Saturday, April 4, 2015

The Three Things Everyone Should Learn: Numero Dos


I never wanted to be a programmer, and I MOST DEFINITELY never wanted to be a financial accountant.  Borrrrr-ing!  But this blog series isn't about things that I hate, it's about things that I think everyone should learn.  And guess what, finance is numero dos!  No matter what you do to make money, or if all you do is spend it, there are a few monumental aspects that invariably penetrate your lives: (1) budgets and cash flow, (2) interest rates, (3) and (4) taxes.  Because these things have a way of creeping into our lives, I think it is imperative that everyone understand how they work, instead of turning away from them because they are not well understood.  In fact, the less you understand these things, the more you should study them.  It is scary to me that some people just ignore them when they don't understand.  That's like laying in bed when a serial murderer walks into your room, and because you don't understand her motives, you just roll over and go to sleep.  Maybe I've been watching too many episodes of The Following lately, but finance can be devastating if you don't address it. 

Unfortunately, it seems that personal finance classes are not required to graduate high school or college, unless you happen to be a business major in college.  What this means is that we are not often presented with requirements to really learn and understand finance.  My first finance class wasn't until I was doing an MBA at the age of 23, and if I hadn't known better prior, I could have gotten myself into a bad situation financially well before that.  Finance should not be one of many topics in school that can be selected for study; it should be a core requirement to become an adult.  I do not understand how people don't understand interest rates.  And to be honest, I'm probably not the right person to actually put on a full introductory course to personal finance.  But I will do my best to provide some tips and tools so that there are at least some actionable things coming out of this post. 
First topic is budgeting and cash flow.  If you want to get control of your finances, or save up for a specific goal, or need to pay off some debt, a great place to start is  This tool is free, and especially useful if you pay your bills and make most of your purchases through online or with credit or debit cards.  In other words, if you use cash for a majority of your transactions, will not really help much, but if you do not use cash for most of your transactions, it will.  To get started, you create an account and connect your bank accounts, credit card accounts, loan accounts, etc., to Mint and it will gather your transactions and put them into buckets.  This will give you a starting point to understanding how much money you spend on, say, food, for a month, and where all your other money is going.  It will show you a net picture of if you're spending more than you're bringing in.  Once you get a feel for where your money is going and how much you need to cut out, you can create a budget for yourself right on Mint.  Once your budgets are all set up, Mint will track your monthly activities and show you how you're tracking against your budget.  Mint can even alert you when a large bill is coming up, or when you've spent over your budgeted allowance in a certain area.  I also use it to track expenses that I will report on my taxes at the end of the year; more on that to come later. 
The one thing I think lacks is a cash flow feature.  I do this on my own in an Excel worksheet, and I've created a dummy worksheet for you to download and use.  The basis is that my money is better employed not sitting in my checking account; either paying off debt or going towards investments that will return something greater than the puny .00001% interest rate earned in most checking accounts.  Thus, I do not keep a large balance in my checking account, so I need to manage the daily in's and out's in order to not overdraft the day before I get paid, for example.  This is called cash flow.  Cash flow can burn you even if on a net level, you make more money than you spend, so it's important to watch the daily transactions. 

You probably hear a lot of advice about how it is important to save.  But, what is hidden in that advice is that simply saving is not actually helpful - you want to put money into an account that will provide interest.  Most checking accounts, as I mentioned earlier, have puny little interest rates.  It is the equivalent to stuffing money into your mattress these days.  They are not meant to be the vehicle for saving, they are meant to help you pay bills and receive your paycheck.  There's this big bad wold called inflation, so if you were to save money in your checking account, not only are you not getting any real interest off of that savings, you are actually losing money.  Over the last ten years, the US inflation rate has bounced around between 0 and 4%, and averaged right around 1.9%.  The rule of thumb that I learned is to expect about 3% inflation.  What this means is that if you have $100 today, and inflation stays around 3% for 10 years, that $100 will only be worth about $73.74 10 years from now.  If your back pays you .01% interest, then it will be worth only 8 cents more. 

To combat inflation, then, you need an account that will at least match inflation, and preferably beat it at least slightly in order for your money to grow.  So if you're assuming inflation of 3%, look for an account that can get you 3.5% or 4% to save in.  This is the interest rate you are looking for.  At 3.5% interest rate with 3% inflation, $100 will be worth $105.11 in 10 years.  There's no major growth, but at least you don't lose money.  At 4% interest with 3% inflation, $100 will be worth $110.46 in 10 years.  The trick to saving is not to put a small bundle in and wait for it to grow, though.  The trick to saving is to put a little in every period, like every month.  So let's say you put $100 in every month for 10 years, at 4% interest with 3% inflation.  You will have put in an actual amount of $12,000 over the course of those 10 years, but you will end up with the equivalent of $12,725.50, a gain of about $725.50, even in the face of 3% inflation.  Take that, big bad wolf! 

Now that you know you can't usually trust your checking account to combat inflation, and that you need to combat inflation, you need to know where to find these accounts that can beat inflation with their interest rates.  In college, I was referred to a Money Market Mutual Fund, and while I am not in a position to make any official financial recommendations, it may be a good place to start.  The MMMF I participated in had around 3.75% interest, and I paid into it every month for a few years.  When I graduated college, I had enough money for a small down payment on my house and to cover the fees of buying the house.  I saw it as a great way to "pay yourself first", put money towards a future goal, and it was as simple as writing a check to get the money back out when I was ready to buy my house.  But again, I am not in a position to make an official recommendation, so all I can officially say is that it is probably worth it to sit down with a financial adviser and discuss options for saving. 

While saving money is the upside to interest rates, we also pay interest whenever we carry loans or debt.  If you have a credit card and don't pay the full balance every month, you are spending money on interest.  So if you are trying to get out of debt, you need to pay very close attention to those interest rates, and pay down or get out of the highest ones first.  Some credit cards can have astronomically high rates, in the 20 - 30% range, while others my be single digits.  If you can move your high interest debt to a lower interest debt account, even if it costs a little bit of money to transfer it, that may make sense in the long run in order to not continue paying a high interest rate. 

Some debt may be at such a low interest rate, it is not financially worth it to pay it down right away.  For example, PayPal credit and appliance stores can often do 0% interest rates for 6 months on large purchases.  So if you have your savings account at 3.5% or 4%, you are better off putting money into your savings account until the 6 months is up on the PayPal credit, then you can pay it off with your accumulated savings before the interest rate gets jacked up.  This takes close monitoring to manage, but if you stay on top of it, these 0% interest rates are a great way to finance something even if you have the money to buy it outright, because you can earn with the money that you would have otherwise spent. 

When considering financing for a car, many dealers try to sell you on the "low monthly payment", drawing your attention away from the total price of the car, the interest rate, and the length of the loan.  It is nice to know that you can afford the low monthly payment, but it is CRUCIAL you understand the deal you are getting, in order to compare it to other offers.  Always do your homework before signing a financing deal: get offers from your bank, any credit unions you have access to, as well as the dealerships you are considering working with.  A quick google search can get you to various calculators that can help you compare different offers.  I like this one:  Remember that the loan amount is the difference between the price of the vehicle and your down payment; the larger your down payment, the less principal you have to pay interest on. 

Finally, a pet peeve of mine is how people get so excited when they get a huge tax refund in April.  Listen, I get that everyone likes to get money, but this is not free money like you may think.  This is money that you paid into the government throughout the year, meaning you had less money to do things
like save or pay down your debt, and now the government is graciously giving some of it back to you.  What's worse, the government doesn't pay you interest.  Think about it: while you're trying to pay down your debt at 5% and 8% interest maybe, you're also giving Uncle Sam some of your precious income at 0% interest for months and months and MONTHS!  From a purely economical sense, it would be better to pay minimal taxes throughout the year, meanwhile saving the additional money that you would otherwise have been paying to Uncle Sam in a high interest account, and then to owe at the end of the year.  The awesome part is that even though you technically may owe as of Jan 1, Uncle Sam gives you until Apr 15 to actually pay it.  That's more free money, if you owe.  Put the money in an investment and grow it, instead of paying it on Jan 1.  Conversely, if you wait until Apr to do your taxes, and you're due a refund, you've let the government keep your money for an additional 4 months interest free. 

Now, I don't particularly like writing checks to the government, either, so my goal is to have a small net tax refund.  This usually works out for me with a large tax refund from state, and owing the federal government a not-so-large amount, so I can file state right away, get my refund, use that money for a little while, and then in April, I use some of the refund from state to pay what I owe to Federal.  I rejoice when I get this right, because I think it's the sweet spot.  I don't have to worry about how much to save to pay for what I owe, but I also get more money throughout the year and let the government have less money interest free from me. 

Getting into the details of taxes, I recommend at least trying to do your own, even if you are going to go to a tax advisor eventually.  Doing your own helps get you prepared, and helps you estimate what you owe or will get back, and then your tax advisor can potentially find more for you.  Also, when you try it on your own, try doing the full deductions instead of taking the standard deduction.  This is where is very helpful, because you can tag transactions throughout the year as tax deductions and tax credits.  Use to track all your charitable contributions, your medical payments and pharmacy expenses, purchases for a home office and purchases for work, professional dues, etc.  If you keep your notes updated in, it is easy to then download the transactions and sum the tax deductions and tax credits using Excel. 

There are a lot more topics within personal finance, but I think these three are the most critical for everyday life and non-finance and non-investment-savvy people.  If you want to learn more about investing, for example in the stock market, there are plenty of resources, but one thing I would recommend is to try a stock market game app to get a feel for it before you dive in with real money. And if something I said above is confusing or you didn't quite get it, I highly recommend that you do more research on your own to learn and understand these concepts more thoroughly. 

In addition to personal finance, I think it's also important when you work at a company to understand corporate finance.  Not every job is easily directly tied to the bottom line, but understanding how you can influence it, either by reducing costs with improvements and efficiency, or by increasing the revenue or margins, can help you shine above your peers.  The higher up in the corporate ladder you go, the more important it is to be able to quantify activities in terms of dollars.  Managers, Directors, and Vice Presidents speak in financial terms, so if you want to impress them, it is always good to tie back whatever you are talking about to dollars. 

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