Debt


This week, over at U.S. News – Money, there was a post by Sabah Karimi that we’d like to talk about today: “6 Worst Money Mistakes You Can Make In Your 20s.”

Your twenties are a very important time in your life. It’s the time where many people are finishing up their schooling and starting their careers. Some may be settling down, getting married, and starting a family.

Unfortunately, we often see people in their twenties neglecting their finances, to the detriment of both their current account balances, and their future retirement. Maybe it’s because they were never taught how to handle money responsibly. Maybe they just have the “I’ll deal with it later” mentality. Whatever the reason, there are plenty of mistakes people in the twenties make with their money.

Karimi gives her list of top mistakes:

  • “Fueling an overspending habit. Breaking an overspending habit during your 20s can prevent serious money problems later in life. Become a mindful spender and keep track of all your purchases.” – Overspending can be a dangerous habit at any age, and a habit you’ll likely carry over into your later years unless you break yourself of it when you are young.
  • “Living without a budget. Knowing how much it costs to live your lifestyle and what expenses you are responsible for every month can help you make better financial decisions throughout your 20s. Update your budget at least once a month, and track your weekly expenditures within the budget so you have a clear picture of where your money is going every month. Review your budget regularly to cut out extra expenses and contribute more toward your savings account when possible.” – If you have been following us for any length of time, you know we are firm believers in budgeting. Not only is it helpful for expense tracking, it can help you spot areas you may be able to save money in that you never would have seen before.
  • “Neglecting student loan repayment and forgiveness programs. About 1.6 million people are eligible to cap their monthly student loan payment at 10 percent of their income by enrolling in appropriate income-based repayment programs. In addition to income-based programs, there are several loan deferment and forgiveness programs designed to make your student loan payments as manageable as possible.” – It’s unfortunate that so many young adults have to start their careers (often with lower than ideal wages) saddled with so much debt. Making those student loan payments when you’re just starting out and not even sure where the money to pay for your rent is going to come from can be daunting. Be sure to look into what your options may be.
  • “Relying on credit cards to fill income gaps. If you’re counting on credit cards to pay for bills or take care of expenses you forgot to budget for, you will be setting yourself up for huge debt problems. Learn to live within your means by taking a close look at your finances with a realistic budget.” – Accurate budgeting can become important for this very reason. There will likely be times when using a credit card is unavoidable (i.e. for emergencies while you work on building up an emergency fund), but relying on them every month for your regular expenses (or to fuel an overspending habit), can cost you thousands of extra dollars in interest and years to repay. It’s just not worth the hassle.
  • “Living without health insurance. Medical bills are one of the biggest causes of bankruptcy in America. No matter how healthy you are, you must be prepared financially for a medical emergency.” – Obviously, health insurance is a major hot topic in the U.S. right now. Regardless of the upheaval, if you are lucky enough to find a job where health insurance is offered as part of your benefits, consider taking advantage. Not everyone has the opportunity, and even if it’s expensive, it can be a good opportunity.
  • “Trying to keep up with the Joneses. […] It’s easy to feel financially insecure in today’s social media landscape, where every major purchase is announced on Facebook and photos from expensive vacations are shared on Instagram. Don’t get lured into that spending frenzy. Your real friends will not care about what kind of cars you drive or whether you have the latest gadget. Figure out your priorities, and don’t let other people dictate your financial future.” – This is another problem that affects people of all ages. Feeling inadequate can cause people to make mistakes that don’t seem like such at the time. It can often fuel an overspending habit, and can cause you to make purchases that you could regret later.

Your twenties can be a time of new beginnings. It can be exciting and stressful at the same time. Don’t compound your stress by making these financial mistakes that could affect the rest of your life.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

A post over at Good Financial Cents this week, “Why You Might Not Want to be an “Average” American” by Miranda Marquit pointed to some “average” U.S. statistics that you should probably strive to be better than:

  •  “the average household credit card debt was $7,149” – Certainly not insurmountable, but with credit card interest rates typically high, carrying that amount of debt on credit cards can lead to large monthly payments. It also can mean many years of paying it down, assuming of course, that you aren’t adding new debt in the meantime.
  •  The average indebted household debt (this doesn’t include the mortgage) was $15,325” – More than double that of the average credit card debt. We would guess that in many cases, this would include debt for a car. Monthly payments on debt this size could be crippling to your finances, especially for lower income families, making it even more difficult to get out from under.
  •  “the savings rate at the end of September 2012 was 3.30%” – This amount wouldn’t even be enough to fund an emergency fund for many families, let alone allow them to save for other necessities and goals. It wouldn’t be unthinkable to say this savings rate is likely why the average debt is so high—when emergencies or other needs and wants pop up, families just don’t have enough cash saved to cover them, so they turn to their credit cards.
  • “According to the Social Security Bulletin, only about 1/3 of people aged 65 and older has an IRA or a 401(k)” – Since Social Security is often not enough to cover people’s retirement expenses, retirement funds are relied upon to cover the gap. However, for those who have no retirement funds, they have no choice but to make do. And with the savings rate so low, it unlikely they have funds elsewhere to turn to.
  •  “Those in the younger age bracket of 18 to 34 aren’t really saving, either: 56% are not saving at all” (referring to retirement) – These years are the best time to get started saving for retirement. Even though it is often the case that you will be making less during these years than later in your career, you will likely have less financial commitments. Maybe you haven’t bought a house yet, haven’t gotten married yet, or haven’t had kids. So, putting money aside may not hurt as badly as when you do these things. Unfortunately, the idea of “I have plenty of time” gets to many people. By the time you realize you need to get serious about retirement, it may be too late for you to make up the ground you lost during these years.

Obviously these statistics don’t tell the whole story. There are always mitigating circumstances: illness, job loss, disability, etc. However, the earlier you start taking these “averages” seriously, the better off you’ll be down the road.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

Yesterday, over at Get Rich Slowly, there was a post by Donna Freedman entitled “Straying Off the Path or Changing Direction.” Essentially, Donna’s message is this: “Bad stuff happens, often to good people […] Pay attention to these lessons because there’s no guarantee that hard luck will stay gone.”

 

When something in your life goes wrong, or simply doesn’t go the way you thought it would (or should), don’t waste your time dwelling on “what ifs” and the past. That’s maybe not so easy, but you likely already know what went wrong. Maybe you did something to put yourself in a bad position, or maybe what happened was in no way your fault. Whatever the case, instead of thinking about what should have been, think about how you can fix the problem if needed and learn from your experiences.

 

Moving forward with your life when you are still dealing with your tough situation isn’t going to be easy. But it will be a far better future for you and your family if you do. Think about all the good things you still have going in your life (because even if you feel your situation is hopeless, there are always still good things). Dwell on the positives while trying to move forward instead of the negatives.

 

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

Yesterday, over at Get Rich Slowly, there was a post by Sarah Gilbert entitled “One Lesson From a Financial Whiz Kid.” The post is really about a book by Zac Bissonnette, Be Richer, Smarter, and Better-Looking Than You Parents. While we haven’t had a chance to read this book ourselves, the post has some great highlights.

 

Zac is a 20-something writer who is targeting his age group, but the lesson he gives can apply to everyone, no matter their age. The lesson he teaches is simple: “Don’t spend money.” Obviously, not spending any money isn’t an option, but not spending money on something that is unnecessary or that will get you into debt is.

 

Sounds simple, but as we all know, this type of discipline can be very difficult to maintain. But it’s such an important part of handling your finances. As Zac writes, “Managing your financial life is not about spreadsheets and compound interest. It’s about your life. The financial decisions you make can give you freedom or make you a slave.” You can spend as much time as you want on dealing with your finances, but if you can’t learn and live by this simple rule, you’ll likely never get ahead.

 

Another important point Zac makes is that many people will buy something not because they really need or even want it, but because they want the status that may come with it. He writes “A house you can’t afford can be a prop. Or a car. Or a watch. When you think about it, we spend a lot of money on props — stuff that makes us look like something we’re not.”

 

Again, the idea is simple, but it’s a great lesson to learn. And it’ll be much easier on you if you learn it before you run up your debt and have to dig your way out.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

Last week, we briefly touched on Dave Ramsey’s Baby Step program and Len Penzo’s commentary on it. This week, we’ll provide our own commentary on the program, step by step.

Step 1: “$1,000 to start an Emergency Fund”

While Len disagrees with this step, we think it’s a smart move. The idea is to pay down your debt, and if you don’t have a safety net for a possible emergency, you could end up creating even more of a problem for yourself than you started with. However, we would say $1,000 should be just a guideline. Depending on your situation, this short-term emergency fund may need to be smaller or larger.

Step 2: “Pay off all debt using the Debt Snowball” (excluding mortgage)

Again, Len disagrees (as do many other financial experts). The Debt Snowball method pays off the smallest debt balance first and doesn’t consider interest rates. We agree with Dave Ramsey here. If you have 2 credit cards, one with a 15% interest rate and a $1,000 balance and one with an 18% interest rate and a $3,000 balance, we would say pay the lower interest card first.

Yes, that means you’ll be paying more in interest. But feeling successful is a great motivator and being able to cross that card off the list will help you feel even more inspired to pay down the second.

Also, paying down the smallest balance first will help you free up cash flow faster. The $200 you were using to pay down your first debt will be freed up in 5 months if you pay off the $1,000 balance first as opposed to 15 months if you pay off the $3,000 balance first.

Len says that the financial implications outweigh the psychological benefits of motivation. People who are truly committed to paying off debt will do so, no matter what and should pay down debt in order of highest interest rate to save money. Unfortunately, we think this doesn’t play out well in the real world. Even the most highly motivated people who want to change their financial situations completely can slow down or give up when they perceive all their hard work is having little payoff.

Paying off the higher interest card may save you money, but we don’t think it’s worth the risk of feeling defeated and giving up.

Step 3: “3-6 months of expenses in savings”

Len agrees, and so do we (to an extent). Depending on your situation, waiting until you’re done paying down debt to save an emergency fund may not be a great idea. If you’ll pay down your debt quickly, have a secure income, and little other expenses, you can probably wait. If it’s going to take you a significant amount of time to pay down your debt, have unsecure income, or many other fixed expenses, you may want to consider splitting your monthly debt payback allowance to begin funding an emergency fund sooner (as the $1,000 from Step 1 may not be sufficient).

Step 4: “Invest 15% of household income into Roth IRAs and pre-tax retirement”

This step is one where we split from Dave Ramsey’s thinking. First of all, 15% is often unrealistic, especially for younger people. We typically recommend 10% for retirement savings. It’s achievable and sufficient for many people, and leaves more cash available for other worthwhile pursuits.

Also, like Step 3, we disagree with waiting until your debt is paid off to fund retirement. This is especially true the older you are and the more debt you have. Suspending retirement funding may help you pay down your debt faster, but it may be too detrimental to your future if you’re not careful.

Also, if you’re lucky enough to have a company matched retirement plan through your employer, we would say always fully fund to get the match, no matter your situation, while you pay down debt. That’s free money, and while it may take you a little longer to get rid of your debt, you’ll likely be better off for it in the future.

Step 5: “College funding for children”

Len completely disagrees, saying his kids will pay for their own college degrees, since it won’t help him in his future. We would say this step is entirely situation dependant. If you don’t have kids or have no intention of paying for your kid’s schooling, this step obviously won’t apply.

We see nothing wrong with even fully funding you kid’s college education, especially if your debt is paid off and you’re sufficiently funding retirement. However, we would recommend putting stipulations on the funding (paying for a local, public university). Make it clear to your kids what is expected (if they choose to go out of state or to a more expensive, private school, they must pay the difference). Again, how you handle it is completely dependent on your situation.

However, we’d like to point our that not all college funding vehicles will go to waste if your kid’s choose not to use it all. We’ve written before about using your own Roth IRA to help fund your kid’s education.

We would also like to say that if your situation doesn’t allow you to save enough to cover your kid’s education, it’s not a good idea to go into debt to fund it, especially when you’ve worked so hard to payoff your own debt! Avoid that situation, even if it means not being able to help your children as much as you may have wanted.

Step 6: “Pay off home early”

Again, this is entirely situation dependent. There are situations where paying off your mortgage early makes sense and situations where it doesn’t. Some people chose to do it simply for “peace of mind” as Len says.

Step 7: “Build wealth and give!”

This is not everyone’s ultimate financial goal in life. If it is, then that’s great, you would hopefully be able to do so after following the program. However, if it’s not your goal, you should spend some time thinking about what your goals are, and what you need to do to achieve them.

Ultimately, like any financial plan, Dave Ramsey’s Baby Step program is designed to simplify. Each step when completed, should make the next easier to manage. And the hardest part is usually getting started.

Would we recommend the Baby Steps program?

As you can see, there are some aspects of the program we agree with. But we would say it’s much too uniform. There are too many variables not considered, and not every universal step is the right thing for everyone following the plan. Yes, it provides a good guideline for people who need to start somewhere. But as we said last week, many people take Dave Ramsey’s word as law and fail to consider what else might work best for their situation. Our recommendation would be that anyone who chooses to follow the plan should carefully consider each step to decide what the right move would be.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

This week over at lenpenzo.com, Len did a great post entitled “Debt Elimination: The Pros and Cons of Dave Ramsey’s Baby Steps.” Basically, he went step by step through Ramsey’s plan explaining what he agreed and disagreed with, and why.

We found it very interesting. Working in financial planning, we often hear people say something along the lines of “But that’s not what Dave Ramsey says…” Honestly, it can sometimes get frustrating. Not to say that Ramsey’s plan doesn’t work. He’s helped many people get in control of their finances and out of debt, so obviously his plan works. However, we definitely agree with Len that the plan works for anyone who is committed to it (which is the same with any sound financial plan).

The problem with some people who follow Dave Ramsey is that they believe he is the end all of financial advice. Any ideas outside of the realm of his advice can’t possible be right (we’ve personally seen people like this). But there are always new ideas and new ways of doing things that are better than before. Your personally situation is going to change, making one plan that you were following completely inappropriate for your life. We think it’s fine to follow his plan if it’s going to help you in your personal financial situation, but it’s not the only way to successfully handle things.

Next week, we’re going to go through Dave Ramsey’s Baby Steps and discuss what we agree and disagree with and why (and touch on what we agree and disagree with Len as well).

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

As promised, here is our last detailed post about The Automatic Millionaire by David Bach. As we discussed before, the first few steps to becoming an “Automatic Millionaire” is to discover your “Latte Factor,” “Pay Yourself First,” and to “Make it Automatic”. But what happens if you have debt to pay down? Bach discusses that issue in The Automatic Millionaire.

 

“Automatic Debt-Free Homeownership”

 

For most people, their mortgage is just anther expense. It’s not necessarily considered to be a debt that needs to be aggressively paid down, like credit cards. You have a specified term on the loan, and you pay it off over that time frame. But what if you want to pay your home off early? What if you don’t want to wait 30 years before owning your home free and clear?

 

Bach gives some tips to achieving “Automatic Debt-Free Homeownership.” First of all, let us say that Bach believes you must be a homeowner to be rich. He doesn’t believe in renting, which as we’ve discussed before, is not something we agree with. Not everyone should be a homeowner, nor is it necessary to becoming a millionaire.

 

However, if you are a homeowner and have the desire to pay down your mortgage early, what steps can you take to do so? First of all, make sure that you have the right mortgage for you. Do your research. There are a lot of mortgage options out there, and you need to be sure that you are getting the right one.

 

Once you are secured in a mortgage and are making the payments, how can you pay it off early? Bach recommends making bi-weekly payments instead of monthly payments. For a 30 year mortgage, you can arrange with your mortgage lender to make a payment on the mortgage every 2 weeks instead of every month. If you do this, you will end up making one month’s extra payment a year ($2,000/month = $24,000/year, $1,000/two weeks = $26,000/year). What kind of impact will that have on the life of your loan? According to Bach, it can reduce your loan length by 5 to 10 years, depending on your interest rate!

 

Bach says that it’s possible to automate this process through your lender. If you don’t want to automate it (and pay the possible fees associated with automating it), there are ways to use this same approach through different, no-fee options.

 

The first is to pay 10% extra each month on top of your regular payment. The second is to pay one extra payment for the year (make sure you send it separately from your regular monthly payment so as not to confuse the bank!). Both of these approaches can save you years on your mortgage, though neither are “Automatic.”

 

“The Automatic Debt-Free Lifestyle”


So, what happens when you have a lot of additional debt, namely high balance credit cards? Where does that leave you in becoming an “Automatic Millionaire.”

 

Obviously the first step is to stop creating new debt. Once you’ve done that, you can concentrate on paying down that debt. Our favorite debt repayment plan is still the Debt Roll-Up. It’s simple and easy, and can make becoming debt-free a real possibility. Bach’s system is similar. Rank your cards in order of how fast you can pay them off (usually the smallest balance first). Then, using half of what your “Pay Yourself First” amount is, apply the higher payment toward the first card, paying the minimums on the rest. Once your first card is paid off, apply that total balance to the second. Once all of your cards are paid off, reapply your “Pay Yourself First” amount to saving for your future.

 

As with everything in The Automatic Millionaire, a key step here is to make this plan automatic. Bach recommends setting up a monthly payment plan to automatically pay the desired amount monthly so you don’t have to think about it.

 

The Automatic Millionaire

 

Hopefully this series has given you some ideas on how to become an “Automatic Millionaire.” Making your finances automatic can really have an impact on your financial success. Try it out! It just may give you the tools you need to be successful. And definitely check out The Automatic Millionaire.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

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