Great book for young adults who are just starting to make decent money for the first time and want to figure out what to do with it, and how to use it wisely. It’s a pretty fun read considering the topic, and it gives you 90% of everything you really need to know to make smart financial decisions.
– Don’t waste your time debating minutiae. Focusing on pointless details is the easiest way to get nothing done. People love to argue minor points, and then do nothing to improve their situation. Let the fools debate the details. Sidestep the entire debate and get started.
– The 85% solution: getting started is more important than being an expert. Reduce the number of choices that paralyze you. It’s more important to get started than to spend an exhaustive amount of time researching the best funds and accounts in the universe. Instead of getting overwhelmed thinking you need to manage your money perfectly, which leads you to do nothing at all, just take one small step at a time and don’t worry about being perfect. Take action and get 85% right rather than doing nothing. 85% of the way is far better than 0%. Once your money system is good enough – or 85% of the way there – you can get on with your life and go do the things you really want to do.
– Ask yourself two questions: Why do you want to be rich? What does being rich mean to you? Most people never even spend ten minutes thinking through what rich means to them. Suckers. Here’s a hint: It’s different for everyone, and money is just a small part of being rich. If you don’t consciously choose what rich means, it’s easy to end up mindlessly trying to keep up with your friends. What do you want to be able to do with your money? Set your goals today. Why do you want to be rich? What do you want to do with your wealth?
– Your credit score is like the Cliff’s Notes for your credit history. It’s a number between 300 and 850 that tells lenders how risky you are, and your goal is to keep this number as high as possible. Lenders use this number, and a few other pieces of information, such as your salary and age, to decide if they’ll lend you money for credit like a credit card, mortgage, etc. They’ll charge you a higher or lower interest rate on the loan, depending on your score. Get this number as high as you can.
– Credit score is based on:
- 35% payment history – How reliable are you? Late payments hurt you
- 30% amounts owed – How much you owe and how much credit you have available, aka your credit utilization rate
- 15% length of history – How long you’ve had credit
- 10% new credit – Older accounts are better because they show you’re reliable
- 10% types of credit – For example, credit cards, student loans, mortgage, etc. Varied is better
– Check your credit score and credit report once a year at www.annualcreditreport.comand www.myfico.com. If you haven’t already done this in the last twelve months, go order both of them right now. Then put a recurring reminder in your calendar to remind you each year. Seriously, go do it now. One of the key differences between rich people and everyone else is that rich people plan before they need to plan.
– Use credit cards responsibly. As long as you manage them well, and pay off you balance in full each month, they’re worth having. But if you don’t completely pay off your bill at the end of the month, you’ll owe an enormous amount of interest on the remainder, usually about 14%.
– Getting a new credit card:
- Avoid those credit card offers you receive in the mail. These offers are always horrible. For something as important as your credit, make the effort and pick a good card. If you hate these credit card offers, visit www.optoutprescreen.comto get off their lists
- Avoid cash-back cards, which don’t actually pay you much cash. Cash-back cards are worthless. You’ll save more with a good travel rewards card
- Compare cards online. The best way to find a card that is right for you is by researching different offers online (try www.bankrate.comor www.nerdwallet.com). For a simple option, a good place to look is your current bank, but the rewards likely won’t be very good
- Rewards are important. You’re going to be using this card a fair amount, so make sure the rewards it offer are something you actually want. Find one that gives you something you value (i.e. if you travel a lot, get a travel rewards that give you free flights and points for every dollar you spend and every mile you fly)
- Don’t go card crazy. Don’t get too many cards. Two or three is a good rule of thumb. Limit yourself to opening one card a year
– The six commandments of credit cards
- Pay off your credit card regularly. Don’t make late payments. Always pay off all of your bills on time
- Get all fees waived on your card. (The only exception is if you spend enough to justify the extra rewards a fee-charging account offers). Call them using the number on the back of the card and ask if you’re paying any fees, including annual fees or service charges. Use this script:
- You: Hi, I’d like to confirm that I’m not paying any fees on my credit card
- Credit Card Rep: Well, it looks like you have an annual fee of $50. That’s actually one of our better rates
- You: I’d rather pay no fees. Which card can you switch me to that doesn’t charge fees? I’d like to make sure my credit score isn’t affected by closing this account, too. Can you confirm?
- Negotiate a lower annual percentage rate (APR), the interest rate your credit card company charges you. Call your credit card company and ask them to lower your APR. If they ask why, tell them you’ve been paying the full amount of your bill on time for the last few months, and you know there are a number of credit cards offering better rates than you’re currently getting. This works about half the time. Note: Your APR doesn’t matter if you’re paying your bills in full every month.
- Keep your cards for a long time and keep them active. Lenders like to see a long history of credit, do if you’re getting a new credit card, don’t close the account on your old one, because it can negatively affect your credit score. As long as there are no fees, keep it open and use it occasionally, because some credit card companies will cancel your account after a certain period of inactivity. Set up an automatic payment for a monthly subscription you have, and then set your checking account to auto-pay the credit card balance each month as well. That way your account stays active and open with zero intervention on your part.
- Get more credit (Warning! Do this only if you have no debt). Increasing the total available credit on your current credit cards will improve your credit utilization rate (30% of your credit score). Here’s how: call up your credit card company and ask for a credit increase every six to twelve months:
- You: Hi, I’d like to request a credit increase. I currently have five thousand dollars available and I’d like ten thousand
- Credit Card Rep: Why are you requesting a credit increase?
- You: I’ve been paying my bills in full for the last eighteen months and I have some upcoming purchases. I’d like a credit limit of ten thousand dollars. Can you approve my request?
- Rep: Sure, I’ve put in a request for this increase. It should be activated in about seven days
- Use your rewards! You can get great on your credit when you’re a responsible customer. If you fall into this category, you should call your credit cards and lenders once per year to ask them what advantages you’re eligible for. Often, they can waive fees, extend credit, and give you private promotions that others don’t have access to. Call them up and use this line:
- Hi there, I just checked my credit score and noticed that I have a 750 credit score, which is pretty good. I’ve been a customer of yours for the last four years, so I’m wondering what special promotions and offers you have for me… I’m thinking of fee waivers and special offers that you use for customer retention
- Credit cards also offer some benefits you might not know about, like automatic warranty doubling, car rental insurance, trip-cancellation insurance, product return protection, and more. Call your credit card company and ask them to send you a full list of all their rewards. Then use them!
– What to do if you miss a credit card payment
- You: Hi, I noticed I missed a payment, and I wanted to confirm that this won’t affect my credit score
- Credit Card Rep: Let me check on that. No, the late fee will be applied, but it won’t affect your credit score (Note: if you pay within a few days of your missed bill, it usually won’t be reported to the credit agencies. Call them to be sure)
- You: Thank you! I’m really happy to hear that. Now, about that fee… I understand that I was late, but I’d like to have it waived
- Credit Card Rep: Why?
- You: It was a mistake and it won’t happen again, so I’d like to have the fee removed (Note: Always end your sentence with strength. Don’t say “Can you remove this?” Say “I’d like to have this removed.” At this point, you have a better-than-50-percent chance of getting the fee credited to your account. But just in case you get an especially tough rep, here’s what to say:)
- Credit Card Rep: I’m very sorry, but we can’t refund that fee. I can try to get you our latest blah blah marketing pitch blah blah…
- You: I’m sorry, but I’ve been a customer for four years and I’d hate for this one fee to drive me away from your service. What can you do to remove this late fee?
- Credit Card Rep: Hmm… Let me check… Yes, I was able to remove the fee at this time. It’s been credited to your account. (Note: If it still doesn’t work, ask to be transferred to their customer retention department and repeat this process)
– Credit mistakes to avoid
- Avoid closing your accounts (usually). If you actively use your credit cards, this will lower your credit utilization rate, which will hurt your credit score
- Manage debt to avoid damaging your credit score. If you do close an account, pay off enough debt to keep your credit utilization score the same
- Think ahead before closing accounts. If you’re applying for a major loan – car, home, or education – don’t close any accounts within six months of filing the loan application
- Don’t play the zero transfer game. Focus on the big wins to get bigger results
- Avoid getting sucked in by “Apply Now and Save 10 Percent in Just Five Minutes!” offers. Stay away from the cards issues by every single retain store. These cards have massively high interest rates (~21%) and contain some of the most onerous terms of any cards, including tremendous rate increases if your payment is late even once
- Don’t make the mistake of paying for your friends with your credit card and keeping the cash – and then spending it all. Put it in the bank!!
– Pay your debt off aggressively. If you’ve found yourself in credit card debt, it’s time to make sacrifices to pay off your debt quickly. Put at least $50 more each month toward any debt you have. Paying any increase over the minimum helps, but try to pay as much as you can. Set up automatic payments to pay your debt each month.
– Five steps to ridding yourself of credit card debt
- Figure out how much debt you have. You can’t make a plan until you know exactly how much you owe. It might be painful to learn the truth, but you have to bite the bullet. Look at the back of your credit cards for their phone numbers, call them, and ask them to tell you the answers to the following: Name of credit card, total amount of debt, APR, monthly minimum payment. Now you have a definitive list of exactly how much you owe
- Decide what to pay off first. There are two schools of thought on how to go about this. Don’t spend more than five minutes deciding. Just pick one method and do it. The goal is to get started paying off your debt and both options are great:
- Standard method – You pay the minimums on all cards, but pay more money to the card with the highest APR because it’s costing you the most
- Snowball method – You pay the minimums on all cards, but pay more money to the card with the lowest balance first – the one that will allow you to pay it off first
- Negotiate down the APR. Call your credit card companies and follow this script. (Note: it doesn’t work every time, but when it does, you can save a significant amount of money with a five minute conversation):
- You: Hi, I’m going to be paying off my credit card debt more aggressively beginning next week and I’d like a lower APR
- Credit Card Rep: Uh, why?
- You: I’ve decided to be more aggressive about paying off my debt, and that’s why I’d like a lower APR. Other cards are offering me rates at half what you’re offering. Can you lower my rate by 50% or only 40%?
- Credit Card Rep: Hmm… After reviewing your account, I’m afraid we can’t offer you a lower APR. We can offer you a credit limit increase, however
- You: No, that won’t work for me. Like I mentioned, other credit cards are offering me zero percent introductory rates for twelve months, as well as APRs of half what you’re offering. I’ve been a customer for X years, and I’d prefer not to switch my balance over to a low-interest card. Can you match the other credit card rates, or can you go lower?
- Credit Card Rep: I see… Hmm, let me pull something up here. Fortunately, the system if suddenly letting me offer you a reduced APR. That is effective immediately
- Decide where the money to pay off your credit cards will come from. Try to avoid balance transfers or taking money from a 401k or home equity line of credit. Instead, focus on reducing spending and prioritizing debt. It’s not sexy to tell people you decided to spend less on other things do you could pay off your debt. But it works. Stop spending on random items, get conscious about making debt a priority, and set up aggressive automatic transfers to pay off your credit card debt each month. Again, try to pay as much as possible above your minimum monthly payment.
- Get started. In the next week, you should be paying more money toward your debt. If you find yourself taking more time than that to get started, you’re over thinking it. Remember the philosophy of the 85% solution: the goal isn’t to research every last corner to decide where the money will come from, it’s action. You can always fine tune the amount later
– If you find that no matter how you run the numbers, you’re not going to be able to pay your loan off in any reasonable amount of time, it’s time to call your lender. Look at the phone number on that monthly bill, call them up, and ask for their advice. Ask them the following questions. Chances are they can help you find a better way to structure your payment:
- What would happen if I paid $100 more per month? (substitute the right amount for you)
- What would happen if I changed the time line of the loan from five to fifteen years?
- If you’re looking for a job, you might ask, What if I’m looking for a job and can’t afford to pay for the next three month
Checking and Savings Accounts
– Open accounts at two separate institutions: a no-fee checking account at your local bank and a high-yield online savings account. If you already have an account at a bank you like, but they’re charging you a monthly fee, try to get them to waive it
– Use your checking account like an email inbox: all your money goes in your checking account, and then you regularly filter it out to appropriate accounts, like savings and investing, using automatic transfers. Pay most of your bills with your credit card, but use your checking account for the occasional bills you can’t pay with your card – like rent, etc
– Think of savings accounts as places for short-term (one month) to midterm savings (five years). Use your savings account to save up for things like a vacation, Christmas gifts, or even longer-term items like a wedding or a down payment on a house. Use your savings account as a “goals” account, where every dollar is assigned to a specific item you’re saving up for.
– Keep your savings in a high-interest online savings account (like CapitalOne360). It takes about three days to transfer money out of it, which is a good psychological barrier that will prevent you from using it. If your friends want to go out on Friday night, you’re not going to say “Hold on guys, I need three business days to transfer money to my checking account.” If you don’t have money in your discretionary (checking) account because you’ve already spent your “going out” money, you’re staying in that night. Having a separate savings account forces you to keep your long-term goals in mind instead of just blowing them off to have a few rounds of drinks
– Look for three things when choosing your bank:
- Trust – The best way to find a trustworthy bank is to ask friends if they have a bank they love. Browse the major bank websites. Within about five minutes you should be able to tell which bank are trustworthy and which are not by seeing how straightforward they are with their accounts and fees. Your bank shouldn’t nickel-and-dime you through minimums and fees. It should have a website with clear descriptions of different services, and easy setup process, and 24/7 customer service available by phone. And ask them if they send you promotional material every week. No more junk mail!
- Convenience – If your bank isn’t convenient, it doesn’t matter how much interest you’re earning, you’re not going to use it. It needs to be easy to put money in, get money out, and transfer money around. This means its website has to work, and you need to be able to get help when you need it – whether by email or phone
- Features – The interest rate should be competitive. If it’s an online bank it should offer value-added services like pre-paid envelopes for depositing money and convenient customer service. Transferring money around should be easy and free because you’ll be doing a lot of it, and you should have free bill paying
– Five shiny marketing tactics banks use to trick you
- Teaser rates – The introductory rates don’t matter. Pick a good bank you can stick with for years. One that offers overall great service, not a promo rate that will earn you some small amount of money in the short term. Avoid teaser rates.
- Requiring minimum balances to get “free” services like checking and bill pay
- Up-sells to expensive accounts. Most of these “value-added accounts” are designed to charge you for worthless services
- Holding out by telling you that the no-fee, no-minimum accounts aren’t available anymore. They are. Bank will resist giving you one, but if you’re firm, they’ll give you the account you want. If they don’t, threaten to go to another bank. If they still don’t, walk out and find one that will. There are many, many choices and it’s a buyers market.
– How to negotiate a bank fee (i.e. overdrafts, processing fees, late fees, and even ATM fees). Call the bank and say:
- You: Hi, I just saw this bank change for over drafting and I’d like to have it waived
- Bank Rep: I see that fee… hmm… Let me just see here. Unfortunately, sir, we’re not able to waive that see. It was [some excuse about how it’s not waive-able]
- You: Well, I see the fee here and I’d really like to get it waived. What else can you do to help me? (Repeat your complaint and ask them how to constructively fix it)
- Bank Rep: I’m sorry sir, we can’t refund that fee
- You: In understand it’s difficult, but take a look at my history. I’ve been a customer for more than three years, and I’d like to keep the relationship going. Now, I’d like to get this waived – it was a mistake and it won’t happen again. What can you do to help?
- Bank Rep: Hmm, one second please. I see that you’re a really good customer… I’m going to check with my supervisor. Can you hold on for a second? (Note: being a long-term customer increases your value to them, which is one reason you want t o pick a bank you can stick with for the long term. And the fact that you didn’t back down at the first “no” makes you different from 99 percent of their customers)
- Bank Rep: Sir, I was able to check with my supervisor and waive the fee. Is there anything else I can help you with today?
The Ladder of Personal Finance
– Rung 1: If your employer offers a 401k match, take full advantage of it and contribute just enough to get 100 percent of the match
– Rung 2: Pay off your credit card and any other debt
– Rung 3: Open a Roth IRA and contribute as much money as possible to it (max: $5,500 per year)
– Rung 4: If you have money left over, go back to your 401k and contribute as much as possible to it, above and beyond your employer match
– Rung 5: If you still have money left to invest, open a regular nonretirement investment account and put as much money there as possible. Also, pay extra on any mortgage debt you have. And consider investing in yourself: Whether it’s starting a company or getting an additional degree, there’s often no better investment than your own career
– Should I invest or pay off my student loans? Do a hybrid 50/50 approach, where you pay half toward your student loans (always paying at least the minimum) and send the other half into your investment accounts. This will give you the benefit of compound interest and tax advantaged retirement accounts
Conscious Spending Plan
– Consciously choose the things you love enough to spend extravagantly on, and then cut costs mercilessly on the things you don’t love. Make your own decisions about what’s important enough to spend a lot on, and what’s not, rather than blindly spending on everything. No more “I guess I spent too much” when you see your credit card statements. No. Conscious spending means you decide exactly where you’re going to spend your money – for going out, for saving, for investing, for rent – and you free yourself from feeling guilty about your spending
– A conscious spending plan involves four major buckets where you money will go:
- Fixed costs (rent, utilities, debt, etc) – 50-60% of take home pay
- Investments (401k, Roth IRA, etc) – 10% (Note: Your 401k contributions count toward the 10%, so you’ll need to add that amount to your take-home money to get a total monthly salary)
- Savings (vacations, gifts, wedding, house down payment, unexpected expenses, etc) – 5-10%
- Guilt-free spending money (dining out, drinking, movies, clothes, shoes, etc) – 20-30%
– Monthly fixed costs to take into account:
- Rent/mortgage, utilities, phone bill, medical insurance, medical bills, car insurance, car payment, public transportation, loans, groceries, internet/cable. If you see any glaring omissions for major spending categories, add them. Don’t include “eating out” or “entertainment” as those come out of the guilt free spending category.
- Write these down and fill in the dollar amounts you know offhand.
- To fill in the costs and categories you haven’t yet accounted for, look at your past spending to make sure you’ve covered every category, and to fill in the dollar amounts. Limit this to the past month to keep things simple
- Once you’ve gotten all your expenses filled in, add 15% for expenditures you haven’t counted yet (like car repair, dry cleaning, emergency medical care, charitable donations, etc). A flat 15% will cover you for things you haven’t figured in, and you can get more accurate as time goes on
- Once you have a fairly accurate number here (remember: 85% solution), subtract it from your take home pay. Now you’ll know how much you’ll have left over to spend in other categories like savings, investing, and guilt free spending. Plus, you’ll have an idea of a few targetted expense areas that you can cut down on to give yourself more money to save and invest
– Go for big wins when trying to reduce spending
- Do an 80/20 analysis, which often reveals that 80% of what you overspend is used toward only 20% of your expenditures. Focus on one or two big problem areas and solve those instead of trying to cut 5% out of a bunch of smaller areas.
- Example: If you take home $48,000 per year after taxes, or $4,000 per month. According to your Conscious Spending Plan, here’s how your spending should look:
- Monthly fixed costs (60%): $2400
- Long-term investments (10%): $400
- Savings goals (10%): $400
- Guilt-free spending money (20%): $800
- Problem: $800 isn’t enough for his spending money. This plan leaves you $250 short each month. What should you do? Pick the three biggest expenses and optimize them. Focus on big wins that will make a large, measurable change. You probably know what your big wins are. They’re the expenses you cringe at, the ones you shrug and roll your eyes at, and say, “Yeah I probably spend too much on ____.” For many people, these big wins are eating out and shopping
– Set realistic goals. When you go from one extreme to another, the behavioral change rarely lasts (i.e. overspending my $500, to saving all $500 the next month). When you make a change, make it bite-sizes in an area that matters and work in increments from there (i.e. cut 5% of spending in a problem area each month). Habits don’t change overnight, and if they do, chances are it won’t be sustainable. Say you were spending about $500/month eating out, here’s how it would look: Month 1: $475, Month 2: $450, Month 3: $400, Month 4: $350, Month 5: $300, Month 6: $250. Within 6 months you’d have cut your eating out spending in half. And it’d be much more likely to be sustainable.
– Don’t just save for the sake of saving. Save for a goal. Saving with a goal in mind – whether it’s for a house or your kids education – puts all you decisions into focus and makes the tradeoffs worthwhile
– The Envelope System
- Decide how much you want to spend in major categories each month (start with: eating out)
- Put money in each envelope aka category (i.e. $200 for groceries, $150 for eating out, $60 for entertainment)
- You can transfer from one envelope to another, but when the envelopes are empty, that’s it for the month
– The A La Carte Method – cancel all the discretionary subscriptions you can: your magazines, Netflix, gym, etc. Then, buy what you need “a la carte”. For example, instead of paying for a ton of challenge you never watch on cable, buy only the episodes you watch for $1.99 off iTunes, buy a day pass for the gym each time you go (around $5 – $10), and buy songs you want for $0.99 each from Amazon or iTunes. Here’s how to implement it:
- Calculate how much you’ve spent over the last month on any discretionary subscriptions you have (for example, music, Netflix, cable, the gym)
- Cancel those subscriptions and begin buying these things a la carte
- In exactly one month, check and calculate how much you spent on these items over the last month
- If you spent $100, try to cut it down to $90. Then $75. Not too low – you want your spending to be sustainable.
- If you find you’re paying more for these things, you can go back to your subscription. And if you realize you were spending $50/mo in subscriptions for stuff you didn’t actually want – now you can consciously reallocate that money into something you love
– How to handle unexpected and irregular expense? Account for the unexpected and build in a bit of flexibility into your savings goals
- Known irregular events – vehicle registration fees, Christmas gifts, vacation, etc. Allocate money toward savings goals where you have a general idea of how much it will cost
- Unknown irregular events – surprise medical expenses, late fees, or $100 to make up to your girlfriend for something stupid you did last night. Start by allocating $50/mo for unexpected expenses, and adjust accordingly over time
– How to handle unexpected extra income?
- Unexpected onetime income – Use 50% of it for fun. The other half of it goes into your investment account
- Raises – Maintain your current standard of living. Buy yourself something nice that you’ve been wanting for a long time, and make it something you’ll remember. After that, save and invest the rest of it. Once you get accustomed to a certain lifestyle, you can never go back
Increase Your Income
– Negotiate a raise
- Companies pay more than $5,000 to hire the average college student, plus thousand more training you. Would they really want to lose you? Asking for a raise takes careful planning. Remember that getting a raise is not about you. It’s about demonstrating your value to your employer. You can’t tell them you need more money because your expenses are higher. Nobody cares. You can, however, show how your work has been clearly contributing to the company’s success and ask to be compensated fairly. Here’s what you need to do:
- Three months before you ask for a raise, start tracking everything you do at work and the results you get. If you were on a team that sold 25,000 widgets, figure out what you did to help make that happen as, as much as possible, quantify it
- At the same time, ask your boss if you can sit down and discuss ways you can excel at work. Make it clear you want to exceed expectations, and ask what that would entail. If you’re really clever, you can hint about discussing compensation in the future
- Two months before you ask for a raise, meet with your boss again and show him your tracking from the previous month. Ask what you could do better. You want to know if you’re on the right track with your work and more important, the way you’re communicating it
- One month before the big event, mention to your boss that because you’ve been doing so well, you’d like to discuss compensation at a meeting next month. Ask what you’ll need to bring to make it a fruitful discussion. Listen very carefully to what he says
- Around this time it wouldn’t hurt to ask your fellow coworkers to put in a good word with the boss. This assumes, of course, that you’ve been exceeding expectations and driving concrete results
- Two weeks before you ask for a raise, ask a couple of friends to role play your job negotiation. This seems really weird, but negotiating is not a natural behavior. It will feel extremely off and uncomfortable the first couple of times you do it. Better to do it with your friends than your boss. And pick good friends, people who have business experience and will give you feedback on how you performed
- On the day you negotiate, come in with your salary, a couple of competitive salaries from www.salary.comand www.payscale.com, and your list of accomplishments, and be ready to discus fair compensation. Remember, you’re not asking mommy for lemonade, you’re a professional who’s asking to be compensated fairly. You want to proceed as partners, as in “How do we make this work?”
- If you get the raise you were looking for, congrats! If you don’t, ask your boss what you can do to excel in your career, or consider leaving to find another company that will give you room to grow
- Starting a new job? There’s an amazing strategy for negotiating your salary on pages 234 – 244
– Do some freelance work
- Think about what skills or interests you have that others could use. You don’t necessarily have to have technical skills. Babysitting is freelancing and it pays very well. Tutoring is also a simple, profitable way to make some extra side cash: You might be able to moonlight at a company like Kaplan and help kids with test prep, or you can post a notice at your neighborhood library and offer to teach English, math or anything. What about dog walking? Remember, busy people want others to help them with their lives. A great place to start is Craigslist’s help wanted section for your city
- If you have expertise in something, reach out to companies who’d need someone like you. For example, email fifty websites from all different industries that look interesting but have poor marketing and copywriting. Offer to help them rewrite their websites. About 15 will respond, and you’ll probably get 1 gig. Or consult with companies to teach them stuff you know like the back of your hand, but that is new to them.
Create Your Automated Personal Finance System
– Link your accounts – Log into each account and link them together so you can set up automatic transfers from one account to another
- Paycheck —> 401k, checking account (direct deposit)
- Checking account —> Roth IRA, savings account (which is sub-divided into savings goals), credit card, fixed costs that don’t allow credit car payments (like rent), occasional spending cash
- Credit card —> Fixed costs, guilt-free spending
– Synchronize your bills by getting them all on the same schedule. To accomplish this, gather all your bills together, call the companies, and ask them to switch your billing dates. Say “Hi, I’m currently being billed on the 17th of each month, and I’d like to change that to the 1st of the month. Do I need to do anything besides asking right here on the phone?”
– Now that you’ve got everything coming at the beginning of the month, go back into your accounts and set up all your automated payments and transfers. Make sure your payment or transfer is set up for the amount you want and on the date you want. Pick the right date for your transfers. For example, if your credit card is due on the 1st of the month, but you don’t get paid until the 15th, how does that work?
– Here’s how to arrange your Automatic Money Flow, assuming you get paid on the 1st of the month
- 2nd of the month – Part of your paycheck is automatically sent to your 401k. The remainder is deposited into your checking account
- 5th of the month – Automatic transfer to your savings account
- 5th of the month – Automatic transfer to your Roth IRA
- 7th of the month – Auto-pay for any monthly bills you have, like cable, utilities, car payments, student loans, etc
- 7th of the month – Automatic transfer to pay off your credit card (always pay the bill in full, if you can)
– Don’t try to pick individual stocks. You cannot reliably pick stocks that will outperform the market over the long term. It’s way to easy to make mistakes such as being overconfident about choices or panicking when your investments drop even a little. Invest in low-cost index funds instead. They aren’t as sexy but they match the market, and return an average of 7-8% in the long-term. “Experts” can’t guess where the market is going. You can earn more than the so-called “experts” by investing on your own. No financial advisor. No fund manager. Just automatic investments in low-cost index funds
– When you hear regular people talk about picking stocks, and fancy terms like hedge funds, derivatives, call options, and complex terms like these, remind yourself that these things are completely irrelevant for individual investors like yourself. It’s like two elementary school tennis players arguing about the string tension of their racquets. Sure, it might matter a little, but they’d be much better tennis players if they just went outside and hit some balls for a few hours each day.
– There’s a difference between being sexy and being rich. Your investment style should sound pretty boring: “Well, I bought a few good funds five years ago and haven’t done anything since, except buy more on an automatic schedule.” Investment isn’t about being sexy, it’s about making money. And when you look at investment literature, buy-and-hold investing wins over the long term, every time. Forget what that money TV station or finance magazine says about the stock-of-the-month. Do some analysis, make your decision, and then reevaluate your investment every six months or so. It’s not as sexy, but you’ll get far greater returns.
– Simple, long term investing works. This idea gets nothing but yawns and rolling eyes during a conversation. But you need to make a decision: Do you want to sit around impressing others with your sexy vocabulary, or do you want to join me on my gold-lined throne as we’re fed grapes and fanned with palm fronds?
– Keep a diversified portfolio. Buy high and sell low. When it comes to the stock market, most people buy when a stock is getting hot and sell when the stock market starts doing poorly to get their money out of the market – for example, when the global financial crisis erupted in the stock market in 2008. That’s almost always a bad move. They compound one mistake – not having a diversified portfolio – with a second: buying high and selling low.
– It’s important to diversity within stocks, but it’s even more important to allocate across the different asset classes – like stocks and bonds. Investing in only one category is dangerous over the long term.
– Remember it like this: Diversification is D for going deep into a category (for example, buying different types of stocks: large-cap, mid-cap, small-cap, international, emerging markets, and so on). And asset allocation is A for going across all categories (for example, stocks and bonds)
– The rule of 72 is a fast trick you can do to figure out how long it will take to double your money. Here’s how it works: Divide the number 72 by the return rate you’re getting, and you’ll have the number of years you must invest in order to double your money
– The Swenson model of asset allocation
- 30% – Domestic equities: U.S. stock funds, including small, mid, and large-cap stocks
- 15% – Developed-world international equities: funds from developed foreign countries, including the United Kingdom, Germany, and France
- 5% – Emerging markets equities: funds from developing foreign countries such as China, India, and Brazil. These are riskier than develop-world equities, so don’t go off buying these to fill 95% of your portfolio
- 20% – Real estate funds: also known as REITs, short for real estate investment trust. REITs are funds that invest in mortgages and residential and commercial real estate, both domestically and internationally
- 15% – Government bonds: fixed-interest U.S. securities, which provide predictable income and balance risk in your portfolio. As an asset class, bonds generally return less than stocks
- 15% – Treasury inflation-protected securities: also known as TIPS, these treasury notes protect against inflation. Eventually you’ll want to own these, but they’d be the last ones I’d get after investing in all the better-returning options first
– When choosing your own index funds, start researching at Vanguard, Schwab, and T. Rowe Price. The first thing to do when picking index funds is to minimize fees. Look for the management feed (aka expense ratios) to be low, around 0.2%. Anything below 0.75% is okay. Second, make sure the fund fits your asset allocation. Use Swensen’s model as a baseline and tweak as necessary if you want to exclude certain funds or prioritize which are important to you. Third, you should absolutely look at how well the fund has returned over the last ten or fifteen years, but remember that, as they say, past performance is no guarantee of future results. Here’s a sample portfolio made of all Vanguard funds:
- 30% – Total market index (VTSMX)
- 20% – Total international stock index (VGTSX)
- 20% – REIT index (VGSIX)
- 5% – U.S. treasury bond index (VFISX)
- 5% – Vanguard intermediate-term treasury fund (VFITX)
- 5% – Vanguard long-term treasury fund (VUSTX)
- 15% – TIPS bond index (VIPSX)
Managing Your Automated System
– If you have a diversified portfolio of index funds, some of your investments, such as international stocks, may outperform others. To keep your asset allocation on track, you’ll want to rebalance once a year so your international stocks don’t become a larger part of your portfolio than intended. Think of your investment portfolio like your backyard: If you want your zucchini to be only 15% of your backyard, and they grow like crazy and end up taking over 30%, you’ll want to rebalance by either cutting the zucchini back, or by getting a bigger yard so the zucchini is back to covering only 15%
– If you suddenly need money for an emergency, here’s your hierarchy of where to get it
- Use your savings account
- Sell any valuables that aren’t critical to you
- Ask your family if you can borrow money from them
- Use the money in your retirement accounts
- Use your credit card only as a last resort
– If you made a terrible investment that’s consistently underperforming, here’s how to decide what to do
- If you’ve invested in an index fund, that means the entire market is down. If you believe the market will recover, that means investments are on sale for cheaper prices than before, meaning you should not only not sell, but you should keep investing and pick up shares at a cheaper price
- If it’s an individual stock, look at the context before you decide what to do. How are the other stocks in that industry doing? (Go to Yahoo Finance, click on “Investing”, and then on “Industries”). If they’re all doing poorly, the entire industry is in decline. All industries experience declines at one time or another. Dig in more to see what is happening with the industry. If you think the industry or investment is simply going through a cyclical downturn, then hang on to the investment and continue regular purchases of shares. If, however, you think the industry won’t recover, you may want to sell the investment. But if your research shows that the stock really has been underperforming against its industry index, you also might consider selling.
– Financial options for super achievers
- Create an emergency fund – that contains six months of expenses, which includes everything: rent/mortgage, other loans, food, transportation, taxes, gifts, and anything else you would conceivably spend on
- Insurance – to use as a protection from downside risk – fire, flood, earthquake, home, life insurance, etc
- Children’s education – save up to pay for college expenses
– Think about elevating your financial goals beyond the day to day. Set larger goals of doing the things you love using money to support you. Part of getting rich is giving back to the community that helped you flourish. There a lots of traditional ways to do this, like volunteering for a soup kitchen or becoming a Big Brother/Sister. You might want to try to contribute on a bigger scale. You can start a college scholarship, give directly to the poor in third-world countries with www.givedirectly.com, donate to your high school, local library, environmental action groups, the Red Cross – whatever means the most to you. And if you’re short on cash, donate your time, which is often more valuable than money
Buying a House
– You should buy a house only if it makes financial sense, not because you “fell in love” with a house and then “had to have it on the spot.” In the olden days, this meant that your house would cost no more than 2.5 times your annual income, you’d be able to put at least 20% of the purchase price down, and the total monthly payments (including the mortgage, maintenance, insurance, and taxes) would be about 30% of your gross income. If you make $50,000 per year before taxes, that means your house would cost $125,000, you’d put $25,000 down, and the total monthly payments would be $1,250 per month. Yeah right, maybe if you live in the Ozarks. Things are a little different now, but that doesn’t explain the stupidity of people who purchase houses for ten times their salaries with zero money down. Sure, you can stretch those traditional guidelines a little, but if you buy something you simply can’t afford, it will come around and bite you
– Can you afford at least a 10% down payment for the house? If not, set a savings goal and don’t even think about buying until you reach it. Even if you’ve got a down payment, you still need to be sure you make enough money to cover the monthly payments. You’ll probably want to buy a nicer house than you’re currently renting, plus you’ll owe property taxes, insurance, and maintenance fees that will add hundreds per month. Your real cost will be about 40-50% higher than your mortgage payment when you factor everything in. Bottom line: If you don’t have enough money to make a down payment and cover your total monthly costs, you need to set up a savings goal and defer buying until you’ve proven that you can hit your goal consistently, month over month
– Next thing to think about: Are the houses you’re looking at within your price range? Unless you’re already loaded, you’re not going to buy the grandest possible house. You need to readjust your expectations and begin with a starter house – a simple house that requires you to make trade-offs but allows you to get started. Your first house probably won’t have as many bedrooms as you want. It won’t be in the most amazing location. But it will let you get started making consistent monthly payments and building equity
– Will you be able to stay in the house for at least ten years? The longer you stay in your house, the more you save – due to the 6% closing cost you pay your realtor, the costs associated with moving, taxes, and more. The bottom line here: But only if you’re planning to live in the same place for ten years or more, or to hold onto it as a rental property (if you’re willing to become a landlord)
– Buying a house is not just a natural step in getting older. Too many people assume this and then get in over their heads. Buying a house changes your lifestyle forever. No matter what, you have to make your monthly payment every month – or you’ll love your house and watch your credit tank. This affects the kind of job you can take and your level of risk tolerance. It means you need to save for a six-month emergency plan in case you lose your job and can’t pay your mortgage. In short, you really need to be sure you’re ready for the responsibility of being a home owner
– Think of buying a house as a purchase, not an investment. And just as with any other purchase, you should buy a house and keep it for as long as possible. Do your homework and then negotiate. And know your alternatives (like renting)
– Be conservative when it comes to real estate. Stick by tried-and-true rules, like 20% down, a 30-year fixed-rate mortgage, and a total monthly payment that represents no more than 30% of your gross pay. If you can’t do that, wait until you’ve saved more. It’s okay to stretch a little, but don’t stretch beyond what you can actually pay
– Here are some of the things you’ll need to do to make a sound decision:
- Check your credit score – The higher your score, the better the interest rate on your mortgage will be. If your credit score is low, it might be a better decision to delay buying until you can improve your score
- Save as much money as possible for a down payment – If you haven’t been able to save at least 10% to put down, stop thinking about buying a house. Set a savings goal for a down payment and don’t start looking to buy until you reach it. 20% down is ideal
- Calculate the total amount of buying a new house – On top of the mortgage payments, this includes closing costs, insurance, taxes, maintenance, and renovations. If all this sounds a little overwhelming, it’s telling you that you need to research all this stuff before buying a house. Ask your parents and other home owners what their surprise costs were
- Get the most conservative, boring loan possible – Keep it simple and go with a 30 year fixed rate loan
- Don’t forget to check for perks – Many state and local governments offer benefits for first time home buyers. Also, check with your employer, who may offer special first-time home-buying rates. Check with any associations you belong to, including local credit unions and teacher’s associations. Heck, even check your Costco membership (they offer special rates for members, too)
- Use online services to comparison shop – Check out www.zillow.comand www.redfin.com, which are rich sources of data about home prices all over the U.S. For your homeowners insurance, check www.insure.comto comparison shop. And don’t forget to call your auto insurance company and ask them for a discounted rate if you give them your homeowner’s insurance business
Buying a Car
– The single most important financial decision associated with buying a car is how long you keep the car before selling it. Understand how much you can afford, pick a reliable car, maintain it well, and drive it for as long as humanly possible. It’s only once you finish the payments that the real savings start
– Calculate total cost of ownership. Besides the total cost of the car and the interest on your loan, this should include maintenance, gas, insurance, and resale value.
– Ask yourself how buying a car fits into your spending and saving priorities (i.e. get a Toyota Corolla and put the extra money toward investing for growth, or get a new BMW)
– Look at your conscious spending plan and decide what you’re willing to allocate toward your car each month. This is the number you keep in your back pocket as the number you can afford to spend up to. Ideally you’ll spend less
– Knowing that there will be other expenses involved in the total expense of having a car, you want to decide how much you want to spend on the car itself (i.e. if you can afford a total monthly payment of $500, you can probably afford a car that costs $200 – 250 per month, the remainder of the expenses will come from insurance, gas, maintenance, parking, etc)
– Any car you evaluate must fit within your budget. This will eliminate most cars automatically. So not even look at cars you can’t afford
– Pick a good car. There are some cars that just objectively bad decisions that nobody should ever buy. You’re not just being the car for today, you’re buying it for the next ten-plus years. Here’s what makes a good car:
- Reliability – Get a car that won’t break down. You may potentially pay more for it, but it will save you in maintenance fees over it’s lifetime. Buy a car that will last you ten years
- A car you love – Since you’ll be driving the car for a long time, pick one that you really enjoy driving
- Resale value – To check out how your potential cars will fare, visit www.kbb.comand calculate resale value in five, seven, and ten years
- Insurance – The insurance rates for a new and used car can be pretty different, and it can add up over many years
- Fuel efficiency – Consider a very fuel-efficient, or even hybrid car
- The down payment – If you don’t have much cash to put down, a used car is more attractive because the down is typically lower
- Interest rate – This will largely depend on your credit score, which is why having good credit matters. Don’t be afraid to walk out if the dealer tries to change the finance terms on you at the last minute. This is a common trick
– Don’t lease. Leasing nearly always benefits the dealer, not you. Buy a car and hold it for the long term
– You must negotiate mercilessly with car dealers, otherwise you may end up making a bad purchase decision. If you’re not a hardball negotiator, take someone with you who is. If possible, buy a car at the end of the year, when dealers are salivating to beat their quotas and are far more willing to negotiate
– Use www.fightingchance.comto arm yourself with information before you negotiate. The service costs $40 and it’s completely worth it. You can order a customized report of the exact car you’re looking for, which will tell you exactly how much car dealers are paying for your car – including details about little-known “dealer withholding.”
– Negotiate from the comfort of you sofa. Don’t even set foot in a dealership until the very end. Here’s how I did it:
- When I decided to buy (at the end of December, when salespeople are desperate to meet their quotas), I faxed seventeen car dealers and told them exactly which car I wanted
- I said I was prepared to buy the car within two weeks and, because I knew exactly how much profit they would make off the car, I would go with the lowest price offered to me
- The same day, faxes started rolling in from the dealers. After I had all the offers, I called the dealers, told them the lowest price I’d received, and gave each of them a chance to beat it. This resulted in a bidding war that led to a downward spiral
- In the end, I chose a dealer who sold me the car for $2,000 under invoice, a nearly unheard-of price. I didn’t have to waste my time going to multiple dealerships, and I didn’t have to bother with slimy car salesmen. I went into only one dealer’s office: the winning one
– Take your car’s maintenance as seriously as you take your retirement savings. As soon as you buy your car, enter the major maintenance checkpoints into your calendar so you remember them. The average car is driven about fifteen thousand miles per year. You can use that number as a starting point to calculate a maintenance schedule based on the car manufacturer’s instructions