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10 Ways to Improve Your Finances Now!

Posted By damien on April 30th, 2010

good defense

The book The Millionaire Next Door has an awesome approach to personal finance.  The authors say that financial security is a mix of good offense and defense (everyone loves sports analogies, right?).

In personal finance, a good offense means having a good income.

A good defense means frugal and wise spending habits.

A  winning personal finance strategy is a combination of good offense and defense. Let’s look at some ways to improve both:

Good Offense

1) Ask for a raise

Perhaps the quickest way to improve your income is to ask for a raise.  Notice how I said quickest, not easiest. It’s an uncomfortable process, but will improve your finances faster than starting your own business or looking for a side job.

Take the time to review your recent performance at work, make sure you have concrete examples of how you have performed above expectations.  Then, take these examples to your supervisor and ask for a raise in pay to match your raise in performance.

2) Look for side income

Step away from the TV and spend your time in more profitable endeavors.  If you need to pay down debt fast or build up savings, look for a side job you can work around your full-time position.

This would be a short-term solution, since you probably don’t want to be working 60 hours a week for someone else for the rest of your life.

3) Start your own business

Does the thought of working for someone else during your free time not appeal to you?  Then strike out on your own and start your own small business.

Chances are, you have some sort of skill you can monetize.  Are you good at an instrument? Teach lessons.  Do you enjoy writing?  Start a blog and offer free information along with paid.  I turned my hobby of web design into a nice side income by designing sites for small businesses.

Take the time to inventory your skills and there’s a good chance you can make money from one or two of them.

4) Work more hours

Don’t do this if you can barely stand 8 hours at your day job.  Personally, I would only use this option for short-term needs.  Work more hours if you need to quickly pay down debt or increase your savings.

5) Sign up for a high-yield checking account

I am constantly surprised by the number of people who still pay to have a checking account.  I thought the days of fee-based checking accounts were long gone, but many dinosaurs remain.

If you are paying your bank to have a checking account, dump it!  Your bank should be paying you to use their services.  Check out your local credit unions for the best rates on interest-bearing (sometimes called “rewards”) checking accounts.

Good Defense

1) Build an Emergency Fund

I have an earlier post dedicated to building an emergency fund.  This is such an important part of a successful personal finance strategy.

Some people call them emergency funds, rainy day funds, or umbrella funds.  Basically, an emergency fund is cash savings set aside for the express purpose of covering an unexpected expense.  Save up 3-6 months (or more) of expenses in an easy-to-access place, such as a high-yield savings account.  Then, don’t touch it unless you have an emergency.

2) Monitor your spending

Mint.com is the software you need.  It’s a free service that allows you to track all of your financial accounts in one place.  Mint.com is an integral part of my personal finance system.

Use it to track your spending by putting all of your transactions into categories (gas, clothing, restaurants).  Then, after a few weeks, go over your expenses and you will be amazed at how much you spend on certain things.

Monitoring your spending gives you a better awareness of where your money is going.

3) Make a budget

After monitoring your spending, I’m sure there are some things you want to change. Maybe you want to spend less on eating out and more on your Roth IRA?  Mint.com allows you to set budgets for all of the categories you use.

After creating your budgets, Mint.com will track your spending, letting you know where you are and alerting you when you’ve gone over the limit.

4) Pay down debt

Too many people, instead of thinking about how much something will cost them, think only about monthly payments.  Can I afford $400 a month on my lease?  This way of thinking, in the long run, will make you much poorer than your potential.

I have a post devoted to my favorite method of paying down debt, what many call the debt snowball.  In brief, list all of your debts, from smallest balance to largest, then pay them off in that order.  Read my post for more detailed instructions.

5) Invest for retirement

We Americans are not saving enough for retirement.  If you are not currently investing in your company’s 401(k) or your own personal IRA, plan on flipping burgers into your 80′s.  You need to be saving at least 15% of your income for retirement.

For lots more information on investing for retirement, check out my free guide, The Minimalist Guide to Investing.

Posted in Building Wealth, Dumping Debt
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The Simplest, Smartest Personal Finance Set-up

Posted By damien on April 7th, 2010

Simple Investing

I love personal finance because it is such a taboo subject.  Everyone knows they should be spending more intelligently and saving for retirement, but hates confronting these facts and taking control.   I want to remove the fear and help others become financially secure, so they can focus on living life.

Today I want to present a brief overview of the simplest, smartest personal finance set-up.  Sort of a minimalist’s guide to financial accounts.  Here I’ll condense months of research to give you the best checking, savings and investing accounts for automated, simple, secure finances.

Remember, this is just a brief overview, if this post becomes popular enough, I’ll take the time to go more in-depth into each account.

1) High-Yield Checking Account

The foundation of all your financial accounts should be a high-yield checking account.  Interest rates are pretty low right now, but I suggest checking out your local credit union.  Some of the credit unions around here are still offering 3% on balances up to $25,000.  Pretty good for the current state of our economy.

There will be some conditions for getting the high-yield rate, but I’m sure you are already doing most of them.  Our credit union requires 10 debit card purchases a month, electronic statements, and one electronic transfer (like from a paycheck) per month.  Set up your paycheck as a direct deposit and do away with paper checks.

2) High-Yield Savings Account

Where do you keep your savings? Under your mattress? Get over your conspiracy theories and put it in a high-yield savings account backed by the FDIC.  Just like high-yield checking accounts, the rates are low right now, but as the economy improves, so will interest rates.

Online savings accounts, such as ING’s, Ally’s and Everbank’s are all the rage right now.  Put your 3-6 month emergency fund in your savings account and set up monthly transfers from your checking account.

3) Retirement Accounts

Are you saving for retirement? If not, plan on flipping burgers into your 80’s.  Everyone should have a 401(k) or equivalent with their employer and an Individual Retirement Account (IRA).

This is a broad generalization, but I suggest saving about 15% of your gross income for retirement.  Make monthly contributions on the 401(k) up to your employer’s match, then max out the IRA with monthly contributions, then, if there’s any money left over, put the rest back into the 401(k).  For more information on investing for retirement, check out my free Minimalist Guide to Investing.

Hungry for More?

This post has only been the briefest of introductions to setting up your financial accounts to function simply and automatically.  If you would like me to go into more detail about each step, let me know in the comments or by twitter, email or my contact form.

Posted in Building Wealth, Dumping Debt
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Your Tax Return and the Problem with Found Money

Posted By damien on March 2nd, 2010

Gambling away found money

Tax returns are coming!  Why is it that so many of us blow our returns on junk we don’t need? You know you should be using it to pay down debt, but instead buy all 13 cycles (seasons) of America’s Next Top Model on Blu-ray.

Read on to learn about the tricks our minds play with us when it comes to “found money” and how to overcome them.

The Myth of Fungibility

In order to find out why we waste some of our money, including tax returns, we need to define some financial terms.  The first is what traditional economists call “fungibility”.  Fungibility means that all money, no matter where it comes from, will have the same value to a person.  $50 from work has the same value as $50 from the roulette wheel or $50 from a tax return.  Which makes sense, in a rational world.  All three of the $50 bills should have the same value to us because they can buy the same amount of stuff.

The only problem is that people aren’t rational.  Emotions hold a lot of sway in personal finance.  We make emotional decisions and place different values on our money depending on where it comes from.

This is where the concept of “found money” comes into play.  Found money is basically money that we weren’t expecting which comes to us from sources other than our earned income (work).  For some reason, we tend to place a lower value on found money than on earned income.

The Problem with Found Money

This is why you blow your tax return, because you place a lower value on it than money from a paycheck.  Why does this happen? Why do we place a lower value on found money and end up wasting it?

There is a whole branch of economics (called Behavioral Economics) dedicated to understanding why people behave emotionally when it comes to their finances.  The field of study is relatively new and economists are researching the topic as I write this post.

From what I’ve gathered, it seems that people compartmentalize their money depending on where it came from.  The experts call this “mental accounting”.  We label our money according to its source and thus attach value to it.

The $100 savings bond from Grandma we leave alone to honor her memory.  The $27 won in Vegas we blow on expensive sushi.  The tax return we spend on America’s Next Top Model Blu-rays and rationalize it by telling ourselves “Miss J” will improve our catwalk (I promise I only watch the show for my wife).  It’s clear that when we label our income based on where it came from, it can have negative effects.

Master Your Mind

So how do we overcome the problems of mental accounting and wasting found money?  Here I offer two simple solutions that have worked for me:

  1. Consider all of your money as earned income:  Do away with mental accounting! No more compartments for your income based on where it came from.  Just consider any of your income, no matter its source, as a paycheck.  Viewing all of your income in one big bucket called earned income will help you give it all the same value and use it equally.
  2. Wait a few days (or weeks): Before spending the money, sleep on it.  This advice is good for all large purchases, but especially for found money because we are more prone to impulse spending.  Since I am prone to impulse spending, my wife institutes the wait policy on me.  Whenever I just have to have something now, she reminds me that I really don’t. A night’s sleep before purchases clears your head and prevents buyer’s remorse.

Hopefully this post has opened your eyes to how much emotions affect our money decisions.  Emotional spending is so important that I wrote about a debt-repayment plan that takes advantage of your feelings.  Now, go use your tax return to pay down debt or invest!

Posted in Building Wealth, Dumping Debt
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Why Can’t Top Stock Pickers Predict the Future?

Posted By damien on February 23rd, 2010

Crystal Ball Gazer

As explained before, I do not place unblinking trust in any sort of “expert”.  Frankly, I don’t think most experts deserve the credence or deference we are wont to give them.  In today’s internet-based world, many self-proclaimed experts are better at self-promotion than at giving expert advice.

When it comes to incompetent experts, the realm of stock picking is no exception. Keeping with the theme that index funds are good and actively managed funds are bad, let’s look at three reasons why stock pickers have such a hard time picking stocks that will outperform indexes.

Random Events

Let’s face it, the future is just too murky to predict.  Who could have seen the most recent stock bubble coming?  Virtually none of the professional stock pickers did.  Jim Cramer from CNBC’s Mad Money certainly didn’t.  The day before Bear Stearns went under, he was telling people to most definitely not sell their stock; that Bear Stearns was A-OK. The next day Bear Stearns went belly up.

There are just too many random variables that go into the price of a company’s stock: natural disasters, defects in a product, new discoveries, terrorist attacks, the list of variables outside of the company’s control goes on and on.  A popular saying among investors is that stock market predictors exist so that meteorologists (weather predictors) can feel good about themselves.

Falsified Financial Statements

A firm’s income statement may be likened to a bikini—what it reveals is interesting but what it conceals is vital.

–Burton Malkiel

One way today’s fund managers decide which stocks to buy is through a process called Fundamental Analysis.  It pretty much means they look at companies’ financial statements (balance sheet, income statement, etc.) to determine if the stock is undervalued or overvalued.  The problem with this approach is the rise in “creative” accounting procedures.  Accountants are very good at manipulating reports to make everything look rosy.

Here is just one example of creative accounting, taken from A Random Walk Down Wall Street:

Eastman Kodak availed itself of “big bash” accounting write-offs.  Kodak took six “extraordinary” charges during the 1990s totaling $4.5 billion, equal to all the company’s profits over the preceding eight years.  By charging off years of expenses at once, the company could make future earnings look that much better.  It’s like an individual making several years of mortgage payments in advance and then claiming that his income has grown.

Conflicts of Interest

Perhaps the biggest reason stock pickers are unable to accurately predict the future is the inherent conflict of interest that exists in the big brokerage houses.  Individual investors like you and me are the small fries in the investment arena.  For stock analysts, the real money is to be made from investment banks.  Investment banks move billions of dollars every month, so stock analysts want to keep them happy.

One indicator of how much analysts want to keep the big guys happy is in their reluctance to give advice which paints the bug guys’ stock in a bad light.  The analyst is torn: he knows he should tell you to sell the lame stock, but his brokerage house has a relationship with that company and it will hurt their relationship if even hints that their stock is stinky.

Here’s a famous example, once again from A Random Walk Down Wall Street:

In one celebrated incident, an analyst who had the chutzpah to recommend that Trump’s Taj Mahal bonds should be sold because they were unlikely to pay their interest was summarily fired by his firm after threats of legal retaliation from “The Donald” himself. (Later, the bonds did default.)

Trust No One…

When it comes to predicting the future, no one has a harder time than stock fund managers.  Even your local weatherman (or woman) gets it right more often.  There are just too many variables: random events, creative accounting, and conflicts of interest.  So what is an investor like you or me to do?  Choose index funds!

Posted in Building Wealth
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How to Invest in Stocks: Investment Tools

Posted By damien on February 18th, 2010

In the previous post, we looked at my investment philosophy, meaning the principles I use when choosing what to invest in.  Since I am investing for the long-term (retirement) I want stock funds that are easy to understand, have a slow and steady track record, and have minimal fees.

Using these criteria, let’s look at the actual stock funds I invest in and recommend.  In a nutshell, index funds are good and actively managed funds are bad.

What to Invest In

When it comes to the three principles outlined, index funds can’t be beat.  Before explaining how they meet the criteria, let’s talk about what index funds actually are.

A stock index is a listing of the largest companies in the various stock markets, ranked by market capitalization.  The most well known index is the S&P 500, a listing of the 500 largest stocks on the New York Stock Exchange.  These 500 companies account for about 75-80% of all US common stocks.

An index fund is a grouping of stocks that follows one of the indexes (such as the S&P 500).  They invest in stocks proportional to the amount of each company’s stock in the market.  So an index fund would have more of GE’s stock than, say, Apple’s.  If you were to invest in an S&P 500 fund, you would own a little stock of all 500 of the largest companies in the US market.

Index Funds vs. Our Philosophy

So how do index funds stand up to our investing philosophy? First of all, they are simple to understand: I just explained one to you in the preceding two paragraphs.  You are investing in a large group of common stocks.  No alphabet soup here.

Secondly, index funds have the least volatile returns available (of common stock).  In fact, this is where index funds really shine.  Since they are so diversified (across hundreds or thousands of companies), when measuring the return of an index fund, you need only be concerned with how the overall stock market is performing.  The performance of any one company is so small (some even negligible) in the aggregate.  This leads to smoother, more consistent returns.

Last of all, let’s consider fees.  Once again, index funds take the cake.  Since index funds simply track an index, there is no advanced analysis needed when picking stocks to include.  Index fund fees are rock-bottom.

What to Avoid

Now that we know what to invest in, let’s look at what to avoid.  As I said in the beginning of this post, actively managed funds are bad.  An actively managed fund means that some smart person or complex computer software is picking the stocks to include in their funds.  Active managers look at financial statements, stock charts, and Wall Street gossip to help them choose stocks.  In future posts, I will go into detail about the methods that are used, and how ineffective they are for our purposes.

Managed Funds vs. Our Philosophy

How do actively managed funds hold up to our three criteria?  Oftentimes, fund managers will invest in all sorts of tools, regardless of our understanding.  The attitude here is “trust me, I’m a professional”.  Most active managers are buying and selling stocks so often that even if you did figure out all the tools you were putting your money into, a month later it would have changed.

Historically, actively managed funds, in the long run, never outperform index funds.  For stretches of 5- 10- or occasionally 15-year periods, actively managed funds have returned more than comparative indexes.  But in the long-run, active managers have not outperformed index funds.  In fact, many managed funds, following the concept of mean reversion, after a period of outperforming the index go on to underperform.  For a more detailed explanation of this argument, I refer the reader to The Four Pillars of Investing or A Random Walk Down Wall Street.

Actively managed funds are the main culprits when it comes to high and hidden fees.  The reasoning goes that if a smart person or sophisticated computer algorithm is picking your stocks, you should pay them more for their efforts.  Managed funds came up with wrap accounts, 12b-1 charges, and a plethora of ways to take your money whenever you buy, sell, look at or think about (not yet, but they’re working on it) stocks.  Here’s the real kicker with managed funds and fees: Any higher return you may receive from them gets eaten up by the higher fees they charge.

Recap

Let’s go over what we’ve talked about today:  Since I am investing for the long-term, I look for funds that are easy to understand, have a steady track record, and low fees.  Index funds fill all of these requirements, so we love them.  Actively managed funds (ex: mutual funds) fail on all three and are to be avoided.  Now that we have laid the groundwork for our investment philosophy, we can zoom in and look at specific aspects of investing for retirement.

Posted in Building Wealth
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