7 Ways to Maximize Your Income Tax Refund

You take a few hours one weekend between February and April to pop numbers into your online tax prep software or prepare documents for your accountant. You don’t know whether you’re going to owe more to the government or get money back in the form of a tax refund.  

Quick side note: Getting a large tax refund may sound like a huge win, it can often mean that you had too much taken out of your paycheck. In other words, you gave an interest-free loan to Uncle Sam. So while it may be tempting to cheer when you get a big refund check, you may want to take another look at your W-4 exemptions to make sure the right amount is taken from your paycheck. Imagine if you overpaid your rent monthly and received your surplus payments back in April of the following year. Not a cause for celebration, in fact, you might be upset and you would figure out what the correct amount was so you didn’t overpay.

So let’s say that you are “fortunate” enough to receive a large tax refund. The question is, what do you do with that money? Well here are seven ways to maximize your refund so you don’t regret a single dollar you spend.

1. Make a donation  

The size of the donation is not important, it’s the act of giving first that’s important and giving to something (or someone) that’s meaningful to you. Giving is one of the most important aspects of my Spending Formula to Win with Money. That spending formula applies to any money you receive, whether it’s a tax refund, paycheck, inheritance or a gift. Giving counterbalances our naturally selfish instincts to spend on ourselves first and also makes us happier.

2. Emergency Fund

An emergency fund, separate from your checking account (preferably at a different bank), is one of the most important financial decisions you’ll make. You should have a minimum $1000 cash in savings at all times. This is to help keep you out of credit card debt in case of emergencies. This is not an account that you’re looking to make a ton of interest on, it’s an account that you put money into and forget about until your car breaks down, you get a bill from an ER trip, or you have to travel unexpectedly for a funeral. Online savings accounts work perfectly for this.

3. Pay Down High-Interest Debt

If you have revolving credit card debt (you carry a balance from month-to-month), check out the annual interest rate on your card(s), It’s likely 15%+. Giving credit card companies and banks interest payments on items you’ve likely already consumed is like lighting money on fire. Credit card companies are NOT charities! Let’s not donate our hard earned money to them. You cannot find a bank that will pay you guaranteed 15%-25% annual interest, but VISA, AMEX, and Discover are making that off of you. Let’s not.


4. Resignation Fund (Emergency Fund with Flair)

If you have at least $1000 in your emergency fund and you have no credit card debt, consider increasing your Emergency fund to 3-6 months of essential expenses. That is different from 3-6 months of income. Essential expenses are your housing, food, healthcare and transportation costs. If you lost your job tomorrow, how much would you absolutely need monthly to get by without credit cards? (FYI – cable and  smartphones are not absolute needs) When you have a fully funded Resignation Fund, it changes the way you look at your job and how you value your time. Remember, 76% of Americans live paycheck-to-paycheck, meaning they don’t have enough cash savings to cover basic expenses if they missed 1 or 2 paychecks. They would have to borrow money. That’s living on the edge! Have you ever noticed wealthy people use different language when they quit? They resign. It’s a polite way to tell your employer, “I’m just not that into you anymore.” Don’t let your employer control your life! A Resignation Fund gives you the flexibility to walk away if you need to and the security to maintain your expenses if you are unexpectedly laid off.


5. Roth IRA

If you have a fully funded Emergency/Resignation fund and no credit card debt, you should consider long-term investing. We discussed before What a Roth IRA Is and Why You Should Care, but it’s a great option for investing outside of your 401k/403b if you have one. There is an annual contribution limit of $5500, and you have until tax day the following year to contribute, so at the time of this writing, you can still contribute for the 2017 tax year until tax day 2018.


6. Personal Saving and Debt Payoff Goals

Now that we’ve got your emergency and retirement savings out of the way, you can stash funds for a vacation, a home, a car, wedding, kids college fund, etc. You can also put extra money down to pay off debts like student loans or auto loans.


7. Splurge

Often with money, particularly when we receive a lump sum, we spend first and if there’s any left over, we may save and donate. This is a broke mindset and broke behavior! Remember 76% of Americans are living paycheck-to-paycheck, so if you want to be different you have to do different! I want you to do the exact opposite. Give first, save second and spend third. Once you’ve taken care of your important giving and saving priorities, you can spend guilt free!

4 Money Lessons from the 2016 U.S. Presidential Election

The 2016 Presidential Election was historic on multiple fronts. Two of the most unpopular candidates battled in one of the most contentious, divisive and unconventional campaigns in modern history. For some, the result was a deeply shocking and painful event, for others it was redemption for voices long ignored. In all, nearly 120 Million Americans voted and the popular vote was separated by less than 200,000 votes, which is about the population of Little Rock, Arkansas. Regardless of your politics or preference of candidate, there’s no question that the country is divided politically. Whether you’re extremely disappointed or excited by the result there are lessons to be learned from the election and how it can affect our wallets and thus our livelihoods. How can the lessons from this election make us better managers of our finances?

1. Conventional Wisdom Isn’t Always Wise

Nearly every political expert and reputable polling firm who had been polling voters on a weekly basis for 18 months were completely wrong about the actual results of the election. Polling models that were used for the electorate in 2008 and 2012, became obsolete in 2016. Conventional wisdom can often be generalized and not specific to our individual situation.

There are certain standards of conventional wisdom in our finances that are also outdated or need to be challenged based on our individual situations. For example, conventional wisdom often stresses going to the best college one can get into (regardless of cost), pursuing a degree in a field of interest (regardless of expected future salary). This is not to say that people shouldn’t go to college or pursue a major solely based on expected future salary. It is to say that mode of thinking was developed at a time when people could pay their full student tuition by working part-time. That’s a 1970’s/80’s model, which needs to be challenged and may not take into account the realities of increased tuition costs and the impact of student loan debt on your future livelihood.

Our motto is Reject the Status Quo. In order to manage your finances well, there are times when you’ll make decisions that are not popular. The status quo embraces consumerism culture in which many people equate spending with projecting wealth or building relationships. It may be tough to navigate being the odd one out if you don’t subscribe to that mode of thinking. You may find that unnecessary spending actually doesn’t project wealth or make you happier, but rather delays and extends the time it takes for you to reach your personal and financial goals.

2. Prepare for the Unexpected

To say that Donald Trump becoming the 45th President of the United States was unexpected is a dramatic understatement, but life can often be very unpredictable. It was the Greek Philosopher Heraclitus who said, “Change is the only constant in life.” Sometimes change is good and sometimes it isn’t, but regardless, we have to plan for the unexpected. [bctt tweet=”Being unorganized with your finances is like playing Russian Roulette. ” username=”moneyspeakeasy”]

One of the lessons learned from the 2008 Great Recession was the people that were impacted the most were folks who carried high levels of debt and lived above their means. That’s not a judgment on them personally, but we need to ask ourselves if we have recession-proofed our finances. The following questions can help you assess your readiness:

Do you have 3-6 months living expenses in an emergency fund?

Do you have more than one source of income?

Do you have a written budget and track your spending?

Do you have life and disability insurance?

Do you have revolving credit card debt?

3. Depending on Government is a Losing Strategy

One of the truly negative impacts of having a divided country and a divided government is that even topics of general consensus may not get accomplished. There are serious financial issues, such as the cost of higher education, the cost of healthcare, student loan debt, social security, increasing wages and tax reform that can have dramatic effects on our finances, both positive and negative.

We believe the best plan of action is to treat your finances as if you will not get any assistance from the government and if you do, it will be a bonus. If you are under the age of 50, you should have no expectation that you’ll receive any social security benefits in retirement. If you have student loans, you should have no expectation that the government will help reduce the cost or forgive any portion of it, unless you are in a loan forgiveness program, have it in writing and understand the nuances.

The point is that our government is not a nimble organization, even when there is a consensus. Big changes can often take years, if not decades. Therefore government assistance should not be an important part of any financial planning.

4. Your Money, Your Values

Finally, if you want to know what someone truly values, you may listen to their words, you may even look into their actions, but one of the most revealing aspects of a person’s values is their spending. As they say, follow the money! We may vote for a Presidential candidate every four years, but we vote daily with our financial resources. [bctt tweet=”The more we control of our finances, the more resources we can direct toward causes we value.” username=”moneyspeakeasy”] For example, if a company decided to move a factory overseas or company funded organizations that were contrary to your values, an organized voter base could decide they were no longer willing to purchase products from that company and impact that decision. Just as many Americans believe that every vote counts, your dollars and purchase decisions count. Make sure your bank statement reflects what you value most.

Financial Infidelity Part 1: Why We Lie About Our Finances

Money is one of the leading causes of stress in relationships, however, it’s not necessarily money itself that causes the pain, but rather the lack of communication and transparency around money. Whether you are the financial cheater, the victim or just looking for ways to avoid it all together, it leads us to the same question – How do we prevent and overcome financial infidelity?
Often times our shame around money can lead us to behave in ways that are totally outside of our character. The shame of not being able to afford our lifestyle, the shame of being irresponsible with credit cards, the shame of not being as “together” as everyone thinks we are. You may be the ‘responsible’ person in your family. You stayed out of trouble, you got through school, you got a good job, but no one knows that even with your salary, you are barely getting by – and no one sometimes includes your significant other.
Often times in relationship arguments, there is the paradigm of the perpetrator (the person that did something wrong) and the victim (the unknowing recipient of the wrongdoing). We strongly suggest that perpetrator/victim could be the wrong paradigm in most cases of financial infidelity. First, let’s define financial infidelity and then talk about reasons why the perpetrator/victim model may not help you overcome it.

Financial Infidelity – The willful and deliberate concealment of financial transactions from a partner in a relationship in which there is financial interdependence.

Financial interdependence can be as simple as splitting the cost of a meal or complex as completely combining your finances. When people in a relationship begin to have joint financial transactions, it creates expectations which require communication and transparency.

The Perpetrator/Victim Paradigm

If someone is walking down the street and gets robbed. The victim has no responsibility to the thief. Anything the victim could have done differently to prevent the thief from robbing them is irrelevant. The thief committed the crime, gets 100% of the blame and goes to jail. Financial infidelity is often not that cut and dry, so before you condemn your significant other to relationship jail, consider there may be a different way to approach the problem.

We Are Often Irrational When it Comes to Money

We are constantly making irrational decisions with our money. For example, if a $100 item is on sale for $40, we’ll convince ourselves we saved $60. We actually spent $40 and saved $0. We spend hundreds of dollars per year on bottled water that in most cases are not measurably better in any significant way to the water in our kitchen sinks. So let’s begin with the idea that we are not purely rational beings when it comes to money.
According to recent studies, the median lifetime earnings for a U.S. college graduate is $2.3M (average of $57K/year for 40 years). That’s almost $5 million for a couple who are both college graduates. $10K in credit card debt or $100K in student loan debt may seem overwhelming, and definitely not helpful in building wealth, but let’s also keep it the context of a larger perspective of $5 million.
 

We Have Different Money Personalities

We also bring different habits and perspectives to money in our relationships. ‘Opposites attract’ also applies to perspectives with money. Many times in relationships you may have a rebel and a conformist dynamic. The rebel lives in the present, appreciates spontaneity and enjoys the discovery. So one of the reasons they didn’t tell you about the $500 purchase beforehand is because they literally decided to make the purchase in that moment. The conformist, on the other hand, is more likely the planner, the one that actually likes to budget and craves organization and doing things ‘a certain way.’ (a.k.a. My way is right and your way is wrong)
Even without financial infidelity, those different perspectives are bound to create conflict. In order to mitigate some of those inevitable conflicts, communication and transparency need to be at the forefront.
 

Our Foundation for Financial Transparency is Faulty

The foundation of financial transparency and communication is the responsibility of both parties. Have you had “The Money Talk” in your relationship? A few questions to assess your relationship’s financial communication:

  1. Have you recently (within the past year) seen each other’s credit reports (not just the score, but the detailed report)?
  2. Do you sit down together and discuss your budget monthly? quarterly?
  3. Do you have a dollar limit that you cannot spend without your partner’s prior knowledge/approval? (even out of your individual account)

In many cases of financial infidelity, the answer to those questions will likely be no, thus the seeds of deceit were planted. In heterosexual relationships, for example, there are often rules of conduct regarding interactions with people of the opposite sex. As an example, dinner and drinks solely with a co-worker of the opposite sex may be inappropriate. Those boundaries will typically be made clear in the course of a relationship. Financial boundaries, however, are less likely to be addressed and without those boundaries, both parties are setting themselves up for failure.
 

Shame and Guilt Can Cause Us to Rationalize Deceit

If lack of communication and transparency are the seeds of financial infidelity, guilt and shame are the fertilizer.

“Shame is a soul eating emotion.” – C.G. Jung

Shame is a very difficult emotion to overcome and can often be at the heart of financial infidelity. For example, if the way one presents themselves to the public is connected to their financial success, admitting financial trouble is like admitting one is a complete fraud. This is another reason why the perpetrator/victim model is flawed. There may actually be multiple victims. It is often difficult to admit failure to yourself, much less a partner or spouse.

“The difference between shame and guilt is the difference between “I am bad” and “I did something bad” – Dr. Brene Brown

Shame can make a liar out of even the most honest person. The extent to which we internalize our actions makes it more difficult to discuss with others. If racking up credit card debt in our mind makes us a terrible human being (as opposed to someone that made poor financial decisions), we are much less likely to admit to someone we are a terrible human being.
Shame lives in hiding, through secrets and deceit. Anger, judgment, blame and contempt only make it worse. The only real way to overcome shame is through vulnerability in an environment of empathy, understanding, kindness and respect. If that sounds too mushy for you, then ask yourself two questions:

  1. Who have you revealed your deepest secrets to?
  2. Were they someone who you knew would be empathetic, kind, understanding and still love you regardless?

If you haven’t created a loving and open environment for your significant other, then you should have no expectation your significant other will be transparent about their shame.

It Takes Two

The perpetrator/victim model doesn’t often work with financial infidelity because the victim doesn’t have any responsibility to the perpetrator. There are certainly extreme cases of gross deceit, identify theft, fraud and financial abuse where perpetrator/victim model does apply (many of these cases are actually illegal). However, in most cases of financial infidelity, both parties have a responsibility to develop a foundation of open communication and financial rules of the road for their relationship. Both parties also have a responsibility to create an environment of mutual respect and empathy from which shame cannot grow.
Financial infidelity, particularly early in a relationship, can be a wake-up call and catalyst for both parties to grow together with their finances. That was certainly the case in my relationship with my wife, which we will share in Part 2.

What You Need to Know About Credit Scores: Part 2

Credit scores are an important piece of your overall financial puzzle. In Part 1, we demystified credit scores by discussing what they are, who uses them and where to find them. Now we’ll describe the best ways to improve your credit score.
In order to improve your score, you need to understand the rules of the game, so you can play it effectively. First, let’s review the five elements of a credit score and then we’ll discuss the best ways to improve your score.

  1. Payment History (35% of the total score) – This element measures whether you have paid your past accounts on time (e.g credit cards, retail store cards, car loans, mortgage loans, student loans)
  2. Amounts Owed/Credit Utilization (30% of the total score) – This element measures the total amount of debt owed on all of your accounts. It looks at different types of debt like installment accounts with a fixed payment schedule (e.g. car, mortgage) as well as revolving accounts (i.e. credit cards).
  3. Length of Credit History (15% of the total score) – This element measures the time since your credit accounts have been established. The longer the credit history, the better. It will consider an average length of your credit accounts.
  4. New Credit (10% of the total score) – This element measures the number of recent credit inquiries in the prior 12 months.
  5. Credit Mix (10% of the total score) – This element simply measures the different types of credit accounts you have.

Note that the first two elements represent nearly two-thirds of your overall credit score. This is where you get the biggest bang for your buck. So let’s get right to it. Here are five tips to improve your credit score.

  1. Review Your Credit Report and Dispute Errors

This may be obvious, but you don’t want to be held responsible for transactions that aren’t yours. Reporting errors happen with regularity, so you should check your credit reports from all three bureaus every few months. By law, you are allowed one report per year from each of the three credit bureaus from annualcreditreport.com, so you can stagger them and check one every four months.
If you see an error (e.g. accounts that don’t belong to you, paid off collection accounts showing as unpaid, incorrect name or address listed) you are able to dispute it online and it is the obligation of the creditor to prove to the bureau that the report is valid 30-45 days from receipt.
 

  1. Pay Bills on Time (Payment History)

    Late payments can significantly impact your credit score, particularly if you do not have much credit history. Even if you can only make the minimum payment, always try to stay current. This includes bills like rent, utilities, medical bills and student loans. If you can’t make the minimum payment, notify your creditor beforehand and see if you can work out a payment plan. Communication in advance is preferable to simply not paying and ignoring them. Creditors will typically report late payments to credit bureaus for balances that are 30+ days past due (180+ days for medical bills).
    Bonus Tip: Recent late payments affect your score more that older late payments, so if you have multiple accounts that you’re behind on, consider getting current on the more recent one first. Also, note that you have a longer window (180 days vs. 30 days) with medical bills before they are reported to get current.

 

  1. Keep Balances Low on Revolving Debt (Amounts Owed)

    A credit utilization ratio (Amount Owed/Credit Available) above 30% will begin to negatively affect your score. Even if you’re paying minimum payments, if your credit cards are maxed out, your credit score will be impacted. Also, trying to reduce your credit card balances while still using the credit card is a losing game. Stop using the card if you are trying to significantly reduce your balance.
    Bonus Tip #1: If your credit card is in good standing and you’ve made on time payments for 12 consecutive months, contact the creditor to see if they will increase your credit limit without a hard pull credit inquiry. If they are willing to increase your limit, you can improve your utilization ratio with little effort.
    Bonus Tip #2: If you have a spouse or close family member you trust who has a credit card in good standing, they can add you as an authorized user on their credit card. They don’t have to give you the card (it’s preferable if they didn’t), but they are simply extending their credit to you, which increases Credit Available and decreases the Utilization Ratio.
    Caution: Being an authorized user goes both ways, so any negative behavior (late payments, collections, etc.) on that account (by either party) can negatively impact your credit just like your individual account.

 

  1. Don’t Close Old Credit Card Accounts (Length of Credit History)

You may have heard advice in the past that if you have old credit cards on your credit report, you should call them and close them out to keep your credit report “clean.” That’s likely bad advice for two reasons. First, even if you don’t use the card, the credit limit adds to your Available Credit and helps your Credit Utilization. Second, the Length of Credit History takes an average of all of your open accounts. The more old accounts you have the longer that average will be. Closing the account simply eliminates the history from benefitting your score.
Bonus Tip:  You can request creditors remove negative incidents from your report. For example, if you had a late payment a year ago or more and you’ve been current, you can contact the creditor and request they remove that incident. They are not obligated to (until after 7 years), but they may oblige as a courtesy for customer satisfaction and to keep your business.
 

  1. Don’t Apply for New Credit Cards Solely to Increase your Available Credit (New Credit)

    Even though New Credit is only 10% of your score, credit inquiries (also called hard credit pulls) stay on your credit for a full year. So applying for a new credit card solely to increase your available credit is counterproductive. You get dinged for the hard credit pull and you’ve reduced the average length of your credit history. If you’re looking more long-term and not concerned about the short-term impact on your score, this is less of a concern.
    Bonus Tip: Checking your own credit is not considered a hard pull credit inquiry (it’s called a soft pull inquiry). Soft pulls are typically for background checks, opening utility accounts, and open a checking or savings accounts. Soft pull inquiries will not affect your credit score.

 
Those are some of the best ways to improve your credit score. Remember to be patient as scores don’t shift dramatically overnight and account changes often lagged by 30 days or more. If you’re looking to make dramatic changes to your score (100+ points) it may take 6 months or more depending on your situation. Credit scores are much easier to pull down than to bring up, so it’s important that you stay diligent. Finally, remember your credit score is just a number, a debt management score. It doesn’t measure your overall financial health and it is a point-in-time metric that can be improved.

What You Need to Know About Credit Scores: Part 1

Credit scores are an important aspect of your financial life and unfortunately, there is quite a bit of confusion about what credit scores are, how they work and who uses them. There’s also a ton of shaming involved with credit that is unjustified. In this two-part series, we will clear up some confusion about credit scores and help you improve your scores.
 

What is a Credit Score?

A credit score is a three-digit number (typically from 300-850) calculated to assess an individual’s credit-worthiness. Said another way, a credit score is based on multiple factors which allow a lender to determine how risky it may be to lend to an individual. The lower the credit score, the riskier (theoretically) to lend.
Remember when you were a kid and you lent your friend a few dollars for lunch or you let them borrow one of your video games. You may actually still remember some of your “ex-friends” that didn’t pay you back or return your possessions! What if you had a way to determine the likelihood of your friend paying you back or returning your item in advance based on their history of borrowing from others in the past? THAT’S the goal of credit scores and while it is flawed, it is important to understand how you are being measured.
There are many companies involved in the business of measuring credit-worthiness. The most widely known and used score in the U.S. is called a FICO Score and there are three major credit bureaus which the majority of lenders access to obtain individual FICO credit scores. TransUnion, Equifax, and Experian are the three major credit bureaus that hold your credit data and calculate your credit score.

Why is a Credit Score Important?

Clearly, credit scores are important for financial lenders because it helps them make decisions on whether or not to lend money and how much to charge. However, even if you are debt free and don’t borrow money, your credit score can still impact you. Increasingly more companies are using credit scores to make decisions including landlords for renting apartments, home and auto insurance companies, and utilities such as cell phone and cable companies.
The ranges on the credit score allow lenders charge you more (i.e. higher interest rates) for the same products. Of course, these ranges can vary by lender, but here’s an example:

  • 720 – 850: Excellent ‘A’ Credit – This score range typically qualifies the best rates on mortgages, credit cards, and car loans.
  • 680 – 719: Good ‘B’ Credit – This score range will qualify for different types of credit, but may not always get the advertised or premium rates
  • 630 – 679: Fair ‘C’ Credit – This score range may or may not qualify for different types of credit and will have higher interest rates.
  • Under 629: Poor ‘F’ Credit – This score range will typically not qualify for different types of credit and may require a cosigner or collateral (i.e. a secured deposit). This is also referred to as ‘subprime’ credit.

For a benchmark, the average credit score in the U.S. is about 690. What is important to understand is not to personalize or internalize your credit score. You are not wonderful and successful if you have an 800 score and you are not a failure if you have a sub 600 score. It is simply a point-in-time metric of your past interactions with credit and fortunately, you have some level of control to significantly impact that score over time which we will discuss in Part 2.

What Credit Scores Do NOT Consider

As mentioned, credit scores are flawed. They can be based on inaccurate or even fraudulent data and there are also important factors that are not taken into consideration. Credit reports (different from credit scores) list the details of financial accounts upon which the credit score is based. Personally, I have found errors on my credit report simply because I share a name with my father. In a separate instance, my father discovered identity theft when checking his credit report and found a $20,000 loan for dentistry school taken out in his name that he had no connection to. These errors are YOUR responsibility to correct which is why you should check your credit score and credit reports regularly.
Credit scores neither take income nor savings into account and credit scores are not a complete measure of how well you are doing financially. Many refer to the credit score as a ‘debt management score’ because it simply measures how well you borrowed money and paid it back. Net Worth is a much better measure of financial success. For example, two individuals (Person A & B) could have the same credit history and the same credit score even though person A makes $1 million in income per year and has $1 million in savings and Person B makes $30,000 per year and has $0 in savings. As a lender, I would likely prefer to lend to Person A, but the scores will show the exact same number. Keep in mind lenders can ask about income and savings before lending, but it is not a factor in your credit score. Also, for those coming out of high school or college that do not have a credit card and have not borrowed money in the past, they may not even have a credit score. So if you diligently manage your finances with cash and don’t rely on credit, you may find that you do not have a credit score.

What are the Elements of a Credit Score?

Let’s talk about what is actually included in the credit score and in Part 2 we’ll discuss tips on how to improve that score. There are five elements in the calculation of a credit score and they have different weights of importance.

  1. Payment History (35% of the total score) – This element measures whether you have paid your past accounts on time (e.g credit cards, retail store cards, car loans, mortgage loans, student loans)
  2. Amounts Owed/Credit Utilization (30% of the total score) – This element measures the total amount of debt owed on all of your accounts. It looks at different types of debt like installment accounts with a fixed payment schedule (e.g. car, mortgage) as well as revolving accounts (i.e. credit cards). For installment accounts, it looks at the remaining balance versus the total amount borrowed, so if you have a $10,000 balance on your car loan and you originally borrowed $20,000, it would show that you still owe 50% of the balance of the loan. For revolving accounts, a credit utilization ratio is used to determine the percentage of your overall credit limit is being used. For example, if you have three credit cards with a total credit limit of $10,000 and you owe a total of $2,000, your credit utilization ratio would be 20%.
  3. Length of Credit History (15% of the total score) – This element measures the time since your credit accounts have been established. The longer the credit history, the better. It will consider an average length of your credit accounts.
    Tip: This is why you should reconsider before closing or canceling your oldest credit card accounts, even if you no longer use them.
  4. New Credit (10% of the total score) – This element measures the number of recent credit inquiries in the prior 12 months. The idea is if you are signing up for several credit cards in a short span of time, it increases the risk to lenders. In other words, people who open up several accounts in a short span of time typically plan to use them and use them heavily.
  5. Credit Mix (10% of the total score) – This element simply measures the different types of credit accounts you have. This is biased toward having credit cards, but also includes installment loans like car loans or mortgages as well as retail card accounts.

Where Do I Find My Credit Score?

Finally, let’s talk about where to get both our credit scores and reports. For the official FICO scores and credit reports, you can purchase them from FICO for a one-time purchase of $60 or different monthly plans. A better option, in our view, is to use FREE sites like Mint, Credit Karma, or Credit Sesame that are not the ‘official’ FICO score but do a decent job getting a close approximation. You can use one or all three and it will not affect your credit score. They can also provide you with the details of your credit report which you can view and check for erroneous information.
So we have demystified the credit score, discussed why it’s important and the elements considered and not considered. Again, your credit score is not a measure of personal value or personal success much like a GPA is not a measure of intelligence, but rather the combination of course grades. Also much like a GPA, your credit score is much easier to bring down than it is to pull up, so we have to be diligent about our finances. The purpose isn’t to have an 850 score, but to monitor your score and know how you can improve it to save money if you borrow in the future.

7 Do’s and Don’ts of Managing Your Finances

Money management can be difficult. There are lots of opinions on how to manage your money successfully, but sifting through all that can be a challenge. We have boiled down our 7 top recommendations for managing your finances.

1. Do: Plan Your Spending Before the Money Arrives

You are the CEO and CFO of You, Inc. Think about running your personal finances like a business. Companies plan their revenues and expenses well in advance. Budgeting gets a bad rep, but successful, profitable businesses formally plan their finances and make decisions in advance of their spending.

Money is like a toddler. If you don’t monitor it carefully, it will wander off and disappear quickly!

2. Do: Aggregate Your Accounts and Track Your Spending

Aggregating your accounts, allows you to see the big picture and a number we highly recommend you track regularly – your net worth. It can be difficult to make tough choices if you don’t have the bigger picture in mind. Tracking is also important. You cannot change what you do not measure. In order to make meaningful change, know exactly how much you spent last month versus the month prior. Guessing doesn’t work well with personal finances. Once you build a habit of tracking your finances, making smart decisions about your money becomes much easier.

3. Do: Understand and Deal with Your Impulse Purchases.

For some it’s the mall, for others it may be online shopping. Have you ever gone into a store planning to spend $50 and come out spending $300? Evaluate how and why that happened. Keep in mind; it is a marketer’s job to turn a “want” into a “need.” Notice on television commercials, often the product or company isn’t revealed until the very end of the commercial. Instead of selling a can of soda, they are selling happiness. Instead of a gym shoe, they are selling peak athletic performance. Instead of selling their own product, they may have a celebrity endorse it as if it is heaven-sent. Companies hire social scientists who study how to influence human behavior, emotions and decision-making to get an edge in selling their products and services. Here are some examples to protect yourself and your wallet:

  1. 24-hour rule – Wait at least 24 hours before making purchases over a certain amount
  2. Do not go grocery shopping on an empty stomach
  3. Deconstruct advertisements: what are they really selling?
  4. Use cash for non-regular expenses
  5. Don’t fall for terrible excuses (“I deserve it”, “it’s on sale”, “I’ll pay it off next month”)

4. Do: Develop a Habit of Saving and Automate It.

Even if you start small (i.e. $25/week), put systems in place that force you to save. The government understands this very well, which is why employee payroll taxes come out of your paycheck even before you are able to touch it. Apply the same strategy for your savings. Some employers will allow splitting your paycheck to different bank accounts (i.e. 75% checking, 25% savings). Another idea is to set a recurring transfer from your checking account to your savings on the same schedule as your paycheck. There are other automatic features to consider such as:

  1. Auto escalating your 401k contributions – some employers with a 401(k) offer an option to automatically increase your retirement savings by a certain percentage on a regular basis (i.e. increase 1% annually)
  2. Keep the change features in checking accounts – Some checking accounts will round up your purchases and put the change in your savings account. It is the e-version of the piggy bank. If you purchase an item for $5.60, it will round up to $6.00 and $0.40 will be deposited in your linked savings account.

5. Don’t: Ignore Your Credit Score and Credit Report

A credit score is very important to be aware of and to know how to improve. Credit scores have traditionally been used to evaluate credit-worthiness for extending loans (e.g. personal loans, mortgage, car loans, credit cards) and the higher the credit score, the more financially credit-worthy one is. The reality now is that both credit scores and credit reports are being used beyond financial transactions. Credit scores and reports are being used for employment decisions, housing, insurance premiums, and even utilities such as cell phones and cable. The challenge is credit reports often have mistakes which can negatively impact your credit. Check out our Resources Page for resources on checking both your credit report and credit score.

6. Don’t: Ignore Your Workplace Benefits

If you work for a company and do not understand the full scope of your employee benefits, it may be time to check out your HR Benefits website or set up a meeting. Particularly with larger companies, there are often benefits that go underutilized that can save you hundreds if not thousands annually. One of the largest ones is the 401k match. For most people, this is a no-brainer to at least invest as much to maximize the match as it is a 100% return on your investment. Wellness Initiatives can often mean big savings as well. Many companies are offering rebates on health insurance premiums for wellness activities, such as physicals or wearing fitness trackers. Let’s think about that for a second, companies are paying additional cash to employees to be healthier. There are several other types of benefits, and we’ve created a FREE Guide to help you maximize benefits that are offered to you.

7. Don’t: Keep up With the Joneses

Most people are familiar with the term ‘Keeping up with the Joneses,’ but just so we are all on the same page, it refers to making material comparisons to your social circle. The idea that if your neighbors or friends buy a new car, you should too. We call this the comparison trap and its one of the lessons we learned paying off our student loan debt. Part of the problem with comparing your financial status with others is that it is very difficult to know someone’s complete financial picture. Money is still a private topic and everyone has different income, expenses, debt obligations and assets. The people you are comparing yourself to could be completely up to their eyeballs in debt or fund their lifestyle through an inheritance. Making comparisons, not only could be comparing apples and oranges, but it also casts your own possessions in a negative light.

“Comparison is the thief of joy” – Mark Twain

A few reasons why keeping up with the Joneses is a bad idea:

  1. The Joneses are broke! According to a recent Bankrate survey, 76% of Americans are living paycheck to paycheck with little to no emergency savings. Why keep pace with people that are one emergency away from financial catastrophe?
  2. When you compare yourself to others, it’s much easier for wants to become needs. Wanting a car becomes needing a brand new SUV. Technology like smart phones, that didn’t exist 10 years ago, are a now a need. We have a desire to show off and have our success validated by others.
  3. Companies are spending billions of dollars to market their products and services to you. Many luxury brands are selling a temporary feeling of exclusivity in exchange for premium pricing. For example, a luxury shoe could be made in the same factory as an off brand shoe, but once they slap the logo on, they can charge five or ten times more. Luxury and quality are not the same. It is easy to get sucked into the consumerism culture. Happiness from possessions is always temporary and fleeting.

This leads us to the fundamental challenge of managing your finances. We live in a consumerism culture and an economy fueled by consumer spending. On one hand, we have many of the influences we described (social, corporate, psychological, economic) with a clear mission to separate you from your income. Those influences contend with our own goals to keep our income and grow it for the future. These recommendations will help you be better equipped to keep more of your income to reach your financial goals.

If You Hate Maintaining a Budget, Track these Two Numbers Monthly

As personal finance nerds, we are interested in where every dollar goes, what bucket it falls into and how that compares to the previous week, month, and year. Most people are generally not interested in tracking every dollar. Some people say, “I’m just not a math person” or “that’s just more detail than I care to know.”

If forced to come up with two metrics to evaluate your financial progress, we would have to say without a doubt, it’s your net income and net worth. Let’s define both and then let’s talk about why these are the most important financial measures to track.

What is your Net Income?

Your net income is simply taking your monthly after-tax income (the amount that comes into your bank account) and subtracting all of your expenses during the month (housing, food, utilities, transportation, debt payments, personal, etc).

Net Income = After Tax Income – Expenses

If you were a business, your Net Income would be called ‘profit’. You need to know what your profit is each monthly. You don’t want to run a business that’s losing money each month. You want your net income to be positive each month and you want it to be growing over time.

A common mistake people make is that as their income increases, they increase their spending along with it (a.k.a. lifestyle inflation). So if you get a 3% raise at work, but you increase your spending by 4%, you could actually be worse off financially, that’s why tracking net income (profit) monthly is so important.

 

What is your Financial Net Worth?

Your financial net worth is simply adding up all your financial assets (everything you own) and subtracting all of your financial debts (everything you owe).

Net Worth = Assets – Debts

Financial Assets can include real estate, securities (stocks, bonds, mutual funds), vehicles, checking, savings, cash or anything you can sell and turn into cash. Alternatively, your debts can include mortgages, credit card debt, personal loans, home equity loans, student loans, etc.

Let’s be clear about a few things, first, never confuse your financial net worth for self-worth. Regardless of whether you’re a millionaire or your net worth is negative, it says nothing about who you are as a human being. We live in a ‘more is always better’ culture, we glorify millionaires and condemn the poor, but that is not the goal of this measure. Your financial net worth is simply a number that applies to you individually or as a family to track and increase over time to assess how close you are to reaching your financial goals (i.e. financial independence).

Second, the majority of Americans have either zero or negative financial net worth, so if they sold everything they owned, they would either have nothing left over or would still owe money. Many young professionals fall into this bucket due in part to student loans. Building your savings and getting out of debt both increases your assets and reduces your debt, thereby increasing your net worth.

Why are net income and net worth the most important numbers to track?

Good question! Why not Salary? Savings? Credit Score? The answer is simple, your net worth is the bigger picture goal, net income is how quickly you’re moving towards that big picture goal.  In your financial journey to your financial destination, your net worth would be the miles traveled to your destination, your net income is how fast you’re driving.  There are all sorts of metrics that you could measure if you were taking a cross-country journey, but if we had to choose only two, we would want to know how far we’ve gone (net worth) and how fast we’re moving (net income).

Both Net Income and Net Worth are simple formulas and there are only two ways to increase them:

  • Increase income/assets
  • Reduce expenses/debt

Increasing Income/Assets

Unfortunately, the majority of our expenses (after our essential expenses) are for items that decrease or depreciate in value. So when we buy a pair of shoes or a phone, if we were to sell it used a month later, we would receive much less in return than we paid for it. On the other hand, if used the same money to purchase stock ownership in the company that manufactured that shoe or phone, that stock could potentially increase or appreciate in value over time. When you hear phrases like ‘the rich get richer and the poor get poorer’ that is partially because wealthy people are more likely and able to purchase appreciating assets (e.g. businesses, securities) and the middle class and working class are more likely to buy depreciating liabilities (i.e. debt – a.k.a. stuff that makes us look/feel rich, but actually make us less wealthy). A depreciating liability, such as a car note, is a double loser because not only is the car rapidly declining in value, but it’s also financed from a bank, which means paying additional money in interest (increased cost & reducing value).

We have to change how we look at what we buy and whether showing off our expensive stuff is more important than actually growing our wealth. Recent studies have shown that 76% of Americans are living paycheck to paycheck, that includes high-income earners, so the people we compare ourselves to or try to impress are likely broke.

We also have to change the way we think about our income. It’s often said when talking about investing, that ‘you don’t want all your eggs in one basket’, you have to diversify your investment assets to reduce risk. Well it’s much less talked about, but just as important to diversify your income because having one source of income is just as risky as having all your investments in one stock.

In order to put more wins in the asset/income columns, the focus should be to develop multiple sources of income and free your income to purchase assets that appreciate in value. Building an emergency fund, increasing your 401k contributions, contributing to an IRA, are all ways to increase your assets in the near term.

Reducing Debt/Expenses

The other end of increasing your net worth is reducing your debt. Everyone has different types and levels of debt, but the most advantageous position to be in financially is having no debt. There are entire industries that rely on people getting and staying in debt. Credit cards, auto manufacturers, mortgage lenders, banks are examples. In fact, the credit card industry calls people that pay their balance in full every month, deadbeats. They are deadbeats because the card companies aren’t making any money off them in finance charges. If you choose to use credit cards, please be a deadbeat! Unfortunately, in our culture we have become accustomed to debt as a way of life. When we start to understand how much debt impacts our ability to reach our financial goals, we begin to make different choices. Keep in mind, our debt is someone else’s asset (i.e. banks, credit cards, auto companies, mortgage lenders), just like your loss is someone else’s win.  If you are a lender, the loan contract is an asset that appreciates. You lend someone $20K for a car purchase and you’re paid back $22K over 5 years.

In order to reduce losses in the debt/expenses columns, the focus should be to free your income to pay off debt more quickly and avoid additional debt. Also, reduce the purchasing of items that depreciate in value. Tracking your spending for a month, using only cash for 60 days or selling possessions are all ways to increase income or reduce expenses in order to reduce debt.

The Bottom Line

The bottom line is that we cannot wear or drive wealth. In one camp, the majority of millionaires live well below their means, drive used cars, and live in modest homes (read: The Millionaire Next Door).  However, in the other camp, the majority of Americans live far above their means, live from paycheck to paycheck and finance their lifestyle with debt. There are free online financial aggregators such as mint.com that will allow you to centralize all your financial accounts and calculate your net worth automatically. Tracking your net worth monthly allows you to become more aware of not only which camp you’re in, but also allows you to know how close you are from moving from one to the other.