July 2006 - Posts
When it comes to investing, you might be on the inexperienced side now, but it doesn’t mean you can’t learn some basic investing smarts. If you develop a solid understanding of your overall financial picture you will be off to a good start. As mentioned earlier, it’s also important to double-check that you are in a secure financial position before investing. A little financial checkup may be in order. Do one final check to see that:
1. You are not behind in your payments on credit cards, or on outstanding loans or operating in the red.
2. You are not investing money that has already been earmarked to pay a line item on your budget.
3. You have some easily accessible cash in a bank account or money market for emergencies or unexpected cash flow problems.
Next, it’s important that you understand some of the basics. A few key investment concepts for you to review are listed here.
1. Asset Allocation
According to a study in the Financial Analysts Journal in 1991, only 7 percent of successful investing depends upon the selection of specific stocks, bonds, or mutual funds. The other 93 percent of successful investing depends upon selecting the right asset classes in which to be invested, as well as when to be invested in them. The question of whether you should be invested in CDs, the stock market, the bond market, real estate, money market funds, precious metals, global investments, and so on is, therefore, the tantamount question that precedes which mutual fund or stock to buy. Essentially, it’s a matter of deciding which mode of transportation is best for you before deciding which airline to fly on or which car to rent.
Henry Block, financial analyst and president of 5Star Management, a money management firm in Salt Lake City, Utah, notes that the wealth of advertising on television, radio, and in print is designed to promote specific investments, telling you how the investment has faired. “All of this is focusing on the 7 percent of the equation. Very little is done out there to help the average person on the street focus on the 93 percent of the equation, which is what I emphasize,” explains Block, who adds that the 93 percent basically says that a rising tide raises all ships. “While an investor can run around deciding whether to invest in a tug boat, a sail boat, an ocean liner, or a cruise ship, he or she needs to appreciate the fact that all the ships will rise or fall with the tide, which holds true for investments in a particular asset class.”
Within the broad grouping of asset classes (stocks, bonds, mutual funds, etc.) there are more specific asset classes. For example, equity mutual funds include large-cap stocks, medium or mid-cap stocks, and small-cap stocks (“caps” equate to the size of the company in regard to their assets), plus various sectors such as utilities, technologies, energy, and financial. There are cyclical stocks, and a host of industries such as the auto industry, airline industry, and so on. Each of these sectors and industries can be defined as a different asset class with very different behavioral characteristics. The stocks within that asset class will most often behave according to how that asset class is doing as a whole more than according to the fundamentals of a particular stock or bond. If, for example, IBM reports below-expectation earnings, then (in most cases) so will Apple, Intel, and the entire industry, unless there is a particular story centering around IBM, such as a merger or lawsuit, etc. The same holds true with funds. Asset classes perform in specific ways, the most notable being the tech stocks and tech stock funds of recent years. Surely, you can find an Internet stock that is the exception to the rule, but by and large, the sector has grown universally.
Asset allocation, therefore, means determining how much of your assets you are putting into each kind of asset class. You will ultimately allocate your assets into stocks and/or equity funds, bonds and/or bond funds, money market funds, real estate (including REITs (Real Estate Investment Trusts), or other types of investment vehicles based on the following factors:
1. Income level
2. Amount of money you have available to invest
3. Level of investing sophistication
4. Ultimate use for the investment, or goal (retirement, college, etc.)
6. Time frame until reaching your goal
7. Level of risk/tolerance
But how do you distribute them?
Combining these factors, you’ll determine what is the right breakdown across asset lines. For example, you might want an 80-20 split between equities and bonds or vice versa.
Generally, as investors get closer to their goals, they will become more conservative, particularly if money is earmarked for retirement. Approaching retirement, many investors will put a higher percentage of assets into safer investments with lower fundamental risk. The thinking is often that if you lower your amount of assets in equities and switch to bonds and cash instruments as you approach retirement, you will have a steady flow of income with less risk.
Another theory, however, would be that since on the long term the stock market has always done well (and the average life span may be twenty years beyond a retirement at age sixty-five), you might be just as well off keeping a reasonably high percentage in equities. The equities will grow, and if you should need income you can always sell a stock. Retirees need not invest so conservatively that the money is no longer growing over the next twenty or even thirty years. Karen Altfest of L.J. Altfest and Company, New York–based financial planners, notes that many people are also investing for two generations. “Many people want to invest for their children, and they don’t want the money to stop growing or stop producing when they die.” Retirees today need a certain amount for living expenses and various wants and needs, so that part is invested in a more conservative vehicle. Beyond that, the approach may be somewhat more aggressive to build up money for the next generation. Ms. Altfast adds, “It’s not only a case of leaving money to family.” She cites one client who does not have a family but wants to leave his money to an animal shelter that he cares very much about. “People have plans beyond their death,” she notes.
The theories vary, but the main idea is to allocate your assets in line with the factors mentioned here and remember that everyone’s situation is different. Do not let financial planners talk you into more-or-less conservative investments that are not right for your personal needs.
While I can’t emphasize enough that your investment strategy must be based on your individual needs and goals, I can still offer a few broad portfolio planning strategies for allocating your funds. These are merely a few allocation breakdowns to give you a ballpark look at what you could do in various situations, tailoring them to meet your needs, income, age, etc.
1. If you have a long-term plan, with a ten- to fifteen-year goal, you might start with a more aggressive approach to asset allocation, going with at least 85 to 90 percent in equities, including 25 percent in an international fund and 20 percent in emerging growth funds or small-cap companies.
2. If your goals are coming up in seven to ten years, such as having a child in grade school and saving for college, you can still be somewhat aggressive, with a small amount of international holdings as part of an 80-20 or 75-25 equity-bond split. You can balance your bond fund between conservative and aggressive bonds or bond funds and have some cash investments as well.
3. If you are looking at reaching your goals in four to seven years, such as having a high-school-aged child heading for college, you may want to lean toward an even split between safer bond investments and equities. In this case, however, you should be opting to invest in more established companies (even some that pay dividends) than going for the higher-risk stocks.
4. If you are reaching retirement, it’s usually, though not always, the time to go in the low-risk safe direction. A 75-25 split with bonds leading the way may be the right approach. Once you’ve established a safe, income-producing portfolio, however, unless you are adverse to risk, you can use the last 5 to 10 percent to play with a riskier equity fund.
These are just some very basic allocation ideas. There are a variety of ways to split up or allocate your assets within the stock or bond market, and real estate, cash instruments, and other investments will also come into play. The overall asset allocation that is right for you will depend on your specific goals, needs, and time frame to reaching your goals. Investment experts agree -- and I agree with them -- that allocating your assets properly will provide piece of mind as well as a good game plan toward reaching your overall goals.
They say life begins at 40. But saving for retirement should have started long before that - if you believe all those retirement planning books and articles. It's advice many people ignore. What if you're now in your 40s and you haven't even started?
The good news is you don't have to panic. But you do have to get serious about it - and you will face some tough choices. Making up for lost time could mean really cutting back on your current spending. If you don't start saving until your 40s, you'll need to set aside 20% of your gross income. If you wait until your 50s, your target will have to be 30%. As a last resort, you may have to sell your house, your cottage and your second car; get a second job; and reduce your leisure spending.
Like I said, though, don't panic. The U.S. Government, as part of President Bush's last tax package, made an allowance for 50-somethings who needed to play "catch-up" with their retirement savings to invest more of their money into their 401(k)'s IRA's. Normally, the IRS cap such annual contributions. But Uncle Sam has removed those caps for those Johnny-Come-Latelies who need to grow a lot of money -- and quick.
If you find yourself in a catch-up situation, you'll likely need to take more risk. That doesn't mean putting all your money into penny stocks. But it does mean having a greater percentage of your investments in higher-earning equities rather than the more cautious Treasury and savings bonds that many people select as they get older.
Consider these examples:
If you start investing $100 a month at age 25 into a retirement account that gains 10 percent a year, by age 65 you'll have $632,000. But if you don't start investing the same amount until you're 35, you'll only take away $226,000 when you retire. Starting at 25 will get you $406,000 more, at a cost of only $12,000.
If you set aside $200 a month at a 10.2 percent return, you could start investing at age 21 and stop 10 years later and have a $1 million nest egg at age 65. That means a $22,000 investment over one decade gets you $1 million down the road. Of course, assuming continued inflation, $1 million then won't buy you what $1 million would today. But it'll buy you a heck of a lot more than nothing will.
The Rule of 72
Here's a trick some financial planners use. To find out how many years it will take your investment to double, divide the annual rate of return by 72. So at a 7 percent return, your money will double in 10 years and quadruple in 20 years. Financial gurus call it "the rule of 72."
The benefits of investing early in life are obvious. But to make it work, you also need to invest regularly. Saving at scheduled intervals in regular amounts has become easier, in part due to defined-contribution retirement options such as the IRA's and 401(k) plans I mentioned above. These are good start-up investments because money is automatically deducted from your paycheck and contributions are often matched by your employer.
Things have changed a lot in 230 years or so.
At the time of the American Revolution, life expectancy at birth was 23 years. By 1900 it had climbed to only 47 years. If you were alive, you worked. There was no such thing as retirement. Today, though, life expectancy at birth is 76; today’s 76-year-olds have a life expectancy of 86. According to some estimates, by 2007, half of all deaths in the U.S. will occur after age 80. These life expectancies are a big part of why we need to plan.
Why are these figures important? Well, if you’re wondering how much money you’ll need in retirement to avoid running out of money during your lifetime, you need to project how long that lifetime will be. Based on data provided by various government agencies, most financial planners assume their clients will live to age 85, and conservative planners use age 90, just to be safe (the longer you live, the more money you’ll need).
Consider food. Assuming you and your spouse retire at 65 and live to your normal life expectancy of 85, you’re going to eat 43,800 meals in retirement! (That’s three meals a day, 365 days a year over 20 years for two people.) If each of those meals costs five dollars, you’ll spend $219,000 on food. Where is that money going to come from?
Most people don’t know – or don’t want to know. Of today’s retirees, 51% have incomes below $10,000 a year. Also, the Social Security Administration defines financial independence as an annual income of $24,000 a year. Would you consider yourself financially independent if you earned just $2,000 a month? Another 30% of retired Americans earn $10,000 to $20,000 a year. That means only 19% of retirees earn more than $20,000 a year. The rest — 81% of all retired Americans — are financial failures.
It used to be that a worker and his family could be comfortable if he retired at 62 on a pension and Social Security. That doesn’t happen anymore. Today, you don’t retire as young as 62 — unless you’ve been downsized out of work. And you’re going to live much longer than your parents and grandparents did, aren’t you? Therefore, your money must last much longer. And that is the dilemma: If you fail to plan, you face the possibility of a retirement filled with poverty, welfare, and charity. A Gallup survey showed that 75% of workers want to retire before age 60, yet only 25% think they will. That suggests people don’t know how they are going to achieve their goals. One thing is sure; it’s not going to happen by itself. It’s going to require effort and attention.
For many Americans, these are things they don’t want to talk about. The biggest shock of their financial lives comes when they learn from a financial planner or a computer software program how much they ought to be saving each year for retirement.
The amounts can be so staggering that some people simply throw up their hands, figuring they will never be able to save anywhere near what's needed.
The good news is there’s a simple way to figure out how much you’ll need to retire on. First, you need to know how much you’re spending today to maintain your lifestyle and then carry the numbers forward, adding a bit of inflation, to see what you’ll need down the road. For example, if you are 40 and want to retire at 60, you have 20 years until retirement. Assuming you could live well on $50,000 annually, and plugging in a moderate three percent inflation rate, you’ll need about $90,000 per year by the time you retire.
In general, the rule of thumb is having about 80 percent of your pre-retirement income to live on in retirement. But a better idea is to count on having 100 percent on hand. Inflation could go higher, Social Security may collapse, and you may live long enough where health care is a major, and expensive, issue.
Tomorrow we'll discuss how to get started on a retirement plan -- including big keys to meeting your financial goals much faster.
Okay. The financial underpinnings are in place. Now it’s time to pour the concrete.
With a renewed commitment to a personal budget, a handle on your net worth, and a new attitude on handling your personal financial records, it’s time to get serious about where you want to be financially and how you plan to get there.
Whether it’s a one-year plan to pay for your daughter’s wedding, a five-year plan to purchase your first investment property, a ten-year plan to pay for your son’s college education, or a 30-year plan to save for retirement, establishing finite financial goals down the road is a winning plan.
Achieve most of your goals--or come close--and you have measurable proof that you are headed in the right direction. Fall short, and it's a head slap that more drastic steps may be necessary.
Unfortunately, we’re seeing more of the latter these days. A recent survey by a Big Six accounting firm shows that unless we save a great deal more than we currently do, three out of four Americans over the age of 20 will have less than half the money they need to retire and maintain their pre-retirement standard of living.
In fact, on average they would have to reduce their expenses by 60% -- or get a job flipping burgers -- in order to make it through their twilight years without running out of money.
If your after-tax expenses currently run $50,000 a year and you retire today, you would have to cut your spending by at least $30,000 if you want your money to last as long as you do. And that huge cut in your budget assumes that you have the good sense to die on the day you spend your last penny. If you survive longer than the actuaries estimate, you'll outlive your money.
That’s why setting long-term financial goals is so critical. Fortunately, it’s also pretty easy.
Here are some ideas that will help you establish your game plan:
Be specific -- Aim for clear targets such as "$2,000 into a retirement account," rather than generalities like "contribute to savings."
Put pay raises directly into savings or toward debt reduction -- If you make ends meet now, then you don't need to live off the cash you get in a pay raise. That being the case, put the extra money where it will do the most good, either increasing retirement savings or trimming debt. In this way, you maximize the good of the pay raise and move toward long-term goals without reducing your standard of living.
Invest in stocks -- It is virtually impossible to beat inflation and generate a decent return without investing in the stock market. You're taking on investment risk, but you are avoiding inflation risk, and if you have a diversified portfolio, you are spreading your investment risk. Inflation risk isn't to be understated, even though it's been relatively non-existent for the past several years. Let's say you're heavily invested in Treasuries that pay 6% interest. Inflation suddenly spikes upward to 10%. You're now losing money and the only way to compensate is to sell those investments at a loss and reinvest the money or to continue falling further behind in real income because inflation is outstripping the return on your investments.
Estimate how much you’ll need to retire in comfort -- Start with a rough estimate based on what you earn now. If you expect a more modest life in retirement, use 60% to 70% of your current income. However, if the future holds too many unknowns, start with 100%. Then tackle more detailed financial calculations-either on your own or with the help of financial planners-to assess such factors as the likely impact inflation will have on your purchasing power.
Develop a savings plan -- How far away you are from retirement plays a large part in how you should invest your retirement money. Historically, there are three stages to a long - term regular savings plan for retirement: capitalization, consolidation and conservation. In the first stage, people should be most concerned with building up their retirement savings portfolio. These investors can take as aggressive an outlook as their nerves can stand because at this point there is little capital to risk. The second step, consolidation, makes up the bulk of your savings plan; balance the aggressive investments with some tamer ones, to better protect your existing assets. The final change, from consolidation to conservation, when your investments should aim to preserve the capital you have, should take place one to three years before you retire. The exact timing of all these should take current market conditions into account
Start saving now -- You'll need to save enough from your 30-odd years of working to live for about 20 years in retirement. So get cracking. When you do ramp up your savings program, overestimate your needs. It's far better to end up with too much money than not enough. Even a little bit more a year can make a difference in the long term.
Get some good life insurance – Solid life insurance is critical to your family’s fiscal fitness. If you’re out of commission, or worse, chances are you may not have enough life insurance to protect your loved ones. Usually, several hundred thousand dollars worth of term life is the way to go. Term is generally the most inexpensive way to insure a life. The policies offer no savings feature, no cash value, and no retirement benefits. If the policyholder dies during the coverage period, the company pays a specified sum of money to the beneficiary. The key for deciding how much insurance to purchase is for each partner to determine how much money he or she would need to live comfortably.
Keep these goals in sight and your financial future will be much more secure.
For some people, getting their financial house is order is more daunting than undergoing root canal. Financial records left to run amok can seem intimidating as you look at boxes and file cabinets overflowing with documents. Fear not, though. Organizing your financial records is as easy as it is well worth the effort.
Where do you start? These days, just about everyone has a separate room in the house, or at least a corner of the bedroom or the dining room, with a desk, maybe a personal computer, and some space to pay bills and conduct their personal business. If you open your mail in the kitchen, keep a file drawer handy. If you have a home office, get an “in-box” for bills and other personal mail. The key is not the sophistication of the space, but just having a dedicated place to handle your bills, your paperwork and your money. Experts say a well set-up work area or home office can help just about everyone reduce stress, improve productivity and add more personal time everyday.
More and more people are turning to multitask computer programs like Quicken
or Microsoft Money
that automatically remind them of the bills to be paid, handle the math calculations and make money management almost a pleasure. Plus, if you have both a computer and a modem, you can link your financial software to on-line services that let you keep track of your spending. A PC- or Mac-based personal finance software package also eliminates what the American Bankers Association
confirms as the single largest reason people overdraw their checking accounts: Math errors. That’s because money management software makes calculating balances a no-brainer even for those who aren't math experts.
Unfortunately, the personal computing era has done little to back up its claim as the gateway to the “paperless” era, so organizing your paper documents is a must. You can start by keeping all of your essentials in one spot. Keep most used items -- store stamps, envelopes, stationery, file folders and note pads -- within arms' reach on your desk. If possible, place bookshelves and filing cabinets nearby. Create an "In" box for mail and "To File" box. Post a running supply list to refer to when replenishing your stock.
Then, go through all your financial records. Throw out all the records that you no longer need, like old credit card statements, pay stubs, and ATM receipts that are more than a year old. Throw away the payment books from loans that are now paid off, including your car. Toss expired guarantees and warranties, and instruction manuals from items you've discarded or sold.
Be practical. Some papers are stored just for sentimental reasons. Ask yourself what's the worst thing that could happen if you threw it away. If absolutely necessary, could you get another copy? If you really want something for just sentimental reasons, transfer it to a scrapbook or chest. Shred the papers you plan to throw away. Your old personal papers are gold mines of information for thieves who may want your Social Security number or account numbers.
After you have thrown out your old financial records, develop a file system for the ones you keep. Here’s a short list of the documents you’re going to have to hang onto for a while:
Tax returns -- The Internal Revenue Service has three years from the time you file to audit you. But if you've underreported your income by 25% or more, the IRS has six years to challenge your returns. And there's no statute of limitations on investigations of taxpayers who fail to file or who file fraudulent returns. So to be safe, keep copies of your tax returns and supporting documents, such as receipts for charitable contributions and miscellaneous deductions, for at least six years.
Investment records -- If your mutual fund company or broker provides a year-end summary statement of your transactions, you can toss the monthly reports. Just make sure you have some record of all your trades, particularly purchases. That way, you'll have the original price of your stocks or fund shares when you sell, which will determine how much you owe in taxes. Also:
-- Keep trade confirmations for a couple of years after you sell stocks or fund shares, in case the IRS has questions.
-- Save records of all contributions to a non-deductible individual retirement account. That way, you'll have proof you already paid taxes on the money when it comes time to start taking distributions. Otherwise, you may end up being taxed twice.
Credit card bills and bank statements -- Visa
have advised customers to review their credit card statements for potential duplicate charges. Even if you don't find any errors, you may want to hold on to your credit card bills for a few months as a precaution. The same goes for your bank statements.
Deductions -- Charity receipts, church donations, etc.
Medical records -- Receipts and insurance payments for dentist, doctors, hospitals, prescriptions,
Home records -- The deed to your house, your property tax paperwork, receipts for home repairs, warranties, etc.
Vital statistics -- Passports, birth certificates, marriage and divorce papers.
After you earmark the documents you’ll need, file them. Make a separate folder or file for each topic (i.e. bank account, loans, credit cards, taxes) so that each item is easy to file and find. After you have separated your records, put the folders in a storage file that is easily accessible.
Set up a monthly budget and schedule. Unless you pay each bill as it arrives, set time aside
either monthly or bimonthly to pay your bills. If you use a money management program, you
can set it up to provide automatic reminders of the bills due. Otherwise, use a simple file
folder and an index card file: Put the due dates and bills on index cards, and file them by the
due dates. This will help you remember to pay your bills on time, avoiding service or late charges.
Balance your checkbook and charge statements each month. Go through the monthly checks
you wrote, ATM receipts and any other direct deposit/withdrawals from your account. Compare the amounts on your charge statement with your receipts. Notify the bank that issued the credit card of any errors as soon as possible. Federal law provides protection from mistakes only if you make notification within 60 days.
Here are some more tips to help you get fiscally fit:
-- Cutting down to one charge card per adult, two if you use one for home and one for work.
This reduces statements and bill-paying time.
-- Consolidate your bank accounts, if you have several.
-- If you can, pay bills by automatic deduction. Most utility bills can be handled this way.
-- Cut junk mail by contacting the Direct Marketing Association at: www.dmaconsumers.org/consumerassistance.html
and ask them to remove you from their
direct mail lists. Or, write them at: Mail Preference Service, Direct Marketing Association, P.O. Box 9008, Farmingdale, N.Y. 11735- 9008. Many states now have "Do Not Call" lists where your name can be added to a list of consumers that telemarketers can't call. Check your local consumer affairs bureau for more information.
-- Consider professional help. Your financial management includes day-to-day living, estate
planning and tax strategies. This means you need a budget, a will, a trust, perhaps, and tax
advice. If you don't know where to start, consider a consultation with a financial planner to
get you started.
-- Also, consider setting up an online bill-paying program through your bank and/or other lenders. With the increased safety of the Internet (financial companies are adding things like security firewalls all the time now) you can safely and easily pay your bills online. They’re much easier to manage that way, with no paperwork or lost documents.
Handling your paperwork may seem daunting, but believe me, it's doable. Once you've started, you'll begin seeing right away the benefits of cleaning up your financial act.
In my last blog I promised more information on building a better budget -- for a better financial life.
In that regard, try these tips for size:
Budget Tips . . .
1. Don't make your budget too inflexible because, like a diet, it's unlikely you'll stick to it.
2. Use exact costs, not just averages, so you know at any point exactly how much you need or have.
3. Use a spreadsheet layout with two main sections - income and expenditure.
4. Categories should be broad so that the budget is not too complex. For example, include
doctor, dentist and medicines under "Health".
5. People always underestimate what they spend. Remember extras such as lunches, public transportation and football memberships.
6. A good strategy is to prepare your budget based on how often you get paid.
7. Review your budget every month for the first couple of months to make sure you are on track.
8. When the economy enters a low-interest rate period, as it did in the early 2000's - take advantage of low interest rates to refinance a home mortgage
and make lower monthly payments. Numerous web sites offer instant calculators that will estimate your new payments, including www.Realtor.com
. Right now, interest rates are higher and I'd recommend holding off on refinancing for six months to a year (when the experts say the real estate market will pick up again).
9. Review auto and home insurance rates and comparison shop for better values. Some companies offer discounts you may not be aware of, such as those for senior citizens, multiple policies or autos with anti-theft devices. Consider raising deductibles, too, in exchange for lower payments.
10. Add up the fees on your bank statements and shop for a better deal or ask your existing bank about lower-cost accounts. While you're at it, find out if your employer will automatically deposit your paycheck to your bank account, to minimize the risk of bounced checks and other mishaps. Consider starting an automatic savings plan that will route some money directly to a separate account before you're tempted to spend it.
11. Obtain an estimate of your future Social Security income by calling (800) 772-1213. Ask for a Personal Earnings and Benefits Statement request form. The response time is quick, and it's a good opportunity to make sure your employment history is reflected accurately.
12. Order a copy of your credit report
from reporting agencies Equifax (800-685-1111), Trans Union (800-916-8800) or Experian (800-422-4879). Again, note that you can get one free copy of your credit report annually
13. Get rid of clutter and raise extra cash by holding a garage sale or get a tax deduction by donating unwanted items to charities. In that case, be sure to keep an itemized receipt of donated goods in case the IRS has questions.
14. Make a detailed household inventory to protect yourself in case of theft or disaster. Engrave your name and an identifying code on high-value items, and record serial numbers. Most insurance companies offer guidelines or even workbooks -- call yours or check out the Nationwide Mutual Insurance Company web site at www.nationwide.com
15. Taking out one manageable loan to pay off various scattered debts is often a smart way to lower your effective cost of borrowing. Credit-card debt
is the prime target for this strategy. Interest rates on credit cards are frequently two to three times higher than consumer loans. Consider the possibility of borrowing on a personal line of credit
to pay off credit cards. Of course, if your credit card spending has gotten that far out of hand, it’s time to break out the scissors and begin cutting.
16. Draw Personal and Professional Lines Between Debt -- If you are self-employed, you may need to borrow for business purposes. Be sure your records are accurate enough to track personal and business borrowing separately. Better yet, use dedicated sources for your business borrowing. For example, use one credit card for your business spending and a different one for personal use.
17. Keep up with Uncle Sam -- If you are self-employed or have substantial investment income, you are probably required to pay all or part of your taxes in quarterly installments. Interest and penalties on unpaid installments can currently reach 12%, compounded daily. Unlike a salaried taxpayer who has tax withheld at the source, it is very easy for a tax installer to slip deeply into debt to the government. It is a good policy to keep your tax money segregated - and fight the temptation to dip into it.
18. Loan or Lease? -- When you are trying to decide whether to buy or lease your next car, keep in mind that a lease is another form of financing. Find out the effective financing rate implicit in any lease proposal, and compare it to prevailing new car loan
19. Stay Squeaky Clean -- Protecting your capacity to borrow is a worthwhile financial-planning objective. Buying a house or a car, going into business for yourself or jumping on that unique investment opportunity are occasions that often require external financing. Also, normal cash reserves may be insufficient to deal with a financial emergency
. Keep your credit rating clean. Do not take on debt you cannot handle. Do not miss payments. If you do find yourself in a default situation, do not try to hide from your creditors. Take the initiative to propose revised repayment schemes and keep them fully informed at all times.
20. Keep it fun. Open a bottle of wine, make a date with your loved one, and flip a John Mayer CD into your stereo. Saving money will put a smile on your face and make you feel good about yourself. It’s time well spent.
The Next Step
When you have filled in the sections of a budget table relevant to you, simply make totals of expenditure (including savings and investments) and income, and subtract expenditure from income. If your total is above zero, you are cash flow positive. If the total is below zero, you are cash flow negative. If the total is zero, you are cash flow neutral.
If you end up with a positive cash flow, you can then consider investing the surplus, preferably in real estate, stocks or mutual funds. Or, you can spend it. If you have a negative cash flow, you should examine what non-essential items you can eliminate.
The most common problem people have with budgets is sticking to them. Individuals who aren't very organized by nature need to have a more flexible budget, with broader categories such as "rent, entertainment, groceries and bills" under expenses, rather than more detailed entries.
The last word on your budget. When you first start your budget, you should review it every pay period to see if you're on track. After that, review it when you do it – every month.
Building a Budget
Figuring out your net worth is a critical step in managing debt
. But if you really want to get serious about managing debt, you must have a household budget.
In an era where consumer spending is high and there are plenty of new goods and services to buy that weren’t available even 20 years ago, knowing how to budget properly is a big key to your financial success. According to a recent American Express
consumer survey on everyday spending, today's list of typical, day-to-day expenses is still dominated by traditional items such as groceries, fast-food lunches, tolls and gasoline. But they've been joined by such new millennium wallet-sappers as cellular phone service, paging fees and Internet service costs.
The survey also tracked increases in expenditures on several traditional household expenses. Insurance premiums were up 35 percent (from $2,016 to $2,722, annually); utilities, up 15 percent ($1,536 to $1,764); fast food, up 43 percent (from $504 to $720), and subscription expenditures climbed 42 percent (from $228 to $324). All climbed within a five-year period from 2000-2005.
In its review of a total of 11 spending categories, American Express found that overall expenses increased by 5 percent.
Consequently, as everyday expenses increase, managing a household budget becomes more complicated. The best solution? Get those costs into your budget as soon as possible. That’s because people tend to spend whatever money is left over after the fixed expenditures and stop only when either the ATM won't give them more cash or the bank calls.
One way to keep money from flying out of your pocket is to write down what you're spending, as you spend it. You may not realize it, but that glass of merlot after work, the dry cleaning you picked up on the way home, and that four-cheese pizza you had delivered to your door for dinner all add up. A record of your daily, weekly or monthly expenditures makes for some interesting reading in most American households, testing the patience of millions of spouses in the process.
Some consumers like to use a credit card
to buy everything (the credit card companies LOVE to push that strategy). That way, at the end of the month, they have a ready-made laundry list of expenditures sent to them by their credit card firm. Bad idea. Sure, you get a nice, clean list of what you spent each month. But getting into the habit of using a credit card is never a good ploy. It’s easy to treat that Visa card like cash – but it ain’t. Sooner or later you’ve got to pay for it, with high interest payments to boot if you’re not on time every month. Besides, in the age of the laptop, it’s easy to sit down at the end of the day and compile your own list. You’ll have your record and you won’t get sticker shock opening your credit card bill every month.
Primarily, all budgets are divided into income and expenses, but most good ones now include a third component, savings. Items in the "income" section can include after-tax salary, pensions, investments and tax refunds.
Items in "expenditure" can include rent, mortgage payments, food, gas, utility bills, childcare, entertainment, gifts and holidays. The "savings" section logs how much you put away each month, after satisfying spending requirements. As much as 10 percent of total expenses should be put into this category to allow for unforeseeable events such as dental emergencies
One way to attack your budget is to use what some debt counselors refer to as “the snowball method”. Using this strategy, simply list your debts in ascending order with the smallest remaining balance first, the largest last. Do this regardless of interest rate or payment. You will pay these off in this new order. This works because you get to see some success quickly and are not trying to pay off the largest balance just because it has a high rate of interest.
Once you pay off the lowest balance, take that payment and combine it with the next payment on the list, so that each month you're making a larger payment on that debt. Repeat the process, again and again, so that your payments are getting larger, your debts are being paid off faster, and the process starts to snowball until all your debts are paid.
If you’re one of those people who can’t sleep at night worrying about bigger bills, go ahead and address those bills first. Just rank your debts in order of highest interest rate to lowest. Then whittle away at them in that order. Make sure you are not comparing apples and oranges. The effective interest rate is often different from the nominal rate quoted by the lender. For example, mortgage rates are compounded semi-annually, while rates on credit-card debt are usually compounded monthly.
Tomorrow I'll list a budget "checklist" that has everything you need to get your budget started.
Last week we spent some time talking about net worth, and why knowing your own net worth is so important.
Let's begin this week with some more information on the same topic.
Here are some hard and fast tips for figuring out your net worth. See if they don’t work for you:
1. List all of your fixed assets, such as real estate and cars, at their current value. Subtract any money that you owe on these assets, such as your mortgage or car loan.
2. List all of your liquid assets: cash, certificates of deposit, stocks, bonds and bank accounts.
3. List all jewelry, furniture and household items at their current value.
4. Add together all of the above. These are your total assets.
5. Subtract all of your debts (except those you already subtracted in step 1) from your total assets. The result is your net worth.
6. Re-evaluate and update your net worth calculations on an annual or better yet, semi-annual basis.
This exercise should only take an hour or so. The time saved in doing so will prive rich dividends when you begin planning your financial future.
And you can't do that without knowing your net worth.
In a robust economy where information is as much a commodity as widgets or weed whackers, it pays to know what you’re worth. While that goes for young and old alike, it’s especially true for people looking to buy their own homes, or build wealth by investing in income producing properties.
That’s where a personal balance sheet comes in handy.
A personal balance sheet gives you a blueprint for your financial life, one that you can work from again and again as you make lifetime financial decisions. It’s a fluid document that you’ll need to revisit every six months or (at the outer limits) every year, but you’ll be glad you have it. Quantifying your financial goals is critical in the whole financial planning process and your personal balance sheet forms the yardstick by which you can measure the success of your financial plan. As time marches on, you can tweak the strategy for your financial plan along the way to achieve your defined goals.
What else can a personal balance sheet do for you? It won’t cut your cholesterol or give you dimples, but it can help you calculate your net worth.
Calculating your net worth is the first step in planning for your financial future. A net worth calculation can serve as a financial planning wake-up call, especially when the end result is a low or even negative number.
Simply stated, your net worth is the difference between your assets and liabilities. Typically, assets include bank accounts, stocks, mutual funds, Individual Retirement Accounts or 401(k) plans and other investments as well as the present value of a home, vacation home, car and any other property that could be sold. You could also include money owed to you by others that you know you will receive and the value of your life insurance.
Liabilities are your debts and obligations. They should be divided into short-term debt (current bills, personal loans, credit card balances, etc.), and long-term debts (Mortgages, other installment loans, etc.). You should also include any income taxes that would be owed, as well as any other obligations.
When you take a crack at your balance sheet, remember to include only what you have now; don't fudge the numbers because you expect a pay raise or bonus. In technology terms those are “vaporware” items – revenues that may or may not appear depending on the whims of your boss, Ben Bernanke, or the “Psychic Friends” hotline for all you know. Those as yet unrealized dollars don't factor into your net worth until you turn that money into an asset.
To be most accurate, you will also want to get a ballpark estimate of the market value of your home (which hopefully has gone up since you purchased it) and your cars (where the value has depreciated or gone down) and other major property items. You might try to get a ballpark estimate on the worth of everything, from your wardrobe to your books, televisions, stereos, jewelry and other major possessions.
Debts comes next, so total up the outstanding amount you owe on the mortgage, student loans, car loans, credit cards, money borrowed from relatives, etc. Exclude monthly bills for things such as the telephone, groceries, rent and the like; they factor into your cash-flow and could be slowing down how much money you pump into increasing your net worth, but they are not a part of a snapshot of your personal wealth.
Once you subtract the debt from your assets, you'll have an interesting number. If it's positive, this is the amount of money you would be worth if you paid off your debts today.
But what makes net worth most interesting is looking at it on a regular basis, seeing how much it has grown or shrunk over the previous year. Charting your progress on net worth is important because many people increase both their assets and liabilities at the same time. They put money away into the company retirement plan, for example, while at the same time financing new cars or increasing credit card debt
They may feel "better off," but it might be a mirage. If your net worth statement churns out a negative number, it tells you how big a hole you would be in if you were forced to liquidate everything to pay off your debts.
While any time of year is a good time to check out your personal balance sheet, year-end may be your best bet. While you’re popping the cork on a vintage bottle of bubbly and wondering if *** Clark has a time machine stashed away that the rest of us don’t about, you can knock off several financial tasks at
once. Think about it. Since you’re going to have to start compiling income and other records to do your taxes, why not check in with your portfolio and see how junior’s college fund is doing or how much of a mortgage payment you have left?
Here’s a simple formula to figure out your net worth. If your pencil’s broken, keep in mind that most investment companies, like Fidelity
, and Merrill Lynch
, offer online net worth calculations forms (and scores of other calculations, too) on their corporate Web sites.
When you do revisit your balance sheet, have a list of questions and/or checkpoints in mind to make your visit worthwhile. Try these for starters:
-- Has your net worth increased each year or since your last balance sheet? If it hasn't, you need to determine the reason and perhaps make some changes in your spending, saving, or other financial habits.
-- Does your balance sheet reflect a preference for personal assets such as an expensive home, cars, furs, and jewelry? Your balance sheet should show a concern for acquiring investment assets, not just personal assets that are far less likely to increase in value or produce income that will help you meet other financial goals.
-- Is your debt out of proportion? If your balance sheet shows excessive debt, especially for personal consumption, that's a signal to review your spending. Keeping debt under control is essential in good financial management.
-- Have you given enough thought to money needed for retirement? If your balance sheet shows total neglect for accumulating funds for retirement, you will want to make some changes as soon as possible.
-- Are your assets diversified? Diversification is a good hedge against inflation and changes in the economy. Having all your eggs in one basket is seldom a good idea. Also, don't keep excess cash in non-interest or low-interest accounts unless you have an immediate need for the cash.
-- Where do you want to be three years, five years, and ten years from now, in terms of your net worth? You might determine this by doing projected balance sheets for three years, five years, and ten years from now.
Hey, it’s not rocket science. But a personal financial check-up every once in a while can pay big dividends down the road.
Whether you opt to handle your debt load yourself or hire a professional, you’re going to need to grip on where you stand financially. Unfortunately, we
Americans don’t do that very well.
There’s an old joke about a guy on his hands and knees looking for some lost money on the street one night. A cop pulls up and asks the man what he’s doing.
“I’m looking for $20 I lost on Mulberry Street,” the gent responds.
“But this is Maple street,” the cop answers.
“I know,” says the man, still crawling along the pavement. “But the lighting’s better on Mulberry Street.”
When it comes to managing our own debt
and our own money, many of us make like the guy on Mulberry Street. We try to take the easy way out, common sense be damned. Whether it’s the loudmouth trader bragging about his big score that day, but who can’t balance his checkbook, or the crazy person down the block who stuffs his savings into a mattress “because it’s a well-known fact that Martians actually run the banking industry”, some people just don’t want to take the time to manage their money correctly.
Not managing your money correctly is a crying shame. Paying closer attention to your personal financial situation is one of the smartest moves you’ll ever make. Sure, you may check your mutual fund every day, and you may always be on the lookout for the next big stock, but that’s not what I'm talking about.
No, we’re talking about the more mundane side of the money picture. Knowing your net worth, crafting a household budget, understanding the machinations behind credit and debt
, and the importance of paying yourself first. These – and not the next hot tech stock supernova – are the cornerstones of your personal financial portfolio. Knowing the financial basics not only will give you a significantly greater sense of security, it will also give you a nice launching pad to arranging the finances you need to attain financial freedom.
Unfortunately, most people address their financial planning in ambiguous terms. They want their money to grow, and may measure performance against the stock market, but they don't look at what they really need to have happen. What's more, they don't consider the effects of spending and borrowing
in concert with the positives of saving and investing.
As the old adage says, you’ve got to walk before you can run. So it’s imperative that you have your everyday financial life in order.
In tomorrow's blog, we will examine the key first step in doing just that.
How can you tell if a credit counseling service is reputable? Follow these guidelines:
Look for credit counselors
who don’t charge for free information, like information on legal rights accorded debt sufferers or data on government-sponsored credit programs.
Make sure you receive a list of what the credit service will do for you before paying them any money. Then only pay if they do what they promised.
Check with your local consumer protection agency.
Once you begin working with a credit manager, gather up all of your relevant debt documents, invoices, account statements, and such, make copies and bring them to your first meeting with your counselor. On the agenda will be scenarios where you begin some sort of repayment plan. So be prepared to figure out how much you can afford to pay.
Also note any aggressive collection agencies and ask your credit counselor to help stop them from contacting you. With a credit service on your side, they can begin fielding such calls – not you.
That’s what you’re paying them for in the first place.
All things being equal, if you create a good, solid debt management framework, one that includes knowing your credit score, knowing what’s on your credit report
, and knowing how to deal with creditors, lenders, and collection agencies, you really don’t need professional help.
The key is finding your comfort level. If you can’t sleep at night worrying about your student loan debt, and have exhausted all other options, maybe having a professional on your side is right for you. But short of that, try to handle debt issues on your own before paying someone else to do it.
Nobody is as interested – or has as much at stake – in your financial affairs as you do.
In that regard, you are your own best debt management advocate.
Taking debt management
matters into your own hands is commendable. After all, if you have tried something and failed, you are still vastly better off than if you tried nothing and succeeded.
Still, taking the solo route may not be viable for many people. Lack of time, lack of education, or simply lack of interest may spur some folks on to going out and getting professional help.
But is a professional debt counselor or credit repair specialist
right for you?
Of course, there are pros and cons to getting good debt counseling
help, too. Yes, having a reputable, smart professional that understands debt on your side can be a big plus in your debt management campaign.
On the other hand, there are plenty of fly-by-night, fraudulent debt counselors out there, lurking on the fringes of the financial services industry. Many of them thrive on the Internet, preying on desperate and vulnerable individuals who don’t realize that they’re placing themselves in deeper financial peril by doing business with debt management con artists.
And even the ethical credit counseling companies will only go so far with you. There’s an old story about the tax attorney who told his client on the way to the IRS office “I did say that as your tax attorney I would accompany you to the IRS in the event of an audit. But I never said that I’d go inside.”
Similarly, if you ever go to court. You probably won’t have your trusty credit service advisor alongside of you. Everyone has limits.
Chances are, the debt management help you’ll be seeking will come from a credit counseling or credit repair service
. These are agencies designed especially to help people get out of their debt problems and get on with their lives.
Usually that help comes within the framework of debt management advice or direct intervention on your behalf to your creditors. The idea is to help people manage their debts responsibly and eliminate any debt in the most economically feasible way possible, to you, that is. Credit counselors stand by your side and give you an educated voice. They can play the equalizer role you’ll need, given the fact that the creditor will be well armed against you.
You have to be cautious about the type of credit management service
you choose. While many are virtuous and ethical, some are not. They over-charge
and under-deliver. They offer bad advice. Check with your local consumer protection agency before you hire a credit manager.
Who hasn’t opened up their mailbox to find a pre-approved credit card offer or two? A cynic might say that whole forests have been toppled for the sole reason of getting your signature on a shiny new credit card.
And why not? Americans love abusing their credit cards. The average U.S. household credit debt
rose from $2,985 in 1990 to more than $8,100 in 2004 as the number of credit cards in use increased from 250 million to 538.1 million, according to credit-card site CardWeb.com.
The best way to keep credit card debt
down is not using a credit card. But if you do receive a pre-approved card that intrigues you, at least know what you’re getting into before signing on the bottom line:
What Interest Am I Paying?
Make sure you understand interest rate you will be paying and for how long. Usually, fixed-rate annual percentage rates (APRs) are the best deal, as card companies have to notify you before raising rates (variable rate cards rise and fall with prime interest rates).
Know That Rates Can Vary:
You may not know it but most credit cards carry more than one interest rate, with balance transfers and cash advances usually carrying a higher rate. Consequently, you may have a 12.9 percent APR on purchases, and a 19.6 percent APR on cash advances. Not
surprisingly, card companies apply any monthly payments to the part of the balance that is subject to the lowest interest rate, before the higher-rate part is paid.
Don’t Pay Late:
Tardy credit card bill payers can expect the back of the card industry’s hand in the form of higher interest rates. Some cards will immediately raise your interest rate from the introductory teaser rate to the regular rate if you're late just one time.
Pay No Fees:
If there’s a fee involved with your new credit card offer, walk away. Why pay a fee for a credit card when, with good credit, you don’t have to?
Cyber-Shopper? Get Protection:
If you like to shop on the Internet, find a credit card with a safe online shopping guarantee. Look for a card with specific guarantees, like 100% coverage for any losses due to fraud when shopping on the Internet.
Don’t Assume You’ll Get Approved:
Pre-approved credit card offers are no guarantee of credit. If you return the card offer, many financial institutions will conduct a "post-screening" process, which typically involves reviewing your credit bureau report
in full as well as verifying information provided on your application. If your financial situation has changed, or if the card-issuing institution determines through post-screening that you don't qualify for the credit line initially, you may still be offered a card, but with different terms or a smaller credit line. Or, your application may be turned down
How Can I Get These Guys Off My Back?:
If you don’t want to receive pre-approved card offers, call 1-888-5OPT-OUT to get your credit file blocked against pre-screening at the three major credit bureaus.
No doubt managing your money situation is difficult if you’re debts are so monumental that you’re considering bankruptcy.
And if you’re facing a mountain of debt, bankruptcy
still is undoubtedly a situation to avoid.
Even so, some of the greatest businessmen in history have survived it. Take H. J. Heinz. His creditors forced him into bankruptcy. Walt Disney suffered
bankruptcy along with a nervous breakdown. And Milton Hershey came out of bankruptcy to dominate the chocolate industry.
But why take a risk? Knowing the ins and outs of bankruptcy is the first, all-important step to avoiding it in the first place. And the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S.256), which went into effect in October, 2005, is a good place to start. If you are an individual or even a small business owner facing debt issues you need to know how the new laws may help or hinder your business venture.
Here are the nuts and bolts – by the numbers: The Internal Revenue Service’s “Chapter 7” is commonly called straight bankruptcy. Your assets are sold (liquidated) to repay your debt. There are some exemptions that enable you to keep your primary residence or a vehicle so you can get to work. Anything that is not repaid is cancelled. Often unsecured debt, which includes credit card debt
, is written off entirely when you file bankruptcy through Chapter 7.
“Chapter 13” is personal reorganization or repayment and “Chapter 11” is business reorganization. In this situation, you, the court and your creditors work out an agreement and you repay a portion of your debt over five years. You stand a better of chance of getting credit in the future if you go this route instead of full Chapter 7 bankruptcy
Under the new law it will be harder for people to file Chapter 7, forcing more people to file Chapter 13. The overall effect is to get folks to take responsibility for their financial actions when they overspend with credit cards
and abuse the system. Although, the main reasons people file for bankruptcy is medical emergencies resulting in high medical bills that health insurance doesn’t cover, divorce, or a job loss.
But many people use personal credit to run their financial lives. Small business owners are particularly susceptible to abusing credit cards. According
to the National Association of Consumer Bankruptcy Attorneys it’s estimated that 20 percent of consumer bankruptcy is actually small business bankruptcy
According to the American Bankruptcy Institute the following is a summary of changes to the old rules and new key changes that you should be prepared for in assessing bankruptcy risk.
The biggest change is that as of October 2005, you must seek assistance from a credit-counseling agency
six months before you file for bankruptcy. You need to show you are making a good faith effort to sort out your financial woes. And you must attend a money management course. There are exceptions in emergency situations but that is up to the court to decide.
Under the old rules the court had wide latitude to decide what cases qualified for Chapter 7 protection. Now everyone is subject to a “means” test -- meaning your ability to repay some of your debt. If your income is greater than the median for your state the court can deny your request for bankruptcy. Your basic living expenses are taken into consideration along with your ability to repay at least 25 percent of your unsecured debt including credit card debt. If your income is above your state median and you can re-pay 25 percent of your debt - you can’t file Chapter 7 but you can try to file Chapter 13. For example, if your income is below median for your state but you can pay the 25 percent then the state will decide if you can file Chapter 13 or Chapter 7.
Starting back in October 2005, attorneys, whether acting as debt relief agencies or bankruptcy attorneys, can be held liable for any inaccurate information you submit when filing for bankruptcy. They must verify your information, disclose their fees, give you a written contract, and inform you that you are not legally required to hire an attorney to file bankruptcy. They cannot advise you to incur more debt in order to qualify for bankruptcy. In this respect attorneys may start charging more for their services and be less willing to go to bat for you unless your circumstances are truly dire.
If you fail to provide all the necessary forms within 45 days after filing bankruptcy your case will be automatically dismissed. This includes proof that you attended a credit counseling service, along with financial paperwork, such as tax return information, a statement of net income, and evidence of employment.
Things to Consider When Deciding if Bankruptcy is an Option:
What to consider first? For starters, there is no such thing as free rent. For instance:
Bankruptcy does not prevent a landlord from evicting you if you fail to pay your rent.
Likewise, you can’t bail on child or other domestic support obligations, and if you do you will be in default and your bankruptcy can be reversed.
if you commit tax fraud any debt that you owe the taxman will not be forgiven by bankruptcy.
In the past if you had a car loan you only had to pay back what the car would currently be worth. Under the new law you must pay the full amount of the loan whether the car is worth less or not.
In the past you were not able to bail out on paying Uncle Sam back for your student loan if you filed for bankruptcy. Under the new Act you still have to pay Uncle Sam and you cannot file bankruptcy against any student loan debt whether it came from a non-government agency or a for-profit company that offers student loan repayment plans.
Once you file bankruptcy be prepared to live with it on your credit report
for 10 years. The damage to your credit can affect your ability to get approved for a home loan, a car loan or even another business loan. In most cases the best defense is a good offense, review these tips on how to avoid bankruptcy
and how to re-build your credit
if you do have to file:
1. Work within a budget and stick to it, don’t live above your means.
2. If you run a small business be a dedicated bean counter, keep track of your expenses weekly so you can anticipate problems well in advance.
3. Try to pay more than the minimum payment on credit card debt
each month or better yet charge only what you can pay off in full each month.
4. If you find yourself swimming in debt seek help sooner than later or borrow from your savings or family if possible, or contact the creditors directly to work out a payment plan.
5. Check with the Better Business Bureau
before signing up with a debt relief agency that promises to erase debt at a low-cost, don’t expect any easy way out.
It's a question that financial advisors hear all the time from clients.
“Should we eliminate debt first - or invest in the financial markets first?”, they invariably ask.
It's a fair question.
Remember, it all comes down to interest rates. In this case it's a good idea to invest money if you can earn a higher interest rate than you are paying on your loans and debts. For example, if the interest rate on a home loan
is six percent and you invest in a mutual fund that promises a higher return, and then you will be netting a gain.
That said there's no guarantee that your mutual fund will even earn six percent next year. As a matter of fact, it could lose six percent.
That's why, in most instances, it's better to pay off your debt first. The interest rate fees you kill by paying off the loan alone make that strategy a savvy move.
If you insist on going the investor route, put the maximum you can in your company's 401(k) plan (or if you're self-employed a “Solo” 401(k) that caters specifically to small business types). If your company has a 401(k) matching plan, it's crazy to turn down free money. But, since your retirement plan distributions are tax-deferred and come out of your gross paycheck amount and not your net, you'll hardly notice the money is missing.
So the school of thought here is, before paying your cell phone bill, or your cable bill, pay yourself first. After all, you have as much right to your money as anyone else. Paying yourself first doesn't mean allotting yourself some spending money right off the top on margaritas with the gang or on a new Hermes scarf. Paying yourself first means giving you a chance to help your savings grow by putting some cash aside for your investments, like you do with a 401(k) or an Individual Retirement Account. It's no secret that progress toward financial independence can be accelerated significantly by putting your money to work for you.
The higher your income, of course, the more latitude you have. You might think about getting into a mutual fund immediately and initiating a systematic plan to make a substantial deposit once or twice a month.
Paying yourself first is all about developing the saving habit. Many people don't save because they don't think they can afford to put anything aside. In truth, they can't afford not to put something aside for themselves.
But only after your most pressing debts
are paid off first.
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