is spent on really doesn’t matter. If you “Pay Yourself First”, meaning that before you sit down to pay your monthly expenses, pay yourself in savings/retirement the equivalent of one hour per workday (or 12.5%) before anything else.
Buying a House/Mortgages
- Get Pre-Approved for a Mortgage before You Begin House Hunting. When you put in a bid on a house, the seller looks at more than the amount you are willing to pay. The seller will give more consideration to a lower bid amount that is already pre-approved by the bank than a higher bid without definite financial backing.
- Pay Your Mortgage First. Sure, your credit can go through the ringer, but you’ll at least have a roof over your head. Many first-time buyer programs require you to attend classes taught by financial experts, and this is one of the first things they will tell you.
- Always Try to Pay More than the Minimum Mortgage Payment. By paying one additional principle and interest payment (mortgage payment minus any escrow payments) on your mortgage balance each year, you will knock 7 years off the life of your note. It all adds up–to a lot!
Credit & Debt
- Don’t Try to Keep Up with the Jones’. Yes, the Jones’ next door might have a colossal house, landscaped backyard with a kidney-shaped, in ground pool and two 9-series BMW’s parked in the driveway, but they also might have $40,000 in credit card debt and owe on their three cars. Giving into social pressures or compulsions as an excuse to buy elaborate items is nothing short of silly.
- Pay Off Credit Cards Before Other Debts. The world of compounded interest is alive and well within the credit card industries. While these companies love it when you only pay the minimum, paying more than the minimum, no matter how much, is better than nothing at all.
- Know that Credit Scores Affect More Than Interest Rates. If your score is less than 620, not only will you pay significantly more money for mortgages and other types of loans, but also more for your insurances. Your car, life and auto policy premiums will all reflect your credit. An adverse score may also keep you from leasing an apartment or getting your dream job.
- Keep Credit Card Balances Below Half of the Credit Limit. Credit cards below the 50% mark create higher marks on credit reports than those past the halfway point of the limit. Continuously “maxing-out” your MBNA rewards card is considered to be almost as bad as a few late payments.
- Always Pay Credit Card Bills on Time. Not only will you have to pay a late fee (as much as $35) for not making your credit card payment on time, but that new fee could put you over your credit limit, which would, in turn, warrant another fee to your balance. And don’t forget that your interest rate will most likely increase after all of these tiny instances, which will make it even harder for you to get rid of the balance. (Remember, balance transfer cards are only a temporary solution.)
- Community College Credits Transfer to Big-Name, 4-Year Universities. By hitting the college books closer to home, not only are you saving money on the courses, you’re saving a bundle on room and board. After an associate degree is attained from your local CC, transfer the credits to your dream school. Your bachelor’s degree will contain the name of your beloved higher learning institute, and you’ll have saved over $50,000.
- Take Advantage of National College Savings Programs for FREE Money. U-Promise, among others, is a medium between corporate moneymakers looking for tax breaks and you, the consumer looking for ways to save money for college for yourself or your kids. Take advantage of it, but don’t be sucked into buying items that you won’t use, don’t need, or are more expensive than you normally buy. If you habitually buy the soda brand that’s on sale at the supermarket, don’t not buy it because of the U-Promise tag–it’s just not worth it.
- Avoid the 20% “Fool’s Tax”- Don’t Buy a Brand New Vehicle. As soon as you drive a brand new vehicle off the lot, it’s value drops 10-15%. Depending on the make and model of the car, the depreciation will continue to drop an additional 10% by year’s end and each year after for the next two years. By purchasing a previously owned or leased vehicle either a year or two old, you’ll still have a quality auto with available warranty while letting someone else take the major financial hit.
- Buy Certain Everyday Items Used. DVD’s, CD’s, books and sports equipment can each cost significantly less bought used than if purchased new. If you don’t have a good used book or CD shop nearby, there are thousands of them on the Internet. Of course, you’ll need to calculate shipping and handling into the price to be sure if you’re truly saving money.
- Don’t Waste Too Much Time with Coupons. Take, for example, coupons. Although these little slips of paper can add up to save you a few dollars a week (ever more if you shop at a store that offers “double coupons”), ask yourself a few questions before busting out the scissors. First, do you need it? Second, is it something that you and/or your family will use? Thirdly, is there a comparable item, possibly generic, that’s cheaper without the coupon? If you were planning on buying an item and have a coupon, great! But if not, don’t even bother–it’s money spent on something you don’t need, which is considered to be a waste.
- If you NEED to Buy Designer Clothes, Buy them Second Hand. Clothes do not increase in value, no matter what anyone tells you. The only millionaires that sport the brand name gear are those who designed it. Celebrities and those in the public eye that are wearing a particular name across their chest are being paid to do so and more than likely received the clothing for free. The designers are hoping that you’ll see your favorite star in their brand and run out and buy some for yourself.
- Always Shop Off-Season. When you want a new patio set, buy it towards the end of the summer (after the 4th of July) and you’ll pay roughly half of what you would have at the beginning of the season. The same goes for clothes and shoes, including for the kids. By stocking up during clearance time, you can save yourself a bundle of cash over purchases at peak times.
- Don’t Skimp on Healthcare. Of all the ways to save money on monthly expenses, cutting your healthcare is the worst idea. Saving a few hundred dollars a year is hardly worth having to pay $50,000 in medical bills a few years down the road.
- Prescription Coverage Is a Must. Even if your doctor has given you a clean bill of health, you just don’t know what could happen–and with the rising costs of medicine, you may very well be stuck with $200 of necessary meds at any given moment.
Insurance (Auto & Homeowners)
- Ask for Discounts. Many insurers won’t volunteer discounts like multi-policy, safe driver and good-grade deductions on your premium, but will be “reminded” when you mention it, so don’t be afraid to ask.
- Don’t File Small Claims on your Homeowners or Auto Insurance Policy. Too many small claims on a policy (at or slightly above the deductible) will send up a red flag to your insurer- when renewal time comes around, you might just get a cancellation notice in the mail.
- Higher Deductibles on Home and Auto Policies are Usually a Good Idea. You want to try to save these types of insurance for the “big stuff” like a fire (on either), not a smashed window that will cost less to repair than your deductible (see previous entry). You can figure on about a 25% savings when raising your deductible from $500 to $1,000.
- Shop Around for New Auto and Homeowner Insurance Every 3 Years. Your car is getting older, so the cost to replace it is dropping. Ergo, some parts of your insurance premium should be dropping to coincide. However, some insurers don’t look at it this way and insist on increasing your premium. Shopping around for a new insurance company and policy from a fresh-eyed agent might just yield a lower payment for you.
- Don’t Even Bother Trying to Pick and Choose Stocks. Picking stocks for the sake of picking stocks is a poor investment decision, to say the least, as 80% of fund managers can’t beat the S&P after expenses. If you’re going to buy into funds, you need to keep the costs low from every possible angle. Warren Buffet, investment guru, suggests ETFs and index funds to individual investors wanting to maximize their money.
- Keep Some of Your Investments in Liquid Assets. You’re going to need to keep some of your investments somewhat close to home in case of an emergency, like in a Certificate of Deposit or other no-risk investment.
- Check out Commission Rates for Potential Financial Advisers. Some financial products out there come with high costs and commissions–paid by you, the investor, to the fast talking advisers who sell them. The high commissions involved can unfortunately steer some advisers to sell some unworthy products, leaving you, the investor, alone and out in the cold. Ideally, you don’t pay a commission to a financial advisor, at all; instead, hire for a fee-only planner.
- If You Don’t Understand an Investment Product, Avoid It. Not understanding where your money is going doesn’t mean that you’re stupid. Don’t try and act like you know what’s going on when you really don’t; in the end, you could lose money–and then you’ll be stupid. If you’re a high-net-worth investor, you might want to employ a financial adviser. These people specialize, so depending on your location or profession, you’ll want to find a reputable local financial manager, or if you’re in the medical field, a financial manager who works for doctors, or if you’re a professional athlete, find one that specializes in managing athletes!
- There’s a Big Difference between Saving and Investing. While saving money is something that should be done regardless (rainy day savings, retirement, etc.), investing should be done when you are relatively debt-free, especially when it comes to credit card debt. Any investment opportunity will hardly make up for the 18% annual interest paid by you on credit card balances.
- When Applying for Life Insurance, Answer all Questions Honestly. Paying a bit more now to accommodate for your skydiving hobby is much better than having your family’s claim on your policy denied when your chute doesn’t open.
- Buy Life Insurance with the Hopes of Never Using it Life insurance should be purchased to help care for your dependents in the unfortunate event of your untimely passing–and that’s all. Mortgage payments, groceries and a college fund should be the goals, not making your family millionaires.
- Keep Life Insurance and Investments Separate The commissions and fees for “Whole Life” life insurance policies can rack up quickly–and guess who’s paying for it? (Hint: It’s not the insurer). Buy yourself about 5 years’ salary worth of term-life insurance and take the difference from what you would have paid for a whole policy and invest it into some index funds or ETFs.
Loans & Borrowing Money
- Shop Around for the Best Interest Rates and Terms. Not all financial institutions are created equal, and no two offer the same rates and terms on similar loans.
- Never, Ever, Under Any Circumstances Take a Cash Advance on a Credit Card. Not only will you pay a ridiculous interest rate on the cash you withdraw, you’ll pay fees- and interest on those fees- for the remaining years on your new, giant–sized, credit card balance.
- Stay Away from Cash Advances/Payday Loans. At a national average fee of $18 per $100 borrowed for each 2 week period , the annual interest rate calculates well into the triple digits. To put it another way: it’s cheaper to borrow money from the Mafia.
- Don’t Count on Social Security. By the time the tail-end of the baby-boomers retire in about 25 years (the last of this generation was born in 1968), there isn’t a very good chance that Social Security will be paying out as much as we have paid in. A solid back-up plan, like a tax-deferred IRA or 401K will help to keep you from living in a shelter.
- If Your Employer Matches 401K Investments, Absolutely Get the Entire Match. This is FREE money that your employer is giving you towards your retirement, but they won’t give a dime out until they see you putting money in too. Plus, 401K paycheck deductions are usually pre-tax, so you’re getting even more free money. And you can raid this money before retirement, without penalty, when you buy your first house.
- Getting a Part-time Job for Retirement Helps More than Your Finances. Besides the fact that you can make up to $17,000 per year without having your Social Security check docked, getting out and earning an income, seeing people each day and basically being a money-making member of society will help your health, happiness and well-being (in addition to your wallet!).
- Don’t Cash Out Your 401K When You Change Jobs. No matter how tempting it may be to pay off that credit card balance or car loan, you need to pretend that your hard-earned, 401K-money was never yours to begin with. Otherwise, be prepared to pay heavy taxes and penalties, and work until your dying day.
- The Fed Gives Tax Breaks for Retirement Savers. The amount that you put away for retirement in an IRA is tax deferred up to a certain amount each year. This means that your money is “hidden” from taxes on your annual income–for now, anyway. You pay the taxes on any money withdrawn from the account only when you retire–and by then your tax rate will probably be minimal, anyway.
- Saving Money is a Positive Habit, not a Negative Burden. Parents who save money have children who save money, as long as the parents make a positive impression when it comes to the savings part. A habit can also be considered an addiction-and an addiction to watching your hard-earned money grow is not a bad one, either 😉
- Save 10 Cents From Every Dollar you Make. The 10% rule has been around since my mom’s mom, I think that it was just misplaced along the way. If I would have saved just 10 cents from every dollar that I ever made, well…wow.
- Always have an Emergency Fund Available Equal to 3 Months Pay. Just in case of illness, auto accident or corporate downsizing, the 3 month rule should be enough for you to get through without having to dip into any long-term investments.
- Get Receipts for All Charitable Donations. Tax deductions come in many shapes and sizes, but none quite as comforting as the one you get for charitable donations. When you head out to donate your used clothing, furniture and knick-knacks, bring them inside of the building and ask for a receipt. Keep all donation receipts together; make sure they total over $500 (anything under that doesn’t require receipts) and come April, you’ll have an extra tax deduction.
- Keep a Travel Log of All Work-Related Miles Driven in Your Car. Any mileage traveled for work-related purposes above and beyond what you normally travel is eligible for a tax deduction. If you normally travel 30 miles each way to work, and a meeting takes you 50 miles away from home, you can deduct the difference in mileage, or 50 miles-30 miles= 20 miles.
- If You’re in a Serious Pinch: For a Fee, the IRS will “Finance” Your Tax Bill. Although it’s not the greatest option, it is one if you’re in a financial bind on April 15. By contacting the IRS with a written plan (like $100 monthly until your debt is settled), it will still cost you some serious fees, penalties and interest, but at least you won’t have the Feds knocking down your door.
One Final Tip
- Money is Important, but It Ain’t Everything. Health and happiness are the most important things in life, but that doesn’t mean that you should be foolish with your money. Fighting and worrying about money isn’t going to solve any problems and could, in fact, destroy your health and happiness. A bit of planning, a common goal and some serious focus will help lay the building blocks for a strong and sturdy financial future.