Getting Stimulus Money? Spend This Money Wisely

Getting Stimulus Money? Spend This Money Wisely

The third and possibly final stimulus check from the federal government is on its way. Most people will get their stimulus money via direct deposit to tens of millions of bank accounts. If you and your family qualify for the most extensive distribution, you likely have some immediate or future needs. Whatever you decide to do, strategize to spend this money wisely.

Stimulus Checks And Extended Unemployment Benefits

Did you get your stimulus check yet? The maximum tax-free amount is $1,400 per individual ($2,800 per married couple if jointly filing), and $1,400 per dependent, including those ages 17 and up. The federal government extended unemployment benefits with a $300 additional supplement to state benefits through September 6, 2021.

Typically, unemployment benefits are fully taxable. However, the IRS gave a tax break by allowing taxpayers to exclude up to $10,200 ($20,400 for married couples filing jointly) benefits on their 2020 taxes for those who made less than $150,000 in adjusted gross income (AGI). As stimulus checks were going out to households, the IRS announced tax returns are now due on May 17 this year instead of April 15.

How To Use Your Money Depends On Your Needs

Every household varies as to their need for this money. For instance, lower-income families are more likely to devote much of their spending to living necessities.

In a June 2020  US Census study,  adults in households with income between $75,000 and $99,999 were more likely to use their stimulus money to pay off debt or add to savings compared to households overall. In contrast, 87.6% of adults earning $25,000 or below planned to use their stimulus payments to meet their expenses.

The stimulus money is part of more considerable fiscal support targeted to boost consumer and business spending. As the economy grows, more people will work.

The Fed has accommodated our weak economy with low-interest rates and continued liquidity. These efforts will stimulate our economy and help our financial markets, but they may cause higher inflation. Fears of higher inflation have added volatility in the stock market.

Some believe higher economic growth and inflation may be transient, causing some stock market opportunities ahead. Chair Powell seems to be staying on course of a stimulative monetary policy and will tolerate higher inflation over the 2% target. 

Is This A Financial Windfall?

Merriam Webster  defines windfall as “an unexpected, unearned, or sudden gain or advantage.” A windfall can range from being a sum of $1,000 to something far more significant. This money may result from an inheritance, legal settlement win, salary bonus, or a winning lottery ticket.

A small windfall, newfound money, or stimulus money can serve a similar function by bringing you a step closer to your financial goals. That is a win for you whether you direct the money to help you with your day-to-day expenses or cushion your retirement nest egg.

Strategize What You Need Now And For Your Future

Strategize before spending your additional money by paying what is most urgently needed now.  The funds should improve your financial situation. Most people receiving checks have had a difficult time making ends meet. They may have lost their jobs, had their hours cut, or their job remains in jeopardy.

You may need to shore up your finances now. Are there holes in your budget that need mending that you can take care of first?   Pay your bills, reduce your debt to manageable levels, eliminating high-interest credit card debt. Should you have money left over, save for emergencies.

On the other hand, if you have little to no debt, devote your extra money to where you can catch up on retirement savings and investing.  Allocate where you can boost your financial future–replenish your emergency fund, retirement, investing– by adding to where the money can potentially grow.

Our Recommendations For Spending The Money Wisely  

 

1. Prioritize Your Everyday Bills

If you have outstanding household bills for your rent, mortgage, or utilities that need attention, consider negotiating with your providers. Ask if lower rates are possible or stretch out due dates. You want to avoid being late paying bills and affecting your credit score. It never hurts to try to do that at a time when people are most understanding.

Staying current on your bills can relieve the angst. And you don’t want to pile on late charges and add to your debt load.

2. Paying Off Your High-Cost Debt First

When you carry a lot of debt–credit cards, car, mortgage, student loans, or personal loans–can be overwhelming. Your stimulus money may not stretch that far. Interest rates are low for mortgages, car, and student loans, so your best bet is to reduce your credit card balances. Card issuers typically charge 15%-16% interest rates, and the compounding effect makes that balance grow faster.

It may be tempting to spread the cash proceeds around to all of your loans but target the most detrimental cost first.

3. Neglecting Any Car Repairs?

During COVID, you may be using your car less. If you are not following through with tune-ups, you can damage your vehicle in the long run. Do you have any car repairs you postponed but now can bring into the shop? Your repair guy will likely welcome you back.

4. Replenish Your Emergency Funds Or Start One

Many people have withdrawn money during the past year. They may have had to close businesses, leave jobs to take care of their family, or lost their jobs. It is time to reassess your emergency savings. Refill this fund so you can cover six months of your basic living needs should something unforeseen happen. A job loss, pet surgery, an unexpected illness, or car accident can mean higher costs beyond your budget.

Replenishing these savings can give you peace of mind. Those unexpected events do happen, as many of us learned the hard way last year.

Make sure to keep this money in liquid assets such as a higher-yielding savings account that is readily accessible. These days there is very little income to earn from low yields. But, economists are expecting higher interest rates as the economy strengthens. Therefore, use short-term securities like CDs so you can roll this money into higher yields when they are available.  

5. Add To Your Retirement Savings

Whenever you have extra money from a bonus, overtime, or raise, consider adding some of this money to your retirement savings. Notably, a 401K employer-sponsored plan or an IRA and Roth IRA makes sense. If you don’t have a retirement account, this is a good time to do so. 

Technically, your tax-free stimulus payment is unearned income. As such, it may be tricky to deposit money into your Roth IRA directly. Therefore, you may want to substitute earned money from other accounts, replacing those dollars with your stimulus money.

It is worth the effort to do so. Putting some money into a Roth IRA makes it a triple tax-free win. You aren’t paying taxes upfront. The contributed amount grows tax-free, and when you withdraw money after your turn 59.5 years.

Be Aware of Contribution Limits

You can have both a 401K and an IRA, but there are IRS contribution and income limits you need to be aware of so you can get the full deduction. Be mindful of those income limits for traditional IRA and Roth IRA for 2020 and 2021. They vary according to whether you are the single or head of the household, married, filing jointly, a retirement plan at work covers one or both spouses.

Contribute generously up to the maximum amount allowed:

The 2020 and 2021 limits are $19,500 for 401K and most 400 plans, and with a catch-up limit, $26,000 for employees aged 50 or over.

Total contributions for 2020 and 2021 are limited for all traditional IRAs and Roth IRAs to $6,000 or $7,000 if you’re age 50 or older.

6. 529 Savings For College

These accounts have federal tax benefits, like retirement accounts. Open a 529 savings account to set aside some money for your children’s college fund. Earnings on investments grow on a tax-deferred basis and tax-free when you withdraw money for educational costs. Generally, there are no contribution limits except for the $15,000 cap to qualify for the annual gift tax exclusion.

Each state has its own plan, and you don’t need to reside in the state to use their program. You may think that they are young and it is too early to think about their future, let alone college, if they are still at the crawling stage. The truth is that time goes by quickly, and before you know it, they are in high school. Don’t let this valuable time slip away without putting money into this fund. It will help your children to avoid borrowing heavily for college tuition.

7. Allocate Your  Savings To Investing

In a perfect world, all of your extra money should go toward investing. If you have a strong financial foundation with manageable debt, you should invest the money. Add to your investments or opening up an investment account for you or your kids.

Any savings you have from stimulus checks to a significant financial windfall should go to your investment accounts. That is if you have taken care of other needs. Invest early and have a plan in mind which considers your risk tolerance, timeframe, and diversification. 

When you are beginning to invest, you may not know where to start. Buying individual stocks can be very rewarding but can be risky. Consider low-cost index mutual funds or exchange-traded funds (ETFs) if you are uneasy purchasing individual stocks. Buying a pool of stocks is a popular way to own securities with diversification, avoiding concentration risk.

Professional portfolio managers actively manage mutual funds. They are constantly evaluating and choosing securities for the fund’s specific investment approach. Mutual funds are available for stocks, bonds, precious metals, other securities, varying risks,  and varying geographic markets. 

Active managers earn annual fees or expense ratios of your investment and are responsible for the fund’s performance. If you invest $1,000 in a mutual fund with a 1% expense ratio, you pay $10 per year towards the fund’s expenses.

Active Versus Passive Investing

Investors who buy actively managed funds pay higher expense ratios than passively managed index mutual funds that track a market-weighted portfolio. The latter index fund replicates the S&P 500 index via computers for a fraction of the fees, averaging 0.20%-0.50% expense ratios, below the typical 1%-2.5% costs of active managers.

You can buy a low-cost index mutual fund or an ETF consisting of a basket of securities, such as money markets, stocks, or bonds depending on your risk appetite. ETFs are similar to mutual funds but tend to be cheaper and more liquid. If both are available, I usually buy the ETF version. There are many funds with terrific choices, such as Vanguard, who pioneered indexed funds.

8. Give To Others

It is always a good time to give charitable donations to others. We always target giving 10% of our income to charitable contributions, but we have done more to offset the time we couldn’t do so. Everyone has their reasons for giving what they can and may stem from religious or ethical sources.

The 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 every year is a desirable goal—those who can do that.

Giving, like expressing gratitude, is among the most worthwhile healthy emotions to feel. Being grateful can even help us with our finances.

As part of 2021 $1.9 trillion American Rescue Plan, Biden extended the favorable tax deduction treatment in 2021 that was available last year. Taxpayers who take the standard deduction rather than itemize their tax deductions may set aside $300 (or $600 if you are married and filing jointly). The IRS suspended the typical limit of 60% of adjusted gross income for the amount of the charitable deduction made in a year.

The IRS has temporarily suspended limits on charitable contributions for those who itemize deductions on Schedule A. Check with your accountant whenever it relates to your taxes. 

 

Final Thoughts

Use your stimulus payment or windfall by spending the money wisely to improve your financial situation. It’s a personal decision based on your needs now or in your financial future. Strategize before spending this additional money so you can get the most of it. Hopefully, you are turning the corner to better times.

 

 

 

 

 

 

 

 

 

Ten Commandments of Personal Finance

Ten Commandments of Personal Finance

We revisit ancient views of money on ten central tenets of personal finance from timeworn texts and stories. Surveying these words adds a different perspective on finances whether you are celebrating the upcoming holidays or not. There is a common thread across varying beliefs on handling money, saving, overspending, debt accumulation, and investing.

Ten Commandments of Personal Finance:

 

1. Financial Planning

A financial plan is essential to achieve your short-term and long-term goals. According to Proverbs 21:15, “The plans of the diligent lead to profit as surely haste leads to poverty.”

Understanding your priorities is an essential first step. With hard work, you can accomplish what you want so long as you know your preferences. Our goals are not always clear to us, especially when we are young. “Complete your outdoor work in order and prepare your field; after that, you may build your house.” (Proverbs 24:12).

Making a plan doesn’t happen overnight. Set reasonable priorities incrementally as you engage in deep thought and conversations with your partner. It is often hard to address many features of a sound financial plan on your own. Reduce some of the risks upfront, whether you are investing in stocks or starting a business.

 One of my favorite books, Richest Man In Babylon by George S. Clason provides some guidance. “Gold slippeth away from the man who invest it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.” Avoid recklessness when investing.

Consult A Fiduciary

Consider a financial advisor who as a fiduciary must act in your best interests rather than his or her own. Such an adviser can provide a framework to help you with your goals for retirement saving, investing and estate planning. “For by wise guidance you can wage your war. And in the abundance of counselors there is victory.” (Proverbs 24:6).

2. Saving More, Spending Less

Saving money is an essential financial habit. According to a CareerBuilder report, 78% of American workers were living paycheck-to-paycheck. The report found almost 1 out of 10 workers making $100,000 were having trouble making ends meet. When facing a weak economy, rising job losses cause financial stresses. For those reasons, having an emergency fund is necessary to pay for at least six months of basic living expenses. Having readily accessible funds in liquid funds such as money market securities helps you avoid increasing debt.

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 famine years. As a result of planning for this disaster, Joseph advises Pharaoh to store grain during the good years for use in 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 make it grow.”

3. Track Your Spending By Budgeting

Spending more than your means is a sour 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 old 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 latter budget is Elizabeth Warren’s rule of thumb using 50% of aftertax or net income for your needs, 30% of net income for your wants, leaving 20% for saving money and paying the debt. Budget in any reasonable way you can control your spending. Consider these budgeting methods.

Avoid Lifestyle Inflation

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 proverb 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 UAWs 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 about the good and bad money habits of the wealthy.

4. Manage Your Debt Wisely

The successful millionaires practice budgeting and bargaining. They avoid debt accumulation to lower their risks.  According to Proverbs 22:7, “The rich rule the poor and the borrower is slave to the lender.” Manage your debt wisely. Pay your bills on time and in full. Don’t carry high credit card balances. You need to pay your card balances in full, not merely the minimum, or your debt will be accumulating quickly because of compounding growth.

Managing your debt and developing good credit habits are essential in your financial life. Learn how to avoid common credit mistakes in a recent post here.

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

5. Retirement Savings

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 your tax-deferred contributions to come out of your paychecks, and employers often match a portion of your contributions. The match contribution is like extra money you can earn from your employer. Separately, you can establish an IRA (Roth IRA) for further retirement savings. Target your contributions to amounts capped by the IRS for maximum growth for retirement.

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.” Providing insurance should be arranged for your family to cover potential risks. “We cannot afford to be without adequate protection.”

6. Diversify Investments

Allocate some of your savings into investments. Whether you have a financial adviser to guide you, manage your assets, and diversify to reduce your risks. Don’t put all your eggs in a basket unless you are using Easter eggs for a holiday hunt. Ecclesiastes 11:2 says, “Put your investments in several places-because you never know what kind of bad luck you are going to have in this world.”

The financial markets go through turbulent times. Reducing risk by diversifying your assets into stocks, bonds, real estate (including home ownership), and money market securities is the best way to weather those stormy times. Diversify within each class of investments to avoid the pitfalls. That means having some stocks with growth portfolios and those with healthy dividend yields.

Bull Market To Bear Market In Record Time And Then…

Since the beginning of the pandemic, the stock market has been volatile. We saw severe moves,  going from a bull market to a short bear market. There has been fiscal support, sending out the third stimulus checks and extending federal unemployment. 

The Fed has stimulated the economy with lower interest rates and substantial liquidity. Fears of high inflation are now on the table concerning investors. Stock investing is always challenging to predict. It is even more challenging to time the market.

Stay the course rather than jumping in and out of the market. For long-term stockholders, staying the course rather than panic selling seems to be a better path. A more robust economy will likely fuel corporate earnings growth.

7. Don’t Obsess About Money

Maintain balance in your life without a focus on just 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

Rev. 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 critical.

8. Add Knowledge And Skills 

Become a lifelong learner adding knowledge and skills. “Wisdom is a shelter as money is shelter but the advantage of knowledge is this: wisdom preserves those who have it.” (Ecclesiastes 7:12). By investing in yourself, whether learning a skill, a language or knowledge, you grow in confidence and are valuable to others. “Lazy hands make for poverty, but diligent hands bring wealth.” Proverbs 10:4

Work hard and persevere in your job, your career, and your profession. As a result of the coronavirus and social distancing, we see many people who do not have the luxury of working from home. I speak of doctors, healthcare workers, grocery store clerks, bus drivers, and untold heroes working hard to save lives or are engaged in essential jobs.

“The Street Sweeper”

Dr. King valued those who worked hard. Another favorite King quote, “If a man is called a street sweeper, he should sweep streets even as a Michaelangelo painted, or Beethoven composed music or Shakespeare wrote poetry. He should sweep streets sp well that all the hosts of heaven and earth will pause to say, ‘Here lived a great street sweeper who did his job well.”

9. Be Ethical

We have a responsibility to be ethical to others. That means not to scam, steal, or be dishonest. Respect others’ property. Wastefulness is shameful according to the Torah and should destroy any useful objects according to Deuteronomy 20-19. Destruction is only forbidden when it is without purpose. For example, only trees that you know do not yield food may be destroyed.   We should not borrow anything without permission. According to Leviticus 5:23, “He must return the stolen article, the withheld funds, the article is left for safekeeping, the found article.”

10. Be Charitable

According to Jewish law, it is forbidden to impoverish one’s wealth by the distribution of all of one’s wealth to charity. However, one can leave one-third of his estate to charity in his or her 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). Give 10% of your net income per year as a desirable goal. Those who can, should.

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

Ten commandments of personal finance come from timeless scriptures. Sometimes ancient words remind us that money management was always a challenge. That said, you can learn money lessons wherever you look. Choose financial success by your actions in dealing with money. Determine your priorities and set out to accomplish them. The building doesn’t happen overnight. Many have lost jobs and the means to pay bills. It will take time to get back to normal. In the meantime, stay healthy.

Thank you for reading our piece. Please visit The Cents of Money for more articles and consider subscribing to get regular updates.

 

A Guide For College Grads On Your Company Benefits Plan

A Guide For College Grads On Your Company Benefits Plan

Congratulations, Graduate!

“Find a job you enjoy doing, and you will never have to work a day in your life.”

Mark Twain

Hopefully, there will be a commencement season this year. It is one of my favorite times of the year, and I don’t even have a child going to college yet. As a professor and a hopeful nerd, I enjoy college grads getting all kinds of accolades and advice on life and read as many commencement speeches as I can. Some of those speeches through the years have become legendary.

For one of the most inspiring, read or listen to the commencement speech of Steve Jobs, co-founder of Apple, at Stanford University in 2005.

Enjoy This Moment of Sunshine

After years of toil at your college and most likely working hard in high school to land at your top college choice, you have earned the chance to enjoy this moment. The time between college and starting your first job is an excellent time to take a breather. And travel time to visit family, friends, and possibly part-time employment.

The value of obtaining your bachelor’s degree remains a significant factor in your lifelong income and financial well-being.

Your First Job After College

On average, most graduates believe the benefits of their education meet or exceed the costs. Likely you are either starting your first job soon or are engaged in your search.  According to its survey, the National Association of Colleges and Employers (NACE), the average annual salary for college grads is about $50,000. Those who majored in computers, engineering, mathematics, health sciences, and business were the highest earners, with salaries ranging between $52,000 and $71,000. 

 Tips For Making The Most Of Your First Job:

 

1. Perfection Is The Enemy Of The Good

You are beginning your professional life. You don’t know what to anticipate in your new environment. Expect to make mistakes and learn from them.

Prepare for your job interview for the job. Start by reading their annual report and articles to understand the company. Competence is what you are aiming for when you first get started in your new job.

2. Paying Your Dues

Initially, you are not likely to get the “cool” assignments. You will be doing a lot of the grunt work or doing something you believe is beneath you. Everyone goes through this feeling. Remain enthusiastic as your co-workers and boss may want to see how you handle the easy work before giving you more tasks.

3. Volunteer To Help Others But Complete Your Work

When I hired associates to work with me I often had “eager beavers” wanting to do everything everyone else was doing, leaving behind the work I asked them to complete. Instead, they would rush their work, doing a shabby job.

4. Seek Opportunities To Learn New Skills

As you get deeper into the swing of your job, complete tasks on or ahead of schedule, become a sponge. Learn as much as possible and take advantage of any company-sponsored training offered to you. Strengthen your existing skills and build your abilities to be a problem solver. 

 5. Do More Than Asked

I heard a great story from a now successful executive at a major newspaper firm. She elevated herself from the entry-level job, by completing her work efficiently, then helping others.  Along the way, she picked essential skills to make herself invaluable. As a result, she is now a senior manager of the firm.

6. Understand Your Company Benefits Package

According to the Bureau of Labor Statistics, the combined benefits plan adds about 30% to your total compensation. In a tight employment market, companies often become more generous with their benefits. Besides the standard vacation days, your benefits package may vary widely.

A recent Glassdoor survey said 4 out of 5 employees prefer benefits to a raise.

Your Company Benefits Package:

 

Retirement 401K Plan

As soon as you begin to work at your new firm, you need to set up an account to start saving in your 401K plan. Better yet, automate contributions directly from your paycheck. You need to understand the dollar amount or percentage of company matching contribution with any defined cap amounts on employee contribution.

For example, Discover, the credit card company, has a generous company match up to 7%.

What is the vesting period of the company’s matching contribution for the 401K? If vesting is partial or two years, you will more likely keep the company’s match amount than if the vesting period is 5 years or more. Many companies have partial vesting.

As this is your first job, you may not expect to stay the five years required to earn the company’s contribution. People no longer stay in the same company for years. However, you should still begin to put money in your 401K. If you leave your job, you have options for your 401K. You can leave it in the old plan or roll it over to your new employer or roll this 401K into an IRA. 

Student Loans Repayment

Student loan repayment as an employee benefit is in its infancy period. It could grow into a core part of a company’s benefits package. According to SHRM’s 2019 survey, about 8% of employers repay student loans as an attractive benefit.

More companies are helping with student loans, especially since the IRS ruling a few years back. Abbott Laboratories was a pioneer in addressing student loan repayments giving employees the option. Employees can contribute toward their student debt rather than to the 401K plan. However, they still get the 401K employer’s match contribution even if the worker didn’t contribute themselves.

Company Stock Ownership Plans Differ Widely

They are a desirable benefit for the employees to participate in the company’s growth and may offer tax deductions.

For closely-held or private corporations, Employee Stock Option Plans or ESOPs means that the company is owned partly or entirely by employees. Publix, the supermarket company, is among the largest owned.

Employee Stock Purchase Plans or ESPPs are offered by 52% of most public corporations through employee participation is relatively low at 42%.

The ESPP plan is usually offered as a tax-qualified plan. All employees may participate based on a minimum number of years at the company. These employees may buy stock during “an offering period” over  3 months-to-27 months, set at a discount up to 15% from the market price.

Employees can profit immediately or over a longer holding period. If holding more than a year and a day, your income is taxed at the capital gains rate. Make sure you diversify your investment portfolio beyond holding any concentrated positions.

A Word of Caution

Sometimes employees can expand their stock ownership on a tax-advantaged basis, even buying the shares inside their 401K plans. I have significant concerns about employees using their employer’s stock in their 401k for three main reasons:

  • Owning too much stock of the company you are working for is too much risk no matter how great the company is as your employer. Too many eggs in one basket are hazardous, and you need diversification.
  • WorldCom and Enron’s financial scandals were devastating for those company employees who received an excessive amount of compensation in their company stock for bonuses and 401K plans. There was little heads up of the calamity coming.
  • Many lost their life savings along with the devaluation of their homes due to their proximity to corporate headquarters. I knew many of the WorldCom folks.

 Health Insurance

Not surprisingly, 58% of new college grads want 100% employer-paid medical insurance but only 7.5% of employers provide that. You need to understand the premiums, deductibles, and co-pays you are responsible for and your plan covers.

HSAs

If there is a high deductible, determine whether your employer contributes to health savings accounts (HSAs). An HSA is a tax-advantaged account for individuals covered by high deductibles, not subject to federal income tax at the time of deposits.  HSA funds are used to pay for qualified medical expenses and may cover over-the-counter medications with a doctor’s prescription.

FSAs – Health Care Flexible Spending Plans 

 A flex plan allows employees to pay for specific unreimbursed healthcare and dependent care expenses with pretax dollars. This plan helps to offset some of the costs not met with the main health insurance up to a capped amount (e.g., $2,000).

Dental and Vision insurance is offered by about 62% of employers and is considered a desirable perk for college grads. Vision insurance is part of the more significant health insurance, allowing regular eye exams and some employer contribution for glasses.

Disability Insurance

According to Social Security Administration, 25% of all 20-year-olds will be disabled by the age of 67. Disability insurance is an essential part of any package, but few believe they need this insurance. 42% of private sector companies offer this insurance.

This insurance plan replaces a portion of an employee’s gross income, usually up to 50%-60% to you, while you are disabled subject to a physician’s approval. You buy this insurance on a short-term and long-term basis. The employer may pay the premium in part or in whole. The employee will pay the rest.

On a short-term basis, the disability benefits extend up to 52 weeks, kicking in 1-14 days after the employee cannot work and has applied their sick days.

Life Insurance 

Usually, employers offer a relatively small amount of life insurance rather than enough to protect you and your family fully. The employee can increase its coverage amount by paying the premiums on a monthly or quarterly basis through its company’s group term life plan at reduced rates than what they would pay on their own.

Tuition Reimbursement 

Most employers are often willing to provide tuition reimbursement for advanced education rather than lose the employee. The refund can correlate to grades. An “A” would 100% reimbursement, “B” gets 75%, and so on.

Increasingly, companies are offering online courses to employees to complete their degrees for high school and college, as well as “English as a Second Language.”

Unique Lifestyle Benefits  

There is a long list of excellent benefits often found to be high quality among the best companies. Flexible work options are becoming more standard after given the broad experience many have had during the pandemic. Here are some of the best I found:

  • egg freezing for female employees
  • adoption and surrogacy assistance and reimbursement
  • employee relief fund for national disaster victims
  • doctor’s office or medical clinic onsite
  •  counseling sessions to reduce stress
  • high-quality dining
  • leave of absences to care for family members or newborns
  • financial aid coaches
  •  career planning
  • discounts or full paid courses for high school, undergraduate degrees, yoga, and ESL
  • flex hours or work from home
  • dry cleaning on-premises
  • paid time off for volunteering
  • pet insurance
  • onsite gym
  • personal or professional time off
  • child daycare or  day elder care

Maybe There Is A Free Lunch

Take advantage of your company benefits plan by reading it thoroughly. Ask questions of human resources to understand it better. Work diligently and convey a positive attitude. Whether this is your first job or your fifth job, your company benefits package is a meaningful part of your compensation.

Thank you for reading! What is in your company benefits package? What are the benefits you value the most? Please share your thoughts with us!

 

 

 

 

 

How Do You Measure Your Financial Success?

How Do You Measure Your Financial Success?

 

I wanna be a billionaire so f**king bad

Buy all of the things I never had

Uh, I wanna be on the cover of Forbes magazine

Smiling next to Oprah and the Queen.

Billionaire, Lyrics By Travie McCoy

 

You Don’t Have To Be A Billionaire

You do not have to be a billionaire to consider yourself to be financially successful. If you have a roof over your head, food on your plate, loving family and friends, you are already in a good class. To measure financial success, use specific personal financial ratios and qualitative factors to evaluate your financial health. These benchmarks can help you develop better financial habits in savings, spending, retirement, investing, and debt payoffs.

 Limitations of Financial Metrics

Financial metrics have some limitations. For example, debt-to-income will be different for people of different ages. At 30 years old, when you are at the beginning of your working career, you are accumulating more debt and likely have a low savings amount. However, by age 60-65, as you enter retirement years, the balance shifts to high savings and low-to-zero debt levels. For those who have unpredictable income, ratios may be difficult to assess without normalizing for volatility.

We zero in on a few of the most important financial ratios. For our post on 18 personal financial ratios where we look at the array of money topics, please visit here.

We look at qualitative factors, those you can’t calculate, that can help you measure your financial success.

Having money is not the only factor in our attaining success and happiness, is it? Money isn’t everything

Have An Emergency Fund That Can Absorb A Financial Shock

Having liquidity on hand for emergency purposes provides much-needed peace of mind. Liquidity refers to your ability to easily convert assets into cash with little to no loss of principal. When you 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.

According to a recent Charles Schwab survey, only 38% of Americans have an emergency fund, with 59% of American adults live paycheck-to-paycheck. It takes time to stash away money for unforeseen events such as a job loss. However, it should be a priority. Without it, you will have to borrow more.

Liquidity Ratio

Monetary assets are liquid investments. The average household can include cash, money markets, savings, and checking accounts. As such, they should be able to provide liquidity to pay your fixed monthly expenses. 

Liquidity Ratio = Monetary Assets/ Monthly Expenses

Fixed monthly expenses are basic living needs like groceries, rent or mortgage, utilities, and car loan for six months. A  ratio of six means that your monetary assets can pay for your basic needs of food, rent, utilities, and a car loan for the next six months, if necessary.

 Emergency Fund Ratio

The liquidity ratio is linked very closely to the emergency fund. This cushion is essentially a cash fund for emergencies in unforeseen events such as job loss, death in the family, unexpected surgery, or immediate house repair.

An emergency fund ratio works ample enough to support you through these unknowns for a targeted timeframe. If you are looking for six months or higher (and this is highly recommended) to set aside in one fund investing in a high yield savings account or a money market account, then:

Emergency Funds Ratio= 6*Monthly Expenses

This ratio will give you a targeted amount of monetary assets needed to be comfortable for the possible emergency. It takes time to accumulate money for these purposes. How long it will take depends on you and your ability to save.

Related Post: Why You Need An Emergency Fund

Net Worth Is A Key Benchmark

Your net worth, also known as net wealth, is a snapshot of your current financial position. How rich are you? You can calculate net worth as total assets, that is, what you own less total liabilities or what you owe. Hopefully, what you own is more than what you owe. I consider knowing what your net worth is to be an essential personal finance benchmark.

Net Worth Ratio

Net worth is your personal balance sheet measuring your net wealth at a point in time. As you add to your assets, hopefully outpacing your liabilities, you will be getting wealthier. Another financial measure is your liquid net worth which strips out non-liquid assets.

Net Worth Ratio= Total Assets Less Total Liabilities

Your total assets are what you own at its current market value. Like art and antiques, some assets are more difficult to calculate and may require a professional appraisal. Your total liabilities are what you owe based on your debt obligations, notably the balances on your credit card debt, mortgage, car loan, and any other loans you have. The higher the positive number you have, the better off you are financially.

 

Targeted Net Worth Ratio (The Millionaire Next Door)

One of my favorite personal finance books, The Millionaire Next Door, is an oldie but goodie. I have read it at least twice and refer to it often when teaching my college students about money habits.

The more successful millionaires are the prodigious accumulators of wealth (PAWs). They tend to be less extravagant, as most of us believe of millionaires. Instead, PAWs lived frugally, often buying used cars. As such, they accumulated and retained their wealth.

This ratio uses age as a factor in the calculation, as some other ratios do.

Targeted Net Worth Ratio= Age x (Pretax Income/10)

Your targeted net worth provides you with an indication of what you should be worth after liabilities.  As a 30-year old making $95,000 annually, your net worth should be $285,000. The calculation amount is 30 x (95000/10). It is a guidepost to help you reach your goals.  Although somewhat arbitrary, it gives you some context of what is achievable if your goal is financial flexibility.

These Ratios Consider Our Age

There is a fundamental relationship between our income, debt, and savings. These ratios (savings-to-income, debt-to-income, and savings-rate-to-income) consider our age. We make lower salaries in our early career years when we borrow for a house and a car and make debt payments. Keep your debt burden at manageable levels and save for 401 K retirement and Roth IRA.

Savings-To-Income Ratio

When looking at savings, add your assets, including cash and money markets, the current market value of retirement savings, notably 401K and IRA balances, brokerage investment accounts, real estate investments, and the present value of other business interests.

Don’t include less liquid assets to total savings like art, antiques, your car, or primary home. The monetization of these assets is less predictable in terms of time. It is also harder to peg a reasonable value as they are usually less liquid than securities.

Savings-To-Income Ratio= Market Value of Savings/ Gross Income

Your ratio will be minimal at age 25 or 30, growing to a multiple of 3 or better when you are 45 years, and continue to grow to 10x-15x your pre-retirement income, so you have a comfortable cushion for retirement.

Debt-To-Income Ratio

A better way to look at whether your debt burden is too high is to compare it to your gross income, that is, the amount you make.

Debt-To-Income Ratio = (Annual Debt Repayments/Gross Income) x 100

Typically, when you are age 30, when your salaries are at the low end of your career, you may be borrowing for a home or a car while still paying student loans. Your ratio should be no more than 36% of gross income. This ratio should decline as you command higher salaries and save more.

An alternative way to calculate the Debt-To-Income ratio is looking at your total debt balances compared to your income.

For example, you owe $175,000 on your mortgage and $25,000 on your car loan. Your salary is $110,000, or (175,000 +25,000)/ $110,000 = 1.81. This amount is a fairly normal ratio for a 30-year-old. As your salary rises and you pay off part of your loan, you should be at a ratio of 1 in your 40s. Target little to zero debt as you enter your 60s, so you are debt-free in retirement.

Savings Rate-To-Income Ratio

Savings should be one of the 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. Saving is difficult 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 good target and allow you to put some of this money to pay down debt.

 Personal Cost of Debt

Carrying too much debt relative to income is problematic. This ratio looks at your cost of debt influenced by your credit mix and FICO score.  If you have high monthly credit card balances, then you probably have a high price of debt. Card companies notoriously charge high-interest rates.

Also, your credit score matters. If you have a lower FICO score, that is, below 650, for example, lenders will see you as a risky borrower and charge higher interest rates. Reducing debt will help you to raise your credit score.

Pay Down High-Cost Debt

In debt reduction plans, there are two types: Snowball Method (tackles the smallest debt first) and Avalanche Method (gets rid of the highest cost first). I prefer the Avalanche Method so that you can get rid of the highest cost of debt first. Try eliminating your credit card balances altogether by paying your bills in full.

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

Personal Cost of Debt = (Loan 1/Total Debt)x(Interest Rate for Loan 1) + (Loan 2/Total Debt)x(Interest Rate for Loan 2)

Debt           Debt Amount             Interest Rate %            % of Total Debt              Interest Rate x Weighting

Loan 1           $25,000                          7.0%                            42%                                      2.9%

Loan 2           $35,000                          4.5%                            58%                                      2.6%

Total              $60,000                                                             100%                                      5.5%

Your goal would be to reduce your higher-cost debt, that is, loan 1. You would first target reducing the $25,000 loan outstanding. In considering net worth, you want your assets to be a more significant amount than your liabilities. Your investments should be ideally earning returns above your cost of interest.

For example, stocks generate higher pretax returns of 9% over the long term, or 6%-7% aftertax returns. Therefore, you should look to carry debt at lower costs than stock returns.

This calculation is very similar to how businesses look at borrowing capital for projects. Companies select projects expected to generate returns above their cost of capital. Your household is your business. You want to have higher returns in your investments than your borrowing.

Retirement Savings Ratio

There is a Chinese proverb: “Don’t wait until you’re thirsty to dig a well.” 

Saving for your retirement should begin as early as possible so your nest egg can benefit from compound growth. As soon as you start your first job, you should take advantage of your employer’s sponsored retirement plans, usually a 401K, and begin contributing to your account. Save enough to earn your employer’s matched contribution. Open a Roth IRA plan.

Retirement Savings Ratio = 25 x Primary Income

If you make $100,000, your retirement savings should amount to $2.5 million. This ratio is also called the 25X Rule.

This ratio complements the 4% Withdrawal Rule developed by William Bengen in his study, “Determining Withdrawal Rates Using Historical Data.” The 4% withdrawal rule means that you should be able to live during retirement by withdrawing 4% of $2.5 million in assets, or $100,000.  It is not a coincidence that 25 x 4% equals 100%. The math at least works perfectly.

Bengen was a financial planner from MIT. His study said that if you withdraw 4% of your assets annually (his analysis pegged the number closer to 4.15%), your retirement savings could last 35 years. Use this as a guideline rather than something etched in stone. Whether you can withdraw 3% or something closer to  5% depends on what kind of lifestyle you will have in retirement. 

The 80% Rule

Some experts use the 80% rule as a rule of thumb for estimating what your income at retirement would be. If your final income before your retirement is $100,000 x 80% = $80,000.

This rule means that you should be able to live on $80,000 comfortably in retirement. The assumption is you may be able to eliminate some expenses associated with work, such as work attire, transportation and can take public transit.

If you use this $80,000 amount in conjunction with the 4% withdrawal rule, then $80,000/ 4%= $2 million. This lower amount (than the $2.5 million above) reflects the reduced lifestyle needs of a retired person.

Related Post: Saving For Retirement In Your 20s

Qualitative Measures of Being Financially Successful

Sometimes number crunching is just not enough, especially for measuring your financial success. We embrace our lives differently. Making a million dollars a year may be a bad year for someone used to making eight figures in the past. Others may feel retiring by age 40 is their mark of success. Being a barber at the age of 108 years was a supreme achievement for Anthony Mancinelli.

What are the qualitative ways of being financially successful?

Being Financial Independent

You are having a target of being financially independent. As such, you have enough savings and income to pay for your living expenses without being employed in a job you don’t want to have or be dependent on others.

You may support yourself through alternative sources of income like dividends, passive income, part or full-time work you enjoy. It is an excellent mindset for those with many interests and who don’t want to work if you don’t like non-flexible hours.

Debt-Free And Financially Flexible

You have paid off all your debt. The only obligation you carry is monthly credit card payments, but not if you pay them in full. You have a financially flexible life, meaning you can meet your current and financial obligations and have savings. You are not living paycheck to paycheck. You have liquid savings in the event of an emergency.

Don’t Fight About Money With Your Spouse

You and your spouse are on the same page regarding your financial goals and communicate regularly to stay on track. You agree on the game plan for spending, savings, and debt. Being aligned is an ideal scenario but challenging to achieve regularly. It is up to both spouses to meet periodically to review their budget for the short term and assess long-term goals.

Couples often fight about money issues. It will happen for most of us. Being honest and transparent to each other is what counts. If you veer off track from your goals, review your plan together and make changes if needed. I don’t think shielding the other from potentially bad or embarrassing developments is the right thing to do.

Be open and proactive about financial problems that should be dealt with promptly. Avoid financial fidelity.

Passionate About Your Career Job

It is easier to increase your chances for financial success if you enjoy your job and career. Some people have had success in starting up several successful companies or even starting up one great one after several failures. Apoorva Mehta, the founder of Instacart, the online personal shopper, reportedly had 20 failed startups before he successfully built Instacart.

I have had success in very different career paths. When I worked as an equity analyst, I enjoyed the quick pace and satisfaction of meeting with senior company management and communicating my research with institutional investors. I was passionate about my job. It was an exciting time for the telecom industry as digital Internet technologies created new products and services.

As a professor, I love teaching and the “Aha” moment when students make connections in the classroom. When I feel I’ve made a difference, it is priceless.

Don’t Compare Your Financial Situation To Others

We often compare ourselves to others. It may give a point of reference to our peers, which may not be a complete picture. Obsessing over these comparisons is unproductive and may be stressful.

Social comparison bias is a human reaction. We allow ourselves to be influenced by comparing our financial achievements–income, net worth, status, job title—to others. We negate different paths, personality traits, and the possibility that some inflation has been taking place.

A better comparison is to look at you are currently against the person you were in the past. What have you accomplished relative to what you anticipated in your plans? How do your results fit with your long-term goals? That is a more accurate picture and will allow you to move forward with your next moves.

Enjoy Learning And Picking Up New Skills

To be successful, keep learning from your experiences and pick up new skills. Continue to challenge yourself with strengthening a weakness or adding competence. Continue to evolve in your career, expand your skills, manage people or learn a language. Not only will it keep you from being hampered, but you will also be more valuable at this job or elsewhere.

Final Thoughts

Financial ratios are proper as a starting point to understanding your financial health. They do not take the place of a sound financial plan. Although they have limitations, like age specificity, these metrics can move you to the next goal post. Consider qualitative measures of what being financial success is. What we all want is to be able to say that we had a life well spent.

Thank you for reading! Please find other articles of value on The Cents of Money where you can subscribe for freebies. 

How do you measure your financial success? How does it coincide with your financial goals? Look at your financial plan relative to your goals regularly. What works for you? We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I wanna be a billionaire so f**king bad

Buy all of the things I never had

Uh, I wanna be on the cover of Forbes magazine

SmIiling next to Oprah and the Queen.

Billionaire, Lyrics By Travie McCoy

 

You Don’t Have To Be A Billionaire

You do not have to be a billionaire to consider yourself to be financially successful. If you have a roof over your head, food on your plate, loving family and friends you are already in a fortunate class. Certain personal financial ratios may help you to evaluate your financial health. These quantifiable benchmarks can help you to develop better financial habits in savings, spending, retirement, investing and debt payoffs.

Financial metrics have some limitations. For example, debt-to-income  will be different for people of different ages. At 30 years old when you are at the beginning of your working career, you are accumulating more debt and likely have low savings amount. However, by age 60-65, as you enter retirement years, the balance shifts to high savings and low-to-zero debt levels. For those who have unpredictable income, ratios may be difficult to assess without normalizing for volatility.

We zero in on a few of the most important financial ratios. For our post on 18 personal financial  ratios where we look at array of money topics, go here.

There are qualitative factors, those you can’t calculate, that can help you measure your financial success.

Having money is not the only factor in our attaining success and happiness, is it?

Have An Emergency Fund That Can Absorb A Financial Shock

Having liquidity on hand for emergency purposes provides much needed peace of mind. Liquidity refers to your ability to easily convert assets into cash with little to no loss of principal. When you 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.

Only 38% of Americans have an emergency fund, with 59% of American adults live paycheck-to-paycheck according to a recent Charles Schwab survey. It takes time to stash away money for unforeseen events such as a job loss. However, it should be a priority. Without it, you will be forced into borrowing.

Liquidity Ratio

Monetary assets are among the most liquid of assets. These assets includes cash, cash-equivalent securities or money markets, savings bonds, savings and checking accounts. Liquid assets can be used to support your fixed monthly expenses for 3-6 months. The larger the amount the more comfortable you will feel.

Liquidity Ratio = Monetary Assets/ Monthly Expenses

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

 Emergency Fund Ratio

The liquidity ratio is linked very closely to the emergency fund. This is essentially a cash fund for emergencies in unforeseen events such as job loss, death in family, unexpected surgery or immediate house repair.

Emergency fund ratio works by using a targeted number of months that you believe is ample enough to support you through these unknowns. If you are looking for 6 months or higher (and this is highly recommended) to set aside in one fund that can be invested in a high yield savings account or in money markets, then:

Emergency Funds Ratio= 6*Monthly Expenses

This ratio will give you a targeted amount of monetary assets needed to be comfortable for the possible emergency. It takes time to accumulate money for these purposes. How long will it take depends on you and your ability to save.

Related Post: Why You Need An Emergency Fund

Net Worth Is A Key Benchmark

Your net worth, also known as net wealth, is a snapshot of your current financial position. How rich are you? It is calculated using total assets, that is, what you own less total liabilities, or what you owe. Hopefully, what you own is in excess of what you owe. I consider knowing what your net worth is to be an essential personal finance benchmark.

Net Worth Ratio

This is your personal balance sheet measuring your net wealth at a point in time. As you add to your assets, hopefully outpacing your liabilities, you will be getting wealthier. Calculating a net worth statement and updating it is important to do regularly.

Net Worth Ratio= Total Assets Less Total Liabilities

Your total assets are what you own at its current market value. Some assets, like art and antiques, are more difficult to calculate and may require a professional appraisal. Your total liabilities are what you owe based on your debt obligations, notably the balances on your credit card debt, mortgage, car loan and any other loans you have. The higher the positive number you have, the better off you are financially.

 

Targeted Net Worth Ratio (The Millionaire Next Door)

One of my favorite personal finance books, The Millionaire Next Door, is an oldie but goodie. I have read it at least twice and refer to it often when teaching my college students about money habits.

The more successful millionaires are profiled as prodigious accumulators of wealth (PAWs). They tended to not be extravagant or status seekers as commonly believed of millionaires. Instead, PAWs lived frugally, often buying used cars. As such, they accumulated and retained their wealth.

This ratio uses age as a factor in the calculation as some other ratios do.

Targeted Net Worth Ratio= Age x (Pretax Income/10)

Your targeted net worth provides you with an indication of what you should be worth after liabilities.  As a 30 year old making $95,000 annually, your net worth should be $285,000. That amount is derived as 30 x (95000/10). It is a guidepost to help you reach your goals.  Although somewhat arbitrary, it gives you some context of what could be achievable if your goal is financial flexibility.

These Ratios Are Linked To Our Age

There is a fundamental relationship between our income, debt and savings. These ratios (savings-to-income, debt-to-income and savings-rate-to-income)  are closely linked to our age. In our early career years, we make lower salaries, borrow for a house and a car and make debt payments. Keep your debt burden at a manageable levels and save for 401 K retirement and Roth IRA.

Savings-To-Income Ratio

When looking at savings, add your assets including cash and cash-equivalents, current market value of retirement savings, notably 401K and IRA balances, brokerage investment accounts, real estate investments, and current value of other business interests.

Your art, antiques, your car or primary home should not be included in the total for savings. Monetization of these assets are less predictable in terms of time. It is also harder to peg a reasonable value as they are usually less liquid than securities.

Savings-To-Income Ratio= Market Value of Savings/ Gross Income

At age 25 or 30, your ratio will be minimal, growing to a multiple of 3 or better when you are 45 years, and continue to grow to 10x-15x your pre-retirement income so you have a comfortable cushion for retirement.

Debt-To-Income Ratio

A better way to look at whether your debt burden is too high is compare it to your gross income, that is, the amount you make.

Debt-To-Income Ratio = (Annual Debt Repayments/Gross Income) x 100

Typically, when you are age 30, when your salaries are at the low end of your career, you may be borrowing for a home and/or a car while still paying student loans. Your ratio should be no more than 36% of gross income. This ratio should decline as you command higher salaries and save more.

An alternative way to calculate Debt-To-Income ratio is looking at your total debt balances compared to your income.

For example, you owe $175,000 on your mortgage and $25,000 on your car loan. Your salary is $110,000, or (175,000 +25,000)/ $110,000 = 1.81. This is a fairly normal ratio for a 30 year old. As your salary rises and you pay off part or your loan, you should be at a ratio of 1 in your 40s. Target little to zero debt as you enter your 60s so you are debt free in retirement.

Savings Rate-To-Income Ratio

Savings should be one of the most important 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. This is difficult 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 good target and allow you to put some of this money to pay down debt.

 Personal Cost of Debt

Carrying too much debt relative to income is problematic. This ratio looks at your cost of debt influenced by your credit mix and FICO score.  If you have high monthly credit card balances, then you probably have high cost of debt. Card companies notoriously charge high interest rates.

Also, your credit score matters. If you have a lower FICO score, that is, below 650 for example, lenders will see you as a risky borrower and charge  higher interest rates. Reducing debt will help you to raise your credit score.

Pay Down High Cost Debt

In debt reduction plans, there are two types: Snowball Method (tackles the smallest debt first) and Avalanche Method (gets rid of the highest cost first). I prefer the Avalanche Method so that you can get rid of the highest cost of debt first. Try eliminating your credit card balances altogether by paying your bills in full.

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

Personal Cost of Debt = (Loan 1/Total Debt)x(Interest Rate for Loan 1) + (Loan 2/Total Debt)x(Interest Rate for Loan 2)

Debt           Debt Amount             Interest Rate %            % of Total Debt              Interest Rate x Weighting

Loan 1           $25,000                          7.0%                            42%                                      2.9%

Loan 2           $35,000                          4.5%                            58%                                      2.6%

Total              $60,000                                                             100%                                      5.5%

Your goal would be to reduce your higher cost debt, that is, loan 1. You would first target reducing the $25,000 loan outstanding. In considering net worth, you want your assets to be a larger amount than your liabilities. Your investments should be ideally earning returns above your cost of interest.

For example, stocks generate higher pretax returns of 9% over the long term, or 6%-7% aftertax returns. You therefore should look to carry debt at lower costs than stock returns.

This is very similar to how businesses look at borrowing capital for projects. They will pick plans that are expected to generate returns above their cost of capital. Your household is your business. You want to have higher returns in your investments than your borrowing.

Retirement Savings Ratio

There is a Chinese proverb: “Don’t wait until you’re thirsty to dig a well.” 

Saving for your retirement should begin as early as possible so your nest egg can benefit from compound growth. As soon as you start your first job, you should take advantage of your employer’s sponsored retirement plans, usually a 401K, and begin contributing to your account. Save enough to earn your employer’s matched contribution. Open a Roth IRA plan.

Retirement Savings Ratio = 25 x Primary Income

If you make $100,000, your retirement savings should amount to $2.5 million. This ratio is also called the 25X Rule.

This ratio is complementary to the 4% Withdrawal Rule developed by William Bengen in his study, “Determining Withdrawal Rates Using Historical Data.” This means that you should be able to live during retirement by withdrawing 4% of $2.5 million in assets, or $100,000.  It is not a coincidence that 25 x 4% equals 100%. The math at least works perfectly.

Bengen was a financial planner from MIT. His study said that if you withdraw 4% of your assets annually (his analysis pegged the number closer to 4.15%) your retirement savings could last 35 years. Use this as a guideline rather than something etched in stone. You need to figure out what kind of lifestyle you will have in retirement.

The 80% Rule

Some experts use the 80% rule as a rule of thumb for estimating what your income at retirement would be. If your final income before your retirement is $100,000 x 80% = $80,000.

This means that you should be able to live on $80,000 comfortably in retirement. The assumption is you may be able to eliminate some expenses associated with work such transportation and can take public transit.

If you use this $80,000 amount in conjunction with the 4% withdrawal rule, then $80,000/ 4%= $2 million. This lower amount (than the $2.5 million above) reflects the reduced lifestyle needs of a retired person.

Related Post: Saving For Retirement In Your 20s

Qualitative Measures of Being Financially Successful

Sometimes number crunching is just not enough especially for measuring your financial success. We embrace our lives differently. Making a million dollars a year may be a bad year for someone used to making eight figures in the past. Others may feel retiring by age 40 is their mark of success. Being a barber at the age of 108 years was a supreme achievement for Anthony Mancinelli.

What are the qualitative ways of being financially successful?

Being Financial Independent

Having a target of being financial independent means that you have enough savings and income to pay for your living expenses without being employed in a job you don’t want to have or be dependent on others.

You may support yourself through alternative sources of income like dividends, passive income and part or full time work you enjoy. It is a great mindset for those with many interests and don’t want to be tied down to a job you don’t like or non-flexible hours.

Debt-Free And Financially Flexible

You have paid off all your debt. The only debt you carry are monthly credit card payments and are able pay them in full. You have a financially flexible life, meaning you can meet your current and financial obligations and have savings. You are not living paycheck to paycheck. You have liquid savings in the event of an emergency.

Don’t Fight About Money With Your Spouse

You and your spouse are on the same page regarding your financial goals and communicate regularly to stay on track. You have a game plan for spending, savings and debt and are aligned for the most part. This is an ideal scenario and difficult to achieve regularly. It is up to both spouses to meet regularly to review their budget for the short term and assess long term goals.

Couples often fight about money issues. It will happen for most of us. Being honest and transparent to each other is really what counts. If you veer offtrack from your goals, review your plan together and make changes if needed. Don’t think shielding the other from potentially bad or embarrassing developments is the right thing to do.

Be open and proactive about financial problems that should be dealt with promptly. Avoid financial fidelity.

Passionate About Your Career Job

It is easier to increase your chances for financial success if you enjoy your job and career. Some people have had success in starting up several successful companies, or even starting up one great one after several failures. Apoorva Mehta, the founder of Instacart, the online personal shopper, reportedly  had 20 failed startups before he successful built Instacart.

I have had success in very different career paths. When I was worked as an equity analyst, I enjoyed the quick pace and satisfaction of meeting with senior company management and communicating my research with institutional investors. I was passionate about my job. It was an exciting time for the telecom industry as digital Internet technologies created new products and services.

Now, as a professor, I love teaching and the “Aha” moment when students make connections in the classroom. When I feel I’ve made a difference, it is priceless.

Don’t Compare Your Financial Situation To Others

We often compare ourselves to others. It may give a point of reference to our peers which may not be a very complete picture. Obsessing over these comparisons is unproductive and may be stressful.

Social comparison bias is a human reaction. We allow ourselves to be influenced by comparing our financial achievements–income, net worth, our status, job title—to others. We negate different paths, personality traits and possibility that some inflation has been taking place.

A better comparison is to look at you are currently against the person you were in the past. What have you accomplished relative to what you anticipated in your plans? How do your results fit with your long term goals? That is a truer picture and will allow you to move forward with your next moves.

Enjoy Learning And Picking Up New Skills

To be successful, keep learning from your experiences and pick up new skills. Continue to challenge yourself with strengthening a weakness or adding a competence. Continue to evolve in your career, expand your skills, to manage people or learn a language. Not only will it keep you from being stymied, you will be more valuable at this job or elsewhere.

Final Words

Financial ratios are useful as a starting point to understanding your financial health. They do not take the place of a good financial plan. Although they have limitations, like age specificity, these metrics can move you to the next goal post. Consider qualitative measures of what being financial success is. what we all want is to be able to say that we had a life well spent.

How do you measure your financial success? How does it coincide with your financial goals? Look at your financial plan relative to your goals regularly. What works for you? We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Best Free Debit Cards For Kids To Teach Them About Money

The Best Free Debit Cards For Kids To Teach Them About Money

Giving your child a debit card can be an excellent way to teach them about money and budgeting early in life. With consumer debt in the US growing to over $14 trillion, according to CNBC and the Fed, any step you can take to help promote financial literacy early can go a long way.

However, not all debit cards for kids are created equal.

Some have higher monthly fees. Others are free but have ATM and card reload fees. And a few cards offer features above and beyond the competition.

It’s important to understand your options before choosing which debit card to get your kid, especially when it comes to cost. So below, we compiled a list of some of the best debit cards for kids, including a couple of free options you should consider.

What Debit Cards Can Teach Kids About Money

There are a lot of money lessons that kids can learn when using a debit card. Though, the one skill that they will likely pick up above everything else is budgeting.

By allotting them a predefined amount of money, you put the power in their hands to decide how they want to spend their cash.

Rather than saying they can purchase one toy when at the store or one candy bar when at the grocer, they have to look at each item’s price and decide what’s worth it and what’s not, just like the rest of us. They have to consider much more in terms of opportunity cost.

Plus, I think using plastic over cash can have some advantages. It’s like using training wheels before getting their first credit card.

With a kids’ debit card, you can put limits on how much they can spend. You can essentially make it impossible for them to overspend, and they might start to learn those boundaries.

Then, you take the training wheels off when they get their first credit card, and I think they’ll have a higher chance of not maxing out the credit limit right away because they have built the habit of sticking to a budget when using a card.

If we were following Dave Ramsey’s Baby Steps, teaching someone about money early would be like step 0. Although, he’d probably frown against the credit card training…

I digress. At the very least, giving your kid a debit card and talking about money will help promote financial literacy. Hopefully, that will go a long way in stopping them from contributing to that multi-trillion consumer debt number mentioned above.

What Defines a Kid Debit Card

Before diving into the list of the best kids’ debit cards, I wanted to define what a kid’s debit card is to me. Generally, I think it must comply with three rules:

  1. A kid (under the age of 18) must be able to use the card on their own
  2. The card must be accepted at most retailers and online
  3. There must be spending controls and parental controls, including transferring preset amounts to the card from a checking account

Also, there are usually features that allow you to track and monitor spending and manage chores.

Most of the best debit cards for kids are prepaid cards that you can load money onto. Since they are prepaid, you avoid the need to open a checking account and eliminate any possibility of overdrawing an account. The card being “prepaid” is the training wheels from the example above.

The 6 Best Kids Prepaid Debit Cards

Before diving into the list, I wanted to call out that the first two options are free! Meaning, there is no monthly fee associated with them.

The rest are still good options, and in some cases, better options, but there will be a monthly fee associated with them.

1. Akimbo Prepaid Mastercard

  • Monthly Fee: $0
  • Card Purchase Fee: $0 (first sub card free, after that $4.95)
    • Reload Fee: $5.95
  • ATM Fee: $1.98

The Akimbo prepaid debit card is technically free. However, even though there is no monthly or annual fee, there is a litany of other costs.

On top of the hefty $5.95 cash reload fee, there is also a $4.95 card replacement fee and a $5.95 inactivity fee (if your card is unused for 12 months).

I like the card because it’s free, and creating sub cards for your kids to use is relatively easy and only comes with a one-time fee of $4.95. Still, the other expenses associated with this card add up fast (especially the fee to transfer money onto the card).

Learn more about the Akimbo Prepaid Mastercard here.

2. Movo Digital Prepaid Visa Card

  • Monthly Fee: $0
  • Card Purchase Fee: $0
    • Reload Fee: $0 (in most cases)
  • ATM Fee: $2.00

The Movo card outshines Akimbo as a free debit card for kids in a few ways.

For one, there is no reload fee if you opt for direct deposit or other approved methods, which is head and shoulders above the Akimbo card. Imagine reloading $20 onto a card for a kid’s monthly allowance and having to pay $5.95. That’s over a 25% fee!

Even if you loaded $100 at a time, Akimbo is still taking nearly 6% from you.

With Movo, it’s free, which is a massive advantage if you plan to load small increments of money onto the card frequently.

However, there is a $4.95 inactivity fee that kicks in after only 90 days (compared to 12 months for Akimbo). If your kid is a good saver and doesn’t use their card often, you may face this fee from Movo. Like many other cards on the list, you have to watch out for ATM fees with this one as well.

Learn more about the Movo Virtual Visa Prepaid card here.

3. Current Visa Debit Card

  • Monthly Fee: $3 ($36 billed annually)
  • Card Purchase Fee: $0
    • Reload Fee: $0
  • ATM Fee: $0 (for in-network ATMs)

The Current card is not free, but it does offer transparent pricing and a one-month free trial. For only $36 a month, you add money to your card as many times as you’d like, worry-free.

Plus, Current offers more than just a debit card. They offer a mobile app with a whole suite of products, including teen banking. It’s one of the most technology-forward options on this list.

Also, for what’s it worth, the card looks cool and wins style points there.

Learn more about the Current Visa Debit Card here.

4. FamZoo Mastercard Reloadable Prepaid Card

  • Monthly Fee: $5.99
  • Card Purchase Fee: First four cards free, then $3 per card
    • Reload Fee: Free when using a qualified bank transfer or direct deposit.
  • ATM Fee: Varys by ATM

The FamZoo card is probably the most popular kids’ debit card option on this list. That’s because it was designed to be a kid’s debit card, whereas some other options on the list are just prepaid debit cards that happen to be good for kids.

Because the card is designed for kids, it offers a lot of neat features, including:

  • Setting up payments for chores
  • Monitoring and tracking kids spending
  • The ability to set savings goals for your kids

The monthly fee is $5.99 per family – so the value gets better the more kids you have using the card. Plus, there are methods to reload your card for free to help keep costs down.

Learn more about the FamZoo prepaid debit card here.

5. Gohenry Prepaid Mastercard

  • Monthly Fee: $3.99
  • Card Purchase Fee: $0
    • Reload Fee: $0 (when loading via debit card)
  • ATM Fee: $1.50

Gohenry offers a free 30-day trial. After that, it is one of the more expensive cards on the list, coming in at $3.99 per month per child.

The premium price could be warranted depending on what you are looking for in a kid’s debit card. Gohenry is designed for kids, similar to FamZoo, and offers a sleek app intended to help teach kids about money.

Last, the ability to personalize the card is a nice touch and could help your kid get a little more excited about learning about money. However, it costs $4.95 to get a customized card.

Learn more about the gohenry card here.

6. Greenlight Kids Debit Card

  • Monthly Fee: $4.99
  • Card Purchase Fee: $0
    • Reload Fee: $0
  • ATM Fee: $0

Rounding out the list is Greenlight, another card designed for kids.

In fact, their tagline is “the debit card for kids, managed by parents.”

The pricing is set up similar to FamZoo, where you pay $4.99 per month but can have multiple kids on the account. It also offers countless great features to promote financial responsibility for kids, including:

  • Chore management
  • Allowances
  • Real-time transaction notifications
  • Parent-paid interest on savings
  • And more…

Learn more about the Greenlight card here.

Bonus: Open a Joint Checking Account

  • Monthly Fee: asdf
  • Card Purchase Fee: asdf
    • Reload Fee: asdf
  • ATM Fee: asdf
  • Rewards/Perks: asdf

The bonus option on this list is to opt for a regular (non-prepaid) debit card.

You can do this by opening a joint checking account with your kid, giving them access to an FDIC-insured bank account and a debit card at the same time.

The two watch-outs with this option are:

  1. You need to make sure that you won’t get hit with any overdraft fees
  2. You need to check the minimum age to open a checking account, which can vary by bank

If you can get by those two hurdles, this could be a great option because it’s free. There are typically no monthly fees associated with checking accounts and debit cards, and you don’t have to worry about “reload” fees either.

Pros and Cons of Getting Your Kid a Debit Card

Kids Debit Card Pros

Teaches Kids to Budget: As mentioned at the beginning of this article, giving a kid a debit card can be one way to teach them about budgeting and enforce good money management practices.

You Can Set Spending Amounts: Most prepaid cards put the parent in the driver’s seat to set spending limits and monitor accounts. You can start to let your kids spend money on their own without completely letting them loose.

Avoid Overdraft Fees: Using a prepaid card, you eliminate the risk of having a kid overdraft a debit card and rack up hefty fees.

Multiple Other Features: From setting interest rates in “savings accounts” to incentivize savings to rewarding kids for doing chores, many of the best prepaid debit cards for kids come with additional useful features.

Kids Debit Card Cons

The Cost: There is no getting around it; whether it’s a monthly fee, reload fee, ATM withdrawals fee, or another type of fee, kids’ debit cards are expensive. The high price you have to pay takes away the risk of overdraft fees, and in some cases, the cost is offset with fun features to help you manage the card and teach your kid(s) about money at the same time.

No Rewards: Unlike traditional credit cards, most debit cards do not offer the ability to earn cash back or rewards.

Age Limits: The age limit to open a card tends to vary by company. This is another thing to keep in mind and look up before moving forward with a card.

How to Choose a Debit Card for Your Kid

Choosing a debit card for your kid is easy once you know your options.

In general, I think there are three questions you should answer to make the decision.

1. Do You Want a Prepaid Card?

If you want the safety and security that comes with loading money onto a prepaid card, then you have started to narrow down your options in the direction of the six cards listed above.

If you are okay with taking the risk of overdrafting an account or are familiar with a bank that stops overdrafting in the first place, going the route of a traditional debit card might be a good fit for you.

2. Do You Want Added Features?

If you want a card and app that comes with many bells and whistles, then opting for the FamZoo, Greenlight, or gohenry card (or something similar) is probably a good choice.

Each card’s website details exactly what it can and can’t do (such as monitoring spending). Before signing up, it’d be wise to read those details over carefully.

3. How Often Will You Reload the Card?

If you plan to reload the card monthly or even weekly, you’ll want to pay extra close attention to the reload fees and methods for reloading a card.

If you only plan to load up the card once a year, the monthly fee associated with the card is the cost you will want to keep lower.

Final Thoughts: Best Free Kids Debit Cards

Getting a debit card for your kid to use can be a great way to help teach them about money and budgeting.

Though it can also be a great way to simplify your finances, instead of doling out an allowance in cash, you can manage money digitally, just like most of us do when paying our own credit cards or monthly bills.

The key when choosing a card is to make sure the benefits outweigh the costs. As you saw reading through this list, these cards are not cheap, and the monthly costs and fees can add up quickly!

This article originally appeared on Your Money Geek and has been republished with permission.

Why Liquid Net Worth Matters

Why Liquid Net Worth Matters

“Liquidity is a good proxy for relative net worth. You can’t lie about cash, stocks, and bond values.

Mark Cuban

Understanding your net worth and how to calculate it is hugely important for measuring your financial health at a particular point in time. It is simply the difference between assets and liabilities. However, it doesn’t consider the liquid nature of your assets.

For example, stocks and bonds tend to be more liquid than other assets as they can be quickly and easily converted into cash. Other assets like your house or car take time and negotiation to sell if you need money. Net worth remains a helpful benchmark but depending on the type of assets you have it may be a less accurate picture.

Liquid Net Worth Is A Realistic Snapshot Of Your Financial Condition

Liquid net worth is what really matters. It is a far more realistic reflection of your financial condition should you face an immediate need for money such as a medical crisis or a business opportunity. While liabilities remain the same for both calculations, your liquid assets have more significance when unforeseen events occur.

Those assets for readily available as cash with little or no loss of value to be counted in liquid net worth. Having liquid money provides a sense of financial security for disasters and opportunities alike.

Asset Rich Cash Poor Can Be Uncomfortable

To a great degree, when you need to take money out to pay for an unforeseen event, would it be easier to take $15,000 out of your savings account or sell your land? Depends if you have $15,000 in the bank. The expression “asset rich cash poor” comes to mind. Often, people have economic assets like land or other economic interests but are not able to easily liquidate them for money.

Land and antiques are assets we have owned and enjoyed. However, you can’t count on those assets to pay for a costly emergency in your life. When I think about mistakes I have made, those purchases stand as major regrets. You sleep easier with access to liquid assets.

What Is Net Worth?

Your net worth is your personal balance sheet that provides a snapshot of your financial position at that time. Net worth is all that you own less than all that you owe. For an expanded explanation, see 10 Reasons Why You Need To Know Net Worth.

The  Formula: Net Worth =  Total Assets less Total Liabilities

Using an excel spreadsheet with different assets/liabilities is an excellent tool for you to put all of your categories in one place that can be periodically updated. You should do it on at least a quarterly basis. However, if you are true to your monthly budgeting, reviewing your monthly net worth is better.

Try putting it on a spreadsheet first. You can use Personal Capital’s net worth app for tracking your investments. Frankly, any way you can keep on top of your net worth with an eye towards building the amount will work.

Knowing Your Net Worth:

  • is a crucial benchmark and report card at a particular time.
  • will allow you to set near-term and long-term goals.
  • track its changes for better money management.
  • highlight your liquid asset balances.
  • helps you to get a loan for a house, car, college tuition, or new business.
  • pay down high-cost debt.
  • refinance your mortgage loans.
  • encourage you to save and invest more.
  • buy your own home, rather than pay high rent.
  • is a great road map to building your wealth.

 

What Is Liquid Net Worth?

Although net worth provides a view of your current financial condition, it doesn’t differentiate the assets that can provide you with liquidity quickly and easily. When facing a medical crisis or an opportunity to buy a business, getting access to your money matters. Sure, you can sell your car quickly but likely for less than the estimated value. Understanding what assets are more liquid means they can be readily converted into cash with little or no loss in value.

The Formula = Liquid Assets Less Total Liabilities

You can either remove non-liquid assets from your total assets or discount their values from their appraisals. Additionally, you need to recognize that tapping certain assets too early such as retirement accounts could result in paying penalties and taxes. More than that, you lose momentum when you withdraw assets that were benefiting from compounding growth.

 

Your Liquid Net Worth:

  1. Understand the differences between your net worth and liquid net worth. Liquid net worth is what you need to count on for immediate funds.
  2. Liquidity varies among our assets which have different growth rates. Money market accounts are liquid but typically have lower returns than stock investments long term.
  3. Consider costs involved in the transactions such as penalties, taxes, fees, and such

 

How To Calculate Your Liquid Net Worth?

Liquid Assets:

  • Cash
  • Cash-Equivalent Securities
  • Brokerage/Investment Accounts

The most liquid assets are cash, cash-equivalent (or money market) securities, and investment or brokerage accounts. These are either already in cash or are those financial or monetary assets that can easily turn into cash with little or no loss in value.

Cash is the best form of liquidity but of course, doesn’t grow unless it is invested.  This category broadly consists of cash on hand, prepaid cards, savings accounts, checking accounts, money market accounts, certificates of deposit (CD), savings bonds, and emergency funds. If your CDs are in a fixed term like 6 months or a year, you may need to pay a small prepayment penalty but this is fairly accessible money. Separately, you need to have an emergency fund earmarked for unforeseen expenses.

Brokerage/Investment Accounts

All types of financial securities can be bought or sold in your brokerage account. Typically, they are stocks, bonds, REITs, mutual funds, and ETFs that are in these taxable investment accounts. While these accounts are liquid in a matter of three business days, you do pay taxes on price appreciation based on the time you held the security. Holding the securities for over one year is taxed at a lower 15% capital gains rate. Otherwise, you pay taxes at the same rate as ordinary income.

Less Liquid Assets

The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes are less liquid.

Retirement Accounts

When withdrawing money from your retirement accounts before you turn  59.5 years,  you will likely be hit with a 10% penalty and immediate payment of taxes, losing the deferred benefit on that amount. Generally, if you withdraw early from a 401K plan or IRA account you will pay taxes at your marginal tax rate. The marginal tax rate is the tax rate paid on the dollar of earnings (eg 22%-24%).  On the other hand, Roth IRAs are treated differently. For those accounts, so long as you have had this account five years or more, you may withdraw contributions you made to your Roth IRA anytime tax-free and without penalty.

While you may have access to your retirement savings, these are not considered to be liquid. You should not dip into your retirement accounts unless needed as a last resort. By withdrawing these funds, you lose the compound benefit on this money for your future when you are less likely to earn money at your job.

A Temporary Exception

The federal government had waived the 10% penalty if you made a withdrawal between January 1 and December 31, 2020, for those impacted by COVID. Qualified individuals that put back this withdrawn money within a three-year time frame will be excused from paying taxes on the money.

If you are including retirement accounts in your liquid net worth, you should discount your retirement balances by 25% to be conservative.

529 College Savings Accounts

Like retirement accounts, withdrawal of money saved in a 529 college savings plan may be subject to a 10% penalty and you will have to pay taxes. The exception to this rule for 529 savings is withdrawals made for qualified education expenses such as tuition, fees, books, computer, and related costs.

If you are including 529 accounts into the liquid net worth, I would use a similar discount of 25% off the account balance.

Other  Assets

The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes is less liquid.

Tangible assets

These assets are real and personal property that reflects your lifestyle and is harder to liquidate for funds.

Your Primary Home

If you own the primary home you live in, this may be your largest asset. While the home is an investment, it is not a liquid asset like financial securities you invest in. You cannot count on liquidating real property for quick conversion to cash. You need to figure out how the real estate market is faring in your area using Zillow Zestimate and other sources.

Selling your home is a complex process that can take several months or more to accomplish. An appraisal value is not necessarily your sales price which is often lower. Also, to complete your sale, you are responsible for fees and costs including broker fees of 5%-6% on the sales price, closing costs of 1%-2%, and attorney costs.

Most likely you are carrying a mortgage that is picked up in total liabilities. Upon the sale of your home, you will pay off your mortgage in full from the proceeds of the sale of your home, reducing your liabilities.

Your primary home as an asset should be discounted about 25%-30% off its estimated value for purposes of liquid net worth.

Other Real Estate

Besides your primary home, you may own other types of real estate, including vacation or second home, timeshares, land, and rental property. Having just sold a plot of land, I can tell you that we took a 30%-35% hit from our cost basis in an ugly market after putting it on the market over a year ago.

Use current conservative market values for real estate. Appraised values may not reflect actual sales or liquidated values. You should not be inflating your liquid or net worth unrealistically.

You would need to approximate the value of your home, cooperative, condominium, cars, boats, and any other large items. To approximate real estate values, you can look at Zillow Zestimate, Redfin, Chase Home Estimator, or real estate websites for your zip code.

Your Business(es)

If you own businesses outside of your primary income, it is tricky to calculate a value let alone consider it to be a liquid asset. While you may want to include in your net worth statement a discounted multiple of annual revenues, it doesn’t make sense to include for purposes of liquid net worth unless you had the business appraised and a ready buyer.

Personal Property Is Tricky To Value

Unless you have a meaningful fleet of cars and boats, you should not add these to your assets for your net worth or liquid net worth.  These assets depreciate too fast and sell too slowly to add fairly to your liquid net worth. If you do have that fleet, for cars, you can look at Kelly Blue Book, Edmunds, or AutoTrader. Similarly, for boats, you can consult Boat Trader.

What Else Goes Into Total Assets?

Art, rare books, rugs, and antiques may be a large part of the net worth of wealthy households handed down to the next generation. Unless they are highly desirable or rare, these assets tend to be wildly low liquidated values to count on if you needed money in a pinch. Musical instruments have their value, but again, they are very difficult to peg and their sales are less predictable to raise capital.

This category has a lot of sentimentalities but its value may be very difficult to ascertain. In my opinion, these assets should not be counted on unless you work with an estate professional steeped in knowledge and who has a terrific network to help you sell the items.

My Own Personal Experience Provides A Valuable Lesson

When I worked on Wall Street, I was restricted from making investments in financial securities. If on that rare occasion I was able to buy certain securities, I was often not allowed to sell that security when I wanted to. So, on either side of the trade, I was burned and finally abandoned investing until I left my career as an equity analyst.

So what did I invest in?

A large part of our assets was in art, rugs, rare books, and antiques. What was I thinking?

These assets are on our walls (art), in our bookcases (rare books such as the first edition of the Federalist Papers), on the floors (ancient rugs), and antique furniture (signed in the mid-1760s by the cabinetmaker).

Ever try to sell an 18th-century Tiger Maplewood card table? We have! And we are still waiting for that sale.

Beautiful stuff, but they can’t pay the bills! So I don’t include these personal assets. The few pieces we have sold were at prices 70% below what we paid for them.

I digress but a worthwhile lesson for those who are collectors.

List all your Liabilities By Current Balances

 

Mortgages

  • Your mortgage loan balance is probably your largest liability.
  • The home equity loan balance.
  • Separate mortgage loan balances for the other real estate property (listed above in assets)

Other Loans

  • Student loans at the current balance.
  • Loans associated with the business(es) even though you aren’t including the value of the businesses.
  • Personal loans
  • Credit card account balances (you should break these out individually).

Related Post: Pros And Cons of Credit Cards

Total Liabilities

As mentioned earlier, the formula is fairly easy:

Total  Liquid Assets minus Total Liabilities = Your Liquid Net Worth

Depending on the composition of your assets, it is possible that your liquid net worth may be negative, especially when you are conservatively discounting large assets like your home but including the full mortgage balance. It is important for you to consider whether you need to adjust your investment strategies, spend less, save more, and make sure you have money for emergency purposes.

 

How Can You Build Up Your Liquid Net Worth: Make Good Trade-Offs

Track changes in your liquid net worth statement as early as possible to make sure you are making progress towards your goals.

Track your spending, review for areas you can reduce and produce savings

Have an ample emergency fund of 6-12 months for unexpected events like a lost job. Invest this fund in a liquid account like money markets.

Put more of your money into investment assets like stocks that can expand wealth rather than in personal possessions.

Add to your retirement accounts to the contribution limit. Avoid withdrawing money from these accounts which trigger penalties and taxes. The same goes for 529 plans.

Making more money at your job or a side gig to boost income.

Consider buying recently used cars than luxury fast-depreciating vehicles.

Choose to invest based on your appetite for risk and where you are in your life cycle.

Related Post: How To Make Better Trade-Offs

Where Should I Invest My Money To Maximize My Liquid Net Worth

Stocks are riskier but generate higher returns than keeping your savings in bank accounts at low returns.

According to Bankrate, the best annual percentage yield (APY) which is your effective annual return as of August 28, 2020 ranges from  0.60%- 0.91% for the top ten banks. Those paltry rates which do not provide much in the way of income. Typically, banks may require a minimum balance from $1 to $25,000 and have monthly fees up to $15.

The younger you are, the more able you are to ride out the greater risk found in stock investing, with the benefits of compounding effects.

Homeownership remains a worthwhile investment with currently low mortgage rates. But your home is less liquid than financial securities.

Decreasing your loans or debt liabilities will increase your liquid net worth.

Your Mortgage Loan Deserves Your Careful Attention

Look into refinancing your mortgage if you carrying a mortgage with more than 5% loan rates. You may realize savings.

Target carefully what you borrow, for how long, and at what rate. Look at taking out a 15-year mortgage loan versus a 30-year mortgage loan. While your monthly payments will be higher for the 15-year loan, total borrowing costs will be lower.

Taking on a mortgage loan is a big cost but home prices have generally kept pace with inflation until 2008-2009 when subprime mortgages played a huge factor in declining home values.

Lower Your Debt Where Possible

Pay off your credit card debt in full. It’s likely your highest cost debt so use extra savings, bonus, or tax refund to lower this amount. Otherwise, slow your spending.

Pay off your student debt as soon as you are able.

Final Thoughts

While net worth is a more common benchmark, refining your assets for liquidation purposes gives you a more realistic picture. Tracking liquid net worth helps you to understand your ability to deal with a crisis or an unexpected opportunity. When facing an immediate need for cash, you don’t want to withdraw funds that are earmarked for retirement.

Thank you for reading! If you found this of value, consider reading other articles on our blog, and join us by subscribing to The Cents of Money. Please let us know your thoughts!

Pin It on Pinterest