Tuesday, March 20, 2007
Big Bucks, No Whammies.....STOP!
I recently closed the cover on a recent Christmas present The 250 Personal Finance Questions Every One Should Ask by Peter Sander, M.B.A. It probably isn't the light reading most people would pick up for a trip to The Cayman Islands, but then again, I am a little different. Whereas some would enjoy their trip to white sandy beaches, I believed it an opportunity to making sure I could come back and retire there. Tomorrow.
While this book didn't make it happen quite yet, it did present generally accepted fiscal practices in an easy to understand format. I consider retirement planning an interest of mine ranking right around wine sampling and far below fantasy baseball. As I said, I am a little different.
No matter how wonderful The 250 Personal Finance Questions Every One Should Ask is or how much I talk it up, I realize no one is going to rush out and purchase it. So with apologies to The Trampoline Bear, I steal JR's gimmick of a Top Ten list to present to you the single most important topics from the book. This way, I can have company on the beach, sipping pina colodas and wondering why the hairiest person out there has to be the one in a speedo.
The 20 somethings are the single most important group of people to try and push to action, as the decisions made at this point in their life will form the habits and foundation for the rest of their lives. Yet at the same time, this age group is the least involved, least interested group in personal finance. Instilling the knowledge and generating the motivation in the 20 somethings is critical toward a lifetime of fiscal stability.
#1) Do not carry credit card debt.
The next nine points might be interchangeable in their importance, but this one is far and away #1. The interest rates on credit cards are insane with 20-30% non uncommon. If you looked at a new pair of shoes that cost $100, you better adjust the price up to $130 to account for the amount you will actually pay to both the store and the credit card company. The damage that can be done to your credit score by carry balances can affect other areas of your life - car loans and mortgages - as well. Credit card debt can start a downward trend that makes it very difficult to get back uphill as seen by the penalties you will pay elsewhere and later on in life.
#2) Start planning for retirement yesterday.
I could come up with all kinds of tables that would show the power of compounding interest, but I'll spare you. Put $100 into anything, have it make $10, and the next go around, you have $110 to invest. Rinse and repeat over 30 years and you can make some serious dough.
#3) Take free money.
Brother Mauris taught me in physics that there is no such thing as a free lunch. He was a cute old guy who used the phrase in inappropriate situations, but the lesson still stuck. There is however such a thing as free money. With retirement pensions a thing of the past, employers new way to help its employees for retirement are contribution matches. Most employers, especially large ones, offer some sort of retirement plan, whether it be a 401(k), profit sharing, or a Roth 401(k). The types of plan are irrelevant to this discussion, but the contribution match is not. For every dollar you put into the account, the employer will contribute a dollar or more. Walgreens, for example, gives $3.00 for every $1.00 I put into said account. There's usually a limit of how much the employer will add, but it makes sense to maximize your account with as much free money as your employer will give.
#4) Make and follow a budget.
It's tedious but enlightening. Some expenses are inevitable - rent/mortgage, car payments, groceries - but seeing just how much money is left over can help make wise decisions later. As those cheesy NBC commercials have taught us: knowledge is power (and comes with a rainbow and uplifting jingle).
#5) Fear not the world of insurance.
The invincibility phenomenon that strikes teenagers makes it difficult for 20 somethings to spend money on insurance. Whereas car insurance is seen as a necessary evil, life insurance might be more viewed as just "an evil." Tell someone just out of school that they should spend some of that new found income on an "in case you die" plan, and you are going to get a crazier look than if you picked Oral Roberts to make the Sweet 16. But because you are going to be healthier the younger you are, the cost of insurance is also going to be at an all-time low. Lock in for 10 or 20 years at this low rate, and you've got life insurance at a low cost. If you have a mortgage and especially a significant other/family, the need for life insurance shoots up exponentially.
#6) Roth IRAs vs. Traditional IRAs: Learn the difference and participate.
They are both individual retirement accounts, but they contain one significant difference. The Roth IRA is an account that you contribute after-tax dollars from your paycheck toward. The traditional IRA is an account that you contribute money toward before taxes are extracted. Being that the government takes such a tremendous bite out of our checks, this difference in accounts can be substantial. The book suggest very heavily that the Roth IRA is the way to go. If you pay taxes now, you can withdraw money in retirement without any additional taxes. If you pay taxes later, the tax rate has the potential to increase and you won't get as much for your money. Either one is better than not saving for retirement, but the Roth takes the risk out of tax rates killing you at 65.
#7) It's not morbid. Write a will.
Much like life insurance, this task shoots up in importance as you purchase a home or have a family. Provisions for who gets the kids in the event something happens to ma and pa as well as dishing out some money for your best friend as opposed to the estranged cousin in Mozambique.
#8) Beware adjustable rate mortgages.
This point is especially relevant at this time in American home buying history. From 2003-2005, new homes were selling like Kevin Durant Celtics' jerseys. Due to a slumping economy, the feds lowered interest rates to historically low levels, which to the average Joe meant that the interest rate attained for a new mortgage was stupidly low. Instead of paying double digits of interest on every month's payment, the new rates were as low as 5%. Over the course of they year, this translated into thousands of dollars in saving, allowing more people to afford houses. The problem arose when people began to overstep their payment abilities. Instead of locking in at the same super low rate over 30 years, youngsters began opting for adjustable rate mortgages, which meant their rate would change as the market changed. The market is no longer offering these favorable interest rates, which in turn means the stupidly low mortgages are out the door and those who went the adjustable rate are paying more. Multiple stories in the USA Today have focused on the high rate of mortgage default from those who, as a result of the now higher rate, cannot afford their house.
#9) Be aggressive investing while young
Again, young twenty somethings making money for the first time in their life have a hard time deciding to push some of that dough aside for investing. When they do, they tend to veer away from any plan that offers risk because they do not want to lose this new discovered income. With the high risk comes the high reward. However, the younger you are, the more time you have to recover from a bad investment. As you near retirement, you don't have time to bounce back from an unfortunate situation. As is, the stock market goes up on average double digits every year. Putting some money into the stock market might lose you money, but in the end, it can kick back some of the best returns out there.
#10) Have an emergency fund
What happens with that booger picker driver veers into your lane, slams into your car, and keeps you from being able to work for 6 months? You have no income and you have incredible medical bills. It happens, and an emergency fund - between 4-7 months worth of normal living expenses - can save you from having to break rule #1 on this list.