Key Financial Concepts When Saving, Investing, and Borrowing

Key Financial Concepts When Saving, Investing, and Borrowing

“Many people take no care of their money till they come nearly to the end of it. And others do just the same with their time.”

Johann Wolfgang Von Goethe

Use Time Value Of Money To Achieve Your Financial Goals

Understanding financial concepts can help you make better decisions. Time and money relate to each other as in  “Time is money.” A dollar in your pocket today is worth more than a dollar received five years from now. The time value of money is the notion that money can grow in value over a given period.

You should save or invest today’s capital so that it is worth more in the future. Present value relates to what the sum is worth today. On the other hand, the future value is what an investment (or a series of investments) made today will be worth later on.

Earning Simple Interest Is Good

Invest your savings today to have more money tomorrow. This earnings capacity’s potential depends on how you invest the money and earn on its interest rate.  One way of calculating interest is using the simple interest formula. Here, the principal generates interest income dependent on the interest rate. So if you had $10,000 in your savings account at 8 percent for four years, you would earn $3,200. However, you can do better by compounding the interest.

Compound Interest Is Far Better In Building Your Wealth

A different and more beneficial way is to earn income through compound interest, closely related to time’s money value. Assuming you don’t withdraw any money, compounding allows you to earn interest on interest on your balance. That is, your principal continues to rise as you make interest—the frequency of the compounding matters.  More frequent compounding (daily rather than annually) adds incrementally to more money.

Compounding serves as the basis of the time value of money. By adopting good financial habits of saving money, compounding over time is what builds wealth. Instead of earning $3,200 over four years at an 8% interest rate, compounding gives $405 more or $3,605 on your initial $10,000 deposit. Over a more extended time of 40 years, that $10,000 would grow to $217,245. Most of that growth comes from interest earned on interest. Ka-ching!

A Positive Effect On Your Money

Compound interest is one of the most powerful forces of investing. It fuels the urgency to set aside money early for your retirement. This financial term simply means that you add interest to the sum of a loan or deposit or interest on interest. Your balance grows at an increasing rate so long as you don’t withdraw money from your funds.

The power of compounding is the basis of key financial decisions, from your personal savings plan, 529 Savings Plan, retirement, and investment accounts. The earlier you save and invest money in the stock market, the longer the compounding works for you.

To better illustrate the power of compound interest is the classic question, “what would you rather have, a penny that doubles every day for 30 days or $1,000,000?” And the answer is the doubling penny which yields $10,737,418.23. Quite a bit more than the one million dollars. Take a look at our excel spreadsheet here.

It is not reasonable to assume a 100% annual growth rate for any investment annually, let alone daily.

However, suppose you save $2,000 per year in an investment account when you are young at 8% return, and save an additional $500 per month over 35 years. In that case, you could accumulate $1.1 million. Try using a compound interest calculator.

Saving For Retirement Early Beneficial For Growth

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

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

Lottery Winners: Lump Sum Or Annual Payments

There is only a tiny probability of winning the lottery. However, it uses the time value of money calculations (present value and future value) to decide whether to win a lump sum or annual payments. Lottery winners, after the rush of adrenaline, have a choice to make regarding time and money. Most lotteries allow the winner to take a lower lump sum or an annuity. The annuity option is a series of annual payments.

If the jackpot is $100 million, the lottery could arrange for 20 annual payments of $5 million while investing a lump sum to fund those payments to the winner. Assuming a present value of a series of equal payments of $5 million at 6%, they would need only $57,349,500 to fund the stream.

What Should The Winner Do?

If the winner takes the lump sum payment immediately (setting taxes aside), they would receive cash of $57,349,500 before taxes. I used a present value of an annuity table, finding a multiple of 11.4699 (at 20 years and 6%), multiplying it by $5 million.

The savvy winner would have the opportunity to invest the money and take advantage of compound interest. They would have to pay federal taxes and possibly state and local taxes as well.  Most lottery winners do take the lower lump sum payment upfront.  They want to have full access immediately rather than over several years, which is fine if they stave off friends and family who often benefit from this sudden wealth.

Choosing the annuity may be better for tax implications than the lump sum. Receiving a large lump sum can lead to sudden wealth syndrome and the risk of overspending for many people.

Like Warren Buffett, Invest early in the stock market, consistently with a long-term perspective, so you can build lasting wealth. 

The Downside Of Compound Interest

When borrowing money, compound interest works against you. Your lenders are reaping the benefits of earning interest on interest on your loans. Consider this when going for a loan such as a mortgage, student loan, personal loan, and credit cards.

Using credit cards can be particularly detrimental when you carry balances rather than paying the entire monthly balance. By merely paying the minimum on your monthly card balance, your debt is ratcheting up quickly with high-cost debt. Most credit cards carry interest rates at the mid-high teens level. Your lenders are channeling the Rolling Stones, “Time is on my side, yes it is..”

Manage Debt Carefully

Let’s say your credit card balance is $5,000 with a 20% interest rate, and you pay only the monthly minimum. The average minimum is usually a small percentage, such as 3% of the balance or a flat amount of $25. We ignore this for illustrative purposes. The issuer will add your interest of $1,000 to your new total of $6,000. At the end of the second year, you will have a debt of $7200, adding interest of $1,200.

The debt mushrooms in a negative way, holding you back from paying your debt off. Spend less than you earn. Make savings your priority, so you outpace the growth in debt and reduce it to more manageable levels.

Related Post: How To Manage Debt For Better Financial Health

Financial Implications For 30 Year versus 15 Year Mortgage

Typically, when buying your home,  you put 20% down and borrow  80% of the value of a house or an apartment. You will pay less interest when opting for a shorter-term mortgage.

When comparing the different loan maturities on a $300,000 loan:

  • The annual percentage rate (APR) will be higher for the 30-year mortgage than a 15 year one, all else being the same.
  • The monthly mortgage payments will be significantly higher for the 15-year mortgage, given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15-year mortgage because you pay less in total interest.
  •  Assuming you have a 720 credit score, the total home price, including total interest paid and down payment, will be lower with a 15-year mortgage loan.
  • The 30-year mortgage is much higher because you are paying interest on your loan longer, so the total home price or principal is $375,000 plus $189,622, equalling $564,620.
  • If you opt for a 15 year mortgage, your total home price or principal  is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $76,012 in total interest equals $451,012 for principal and interest.

Rent As An Alternative To Buying Your Home

On the other hand, renting provides flexibility and freedom. Your rent is usually more affordable than home costs, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not having to worry about potential declining home values. The downside of renting your home has restrictions to do what you want to make your place more livable. Your landlord could decide to sell the property and require you to move. There is always the risk of having a bad landlord whose actions force you to pick up and leave.

Related Post: A Guide To Buying Or Renting Your Home


Rule Of 72: How Long To Double The Principal

This handy formula always reminded me of a card trick. The Rule of 72 is a simplistic formula used to determine how long an investment will take to double given a fixed rate of return. Simply divide the interest rate that the money will earn into the number 72.

For example, suppose that you owe $1,000 on a loan and the interest rate you are charged is 20% per year, compounded annually. If you didn’t pay anything off at this interest rate, how many years would it take for the amount you owe to double? The formula for this rule is 72 divided by interest rate or 72/20 and equals 3.6 years.

As mentioned earlier, it is always key to use the magic of compounding in your favor and money growth, not debt. For other financial ratios like the Rule of 72, read this related post.

Opportunity Costs in Decision Making

The opportunity cost of any decision is the cost or the value of the following best alternative that must be foregone. We have many choices that may consider time, money, effort, health, and enjoyment in our lives.

When we invest in financial assets and building our net worth, we should consider risk, return, safety, and liquidity. We are making tradeoffs between these variables that we balance off of each other. Am I seeking higher returns in my portfolio and taking on some high yield bonds, or am I opposed to such high levels of risk?

When managing money, you may need to reduce high-cost debt before actively saving and investing. Consider your alternatives and research to find reasonable options. We have written on How To Make Better Money Tradeoffs here.

Final Thoughts

Time value of money and compound interest are among the most important financial concepts. Understanding these terms can improve your decision-making when managing your finances. Time is money though time is a priceless resource. Use it wisely and more productively.

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How To Make Better Money Tradeoffs

How To Make Better Money Tradeoffs

“There are no solutions; there are only trade-offs.”

Thomas Sowell

There are tradeoffs in most aspects of our lives. We have a plethora of choices and cannot do everything we want to do. For every choice we make, opportunity costs requiring us to forego benefits for the option not selected. Opportunity costs are the loss of potential gains from other alternatives when making a choice.

Tradeoffs between time and money differ significantly based on age and lifestyle based on our unique set of values. With less time like Boomers as an older generation, you might place more importance on time while young people may favor money. That is not always the case.  Based on this global survey, those in the 20s and 30s tend to lean more time than money, valuing experiences over possessions than boomers, as seen in this infographic.

Each of us has to decide based on our characteristics and circumstances. Typical examples of trade-offs between time and money as we ponder our individual decisions, we:

  • Opt for a job requiring a long commute for a pay hike.
  • Have one income with mom or dad staying at home with the kids.
  • Go to a movie instead of working on an assignment due the next day.
  • Job security with the government or seeking a wealth opportunity with long hours and traveling.
  • Attend a community college initially, then transfer to a four-year college.
  • Work at home to spend more time with family.

Sure, we can try multitasking or combine activities when we face conflicting demands on us. However, there is often a price to pay when poor execution results.

Make Diligent Choices

Instead, we may inform ourselves by making diligent choices. How conscious are we when we make these decisions? For some decisions, make complex financial calculations as needed. On the other hand, there are times when we may not even be aware of having made a choice. Time, money, productivity, and health may act as alternative constraints, reflected in your priorities.

Time is a precious finite resource we often waste. Even if we have unlimited capital available, we just don’t have the time to spend it fruitfully. We want to enjoy our lives to the fullest, with health on our side. Without taking care of ourselves, time is short, and no amount of money may cure our illness. Since we have longer life expectancies, we need to support ourselves by fulfilling well thought out financial plans.

Typical Tradeoffs We Face:


Your Home: Buy or Rent

Owning versus renting your home is among the most common tradeoffs involving personal preferences, age factors, and your financial situation. Our family has rented and owned our home. After many years of ownership, we are renting a home in a lovely town, taking advantage of a great public school system.

If you seek to own a home, do you prefer stability, building equity, control over the home, and its responsibilities and tax benefits? Will you enjoy a sense of pride in ownership? These benefits come at a high cost based on a 20% down payment and mortgage loans for 80% of the home’s principal price, with interest rates strongly determined by your credit scores. The opportunity cost of owning your home may prevent you from saving for retirement and making other investments. Your home will not likely appreciate more than inflation.

The term of your loan can vary based on 15 years versus 30-year mortgages–another trade-off. The longer the loan, the lower your monthly payments. However, the 30-year mortgage raises your total costs compared to the 15-year loan.

Financial Implications For 30 Year versus 15 Year Mortgage

When comparing the different loan maturities on a $300,000 loan:

  • The APR will be higher for the 30-year mortgage than a 15 year one, all else being the same.
  • The monthly mortgage payments will be significantly higher for the 15-year mortgage, given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15-year mortgage because you pay less in total interest.
  •  Assuming you have a 720 credit score, the total home price, including total interest paid and down payment, will be lower with a 15-year mortgage loan.
  • The 30-year mortgage is much higher because you are paying interest on your loan longer, so the total home price or principal is $375,000 plus $189,622, equalling $564,620.
  • If you opt for a 15 year mortgage, your total home price or principal  is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $76,012 in total interest equals $451,012 for principal and interest.

On the other hand, renting provides flexibility and freedom. Your rent is usually more affordable than home costs, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not have to worry about potential declining home values. The downside of renting your home has restrictions to do what you want to make your place more livable. Your landlord could decide to sell the property and require you to move. There is always the risk of having a bad landlord whose actions force you to pick up and leave.

My Take

The necessity of the tradeoffs of owning your home versus renting considers the tug between time and money differences.  When buying your home, you are making a long term commitment to the neighborhood, greater responsibilities in maintaining the property, insurance, and keeping up with monthly payments for some length of time. Alternatively, renting is usually a shorter-term commitment that may require future moves but with less responsibility and costs.

For families who want to control their home, buying is the way to go, especially if you can handle the shorter mortgage terms so you can pay off your debt sooner. Understand your long term goals for your family and financial priorities for your money. Don’t take on too big a house that you can’t afford. Renting is a great choice, especially if you don’t want the headaches of your own home. We compare advantages and disadvantages in our guide to owning and renting your home here.

A Car: Buy, Lease or Borrow

If owning your home is seen as the American dream, our culture has long embraced car ownership as a faithful supplement to our lifestyle. When seeking a car, you have a few alternatives. Do you want a new or used car, preferably certified pre-owned? Are you buying or leasing this car? If you are getting this car for personal rather than business use, the tradeoffs between buying the car with a loan or a lease are relatively straight forward. Assume you are getting a new car in a low-interest-rate environment and similar credit scores whether you are buying or leasing. About 30% of those getting a new car is leasing.

The Advantages And Disadvantages Of Leasing A Car:

There are lower upfront costs requiring a security deposit and usually the first month’s payment. Payments for registration and taxes are needed for leasing and buying the car. When leasing, you will make lower monthly payments for the lease term. Your credit score influences the amount, favoring those with very good to excellent scores.

The manufacturer’s warranty covers most if the leased car’s repairs.

Depending on your term, you are getting the latest technology available in safety, entertainment, and comfort. Those who lease can get a new car every 2-3 years.

There are mileage limits on the car though you may be able to negotiate a bit.

You don’t own the car at the end of your lease. Gap insurance is an optional add-on car insurance covering the difference between the amount owed on a vehicle and its actual cash value in the unforeseen event it is totaled or stolen. When returning the leased car, you may have to pay for excessive maintenance, wear and tear costs.

End of lease costs can be a bit shocking when returning the car. When we finished our lease recently, we were quite surprised at some of the hidden fees discussed when we initiated the lease. We incurred costs close to $1,000 to the lessor to reimburse them for taxes to the local municipality. These fees were relatively new to us, causing dismay. This lease was likely our final one.

Advantages and Disadvantages Of Buying A Car:

Higher upfront costs, including down payment and trade-in, if you have another car. Of course, the more the upfronts costs, the lower your monthly expenses.

Owning presents higher monthly costs than leasing, depending on term length. According to ValuePenguin, the national average of US auto loans is 4.37% in 60 months, though in recent years, buyers have increasingly extended their loan terms to 72 months, with 84 months gaining popularity. The longer the loan, the higher the total interest you are adding to the car’s cost. Experian has reported that new car buyers with the highest credit scores have average loans of 63 months versus those with the lowest scores taking out loans of 72 months.

As you own the car, there are no restrictions on mileage or what tires you want. While you can resell your vehicle, keep in mind that it is a depreciable asset that loses value in the early years and is impacted by mileage long term.

My Take:

The tradeoff on buying or leasing a car is similar to owning or renting your home. A third option to buying or leasing a new car is buying a certified used car. Depending on its age and mileage, it may have remaining time left on the manufacturer’s warranty. After purchasing and leasing cars for years, we recently chose this third option. We paid cash for a 4-year-old certified Subaru as a second car, given its strong reputation for longevity. We are tremendously happy with it.

Spending vs. Saving

This tradeoff’s concern is that it ignores the need to temper spending in favor of saving money. If you spend more than you earn, you either will be withdrawing from your savings and investment accounts or, worse, borrowing to pay for your purchases. On the other hand, if you spend less than you earn, you can better afford your living costs and enjoy life. Having money left over to build an emergency fund, save for retirement, and make investments provides you with more options over the long term.

Adopt an attitude that allows you to enjoy life but not be so costly that you can’t afford your bills. Avoid lifestyle inflation, which comes about when your earnings rise, and you increase your spending. The more you can delay spending and reduce impulse buying, the better your financial health. Many experiences are free, healthy, and worthwhile pursuits. Make room in your budget for a solid emergency fund, pay off your debts to manageable levels, and save for retirement.

Emergency Fund Vs. Debt Payoffs

You should be put savings aside for an emergency fund to cover at least six months of essential living costs. This habit will eliminate the stress of the unknown and reduce your need to abuse your credit card. Many people lack $1,000 in savings to pay for unforeseen costs like a job loss, an emergency surgery for a favored pet, or a damaged car. Having to pay for these costs often leads to higher debt, especially credit card debt with higher interest costs. Set small savings amounts aside earmarked specifically for an ample emergency fund and invest this money in a readily accessible liquid account.

Paralleling these savings, you need to pay your monthly student loans and your credit card bills. If you can’t pay your credit card balances in full, reduce your spending. It is easier said than done. However, committing to keeping debt at a manageable level is critical.

Saving For College Or Retirement: A Tough Choice

When faced with helping your children with their college funding or tapping your retirement money, it becomes a tough choice you don’t have to make. If you are in your 50s or more, you should not touch your retirement account. True, you want to avoid burdening your kids with student loans early in their lives. The average student loan is $31,172, a significant amount of debt to carry. However, they have the benefit of a longer-term horizon than you.

As a young couple, your earnings are rising through your 20s, 30s, and beyond. To avoid having to make a difficult choice, later on, save, and invest now. These are the years you should make your money work for your future. It may mean spending less now, so you have more money to address critical areas of your lives later consciously. These involve essential trade-offs.

Don’t ignore what you can do now to provide plenty of benefits to you and your family long term. Handling money allocation into key baskets for college funding, retirement, and investments early will improve your financial outlook.

Save For College Early Using A 529 Savings Plan

When you expect a child, put aside some money into a 529 Savings Plan or other plans you can read about here. You get tax benefits using pretax money invested in several options based on your preferences. The more money you can put into these funds, the greater likelihood of lower borrowing in your children’s college years. Most states have their plans and have a lot of investment choices. Prioritize saving early in your child’s life so that you don’t have to borrow from your retirement funds.

Retirement Savings In Your 20s

You should begin to save for retirement as soon as you enter the workforce, if not before. Most employers offer 401K retirement plans that make it easy to fund your account through your paychecks. Automating these payments is simple though it may require an opt-in process. Setting this up at work is among the first things you should do when you start your first job.

Many employers will contribute to your retirement account based on a pre-determined match formula. For example, if you save a targeted percentage of 6% of your paycheck to your company-sponsored retirement plan, they may add 50% of that amount or an additional 3% of the money to your account. Separately, you should also set up an IRA or a Roth IRA and focus on contributing up to the maximum amount allowed.

Saving for retirement in your 20s allows you to have a sizable nest egg with compounding returns when you are ready to move to the next stage of life. On the other hand, catching up to saving for retirement in your 50s, while possible, is very difficult. It may mean working longer or tapering down your lifestyle in your later years. The risk you have of waiting too long to accumulate retirement money is that of losing your job in your 50s or if, for health reasons, you no longer can work.

Facing these tradeoffs head-on and early in life create a lot of flexibility and freedom in your later years. Make your money and time work for you as productively as possible. It is easier to sacrifice some choices for the more significant wallet needed later on. Long term comfort in retirement is a worthwhile aim.

Final Thoughts

Making tradeoffs that consider time and money may be intuitive or involve financial calculations balanced with your financial priorities. Addressing many major decisions early in life may provide you with financial flexibility and the freedom to choose an array of lifestyle options. The more you delay thinking about your choices, the harder the trade-offs you have to make. Your 20s and 30s are golden times to tackle savings as your earnings rise. Avoid finding more things to spend on that don’t positively add to your comforts.

Thank you for reading! Please visit us at The Cents of Money to see other such posts and subscribe to our weekly newsletter.

What kind of tradeoffs have you been facing? Did your choices involve your lifestyle or career? We would love to hear from you!







How To Talk To Your Kids About Money

How To Talk To Your Kids About Money

“Poor or rich, money is good to have.”

Leah Eliash Kaufman, my grandmother

I worked in my parents’ housewares store after school, weekends, and summers. From the age of 12 until I got my first full-time job after completing college, I helped out my parents. It was a family obligation, and I was not paid but got a wealth of knowledge running an up and down business.

Mom and Dad did share their values about money. My mom was mostly frugal, particularly when we had difficult times. My friends came from modest means as well, but they always seemed to have more than me. They had the latest toys, trendy clothing, a new bicycle, and a new car later. We rarely went on vacation because the store was open six (and sometimes seven) days a week.

Memorable Lessons Passed On

While I didn’t have a ton of material things, my parents did pass on life lessons about the importance of education, working hard, and giving back to the community. They also encouraged me to set up a bank savings account, invest in stocks, pay more with cash than borrow, and quickly pay off debt. 

My mom was never able to go to high school though she wanted to be a lawyer. Circumstances prevented her from moving ahead. She was so savvy about money, investing, and running an ultimately successful business.

Are We Rich?

As a mom, I feel her influence, especially with my kids, now in their teens. When they were younger, one or both accompanied me to the college finance classes I taught. That opened the door for my husband and me to have some early discussions about money with them.

I always asked my mother when I was a young child, and my kids have asked us, “Are we rich?”

According to Charles Schwab’s 2019 Modern Wealth Survey of Americans ages 21-75, you are wealthy if your net worth is $2.27 million.

However, the amount varied by generation:

Gen Z         $1.49 million

Millennials  $1.94 million

Gen X         $2.53 million

Boomer       $2.63 million

Those surveyed said that 72% based their definition of wealth on how they live, and 28% considered wealth on the dollar amount.

The average US household’s net worth is $692,000, skewed because the super-rich pull up the number. A more realistic number is the net worth of the median US household, which is $97,300.

The truth is the majority of Americans need help in better managing money with these statistics:

  • Only 38% have an emergency fund
  • 59%  live paycheck-to-paycheck
  • 44% carry a credit card balance at medium to high teens interest rates
  • On average, we spend almost $500 per month on nonessentials

For these reasons, we, as parents, have an essential role in fostering our children’s attitudes and adopting good financial habits.

Here are 10 Ways To Talk To Your Kids About Money:


1. Start to teach them early.

Conversations with your teens about anything sensitive can be awkward, especially about money. According to a 2018 T. Rowe Price survey, 66% of parents are reluctant to discuss money matters with their children. Only 21% of the kids recall their parents speaking about money at least once a week.

Speaking to children about finances takes some of the mystique out of money for them at an early age. It is more comfortable for parents to talk about savings, giving them a head start in math. Explain how the bank holds money for people and explain how it lends money. This will begin a conversation about financial literacy, leading to developing money management skills.

I did take my kids at a too-early age to an ATM to take out money.  My daughter, Alex, got too excited and wanted to try pushing buttons to get some money. She also gave $10 to a friend in her pre-K class for being her friend. It was her tooth fairy money. Luckily, his mom tipped me off. We talked to her about how that money goes into the bank to grow into more money.

2. Wants versus Needs

As they got older, my kids became accustomed to asking for and expecting everything.

It is tough to teach “needs” and “wants” when your 8-year-old says that he needs a smartphone. His friends had one for a long time. We began to set money limits by giving money for after school for the whole week. They learn something about allocating more money for the days they have plans with friends.

Spending money is a neglected topic for many. When kids see us spending money on big-ticket items like a 65″ TV screen, I usually share my thoughts with them with examples. 

We took a vacation with the kids, and when I was eyeing a decorative bowl,  my son Tyler was upset with me for buying something and not limiting myself. He asked me, “if I needed it?” I thought about the bowl and realized I had one just like it. I passed on the bowl and let him know he helped me make the right decision.

Teach your children to shop wisely and not to be impulsive about spending. Emphasize need, quality, and price.

3. The Dangers of Credit Cards Versus Debit Cards

Having credit cards are a big responsibility for everyone. Credit card debt is toxic to all to carry large balances. Parents should speak to kids about the difficulty of mounting debt if you don’t pay your credit card balance fully. Parents are having their children become authorized users on their cards at an early age. Many banks do not restrict age, allowing a 10-year-old who may not be truly ready to have one.

Parents should use this opportunity to allow their children to learn to take care of cards by getting debit cards. Reasonable spending limits can encourage to make choices. Parents should talk to kids about what to use the cards for and when to use cash. A debit card is an excellent way for your kids to acclimate themselves to using a card with care. 

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

4. Financial Education For Your Family

The T. Rowe Price study found the effectiveness of financial education in the home or school were both falling short.

Most young adults who received some financial education in school are more likely to have a budget, emergency fund, be good with money, and have a retirement account. However, 34% said that their parents have more influence than schools on financial habits. 78% of young adults who received financial education had it in the 12th grade or later.

Encourage your children’s active participation in family matters that concern them. For example, they can make their case about the allowance they will receive, participate in family budgets for items you are shopping for like school supplies, clothes, and vacations.

Parents should enlighten their kids regarding their attitudes about money management. These are essential skills. For example, discuss getting another car. They can discuss why they may prefer to buy a new or used car outright versus taking a loan or leasing a vehicle.

Saving Money

If your goal is saving money, give your children reasons why buying a used car is better. A new car depreciates about 20% on average as soon as you drive it, plus most new cars lose some value in the first year. Along with these savings, you may pay less for sales tax, insurance, and registration fees.

Parents are in the best position to model responsible behavior about money. Once kids make some money on their own, parents should require their kids to save for their car when they begin to drive.

Still, the problem may go beyond parents’ reluctance to discuss money matters. Parents may be lacking in some areas of financial literacy themselves. It is a good idea to learn about money and to invest together as a family. I often talk to my kids about a favorite stock I own and why I still like it. They ask for updates at times.

5. Be Honest With Your Mistakes

We all wish we did everything well. The truth is that we make mistakes. We want our children to do better than us in education, making money, and managing money. If you have made money mistakes, whether it was taking on too much debt and paying it off or not having enough liquidity at times, share that with your kids.

We bought a lot of art and antiques at probably peak prices before we had kids. Frankly, I developed the bug to buy 18th-century Federal furniture and other collectibles, but it doesn’t contribute to retirement savings.

6. (Kiddie) Roth IRA

My mistake in buying antiques, although beautiful, is that antiques are less liquid than other assets when you want to raise money. This realization does allow me to discuss retirement savings with my Generation Z kids. Studies show that this generation is more aware of the need to set up IRA accounts early. Teenagers can contribute to a Roth IRA up to the amount they make from eligible employment.

If my son Tyler earned $2,000 as a camp counselor or at the movie theater, he can invest all or part of the $2,000. If kids invest all of it, parents can’t contribute up to the current maximum of $6,500 in 2021. Contributions to Roth IRA is limited to Tyler’s earned income of $2,000. If your teen is under 18 years, typically the age of majority, they are minors, and a parent has to serve as a custodian.

While it would be great for your teenager to contribute as much as possible to a retirement savings account, even a portion of their earnings would be a great start. The lesson for them is the growth of their contribution is tax-free and will benefit from compounding returns over the decades.

7. Investing In 529 Plan

As parents, you should set up 529 savings accounts for your children’s college education as early as possible. Your children may not even be walking or talking yet, but that shouldn’t stop you from beginning to save for your children’s future with tax-deferred dollars.

It is way too early to know if they will go to college. However, getting an early jump may allow you and your children to reduce the need to take on debt. If you haven’t opened an account yet, involve your children when you open the account and explain it to them. It is good to know that saving early may reduce the need for student debt later on.

8. Showy Social Media…Keeping Up With The Jones

Our kids are growing up with smartphones. They are continually interacting with their friends, reading about restaurants and vacations they have gone on, shopping for trendy clothes, shoes, and bags. They are exposed to many different lifestyles at a much earlier age than we as parents have been.

It is “Keeping Up With The Joneses” on steroids. Social media has led to many conversations after we recognized our kids looking a little crushed at times. They would point out that their friends were getting more things than they were.

An Example

Our son, Tyler, was on X-Box playing Fortnite with his friends all the time. Most of the kids were buying “skins” which are costly (up to $20 per skin), an expensive endeavor if you splurge for 60 skins.

We didn’t want to have to pay for this unnecessary game expense on an ongoing basis. We had to sit down with our son to explain that every family has different resources and spending patterns.  Some families make more, and some families make less. He gave us good feedback.

Weeks later, his group of friends moved on to another game.

9. Share Family Values versus Sharing Your Salaries

Discussing salaries are a complicated topic, requiring thought. Most families are uncomfortable discussing money in general, and even more so sharing their salaries. About 30% of families do not earn a regular paycheck. Besides, what does that figure tell your children? Often, it is an abstract number. Salary is different than your take-home pay because of the taxes you are required to pay.

Some say that revealing your salary is an essential part of educating your children about finances. It may help your children by being open and build trust in your relationship. Explaining how your take-home pay relates to your household expenditures could help your kids make your budget more transparent.

 A Better Life Lesson

Others say that salaries are personal information and children do tend to share everything. How do you explain your salary differences, or do you have to do so? 

There are many variables to discuss money without necessarily sharing your specific earnings or net worth. They prefer to know what you do for a living, do you like your job, and you will always have one.

It is better to share what you value, such as your family, friends, how you live, spirituality, and your beliefs. Learn what they value as well.

10. Charitable Giving

“To whom much is given, much shall be required.” KJV

It is never too early to involve your kids in giving to important causes to the family. It is a way to talk to your kids and find what their interests are. They can put aside some small amount and physically drop it in a box at a local shopping center or send a check. The point is to have them recognize they have social responsibilities larger than themselves.

Final Thoughts

Communicating openly and clearly with your children about money will help them grow more financially confident. It will strengthen their bond with you and earn their trust about financial literacy, a topic you don’t generally talk about with others. Their increased comfort with you will help them with important money management decisions they will need to make, such as college, career, buying an apartment or home.

Related Post: Why You Need An Emergency Fund (And How To Invest It)

What is your experience in speaking to your children about money? What works and doesn’t work? We would like to hear from you!










Working On The Street: Wall Street Jargon Explained

Working On The Street: Wall Street Jargon Explained

I worked on the street. It’s true!

For years, I told my college students and colleagues what I had done for a living before I taught business courses. They would exclaim, “Wow! I never knew anyone who did that!” or “What was that like?” “That’s tough, man!”

A True Story

The first time it happened, I was surprised. I realized, with a delay, the students were replying to another universe until Ron approached me. Ron was a disheveled-looking student I had noticed sitting in the back. Walking toward me, he said, “Professor, that took a lot of guts to share your background with us. I, too, live in the park most nights.” 

Suddenly I was aware I was taking it for granted that they understood “the street” as a common phrase for Wall Street. No, I was not “a lady of the night” but had been an equity analyst on Wall Street. This student had awakened me not only to a misinterpretation I was conveying but his plight living on the streets. With the school’s help, I was able to get him some support, but that story is for another day.

Language can be confusing. Those who have worked on idiosyncratic Wall Street recognize a different language and culture that permeates the business. Each area–research, sales, trading, investment banking, and money management— has its jargon that can be interchangeable. For those who want to work on Wall Street or simply want to know the basics of investing, this post is for you. Invest as early as possible. Use small increments of money at first just to get started..

Wall Street Jargon That Can Be Confounding:

Sellside/ Buyside

When I began my first Wall Street job, I had a lot to learn. As a newbie sell-side junior analyst, I was unfamiliar with a lot of jargon and felt stumped in others’ conversations. I had one particular experience that gave me a lot of personal grief and embarrassment.

It was a conversation with one of my peers, Amy, when she introduced herself. Amy asked me where I had previously worked and shared that she had come from the buy-side. I had come internally to join equity research from the “back office,” that is, the non-revenue producing part of the term.

When Amy said she came from the buyside, I had no idea what she was talking about nor what side I was on. I felt like I was in a war zone for a moment. In my early 20s, I used to turn bright red and never be able to hide it. Immediately, I marched into my boss with my beet-red light bulb face to ask him to explain. He patiently drew a lot of pencil diagrams. We were on the sell-side working for a brokerage/investment banking firm.

As a sell-side analyst, I covered the telecommunications services industry. I evaluated relevant stocks within that sector, published research reports, and made Buy/Sell/Hold recommendations.

The telecom industry was undergoing dramatic deregulation changes, facing new competition, entering the cable, internet, and video markets. I was marketing my research ideas to the buy-side analysts (did their own research) and portfolio managers, that is, institutional investors who were buying equities in my sector.

Long/Short Or Go Long/Go Short

Long/Short refers to what kind of security positions you have in shares. Investors who have “long” Apple shares expect that the stock will rise in value in the future. Short-selling or shorting is a more complex term. A short position is the opposite of a long position. It refers to the borrowing of shares by an investor and immediately sells them, hoping he or she can purchase them later at a lower price for a profit.

Short Interest

Short Interest is a gauge reflecting the number of shares sold short but not yet covered. Investors track them as a percentage or a number. An extremely high short interest for a certain stock may indicate negative market sentiment or high pessimism for that stock.

Short Squeeze

A short squeeze may occur when there is a rapid rise in stock. That happens due to a lack of supply accompanied by an excess demand for that stock. Stock prices rise when unexpected good news or better than expected earnings.

Overly negative sentiment about the company spurs short interest in the company’s shares. Short sellers get caught racing to cover their short position in the stock. Short covering happens to controversial or cult-like stocks like Tesla rise very quickly. Some investors didn’t believe Elon Musk or analysts’ bullish stance and shorted the stock. Then they got squeezed when the Tesla shares rose due to higher revenues than expected. 

GameStop Example

GameStop, a company with uninspiring fundamentals, is a recent example of short squeezes. Influenced by  r/WallStreetBets, there was excessive buying of this stock for no apparent reason other than seeming to want to impact short-sellers. Short squeezes resulted to cover high level of short-selling by hedge funds, among others.

As a result, GameStop (and other stocks) soared in this frenzy, before coming back down to more appropriate prices. Many young investors were caught, owning GameStop shares at these irrational levels, and potentially losing money.

Bull Market And Bear Market

We had a long bull market, or a rising market without a bear market threat until March 2020. The pandemic effects on our economy and the market came swiftly. The bear market arrived, but for only a few weeks.  For it to be a bull or bear market, the rise or fall has to be 20% or more. The term “bear market” came from the early 18th century.  Daniel Defoe said: “Thus every dissembler, every false friend, every secret cheat, every bear-skin jobber, has a cloven foot.” The bear market was first popularized when there was a huge market crash known as The South Sea Bubble of 1720.

There is more to the history of the origination of bulls and bears here. Envision these animals’ movement: bears swipe their paws downward while bull horns rise.

And The Pigs

“Bulls make money, bears make money, pigs get slaughtered,” a saying often recited by investors, portfolio managers, and traders alike. This old Wall Street saying warns investors against excessive greed. If you have a nice profit in your investment, it is a good idea to sell all or a portion to “ring the register.” No stock or investment continues to rise without abatement. A good strategy is to sell part of your position after your security has generated a 20%-25% return.

Taking Profits Off The Table/ Frothy Market

These terms are not synonymous but gradations. Taking money off the table or profit-taking are terms that indicated you sold your shares. Trimming some stocks is a smart move when you have made 20%-25% profits. You do not want to be too greedy. On the other hand, a frothy market is akin to a bubbly glass of beer leaking on the top. These are times when the market has been rising unsustainably.

Irrational Exuberance

As Federal Reserve Chairman, Alan Greenspan, in a late 1996 speech, referred to the risk of irrational exuberance associated with “unduly escalated asset values.”  Asset price inflation occurs when the S& P 500 index carries a price-to-earnings ratio well above its historical range.

Market Correction

A correction usually refers to a 10%  or higher decline of any security or the market. It may occur when the stocks have been rising without many drops and need some kind of pause. Corrections may happen over weeks or months. This produces buying opportunities in the long run. Historically, there have been more corrections than bear markets. Since November 1974 there have been 22 market corrections but only four bear markets according to Schwab Center For Financial Research.

Headline Risk

Sometimes markets seem impervious to bad news and continue to climb. Those are great days but seem too rare. More often, one or more negative financial news stories can provide an overhang to the financial markets, a certain sector (e.g., energy), or particular stock (e.g., Tesla).

Headline risk is news that may affect the price of stocks. Examples of this in past markets are US-China trade talks, Mideast conflict potential, Fed action, coronavirus. or Boeing 737 Max safety issues.

Black Swans

A black swan event comes as a surprise (can be negative or positive) that has a major effect impact on potentially ground shifting magnitude. The term is an ancient saying that relied on black swans not existing in contrast to white swans. However, Dutch explorers were reportedly the first to see black swans in Western Australia in the late 1600s.

Nassim Nicholas Taleb wrote of its theory in his book, “The Black Swan: The Impact of the Highly Improbable.” He argued black swan events have three characteristics:

  • Unpredictable;
  • Massive impact; and,
  • After the fact, an explanation is concocted that makes the event appear less random.

Some examples of black swan events are the rise of the personal computer, the Internet, September 11, 2001, World War I, and the financial crisis.


The most famous bubble is the Dutch tulip mania of the 1630s. It’s considered to be the first speculative one. It occurred during the Dutch Golden age when tulip bulbs were fashionable and had grown to extraordinary levels until their collapse.

A more recent well-known bubble was the US dot-com era in the 1990s until March 2000. Any company that had a “com” at the end of its name benefited from being associated with the hot Internet market. The company LDDS changed its name to Worldcom in the hopes that they would receive a higher valuation like the dotcom companies. The housing bubble is a more recent and familiar phenomenon. The higher pricing of housing financed by subprime mortgages caused the Great Recession.

When stocks rise without taking a pause, market participants fear their prices exceed reasonable valuations causing bubbles. Investors have growing concerns about cryptocurrency and SPACs  (special purpose acquisition companies) becoming bubbles. 

History Rhymes

There is an old saying that, “History doesn’t repeat itself, but it rhymes.” It is often credited to Mark Twain though there is no real proof that he said it. The saying (sometimes  “history rhymes”) comes up as people like to spot new bubbles or new patterns to point out that we have not learned our financial history lesson. Lately, I have been hearing there may be too much corporate debt taken on because of lower interest rates and that this be a bubble about to burst.

Following The Herd

A herd mentality is when investors follow what they believe other investors are buying without using their analysis. There is a danger in doing that as they may be purchased at higher prices at the end of that bullish cycle. This can be seen in stocks rise 20% on average after their initial public offering (IPO). Investors who didn’t participate in the IPO jump in to buy stocks after a big rise. In contrast to the herd instinct, investors often look for stocks with strong volumes as an indicator of increased institutional interest. I have used this strategy to a great degree to spot increased bullishness.

A Dog With Fleas

This saying points to some kind of defect in a company, for example, a business that has little to no growth or potential for any improvement. Most of the time, you can take a dog with fleas to a vet for treatment. Every investor wants to find a stock that has declined or has been “beaten to a pulp” undeservedly because its businesses are performing well. Sometimes it may mean that the shares are trading at a low valuation compared to their peer companies. Therefore, the shares could be “cheap,” “attractive,” or “value” or it may be like a dog with fleas.

An Improved Apple

One example of a dog with fleas was Apple a few years ago. Its growth had appeared to slow. Apple shares were trading at a low valuation despite having reliable businesses. However, no significant new products were being rolled out. Investors were lukewarm to Apple’s uninspiring new releases of its iPhones, iPads, and iMacs. Had it become a dog with fleas? 

The Apple Watch then gained popularity while the company transitioned to a service company from its lower-margin equipment roots and began its streaming business.  As a result, Apple shares have been performing well for a while.

Clearly, Apple is not a dog with fleas now.  On the other hand, dogs with fleas often refer to a company whose weak businesses may not be that apparent. The Boston Consulting Group (BCG) matrix recommends selling dogs as businesses with little potential for growth. Unfortunately for dogs, a lot of terms use them with negative sentiment.

Dogs Of The Dow

The Dow refers to  30 stocks of well-known large publicly companies, also known as “blue-chips”,  that compose the Dow Jones Industrial Average (DJIA).  An investment strategy popularized by Michael O’Higgins in 1991 was to buy the Dogs of the Dow, the 10 stocks which were part of the DJIA and had the highest dividend yields. The premise was investors could buy these high yielding but relatively safe stocks that had sold off. Many believe these stocks would rebound faster than the overall Dow.

Dividend Aristocrats

Another investor strategy is to buy stocks that are “Dividend Aristocrats.” A dividend aristocrat is a company that pays dividends consistently and raises its dividend relative to the size of its payouts to shareholders for at least 25 years consecutively.

Flight To Quality Or Safety

At times there may be several factors that converge on the markets, which add substantial risk. Stocks may decline if there are rising interest rates, a slowing economy, and reduced earnings estimates for the upcoming quarters. Investors may rotate out of specific sectors like tech growth stocks and flock to safer stocks with above-average yields. They may even rotate out of the equity markets and put money into Treasury securities. As the housing sector weakened leading up to the Great Recession, buyers sought refuge in these safer securities.

Widows and Orphans Stock

During times when there is an economic downturn, investors turn to safe harbors or “a flight to safety.” When a broker refers to buying “widows and orphans” stock for your portfolio it is usually for your protection against market volatility. Along with elderly people, widows and orphans refer to those most vulnerable in our society. These “vulnerables” require the preservation of capital associated with stocks like utilities with lower risk and lower return profiles.

Rising Tide Lifts All Boats

This term typically means that an improving economy will generally help most industries. Investors seeking shares in a specific industry, say energy or apparel, may see all such companies in the sector benefit from their industry’s fundamental strength. Often, some investors seek the best stock in the group, which may carry a premium valuation. On the other hand, value investors may look for those stocks in that particular industry trading at a discount hoping the valuation gap will narrow, thereby making a profit.

Bottom Fishing/Taken To The Woodshed

Going bottom fishing is often done by investors looking for bargains in stocks. Bad or unexpected news cause declines in share prices. It could be that the company reported earnings below expectations or apparent weakness in its business. The market–analysts, traders, investors–may have taken the company to the woodshed. That stock is now reflecting a cheap valuation because of its disappointment in the market. When valuation reaches a depressed level, and its risk is now fairly reflected in its price, investors go bottom fishing for potential good value.

Priced For Perfection

When shares are at high valuations relative to their historic levels, some say they are “priced for perfection.”  It may be challenging to hold these stocks because investors may treat the shares harshly if there is any earnings disappointment.  Any disappointment in its earning report–revenues, margins, subscribers, earnings, or forecast–will be why the shares sell-off.

Catch A Falling Knife

The image of this term used to make me wince a bit. When you own a stock that seems to be falling day after the trading day, there is a tendency to think that those shares must be reaching the bottom. If so, it could help you to reduce your cost of those shares by dollar-averaging. However, catching a falling knife refers to a stock that has its own downward trajectory, and investors should exercise some patience.

In 2017-2018, GE shares, historically considered a blue-chip stock part of the Dow Jones index, became such a stock. It was an absolute wreck, and its shares were in a downward spiral. Many analysts who covered this stock essentially said, “Don’t touch,” which caused GE to fall further. Sometimes, these falling knives may become bargains or even beautiful swans but it often takes major management changes and aggressive restructuring, which appears to be happening for GE.

Dead Cat Bounce

We have to give cats their due after using dogs, swans, pigs, and fish. After a long downward decline in the market or certain shares, a dead cat bounce occurs when there is temporary upward movement until the decline resumes.

Pound The Table/Back Up The Truck

Analysts on the sell-side must back up their recommendations or any changes they make to their earnings model, price targets, and earnings results. If a company reported better than expected numbers, the analyst would speak to their salesforce at the morning meeting, aggressively recommending a “Buy” on the stock. This event is “pounding the table” or telling others “to back up the truck” to load stock. Having a lot of confidence in a stock or sector often is mixed with the fear of being wrong as analysts undeniably are.

Among the more intimidating experiences analysts face is when you have to address this same audience with disappointing news in one of your stocks. That often feels like going in front of a firing squad. If you were downgrading your stock to “Sell,” this was an awkward conversation if they had recently bought the shares from your firm. The salespeople had the difficult task of explaining to their clients why their analyst’s perspective had changed.


Final Thoughts

Every industry has its bewildering lingo. When investing on your own and doing your own analysis, running into Wall Street jargon can be a distraction. This list of terms or sayings is only a small portion of words that belong in a larger glossary. I will add investment banking and equity analyst terms to make investing more manageable for you. I believe that everyone should be learning how to invest. Make use of a longer horizon, so you benefit from compounding returns for your retirement and investment accounts. For now, I hope this helps.

We have several related posts on Investing:

Guide For Investing Beginners

Diversifying Your Portfolio

How Stock Markets Games Can Teach Investing


Why You Need An Emergency Fund (And How To Invest It)

Why You Need An Emergency Fund (And How To Invest It)

“Life is just a bowl of cherries * but every once in awhile we get the pits.”  *Lyrics by Lew Brown

Emergencies happen. They can put a serious dent in our budget and our lives. My parents kept money in envelopes around the house, under mattresses, and in cookie jars. That works for some of us. Having your savings in a bank generating interest income even at low rates is preferable.

You need to have an emergency fund as a financial safety net for unexpected expenses that are necessary and urgent. How large it depends on your basic living expenses and lifestyle. Establish your emergency fund gradually to cover your family’s basic needs for six months to a year. Many people have been out of work for virtually a year due to the pandemic making us realize how important it is to prepare for emergencies.

Expect The Unexpected

Our family recently went through a recent emergency in our house during the cold winter. Our water just stopped sinks, no toilets! We had heat, which runs on a different system. We checked to make sure our circuit breakers hadn’t tripped. Our pipes appeared not to be frozen. We had no leaks anywhere.

Our plumber came over quickly. He went to the pump and tank in our basement. He tapped the control box and water to flow correctly. Lo and behold, our plumber declared our 40 plus-year-old tank and pump had lived its life to its fullest. We “mourned” its passing as it will cost $1,200 for the equipment’s replacement. However, we are celebrating the avoidance of potentially significantly higher expense (in the tens of thousands) if it had been frozen and burst with water damage.

I was thankful that we were able to have our plumber come over quickly. Having an ample emergency fund in place to fix this annoying event is a reminder for all of us. Yet, only 40% of Americans have $1,000 emergency savings on hand, according to a Bankrate survey. Protect yourself from having a cash squeeze or toilets not properly flushing.

Focus On Savings, Not Excuses

Yet, we all have excuses as to why we don’t need to set up an emergency fund account. You believe you have a stable job, your parents will help you out, or you can always use your credit cards. You may not be able to fathom putting one month of savings, let alone the recommended six months of money, in an emergency fund. It could simply be that you are procrastinating and intend to have one.

Unfortunately, you can’t time your financing needs for the unexpected times you need cash. As I indicated from our recent experience, you never know when equipment fails.

Make Savings A Habit

Start saving a little at a time if you don’t yet have it. Saving is a good financial habit. You should budget for 10% of your income going into savings. Part of those dollars should go towards unexpected needs. Here are some ways to save, ” 25 Ways To Save Money And Feel Good About It.”

Plan your emergency fund for six months or more as your goal. Your fund should be a big enough cushion to pay your monthly bills and costs such as food, rent or mortgage, utility, health care, car, property taxes, and pet care.

According to the 2018 Report of Economic Well-being of US Households, 40% of adults, if faced with unexpected expenses of $400, would either not be able to cover it or would do so by selling something or by borrowing. Data from says 62% of Americans have less than $1,000 in savings.

Your Emergency Fund Is A  Priority

The dollar amount you should have in the emergency fund account varies by a few factors:

Household Size

The larger your family is in terms of dependents, including aging parents, the more money you should have on hand. You will need an ample cash amount when dealing with young children and the elderly which may be subject to more unknown medical circumstances than a young couple.

Income Streams

The more predictable your income is, the less you may need. Regular income is in contrast to generating less predictable income. About 30% of Americans have income that occasionally varies or quite often.


The younger you are, it is generally easier and quicker to find a job. A job search varies from 4-6 weeks if you are young to 55 weeks if you are  55+ years.

Your fund should be readily accessible and liquid. Later on, we will talk about how to invest this money.

10 Reasons Why You Need An Emergency Fund


1. Certain Events May Result In Higher Costs Are:

  • Dental bills for root canal surgery;
  • Emergency pet care;
  • Home repairs like your roof from a sudden storm;
  • Car repairs after running into a deer;
  • Emergency room visits;
  • Significant health expense for surgery, and
  • Job loss.

We have experienced all of these unforeseen events; sometimes, two of these happened simultaneously. It can happen to anyone. Without readily available liquidity, it can be costly to pay for it through other means like borrowing.

2. Avoid Adding Debt

When faced with unexpected expenses, tapping your emergency fund is much more cost-efficient. Personal loans can get expensive unless you have a 700+ credit score. If you regularly pay your monthly credit card balance in full, then putting unforeseen expenses on your card may make sense.

However, if you have a less than stellar credit score, say in the 600 or below level, you may face mid-teens or high rates on a personal loan. Similarly, adding more debt to your card balances can be moving you in an inferior direction.

3. Insurance Doesn’t Cover Everything

For some unexpected events, you may assume insurance will cover those costs, such as medical expenses.   However, insurance may not cover your whole bill, and there may be a deductible amount you have to pay. Insurance is always great to have, but you may be surprised about the additional expenses you may incur.

4. You Don’t Want To Sell Something You Want

Even if you are someone with many assets, like investment and retirement accounts, land, jewelry, art, and antiques, you may think you don’t need to have a separate cash account.

I can attest to the need for a separate fund from your investment accounts. The last thing you want to do is sell your stock investments in a volatile market to pay needed bills that you didn’t plan.

Other assets, especially those of sentimental value, may be even less liquid. Selling those items are usually not quick or easy when you need funds in a hurry. Bargaining power goes to the buyers in those situations.

5. Avoid Withdrawing Money From 529 Savings And Retirement Accounts

Don’t be tempted to use savings for college tuition and retirement for your emergency. These accounts are for specific purposes and beneficial for their compounding growth and tax-deferred nature. You don’t want to reduce your savings here, mostly when you may incur penalties and have to pay taxes on the amount withdrawn.

In the case of traditional IRA and 401K accounts, you may incur a 10% withdrawal penalty unless you are 59.5 years or meet IRS exceptions. The amount you took out is taxable income subject to an ordinary tax rate. There is a 10% withdrawal penalty if you are using the funds for non-qualified education expenses.

Related Post: Saving For Retirement In Your 20s

6. Borrowing From Your 401K Retirement Account Should Be The Last Resort

If you don’t have an emergency fund, you may consider borrowing against your employer-sponsored 401K account. Most employers do allow this. However, it is complicated to borrow from your 401K account and be a last resort to pay for emergency costs. You may want to consult a financial advisor.

Related Post: How To Choose A Financial Advisor

Generally, you are not allowed to borrow against an IRA account, either Roth or traditional. If you have an employer-sponsored 401 K retirement plan, your company may allow you to borrow from your own account.

There Are Downsides To Understand

You still lose the benefit of tax-deferred growth on earnings and potential employer matches during the time of repayment. There are borrowing costs, fees, and possible tax implications.

It is still preferable to have an emergency fund than borrowing from your retirement account. Remember that these savings you are investing are for your nest egg benefiting from compound growth. Removing these dollars will reduce your retirement money.

Moreover, Fidelity has found 10% of 401K participants who borrow from these sources to take a hardship withdrawal, resulting in taxes and penalties.

Subject To IRS Limits

The IRS limits 50% of your vested balance, up to a cap of $50,000. Repay the loan within five years. Payments are usually made monthly or quarterly. The loan’s interest rate is generally 1%-2% over the prime rate, currently 3.5%. Besides the borrowing costs, there are likely to be fees charged by the employer.

That loan rate may not sound too demanding to you. Remember, you are borrowing from your retirement dollars and paying it back with after-tax dollars. This withdrawal is a double whammy since you made contributions with pre-tax dollars.

You may have to quickly repay the balance to avoid turning your loan into an early distribution (when you are younger than 59.5 years)  if you want to leave your job sooner than five years. Think carefully about an emergency fund that can be more helpful than using your retirement account as a cash cow.

7. If You Cannot Get Unemployment Benefits or Have Volatile Income

If you are self-employed, an independent contractor, or a freelancer, you will not be entitled to unemployment benefits. You may also be subject to irregular earnings, which requires good savings habits for the months when your cash flows dip.

According to the Federal Reserve’s report, 30% of Americans have income swings occasionally to quite often. You need to have a robust emergency fund for those times.

8. Job Loss

The loss of a job within a household can be detrimental. Attaining a new position is dependent on the economy, time of year, the person’s qualifications, experience, demand for his or her skills, potential pay cut, a geographic move (which adds more costs), and age factors.

The duration of unemployment significantly expands during weak economies. As the national unemployment rate rises, your job search will take longer. It doubled during the Great Recession, and many workers took pay cuts, temporary jobs, or did part-time gigs. We hear similar stories due to the pandemic-related recession that is ongoing.

Our Set-Aside Fund Helped Us

My husband, Craig, and I lost our jobs on the same day. Luckily, it was before we had children and our dog. We still had to pay our mortgage and our required bills rather than face hits to our credit scores.

My search took a few months, and I felt quite fortunate. Craig decided to start his law firm. It required upfront spending for his new office for furniture, security deposits, and other costs. Without access to cash, he probably would have had more difficulties setting up his new venture.

9. Financial Support For Aging Parents

As our parents get older, we want to do as much as possible for them. Their medical conditions may worsen unexpectedly. An emergency fund may give us access to funds to help them financially.

Did you know there are 30 states in the US and Puerto Rico that have Filial Responsibility laws that pass the obligation for primary care and needs of aging parents to their adult children? These laws are from England and specifically the 1600s Elizabethan era (where most American laws come from) but very much in place today.

Essentially, these filial laws require adult children to financially support their parents if they are unable to or if there are unpaid medical bills or assisted livings costs that are due. Basic needs include food, shelter, clothing, health care, and medical requirements. Every state law differs and may extend to other relatives.

There is a Yiddish proverb: “God gave burdens; he also gave us shoulders.”

10. Peace Of Mind

Having some money available for emergencies gives us all peace of mind. As sure as death and taxes, unexpected events will occur, and we may not have the money for unforeseen costs. Build your emergency fund to meet that financial burden. The event on its own will likely cause us a lot of stress.

So making financial arrangements will help us have the liquid funds to pay for those costs. Having financial flexibility is having the financial ability to pursue your goals purposefully. It also allows you to take advantage of opportunities as they present themselves during your life. That is peace of mind. Having an emergency fund will help you get it.

5 Ways To Invest Your Emergency Funds

Are you convinced now of your need for an emergency fund? I hope so! Where should you invest your emergency funds? Your family should keep his money in readily accessible and liquid accounts. Liquidity means the ability to convert into cash with little or no loss of principal value. That said, you will be losing money to inflation each year by leaving your money in cash.

Inflation risk refers to purchasing power loss when you will not earn at the same rate of inflation. The average target of inflation is 2% annually. Ideally, you want your emergency fund account to keep pace with the inflation rate.

What Is Not A Good Place To Invest

It is not good to invest your emergency funds into growth stocks because of their inherent risk factors. Growth stocks have higher risk/higher returns and are volatile. They are significant investment assets when you have a long horizon. However,  you don’t want to withdraw funds from stock investment accounts when there is a market downturn. 

High quality corporate bonds are usually less volatile and provide lower risk/lower return than stocks. You also want these securities for the long term and do not necessarily rely on them for raising cash. The one exception are Treasury Inflation-Protected securities discussed below.

Related Post: 10 Tips To Diversify Your Investment Portfolio

Here are some of my recommendations for investing in your emergency fund:


1. High Yielding Saving Accounts

The average savings account in banks pays minimal interest of 0.10% APY or annual percentage yield. This return is not very exciting though better than keeping emergency funds in your checking account.

A better place is high-yielding savings accounts, whether a financial institution online or at the bank.  They generally come with low fees or without fees depending on whether there is the minimum amount required to be kept in the bank. Importantly, your account is insured up to $250,000 at banks by the Federal Deposit Insurance Corp. (FDIC), providing safety and interest for your account.

According to Bankrate, the best high yield savings accounts in July 2019 range from 2.40%-2.55%. Today, these amounts are far lower due to the Fed lowering fed funds rates so check your bank.

2. Money Market Accounts

Another choice is Money Market Deposit (MMDA) accounts consisting of low-risk short-term (one year or less in maturity) money market securities like treasury bills, commercial paper, and certificates of deposits known as CDs.

They are a type of savings account that is FDIC-safe and provides interest rates of 2%-2.50%. Some offer debit and ATM cards along with check-writing abilities. There may be minimums and low fees. Again, rates may be lower, so please check to see what the current is.

3. Money Market Mutual Funds

Money market mutual funds are similar to a money market account as they both contain money market securities. However, investigate sponsored mutual funds by an investment fund company. These funds do not  have FDIC protection. They issue shares to investors. The Securities Exchange Commission (SEC) oversees the funds. You can buy a fund containing all government securities like virtually risk-free treasury bills.

Vanguard offers a conservative money market mutual fund for $1 per share, with a low expense ration of 0.16% with a minimum investment of $3,000 with a recent yield of 2.31%.

4. CD Accounts

You may want to consider a CD account rather than a mix of money market accounts, including virtually risk-free treasury bills. A CD account may provide higher interest rates than a mix of money markets and are FDIC-insured.

Buying CDs may reduce your access to this money for some time. They are typically from 3 months-1 year but can go as long as five years. Don’t get locked into five years. The longer the time frame, the higher the interest rates. However, if you need access before the maturity date you may face penalty fees that may defeat your emergency fund’s goal.

5. Treasury Inflation-Indexed Protected Securities (TIPs)

Another option will be to buy TIPS outright from Treasury Direct online or Fidelity if you are concerned about inflation risk.  You can also consider a  TIPs mutual fund from Vanguard. As their name implies, these securities tracks an inflation index like the consumer price index or CPI. Its yields reset when there is higher inflation based on a formula.

Vanguard has a TIPS mutual fund with an average duration of 2.6 years. It has a minimal expense ratio and a $3,000 minimum and yields a 0.44% return, commensurate with the low inflation risk reflected in our economy. The motivation to put some money into these securities is if you want to keep pace with potentially higher inflation better.

Final Thoughts

You may want to consider allocating your emergency funds into different accounts based on your preference for safety, liquidity, higher interest rates, and inflation risk. Don’t let these issues become an excuse to delay saving for the emergency fund itself. You have at least ten reasons to inspire you to take control over the “what if’s” in your financial life.

Thank you for reading! Have you put savings into an emergency fund? Do you put savings into your budget?  














5 Budgeting Methods To Boost Financial Discipline

5 Budgeting Methods To Boost Financial Discipline

I have to admit that  I am hostile to the term, “Budget.” The word signifies limitations as if I will have to change my lifestyle. Before I prepared a budget, I felt anxious about doing one. Only one out of three (32%) people prepare a monthly budget, and those making at least $75,000 a year are likely to do so. Why do people not want to do a detailed budget?

Common Reasons For Not Having A Budget

  • It is too much work, and I don’t know where to start.
  • I don’t know if I need one.
  • Fear of finding out about mistakes I was making.
  • “Don’t want to rock the boat,” as it may involve confrontation and change.


The Mistake Of Not Finding Out

I had a vague idea about preparing a budget but was reluctant to do one. Craig, my husband, paid the bills, went grocery shopping, and we dined out most of the time. Financially, we were in good shape, living more modestly than others we knew earning less.

Changes like these often require a financial review. We never really sat down to discuss our finances through the years though we met several times with a financial advisor to draw up a financial plan. We were enjoying financial flexibility, but we wanted kids and more space. At some point, virtually overnight, we had two babies and needed a bigger apartment.

These changes meant thinking through our finances since I had left my lucrative career, and Craig was building his law practice.

As I was in law school, I relied on Craig to work through some of the numbers as to what we could afford in terms of more space. That was a big mistake on my part and unfair to Craig. I was the numbers person, yet unaware of our finances. Many of our assets–land, arts & antiques–were less liquid than I realized.  Later on, I found many late notices from delayed payments on bills. And it was the beginning of the financial crisis, and it impacted Craig’s practice.

My Epiphany

We had two kids, a dog, a spacious apartment in less than three years, generating lower-income and still spending as when it was just the two of us. I felt lost, realizing Craig’s income was down, and I did not have a good handle on our monthly costs.

Where was our money going? I soon realized that I needed to create a budget to review and analyze our finances better. It sounds like a cliche, but it was an epiphany for us. Yes, I found mistakes I didn’t want to admit to making, and yes, Craig and I had arguments. We worked to resolve them together by making changes, some more drastic than I wanted. We still handle money differently, and I am more firmly in the frugal camp.

Start Budgeting Early

Don’t wait to budget as I did, using excuses of not needing one or not knowing how to start.  It can be easier to create a budget when you are young because you have less money and few assets. Sure, budgeting is tricky when you are just starting in your life. You may be carrying student debt and renting an apartment while your salary is at the beginner’s level. On the other hand, you have fewer costs to monitor, making it an excellent lifelong habit. Use it as a motivational tool to save more and spend less. Be diligent in improving your money management skills. 

Yet, preparing a budget is the cornerstone of a successful financial plan. Budgeting is a lot like dieting. It is hard to start one when there are many choices. Each works differently for each person. Both diets and budgets, may provide lasting benefits and bring you closer to achieving goals.

There are many benefits to having a budget at any income bracket. Even if you were to inherit $100,000 tomorrow, you need to understand how to deploy this money best. A budget can help you.  You just need to find the best budget method that works for you. We discuss five different budget methods below.

Reasons For Having A Budget

  • Having awareness provides essential financial discipline.
  • Make changes to patterns you want to avoid.
  • It helps you to achieve your financial goals.
  • Be more conscious of how you handle money, so you rein in overspending.
  • Improves your ability to pay off credit card debt by allocating saving better.
  • When you have better control, you can allocate more savings to investments.



5 Budgeting Methods To Boost Financial Discipline


1. The 50-20-30 Budget Rule

This budget rule is straightforward. It prioritizes your needs over wants to build your financial future.

Essentially, you are dividing your after-tax income into three buckets:  

50% For Basic Needs

Paying for your basic needs is your priority. About 50% of your earnings go toward your basic living needs. Housing is the proportionally most considerable amount of your basic needs and includes utilities, groceries, car, loan payments, minimum debt payments, and other monthly fixed expenses. 

20% To Savings And Debt Prepayment

This income bucket devotes 20% to savings. This amount is building your financial future. If you have significant debt levels, then a higher percentage should go into this bucket and be reduced from the wants category. Your savings can pay down debt, build an emergency fund, retirement savings, and investing.  When paying off your debt, you are likely saving money by eliminating the interest costs you carry on your balance, especially credit cards. 

30% For Wants 

After the above priorities, allocate 30% for wants or desires. This allocation is for discretionary or flexible spending for entertainment, vacations, and shopping. After your preferences, the remaining amount is for your desires. Overspending here means you will have a debt to pay above. 

The Pros of the 50/20/30 Budget Rule

This method is simple as you are only tracking three categories, needs, wants, and savings. You have the flexibility of allocating the savings into other areas, like debt pay-offs.

The Cons of the 50/20/30 Budget Rule

It is not as structured as other methods, and some people just need that discipline. You may have little to no savings but have more debt in that bucket. Then proportion the buckets to fit your needs. Paying off debt may be more of a priority than spending as much as 30% on your discretionary wants.   

 2. “Pay Yourself First” or Reverse Budget

This budget strategy to pay yourself first aligns well with a lifelong principle of personal finance. It is a reverse budget because, unlike other methods, you are saving before paying your bills. It emphasizes savings as the golden rule to learn early in life.

For some, saving money is hard, let alone putting 5%-10% away, which may be virtually impossible. Instead, set aside even small amounts like $50-$100 for your retirement, emergency fund, and savings accounts first. Automate a savings plan for these accounts. When you can, earmark more money, so you will grow your financial future.

That does not mean you don’t have to pay your monthly bills (you do!) but make savings your mantra. You may need to be more frugal at times to restrain some of your spendings so that you can put some away out of your reach.

The Pros of the “Pay It Yourself” Budget

By prioritizing your savings to a retirement account, you can earn compound interest on interest or pay off your debt if your levels are high.

The Cons of the “Pay It Yourself” Budget

As a standalone budget plan, “pay yourself first” may be too simple. You should understand the trade-offs between paying off high credit card balances, which will grow faster than savings as the card issuers charge far higher interest rates than you will get on savings.  However, saving money is an essential personal finance concept that will lead you to invest more at higher returns.

3. The Envelope (or Cash Diet) System

The envelope system may be a more comfortable budget method to adapt to if you are more cash-oriented. If you are paying for everything via credit card, this could be a rigid way to budget. This system entails placing exact amounts of cash into envelopes for each monthly expenditure you make, including your fixed costs. Putting money in jars or socks can substitute for envelopes, but I don’t think you want to walk with that.

Here’s how it works. You need to go to the bank to get a large amount of cash and allocate amounts into your spending categories. You would label each envelope and its amount for each of the following typical costs:

Groceries $500

Rent/Mortgage $1,000

Utilities $300

Dog Grooming $75

Gas $100

Gifts $100

When an envelope is empty, funds are exhausted for that category, and you can’t take out money from another envelope. This method involves a good understanding of how much you typically spend on each classification. The envelope system provides strict budgetary control and may reduce overspending. You run out of money for dining out, and you may have to change plans.

 This budget is essentially a cash diet, and some categories, such as rent or your mortgage payments, don’t translate that well into cash. You can still pay most things with checks. Studies show that people tend to spend less when they use cash payments.

You can use white envelopes for this system if you are frugal like I am. I have seen beautiful Celine envelope wallets ($700+), binders, and there are envelope apps to use like Mvelopes and GoodBudget.

Pros of The Envelope System

You are using cash, which can teach you to be more financially disciplined. It will require you to know your budget and the key categories well. You will likely spend less when you know you are running low on cash.

Cons of The Envelope System

This method is time-consuming, especially at first. It is inconvenient to have to withdraw money and carry cash around. Carrying cash conjures up that scene from The Wolf of Wall Street when Donnie Azoff (Jonah Hill’s character) was lugging around a suitcase filled with bills to deposit in a Swiss bank.

Paying cash is not always welcome. A cash diet may be challenging for particularly fixed costs, like paying your mortgage. Instead, you can try the envelope method for discretionary spending and then see if you can pay fixed costs by check. Using checks may mean more work or creativity on your part.

4. Zero-Based Budget or Every Dollar Budget

The Zero-Based budget originates from a business concept where every expense needs justification by a project’s need. This method is number-crunching heaven for those who need more structure in their budget. Essentially income minus costs need to be zero.

Households can implement this budget, similar to a traditional budget. The primary difference here is the budgeter proactively allocates remaining money, if not spent, to a financial goal.

Expenses are costs, outlays for savings, debt payoffs, investing, and charity. You assign a role for each dollar of your earnings to your expenses, savings, debt payments. Savings is a line item on your budget.

For a family, you would total the household earnings from multiple sources minus costs and allocate the rest of the money to where best it should go. When you have minimal debt, you can add the remaining cash where you need it. It could go to your emergency fund, retirement, or investment accounts. On the other hand, if you have high debt balances, use your savings to reduce those levels.

Preparing the Zero-based budget is a lot of work, combing through many details by itemizing your bills and overall spending. At the same time, you need to consider your financial goals, matching where the leftover budget money may best go. This budget method requires a good understanding of your household’s needs, wants, and financial future.

Pros of the Zero-Based Budget

It is structured to pay your costs and use the remaining money where it best should go. This method is goal-oriented, relying on a detailed account. If your expenses are high, variable expenses fluctuate; and are the best area to cut spending.

Cons of the Zero-Based Budget

It is detailed, time-consuming, and can change monthly. You need a good handle on all your expense items and your goals, understanding trade-offs between saving or paying off debt.

5. Traditional or Line-Item Budget

This budget is a personal income statement for an individual or household. It is similar to the zero-based budget but a bit simpler.  It totals net income from multiple sources minus total estimated expenses equal plus or minus amount. I use this budget on an excel spreadsheet, making changes over the years. For years, I did not use a budget for many reasons. There were only two of us; we were financially comfortable; it seems like a lot of work, and we kept postponing the task.

Monthly income sources include wages, tips, commissions, dividend income, and passive income.

Total monthly expenses are fixed and variable costs. Fixed costs are housing, food, transportation, utilities, and loan payments. Variable costs are less predictable and are associated with entertainment, medical, clothing, personal, and discretion expenses.


Total  Monthly Income                     $___________

Total Fixed & Variable Costs          $___________

Minus- Total monthly expenses      $___________

Total Savings/Deficit   $___________

Pros of The Traditional Budget

The traditional budget is a good starting point for understanding your household finances. It pulls a lot of detail together about income sources and expenses. Unlike a zero-based budget, it doesn’t have to a goal per se. Instead, if there are funds left, you can allocate it as you please. That is easy enough to figure out.

Cons of The Traditional Budget

Like the zero-based budget, it is detailed and time-consuming. It is a tool rather than a mechanism to help you identify areas to reduce your spending.

When Our Budget Became A School Project

Whenever I think of the line-item budget, I remember this story. I set up the template that had primarily been a back-of-the-envelope work of art. A few years ago, my son, Tyler, showed an interest, and we worked on it together. At the time, I didn’t realize he had a PowerPoint project due for his computer class.

After a few days, I was comfortable with doing a simple budget table jointly with Tyler. About a week went by, and Tyler came home, telling me that he used the budget we worked on for his project. I remember gulping, tensing up, and asking Tyler, “With numbers?#!” And he said, “Yeah, Mom, they didn’t care about the numbers, but they liked the colors.”

Hybrid Budgets

All of these budget methods have advantages and disadvantages. They can be used together, breaking envelopes into three bucks of needs, savings, and wants, and dividing into more categories with our needs, and so forth. In any budget you do, consider paying yourself first, that is, saving before overspending on discretionary categories such as entertainment. Be conscious of your spending, so you have money to save and invest.

Irregular Income

About a third of Americans generate irregular or less predictable income. Uneven income can be a problem for many, including us. Craig and I had budgeting challenges for many years, as most of our earnings were irregular and unpredictable. I had a salary with an annual bonus that varied significantly from year-to-year. Craig is a self-employed attorney and receives payment dependent on deal closings or other legal areas. Each area varies.

How do you budget in that case? Depending on your income sources, where there is variability, it is best to look back to the last three years and divide by 36 months to develop a meaningful income figure. The more conservative your estimate is, the better.

Final Thoughts

 The reasons for preparing a budget far outweigh any reasons not to do so. There are at least five different budgeting methods to choose from ranging from simple to more detail-oriented ways to review your finances. Creating and reviewing your budget is the cornerstone of a successful financial plan. It helps you identify your household’s strengths and weaknesses and help you devise a plan to make corrections. Find the best budgeting method for you.

Thank you for reading! If you find value in this article, please visit us at The Cents of Money for more articles of interest. Please consider subscribing to get our weekly newsletter.





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