MY 21 MONTH OLD'S NET WORTH IS....

My previous POST talked about the 4 investment vehicles that parents can use to create a solid financial future for their kids. One of the things that's important to DH and I is the ability to create a legacy for our son. Part of that process involves assessing how we spend money and allocating it in areas that will help us win. I decided to lead the charge in securing a financial future for the family but particularly our son. As of today our 21 month old son has a net worth of $23,299.89. While that isn't a lot of money, about $20,151.98 has been put to work in aggressive investments and the remaining amount is in cash which will probably be put to work soon. I'd like to share how that money is invested but I think it's important to highlight how we started saving for him and our spending philosophy.

We received about $1,400 in cash gifts at the baby shower which was used to establish a bank account for him. We used gift cards to buy as much we could in the beginning and cash flowed everything else from our incomes. When LO (Little One) was about 3 months old, I liquidated my secret stash fund and deposited about $2,700 in his account and started contributing $100 every paycheck to his account. This continued for another 12 months. It's normal for many parents to want to buy the best of everything for their child. We received the big gifts like furniture and stroller/car seat but the latter was one of the most expensive options. I now regret that although DH doesn't. We try not to overspend on clothing, shoes and toys but we've definitely made a few silly purchases in the past. 

Since starting this financial journey, DH and I have changed our general spending philosophy and have set price parameters for many things. A big area of spending for parents are Kid Birthday Parties. DH and I wanted to do a grand 1st birthday party like most people do and  assumed a $1,200 budget was fair. I then thought about how I can create the most value for that $1,200 and decided instead to save it. When LO is 25, I think he'll agree that saving and eventually investing that money was a more worthwhile decision than spending it on a party he'll never remember. So we spent $75 on 2 cakes and other goodies and had 2 parties (one at daycare and one with family and friends) and took photos with the 4 generations of women on my side of the family. Yes, LO still has his Great-Grandma and Great Great-Grandma. I think those are the photos LO will cherish from his first birthday. I don't judge or criticize what other parents choose to do regarding their kid's birthdays, but as for us, his first few birthdays will be spent just like the first. 

QAPITAL
I discovered a cool way to save small sums of money incrementally, based on our purchases. Qapital is an app that you link to your checking account and it will round up all debited transactions to the nearest $1 or $2 (Rounding Rules). If I choose the Round Up to Nearest $1 rule, and I make a purchase of $1.09, Qapital will withdraw $.91 from my account. If I choose the Round up to Nearest $2 rule and pay a bill for $201.49, Qapital will withdraw $1.51. DH loaded the app on his phone March of 2016, chose the Round up to $2 Rule and by the end of December had $550 in the account. We transferred out $500 to LO's savings account. Between January and today, DH has accumulated another $600 in his Qapital account. I'm a bit slower in accumulating money because I mostly use my credit card for cash back. I've only accumulated $224.62 in the last 12 months. I wouldn't suggest using Qapital as your main savings vehicle, since true saving is only done with great intention, but it is an excellent way to passively save.

529 PLAN
Over the Christmas break of 2015, I spent a tremendous amount of time researching 529 Plans and considered other state options but decided the state income deduction on our taxes was too good to pass up. I established LO's 529 account that same week right around him turning 5 months old. My previous post talks about the limited life of a 529 Plan (18 years to save for college) and I wanted as much investment gain as possible. Again, with investing, starting early is the key. Prior to opening the account, DH and I talked about skyrocketing costs of tuition and research indicates that college costs increase 7% annually. According to the College Board, the average cost of private college tuition is $33,480 for the current school year and doesn't include room and board. With these cost levels in mind, we agreed to contribute $500 monthly. I've since realized that once we're debt free, we'll need to increase this amount a bit because the cost of college will still outweigh the investment performance at the current contribution rate.

The first contribution was made January 2016 and I was very leery of investment losses so I selected the Moderate Growth Portfolio which is also a Conservative Age Based Option. This option has an allocation of 50% stock/50% bond. An Aged Based portfolio starts out with more risk and becomes more conservative as the child ages. After educating myself a bit about risk tolerance and investment time horizon, I switched out 60% of the assets to a Growth Stock Index Portfolio (75% Stock/25% Bond Allocation) and the other 40% in an Aggressive Portfolio which has 100% Stock allocation. I decided to move away from the Age Based option because I was willing to take more risk for greater growth wanted more control over re-balancing the portfolio as I see fit. In February after fulling understanding the importance of my investment horizon, I put 100% of the assets in the Aggressive Growth Portfolio. So LO's college money is heavily invested in 100% stock. I will re-balance as needed in the coming years to preserve as much of the principal and gain as possible. So far we've contributed $8,500 and have $1,072.93 in gains alone (gain was realized on $8,000, since contributions for May went in just a couple days ago).

BRINKS SAVINGS ACCOUNT
In April of 2016, I came across a 5% savings account on balances of up to $5,000 and established an account. The idea of 5% interest on $5,000 seemed like a no brainer since there's no risk for the return. Unfortunately, Brinks changed the terms of the account 3 months later and only offers 5% interest on balances up to $1,000. So I withdrew $4,000 and left the $1,000 plus whatever interest I earned. Just a year later the account, now has $1100.29. A $100 isn't a lot but it's certainly more than the $40 interest payment my friend received on her bank balance of $115,000.

UGMA/Custodial Account
LO's savings account grew to about $9,500 and I grew tired of the bank giving almost nothing in interest. So in February 2017, I transferred all the money into an UGMA account I established with Vanguard and invested everything into a 100% stock fund. LO has 19 more years before he can ever touch the money, and my goal is to teach him small money lessons by age 10 so when he grows into adulthood he will continue on the same trajectory. I could've invested the money in my personal account but wanted to leverage the kiddie tax benefits.

Roth IRA
There was a period last year when I spent everyday I was heavily reading about investing and I came across a article that talked about how parents can use Roth IRAs to make their kids rids. The idea of creating wealth for a child from a young age really forced me to start thinking how I could get LO to have earned income. For babies the only option for earned income is baby modeling and I certainly don't have the time to attend casting calls in hopes he'll be the next big thing. For the last couple of months, I've been engaged in discussions with someone who owns a company that sells athletic gear and promotional products to use LO's photos on his website (for promotional items like coffee mugs, magnets, mouse pads etc) for a monthly cost of about $200. It looks like we'll have this deal solidified in the next month or two and I'll be free to set up a Roth IRA for him. I'm really excited about this opportunity.

OTHER
The money that remains in his regular bank account was gifted to LO from Mr. Mindful Dollar when he cancelled a life insurance policy with cash value he had from a few years ago. The cash value was almost $2,300 and he gifted LO $2,000. We seek every opportunity to pad LO's bank account as much as we can. When we're debt free we'll consider where we can allocate more money to continue to build wealth for LO and change our family tree.

Have you started planning your child's financial future?

 

 

 

 

 

HOW TO MAKE YOUR KIDS RICH

Adults have a plethora of things to consider when thinking about their finances - from budgeting, saving for retirement, personal investments and planning for a rainy day. An often overlooked category is planning for your child's future. Traditionally parents have always opened bank accounts and made regular deposits assuming this was the best way to prepare for their child's future. There are more sophisticated tax advantaged savings vehicles that offer more up side than a traditional savings account. Whether the plan is to save for the future college costs or to set up an investment to eventually pass down when they become an adult, knowing what your options are is the first step in creating a solid financial plan for your child.

ESA
An Education Savings Account (ESA) is a tax advantaged account that allows saving for the future costs of education, pending the funds are used for elementary, secondary or college education expenses. Funds are withdrawn without having to pay federal income taxes though you should double check at your state level if withdrawals are income tax free or income deductible. There are potential drawbacks with ESA's that might make this option less than suitable for your future planning goals. The maximum annual contribution to an ESA is $2,000 per beneficiary until they reach the age of 18, which may prove to be insufficient (even with tax free growth) to cover the cost of a 4 year college education. The other downside is the income restrictions which limits higher income earners from contributing. For single filers, your adjusted gross income must be less than $95,000 to make a full contribution although partial contributions are allowed if your income is between $95,000 and $110,000. If you're married, your adjusted income must be less than $190,000 for full contributions and between $190,000 and $220,000 to make partial contributions. What if you want to contribute more than $2,000 annually and you happen to make more than the income designations? Then a 529 Plan is your best option.

529 PLAN
A 529 plan is a educational savings plan designated by a state and operated in conjunction with a financial services company to help families save for future college costs. Most states offer 529 plans and the choice of college doesn't affect your ability to use the funds. You can invest in NY State's 529 plan and send your child to school in California. 529 Plans operate like your company 401K or IRA with mutual and bond funds from a list of investment options available within the plan.  Perhaps the greatest benefit of a 529 Plan is that the investment grows tax free and withdrawals for qualified expenses are tax free as well.  While contributions receive no deduction on federal taxes, you may be eligible for state income deductions. NY State allows married couples to deduct a maximum of $10,000 from state taxable income and up to $5,000 for single filers. Funds in a 529 can be used to cover the cost of tuition, books, room and board and other educational related expenses. While there is no set contribution limits for 529's, it's important to consider the gift tax rule. Any money given to another individual that exceeds $14,000 is subjected to gift tax of up to 40%. So if you have incredibly generous parents who want to gift your child money for college, each grandparent is allowed to give a maximum of $14,000 annually (for a total of $28,000 yearly) without the funds being subjected to taxes. The account owner maintains full control of all assets in a 529 account and decides how or when the money should be spent.

If you have more than 1 child, it might be best to establish only ONE 529 account since funds can be easily transferred to related beneficiary of without penalty. If you have 2 children to plan for and you set up 2 separate accounts, you run the risk of facing taxes and penalties if you liquidate the account in the event one of those children decide not to attend college. Non-qualified withdrawals are subject to federal income taxes on the earnings as well as a 10% penalty. It's important to set up these accounts after carefully considering all the scenarios to reduce the likelihood of facing unnecessary penalties. What if your child is smart enough land a scholarship? Not to worry. You'll qualify for the scholarship exception which allows a non-qualified withdrawal equal to the amount of the scholarship without incurring penalties. So if your child lands a scholarship that covers $20,000 annually for tuition, you're allowed to withdraw a total of $80,000 without incurring the 10% penalty but you'll still be on the hook for paying taxes on the earnings.

While there are limited investment options to choose from in a 529, you can choose an option that matches your risk profile. There are aged-based portfolios which are designed to offer greater growth during the child's younger years and get more conservative as the child gets older. There are also individual options to choose from. As with any type of investments, the sooner you start the more you can take advantage of compounding interest. Because the investment life of a 529 Plan is limited to 18 years, starting before their first birthday ensures you will get the full advantage of the account. I spoke with a friend recently who has 2 kids between the ages of 6 and 8 and inquired whether he had a 529 in place. When he responded no, it occurred to me that most parents are more concerned with providing for the immediate needs of their child and focus less on anticipating their future needs. With the cost of college increasing at an average of 7% yearly, my friend will probably go in debt trying to finance his kids' college education. The last thing you want to worry about as you're 10-15 years from your retirement is taking out loans to pay for college. Since we live in a culture of wanting to give our kids the best, it's important to take charge of securing their college future TODAY.

UGMA/UTMA
Prior to the inception of 529 Plans in 1996, a popular way to save for a kid's college education was via a custodial account or UGMA/UTMA (Uniformed Gift to Minor's Act/Uniform Transfer to Minor's Act). This account allows the parent to act as custodian while protecting the assets for a minor until they reach the age of majority which is usually 21 in most states. The custodian maintains full control how the money is invested but it's important to note that all assets in a custodial account BELONGS solely to the minor and shouldn't be withdrawn. Once money is transferred to the custodial account it becomes irrevocable, which means it cannot be returned to the person who made the deposit. Any withdrawals made before the minor becomes majority of age has to be for the direct benefit of the minor, although that can later become questionable and lead to potential lawsuits. It's important to seek legal counsel before withdrawing money from a custodial account. Since the funds in the account belong to a minor, the tax liability is shifted to the child and the government offers a small tax break on investment income called the "kiddie tax". The "kiddie" tax allows investment incomes up to $1,000 to go untaxed, while income between $1,000 and $2,000 is taxed at the child's rate and income exceeding $2,000 is taxed at the regular income tax rate of the adult who gifted the money.

A custodial account has a bit more flexibility than a 529 since there are a plethora of investment options to choose from and can be established through any investment company like Charles Schwab, Vanguard, Fidelity, etc. One downside of a custodial account is the potential impact it can have on financial aid since the assets belong to the minor. It's important to note that the assets in a UGMA/UTMA account isn't solely for educational purposes and the minor can use the money for any reason once they reach the age of majority. The maximum annual contribution is $13,000 and $26,000 for couples filing jointly. Any contributions above these limits will incur the gift tax. Although UGMA/UTMA accounts were originally used for college savings, it's certainly NOT the most optimal choice since there are no special benefits for spending money in these accounts on education. Regardless of how the beneficiary chooses to use the money, education or otherwise, they will be subject to income tax. With that in mind a 529 remains your best option for saving for college and an UGMA/UTMA is best used for creating additional investments for your kids.

ROTH IRA
When people hear IRA, the first that comes to mind is Retirement. While an IRA is most widely and commonly used as a tool to save for retirement you can actually set one up for your child. The stipulation with IRAs is having Earned Income. This is an EXCELLENT way to start building wealth for your children before they even become adults. Roth IRA's for kids can be set up with financial institutions (Vanguard, Fidelity) and the parent acts as the custodian and controls the account on behalf of the minor. Your child can enjoy the same benefits you enjoy with a ROTH but the golden opportunity is the ability to set one up year earlier than you did. You can read more about the benefits of a Roth IRA HEREThat means if your 14 year old mowed lawns in the neighborhood for the whole summer and made $1500, the entire amount can be deposited into an IRA. If your child isn't keen on the idea of using their summer income to invest for their golden years, you can match their earnings and deposit the money in the IRA on their behalf. Unlike an UTMA/UGMA account, money in an IRA has 0 effects on financial aid eligibility since the IRS doesn't it as assets. So if your kid has a job or you plan to pay them a reasonable amount of money to do work, setting up a Roth IRA for your child will yield results that are incalculable

While the idea of saving for retirement at 16 can sound a bit far fetch, this would be an excellent opportunity to get your kid excited about investing and help them understand the benefits of how starting early yields big rewards. Children can earn money babysitting, dog walking/sitting, mowing lawns, washing cars or even doing additional housework. If they're on the younger end, paying them for doing some of these tasks is worthwhile but the pay rate has to be reasonable. You can't pay a 10 year old $1,000 for 2 week's worth of dog walking. If you have a teenager who has a summer job, consider encouraging them to open and IRA and start investing. . Once the minor becomes an adult, they assume full ownership of the account and should be encouraged to make annual contributions throughout adulthood. If you own a small business, hiring your kid as a part-time employee provides additional benefits for both you and the kid. They can do basic work like shredding paper, filing or stuffing and stamping envelopes. And you can claim their income as a business expense. As long as the number of hours worked and pay is reasonable, the money can be deposited in a Roth. Be sure to double check with your accountant to learn more about the additional benefits of hiring your kid.

I can't stress enough....establishing a UGMA/UTMA or Roth IRA account provides a teachable moment. I firmly believe kids should be active participants in the planning process of their financial future. There's no benefit in giving a 21 year old a windfall of $50,000 if they don't know how the money was accumulated and how it can transform their future if they continue to invest. Teach them the basics of mutual fund investing, how market works and get them excited about the idea of watching $1,000 grow to $5,000. A really awesome benefit of owning a Roth IRA is that the owner doesn't have to withdraw funds while they're alive. That means if you set up an IRA for your child at 12 years old, and they apply the wisdom and knowledge you impart about managing money and investing, they can create other means of wealth. This will allow them to can pass down the money in the Roth to their children. Even if they have to use a portion of the Roth for retirement, there will be so much money accumulated over the course of 60 years that they will essentially be wealthy. And that is a great way to create generational wealth.

 

So there you have it....4 easy ways to create wealth for kids. For college savings, a 529 is a better option with its high contribution limits and tax free withdrawals, but the trick is starting early to get the full benefit. While saving for college won't make your kid rich, it will prevent you and them from going in debt which grossly drags on one's ability to create wealth. If you want to really want to help build long term wealth for your children, then an UGMA/UTMA and Roth IRA accounts are excellent considerations to get the process started. If you choose to establish either of these accounts, it's imperative to help the child develop good money habits from a young age so they can use it wisely when they get older or use it as a tool to build wealth throughout adulthood. After all, even if you never formally teach them the principles of budgeting, spending less than you earn and the critical impact of saving and investing, they're already receiving cues as they watch how you handle money now. Better to be intentional about your efforts to pass down smart money lessons so they can start winning from a young age.

 

TERM LIFE: THE MOST PRACTICAL LIFE INSURANCE POLICY

Most of my previous posts highlighted the importance of budgeting, managing debt and investing to secure a better financial future. You're never too old or too young to secure your financial future. The sooner you start, the greater the results. Planning for the future takes on a whole new dimension when marriage and kids come in the picture. College planning, paying closer attention to health insurance benefits and the dreadful thought of a spouse dying forces you to build protection around your lives by way of life insurance. Several of my friends and I have recently or are currently going through the process of obtaining life insurance and seem to differ in our perspectives over the options that are available. I wanted to share my perspective about the 3 most popular life insurance options.

WHOLE LIFE
Whole life insurance is a form of permanent insurance that offers protection through the entire life time of the insured individual and creates a cash value that can be borrowed against in the event of an emergency or that can be taken upon surrendering the policy. Whole life requires the policy owner to pay a fixed monthly premium for the rest of their life, and upon death, the company will payout the face value of the policy (death benefit) to the beneficiary. It's important to note that the company is the sole determinant of the dividend rate payout which makes up your cash value.

If you've ever received quotes for Whole Life policies you'll know the premiums are incredibly high for relatively low coverage. Whole Life is a combination of 2 products: life insurance and an investment, indicating that you're protected with some growth. The cash value element is usually the point of attraction that convinces most people to purchase this product, for which you can borrow against at anytime. This is a supposed benefit, however any loans taken against the policy must be repaid with interest. If the loan isn't repaid, your death benefit will be reduced. If you had a $200,000 death benefit with $40,000 in cash value and you withdrew $20,000, your resulting death benefit would be $180,000.

So it must be smart to purchase a policy with cash values? According to ConsumerReports.org, the annual rate of return on a whole life policy is about 3.5%, rendering this product a poor investment. If you read my post on How to Approach Investing then you're aware that inflation is about 3%, which means that the returns on the whole life are being undercut by inflation. I was quoted monthly premiums of about $200 for a $250,000 policy. If I purchased and kept this policy for 10 years and died in the 11th year, my beneficiary will ONLY receive the face value of the policy ($250,000), NOT the cash value that accumulated because that DIES with you. Essentially I would've paid north of $24,000 in those 10+ years and the payout is only $250,000. Simply put, Whole Life Policies are just an expensive form of insurance with a Savings account. If you think about the purpose of a savings account - do you really need a middleman telling you to repay yourself  after borrowing your own money with interest? NO THANK YOU!

One more thing to note about cash values....the first few years of a Whole Life policy yields no return because of fees and the cost of insurance and you start to see some positive returns around year 8. It will take a several more years after that for the returns to finally look somewhat promising. By the way, a portion of those fees happen to go to the person who sold you that policy and that money is not invested on your behalf. The company takes their profit, a portion goes into a pool to pay death benefits to those who die,  the salesman gets their percentage and the remaining goes into a conservative investment. You can invest your money YOURSELF.

INDEXED UNIVERSAL LIFE
Index Universal Life is similar to a regular whole life policy in that it's comprised of permanent life insurance and and a cash value account. The cash value portion is directly linked to the performance of the stock market. I was quoted $125 in monthly premiums for a $200,000 policy. Not as expensive as Whole Life, but again, I would be way under-insured than I'd like to be. The main selling point for an IUL is that in the event the stock market has a terrible year, you won't lose because there's a guaranteed payout of 0% to 3% payout. If the market has higher returns, you can experience gains as high as 13%.The high return would be part of their cap rate which is anywhere between 10% to 15%. It sounds nice to be getting a minimum guaranteed return, however this is just another fancy selling point to get you to fork over your cash. This begs the question, WHY WOULD I PAY AN INSURANCE COMPANY TO INVEST MY MONEY, TO THEN DETERMINE HOW MUCH RETURN TO PAY OUT? The cap rate poses a major issue because when index funds posted returns in excess of 30In 2013 , the insurance company would've only paid you a maximum of 15%. The other 15% gain is kept by the company to pay for the cost of the insurance and massive fees. This doesn't seem to pass the common sense test.

So what's the alternative?

BUY TERM LIFE AND INVEST THE REST
Term life provides a level premium and a death benefit protection for a set period of time. This is usually a good fit for younger individuals or families who are concerned about replacing loss of income. Term insurance doesn't build any cash value and has no value upon expiration. Term life provides bargain-price protection that pays out a large sum to the surviving beneficiary upon death during the 20 to 30 year life of the policy.

 I'm currently waiting for approval for a 30 year term life policy for $1,000,000 that will cost me about $55 a month for the entire life of the policy. Once approved, this will replace the current policy I have that costs $45 monthly but has increasing premiums as I age. In the event I die before the policy expires, my beneficiary won't get $200,000 like the permanent insurance options discussed above, but he will get $1,000,000 CASH. Now that sounds more like it and I won't be financially burdened to pay this policy. 

The sales people selling Whole and IUL's, will tell you term isn't a good option because most people outlive their policy and there's no cash benefit. This is true but let's give that some context. I've had my car insured with Geico for 6 years now at about $170 a month which today totals over $12,000 paid in premiums thus far. I haven't had to file a claim yet. Should I call Geico and demand that they pay me back a portion of that money? NO. That's what insurance is for. Protection. If I got into an accident and severely hurt someone, Geico would pay them up to $250,000 in bodily harm damages not to mention the cost of repair to their vehicle. I certainly couldn't afford that out of pocket. So $12,000 over a 6 year period to have protection against the results of a potentially tragic accident is well worth it. Term Life works the same way.

It seems most sales people will argue that Whole Life is a great way to build wealth. Life Insurance isn't a vehicle meant to create wealth. It can jump start your beneficiary's future in the event you die prematurely. But since most people outlive their term policy, how can you build wealth? The Best and Only way to build wealth is to:

  • BUDGET
  • Live Below your Means
  • Reduce DEBT
  • INVEST Early

Paying insurance companies via a Whole Life or Indexed Universal Policy to build wealth can leave you and your family short changed in the event of death. If you implement all the personal finance principles I've highlighted in my previous posts, you will effectively create wealth. If I happen outlive my term life insurance, I can still pass down wealth to my son from the money that will be in my retirement accounts. 

If you're still not sold on Term and think permanent insurance is best, it might be because you don't have the discipline to "save" or the risk tolerance to invest. If you like the built in security of accumulated cash value even if the returns aren't great and don't mind paying the high cost to get it, then permanent insurance might be right for you. If you are risk averse and prefer "guarantees" and don't mind paying the high cost then permanent insurance might work for you. If you've been in your whole life policy for a while and like the cash value you see, then it might be worth keeping. It's always a good idea to explore all the options available but I'm confident that for all the reasons I mentioned, Term life will be the clear winner.

If you plan to be Financially Independent, buy Term Life and invest the difference so you can be wealthy enough to be self-insured against your death. 

Do you have your life insurance policy in place? Which option best suits your family's needs?

 

 

 

 

 

HOW TO APPROACH INVESTING

Planning for the future can be a daunting task but it's never too late or too early to start. I've talked about the importance of defining and identifying the steps to create Financial Freedom, the importance of Investing and Investment options for the average investor. Whether you're debt free or working on getting out of debt, planning for the future inevitably yields rewards that are incalculable. Now that personal finances have taken a front seat in my life, I pay closer attention to conversations I have with people to glean a better understanding of their perspective towards money and investing.

Some of the reactions I've heard from personal friends about investing was the driving force to starting this blog. I wanted to help educate the people around me to make smarter decisions so they can change their own money tree. I've heard friends say things like "I haven't started a college fund for my kids yet because 529's aren't FDIC insured" OR "I've been doing research on college planning and I think I'll be fine with a regular mutual fund vs a 529 plan" OR "I want to invest my money but I can't risk losing anything" OR "I want to save $150,000 before I feel comfortable with investing". I understand the general fear with investing because just about a year ago, I too was afraid of risking my hard earned dollars. I did some research and I learned a few things that helped me understand the right approach to investing. This article is dedicated to my friends and anyone else, who for one reason or another has allowed fear to sideline them. 

The first rule of thumb is to ALWAYS keep  about 6 months of expenses in cash reserves. Cash reserves are short term investments with low rates of return that are held in checking accounts, CD's, savings and money market accounts. This money should NEVER be invested.

IDENTIFY YOUR GOALS
What are you saving for? Retirement? A Kid's College Fund? A House? A 3 week vacation in Italy? Categorizing your short and long terms goals serve as a road map to making the best money decisions. Saving for a house or a vacation would fall under the short-term category while retirement and college are under the long-term category. The distinction between short and long term goals determine your Investment Time Horizon. Your time horizon is measured by the amount of time you have from today until your reach your savings goal. Short-term goals are those that are within 5 years of reach, intermediate goals are from 5-10 years out and long term goals are those that have a time horizon 10 years and greater.

DH and I don't have any short-term goals besides paying off debt. Our long term goals include college and retirement planning. We started our son's college fund when he was 5 months old and the time horizon for this investment is about 17 years. Our time horizon for retirement is another 20-25 years depending on when we decide to retire. If your goal is save and buy a house in the next 3-5 years, this would be considered a short time horizon, rendering investments in securities a NO GO because you simply wouldn't have enough time to recoup losses in the event of a market downturn.

RISK TOLERANCE & RISK CAPACITY
Your investment time horizon dictates your Risk Tolerance, which is the level of market volatility you can tolerate. Risk tolerance is all about your emotional reaction to market swings. Are you more inclined to take on more risk for a more favorable outcome? Can you withstand losses without panicking? When the market crashed in 2009, people who were heavily invested in stocks saw declines as high as 50% in their portfolio. They panicked and reacted on emotion and sold, which effectively locked in their losses. This is a classic example of a portfolio that is misaligned with risk tolerance. As stated above, a friend of mine didn't start a college fund yet because she wants some type of guarantee on the money, which indicates a very low risk tolerance. 

Risk Capacity is the amount of risk you can "afford" to take on in order to meet your financial goals. If you're 30 years away from retirement and have a high risk tolerance (having mostly stock in your portfolio) then a market crash will not jeopardize your investment objectives because you're years away from having NEED for the funds. If you're 4 years away from retirement, your risk capacity will be low because you can't "afford" to lose much money and you would adjust your portfolio away from stocks to include safer investments. As it stands today, I have my emergency fund in place, retirement is at least 20-30 years away and I'm looking for high growth...therefore my risk tolerance and risk capacity are both high. If the market sinks tomorrow, I will make no changes to my investments except to hunker down and take advantage of low prices and buy more.

ASSET ALLOCATION
Your risk tolerance and risk capacity will determine your asset allocation, which is strategy geared towards balancing risk by distributing funds across a set of assets according to your goals, time horizon and risk tolerance. In other words, it's a collection of your investments across various asset classes. The 4 main asset classes are Stocks, Fixed Income or Bonds, Cash Equivalents, Real Estate or other tangible assets (Read more about these HERE). The average investor has at least 3 or all 4 of these elements in their portfolio. What varies from person to person is the % of each category in the portfolio. Within a portfolio an investor can be exposed to many different sectors like Retail, Health Care, Energy, Technology, Financials etc, if invested in a stock mutual fund. Mutual Funds provide broad sector diversification and limit your exposure to risk associated with one particular sector. 

A 30 year old investor with a high risk tolerance and risk capacity can easily have an asset allocation of 80% stocks and 20% bonds. Bonds are recommended because they offer protection when stocks are plunging. When the 30 year old advances in age to 55, they would probably want to re-balance their portfolio and shift to a more conservative allocation of 60% stock and 40% bonds. Your asset allocation is based solely on the level of risk you can tolerate and the length of time you have before needing that money.

THE COST OF HAVING TOO MUCH CASH
For my friends who allow fear to continue to sideline them from investing, consider that too much CASH is a DRAG. In addition to investing for retirement, you should aim to invest all personal cash above your emergency fund. We've established above that emergency money should be kept in safe low risk accounts. Keeping any money above the designated amount for emergencies, is futile. Why? For every $10,000 you keep above what's needed in a money market account that returns 5% less than a long-term investment, you lose $500 every year it's kept there. 

COST OF INFLATION
We've all heard the term "inflation", which refers to the increasing cost of goods and services while the purchasing power of your money declines. Experts estimate the rate of inflation at about 3% annually. That means that what $1,000 can buy you today, will cost you roughly $1,060.90 by the end of 2018. Excess liquidity (large amounts of cash not invested) means time spent out of the market, which carries the high cost of inflation. Let's not forget that those excess funds are gaining about .01% interest in your local bank.

Let's sum up the takeaways:

  • Keep an emergency fund liquid in checking, savings or CD. Never invest this money
  • Identify your short and long term financial goals
  • Money for short-term goals should NOT be invested
  • Money for long term goals greater than 10 years SHOULD be invested
  • Know and understand your risk tolerance and risk capacity
  • AUTOMATE: If you've already met your short-term goals, set up automatic withdrawals from your brokerage account to buy more shares of your investments. Remember the key is to make excess dollars make more money for you.

Investing isn't only for retirement but everyone should consider having their personal savings working for them. If you want more information to determine your your risk tolerance, I suggest using Vanguard's Investor Questionnaire.

 

Are you ready to overcome your fear of investing? What's your general feeling with investing your personal savings? Drop me a comment below.

 

MARCH DEBT REPAYMENT PROGRESS

If you've been following this blog, then you know that I started to take money management seriously about 2 months ago. Part of that journey is getting rid of debt  and you may have read my DEBT ROUNDUP post about how much of DH's personal credit card debt we paid off and where our current debt was as of February 28th. We set out with an aggressive goal of paying off $62,570.33 over the course of the next 12 months. As promised I'm here to provide you with a monthly update of our debt repayment progress. As of today, our total debt is now down to $38,891.76. That seems like a drastic difference in a period of just 30 days, but it had nothing to do with our income or savings. We receive a sizable windfall from the federal government every year during tax season and we committed every penny and then some to reducing our debt. Here's what we did:

I had school loans that totaled $13,385.42 and I called and paid that OLD HAG Sallie Mae her money in full. That's right....Sallie Mae no longer has a seat at our money table. We put $5,000 on our car note and paid roughly $5,293.42 on our credit card debt. That brings our total payments on our debt to $23,678.84 in just ONE month. A dent this large won't be the norm but we're pretty excited that we were able to give our debt a swift kick in the tail this month. Our journey ahead will be much slower but we're committed to being debt free in 11 months. To help ease this ride along, DH and I made a deal that we wouldn't buy ANYTHING until our debts were paid off. That means we're no longer entitled to treating ourselves to shopping sprees for wardrobe updates as we enter new seasons. The only exception would be our LO (little one) who's a pint sized 20 month old who requires clothing and shoe size upgrades every  3-4 months.

In all money plans, it's important to maintain flexibility since we can't predict the curve balls life will throw us in the next year that could potentially slow down our debt payoff. The one downside in aggressively paying off debt, is not seeing our savings grow. But that's the price you pay when you wander into debt, because it's not so easy to wander out.  

Are you currently focused on paying off your debts? Drop me a line below and let me know the biggest challenge you face in paying off your debts.

HOW SHOULD I INVEST MY MONEY?

My last post HERE talked about the pitfalls of individual stock picking from my personal experience of investing in what I believed were winning stocks based on my dear friend Carl's suggestions. It wasn't that the stocks were bad picks, but I lacked the experience to be involved in such a risky game. I sat on the sidelines for years in between each stock market attempt, and wasted valuable time because I simply didn't know how to build a portfolio with diversified risk. I'd heard of Mutual Funds before but wasn't really focused on building wealth and only thought about making big gains by investing in individual stocks. Now that I'm focused on securing a future nest egg, I did some research on Mutual Funds and other investment options and here's what I learned:

A Mutual Fund is an investment vehicle that pools your money together with other investors to purchases securities like stocks and bonds. Mutual funds are a easy and cost-effective way for individuals who don't have a lot of money to invest and own a piece of the market. Investing in a mutual fund doesn't mean you own actual shares of the particular stocks, rather you own shares of the specific fund itself. Perhaps the greatest benefit of mutual funds is the diversification is provides, allowing investors to spread their risk. Rather than my previous experience of investing in individual stocks which is synonymous with the old adage of "having your eggs in one basket", mutual fund investments provide exposure to hundreds of stocks. If you're currently invested in a 401K or IRA, then chances are most of your assets are in mutual funds.

Mutual Funds are actively managed by a portfolio manager(s) and a team of analysts who together seek to pick investments that will ultimately outperform its benchmark (S&P 500). Their ultimate goal is to maximize your return. The fund charges a fee, referred to as the expense ratio, and is deducted from the funds total assets to pay salaries for the portfolio managers and analysts as well as other overhead costs involved with managing the fund. The expense ratio is charged against each individual investor's account. Average mutual fund expense ratios hovers around 1%. That means for every $1,000 you invest the fund will charge $10. Fees this high start to really chip away at your returns over time. What if you don't want to incur such high fees but want the benefit of diversification? That's where Index Funds come in.

INDEX FUNDS

John Bogle is known as the father of Index Funds, having introduced the first fund in 1970, and later became the founder of The Vanguard Group in 1975. Index funds are still mutual funds in that assets of many investors are pooled to purchase stocks, bonds and other securities. The main DIFFERENCE is that  an Index fund doesn't pay a portfolio manager or a team of analysts. Because index funds cut out the middlemen you incur a much smaller expense ratio (as low as .03%) for management of the fund. Index funds seek to track and mirror the performance of a market index like the Standard & Poor 500 (S&P 500) or the Russell 3000. Like the name suggests, the S&P is comprised of the 500 largest publicly traded companies in the US and similarly the Russell 3000 is a combination of the 3,000 largest publicly traded companies. Buying shares of an index fund that tracks either one of those indexes, will give you the growth in aggregate of all the companies represented in the fund.

Index fund investing is often referred to as passive investing because it's essentially a "set it and forget it" strategy. It's also an excellent long term wealth building strategy that provides broad diversification (depending on the index the fund tracks) that is aimed at maximizing your returns over time. Passive investing is all about a slow steady pace to creating wealth rather than aiming to make it big with one quick bet on a stock. It's synonymous with the "buy and hold" strategy surrounded by the idea that you'll make more positive gains over a longer period of time

If you feel you're ready to get on the road to building wealth, consider passive investing with Index funds. You can check out Vanguard, Fidelity, Charles Schwab and Blackrock for their low cost, no load mutual funds. (Load refers to transaction costs incurred to buy and sell shares in a fund). Always double check expense ratios before making a decision. It's not unusual to come across 2 index funds that track the same index but the kicker could be in the expense ratios. I recently did a over haul of fund selections in my 401k and I realized that I blindly followed the recommendations of an adviser and I was invested in funds with fees .46% - 1.15%. After revisiting my allocations, I switched to funds that range in fees from .05%-.09% that will ultimately help me meet my investment goals without swiping some of my cash in fees. Paying close attention to fees can save you hundreds of thousands of dollars over the life of your investments. When assessing what funds to invest in, it's important to look at their 10 year performance but equally important to note that a fund's past performance is not an indicator of future performance. If you follow a long term investment strategy, the goal is to experience the positive gains over a period of time. If you review the investment options in your company's 401K, chances are 75% of the offerings are mutual funds.

BONDS

Bonds are a form of debt like an IOU except the bond purchaser acts like the bank. Entities like corporations, cities and governments issue bonds and promise to pay it back with interest payments, generating a regular stream of income. Local governments may issue bonds to build bridges, tunnels while the federal government sell bonds to finance their debt.

Most financial advisers would recommend allocating a portion of your portfolio to bonds.  Like stocks, you have the option of buying individual bonds or buy a bond mutual fund. For the average person, a bond fund would be the easiest option. Bond mutual funds are just like stock mutual funds where funds are pooled with other investors and an investment professional invests the money according to the investment goals of the fund. Similar to a stock mutual fund, a bond fund offers excellent diversification since there are hundreds or even thousands of individuals bonds included in the fund. Investing in bond funds is known to reduce the volatility in your portfolio that's associated with stock funds, and can produce the income for your portfolio unlike stock funds. Your risk tolerance will help determine what percent of your portfolio should be allocated to bonds. 

REITs

If you've ever had an interest in investing in estate but didn't have the capital to directly buy properties, you can actually add REIT's (Real Estate Investment Trust) to your portfolio. A REIT is a company that finances or owns income producing real estate. Similar to mutual funds, REITs allow investors to have ownership in real estate ventures without having to actually go out and buy property directly. REITs pay out a stream of income produced from the properties with high yield dividend payouts (minimum of 90% by law) to shareholders, making this type of investment incredibly attractive. Dividends can be reinvested which makes the power of compounding even more robust. There are 2 types of REITS: Equity REITs and Mortgage REITs. Equity REITs produce income from collection of rent and sale from properties. Mortgage REITs invest in mortgages from commercial and residential properties. REITs provide diverse exposure to real estate ventures including hospitals, apartment buildings, shopping malls, office buildings, hotels and warehouses. Before adding REITs to your portfolio, do your research to ensure it's the right fit for your investment goals and needs. Like any investment, there are risks to be considered.

Now that I've covered the basic investment options for the average investor, I'll highlight some of important factors worth considering before actually making a decision to invest in my next post.

Do you have any experience investing in mutual funds? If not, are you interested in starting your personal journey to building wealth? Leave me a comment below.

PITFALLS OF INDIVIDUAL STOCK INVESTING

I had a friend in college who was a Finance major and he landed a banking job after we graduated. We lost touch for the first couple years after graduation, but reconnected on the train platform at Grand Central in the busy hustle and bustle of rush hour commuting one evening in 2007. Over the next few months we would spend everyday sharing a train ride home while we were jammed like sardines in a can. It was during these train rides, that Carl revealed his passionate obsession for stock trading. I would listen to him recount his major successes of investing $15,000 in a stock on Monday and by Friday he would execute a sell trade and walk away with $20,000. He would always recite, "There's no other place you can legally make this kind of gain except in the stock market". No matter how much he loved highlighting his victorious wins, Carl was careful to highlight the downsides of individual stocking trading, which as he would say "Left him without his Shirt". In other words, every trade didn't lead to successful money gains. On the contrary some trades were total blunders that left him at a loss so great, that he would probably die before he can claim all the losses on his taxes (The government allows you to carry losses forward up to a certain amount annually).

It was Carl's excitement for the wins that motivated me to take a stab at this stock trading thing. I wasn't hoping to get rich but I wanted a chance to tell a story of a successful money win just like Carl. He had a knack for buying stocks during earnings seasons (the period in which companies release quarterly performance info). If you think back to 2007, Research in Motion (the company that made Blackberry phones) dominated the cell phone space. Carl convinced me that this stock was a winner for that particular earnings season. So I established a brokerage account with Scottrade just in time to buy $5,000 worth of shares of Blackberry stock. After earnings were released I had a gain of $800 in 2 days. To say that I was riding a cloud was an understatement. I finally had a small story of success to share.

UNTIL....

I started to lose all the gain within a couple weeks. Suddenly I couldn't focus on work, I couldn't sleep and I couldn't think. At that point all I wanted to do was protect my $5,000 investment. Eventually I got rid of the shares because I wasn't strong enough to handle the volatility of the market. It would take 8 more years before I would give stock trading another go around. This time it was on the heels of the much anticipated Alibaba IPO (Initial Price Offering). This experience would teach me that the talked about IPO price isn't the price regular investors get by the time the market opens. The IPO price was $68 and I bought in at $98 within a couple mins of the market opening. I had another success story on my hands because 2 months later had a $4,000 gain on my initial investment. Until earnings season approached and Alibaba posted less than expected earnings and the stock went south from $121 down below $90. Not only did I lose my gain but I lost some principal. Somewhere along the road while the stock was tanking, I bought Apple to hedge my losses. While Apply gained, Alibaba tanked. Eventually I sold both stocks and recovered my principal.

While I didn't lose much money in both cases, what I did lose was sleep and my general sense of calm. It's no fun being glued to your computer everyday watching the stock market do it's funny dance with your money tied in somewhere. These experiences taught me a few lessons that are critical to highlight:

INEXPERIENCE: In hindsight, I should've locked in the gains and sold my shares, making both plays good short-term moves if that was my strategy. However, I didn't really have a strategy because I didn't know what I was doing. First of all, both experiences in the stock market were based on the whimsical feeling of my dear friend Carl. I didn't do the research in company fundamentals nor did I check their balance sheet. I went in both times hoping to make a quick gain. I didn't educate myself about investing basics like knowing and understanding the importance of my risk profile, asset allocation, diversification nor did I even consider my investment time horizon. Simply put....I was INEXPERIENCED. If I had to give advice to anyone who wants to invest, I would urge them to know and understand what they're investing in. Don't put your money in investment vehicles you don't understand just because it may have worked for someone else.

RISK - Buying individual stocks is purely speculation, thus increasing your level of risk. In both cases I owned one stock at a time which means there's a chance I could lose all my money. According to a study by Longboard Asset Management which assessed stock performance from 1983-2006, 64% of stocks underperformed the Russell 3000 Index (a broad index of US stocks) and only 25% of stocks accounted for market gains. So the next time whimsical Carl has a good feeling about a stock, how would I know that that stock is a winner? I don't know, so I won't buy it. I'm not interested in the level of risk that keeps me up at night or unable to focus at work because I'm too busy watching the market do its funny dance with my money. There are other ways to invest in the market that will provide gains (albeit not quick), while minimizing overall risk.

MARKET EFFICIENCY:  I would later learn that holding individual stocks indicates that I expect the stock to outperform the market. Then I became familiar with a phrase called Efficient Market Hypothesis which is an investment theory that states that it's impossible to beat the market because stock market efficiency causes existing share prices to incorporate and include all relevant information. In other words, stocks trade at fair value and all investors have access to the same information making it impossible for anyone to beat the market. Carl's explanation for picking certain stocks often seemed magical and special, but he was just making good guesses that sometimes worked out and other times didn't.

I'm not merely suggesting that holding individual stock as part of an investment portfolio is the worst thing in the world but it should probably represent a small portion (maybe 4%) of your overall portfolio from purely a risk management perspective. In my case a single stock represented 100% of my portfolio which goes against the very basics of investing. In recent years Carl has called me at least 3x to invest in stocks he felt were winners. He called me when Tesla was $85, and had I listened I would've doubled my money when the stock hit $220. When the country was experiencing the Ebola scare a couple years ago, Carl called me and told me about the company that was manufacturing the protective gear that healthcare professionals were using for precautionary measures. Back then hospitals were ordering in bulk quantity. The stock was $14 that Tuesday night and by that Friday Carl had doubled his money. When oil prices were on a sharp decline, Carl was watching 2 oil ETF's (Exchange Traded Funds) that had an inverse relationship to each other. Carl made  a play in one of them that gave him a net gain of $28,000 in one week. I beat myself up when I think about these missed gains, but I was just too afraid. And if past experience means anything, I'm just not ready to handle the risk that comes with individual stock picking.

 In my next post, I'll talk about how to invest in the market to achieve diversification while spreading your overall risk to create the wealth my previous posts have referenced.

Have you experienced success and/or failures with individual stock picking? What's your current feeling on investing in the market?

HOW I REDUCED MY MONTHLY EXPENSES

My very first post about Financial Freedom talked about spending habits and the importance of creating a budget. Having a budget is really essential to managing your money. Budgeting can seem like it comes with restrictions but it actually helps save money because it identifies areas of overspending. Budgeting creates cash flow visibility and ensures that you have enough funds available to cover your most important bills and help you reach your goals by spending on the things that are most important to you. Creating and sticking to a budget eliminates worry and creates more control over knowing where your dollars are being spent. Ultimately, a budget puts you in control of your money and is the biggest tool to changing your financial future.

Automating payments without having done an actual budget follows the "Set it and Forget it" method.....setting bills on auto-pay and/or paying monthly bills like clockwork. Most people who live without a budget follow the "Set it and Forget it" method and more than likely overpay on expenses where they actually could be saving. When Mr. Mindful Dollar and I created a budget a couple years ago, we soon realized that we spent far too long overpaying on certain bills. There's something to be said about plugging numbers on an excel sheet or writing it on paper. Numbers don't lie and we quickly realized we needed to control our expenses. Below are the areas we successfully reduced our monthly expenses:

Heating Bill -  For the first few years of home ownership DH had a regular thermostat that had to be programmed manually. The claims on programmable thermostats is that they help save money and energy through set programming. But what if you set your thermostat to come on at 4pm but for whatever reason you get home at 9pm? You just wasted 4 hours of heating (considering it may take an hour to heat the space) for which couldn't be changed while you weren't in the house. To remedy this, DH being a tech savvy guy discovered the power of Nest about 3 years ago. Nest Labs is the producer of programmable, self-learning, Wi-Fi enabled thermostats and security systems. We paid roughly $300 for the system and installation and we have the power to control our heat from our iPhones via the app. The Nest Thermostat  gets to know the temperatures you like and when you like them and creates a schedule and automatically creates a schedule for you. Since using Nest, we've realized a savings of at least $20 a month on our heating bill just by making the switch.

Car Insurance - When Geico sent a letter 3 months ago and threatened to increase  DH's rate by 55%, he immediately shopped around and secured a rate from Allstate that was $70 cheaper per month. Never assume that your current rate is the best in the market. Always try to test the market to see what competitors are offering. You can do a quick comparison on Ever Quote which scans databases of several insurance companies and provides suggested quotes. 

Cable Bill - Consumerreports.org state that the average price of your cable bill will increase this year by 3-4% in addition to add-on fees. Our bill in 2014 was roughly $189 for TV an Internet alone. When our contract was up for renewal we reduced our bill to $140. Within the personal finance space, there are a lot of people who make the bold move to cut off their cable bill and only use Netflix or Hulu. While this may feel like a sacrifice, if you're in the midst of aggressively paying off debt, it's an expenditure worth ratcheting back until you  hit some financial goals. If cutting off cable seems too drastic, consider calling your cable carrier once a year to inquire about better priced packages and express your disdain with the current rates you're paying. Competition among cable companies are pretty stiff and they want your business.

Medical Expenses - My health insurance has been relatively good but I realized that in the last 2 years my employer made changes to my benefits plan. After a recent annual checkup, I received bills for laboratory and radiology services. Turns out there's a deductible I have to meet before the insurance company covers any expenses for laboratory and radiology imaging services. The hospital in the area billed me for the lab work and I called and explained that the bill was unexpected and not in my budget and inquired about a discount. They immediately offered me a 25% discount which saved me $37. Never be afraid to call and inquire about paying a lower rate. Your attempt may not always be successful but not trying guarantees no discount. If you're facing financial hardship, they provide assistance to help meet your situation as well.

House Phone - DH had an international phone plan that cost $45 a month. Why did we need to spend $540 a year on a house phone? DH did some research and found a phone company called Ooma that cost $100 a year and that rate includes free calls to Canada and some European countries. DH calls Paris often to chat with his friends and cousin which works out nicely. That's $8.33 a month for home phone service and we have the option of adding additional funds to enable calls to other countries. The company even has an app that enables phone calls from anywhere. If I'm at work and I want to call my uncle in Canada, I simply make the call from my iPhone through the app and I won't incur charges from my cell phone carrier since the call was made through Ooma.

Water Bill - DH and I are landlords with a multi-family house with 2 rental units. Water rates in NYC tend to be a bit higher compared to the suburbs. DH has become a fanatic of logging into the city's website to check the daily water usage to ensure it's within a reasonable range. Average daily water usage costs about $2.95-$4. A couple weeks ago he realized the usage spiked to an average daily rate of $11 and even spiked to $23. This prompted us to contact the tenants to see if they were experiencing a running toilet, since past issues have taught us that this can almost double our quarterly bill if it goes unchecked. We discovered that there was in fact a runny toilet and we quickly scheduled a plumber.

Home insurance for appliances - In addition to regular home insurance, DH secured additional insurance for all appliances when he completed the home purchase which covers both boilers, microwaves, refrigerators and toilets for the entire house. The service is a MUST for all homeowners because you grossly reduce your costs for repairs over time. The company charges a monthly premium and if a repair is needed a deductible is charged once service is rendered.  Our home comes equipped with Over-The-Range Microwaves. I  recall shortly after Mr. Mindful Dollar bought the house, the tenant's microwave unit blew a fuse and when GE sent their repair guy, he paid $300 out of pocket for the service. A couple months later, the fuse blew again and that was another $300 out of pocket expense. It was these 2 incidences that lead him to search for home appliance insurance. Our initial company charged $55 for monthly premiums and charged a $75 deductible each time we had an incident. About 7 months ago, DH decided to shop around and we switched to a company called Home Choice Warranty. They charge $45 for monthly premiums and deductible. When we had the runny toilet issue 2 weeks ago, we called the company and they sent out a plumber last week and our out of pocket expense was only $45. Had we called a regular plumbing service, that one time service could've easily been $150-$200.

If you haven't already done a budget, do one TODAY. Looking at your monthly expenses will provide an opportunity to comb through your actual payments and prompt you to shop around to ensure you've secured the most competitive rates in the market.

THE POWER OF CHOICE

The greatest power every individual has been born and gifted with is the power of choice. The ability to choose is perhaps the one thing that separates all of us and highlights our individuality. We have the power to choose between good or bad, to grow or remain stagnant, build meaning relationships or remain in a shell of loneliness, manage our finances or ignore them. Multiple sources on the internet claim that adults make about 35,000 decisions a day. On any given day, can you count the number of decisions you've made? Probably not, unless you a made a big decision that creates impact for your life going forward. Making conscious decisions is the one thing that separates you from those who just go with the flow. Your future is based on the decisions that you're actively and consciously making today and the life you live today is a direct result of past decisions. This is directly in line with a popular quote by Wayne Dyer - "Our lives are the sum total of the choices we have made".

I've often pondered how people's lives can turn out so differently. Everyone may not be equipped with the same level of intellect but achieving greatness is possible if we become intentional about developing the areas in which we can excel. Then I realized that some people make a choice and others simply don't. Not making a decision is still a decision. Even indecision carries its own set of consequences. Choices are difficult because they often require sacrifice. After all, the essence of making a choice requires choosing something and giving up something else. It's easy to reflect on the past and acknowledge how big decisions have impacted our lives. But have you considered the impact that small everyday decisions have on your life? Small decisions seem insignificant because they don't seem to add much value, but they snowball and lead up to BIG decisions. If your goal is to lead a healthier life and lose weight, would a decision to have a banana split sundae disrupt your goal? One little desert won't detract you from the big goal right? Pending it was an isolated decision. What happens when you start to make more of those banana split decisions? The banana split decision is antagonistic to your goals and eventually erodes the big picture. The more you make those banana split decisions, the longer you delay reaching your weight loss goal. The more you view daily decisions as small, the more you miss the big picture. The net effect of daily decisions add up quickly.

Making life decisions require careful thought and planning. Some of the most important decisions in my life surrounded strategy. Strategy by definition is using a plan, method or series of maneuvers for obtaining a specific goal or result. My first strategic decision came at the age of 13 when I had to select and apply for high schools. Most of my peers' choice was location or social dependent. They chose schools because their friends were going or because it was close to home. I was attracted to schools that had specific programs that would prepare me for my years beyond HS. It was then I learned the value of long range planning. This is a term that is most applicable in business which involves a set of goals that outlines the path for a company's future. A long-range plan sets the course for a strategic plan that helps define the objectives and actions necessary to achieve the goals outlined in the long-range plan. The benefits I reaped from choosing the HS with the specific program of interest, delivered critical career benefits starting at the young age of 16. 

Long range planning might be a business term but can be easily applied to our personal lives. What are your 5 , 10 or 20 year goals? Apply strategy to every set of decisions that support the big picture. Avoid those "banana split decisions" that seem simple and insignificant. Instead focus on everyday decisions that compound towards the big picture. My long term goal is to build wealth. That means making everyday decisions with money that will allow my wealth to compound over a period of time to achieve this goal, and requires some level of strategy, sacrifice and even risk. My simple strategy to achieve this goal is getting rid of debt, spending less on unimportant things, leveraging all pre-tax accounts at my disposal and investing to watch it grow. It's that simple. Making those daily money decisions will create the outcome in aggregate that I'm hoping for.

 

Are you making any "banana split" decisions in your life that's preventing you from achieving your goals? Would love to hear from you so leave me a comment below.

 

 

 

 

 

IRA CONTRIBUTIONS & THE BACK DOOR ROTH

The Federal government allows anyone with earned income to contribute up to a set amount of money annually in an IRA in addition to an employer sponsored retirement plan. The biggest mistake most people make is NOT contributing anything at all in their IRA accounts. In a recent TIAA-CREF survey, only 18% of Americans are actively contributing to an IRA. Each year you avoid making contributions results in a huge loss of retirement income that could've been benefiting from compounding interest. When you're young with many years ahead of for retirement, time is your greatest asset. With current contribution limits set at $5,500 for individuals up to age 50 and $6,500 for adults 50 and older, if you haven't yet established an IRA account the time is NOW. 

TRADITIONAL IRA

If you think your tax bracket will be lower in retirement, then it might be worthwhile to consider contributing to a Traditional IRA. Traditional IRAs allow you to make pre-tax contributions while your investment grows tax deferred, meaning you don't have to pay taxes on any gains until withdrawal, but you'll pay ordinary taxes in retirement on the contributions AND investment gains. Contributions are also deductible on your tax returns but are restricted based on income. If you decide to make contributions to a Traditional IRA talk to your accountant about your eligibility for potential deductions. There are also minimum required withdrawals that begin at age 70 1/2. Failing to meet these requirements can result in heavy taxation which can make this option less desirable.

ROTH IRA

The ROTH IRA is perhaps the most favored option of the 2 because of the tax free compounding benefit. A ROTH is funded with after tax dollars and the entire account is free of any income tax on withdrawals in retirement. That means Uncle Sam won't put  his crummy fingers on the contribution or the gains. That is a HUGE benefit that offers an opportunity for tax diversification in retirement. What if you've been diligently contributing to a Roth for 15 years and at age 50 you find yourself in a pinch and have no emergency fund? Although a ROTH is an investment account, it's also technically a savings vehicle since contributions can be withdrawn tax and penalty free at any time. Why? The key to remember here is that you've already paid taxes on the contributions. So the principal is yours free and clear. Things start to get hairy once you start touching investment gains, which is subjected to tax. There are instances in which withdrawals of earnings can be taken without incurring penalties (although still subjected to taxes), which makes ROTH IRAs more attractive than Traditional IRAs. If you've had a ROTH for more than 5 years, and you decide to purchase your first home, the First Time Home Buyer Clause allows you to withdraw a maximum of $10,000 towards your purchase. Funds can also be used for qualifying educational expenses. A deeper dive in the rules surrounding a withdrawal should be conducted depending on your particular situation. The general rule of thumb is withdrawals of any kind are highly discouraged before 59 1/2 to harness the full benefits of consistent contributions with time and compounding interest.

INCOME LIMITS

The Federal government designates income limits for Roth IRA contributions that are subjected to change yearly. For Traditional IRA's, regardless of your income level you can contribute any amount up to the IRS's annual maximum ($5500 up to age 50 and $6500 over age 50). However, there are income restrictions on the ability to deduct Traditional IRA contributions. Again, if you decide to go this route, your tax accountant can help guide you through the income limitations with deductions. The ROTH is undoubtedly the most popular option with tax free earnings and the flexibility it offers. However, NOT everyone is allowed to contribute to a ROTH. If you filed Single in 2016, your ability to contribute the maximum to a ROTH was capped at the adjusted gross income of $116,000. If you filed Married in 2016, full contribution was possible if your household adjusted gross income was less than $184,000. Beyond these limits, the IRS allows partial contributions within specific thresholds for each category. For single filers the threshold was $117,000-$132,000 and for married it was $184,000-$193,999. In essence, if you were single or married and your income exceeded $132,000 & $194,000 respectively, then you were NOT eligible to contribute directly to a ROTH IRA. If your income exceeds these limits, then the federal government considers you a high income earner.

HOW CAN HIGH INCOME EARNERS CONTRIBUTE TO A ROTH?

 

High Income Earners  and wealthy individuals can still enjoy the benefits of tax free earnings by leveraging the BACK DOOR CONVERSION to a ROTH account. A back door ROTH allows you to skirt around the income limits by converting a Traditional IRA  into a ROTH IRA. The most optimal way is to contribute to a Traditional IRA with after tax dollars first, and then convert to a ROTH IRA. The sooner the conversion is done, the less chances of having a tax bill on potential gains. Although if you do have some gain, the tax bill is likely to be minimal.

IRA CONTRIBUTION DEADLINES

I regretfully admit that neither I or Mr. Mindful Dollar ever opened an IRA in the past. Since I recently started taking a more serious approach to managing our finances, I was thrilled to learn that the IRS allows you to make 2016 contributions up to the deadline of April 18, 2017. Not wanting to lose another year of tax free retirement savings, I immediately sprung into action and established our IRA acounts and made contributions for 2016 and 2017.

Where can I establish an IRA?

There's a plethora of options to choose from to establish and fund your IRA. I personally set up our accounts with Vanguard not just because they invented index funds, but also because they're known for having the lowest fees in the industry and they also offer a selection of no-transaction-fee mutual funds and commission free ETFs. Vanguard's retirement funds have a $1,000 investment minimum so much isn't required to get started. There are other options that might be worth considering like TD Ameritrade, Fidelty, Charles Schwab and E*Trade. Do your research to see what account best suits your needs. See Nerd Wallet's full review for 2017's Top Picks for the best IRA account options.

 

Do you consistently contribute to a ROTH IRA year after year? If not, will you sign up TODAY and get on the road to planning for retirement? 

The $20 Weekly Challenge

We all know saving money should be a priority. But do you actually pay yourself before your pay bills? Practicing frugality by identifying the small unnecessary purchases can amount to large savings over the course of  6 months or a year. Do a careful analysis of your budget and identify those unnecessary purchases or bills that can create an opportunity for savings. We've all heard experts talk about cutting back on the daily coffee purchases. If you're not a daily coffee drinker it could be as simple as downgrading your cable package, switching cell phone carriers, cutting back on lunch purchases, switching car insurance companies or buying one less cocktail every time you go out. The point is to become intentional about saving.  If you're able to reduce spending and save $20 a week, get EXCITED. I know $20 can't buy a lot, but if you apply the principle of time and compounding interest (as discussed HERE) the results can be astounding. If you managed to save $20 over the course of 12 months, that's $1040. If those funds were placed in an investment account with an average annual rate of return of 7%, with continuous weekly deposits of $20 over the course of 10 years, you would have $15,309 as indicated in the graph below. Never underestimate the power of small sums of money and the impact it can create to bring big returns.

Initial investment of $1040 with $20 weekly deposits, compounded at an average annual rate of 7% annually.

Initial investment of $1040 with $20 weekly deposits, compounded at an average annual rate of 7% annually.

Saving larger sums of money can have exponential impacts on investment returns. This could involve a decision to buy a Honda Accord over a Mercedes or choosing to buy a house that's $100,000 less than your pre-approval rate. Several years ago when I purchased my Accord I had the option of buying the basic V4 engine for $16,000 or the V6 option for $22,000. Guess which one I went with? I went with the cheaper option. I'm not suggesting that more expensive vehicles with upgraded options aren't nice to have. I made a conscious decision that it was more important to save $6,000 on that purchase. During the time I purchased my car I had a friend who was car shopping and I suggested a Honda Accord. His response was, "I wouldn't drive a Honda". Instead he spent about $31,000 and bought a BMW. There was nothing wrong with his decision but if creating wealth was a priority perhaps he would've chosen differently. Actually that goes for both of us. Car purchases can be a major drag on net worth when you're in your 20's and 30's because these are the critical years for jump starting a retirement nest egg and having time and compounding interest on your side. Every big purchase decision you make should have a forethought on the impact of your net worth.

In both instances, making smarter money decisions and choosing to spend less creates an opportunity to save, invest and remain on the path to building wealth. I would love to drive a Mercedes, live in Manhattan, dine out twice a week and frequent random Broadway plays like Hamilton at $3500 a pop. The truth is, we can't have everything. You have to become intentional about creating priorities, setting goals and managing expectations. Decide what's important and what's not. Spend on things that are important and spend less or nothing on the things that aren't. There's a saying that says "Whatever your mindset is your bank account will follow".

Choose today to become INTENTIONAL about creating opportunities to save. Spring into Action. Be Active about your goals. Don't wait for a $10,000 salary increase to start making changes. Start TODAY. Apply the principle of time and compounding interest to every financial decision you make and you will see your net worth start to grow year over year.

Join me in the $20 Weekly Challenge. I've already identified where I can reduce expenses and I'll commit to saving $20 a week. I'll provide updates on my progress every couple of months

 

What are some areas in your finances that can create an opportunity to save $20 weekly? Drop me a line below and let me know if you plan to join the challenge.

 

THE 8TH WONDER OF THE WORLD: COMPOUND INTEREST

One of my favorite quotes by Albert Einstein says "Compound interest is the eighth wonder of the world. He who understands it earns it...he who doesn't...pays it".  

Compounding interest is blind to color, race and gender and it's the one element that exists in the universe that treats everyone equally. Time is your most valuable asset. You always hear people say "I wish I had more time" or "If only I could go back in time". If a person is on their deathbed and they had one wish, I imagine they would ask for more TIME. When you apply the power of Time to compounding interest, the results are truly immeasurable. Simply put, Time and Compounding interest are the most critical elements of investing.

Every dollar has the potential to become $10 some day, so why spend a dollar more than is needed? How can $1 become $10? That, ladies and gentlemen, is the snowball effect of compounding interest. With enough energy a tiny snowball eventually becomes a colossal snowball rolling downhill until it becomes an indomitable force. Wealth works in the same exact way. The money you invest today will grow at an exponential rate as it's rolling forward over time.

Compounding interest won't make you rich in a year. Ever heard the phrase, "Slow and steady wins the race"? The same can be applied to investing over time. The trick to making this work at a faster rate is reducing expenses and increase your savings rate. Steady investing over time will eventually make you a millionaire especially if you start when you're young. Critics of this notion will say it's easier to start your own business and become wealthy. And they're right. But until you land that viable business idea that will make you millions, invest as much as you can from earnings and start on the road to wealth.

DEBT NEGATES COMPOUNDING INTEREST

High rates of spending on credit starts negates the inevitable force of compounding interest. Why? The average American who makes a purchase on credit almost never pays the balance in full at the end of the month and is subjected to high interest rates. The 2016 American Household Credit Card Debt Study revealed that the average American household owes $16,061 in credit card debt with an average interest rate of 15.07%. Meanwhile the total stock market returned about 12.68% for 2016 alone. So that means the average American paid debt at a higher interest rate than the total rate of return of the US stock market. What's worse? According to Bankrate's  Money Pulse survey, only 48% of American adults have money invested in stocks. The remaining 52% have $0 invested because they simply didn't have the money to invest. The debt problem doesn't just end there. In a recent study by Experian, the average car note now stands at $503 a month while the average length of the loan is 68 months. We've gotten very good at spending and incurring large amounts of debt that restricts our ability to invest money and take advantage of time compounding interest. The big problem is our decision patterns. We continuously make wrong money decisions by spending and that creates a giant snowball that gets so big it becomes uncontrollable. Why not make the decision to spend less and invest and create a snowball that creates wealth?

HOW TO MAKE COMPOUNDING INTEREST WORK FOR YOU

The ability to effectively harness the power of compounding interest requires a change in mindset about money, making the decision to invest and exhibiting discipline. Creating a budget, reducing spending, paying off debt will inevitably increase your savings rate. The simple act of diligently saving is the single most important mechanism that makes investing work. A consistent saver who makes the decision to invest will outperform an investor who doesn't consistently save. If you're a consistent saver over time but don't invest then you're at a gross loss.  I emphasize the word DECISION because I come across a lot of people who master frugality but fall short with making their money work for them. Instead they're comforted by large amounts of cash accumulated over time in a savings account, without regard of the effects of inflation. Most people don't invest because of risk aversion. They're afraid of seeing their $10,000 investment drop to $8,000. Fear has the power to control and distort our perspectives, leading to decisions that hinder our growth. Have you ever stayed in a relationship longer than you should have? Or maybe you stayed at a job longer than needed because you were afraid to try something new? You either make fear decisions or growth decisions. Your decision to invest is a GROWTH decision because the performance of the stock market is always more positive than negative over a period of time. Investing falls in the long term planning bucket because it's not a get rich quick plan.

Then there's the one element that most people lack in many areas of their life, especially with money....DISCIPLINE. Discipline is perhaps the single most important character trait that applies to good money management and investing. Lack of discipline is the primary reason for most financial problems and also accounts for poor investment returns over time. As I referenced above, investing should NOT be part of a short term growth plan. The money you invest are funds that aren't needed in the near future. If you plan on buying a house in the next 5 years, your down payment should be parked in a money market account. If you make the decision to start creating wealth, your investment horizon should involve a 10-20 year plan. The longer you invest, the greater the returns. Discipline becomes important when you avoid responding to big market dips or even a major crash. There's a saying I learned years ago when I got into sales, "Keep your knees bent". It just simply means to be flexible or expect the unexpected. If you had invested $50,000 in 2007 in a mutual fund that tracked the stock market, when the market crashed and bottomed out 2 years later your account balance would've probably been hovering around $23,000. Those who panicked and sold, effectively locked in their losses. Those who "kept their Knees Bent"  and kept the course would today have $80,000. The benefits of applying discipline and prudence to your investment strategy is the key to success.

 

Are you taking advantage of time and compounding interest? What steps can you take today to apply this concept to your personal finances and start building wealth? Would love your feedback so drop me a line below.

 

 

 

 

 

DEBT ROUNDUP

Over the course of about 20 months DH and I paid off about $31,000 of his personal credit card debt (More about that HERE and HERE). I mentioned in my 2nd Post that I started listening to Dave Ramsey's podcasts. After hearing the DEBT FREE SCREAMS, featuring listeners who call in to shout out loud that they're finally debt free except for their mortgage, the light bulb went off in my own head. For the first time in my life, I was ready to put a stop to my consumerism lifestyle and to DH's mindset that debt is a part of life.

After a full week of listening, I went home one day in mid January and told DH we should get rid of all our debts. I explained that this would require suspending all savings to our joint account for the period that we're paying off debt and throw all extra cash towards debt. He didn't share my excitement because he likes the idea of seeing money accumulate in a savings account. But it doesn't make sense to stockpile cash that's gaining no interest while interest rates continue to ravish our debts. He simply said "I'll think about it". Determined not to lose focus, I kept listening to the podcasts and after hearing more stories of sacrifice to pay off debts, I approached DH with a more compelling argument.

The second time around, I pointed his attention to his $90,000 total debt baggage from credit card, school and car loan. He disagreed and called me CRAZY because he assumed the figure was a lot less. When you spend your life swiping credit cards and signing loans without calculating the total weight of debt, you tend to believe you're in control because you make your payments on time. Most people never do a DEBT ROUNDUP but when they do, they quickly realize the damage of past decisions. Armed with the one trusty method that NEVER lies, I pulled out a spreadsheet adding up his total debts since we've been married. The look on his face was quite sobering. The next day he said "Let's just pay off everything....I'm tired of being a slave to debt". That conversation was the catalyst to a future of financial accountability and better money management.

As of today, our DEBT ROUNDUP total stands at $62,570.33. This amount consists of all debt including credit card, school loans and car note but does not include our mortgage. Our goal is off this debt in 12 months. While Dave Ramsey motivated this plan, we'll be veering off his suggested Baby Steps. Let's take another look at the sequence of the Baby Steps:

  • Baby Step 1 - $1,000 to Start an Emergency Fund
  • Baby Step 2 - Pay off all Debt except the house using the Debt Snowball
  • Baby Step 3 - 3-6 months of monthly expenses in savings
  • Baby Step 4 - Fund retirement accounts using 15% of household income between 401K, Roth or Traditional IRA
  • Baby Step 5 - Establish college fund for kids
  • Baby Step 6 - Pay off mortgage early
  • Baby Step 7 - Build Wealth and Give

DH and I are a bit out of sorts on the order, having all the steps completed except Baby Step 2 and Baby Step 6. First of, DH and I are Christians who believe in tithing. I've heard all the arguments against it and I understand why some people feel the way they do. But it doesn't change the fact that we tithe. I go a step further and I consistently tithe up to 15% of my income. That giving covers Baby Step 7. We own and live in a multi-family property which means that $1,000 is barely enough should one of our tenants fall on hard times and isn't able to make their rental payment. As a landlord, those unexpected curve balls can happen like when the balcony on our master bedroom collapsed last summer and fell directly on top of the balcony on the first floor. That's 2 balconies that need replacement and repair. So we keep a lot more than $1,000 on hand.

Listening to his podcasts, Dave Ramsey suggests temporary suspension of any funds going into retirement or college accounts. We've decided not to suspend either because we are late starters in focusing on our retirement and we're in our mid 30's. Lastly, we've decided not to suspend 529 contributions for my LO (Little One) because I'm determined to NOT let him pay the price for our poor decisions over the years. My responsibility as a parent is to plan and secure his future no matter the cost and I take that very seriously. I know the math makes more sense to throw as much cash towards debt to reduce interest, but so far our investments have outpaced our interest rates. We're also conscious of the fact that we can't predict future returns of the market. So the plan is to continue our respective retirement contributions, continue to fund 529 and use every dollar left over after expenses to aggressively pay down our debt. 

I'll provide a monthly update in our debt repayment journey.

 

Have you conducted a debt roundup? How prepared are you today to start aggressively paying off all debts ?

 

 

FINANCIAL COMPATIBILITY WITH YOUR MATE: PART 2

Part I of the financial compatibility series highlights the importance of having the money conversation with your mate early in the relationship. I talked about my personal story in discovering DH's (Dear Husband) bad debt management habits, the difficulty in getting him to admit and acknowledge the gravity of the situation and how we worked together as a team to overcome it. To recap, we used some tax money and took advantage of a balance transfer credit card offer to pay off $20,000 in credit card debt. The debt repayment journey took 19 months and the balance was paid in full in December 2015.

In February 2016, things seemed to be moving in the right direction with our finances. The monkey on DH's back that was riding him for 6 years was FINALLY gone. I decided to inquire about any additional credit card balances and he casually mentioned he had a balance on a Visa card. His response was simply, "I have it under control". Having an investigative type personality coupled with distrust, I called the company directly and the balance was a whopping $10,400. I was dumbfounded and it was difficult to control my emotions of shock and anger. I just couldn't understand how he was comfortable with having $31,000 in credit card debt just a couple years earlier. I suppose he felt ashamed, embarrassed and a bit of guilt. I felt sympathy to some degree but realized there was an elephant in the room and it wasn't just the debt. It was his attitude towards money and debt management. A person's attitude towards money is more about behavior than it is about math. 

In a follow up conversation, to address this problem once and for all, I went as far to say that our marriage would probably be short-lived if he continued his awful approach to money and if he persisted to hide his money problems. Some may say that that was harsh, but I was living a firsthand experience that could've easily been a part of that 40-50% statistic of marriages that fail over issues like money. Determined to not let that be our fate, I pleaded with DH to let this be the final time we allow money to be a source of dissension in our house and I asked for his commitment to be more transparent about finances.

How did we pay off a $10,400 debt with an insane interest rate? I wasn't willing to consider another balance transfer offer or monthly payments. I took the responsibility of using our taxes the following month and I handled the lump sum payment directly with the credit card company. In exchange for using marital funds twice to repay past debts, I asked him to commit to paying back the family savings for the remainder of 2016. He gladly agreed and he set up automatic deposits to our joint savings. With the exception of about 3 pay periods, the funds were transferred like clockwork over the next 9 months.

Having learned a thing or two in the first 3 years of marriage, what would I tell my 27 year old self? It's clear that I was bold enough to ask some of the right questions in the early stages, but we failed at creating and executing a financial plan. Needless to say, DH and I missed some critical points of discussion that are important to highlight:

It's okay to talk about money.
Talking about money in depth is important to understand how your partner views money. It reveals how they view saving, spending, budgeting and their overall attitude towards debt. If DH and I had really honed in on this issue earlier in the relationship, it would've exposed my bad spending habits and his poor attitude towards debt. Perhaps it would've empowered us to set some financial goals for saving and debt repayment from the beginning of the marriage. 

How did your parents handle money?
What we learn about finances growing up grossly affects our relationship with money. If you come from a household where money was tightly handled, you may be more of a tightwad compared to your spouse who's more liberal with spending. Our parents taught us some great lessons - the value of education and hard work but fell short when it came to money. DH and I spent years overspending, under budgeting and operating without a solid financial plan. We're now learning to take control of our financial future to teach ourselves what we weren't taught. The changes we are making today will change the future of our family tree and create a legacy for our son. Now it's our job to shape our son's attitude towards money.

What's the total debt baggage between each mate?
Asking your partner about their debt situation reveals a financial nakedness that's downright uncomfortable. Most people have debt stemming from school loans, car notes, credit cards or a mortgage. Don't be afraid to ask your partner how much debt they have and what their plans are to repay it. An honest conversation may reveal financial mistakes that led to bad credit or a bankruptcy. Being financially naked will help determine how to move forward to repay debt, repair bad credit and how to handle larger purchases like a car or home.

What are your future goals?
We got married and settled into our new life without any real conversation about future goals which led to a lot of financial waste. Having short and long term goals will dictate your spending choices. If your goal is to travel the world for 6 months, then prioritize your finances around that goal. If eating out often represents a large chunk of cash in your monthly budget, cutting back in this area won't rob you of the ability to eat out. Rather, you'd be robbing yourself of the ability to travel the world for 6 months. Grasping that simple concept will change your spending habits and shift your focus on the goals that are most important.  

Should we create joint accounts?
This has been an ongoing conversation in my household since we've been married. I'm perfectly fine with the level of openness and transparency that comes with merging all aspects of our finances. I lived on my own for 6 years and was in full control of handling my monthly bills. DH had all the bills linked to his checking account and wasn't very open to changing the way business was handled. Most people differ in their opinions on this subject. Some believe in maintaining a level of autonomy by keeping separate accounts. Others believe merging finances eliminate trust issues and can help to optimize budget planning. The most popular theory seems to be the case for having a family account where bills are paid jointly and each person has an individual spending account to take care of personal expenses. I think all points are valid and it's important for couples to decide which scenario works best for them. 

Most women I know are huge proponents of having a "secret stash" as a means of security. I don't disagree since I had an account that received automatic deposits each payday from my checking account. I've since liquidated that account to fund my son's bank account. At the present moment, a "secret stash" account is no longer in line with our current financial goals. I'll explain why in a future post.

 

How did you (or would you) handle merging finances? Would love to hear your thoughts so drop me a comment below.

FINANCIAL COMPATIBILITY WITH YOUR MATE: Part 1

There's no doubt you're compatible with your mate - you both love the same movies, playing tennis and Cuban food. But are you financially compatible? Many couples overlook the gravity of this issue and the long term impact it can bring to a relationship. While these conversations can be uncomfortable, having open and honest discussions about money is key to a successful relationship.

 I met DH (Dear Husband) in the summer of 2010. He was a pretty serious guy having expressed his intentions for the future of the relationship after only a few weeks of dating. We had open and honest conversations about income, credit status and debt history. But I was ill prepared for the debt portion of the conversation. Up to this this point I had had no major debt except a small credit card balance. DH revealed that he had $18,000 in school loans and $20,000 in credit card debt. Subsequent conversations led to some revelations that highlighted a few things about his mindset towards money - he was a spender that had a nonchalant approach towards debt repayment, believing that as long as minimum payments were met on time all was well and lastly he never calculated the math on interest payments.

To be fair, my approach towards money wasn't the best because I was a spender. The clear differences were how we approached debt. With DH's recent home purchase at the time, there were no plans to aggressively pay off these other debts. I expressed my discomfort with his level of debt and suggested that he use tax returns to get ahead of them. He was incredibly smart and reasonably logical so I assumed he understood the gravity of the situation.

Three years later we were married. The first few months were spent without any real financials goals. No Financial Goals = No Budget. No Budget = Financial Mismanagement. One day within the first year of marriage, I decided to conduct a financial health check on DH. I called his credit card company to inquire about the balance and interest rates and to my surprise the balance was still over of $20,000. A balance at this level was carrying monthly interest fees north of $200 while his payments were roughly $300. Simple math indicates that he would carry this debt for more years than I'd like to count. To be exact, if DH continued this trend, it would've taken him over 30 years with total payments nearing $79,591.82. OUUUUUUCH!!! What was more concerning was his passive indifference to how little sense the math made. He simply felt that as long as he allocated more than the minimum payment and paid on time, things were fine. I was baffled as to why a computer science major couldn't understand the simple math behind debt, interest rates and minimum payments. This was another revelation that being college educated and having a great career doesn't equate to smart money management. 

DH had been carrying this debt a couple years before I met him. So to address the 6 year long credit card debt problem, I suggested using a balance transfer offer from my credit card providing 15 months interest free to pay off the balance. The cost to do this transaction was about $400. We had the cash to cover the debt in full. A friend asked, “Why pay $400 when you can use cash to wipe out the debt”? I wrestled internally with this question. In the end, I decided that wiping out a 6 year old problem coupled with DH's mindset towards debt, wouldn't leave scars deep enough to avoid creating the problem again. His poor relationship with money warranted the burden of slaving to the debt in an aggressive manner to hopefully learn the right lessons. When I presented the plan to DH, he vehemently disagreed which led to arguments for 3 weeks. From his perspective it was admitting a weakness and facing a problem for which he had perfected an escape. The facade he created over his money management, had finally crumbled and it was time to face the tough reality. This was the first major lesson in marriage….there’s no such thing as SELF. Every problem solved, every burden you overcome and every success achieved is a direct result of teamwork. After 3 weeks of disagreements, he finally agreed. We used $4000 from our tax return to pay towards the debt and  he was on the hook for 15 months to pay off $16,400.

What are the bright sides and downsides of this lesson? Thirty days after paying off his credit card free and clear, his credit score jumped 43 points. Mine tanked 40 points because my credit position went from owing roughly  $2,000 to $18,400. While he rejoiced at his positive credit change, I chalked up my diminished score as a temporary sacrifice. The debt repayment process  began in May 2014 and was supposed to end 15 months later in August 2015. I'm happy to report that DH stuck to the plan but slowed down a bit at the 10 month mark as we anticipated the arrival of our son. The debt was paid in full an additional 4 months later in December 2015.

Stay tuned for PART 2 as I'll discuss another DEBT issue that came the spotlight.

What are your thoughts on having open discussions about money during dating?  Would love to hear your feedback so drop a comment below.

 

STEPS TO FINANCIAL FREEDOM

Over the years, I struggled through several periods of poor spending. I would spend half the year spending and the other half cleaning up the mess. I would eventually calculate the damage in dollars and would feel so much guilt that I would automatically shift into a frenzy of aggressively paying off the debt. During these moments, I would convince myself that I was finally ready to put aside my atrocious spending habits. I always thought of myself as a pretty logical person so I was able to rationalize that spending $5000 on "stuff" was illogical. The only problem was that I would repeat this pattern of behavior year after year.

When I first learned I was becoming a parent, I made a couple smart financial changes (more on this in a future post) that signaled the beginning of long term financial planning. However, everything else in my behavior said otherwise. I was still spending and operating without any real goals. At the start of this year, I decided it was time to take control of my finances. As I reflected on my poor money habits, I felt disgust and anger because I realized I was robbing my son of his future. That single thought fueled my desire for change.

I was suddenly motivated to change my relationship with money but wasn't sure where to start. There are a plethora of articles available on money topics but I wanted to be connected to something more concrete. Then I discovered Dave Ramsey and his daily podcasts. I heard the name before and knew he was a financial guru but never intentionally tried to learn about him. Dave Ramsey is a money management expert, NY Times Best Selling author, radio show host that has helped millions of people get out of debt. His podcasts involve him taking calls from listeners who are seeking financial advice. The callers would often reference the Baby Steps but wasn't really sure what that meant. A quick search later and I would discover Dave Ramsey's Baby Steps to financial freedom. This was the tried and true method that helped his listeners experience some level of financial freedom. The 7 Baby Steps are:

  • Baby Step 1 - $1,000 to Start an Emergency Fund
  • Baby Step 2 - Pay off all Debt except the house using the Debt Snowball
  • Baby Step 3 - 3-6 months of monthly expenses in savings
  • Baby Step 4 - Fund retirement accounts using 15% of household income between 401K, Roth or Traditional IRA
  • Baby Step 5 - Establish college fund for kids
  • Baby Step 6 - Pay off mortgage early
  • Baby Step 7 - Build Wealth and Give

The opening line for the podcasts starts out with Dave saying "This is the Dave Ramsey show where Debt is DUMB, Cash is KING and the paid off home mortgage has taken the place of the BMW as the status symbol of choice". Talk about an opening! Dave takes calls from listeners who are seeking financial advice and those who want to do their DEBT FREE SCREAM. The DEBT FREE SCREAM involves people recounting their debt journey by using Dave's recommended GAZELLE approach towards paying off debt - think of a gazelle frantically running away from a cheetah. People were paying off $50,000 in 11 months making a household income of $65,000-$85,000 or in a more extreme case, paying off $285,000 in 5 years making $78,000 in the beginning with an ending salary of $150,000. Talk about gazelle intensity. After listening to a week's worth of podcasts loaded with these amazing debt repayment stories, the light bulb went off in my head. I decided I wanted to experience the financial freedom that Dave Ramsey was talking about. I want to live a life without ANY debt except for our home. This was my idea and my motivation. I just needed to finesse this idea to get DH motivated to make this a family goal.

What are your thoughts on Dave Ramsey's Baby Steps? Where are you in the Baby Step process?

 

What Does Financial Freedom Mean to You?

Financial freedom often means different things to different people. From being debt free, retiring early or just having enough money to quit the job you hate. I pondered on the real meaning of this question in my own life and I concluded that financial freedom would enable me to make decisions without having to think about the constraints of money.

On my quest for financial freedom, I’m forced to face the unhealthy relationship I’ve had with money for the last decade. While I was a “saver” I primarily used money to accumulate stuff….I loved to shop and I did it often. I was a shopaholic and did it without regard of my annual cumulative spend. As my income grew, so did my taste and level of spending.  Making more signaled my ability to afford more expensive things. I always felt somewhat responsible because I always had cash on hand, equivalent to an 18 month emergency fund. Whenever my credit card balance approached $5,000, I would pump the brakes on spending and "borrow" money from savings as part of the repayment process and use the rest from paychecks. I would be free from spending for a while but it would only be a matter of time before the vicious cycle took over a gain. The real truth....I employed the mindset that so many people have - "Work hard play hard", "Live for today because tomorrow isn't promised", OR "You can't take it with you so you might as well enjoy it". All these statements are true. However, if indulging in consumerism is the response to these statements, then chances are you might be spending close to what you earn if not more, accumulating debt along the way and not really investing for the future. Yep....that was me to some extent…enjoying life for the short-term without any real planning for the future. Instead, I spent the last decade blissfully satiating in the reigns of consumerism. 

FINANCIAL FREEDOM IN AN EQUATION

I knew that spending into oblivion was the recipe for being broke and I wanted to change the future of my family tree for my son. As I explored and read extensively about financial freedom, I came across a term quite often used on the internet called FIRE (Financial Independence Retirement Early). FIRE indicates that you have enough passive income from savings and investments, which means you no longer have to work a traditional 9-5 job. If traditional retirement happens at 65, people were defying the status quo and retiring as young as 35 years old. How did they do this? They developed a non-traditional mindset towards money by keeping their expenses low, increasing their savings rates to levels as high as 75% of their income. That may feel impossible for a lot of people but imagine what the outcome would be if you created a budget, focused heavily on reducing expenses and increased your savings rate to say 40-50% of your income and invested it?

How does FIRE work?

The equation for FIRE = 25 x A (A is average annual expenses) with a 4% withdrawal method. The 4% is a rule of thumb used to determine how much should be withdrawn annually from a retirement account. Here's a simple example assuming your annual expenses are $35,000:

FIRE - 25 x $35,000 = $875,000

$875,000 x 4% = $35,000

If my annual expenses were $35,000 I would need at least $875,000 to retire, and based on average stock market returns, 4% could be withdrawn to pay annual expenses. When I plugged in my actual annual expense, I was a bit out of sorts as I coped with the sad realization of how my spending habits and poor relationship with money has derailed my ability to experience FIRE.

Where do I go from here?

2017 started and like most people, I reflected on the past and thought about what I’d like to do differently and immediately felt a strong level of guilt. The guilt surrounded how little I valued money, and the poor choices I've made collectively over the years. I realized that a healthy approach towards money isn't so much about doing simple math and deciding to just save more….I needed to change my mindset and relationship with money. Until there’s a shift in perspective, the behavior won’t change. Having a college degree, being smart in math or having a career in finance doesn't determine good money management skills. 

The first step is actually being serious about making a decision to change your financial life. If your'e single, it starts there and ends there. If you're married or have a mate, they have to agree to join the journey to financial freedom. Without their buy in, change won't be effective. It wasn't easy to get DH (Dear Husband) to admit we weren't spending wisely and that debt represented a larger seat at our table that it should. I decided change was necessary after accepting that everything I had purchased in the last 10 years produced ZERO return. That's the thing...."things" don't give returns. That reality hit home hard as I rationalized the damage of the loss of time. The loss of years and compounding interest. That was the catalyst for change. While I can't get back the time lost, I can still take full control of my future. My goal in documenting this journey to changing my relationship with money involves functioning like the CFO of my family and implementing the basic principles of money management that never change:

  • Create a Budget
  • Spend Less than you Earn
  • Reduce Debt
  • Increase your savings rate
  • Optimize investment opportunities (401K, IRA's, Brokerage Accounts etc)

This journey isn't about deviating from poor spending habits to obsessing over money because there's no satisfaction in that. Instead I'd like to challenge myself to become a better steward of my finances by optimizing every dollar earned and planning for the future. But first I want to wake up every day and acknowledge the blessing of health and strength....the source of what allows me to think, work and get through each day. In my desire to build wealth, I acknowledge that true wealth isn't the sum total of my financial net worth - but the growth I hope to experience in changing my relationship to money , shifting my focus from accumulating things to building a storehouse  of great relationships and experiences.                                                                                                                                                                                                      

What does Financial independence mean to you? Does FIRE seem like a reasonable goal?