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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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What To Do With Your Tax Return

Posted By damien on February 26th, 2010

A few days ago, a friend and I were talking about filing this year’s taxes, and the conversation drifted to what to do with our returns.  My friend asked a very common question:

Should I use my tax return to pay down debt or invest?

This is a pretty common question and one that can be generalized to “What should I do when I receive a lump sum of money? Pay down debt or invest?”  I’ve already told you how to invest a lump sum of cash, but here let’s talk about how to decide between dumping debt or buying stock.  Before I tell you the right way, let’s look at the conventional wisdom, because it’s wrong.

The Conventional Wisdom

Here’s what most people would say: compare the rates of return, and put your money on the higher one.  If your credit card charges you 8% and you can invest at 11%, put your money in stocks.  If your credit card charges a higher rate than you can earn by investing, then pay down the debt.  Sounds good, right?

Wrong! If you play this game, you walk a dangerous line.  So where does this way of thinking go wrong?

It disregards the element of risk.

A Better Approach

This comparison is not apples to apples.  A credit card rate is pretty much guaranteed.  Sure, it could go up or down, but only at the discretion of the credit card company.  For our purposes, the credit card interest rate is guaranteed.

Stocks, like most investments, are inherently volatile.  In the short-run, the rate of return from stocks is anything but guaranteed! In the long-run (20+ years) the stock market has averaged around 11%, but once again, this rate is not guaranteed.

Comparing the interest rate on stock investments to credit cards is comparing apples to oranges.  A risky investment (stocks) versus a guaranteed obligation (credit cards).  In order to compare apples to apples, we have to adjust the stock’s rate of return down.

Now, I’m pretty good with a financial calculator, but the formulas for adjusting for risk are a bit outside the scope of this blog and my mathematical skills.  Suffice it to say, you will almost never find a guaranteed investment offering a higher return than what your credit card charges.

Let me say that again, because it is the point of this post: you will not find a guaranteed investment with a higher return than what your credit card charges.

So my advice to my friend (and to you) is to pay down debt before investing your tax return.

Unless you find a guaranteed 11%+ return.  Then I’m all ears.

Posted in Dumping Debt
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How to Snowball Debt ‘Till It’s Gone

Posted By damien on August 31st, 2009

snowballNow, just to set things straight at the outset, we’re talking about a debt snowball here, not the kind made by Hostess.  Many personal finance gurus have variations of the debt snowball; I prefer Dave Ramsey’s as written in The Total Money Makeover.  In the last post, I discussed how debt is not a tool to become wealthy, an assertion backed up by lots of empirical evidence gathered by Thomas Stanley in The Millionaire Next Door.

Problem is, the average American is in debt, and not just a little bit!

So, let’s work out a plan to get you out of debt.  Before we can talk about where to put your money to become wealthy, we have to free that money up from creditors.  Once you are out of debt, then we can talk about 401ks, Roth IRAs and real estate investing.  The Debt Snowball is at once simple in definition and difficult in execution (will power required).  It is not a get-rich-quick scheme.  It will not get you out of debt overnight.  It will, most likely, require some changes to your lifestyle.  It is difficult, but it works.

Brain versus Heart

There are two approaches to the debt snowball: the math-based and the emotion-based.  For the math based approach, list all of your debts in order of highest interest rate to lowest.  Pay the minimum on all debts except for the one with the highest interest.  Put all the money you possibly can towards this debt (highest interest).  Once you have paid that one off, roll your payments into the bill with the next highest interest rate.  Keep doing this until all your debts are paid off!

Do you see where the term “debt snowball” comes from? You start with a small snowball: the payments toward your first bill.  Then, once it’s paid off, you roll that payment into the next, then the next, and your snowball (payment) grows and grows!

Most of Us Are Humans, Not Robots

The other approach, what I call the emotion-based one, has you list your debts in order of smallest amount owed to largest.  You then start the snowball by focusing on the smallest amount and working up to finish with the largest.

The math-based approach, in theory, will get your debts paid off the quickest.  Notice that I said in theory.  Dave advocates an emotion-based approach to the debt snowball, not because the math adds up better, but because it takes advantage of the non-rational human heart.  Here’s what he says:

The reason we list smallest to largest is to have some quick wins…Face it, if you go on a diet and lose weight in the first week, you will stay on that diet.  If you go on a diet and gain weight or go six weeks without any visible progress, you will quit.  When training salespeople, I try to get them a sale or two quickly because that fires them up.  When you start the Debt Snowball and in the first few days pay off a couple of little debts, trust me, it lights your fire.  I don’t care if you have a master’s degree in psychology; you need quick wins to get fired up.  And getting fired up is super-important.

I think Dave makes a pretty strong point here.  A few easy wins boosts a person’s confidence and gives them the drive to keep going when it gets tough.  This is why I recommend the emotion-based debt snowball.  List your debts from smallest to largest, pay the minimum on all except the smallest, and conquer your debt!  Then we can get into the exciting stuff: wealth building.

Unless, of course, if you’re a robot.

Posted in Building Wealth, Dumping Debt, Selp Improvement
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