You Need Financial Knowledge

You need financial knowledge to take positive financial actions. The little things you do with your money matter. Cumulatively, a fortune will flow your way during your lifetime. How much of it will you keep? How much will you let flow away? Will you be able to support the lifestyle you dream about? Do you have a financial plan? The more knowledge you acquire, the better your money management skills will be.

The information in this section is designed to help you start thinking about your personal financial strategy. As you gain more money management skills, you will find what actions serve you best. We all want to be on solid financial ground. You may not earn much with your first job. 

You may find it’s hard to save a dime. That’s the way most of us started out. You may be attending college, receiving financial assistance, and find you have a hard time making ends meet. Don’t lose your motivation. Remember, it is possible to meet your financial goals—even moving at a snail’s pace. Just build up your financial knowledge and trust your instincts.

Know Financial Terms

Familiarize yourself with the following:

• Certificate of Deposit (CD)—A savings certificate issued by a bank, credit union, or savings and loan that allows you to receive interest on the amount of your deposit. The interest rate is determined by the amount deposited and the length of time you agree to keep the funds deposited. You will be penalized if you remove funds before this maturity date.
• Exchange-Traded Fund (ETF) —These securities are a variation of the mutual fund, but they trade like a stock throughout the day. They generally have lower costs than the average mutual fund. You purchase ETF’s from a brokerage account.
• Money Market—A deposit account that generally requires a minimum balance, pays a slightly higher rate of interest than a traditional checking account and allows you to write a limited amount of checks per month. Mutual fund money market accounts usually offer unlimited check writing privileges, but the federal government does not insure the accounts.
• Mutual Funds—Investment companies pool small investors’ money into a fund used to buy and sell stocks and bonds and other securities. Mutual funds are operated by professional fund managers who carefully select a mix of investments. Investors own shares of the fund in proportion to their investment. Make sure you read and understand the fund’s prospectus (facts and terms) before you invest. A mutual fund with a load requires a fee to purchase it, a no-load mutual fund does not.
• Traditional savings account—An account that typically pays a low interest rate but does not require a high minimum amount to open. It is insured by the U.S. government up to $250,000.
• U.S. Savings Bonds—Buying a savings bond is like lending money to the government. Bonds can be purchased at most banks and credit unions. Electronic bonds can be purchased directly from the government at www.treasurydirect.gov for as little as $25. Learn about both kinds.
• U.S. Treasury Bills, Notes, Bonds and TIPS—These are U.S. government securities and are considered the safest of all debt instruments. Treasury bills are currently issued for periods of a few days to 52 weeks; notes for 2, 3, 5, 7, or 10 years; and bonds for 30 years. TIPS, or Treasury Inflation-Protected Securities, are designed to offer protection against inflation. The minimum purchase price for any of these securities is $100. You can obtain more information by contacting the Bureau of Public Debt Online—www.treasurydirect.gov or by calling Treasury Direct at 800.722.2678.

Also understand the differences among the following:

• Bank—A business that is designed to offer its customers savings and checking accounts, credit, and loans and negotiable securities issued by the government or by a corporation. There are three kinds of banks: commercial banks, savings banks, and savings and loans.
• Credit Union—A not-for-profit financial institution formed by a group of individuals having something in common (such as a religious organization, labor union, or employees of a company). A credit union may offer a full range of services, generally paying higher interest rates on deposits to its customers and charging lower interest rates on loans than a commercial bank or savings and loan association.
• Brokerage Firm (or brokerage house)—A business that helps you exchange securities, such as stocks and bonds or mutual funds. Full-service brokers give advice on picking investments and planning your financial strategy. Discount brokers charge lower commissions than full-service brokers, but they give little, if any, advice.

Create Your Financial Plan

Did you know just what you were going to do with your first paycheck? Did you buy something, or did you save it, or a combination of both? You need to know exactly what to do with your money coming in. You also need to be comfortable with the decisions you make. 

For instance, you do not want to be so strict with yourself about not spending any money that you break down and make an extravagant purchase because you feel deprived. You need a plan, but it needs to be a plan that takes into consideration who you are, what responsibilities you have, and what you can reasonably expect from yourself.

You notice I am not saying budget. I am not going to tell you to make up a budget, because I don’t know anyone who successfully follows one his whole lifetime. I am telling you to be absolutely aware and totally conscious of exactly how you manage your money. Make it a lifelong habit to be in control of your money. You choose how to earn it, save it, spend it, and build security for yourself and those you love.

I want you to formulate a plan according to your own needs. Remember the life goal chart in Chapter 1? After reading through the nine ‘positive actions’ listed below, please use the chart again, this time to organize your financial goals. I recommend that you structure your plan around the following:

Positive Financial Actions

In addition to being conscious actions, these suggestions are also long-term positive habits. It doesn’t matter if you are not able to start all nine at once. What does matter is that you are developing a long-term personal commitment to your positive financial future.

Make Money

You may think “make money” is too obvious, but consider this: There is a big difference between knowing you need to make money and actually acting on that idea. You can live well by making money. You can become wealthy. You can significantly help others with the money you earn. 

Perhaps all of us secretly wish for a money miracle—but a wish, as they say, is not a plan. A lottery ticket is a pretty financial crummy plan. Hitching your cart to someone else’s star is also not a very good plan. Making money can be your plan—and it can be a great one.

When you don’t have enough money, it’s time to accept responsibility and use your energy, knowledge, and skills to set things right. Yes, you may need to make some immediate changes to live within your limited means. Yet, you don’t want to get stuck focusing on cutting costs. 

Having a “make money” mindset is all about positive actions—earning extra money through a side project or a better-paying job, for example. Then the really interesting and exciting work begins as you manage your new money well—even eventually using it to create more cash-producing assets!

As a young person just starting out, you may already be doing all that you can to generate income, get an education, and gain valuable skills. One day in the future, your older self is going to be very grateful for the hard work you’ve put in, laying the foundation of your solid financial future. 

Having a “make money” mindset is not only about taking care of yourself now, but also about positioning yourself for a better life as you age. For many reasons, people all too often give up and resign themselves to their current level of life circumstances. They may believe they are powerless to move forward. 

They may think that things are somehow just going to change for the better without actually making that change happen. They may sincerely believe that they live without opportunity. Or they just may not want to take on that extra job or start a business on the side. 

Yet, if you commit to a “make money” mindset, you resolve that no matter what the external circumstances around you may be, you will choose to act in your own best interest, keep going, and earn and create the money that you want and need to accomplish your financial and life goals.

Always Live Debt-Free

I believe your life will never truly be your own if you are harnessed to a burden of debt. Owing money is a burden, no matter if you owe an institution, such as a bank or credit card company, or if you owe a friend or relative. Even if you have an interest-free loan (like from Mom or Dad), debt can mentally and emotionally wear you down.

Respect yourself and your financial game plan enough to make decisions that will take you toward meeting your goals, not move you backwards. Having debt is going backwards. When you take out a loan, you are charged interest for the use of the money you borrow. 

When you pay interest, you are not only losing that amount, you are also losing the amount your money would earn if it were working for you, as in investment. It is not uncommon to still be paying on a loan to purchase an item that has long since broken or is no longer important in your life.

Before you take on any debt, ask yourself, “Is what I want to purchase truly worth the obligation?” For example, is that particular brand-new car you can’t stop thinking about really worth five years of monthly payments? Every month? No exceptions?

You will take on debt in your life. We all do. A home mortgage is generally considered an acceptable form of debt. We all know it is going to cost us something every month for shelter, whether we rent or buy.

Student loans may be considered tolerable obligations because the education we receive will help get us get a better job and salary. Few people are fortunate enough to be able to pay cash for their cars, and so take on auto loans out of necessity for transportation. 

There are logical reasons for taking on debt, but maintain the mindset to take on debt only if it is in your overall best interest. Assume the least amount possible, and pay it back as quickly as you can. 

I suggest you seriously think about and research the true cost of any debt you want to take on. Know exactly how much interest you will end up paying. Is the payment so high it will interfere with your savings plan? Would you be better off financing a less expensive vehicle that is just as reliable? Would you be better off investing what you would save by having a lower payment?

Staying debt-free requires determination. You will be tempted. You will face tough choices. Yet the rewards of a debt-free lifestyle more than compensate for the challenge.

Always Pay Yourself First

If you are like most people, you tell yourself, “If there is anything leftover at the end of the month, I’ll try to put it in my savings account.” In much the same way as to how our earthly possessions take on a life of their own and expand to fill every empty space we have to store them, money also seems to have a life of its own and tries to keep flowing out, in spite of what our intentions for it may be.

One way to deal with our outflowing money is to grab it at its source. Take your savings first! There will never be enough left over. No matter how much money you make, you will be inclined to spend more if you are like the rest of us. Develop the lifelong habit of taking a certain amount right off the top of any money that comes in. 

Once you have regular earnings, you may want to consider setting up an automatic deposit from your checking account straight into your savings. An old rule of thumb is to save at least 10 percent every pay period. 

If you are working but do not yet have the financial responsibilities of living on your own, perhaps you can save a much larger percentage. You can adjust that amount, taking into consideration what your personal goals are and how fast you intend to reach them. It is the habit of consistently adding to your savings that is important here. 

Don’t put it off. Do you know people who pass up a gourmet cup of coffee because they want to save the money, then drive to the bank to deposit the two dollars they saved? Of course not. Don’t give all your money the chance to flow out. Paying yourself first assures that you save something, and the accumulation of little somethings over time helps build your financial independence.

Be Accountable to Yourself for Your Spending Habits

Have you ever thought you had more money in your wallet or purse than you did? Did you have a hard time trying to remember what in the world you spent the missing money on? Inattention to our spending is another area that trips us up.

While it would drive you crazy to account for every single cent you spend, you do need to have an accurate idea of where your money is going. Is the amount you are spending every month on target with your financial game plan? Do you recognize your riskier spending habits? When you feel bad, do you regularly buy yourself something to cheer yourself up? Are you an impulse shopper? Do you give yourself convincing little lectures on why it’s okay to buy something new when you know that you really should wait?

Some people are better at watching their pennies than others, but most people spend more money every month than they realize. This is where the danger starts. Benjamin Franklin had it right when he said, “Beware of little expenses; a small leak will sink a great ship.” It’s hard to visualize how saving on little things can make a significant difference to your long-range financial goals. 

It’s also hard to remain committed and motivated to be accountable for how you spend your money. Make up your mind to stick to your financial game plan. Even a small thing like eating lunch out every day can affect your long-term financial picture. Maybe you’ve heard that you can save hundreds of dollars every year by brown-bagging your lunch. It’s true. 

This may be an area where you can save money. Yet the decision to pack your lunch is just one example of the attention, the mindset, and the conviction it is going to take for you to live within your means and be true to your financial plan. It also requires a daily consciousness about your goals and what you do with your cash. How important to you is your financial independence? Will you take your financial game plan seriously? Every day, you will need to commit yourself again to your financial future. Every expenditure requires thought.

The need to be aware of how you are spending your money doesn’t go away when you start making more. Your financial portfolio will change, but the necessity of spending your money wisely will not. No matter how much money you have, you will still be accountable—at least to yourself—for your spending. 

I’m not suggesting you become a real cheapskate. Just keep in mind that you will need to act responsibly, not only for the rent and the car payment, but also for the extras like magazines, music downloads, smartphone apps, and those huge buckets of popcorn at the movies. The little totals do add up.

Another danger, of course, is in thinking you’ve been so good at saving on the little things that you make a huge purchase you are not ready for. Be careful of those big-ticket items! The wrong one at the wrong time may throw you financially off balance. 

Meeting your financial goals is too important not to give every purchase the consideration it deserves. You are accountable to you. Just pay attention to both the small and the large expenditures, and you won’t have to answer to yourself for messing up.

Establish an Emergency Fund

Everyone needs a savings account, as I will discuss a little later. You should also set aside money in an emergency account. This means, of course, for emergencies only. It is not the money you use when your friend wants you to go along on a spur-of-the-moment vacation to Aruba. 

It is the money you set aside for when, not if, unexpected expenses come up. Cars break down. You may get sick and miss a lot of work. You may even lose your job. Having this safety net in place may mean the difference between being able to meet your rent or having to move, or worse.

Ideally, if you have not yet set out on your own, you should try to make sure your emergency fund is in place before you move. It is generally recommended that you have from three to six months of living expenses saved. 

This means you figure out how much you will need every month just to get by (include everything: rent, utilities, food, gas, etc.) and multiply it by the number of months you want to have in reserve. Sounds like a lot, doesn’t it? 

Make sure you have at least three months worth of expenses set aside. After that, guess what? Then you can actually start saving to move out. Yes, only after you have enough put away for emergencies can you even begin to think about saving to move out.

You notice that I said “ideally.” Perhaps you are already on your own, struggling just to pay the rent. Whatever your circumstances, make funding an emergency account a priority—even if you have to temporarily take on a second job to come up with the money. It’s that important. 

Here’s why. In addition to wanting to be prepared for an emergency, you will also need to build a solid financial future. Part of that process involves saving and investing. You will not be able to invest effectively if you have to take money away from your investments to cover life’s surprise expenses. 

It is very hard to build a solid financial future without benefiting from solid investing. Investing just a few dollars regularly helps you tremendously over time. Having to interrupt your investment strategy may end up costing you more than you realize.

Once you are on your own, an important thing to remember about an emergency account is to make sure you can get to the money without delay and penalties. With some savings vehicles, such as certificates of deposit (CD’s), you will be penalized if you make a withdrawal before the agreed-upon time has passed. Don’t tie up all the money you have into such an account.

Another consideration is that you may not want to keep such a large amount of money in your checking account or regular savings account that pays a low interest rate. One reasonable option may be to have your emergency fund in a money market account. 

Money market accounts generally pay more than a regular savings account, and you can get to your money whenever you need it. You are allowed a limited number of transactions per month, which, with luck, you will not need anyway. Generally, a minimum amount is required to open a money market account, so you may need to plan accordingly. 

Money market accounts that are insured by the government are available at many traditional financial institutions, such as banks, savings and loan associations, and credit unions. 

There is a similar fund called a money market mutual fund. This is a type of mutual fund, and it is not insured by the government. There is a difference. If you open a mutual fund money market account, I suggest you use a large and well-known fund. Make sure you read and understand all of the available information on the fund.

When you live on your own and have more than six months of living expenses set aside, you may want to spread the money over a couple of different accounts. Perhaps use both a money market fund and a short-term CD. Wherever you decide to put your emergency fund, knowing you have a safety net to fall back on will give you peace of mind. It will also play an important part in your saving and investment strategy. As you prepare to step out on your own, an emergency fund should be one of your top priorities.

Establish a Short-Term Savings Account

A short-term savings account is for saving up for the near and sort-of-near future. Having such an account is better than stashing cash around the house, because you cannot get to it on a second’s impulse, and because your money will be earning interest, or a return, on what you deposit. 

I believe saving up and paying cash for a purchase is always best. (Using a credit card to make the purchase is fine, but don’t buy the item unless you already have the money set aside and can pay the credit card balance when it arrives.) 

A short-term savings account is the account you use to save to meet those not-too-distant goals. This is where you park the money that you are hiding from yourself. Remember that 10 percent rule from “Pay Yourself First?” You may want to divide part of the amount you save into a short-term account and part into a long-term account.

Make it easy on yourself to save. People who do better at consistently saving are those who automate the process and schedule payments regularly. These transactions may involve transfers from a checking account into a savings account or direct deposit transfers from your paycheck. Use whatever method of saving that works best for you. It’s the development of the habit of systematic saving that is so important here.

Establish a Wealth Investment Account

Did you notice I used the term “investment” here and not “savings”? Investing is taking your capital (money) and using it in a way that helps you gain more capital or income in the future. Think of this account as being your “wealth creation account.” You will use this money to make more money. 

Even if you can only set aside a few dollars a month, set up an automatic payment to this account as soon as possible. Using both your youth and your dedication to your financial game plan to your advantage, you can certainly set yourself on the road to financial independence and enjoy security for yourself and those you love.

Are you ready to start investing? You will need to have some dollars available for investing, of course, but you will also have to educate yourself on the types of investment opportunities that are right for you. 

Since investing involves a certain amount of risk, some people are more comfortable putting their money in traditional savings accounts or in securities issued by the U.S. government. They may need the peace of mind of knowing their money is insured by the government’s full faith and credit. 

However, true investing, while presenting some risk, offers the potential for the greatest return. Educate yourself as thoroughly as possible to decide what the best investments are for your risk level, and never commit yourself to an investment you do not completely understand.

Always Use Your Credit Cards Responsibly

A credit card company is not your friend. Issuing you a large credit limit is akin to giving you enough rope to hang yourself with. Don’t get caught in the credit card snare! It is so easy to get in the habit of using your credit card and end up spending more than you can afford. 

Credit cards are accepted almost everywhere. However, the convenience is not worth the price you pay if you lose touch with your money. If you use cash for every purchase, aren’t you just a little more careful of how you spend your money? Do not become desensitized to the fact that accumulating credit card charges is spending real money. The green stuff. Treat your credit card like you treat your cash.

If you do use a credit card for convenience, make sure you pay off the balance every month. If you find you spent more than you should have and think you’ll carry a balance just this once, you will be best served by putting the card away until the balance is paid in full. It is easy to start carrying a small balance and end up in over your head. 

If you cannot get by without charging, you are living beyond your means and need to fix the situation immediately. Does this sound a bit harsh? Well, few things can ruin your financial life as quickly and as painfully as credit card debt. Clearing your credit card debt can be one of the best investments you can ever make. 

You indeed need to establish a credit history. Having a good credit history will help you get favourable interest rates from lenders when you take on “acceptable debt,” such as when you buy a house or new car. It is also true that a credit card can be invaluable in an emergency. Yet, promise yourself that you will not succumb to the temptation of using credit to purchase the things you really should save up for. Credit cards are best left for emergency use only.

Establish a Retirement Account as Early as Possible

I bet you can’t believe I’m writing this. Just two chapters ago, I was telling you how to get your first job and now I want you to worry about your retirement? Am I kidding? No way! Funding your retirement account now will pay you colossal returns later. 

Just about any book you pick up on investing for your future will contain charts, graphs, and tables explaining how much more you can earn for your retirement by starting sooner rather than later. There’s a major difference.

One of the best parts of saving for your retirement is that the U.S. government wants to help you and has created some incentives for you to save. The IRA (Individual Retirement Account) is one such incentive. 

An IRA is a personal retirement savings plan that offers you tax advantages. With a traditional IRA, your contribution of earned income may be tax-deductible; taxes are deferred until you withdraw the money, including interest, during your retirement. This means that you are setting aside money before you give part of it away in taxes! A Roth IRA is not tax-deductible, but it allows you to put a certain amount of earned income away every year, with the benefit of being able to withdraw the money tax-free in the future.

You decide where you want to set up your IRA, whether it’s at a bank, credit union, insurance company, or brokerage firm. Make sure you are aware of any fees or loads that may be involved. Setting up an IRA is as easy as opening any other account and the benefit of starting now is tremendous. Make the generous funding of your IRA a habit you start as soon as possible and continue all your working years.

If you are employed by a company that offers a 401(k) retirement plan, be sure to study the options carefully so you can take full advantage of the opportunity. A 401(k) is a deferred compensation plan in which you elect to have your employer contribute a portion of your wages to an account set up in your name. 

With some plans, your employer may match some or all of your contributions. With most plans, you make your own investment decisions. You are choosing only among investment alternatives offered by the plan, however, so it is important that you are comfortable with those choices. Although it takes a little time to research your 401(k) options, it is a positive move to have such a plan in place. Fund your 401(k) to the fullest extent that you can, or at least enough to take full advantage of your employer’s matching contribution.