Did you know that you can build a house without a foundation? Despite commonly held beliefs and frequently used metaphors, nothing is stopping you from having a foundation-less home.
That being said, there is also nothing stopping it from collapsing from the never-ending movement of the earth beneath it.
Can and should are two very different things. Just as you can, but shouldn't, build a house without first laying a foundation to stabilize it, you also can go about your life without any foundation of financial knowledge.
But should you? That's for you to decide.
January is Financial Wellness Month, so this month's blog posts are all going to be centered around the topic. We'll start off by going over the eight foundational building blocks of financial wellness, followed by a focused look at the financial needs of two categories of people: families and seniors.
First, though, let's talk about why need a strong financial foundation.
Why We Need a Strong Financial Foundation
Going back to the illustration of a house, all the other parts of a home are built on top of the foundation. Having a strong understanding of financial concepts can also do this, giving us the ability to make more informed decisions, have greater opportunities, and use money as a tool.
Let's think about the opposite for a moment. Imagine you knew nothing about budgeting, high interest debt, or equity. You lived paycheck-to-paycheck because you didn't use your money wisely, your credit cards were maxed out because all unexpected expenses went on them, and you rented your entire life, so you had no home equity. This is a real situation many people find themselves in.
As a disclaimer, I'm not by any means saying that people who struggle to pay their bills are bad at managing their money, or that renting is an unwise choice. Every situation is different. In this particular circumstance, though, the problems could've been avoided by making different decisions.
Being financially literate has plenty of benefits, such as peace of mind, access to better loans, a backup in case of emergencies, more flexibility, the option of a work-life balance, and teaching your kids about money management, just to name a few.
Notice we're talking about having financial wisdom, not being rich. This isn't about how much you have, but what you do with it.
Now that we've established the benefits of having a financial foundation, let's look at the individual pieces of one.
Having a Realistic Budget
The concept of a budget is simple: it's how you spend the money you have. In action, though, budgeting can get much more confusing. On top of that, some people feel budgeting is as restrictive as a straight jacket. It doesn't have to be that way, though, as we'll see.
First, let's talk about building a budget. You'll start by figuring out your net income, which is your total take-home pay after taxes and employee benefits, like your 401(k) contribution or health insurance premiums.
Next, you'll need to track your money habits to know how much you're spending, and on what. I personally have a note on my phone with categories, like "groceries", "fun money", and "gasoline". Each time I spend money, I write it in the proper category.
If that sounds too labor-intensive, there are apps out there that you can connect your bank to. They'll divide your expenses into categories and tally it all up for you. Be careful, though –– always double check the validity of an app before putting in such sensitive information as your bank account number.
Once you have your totals for the month, give them an honest look-over. Are you spending more than you thought? Are there any changes you'd like to make?
I know that I always struggle with my "fun money". As a coffee addict, it's an ongoing struggle to lower my spending in that category. If you have a category like that, ask yourself: can I buy less of this?
The point isn't necessarily to get rid of it entirely; that likely wouldn't be sustainable. Why not pick a reasonable weekly spending limit, though? Then you can adjust from there.
From there, there are endless budgets to follow. You have the "50 30 20 budget", which is when you spend 50% on your needs, 30% on wants, and 20% on savings. There's also "zero-based budgeting", where you makes sure your income and expense equal each other out –– aka get to zero. You know exactly where each dollar is going. The list goes on.
Tracking your expenses and budgeting is all about awareness: being aware of what you're spending, where you're spending it at, and if you're spending more than you budgeted for. The more you do it, the more natural it becomes.
Building Up Emergency Savings
Putting together an emergency fund is one of those things in life that we all know we need to do, but procrastinate getting around to. It's in the same category as getting your toothache checked out or cleaning out your gutters; you find yourself asking, "Can't it wait one more day?" But before you know it, what would've been a simple filling turns into a root canal, and a clogged gutter becomes a leaking roof.
In fact, those might be the very things that an emergency fund would come in handy for. Having money put away for unexpected expenses saves you from having to take out a loan or put the charge on high-interest credit cards.
That being said, how much should you have put away for emergencies? Each person's circumstances differ, but experts recommend enough to cover at least 3-6 months worth of expenses. That way, if you lost your job as many did during the pandemic, you'd have a cushion.
"But that's a lot of money to save!" you may say. Yes, it is, especially if things are already tight. I get it; we live in or near a high cost of living area, and more and more people are feeling it. Still, saving a little is better than nothing, so why not start small? Can you spare $5 a month? How about $20?
Another factor of an emergency fund is where to put it. You could keep your money "under the mattress", or in cash at home. Another idea, though, is to put it in an account that you'll earn interest on. High yield savings accounts (HYSA) are one option, as are money market accounts. The key is high interest, low risk, and quick liquidity.
Personally, I just opened up a Kasasa Cash and Kasasa Saver account at a local credit union, and I'm happy I did. If you meet the reasonable criteria of how often you use your debit card a month, you can earn up to 5% on checking and 3.5% on savings. Compared to my traditional savings account, with a rate of .05%, that's a pretty good increase!
No matter what method you choose, the same goal is met: protecting yourself against future emergencies.
Limiting High Interest Debt
We hear interest talked about a lot, but what is considered "low" interest versus "high" interest? Most experts consider mortgage and student loan rates "low", usually ranging between 2-7%. Anything over that is considered "high". That includes the interest rates for credit cards and personal loans, which can often get up to 30%.
One large factor that goes into whether something has high or low interest is the security of it. So for things like mortgages and car loans, the rate is lower, because there is a tangible asset behind it (which can be taken away if the bills aren't paid).
So why is high interest so bad? It comes down to compound interest. You may have heard this term when referring to saving for retirement; when it comes to saving money, compound interest is your friend. Not so much with debt, though, because this time you are the one paying.
Compound interest works like this: imagine you have a $2000 credit card bill with 20% APR. Even if you make a $200 payment every month for a year to pay it off, you end up paying an extra $206 worth of interest.
What if it took longer, though? What if you could only pay $50 a month? It would take over 5 years to pay off $2000, and guess how much extra you would pay in interest? $1,323. That's more than half of your original bill!
The point is clear: high interest debt can get out of hand fast. If you want to do some calculations with your own balance, this compound interest calculator is a good start.
That's not to say you need to go cut up all your credit cards right now and never use one again, though; it's all about knowing how to use them. Many experts recommend paying off your credit card bill in entirety every month, or at least paying more than the minimum payment.
It comes down to this: the lower of a balance you have on your card, the less you end up paying in interest.
If you're at the point where you feel like you're drowning in credit card debt, don't despair; there are options to help you. One way you could handle this is by getting a balance transfer credit card with an intro 0% APR. Then you can transfer balances from your other cards to this one. The one catch is that you'll have to make sure you pay off the balance before your intro period ends.
Another option is a debt consolidation loan. You can take out a loan with a lower APR than your credit cards, use it to pay off the balances, and then only have one loan to pay instead of many. This can be easier to keep track of.
If you aren't in this situation, though, try to avoid it by limiting your high interest debt.
Saving Up Retirement Money
Remember that compound interest we talked about earlier? When it comes to retirement savings, it works for you, and the sooner you start collecting it, the better. This is especially true if you start in your twenties or thirties. It may feel like retirement is ages away, and you're too busy just starting out in your career or raising a family to spare money for retirement. I get it. But you'll thank yourself later.
Why do you need to save for retirement, anyway? Isn't that what social security is for? Yes and no. The thing is, social security isn't usually enough to live on. According to Investopedia, "payments replace about 40% of the average wage earner’s income after retiring". With only a fraction of their needs covered, many retirees end up needing to go back to work part-time.
On the other hand, if you start preparing now, wherever you are in your life, you'll be that much ahead of the game.
Some popular ways to save for retirement are IRAs, 401(k)s, and pension plans. Each have their unique perks and tax considerations. For example, a 401(k), which is provided through an employer, often offers an employer match. What that means is that for every amount of money you contribute, your employer will add the same amount. Usually this is only up to a certain point, like 4% of your income. If you have that opportunity, though, why not take advantage of the free money on the table?
Also, by applying these eight financial building blocks, you're preparing for retirement by building healthy money habits. You're already ahead of the game!
Considering Your Credit Mix
Let's go back to the topic of credit again, but at a different angle: what types of credit you have. Your credit score is decided by many factors, one of which is your credit mix. For example, if you had only ever built your credit with a credit card, called revolving credit, then your score won't be as high as it could be. But if you have a mix of revolving credit and installment credit, like auto or student loans, your credit score will benefit.
Why? Juggling different credit types successfully shows lenders that you're reliable. Plus, the more loans and credit cards you have, the higher total available credit, which will improve your credit utilization ratio –– your balances owed compared to what you have available.
Of course, as previously discussed, credit debt can be tricky, so always carefully consider the pros and cons before making any decisions.
Covering Your Bases With Insurance
Health, life, disability, homeowner or renter, auto, pet, umbrella. Insurance, insurance, insurance. It's nobody's favorite thing –– until it comes to the rescue.
Each type of insurance is different. Some are required, some are optional. They're all built around the same idea, though: you pay a company each month (called a premium), and in return they promise to cover a big expense, if it were to ever come up. That's really nice of them, isn't it? Except this expense never occurs for most people, so the company makes big money without any negative impact on them. Plus, even if it does happen, it has to fit perfectly into their fine print criteria, or they may not accept the claim.
Why have insurance, then? For one thing, it provides peace of mind in case something ever were to happen. For example, I have a dog, AJ. Over a year ago, he had an allergic reaction to a flea and tick medication and went into anaphylactic shock. The Port City Veterinary Hospital in Portsmouth, NH was able to save him, but the bill came to almost $2000. AJ is perfectly fine now, but ever since that incident, I have paid for pet insurance for him. It may be needed, or it may not. But after reading stories of others online who, without pet insurance, had to decide between forking over $10-15,000 for a surgery or putting their beloved pet down, it made sense to me.
Of course, there are experts to help you figure out what insurance is best for you. Eric would be happy to help you navigate the ins and outs of life, disability, and long term care insurance, and he can also refer you to agents with different specialties.
Getting Started Investing
Though putting your money into savings is the safest bet, it's not going to do very much there; that's why many people feel that investing a more powerful tool to build long-term wealth than saving. There are different levels of risk, but usually the more risk, the higher potential rate of return.
For comparison, some of the lowest risk investment options are Certificates of Deposit (CDs) and High Yield Savings Accounts (HYSAs). They're virtually riskless, since they're insured by financial institutions. However, their yield is lower than many other investment options, both coming in around 4%. This means that even though they have zero marked risk, they have a very high inflation risk –– you may need to save more to make up for lower interest rates. You can calculate Certificate of Deposits here, if you want to get familiar with their yield.
Moving up the risk scale, you have bonds, real estate, mutual funds –– the list goes on. One truth stays consistent no matter the investment vehicle, though: the more time you have, the better off you'll be.
As Charlie Munger, Warren Buffett's business partner, once said, "The big money is not in the buying or the selling, but in the waiting.”
A last note on investing: diversification is your friend. With so many different options out there, it's recommended to dabble a bit in at least a few categories. Then, even if one isn't performing well, the other one might be. "Don't put all your eggs in one basket", as they say.
Learning Continuously
No matter where you are in your financial journey, we all can benefit from continuing to learn. After all, we live in an ever-changing world, where new concepts are being thought of on the regular. Who would've thought artificial intelligence would've become such a big deal over the past few years? Or that you'd be able to take out a loan entirely online, without speaking to a single person?
Just as the markets keep changing, so will trends, investment opportunities, rates of return, and more. So staying informed is the best way to protect your financial wellness long-term.
Of course, one of the easiest ways to stay informed is to have a financial professional like Eric in your court. From weighing risk levels to helping you make a plan for retirement, he is there for you. Feel free to reach out with any questions, whether you're a long-time client or only just hearing of us.