Ten Commandments of Saving Money

Ten Commandments of Saving Money

“Do not save what is left after spending, but spend what is left after saving.”

Warren Buffett

Warren Buffett’s quotes are timeless, reflecting his wisdom. His words on saving and investments are inspiring. Saving money is the cornerstone of a sound financial plan. Through discipline and hard work, we can save money to reward ourselves with financial flexibility. By making saving a priority and making your money work for you, you are more likely to achieve financial success.

Key Reasons To Save Money

  • Help to achieve our financial goals.
  • Pay our bills on time and entirely, so we don’t need to carry costly debt.
  • Provide an emergency cushion for unpredictable costs.
  • Set aside funds for our children’s college tuition and our retirement.
  • Make investments, the best way to build wealth.

I like to revisit ancient views of saving money from timeworn texts and stories. There is a common thread across varying beliefs on saving, avoid overspending, and investing for a better financial future. Surveying these words adds a different perspective on finances. In the companion Ten Commandments of Personal Finance, we look at home ownership, investing,  retirement, and debt management.

Ten Commandments of Saving Money:

 

1. Spend Within Your Means

Saving money is an essential financial habit. According to a CareerBuilder report, 78% of American workers are living paycheck-to-paycheck.  Even those with higher incomes of at least $100,000 (nearly 10%)  are having trouble making ends meet.

I grew up in a modest household that saved diligently. As a young girl, I didn’t always understand why we were having financial problems. My mom reminded us often that our needs exceeded our wants, and we had to be careful about spending. Later on, I learned that my parents set up a small retail business that took a long time to get off the ground. Savings became part of our mindset from then on.

Control thy expenditures.”

To set aside money for saving and investing, you may need to cut some costs. To control your expenses, assess what your necessary living needs are. These are predictable monthly fixed costs such as mortgage payments or rent, property taxes, utilities, car loans, typical grocery bills, credit card payments, and any expenses you pay monthly. Remember, these costs are for our needs rather than for our wants and desires.

Be reasonable about satisfying your every want. A rise in earnings may not fully accommodate every gratification we seek. For example, that 10% raise on your $80,000 salary may not significantly help you to buy that luxury car (or chariot in ancient times), you have been eyeing.

 

2. Build A Healthy Emergency Fund

As a result of the coronavirus pandemic, record jobless claims caused a dramatic slowdown of the economy. Although federal stimulus packages have added to state unemployment benefits, there is no guarantee this government aid will be ongoing. 

 Economic downturns are cyclical events you can’t time. They cause substantial financial stresses. Recessions remind us of the need for savings on hand. Having an emergency fund is necessary to pay for basic living expenses for at least six months, if not a year. Having readily accessible funds in liquid funds such as money market securities helps you avoid borrowing money.

Joseph’s Emergency Funds

Emergency funds as a prudent strategy appear in Genesis 41:34-36. In this passage, Joseph interprets Pharaoh’s dream about seven fat cows grazing by a river swallowed up by seven skinny cows. Joseph views the seven fat cows as seven prosperous years for Egypt, followed by seven years of famine. As a result of planning for this disaster, Joseph advises Pharaoh to store grain during the good years to use for more challenging years. Save when you have more for those times you have less due to job loss, illness, or crisis.

Adopting a habit of saving more provides you with more flexibility to allocate into investment and retirement savings. Begin by setting aside small amounts of savings of $1,000 but don’t stop there. Tough times prove that amount is inadequate. Don’t think of these savings as wasteful assets. Instead, it is a means to avoid higher debt levels. As Proverbs 13:11 tells us, “Dishonest money dwindles away, but whoever gathers money little by little makes it grow.”

Having Liquidity is Key

Liquidity refers to your ability to quickly convert assets into cash with little to no loss of principal. When your resources are liquid, you have the financial ability to pay for unexpected costs such as a loss of job, death in the family, or your roof is leaking. Monitor your liquidity levels periodically. 

Monetary assets are among the most liquid of holdings. These assets include cash, cash-equivalent securities or money markets, treasury bills, savings bonds, savings, and checking accounts. True, you won’t earn much income as interest rates are still low, but you avoid having to use your credit cards with borrowing rates in the mid-teens.  Use liquid assets to support your fixed monthly expenses for six months or more. Here are two benchmarks to use:

Liquidity Ratio= Monetary Assets/ Monthly Expenses

Your monetary assets should support your fixed monthly expenses such as groceries, rent or mortgage, utilities, and a car loan for six months. A ratio of 6 means having six months of monetary assets to pay for your basic needs of food, rent, utilities, and car loan, if necessary.

 Emergency Fund Ratio

The liquidity ratio is linked very closely to emergency funds. This ratio is essentially a cash fund for emergencies in unforeseen events such as job loss, death in the family, unexpected surgery, or immediate house repair. It works by using a targeted number of months that you believe is ample to support you through emergencies. If you are looking for six months or higher (and this is highly recommended) to set aside money in a high yield savings account or money markets account, then:

Emergency Funds Ratio= 6*Monthly Expenses

This ratio will give you a targeted amount of monetary assets needed to be comfortable for a possible emergency. If your household generates less predictable income, you need to set aside more than six months for a more significant cushion. You can use personal finance ratios as benchmarks to see how you are doing.

3. Pay Yourself First

Start thy purse by fattening

George S. Clason, who wrote The Richest Man in Babylon, is believed to have coined the term “pay yourself first.”  That means you should put away at least 10% of every paycheck into savings. Start to save small amounts working your way up to 20% of income to allocate into retirement savings investment accounts. You can distribute the initial savings to an emergency fund amounting to at least six months’ coverage for essential living costs. Unforeseen events are unpredictable and undesirable but do your planning.

Once establishing this fund, use some savings stashes to invest for retirement and taxable investment accounts. Putting away some money may be difficult at first, depending on your spending habits.

Savings should be one of the most essential parts of your household’s financial goals. Adopt a “Pay Yourself First” attitude. Your monthly budget should call for savings to be at least 10% of gross income.

Savings Ratio = Savings/Gross Income

Savings refer to money in the bank, liquid funds, deposits, money markets, and other liquid funds, such as your emergency fund. Gross income is your total source of income on your budget and includes what you earn, side businesses, bonuses, dividends, and interest income.

Your savings rate should be at least 10% of gross income. It may be challenging to do when you first start to work. As your salary or what you make rises, it should get easier to put money away for savings. A healthy savings ratio of 20% would be a bonus (pardon the pun).

4. Track Your Spending By Budgeting

Spending more than your means is a bad recipe that leads to borrowing more. It is far more profitable to save money and allocate to investments that yield 5% returns or more than having to borrow at mid-teen rates with credit cards to pay for your overspending habits. “Whoever works his land will have plenty of bread, but he who follows worthless pursuits will have plenty of poverty.” (Proverbs 28:19).

Track your spending carefully by budgeting according to your priorities. Bava Metzia 42a instructs us, “A person should always divide his money into three: one-third in the ground (for the future), one-third (invested) in business, and one-third in possession.” That may be an ancient way of splitting your funds. There are several ways to budget, such as tracking your expenses, creating a monthly budget, or using the 50/30/20 rule. The 50/30/20 budget uses 50% of aftertax or net income for your needs, 30% of net income for your wants, leaving 20% for saving money and paying off debt.

Budget In Any Reasonable Manner

Budget in any reasonable way that allows you to control your spending. It is easier now than ever to track your spending using various (free or fee) apps such as Mint, Personal Capital, PocketGuard, and YNAB for zero-based budgeting.  Alternatively, scrutinize your credit card bills and build your own excel spreadsheet.

Our spending changed dramatically during the pandemic. Our bills for grocery and household goods were higher than usual. On the other hand, we saved more from cutting out retail shopping, dining except for occasional outdoor places, hair salon appointments, gas, tolls as we stayed closer to home. While I appreciated the extra cash, I like the return to normal, even as Covid cases are rising.

5. Avoid Lifestyle Inflation

As our income grows, we often increase “essential costs,” leading to lifestyle inflation. While we are allowed the occasional latte and extravagant dinners, we need to keep our spending in check. You shouldn’t deprive yourself of everything. However, fulfilling every desire is no longer a special treat.

“Keeping up with the Jones”  and conspicuous consumption often refers to material goods we may accumulate to fit within a particular social class we admire.  We compare ourselves to our neighbors or colleagues at work.  As a result, people fall into the trap of spending on a better car or house simply to enhance their prestige and social standing. Targeting social status may be costly and divert resources better used for investing your money for more incredible long-term wealth.

It is pretty common for people to spend their raise and bonus as soon as they receive it. Temptation runs high to buy something special upon getting a raise and bonus after a year of working hard. I often bought something special to reward myself for hard work. However, you soon realize your pay hike is pretax and shrinks on an after-tax basis. If you need some things, make a list of what you believe is essential if you had some extra cash.

Overspending And Materialism

Overspending leads to materialism and lifestyle inflation that is hard to maintain. Mishlei Proverbs 13:7 tells us, “There is one who feigns riches but has nothing; one who feigns poverty but has great wealth.”  According to Psalms 128:2 “You shall eat the fruit of your effort–you shall be happy and it shall be well with you.” This text reminds me of another favorite book, “The Millionaire Next Door: The Surprising Secrets of America’s Wealthy by Thomas J. Stanley and William D. Danko.

Stanley and Danko profiled and compared millionaires in two categories: those under accumulators of wealth (UAW) and the prodigious accumulator of wealth (PAW). The UAW’s were individuals who had a low net wealth compared to their high income because of spending to maintain their status. On the other hand, PAWs managed their wealth better, often living in blue-collar neighborhoods and buying used cars. It is an eye-opening account of the good and bad money habits of the wealthy.

 6. Bargain hunting or Shopping Addiction?

Shopping is often a fun activity to do with friends or on our own. Marketing experts count on our emotions when we shop. Be aware of the biases we wear when shopping. Retail expert Mark Elwood has written about the psychological benefits of seeing bargains. He points out that stores like Best Buy use Goldilocks pricing or three-tiered pricing from low to high prices. The store hopes you will buy the middle option with higher pricing than the low-end but not necessarily feature-worthy enough to pay more.

We should not pay the list price for anything but make sure it is a real bargain. There has been a lot of worthwhile academic research about bargain hunting being a form of shopping addiction. 

There is the thrill of getting a deal,  even when we may not want that item.

Impulse Shopping vs. Compulsive Shopping

Overspending can cause financial difficulties if you are subject to impulse or compulsive shopping. There is a difference between the two though often seen interchangeably. Impulse buying happens more frequently when a consumer has a sudden urge to buy on the spot without much deliberation. We all do this from time to time. Compulsive buying, on the other hand, happens where one experiences an uncontrollable urge to buy. We may trigger negative feelings relieved by that purchase. This kind of shopping may be more like a shopping addiction that potentially needs therapy before financial hardship occurs.

7. Compounding Growth

Start saving for retirement in your 20s through your employer’s sponsored 401K plans. Deposits in small amounts in retirement accounts regularly benefit from tax advantages and compound growth over a long horizon. Automate these savings out of your paychecks. As such, your contributions are tax-deferred. Employers often match a portion of your contributions. Match contributions are extra money you can earn from your company. Separately, establish an IRA (Roth IRA) for further retirement savings. Target your contributions to amounts capped by the IRS for maximum growth for retirement. Avoid withdrawing from these accounts as you may then trigger penalties and taxes you will need to pay.

As a goal, try to contribute to your 401K plan to the maximum level, which is $19,500 in 2021.  Some years it may be hard to do, especially when you are experiencing a job loss. Resist withdrawing money from your retirement account as there is usually a 10% penalty and taxes to do so before you turn 59.5 years. Withdrawing retirement money will put a dent into your retirement fund that will be painful longer term.

One of my favorite quotes in The Richest Man is this: “It behooves a man to make preparation for a suitable income in the days to come, when he is no longer young, and to make preparations for his family should he no longer be with them to comfort and support them.”

Compounding Works Best When Investing Early

The power of compounding interest, linked to the time value of money, will benefit you the most if you save and invest early. Let your earnings accumulate and grow rather than withdraw cash from your accounts. It makes a big difference if you start saving for your retirement ten years later than your friends or if you invest for ten years and then stop contributing to your 401K retirement account. It is difficult to catch up by doubling the amount if you start investing later on.

As soon as your child is born, start saving for college through a 529 plan. These plans vary but are available in virtually every state. Like retirement accounts, they have deferred tax benefits and may have contribution limits. Check with your respective state program for details.

 8. Make Savings A Priority

Saving money is hard work and not necessarily natural for many of us. To make it a good habit, take steps to automate your savings. Most banks will allow you to automatically transfer a set amount of money from one account to another account. Your employer will be able to automatically deduct a percentage or a set amount of your paycheck to deposit into accounts such as retirement or investment accounts. Essentially, you are adopting a “pay yourself first” attitude so that you can allocate money into different buckets, especially for unforeseen expenses.

In recent years, there have many headlines about insufficient savings by Americans for years. As the outbreak of the virus caused lockdowns, most of the country stayed home. The personal savings rate rose dramatically to an unusual 32.2% in April 2020 as consumer spending dropped significantly. Over time, it will likely come down to the more normal 7%-8% range. Spending versus saving is a common trade-off with lots of tension. Motivate yourself to save by setting short-term and long-term goals proactively. Reduce spending you can’t afford. Money trade-offs require you to consider the best balance for you and your family.

Saving As A Good Habit. How Long Does It Take?

I had always heard that it took 21 days to break a bad habit. As a member of Weight Watchers, which is ALL about breaking bad eating habits (and it works for me as I am down 30 pounds and declining!), they always refer to the 21 days. However, I did not know of the 21-day origin.

Dr. Maxwell Maltz, a 1950s plastic surgeon, found that it would take his patients about 21 days to get used to seeing their new face, or post-amputation, they would still sense a phantom limb. The 21-day time frame dates back to nearly 70 years. Dr. Maltz wrote about his adjustment period to changes and new behaviors to form a new habit….”.it requires a minimum of about 21 days for an old mental image to dissolve and a new one to jell.”

More research indicates that it takes a longer time to form a new habit than 21 days. A 2009 study published in the European Journal of Social Psychology by Phillipa Lally, a health psychology researcher at University College London, indicated it took 66 days on average (in a range of 18 days to 254 days) to form a new habit.

Whether 21 days or 66 days, it takes significant time, effort, and determination to create a new habit

What About A Savings Challenges?

I have been skeptical about savings challenges. Like diets, they work for many and can be fun, especially if you do so with others. The question is whether the challenge can result in having long-term effects. I think any challenge that can motivate someone towards a good habit with lasting results has my endorsement. There are so many good savings challenges to consider. I tend to favor the 52-week challenge, which may help you build some money along with good habits. On the other hand, the no-spend month reminds me of a fasting diet and seems too difficult to attempt for most people with families or busy lives.

I often have turned to using cash only and leaving my credit cards behind. Paying for meals at restaurants or window shopping without cards has rewarded me by limiting my consumption to cash. I am not a big shopper or enjoy going into stores unless I am going purposefully for a specific outfit or electronics. My daughter, Alex, is often upset with me, encouraging me to buy something for myself. She wonders why I don’t love shopping as much as she does. Now that she is working two jobs that she loves this summer, she has become quite a hoarder herself and has asked me about my stock picks. (Okay, I am proud of her!).

9. Don’t Obsess About Money

Maintain balance in your life, and don’t just focus on wealth accumulation. According to Proverbs 21:20, “Precious treasure and oil are in a wise man’s dwellings, but a foolish man devours it.”  While no one seeks to become poor, there are dangers of solely wanting to be rich. “Keep your lives free from the love of money and be content with what you have.” Hebrews 13:5

Martin Luther King Jr. worried about the obsession with money in his famous speech called False God of Money. He said, “We attribute to the almighty dollar an omnipotence equal to that of the eternal God of the universe. We are always on the verge of rewriting the Scriptures to read, ‘Seek ye first money and its power and all these things will be added unto you,’ or ‘Money is my light and salvation, what shall I fear.”

King himself lived frugally, leaving little money for his family. However, he saw other goals like working hard, investing in education and having faith as far more critical.

Price Versus Quality

Being financially secure is important. The alternative is stressful. However, don’t be frugal for frugality’s sake. Consider price versus quality in your buying considerations. The cheapest thing may not be of the best value. Indeed, there are some items where quality doesn’t differ, and I  will pay the best price. I like buying private label products such as Kirkland sold in Costco, discounted from the branded items.

However, quality matters more when buying furniture, mattresses, a car, or a home. We have been burned by looking to get a bargain and not balancing quality. Buying solely on a price basis is foolish for these products or services that I intend to use for a while. That doesn’t mean I am averse to getting a bargain by negotiating.

10. Be Charitable

According to Jewish law, one cannot impoverish oneself by distributing all of one’s wealth to charity. However, one can leave one-third of his estate to charity in their will. A minimum of one-tenth of one’s income belongs to God per measure handed down from the Patriarchs as Jacob himself said to God, “Of all that You give, I will set aside a tenth to You” (Genesis 28:22). Giving 10% of your net income a year is a virtual goal—those who can.

According to HW Charles in The Money Code: Become A Millionaire With The Ancient Code, “Those who love people acquire wealth so they can give generously, after all, money feeds, shelters and clothes people.”

We should strive to be as generous as possible to those in need.

Final Thoughts

I found inspiration from timeless scriptures when writing this article.  Sometimes ancient words remind us that money management was always a challenge to overcome.  Choose success by your actions in saving money. 

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What You Need To Know About A Sinking Fund

What You Need To Know About A Sinking Fund

We all have something special we’d like to buy for our home or in life. That old couch that has seen better days in your living room begging for a replacement or a vacation you thought about for a long time but keep pushing off because it is too costly. Paying for these significant expenses can be challenging for us, but a sinking fund may pave a better way.

Sinking funds can be a gamechanger for individuals and households. It is a valuable tool to add to your financial toolbox for savings. This strategy helps those who want to manage their finances better and gain peace of mind.

The timing for setting up sinking funds could not be better. Americans have been saving more, as illustrated by the US personal savings rate of 14.9% for May 2021. The unusually high rate due to pandemic-related spending constraints compares to 7.6% at the end of 2019. So why not make your savings work better for you?  Setting up a sinking fund is easy to do and enhances your ability to save money for large purchases you will make in the future.

What Is A Sinking Fund?

Sinking funds have long been helpful for companies and bondholders to minimize risk. For example, when corporations need to raise capital, they may issue a bond that matures in 20 or 30 years. Bondholders receive coupons semiannually and the principal (their investment) at maturity.

Many bonds now have a sinking fund managed by a trustee who oversees the fund. Money is set aside periodically with a trustee for repayment of the portion of the principal. This action eliminates the need for a significant cash outlay for the company at maturity.

There is less risk of the company defaulting by using the fund if it doesn’t pay back the principal to bondholders. The fund adds protection and security for the bondholder that the company can pay off their debt. A sinking fund allows a company to raise capital with a lower interest rate to bond investors. As such, it improves a company’s creditworthiness.

A Sinking Fund For Your Household

Similarly, you or someone in your family can create a sinking fund, dedicating a savings account for a specific household expense that may be too large to handle without borrowing the money. We will explain later how your sinking fund differs from your emergency fund.

Once you determine what you want, say a new couch for $1,000-$1,500 for your living room, your sinking fund is for the sofa, not for another expense. You intend to save money to buy a couch, making monthly contributions to the “couch” sinking fund. Everyone has their budget, lifestyle, and timeframe for getting the couch or whatever it is you are targeting.

With a bit of planning, you can have what you need or want in your life without guilt. If you have your heart on a particular $1,500 couch within a year (i.e. 12 months), your monthly savings goal is to contribute $125 to the sinking fund each month.  Break the estimated spending amount into the monthly savings you plan to deposit into the respective savings account.

Without a fund, there is a greater temptation to pull out your credit cards for these large purchases. Your challenge is that you would have to pay your card balance in full or face a card balance growing on a compound basis at high-interest rates. There are more benefits to setting up a sinking fund for purchases than the downside of adding to your debt.

Sinking Fund Vs. Emergency Fund

Both your sinking fund and emergency fund are safety nets but for different purposes. An emergency fund is for the money you set aside in a savings account for unexpected costs you may face when losing a job, boiler breaks, a medical necessity, or pet surgery. Emergencies, by definition, are unknown as to timing and amount needed. You still have to pay bills, rent, or mortgage. Unplanned events happen, upsetting your finances. We recommend having your emergency fund cover six months of your basic living needs. You want to have access to liquid assets quickly.

The sinking fund is for saving money for a known purpose you expect to purchase in the future. Typically, your sinking fund is for a specific planned amount. You know its timing and have been saving for it. The point of having a sinking fund is not to tap your emergency money or a general savings account.

Just like you have loans for a house, car, and college, you are earmarking savings for larger items you want to purchase. Dollars are fungible and can go into a “car or house down payment” sinking fund. You can have a sinking fund by categories such as a house, car, vacations, Holidays, Christmas gifts, or charities. Alternatively, you can name these reserves by being more specific:

  • Kitchen remodeling
  • Sofa
  • Flat-screen TV
  • Refrigerator
  • Car maintenance and repairs
  • Down payment for Car
  • Down payment for House
  • Pet bills
  • Taxes
  • Vacations

Labeling the sinking funds is a personal decision based on your household and its relevant savings goals. 

How To Set Up Your Sinking Fund

 

1. Review Your Budget

Before setting up your sinking fund, you should a good grasp of your household’s budget. Budgeting is an essential tool for understanding your income sources less fixed and discretionary expense categories. Fixed living costs include your rent or mortgage, utilities, loan payments, and savings. You should have “savings” on your budget for when you are paying yourself first. Depending on how granular your budget is, you should separate line items for an emergency fund and the sinking fund. Pick a budget method that works for you.

When it comes to fixed costs,  you have less flexibility to reduce amounts. On the other hand, discretionary spending varies based on money left over.  You can learn more about different budgeting approaches here.

2. List Your Planned Purchases

Make a list of fund categories, break them down into more specific items. Then determine the target amounts for each. Name your sinking fund by its discreet type. Some funds may have higher amounts and longer timeframes. Divide each type total by the numbers from the planned purchase time. For example, if you are saving up for a new car’s down payment in two years, estimate the cost of the car is, say, $38,000, so you would want around a down payment of  $4,500. That equates to about $190 of the planned monthly contributions for two years or 24 months.

There is no set number of sinking funds though I would caution you about having too many sinking funds to manage.  This process is about organizing your finances to make things more effective and efficient for you. As in the sinking bond for businesses, you are the trustee or manager of the funds.

3. Where Your Savings Will Go For Purchases

You can open an FDIC-insured saving account for each type or have one large sinking fund with named sub-accounts. Keep in mind that the sinking funds are separate from your emergency fund and savings accounts. The type of accounts you should look for should be readily accessible and liquid, similar to the account you use for an emergency fund.

When you open a sinking fund for each type, each of your accounts differs from target amounts and timeframe. For example,  when you are saving money for a house makeover or a down payment for buying a home, you probably are looking to build a five-figure money chest. If so, you can look for higher-yield savings or a money market account. For smaller purchases and shorter timeframes, avoid accounts that require minimums that penalize you with fees for not maintaining a specific balance.  Essentially, you want safety and liquidity for the sinking funds.

Use Sub-Savings Accounts

Some banks, such as Ally, allow you to have a savings account and sub-savings accounts when you have multiple savings goals for concrete purchases.  You can automate transfers to each of your sinking funds based on varying monthly contributions. Having the ability to transfer money can ease the process for you. However, you will be receiving more monthly statements.  Consider the account details regarding fees, minimums, if APYs are different, and whether this works for you.

4. Need An FDIC-insured Account

Whatever you decide to do, each sinking fund should be in an FDIC-insured savings account that is readily accessible. For longer-term purchases, look for higher yields and minimize fees you may have to pay.

Benefits of A Sinking Fund

 

1. Better Budgeting

When you have a good understanding of your budget, your fixed living costs, it is easier to plan for discretionary spending. You can decide what amount you can contribute to your specific sinking fund each month without becoming a hardship.

The better your budgeting, the better you can plan for your savings goals and spending. It is easier to save money when you have an intended target to set money aside for that purpose.

2. Conscious Spending

When you set up your sinking fund, you essentially are planning to buy something you need or want for your home or life. It is an act of conscious or mindful spending when you are intentionally saving for something. You know the specific couch you will buy, have a plan, and focus your attention on that couch.

By taking time and doing comparison shopping, it is less stressful and more enjoyable anticipating the arrival of something new that you specifically want to get. You are not at that stage where salespeople will push you into an impulsive purchase you’ll regret. You are more in control of your spending and more likely to negotiate where and when possible.

3. Delays Instant Gratification

The need for instant gratification is all around us, with social media ads tinkering with our brains. The present bias plays a significant role in our leaning toward immediate pleasures. It causes us to favor the present over the future with immediate rewards. With effort, you can counter tendencies to overweight decisions that can cause overspending with planning.

With your sinking fund in place and growing closer to your spending goal, you can delay instant gratification. You have your mind not just on your expected purchase but on other things as well. Setting goals for one part of your life makes you more purposeful about your needs and wants. Achieving something on your list can be very fulfilling.

4. Avoids Adding Debt

Overspending can lead to higher debt, significantly rising credit card balances. Card balances are especially higher cost and challenging to handle. As in the sinking fund for corporate bonds, a household sinking fund can help us avoid reaching for our credit cards to pay for large ticket items. Increasing our monthly savings by earmarking money to contribute to a specific account that earns interest is the path to better financial health.

Saving first, spending later, and avoiding debt where we can, can improve our creditworthiness.

5. Peace of Mind

Having peace of mind is priceless. While you may not be able to get rid of every stress you have, planning out expenditures for important things you want to get or do can help your mindset.

Drawbacks

 

1. Don’t Have Too Many Sinking Funds

You may get good at organizing your finances. The next thing you know, you have too many sinking funds, overlapping purposes. That reminds me of an ad for Post-It notes, stating that they should be used “for the little things you’ll forget,” and then you see yellow Post-Its all over people’s foreheads. You get the picture. You don’t want to create chaos. The sinking fund process should help to organize where your savings should go.

2. Sinking Funds Are Not Interchangeable

When creating sinking funds, they are separate from each other. Keep contributing to each based on the estimates you determined. Try to label them as discreetly as possible, so it is not confusing to you. If you wanted a couch and estimated $2,500 for it, but found the one you love for $1,800, then you can reallocate your savings to other areas. Sometimes you under or overestimate the expected cost, so make changes but don’t blur the lines.

3. Keep Emergency Funds Separate

Having an emergency fund is essential, and its purpose is different from any sinking fund. Don’t transfer funds from your emergency account to your vacation account. That’s cheating, and if an emergency arises, you want that fund to be there for you in its safe and sound place.

4. Don’t Forget Savings For Other Goals

Saving for retirement and investment accounts is vital for your long-term future. Make sure to automate contributions to your 401K retirement plan, if sponsored by your employer, and for your Roth IRA. You should contribute some of your savings to investments, whether you are managing the account or you have a financial adviser to do so.  Over the longer term, these accounts grow faster than savings bank accounts, depending on your respective investments (i.e., stocks, bonds, real estate), and benefit from compounding growth.

Final Thoughts

Establishing sinking funds by saving for large purchases can be beneficial. It is a terrific organizational tool that enhances your mindfulness. By being thoughtful about your spending, you will reduce your need for instant gratification while reducing your buyer’s remorse.

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9 Ways To Avoid Lifestyle Inflation With A Savings Plan

9 Ways To Avoid Lifestyle Inflation With A Savings Plan

Lifestyle inflation happens when our income rises, we increase our spending.

Like a balloon that gets larger, we tend to spend our expanding pocketful of extra dollars.

When we get our first job after college, we begin to earn money, get raises, bonuses, or change jobs for more pay. We conjure up what we had considered buying before this newfound financial freedom and spend it too quickly. Instead, we should be using this money wisely.

To avoid lifestyle inflation or lifestyle creep, we need to make a reasonable budget when we start our first job and throughout our career.

9 Ways to Use Our Savings

  • An emergency fund.
  • Set up a budget.
  • Spending limits.
  • Pay down debt.
  • Pay down student loan repayment.
  •  Retirement savings.
  • We leverage the power of compound interest.
  • Diversify your investments.

College Students Are Probably Better Budgeters

When we go to college, we become frugal out of necessity.

College needs for money for the academic year are housing, meal plans, public transportation or car costs, including insurance, gas, repairs, parking permit, textbooks/supplies; cellphone/cable/streaming; clothing, food outside of meal plan, entertainment, clubs/ activities; clothing, computer, travel, laundry, and personal items.

Parents may share or pick up school-related costs such as housing, meal plans, car insurance, clothing, textbooks, travel, and computer. Students may also have their mobile phones and streaming through shared family accounts. Parents may provide their kids a monthly allowance or an emergency fund for miscellaneous expenses.

Students will most likely pay for lifestyle needs like meals and alcohol off campus, gas or public transportation, extra clothes, entertainment, gifts, personal items, and belong to clubs.

Working Through College Helps

The average full-time college student makes $195 per week and may stay on for winter break or summer. Many college students may work 30 hours per week or more at various jobs on and off-campus.

The majority of college students make between $7,500 to $42,000 per year while in school, according to Bizfluent. The wide gap is likely due to hourly differences for full-time and part-time students who may work full-time jobs.

According to a Digest of Education Statistics (NCES), working students comprise 43% of those going full-time and 81% of part-timers in 2018.

What College Students Think About Money

LendEdu survey illustrates attitudes held by college students about personal finance topics.

Current financial situation:

  • 49% of students were in fine shape versus 51% barely making ends meet.
  • 42% were saving money monthly, 58% were not.
  • 71% were saving some part of their income, while 29% were saving zero.

Budgeting/Emergency Fund

  • 59% were very knowledgeable or moderately knowledgeable about budgeting.
  • 57% were budgeting either using an app or doing it by hand.
  • 43% were not tracking their monthly spending.
  • 19% had an emergency fund, while 81% did not.
  • Their most significant monthly expense, the most prominent categories were: food (38%), rent (29%), alcohol/drugs (25%), and clothing (8%).

Knowledgeable about Personal Finance

  • 51% were very knowledgeable or moderately knowledgeable about the need for saving for retirement.
  • 34%  took a personal finance course in college, 21% hadn’t but planned to, and the rest have no interest in taking such a class.

Personal Finance Goals: 29% want to pay off student debt, 19% start saving for retirement, 23% plan to build good credit, and 20% want to save for a vacation or a unique vacation.

This survey indicates that college students need to learn how to manage their money as they start their careers. After college, they are prone to lifestyle inflation, spending more of their income than they should. Instead, they should seek financial security and freedom long term. 

First Job Post College Leads to Lifestyle Inflation

A college student with fewer funds is more budget-oriented. They may have accumulated some cash while in school or parental contribution, but they use it sparingly.

Once getting their first job, a $50,000 plus annual income feels pretty sturdy in former students’ hands and quickly disappears. Their college life of squeezing dollars seems to dissipate soon. If they are living at home, they may feel even more prosperous.

The latest average salaries for your first job after college will probably be in the $50,000 per year range according to Indeed. Salaries will be higher for majors like aerospace, software, or mechanical engineers.

Your gross monthly income is $4,167. However, you will be paying your bills with your monthly take-home pay, net of taxes, of about $3,173. Budgeting is easier when you are younger and have fewer bills to pay. Start early and get into the groove of budgeting by finding a free mobile app (e.g., Mint, Personal Capital).

 Related: A Guide For College Grads On Your Company Benefits

Start A Budget As Soon As Possible

The monthly income may seem like a lot of money to someone just out of college. However, it needs to support many fixed monthly bills, including rent, utilities, student loan debt, public transportation or car payments, gas, and health insurance payments.

You should start a budget, using your current income, and add your fixed monthly payments such as rent, utilities, and groceries. Remember to pay yourself an amount that reflects savings to target money for your retirement, an emergency fund, and investment accounts.

There are variable expenses, mainly for discretionary spending. These costs include food (groceries at home and eating out), clothing, entertainment, personal care, and services. Track your spending on your mobile app or via credit card bills. 

With that in mind, we can calculate average monthly expenditures for major categories by age group drawn from the Bureau of Labor Statistics (BLS) Consumer Expenditures Survey of 2017. This survey tracks the average American as well as provides respective demographics.

Post-College Demographics Consumer Unit

After a few years in the workforce, the post-college graduate falls comfortably in the “25-34 years” group, with the age of the reference person being 29.8 years old. As such, there are 2.8 people in this consumer unit, including a child under 18 years old.

This household has 1.5 earners with 1.7 vehicles. Of this group, 75% went to college.

The 25-34 year reference person earns $61,145 aftertax annually or takes home about $5,095 per month.

Average total expenditures are about $4,610, falling into the following:

Housing is the most significant expenditure category at $1,660 per month

When you are just out of college and working at your first job, you will likely be renting an apartment with two or three other people. However, as you move through your 20s, you will want your place for privacy and, potentially, a family.

Where you live will have implications on not just your housing costs but your overall living costs. Living in an urban market like New York or San Francisco is much more expensive than living in Boise, Idaho, regardless of whether you buy or rent.

Roughly 59% of this age group are renting, while 41% are homeowners. Of this age group, 33% have mortgages.

Housing accounts for 36% of total expenditures. However, housing costs vary whether you own your home, pay a mortgage, or are a renter.

This broad category includes utilities, mortgages, maintenance, insurance, repairs, telecom, mobile, household supplies, furnishings, furniture, flooring, appliances, and household equipment.

On its own, utilities ( including gas, electric, water, telecom, and mobile services) are 8% of your total housing costs. Your utilities may part of your rent. Many homes have cut the cord and use mobile which may not work in some rural areas.

Be Cautious About Housing and Related Expenditures 

You should keep your housing costs to 25%-30% of your total spending budget. Lifestyle inflation is going to play a significant role in your housing costs getting out of control. If you want the most prominent house in the high consumption neighborhood to “keep up with the Jones,” your costs could quickly spiral out of control.

The house is often the least of the problem. Add in the decorator and furnishings, the luxury cars, the private schools, cruises, and the country clubs, and other items adding to your conspicuous spending tally.  Suddenly your six or seven-figure income is drained from spending and higher debt.

Food: $616 per month

What we spend on our food is dependent on the type of household we have. Our reference household of three, including a young child under 18, eats home 54% of the time and 46% away from home. Food accounts for 13% of total expenditures.

As we all know, and I can attest in our household, eating out is far more expensive, especially when you add beverages.

It is good to do comparison grocery shopping, use coupons wisely, eat out more prudently to save more. Food should account for 10%-15% of your budget, especially if your household has four people.

Transportation: $760 per month

This category amounts to about 16% of total spending. It matters if you live and work in an urban market with access to an excellent public transportation system or need a car(s).

While NYC is super expensive, monthly MetroCards are among its few bargains at $127 for a 30-day unlimited pass if you depend on the train. On the other hand, buying a new or used car, net of trade-in,  car insurance, finance charges, gas/oil, and repairs can be costly. You can eliminate about $58 per month if you are handy with cars.

You should aim to keep transportation below 10%-15% of your spending.

Gas, fuels, and oil cost $168 per month in 2017, lower than previous years, and can significantly swing. Shopping around for a used car that you buy outright and comparing vehicle insurance costs can reduce your monthly burden.

Cars are often a big part of our conspicuous consumption. For some, it is a functional device to transport us from place to place. For others, the “dream” car has to go with the “dream” house. Resist spending that may go with your success and higher income.

Budgeting Is For Everyone, Even Millionaires

In one of my favorite books, “The Millionaire Next Door,” authors Stanley and Danko portray the differences between the self-made millionaire and the typical wealth inheritor.

The one who became rich by working hard often bargain shops for low-key used cars, saves and invests wisely. On the other hand, the classic wealthy person who has accumulated wealth through legacy tends to be a big spender for the sake of image. The last exhibit similar traits to those in the early stages of lifestyle inflation, ramping about debt quickly.

Healthcare: $264 per month

This category is 5% of our total spending and is associated mainly with health insurance.  If you are fortunate, your employer substantially pays for the plan. Medical services, medical supplies, and drugs account for the rest. As your family grows and especially ages, healthcare costs rise for the household.

You should target these costs to stay at the 5%-10% level.

Apparel: $170 per month

Apparel is just under 4% of total spending and certainly is a variable annual cost. You could always use a rule of thumb of 2%-4% of your total expenditures for budget purposes.

More likely, families will spend seasonally or back-to-school and special events. For young families with young children, clothes could amount to more significant expenditures because of outgrowing (sizing out) or fashion-conscious teens. Shopping wisely really matters, whether in the mall or online, to keep spending down.

Entertainment: $220 per month

We entertain differently depending on our age, household, hobbies, video, sports, music, and pets. These variable costs are something we can exercise some control over. It may be more challenging when we have children, however.

Here, entertainment is a tad under 5% but may increase if you count eating out as part of the entertainment.

Personal Insurance and pensions: $549 per month

Your social security payments are your contributions deducted from your paycheck and in this category. Also, there are life insurance, railroad retirement, government pensions, private pensions, and retirement programs for the self-employed. This category accounts for 12% of your monthly expenditures.

Education: $102 per month

Education is part of “Other Expenditures” but deserves its mention. It includes tuition, fees, and supplies for all levels of private and public schools, including colleges.

The relatively low amount may not fully reflect the burdensome student debt. Typically, students pay their loans over a ten-year or longer time frame. Some students may accelerate their payments to get rid of their debt. Others pay just the monthly minimum, which could be as low as $50 per month. Others make late payments.

Other expenditures: $269 per month

These are miscellaneous items, primarily personal care products, magazines, credit card memberships, legal fees, tobacco, donations,  and alimony. This category amounts to 5.7% of total spending.

Those that can give to their favorite charities should donate higher amounts. We have used a rule of thumb of 10% of spending though recognizing that is not possible for every year and everyone.

 Related: 10 Ways To Better Manage Spending

Related: Saving For Retirement in your 20s

What Does Your Budget Look Like?

Monthly income of 5,095 less total expenditures of $4,610 for the average 25-34 year household leaves $485 or almost 10% of net income.

Boost your “monthly savings” of $485 or $5,820 a bit, especially if you can keep your housing costs to 30% of total expenditures or less. Certainly, if you are renting or buying a modest home and getting an affordable mortgage, your savings will have room to grow.

Monthly Savings Should Be at least 10% Of Your Earnings

To combat the likelihood of increased spending as your income grows, you need to have a financial plan in place: 

#1 Pay Yourself First

Allocate at least 10% of your earnings to go savings and allocate to paying off debt, emergencies, retirement accounts, and investments.

#2 Establish An Emergency Fund

Establish an emergency fund for at least six months of necessary expenses such as rent, student loan payments, transportation, utilities, phone, food (even pizza). You may be living on your own or with roommates, and they’ll be expecting your monthly contribution.

#3 Set Up A Budget

Put a budget plan in place once you know your take-home pay, you should think about your fixed and variable expenses. Keep your housing costs from expanding as you grow your family. Consider a used car and paying cash. It is not unusual to quickly ramp up spending for entertainment, eating out, clothing for work, and play as your earnings grow.

#4 Spending Limits

Spend within your means by tracking and limiting purchases. The problem is that the new freedom you have to enjoy more things with your latest paycheck, the more likely you will spend more than you should. You want to live well within your means so you can grow savings. Bargain hunt and consider ways to avoid impulsive shopping.

#5 Pay Off Debt

If you are living home initially after college, that is a great time to put some savings away to pay off debt. Reduce your high-cost debt by paying your bills in full. Credit card balances grow fast on high interest rates. Instead, pay your credit card balances in full. If you can’t, stop spending with your cards.

#6 Student Loan Repayment

Have a plan for your student loan repayment. This has to be an essential part of your priorities. The Consumer Expenditures Survey may be underestimating education costs or in other categories. Your household may have higher student loan repayments closer to the national average of $304-393 per month.  Pay your fully monthly bill, not just the minimum for student loans.

#7 Consider Increasing Your Loan Payments

When you have extra savings or your income rises, pay down your student loans. You may decide to pay more than your current student loan bill if you get a bonus or substantial raise. If you can handle paying back your federal and private (if any) student loans sooner, that may be good. Look to pay the higher cost of debt first, usually the private loans.

If you buy your home or condominium, consider a shorter term for your mortgage, say 15 years versus a 30-year mortgage. The latter is a higher total cost because of the higher over interest costs.

#8 Retirement Savings

 Jumpstart saving for your retirement when you start your job by contributing to your 401K plan, especially if your company has a matching contribution. There are tax-deferred savings benefits. You need to save up to the amount that will trigger your companies’ matching contribution. At the same time, allocate some savings for an IRA/Roth IRA.

#9 Leverage The Magic of Compounding Interest

Get familiar with the benefits of compounding to grow your money faster. Regular contributions in your 20s amount to substantial savings for your retirement decades later through compounding interest. A monthly amount of $800 for 30 years at an 8% rate produces savings of $1,203,223.29. Not too shabby! The earlier you invest, the better your retirement grows.

#10 Diversification Is An Essential Investing Strategy

When investing money,  you should diversify your investments among different financial instruments and asset classes, such as real estate. That strategy will help you reduce your risks. 

By diversifying, you can reduce risk by buying different kinds of stocks in various industries, even in foreign markets (the US versus emerging markets). You can never eliminate risk or loss, but you never want to put all your eggs in one basket.

11. Taking Advantage of Retirement Savings: 401K and Roth IRA

In 2021, the maximum contribution you can make to your 401K is $19,500, likely a steep amount to make if this is your first job. Make some arrangements for some percentage of your paycheck to be withdrawn for your 401K. It is a good habit and essential to start as early as possible, given the benefits of earning on a compounded basis.

You should also open up a  Roth IRA account to begin saving outside of work. In 2021,  the maximum amount allowed was $6,000 ($7,000 if you’re 50 or older). Maybe you received some graduation presents from your family, which would be perfect seed money to put into these accounts.

At an early age, post-college, you can learn how to reduce spending, save more to pay down debt, create an emergency fund and invest in your future. What has worked for you when you are budgeting? What ideas have you tried that worked for your household? We would like to hear from you!

 Final Thoughts

Avoid lifestyle inflation by carefully budgeting your spending so it doesn’t get out of control. Spend within your means and allocate your savings with care. Sure, you deserve treats in life but you want to make sure your costs don’t spiral out of control so you are constantly borrowing. Financial security and freedom are desirable goals so that you can achieve financial success and enjoyment in life.

 Thank you for reading! If you found some value in this article, please visit The Cents of Money for more articles of interest. Consider subscribing and getting our weekly newsletter for free!

 

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The Pros And Cons of Credit Cards

The Pros And Cons of Credit Cards

“Once you get into debt, it’s hell to get out. Don’t let credit card debt carry over. You can’t get ahead paying eighteen percent.”

Charlie Munger, Vice-Chairman, Berkshire Hathaway

 

For me, credit cards have always been a double-edged sword, a fight between good and evil, or in Biblical terms, a blessing and a curse. Growing up, my parents predominantly used cash, using their retail business’s checking account to pay bills. I was the first in my family to go to college and the first to have a credit card. My parents celebrated the former and not so much the latter. They only accepted cash from their customers, refusing to believe in the benefits of the credit card. That’s where I probably get my reluctance to use credit cards instead of cash at times.

They may have been onto something though it may have been something else altogether. My mom, I still believe, may have been irked by the fact that women, on their own, could not get their cards until the passage of the Equal Credit Opportunity Act of 1974. Before that, women needed to have a man (husband or father) cosign for a credit card. How was it fair that my Dad, not my Mom, the brains behind all our finances, could get a credit card? Just saying why I think my Mom, until the day she died in 2000, never had any interest in a credit card (pardon the pun!).

The Credit Card Landscape

Credit cards are a financial tool. But like buying a new buzz saw, you need to use it with care. Some people collected credit cards like baseball cards when I was growing up. That seems like a formula for disaster to me. Clearly, we are not yet a cashless society with nearly 1 in 4 people unable to get approval for a credit card due to lack of credit history or discipline. Roughly 33 million people in the US are unbanked or underbanked, meaning they largely use financial products outside the banking system.

When COVID hit our shores in March 2020, new card applications dropped 40%. Inquiries for all kinds of loans–auto and mortgages–dropped substantially as our priorities changed during the pandemic.  The irony is that the use of credit cards increased out of necessity due to fear of touching cash on the risk of getting a coronavirus-related infection. That behavior is just another example of the strange happenings in 2020. Growth in new card applications should resume in 2021. 

Credit Card Statistics:

  • About 176 million or  67% of Americans have a credit card with about 3.1 cards per person.
  • The average card balance is $5,897 per person end of 2020.
  • Roughly 58% of cardholders carry some kind of balance.
  • The average FICO score for credit cardholders was 735.
  • The current credit card interest rate averages were 14.58%, but for those with fair credit scores, the rates rise to 23.13%For new credit cards.
  • The average rate was 17.87%.

 

Advantages of Credit Cards

 

1. Convenience

Compared to cash, credit cards are a suitable financial product. Before COVID, retail businesses were increasingly not accepting cash from customers. Credit cards provide fast payments, transfers between accounts, and withdrawals.

There are far more shopping options with a card. It is easier to make, change, and cancel travel, hotel, and car rental arrangements.  When traveling overseas, credit cards allow you to realize currency conversions automatically.  Let’s face it, carrying a lot of cash is hard –bills and change– around in your pockets, jingling around. That said, I do like window shopping without my wallet, so I don’t feel tempted to spend money unnecessarily.

2. Build Up Your Credit

For those who lack credit history, like young people, becoming an authorized user on your parents’ credit card is a rite of passage. This is an excellent way to build up a credit history so long as your parents’ credit scores are strong. Otherwise, it won’t help your credit situation at all.  Most states do not have minimum ages for your child to become an authorized user. I’d suggest you teach your kids about the responsibility of using a card safely and responsibly first.

Getting a new card may be a second chance to improve your credit score. You have missed payments, hurting your credit score in the past. If you are ready to be responsible, you should consider getting a secured card, putting some cash on account. You don’t need a massive number of cards to strengthen your payment history and length of credit history. Understand common credit mistakes and how to avoid them.

Related Post: 6 Ways To Raise Your Credit Score

3. Easy To Track Spending

You should regularly review your credit card bills helps you track your spending. It is easy to do (except when you know you spent a lot of money) and an excellent way to improve your financial discipline. Although spending cash is the best way to feel pain immediately, regular examination of the amounts you are consuming is a realistic way to correct yourself. The credit bills provide a purchase record when making returns.

One particular month, I recall seeing a very high bill with several items that seemed uncharacteristic of me. It was a posh store with a great salesperson.  Looking around,  I realized that the dress  “I had to have” was still in the bag with the tags on along with new shoes. Who did I buy that for? Not me, apparently so I returned those things and stayed clear of that salesperson.

4. Automate Your Payments

Paying your bills, especially credit cards, are so much easier when you use the automation feature. Most cards have this feature that you can set on or before the due date so you are not late on your bill payments. Also, consider paying more than once a month if the lower amounts feel better to digest. As payment history accounts for 35% of your credit scores, automating payments is one way to help you not miss the due date.

5. So Many Perks

Having a credit card may entitle you to perks. Typically, the card use may provide perks such as cashbacks, rewards, airline points, merchant discounts, hotels, travel insurance, welcome bonuses, access to tough-to-get tickets, and free museum passes. Before signing up a specific perk, make sure it aligns with your needs. One time I ordered four tickets for Hamilton on Broadway for my family, only to realize they were preview tickets for the opening in LA, 3000 miles away. The issuer reimbursed us and waived the fees.

6. Protections For Consumers, Not Necessarily For Businesses

Credit cards offer several features for consumers. When you lose cash, it is gone forever. The good news is that money is typically not attached to your personal information, like the loss or theft of your credit cards. Some cards provide zero-liability fraud protection. In a fraud situation, just notify your issuer to cancel your card. Alternatively, the issuer can get you a new account number at no charge. Safety is important.

Typically, when you lose your credit card, your losses are capped at $50 so long as you let the issuer know promptly. There may be a higher fee and responsibility for any charges that aren’t yours if you delay reporting them. I once thought I lost my card, I called the card company quickly to find that my card fell out of my wallet into a nook in my bag. Paying the fee was a fine for a lesson learned to at least look for your card first.

Cards often have spending limits. Occasionally, you may want to lift the limit if you know you may be spending more for an overseas trip, for example, where you plan to shop for jewelry. A cardholder can let their issuer know that they want to “opt-in” to allow for transactions that may put you over your credit limit. You can let them know the specific dates you’ll be traveling. Spending limits are a good feature, especially if you’re prone to overspending.

The Credit CARD Act of 2009 enhanced more protections for consumers that do no apply to businesses. With this law, issuers need to notify consumers of significant interest rate hikes at least 45 days beforehand. Also, fees, previously hidden, must be better disclosed clearly. There are some other practices that improved with the CARD Act discussed here. Still, it is always important to read the tiny fine print, especially when it comes to credit cards.

Disadvantages of Credit Cards

 

 

1. Overspending Leads To Higher Debt

Spending beyond your means can be the root of all evil related to your finances. Credit cards enable people to shop impulsively.  Having a card rather than a finite amount of cash gives you the ability to borrow more than you should. Overuse of your card leads to carrying high-cost debt on your balances. Paying double-digit interest rates on these balances can be overwhelming.

The convenience of using credit cards as compared to cash may encourage higher spending, according to studies. In the now-classic MIT study by Drazen Prelec and Duncan Simester, MBA students held an auction for tickets to sporting events. One event was a desirable basketball playoff game, and the other was a regularly scheduled baseball game. Those participants were encouraged to buy tickets using credit cards spent up to 100% more than those paid in cash. They called this the credit card premium.

Other studies seem to validate the MIT findings that we tend to spend more with a credit card than cash. For me, spending cash for purchases gives me an immediate pain instead of a nearly month delay of having to pay my credit card balance.  to me, mental accounting bias and overspending

2. Irresponsible Use of Your Credit Card

When you pay your card bill in full every month, you don’t pay any interest. Your credit card provides a lot of benefits without the pain of paying high interest costs. Unfortunately, many people just pay the minimum amount due at the end of the month, carrying a balance forward. The issuers prefer cardholders to carry balances as it is a lucrative income stream for the companies. 

At an average balance of $3,000 with an average interest rate of 16%, it can take 16 years to pay off that balance at the monthly minimum rate, roughly 3%-4% using a credit card interest calculator. That assumes that you haven’t used a credit card during those years. It is a vicious cycle. The magical powers of compounding that work so well when investing or saving for retirement works against you when you are paying interest charges on interest accumulated. If you cannot use your card responsibly, you should work hard to reduce your spending. Some people have too many credit cards, maxing out their limits, losing control of their spending.

Watch out for the particularly punitive penalty interest charge when you are late on your credit card payment. The penalty interest rate could be as high as 29.99%, above your regular interest rate, and may stay in place for some time.

3. Lower Your Credit Score

Just as you may raise your credit score, misuse of your credit cards can destroy your score. Missing payments, applying for credit too many times, and using more than the 30% limit of your available credit all can hurt your scores. Even closing a credit card account, you don’t use will result in a decline in your score. Your credit score reflects your creditworthiness to lenders, landlords, and other professionals and could negatively impact you.

4. Read The Fine Print

Just like any contract you sign, make sure to read the terms and conditions of the credit cards you are considering. Despite legislation to protect consumers, issuers are well known for hiding information about their perks, fees, charges, and other liabilities from consumers. In recent years, consumers have been able to compare credit cards more quickly. Among my favorite sites are WalletHub, NerdWallet, and CreditCards.com, which have a ton of good information on credit card features.

Be aware that you are usually subject to mandatory arbitration if you have a dispute with your card issuer. This has been relaxed in recent years but is still in the terms and conditions. It is one of my pet peeves and a project I assign my law students to look at the fine print. The average consumer can’t fight the legions of arbitration attorneys that support card issuers.

Exercise Financial Discipline By Using These Rules:

  1. Shop wisely for a credit card, finding the perks that most suit you.
  2. Read the terms and conditions carefully even after you made your selection.
  3. Pay your credit card bill in full, so you don’t carry a  balance.
  4. Have an ample emergency fund, so you don’t put high unforeseen costs on your card.
  5. Spend below your means always and make savings and investing a priority.
  6. Don’t close any credit card. Instead, cut your card in a million pieces or simply put it in a drawer.
  7. If you have multiple cards, decide how to use them for different categories and don’t max out their limits.
  8. Avoid cards with annual fees unless they have essential features you will use.
  9. Don’t get addicted to credit cards. Limit the number of cards you have.
  10. When it comes to paying your card bills, automate and don’t procrastinate. The penalty rate is punitive for a reason.
  11. If your child is an authorized user of your credit card, teach them how to use the card wisely and safely.
  12. Be aware of behavioral biases of spending more when using your credit card instead of cash.
  13. Review your credit card bills for errors, poor judgment on your part, or correct impulsive spending.
  14.   Use cash for some of your discretionary spending.

 

Final Thoughts

Credit cards serve an essential purpose as a financial tool in an increasingly cashless society. Used wisely, the advantages of credit cards will outweigh their disadvantages. Practice financial discipline in all aspects of money management. We have had our druthers about using credit cards, learned a hard lesson or two.

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6 Ways To Raise Your Credit Score

6 Ways To Raise Your Credit Score

Our financial lives depend on our creditworthiness. When we go for a loan, lenders review our credit report and our FICO credit scores to determine our annual percentage rate (APR). Generally, the higher our score on a 300-850 score, the lower the borrowing rate we will pay on our loans for our car, mortgage, or college tuition.

7 Reasons Why You Need To Review Your Credit Report And Score:

 

  • People want to know where you stand before making important financial decisions.
  • I am borrowing for a home purchase.
  • Car loan or lease.
  • Student loan.
  • She is hecking for inaccuracies, identity theft, and fraud.
  • He was getting a job.
  • We are renting an apartment.

 

Can You Improve Your Credit Score?

The short answer is yes, you can!  We will go over tips to increase your scores. First, let’s talk about how the FICO Scores formula is calculated with its five different criteria of the total:

Payment History: 35%

This category carries the most significant weight in your score and is the most critical factor. The longer the credit history, the better. Having a sound track of not missing payments and being on time works in your favor.

So those who are new to being approved for their credit cards need to show a consistently positive pattern.  These are different account types such as credit cards, retail or store accounts, installment loans, mortgages, and finance company accounts.

Credit Utilization: 30%

As a significant influence on your credit score, credit utilization is the ratio of your total outstanding revolving credit balances divided by full available credit. Revolving credit refers to your credit cards and credit lines you may have but does not include your car loan (unless on your credit card) or your mortgage.

The utilization ratio is known as the balance of debt to available credit or debt-to-credit. It measures how much credit you have used for the amount available to you. You don’t want to “max out” your cards. You should not be above a 30% ratio as it will impact your score. I would stay in the mid-20s range so as not hitting the 30% level.

Credit History: 15%

How you handle credit is essential to lenders. The length of time of your oldest credit account and the average age of all of your accounts determine your credit history. The older the account, the better your credit score. If you are new to obtaining credit, it will take time to benefit from showing up in your score.

Credit Mix: 10%

Lenders favor some variety of borrowing in your mix of credit. A borrower handling different kinds of debt products may reflect less risk to lenders. When you don’t yet have a credit card, you may be at higher risk. That said, don’t go out and get different kinds of loans for the sake of improving your mix.

New Credit: 10%

When you apply for new credit, that inquiry is reported on your credit report for up to two years. That is called a hard inquiry and can negatively impact your credit score, particularly if you are making multiple inquiries. However, don’t let it stop you from doing comparison shopping for the same type of loan.

A soft inquiry occurs when you are checking your credit score or report. Soft inquiries do not generate negative hits.

Related Post: Common Credit Mistakes And How To Avoid Them

6 Ways To Increase Your Credit Score:

 

1. Check Your Credit Report For Errors

Reviewing your report for inaccuracies and missing information may be the fastest and easiest way to improve the score. An FTC study reports that 5% of consumers had errors that may carry enough weight to result in getting a lesser favorable loan. One in four consumers had errors in one of three credit reports.

If you find an error, contact each of the credit bureaus (Experian, Equifax, and TransUnion). You will need to give them specific information as to what you believe is incorrect. They must investigate the item(s) you have raised, usually within 30 days. You can do all of this online, but it is a good idea to follow up if you don’t hear back from them.

Fix Errors As Quickly As Possible

Initiate your inquiry as soon as you spot the error by following these steps. The credit bureaus may back burner your issue if they deem it frivolous, so be specific and provide the needed information as part of your inquiry.

Sometimes what appear to be errors are fraudulent charges and scams.

Read our related post: 9 Ways To Better Protect Your Privacy Against Fraud And Scams

2. Pay Bills On Time

The credit bureaus require you to pay the minimum amount required on time. They are looking at your payment history, which counts a lot towards your overall credit score. Missed or late payments are harder to repair and can lead to delinquent payments that take seven years to get rid of on your report.

Automate Payments

Consider automating payments online through your bank portals for credit card companies. Set up online payments with your other loan providers. Stick to a monthly schedule or pay these bills every two weeks to lessen the burden.

If you have missed payments, get current as quickly as possible. Be consistent after that as the creditors look for a clear pattern of timely payments before you see score improvements.

You do not want a collection account to appear on your credit report. Even if you pay that account, it has long-lasting adverse effects. It puts a 7-year stain on your report. Don’t let that be a disincentive from paying off the collection debt as it will stay on longer. You might want to check with the creditor to see if it was “charged off” as lousy debt before making a payment.

Pay Credit Card Balances In Full

Although the strategy of making the minimum payment on your credit balance is good for your score, it will keep you in debt longer. It is far better to pay off your monthly debt balances in full. Otherwise, you are paying those card balances at mid-high teen interest rates.

That makes the credit card companies happy, but, of course, that is not your goal.

3. Reduce Your Debt

The credit utilization ratio is an essential contributor to your overall credit score. Being disciplined about your debt levels is vital for the financial future. This ratio reflects how much of your available credit has been used. Lenders look at debt usage on a per-card basis and total debt relative to total credit available.

Creditors look at a 30% threshold. Ratios above that level may provide negative consequences to your score. Consider targeting a lower percentage in the mid 20’s if you must carry month-to-month balances at all. You may not realize that making sizable purchases such as moving to a new home caused you violated the 30% ratio.

Raising Credit Limits Too Tempting For Some

I have read others recommend that you seek higher limits on your credit cards to lower the ratio. That may work mathematically, but it is too tempting to have more credit available to spend more for some of us. It sort of reminds me of how our elected officials thrash out at each other, then raise our nation’s debt ceiling rather than reducing our borrowings.

Rather than raise limits on your credit cards, make a plan to zero out your debt balances to gain financial flexibility or stop using your cards and spend less.

If you are having trouble making ends meet because of exigent circumstances (e.g., job loss, death in the family), contact your creditors to see if there is something they can do, such as modify your credit terms temporarily. Another recommendation is to go to a financial counselor for some strategies to reduce your debt significantly.

Related Post: How To Pay Down Your Debt For Better Financial Health

4. Little To No Credit History

When you have a relatively “thin credit file,” it means you don’t have much in the way of showing that you are responsible with credit yet. Minimal credit history accounts for about 15% of your credit score. There are a couple of things for you to do.

You can become an authorized user on someone else’s account like a parent. Make sure that they use their credit responsibly, or it won’t be beneficial to you.

Related Post: A Guide To Your Child’s Credit Report: Pros And Cons

Strengthen Your Credit File

You can apply for a secured credit card where approvals are easier to get than unsecured credit cards. Your credit limits will be far lower, usually capped at around $500. You will need to post a refundable deposit as security. Secured credit cards are suitable for those with lousy history and those with little or no track record.

You may want to consider Experian’s recently launched free product, Experian Boost. It allows consumers to include utility and cellphone payments into their credit score calculations using this tool. It may provide an incremental boost for those with thin or poor credit history files. You are connecting your online bank account to your Experian credit report.

5. Don’t Close Any Unused Credit Accounts

If you have credit cards, you no longer use or need it, it is better to cut them up and put those cards in a drawer and forget about them. The exceptions to de-classing them to your sock drawer are you will be too tempted to spend or pay annual fees.

Otherwise, if you call the company to close the account, you will likely lose a few points off your score. Closed accounts, even if they have zero balances, stay on your credit report for ten years.

Keeping the account open and unused benefit your scores at least two ways:

  • your credit utilization ratio will rise because you have removed available credit.
  • Eliminating an account might hurt your credit history if it is an older account.

The impact of closing an unused account may be tougher on young people or someone trying to build up their credit file. I made this rookie mistake by closing a retail store’s account when I was younger. It was an expensive store and not one I found myself shopping at anymore.

I thought I was making a smart move when I closed the account and had my score dinged. I recommend the “scissors approach” and cutting the cards and put it away.

6. Apply For New Credit Sparingly And Only If Needed

Credit mix is a factor in your score, though not as influential as credit utilization. Think carefully before applying for more credit than necessary. It may result in counting as a hard inquiry on your credit report and, therefore, a harmful point reduction in your score.

 

How Long Does It Take To Rebuild Your Credit Card:

 

  • Credit errors or repairs  3-6 months
  • Closing accounts           three months
  • Hard inquiries                two years
  • Missed Payments         18-24 months
  • Car Repossess              seven years
  • Delinquencies                seven years
  • Bankruptcies                  7-10 years

 

Credit Score Ranges Per Experian:

  • 800-850 Exceptional
  • 740-799 Very Good
  • 670-739 Good
  • 580-669 Fair
  • 300-579 Very Poor

 

How Much Of A Difference Does A Credit Score Make On Your Loan?

Using myFICO Loan Savings Calculator,  here are national 30 year fixed mortgage rates with a 400,000 on April 16, 2021, according to the following scores:

Scores      APR                  Monthly Payment

  • 760-850    2.676%                 $1,617
  • 700-759    2.898%                 $1,664
  • 680-699    3.075%                 $1,703
  • 660-679    3.289%                 $1,749
  • 640-659    3.719%                 $1.845
  • 620-639    4.265%                 $1.971

 

If your score is currently at the low end, you can save up to $127,421 in total interest paid over the life of the loan by improving your credit to the 760-850 level. Becoming more creditworthy helps you save money.

 

Final Thoughts

Most of us are in the 620-719 score range. We have several ways we can raise our credit scores incrementally and produce meaningful savings. A better credit score improves our ability to borrow and satisfy those like our landlord who want us to be creditworthy.

We should be more financially responsible by reducing debt, paying our bills on time and zeroing out our costly credit card balances. We need to have greater financial flexibility and make better decisions for our  fulfilling our needs and wants in our lives.

If you are new here, welcome! Subscriber and join our growing community, get our free newsletter, freebies and free Personal finance email course.

Related post: Are You Creditworthy? All About Your Scores And The Five C’s

Have you checked your credit report recently? It is important to review to do so for errors and ways to improve before core ahead of your needs to borrow. Do you have any experience you can share that you dealt with repairing credit errors  or increasing your score?

We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Being Frugal When Saving Time And Money

Being Frugal When Saving Time And Money

“Price is what you pay; value is what you get.”

Warren Buffett

I bristled when they called me a cheapskate when I was a young kid. It cast a dark shadow over me. We lived in a modest neighborhood in the Bronx, so it wasn’t like some of us were from the upper class. Still, our lifestyle was far more humble than others. I was laughed at for getting an ice cream without sprinkles or wearing ratty clothes. My parents were more frugal for a good reason. They struggled with their small business and needed to save money for our basic needs. For many people, frugality is a necessity. For others, it may be a choice.

Cheap Vs. Frugal

Nowadays, calling someone frugal is more of a virtue, like giving a badge of honor to that person. Being frugal or cheap is sometimes used interchangeably, but the terms have different meanings. According to Merriam-Webster, frugal is characterized by or reflecting economy in the use of resources. On the other hand, cheap has a range of definitions. Cheap has two or more meanings: charging or obtainable at a low price and inferior quality or worth.

While both terms are about saving money, being cheap is usually motivated by price and paying less. On the other hand, being frugal considers price along with quality and value in evaluating the purchase. There is a gray area but considering if a person is cheap or frugal, you’ll know the difference by their actions or words. Cheap people are penny-pinchers who will mostly pick the lowest price option even if the quality is suspect, regift presents, and are poor tippers. Many will engage in D-I-Y projects like plumbing and electrician work just for the sake of not spending the money.

When Frugality Can Go Too Far

Being overly cheap or extreme frugality without reason and lack of generosity is a symptom of obsessive-compulsive personality disorder (OCPD) by the International OCD Foundation. The American Psychiatric Association has pointed to this symptom as when “a person adopts a miserly spending style toward both self and others.” Growing up, my Uncle Harry lived with us for many years. He was a Holocaust survivor of the death camp Auschwitz. As a teen, he suffered from the camp’s traumatic effects. He lost his family, except for my mom, and married late in life. Unfortunately, he divorced soon after.

It was extreme frugality that killed his marriage. His wife, Doris would come home with a dozen eggs or too many groceries and he would have a breakdown over the potential for wasted food. His psychiatrist noted his anxiety about saving money or extreme frugality was a tragic symptom of his experience.

In contrast to being cheap, frugality is a strategy that saves money and considers the whole picture: quality, durability, value, and price of what you are buying. Those who are frugal are savvy about saving money for themselves and others. They will consider other variables like whether that purchase is good for the environment and other causes.

The Frugal Warren Buffett

Warren Buffett is as legendary for his frugality as he is for his investing acumen. He lives in the same Omaha home since 1958. Buffett frequents McDonald’s and his company’s cafeteria. He is a value-seeker when investing or in his lifestyle. Yet, for all of his frugalness, Warren Buffett has generously donated $37 billion since 2006.  One of my favorite Buffett quotes: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

6 Benefits To Being Frugal  

 

1. Having A Purposeful Mindset

Adopting a frugal mindset means being more thoughtful about your purchase decisions. It is not about having it all but about choosing your purchases carefully for you and your family.  Having a frugal attitude favors good money habits like saving money and better financial management overall. It is not about choosing the lowest price option basing your decision on price alone. Other factors are part of the value proposition.

Frugality is a lifestyle that people adopt for the simple pleasures of life. It is not new. Plato and Henry David Thoreau in Walden advocated modest or minimalist living. It contrasts with societal desires for materialistic possessions which often leads to overspending just to keep up with your peers. Being thrifty has its merits and can lead to sound well-being.

Related Post: 10 Ways To Better Manage Your Spending

2. Motivate Yourself By Knowing Your Goals

It is easier to save or manage money when you have a plan for your future. Determine your short and long-term goals. Those who plan to retire early,  work hard to set aside money for savings, retirement, and investments. Their plan will motivate them to be financially independent and retire early (FIRE). It is not for everyone, but it does give you a chance to develop good money habits for future financial flexibility. By adopting frugal ways to save more, spend less now so you can retire early in life. Spending within your means allows you to choose what you want to do later on at a still young age.

I left my job on Wall Street in 2001, before the FIRE movement became popular in the 2010s. My choice was to go to law school and practice for a few years, have kids, and teach at a college. For me, it has worked out fortunately though it was a big adjustment that could have been smoother. To be honest, I didn’t have a well-developed plan though I did want to return to school because I enjoyed learning new things. Goal setting is essential even if you finetune through the years.

The Frugal Millionaire

In The Millionaire Next Door, a favorite read of mine, millionaires were profiled in two groups. The Under Accumulators of Wealth (UAWs) were the more typical white-collar professional millionaire, devoting more of their high income to luxury goods to maintain their status. As a result, they had lower net wealth compared to their income by neglecting savings and investments.

The Prodigious Accumulator of Wealth (PAWs) were more frugal millionaires. They avoided a showy lifestyle, bought used cars, often living in blue-collar areas. Goal-oriented, they made intelligent buying decisions, using savings to invest more of their money in securities or in businesses for good returns. PAWs spent less on luxury, accumulating higher net wealth relative to income from less.

3. Prioritize Spending To Improve Your Financial Health

Although you don’t want to penny-pinch, prioritize your spending. Frugal spenders tend not to be compulsive shoppers, accumulating lots of material possessions to regret. That doesn’t mean you can’t travel, buy good things, or enjoy your life. Quite the contrary. It is about spending thoughtfully and moderately and not on a whim. Know the difference between your wants and needs or living essentials. Your needs–food, rent, clothes, medical, education– should be a priority. Yes, you can have that latte if it gives you a particular pleasure.

Being frugal means spending below your means so that you can save money to improve your financial health. Those who are frugal tend to:

  • Save money rather than spend;
  • Avoid debt rather than purchase on credit;
  • Pay their credit card balances in full;
  • Have an ample emergency fund invested in a money market deposit account;
  • Contribute at least the minimum amount into your employer-sponsored 401K plan to earn their match; and,
  • Set aside money to build up an investment account.

Related Post: 10 Commandments of Saving Money

4. Price Vs. Value

Buying solely on a price basis without regard to quality is a hallmark of cheapskates. Those who are frugal make economic rather than impulsive decisions. Price is important, but there are other factors to consider. When making purchases, economic people will evaluate the quality, usefulness, reliability, durability, style, convenience, experience, and trustworthiness of the company or the brand. In other words, they will look at the whole picture.

Of course, the price versus value equation depends on the product itself. Frugal shoppers are not going to evaluate many factors for convenience products bought frequently. Price plays a bigger role when buying toothpaste or laundry detergent. For these products and many others, you can save money by buying generic brands at a discount to name brands. The price will be lower for generic brands, as much 35% reductions compared to name brands but the quality is often the same.

Don’t Shop On Price Alone

On the other hand, shopping for appliances, furniture, clothing, and other items less frequently bought quality and other considerations matter. Buying furniture chiefly because it is inexpensive is a recipe for disaster. That is being penny-wise pound foolish. Robert Burton is credited with that British saying in 1621 and is in The Anatomy of Melancholy. I am not sure Burton had our cheap bookcases in mind. However, that is what Craig and I remember saying after we bought cheap bookcases at a “bargain price.” We regretted that purchase made in our early years together almost immediately. The bookcase crashed in the middle of the night. Cheaply made, it didn’t hold up our books for too long.

5. Frugalness Is Good For The Environment

Practicing frugality has become part of the minimalism cult and more acceptable in recent years.  Mindless consumption is being frugal and less wasteful, which is good for the environment. Even if you are not saving money, reusing bags at the grocery store, or not taxing our utilities makes economic and environmental sense. Turn over your lights when leaving your room or home. Wash your clothes on the cold setting and lower or raise your thermostat. You may have personal savings, but you are also helping a cause.

6. Be Frugal About Wasting Time

Time is money. Both are valuable resources, but time is more precious because it is finite. We cannot replenish time. Saving money is necessary, but not when it causes you to waste time. Time is an element that many of us use poorly. Examples of how we splurge on time when trying to save money are:

  • Driving around to get the best gas price;
  • DIY projects when you aren’t handy or don’t even like doing them; and,
  • Grocery shopping at different places to get the best price at each store

Being frugal with our time means being more focused on how we are spending it. To save money, I sometimes over-research things for the best product. Make a “to-do” list to organize your time more meaningfully. Don’t go shopping without a list.

When your time is short, consider spending money on time-saving services. Studies say it can promote happiness when time constraints are stressing you out. On the other hand, Some people work more efficiently under a tight timeframe. I find that I often accomplish more with time constraints which help me to be more focused. Balance your needs of saving money and saving time according to your abilities and preferences.

Related Post: The Relationship Between Time, Money, And Productivity

Final Thoughts

No one wants to be a cheapskate. On the other hand, being frugal is often a virtue that may lead to a happier lifestyle. Just be sure you are not becoming obsessive like my Uncle Harry. Saving time and money are valuable goals that can help to eliminate stress while strengthening your financial health. Maintain a balance to live a life you enjoy. You don’t need to stop pleasures just for the sake of being frugal. Instead, prioritize what is essential for you.

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