New Years Resolutions: 11 moves for 2011

Its the time of year when we begin to take stock of our lives. Each January 1, we count our blessings, remember times gone by, and think about what we can do to improve ourselves in the coming year. New years resolutions will vary from losing weight, to paying off debt, to spending more time with our families. In the spirit of the season, we at compounding returns have come up with a list of 11 financial resolutions for 2011.

1. Fund your retirement accounts. If you haven't signed up for your employer sponsored 401K or other retirement savings program, 2011 is the time to start. If your employer offers matching contributions, contribute at least the level of matching funds. You can contribute up to $16,500 in 2011 if you are under 50 years old, and an additional $5,500 if you are over 50. If you are already contributing up to the employer match into your 401K account, consider a Roth IRA. If you are single and make less than $107,000 per year, or married with a combined income of less than $169,000 per year, you can contribute up to $5,000 in 2011.
2. Start or increase your emergency fund. If you find yourself entering 2011 without an emergency fund in an interest bearing, accessible savings account, this should be a priority. Emergency funds offer security in the event of illness, job loss, or other unforeseen life events. Make your savings goal measurable. If you are just starting out, shoot for $1,000, if you are passed that level, set a new goal. At compounding returns, we believe your final goal should be a year's worth of expenses.
3. Start a budget. If you don't have a working budget, there is no better time than now. Budgeting is one habit that the wealthiest Americans share. See building a budget, for more information.
4. Pay down high interest debt. This one is a no brainer. You will get no better return than paying off your high interest consumer debt. See our post on holiday debt hangovers, or if you are looking for a more in depth strategy, try Dave Ramsey's The Total Money Makeover: A Proven Plan for Financial Fitness
5. Review your insurance situation. A close look at your insurance coverage may be in order. Are you adequately protected? Are you paying too much? If you rent, do you have renter's insurance? If you are a homeowner, do you have flood insurance? Can you raise your deductibles and save money on coverage? Asking these questions could save you a great deal of money and worry in the new year. 
6. Invest in education. See our post on the benefits of advanced education. It may be the perfect time to enroll in a degree program.
7. Learn about finance. We recommend The Millionaire Next Door: Surprising Secrets of America's Wealthy, The Total Money Makeover: A Proven Plan for Financial Fitness, and Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies. Every minute you put into understanding the steps to financial freedom is a minute well spent, and a great investment in your future. 
8. Buy your first stock. If you don't own any stocks outside of your retirement accounts, or if all of your investments are in mutual funds or index funds, 2011 is the time to begin the extremely rewarding process of owning a piece of a great publicly traded company. We strongly recommend The Motley Fool as a free learning resource and community of individual investors.
9. Invest in your possessions. The longer you keep something, the more it pays you back. Have a malfunctioning appliance? Have it fixed. It will no doubt be cheaper than buying a new one. Car troubles? Take it to the shop, or risk the problem getting much worse.
10. Join a gym. This one may seem counterintuitive, since this will result in another expense, but taking care of yourself now will reduce your medical and insurance costs down the road and will increase your lifespan (and the years your investments have to compound).
11. Start a side hustle. Earning a little bit more on the side never hurt. Like to work outdoors? Offer to do some gardening for an elderly neighbor. Web designer? Offer to work on a web site for a local small business. The list is long and varied. You know your talents. Use them, and pocket a little extra cash in 2011.

With any new year's resolution, success is much easier when you choose a goal that is realistic and measurable. Picking one of the above goals is a great start, but keep yourself honest. Set a realistic goal, and track your progress. Best wishes for a prosperous and productive new year!

Education: The key to a rich future

It is no secret that higher education has traditionally meant higher earning power. This is an unmistakeable fact, as seen in this 2009 chart released by the Bureau of Labor Statistics (BLS). 

At compounding returns, our motto is invest in yourself, your family, and your future. There is no investment that offers the potential for as great a return as a high quality education. The choice to continue your education yields returns for the rest of your life. It offers the intrinsic rewards of knowledge, discipline, and perseverance, and the financial rewards of job security, higher wages and greater benefits.

As you can see from the chart above, the pursuit of more education will yield a great return even for those who may already have a high school diploma, an undergraduate degree, or even a graduate degree. Taking your education to the next level will yield significant results no matter what the job market or the financial markets are doing.

The following will offer some idea of the potential return on taking your education to the next level:

H.S. Diploma: For those who didn't complete high school, obtaining a H.S. Diploma or GED results in average unemployment rates decreasing by 4.9%, and income rising by 38%.

Associate's Degree: Attending a technical school, career college, or junior college for an Associate's will result in unemployment rates going down by 2%, and average income increasing by 21% over a high school education.

Bachelor's Degree: Getting your Bachelor's degree will decrease the average unemployment rate by 1.6%, and income by 34% over the Associate's. On a side note, according to The Millionaire Next Door: Surprising Secrets of America's Wealthy, over 80% of American millionaires have at least a Bachelor's degree. I'm just sayin...

Master's Degree: Continuing beyond the Bachelor's level for a Master's degree will  result in the average unemployment rate decreasing by 1.3%, and income increasing by 22%.

Doctoral Degree: Besides sounding really cool, being called "Doctor", does bring some hefty financial rewards to those who continue beyond the Master's level, as the Ph.D. or professional degree holder will see unemployment decrease by 1.4%, and income rise by 21% over the Master's.

Education is an investment in your future that will never lose value. The benefits are clear, as this 2009 study by the U.S. Government shows. Today, more than ever, with the plethora of legitimate community colleges, colleges, and universities that are offering accessible and affordable online, evening and part time programs, there has never been a better time to take your education to the next level, and reap the personal and financial reward for years to come!

Buyer Beware:

If you chose to act on this data, please ensure that the school you choose is accredited by one of the Six Regional Accreditation boards in the United States, found here: http://www.chea.org/Directories/regional.asp

If you will be financing any part of your education, work with your school financial aid department. Beware private student loan companies, and above all, always understand what you are signing, and question terms and amounts of your loans assertively. For more information:  

http://studentaid.ed.gov

Many people have been taken advantage of by predatory lenders at some less than reputable for profit schools. Be aware that while the advent of for-profit-education has made college more accessible to many people, in most cases you are much better off sticking with traditional community or state colleges and universities, who often offer cheaper tuition and a far more respected degree. 

The U.S. Government Accountability Office (GAO) released a report just last year on deceptive practices amongst for profit universities, a summary of which can be found here:

http://www.gao.gov/products/GAO-10-948T

Holiday Debt Hangover: Steps to a debt free 2011

Hopefully, you had a happy and joyous Christmas holiday! But as the egg-nog fog and turkey induced paralysis begin to wear off, and we take stock of our financial situation in anticipation of the new year, many of us will have found ourselves overextended in providing a nice Christmas for our families. Perhaps we financed some holiday travel, took out a loan for a large purchase, or ran up our credit cards in a frenzy of holiday shopping over the last months. Whatever the case, January will for many of us, bring new revolving debt payments which we should resolve to get rid of as quickly and painlessly as possible.

If you find yourself resolving to rid yourself of the holiday debt hangover, the following should provide a good starting point for paying off your high interest holiday debt, and setting the course for financial health in the new year. 

Go cold turkey: Stop using credit cards. If you don't already have a budget, the new year is a great time to start one, and begin paying cash for your purchases.

Know what you owe: Take stock of your outstanding debt, and order the debt from smallest to largest amount on whatever is handy (I like spreadsheets, but you could do it on a cocktail napkin or anything you have handy).

Make some phone calls: Call your creditors and request lower interest rates on existing balances. 

Fund your emergency account: Build up your emergency fund (in a high interest online savings account like ING Direct), while making the minimum payments on your outstanding debt. (I know this is painful as you will be bearing the full brunt of the interest payments over this period, but it is imperative to long term financial health). Keep in mind, if you don't have an emergency fund, one big setback is all it takes to put you back on the debt treadmill. Once your emergency fund reaches your determined threshold ($1000 is a good starting point), you will be ready to begin snowballing your debt and crawling out of the holiday financial hole. 

Start paying off your debt: While making the minimum payments on all of your accounts, choose the account with the lowest balance, and after looking at your household budget, apply the maximum amount of available money to this account. Do this every month until the first account is paid off.

Enter the holiday debt snowball: Once your first account is paid off, take the payment you had been applying to the first account, and steamroll it right into the account with the second highest balance. 

Repeat the process: Continue this process, focusing on one account at a time, working from the smallest account to the largest. Be patient, stick with the plan, stay within your budget and this debt elimination strategy will work in your life. 

For those of you who have read The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey, this will no doubt sound familiar. Dave Ramsey certainly believes this to be the best way for average Americans to begin to break the bonds of credit slavery and offers a program with a wonderful psychological rewards as you begin to see results immediately (which is why we start with the smallest balance, and not the card with the highest interest rate).

Getting out of debt in 2011 is step one towards securing our long term financial health for the sake of ourselves and our families. Paying off debt also offers the single best return possible inside or outside of the financial markets. No mutual fund or hedge fund manager could guarantee you a 20% annual return, but a 20% return is absolutely what you will get by paying off your high interest credit debt. 

Happy holidays, and have a prosperous new year!

Culture of Debt: The good, the bad and the ugly

For argument's sake, you are an average American. You financed the holidays with credit, and are left with an average of $4,440.87 in credit card debt. Add to that the national average of $21,000 in student loan debt (MSN Money), average auto loan debt of $12,500 (Marketwire.com), and average home loan debt of $69,227 (MSN Money), and you owe $107,167.87. Assuming a 5% average interest rate (which is extremely conservative), you are paying $5,358.39 annually in interest.

The numbers above are based on national averages. The amount of debt that each individual carries, and the interest rates associated with that debt will vary. Financial institutions make billions every year loaning money. They count on people like you and I thinking based on our short term needs and wants in order to charge large rates of interest in order to finance items which we cannot afford in the first place. 

Not all debt is bad. Some debt allows us to leverage our existing resources in order to achieve greater financial returns. Traditional examples of good debt would be federally subsidized student loans (for education that increases our earning power), and mortgage debt which allows us to finance a roof over our heads and build equity in an asset that serves a very important purpose. I would take this one step further. In this writer's opinion, any debt we incur that allows us to obtain a financial reward can be good debt, as long as we consider interest rates, necessity, and are aggressive in paying down the principal and interest. An example would include financing equipment for small businesses.

The debt that cripples many Americans, however is consumer debt. Automobile loans, credit cards, and other debt associated with consumer discretionary spending is dangerous in a number of ways. 

1. It is used to finance depreciating assets.
2. It carries the highest interest rates.
3. It is unsecured.
4. It is used to finance a lifestyle that we cannot afford.

Using a credit card to finance a depreciating asset:

This is a double whammy, as they say. Heres an example to quantify the danger of this one.  

I'm going to purchase a 52 inch LCD HDTV. It's sweet! I've got to have it NOW! 

I don't have the cash for it, but lucky me... I just got a new American Express card with a HUGE limit! The T.V. costs $2,500.00. I whip out the plastic, and with a thoughtless swipe of the card, I'm loading my new T.V. into the car. 

If I make the minimum payment on this single purchase, I will pay $62.50 per month. Not bad, huh? Except for the fact that it will take 17 years to pay off the balance (By which time I will likely no longer have my SWEET T.V.), and assuming an 18% interest rate, I will have payed $5,673.22 for something that has long since become worthless.

Interest rates matter:

In the above example, I used a credit card with an 18% interest rate. If my credit card carried a 9% interest rate, instead of $5,673.22, I would have paid $3,998.45. Still a horrible idea to finance a depreciating asset with credit, but interest rates truly do matter. The lesson? Check your credit report for errors, and shop around for credit cards with the best interest rates. Or, best yet, don't finance anything using credit cards.

Unsecured debt:

Unsecured debt is debt that is not attached to a purchase. Credit card debt, personal loans, and store credit are all examples of unsecured debt. The danger of unsecured debt, in this writer's opinion, is that if you end up in financial hardship and are unable to make your debt payments, there is no recourse for your creditor but to try and squeeze the proverbial blood from a turnip. They are not going to repossess your assets, because your debt is not collateralized, instead, they are going to sell your debt to collection agencies where you will be hounded, harassed, threatened, and pursued until you either declare bankruptcy or pay off the debt. 

Financing the lifestyle (we think) we deserve:

The thing that gets us in the most financial trouble. We spend more than we make. Sometimes we just don't know any better (we may not have a working budget), and sometimes we think we can afford the stuff we want because our culture surrounds us with people who have leveraged their futures in the form of credit debt in order to fund their lavish lifestyles today.

The moral of this story is short and sweet. Debt can be good. Debt can be bad. In all cases, however, if you owe money and are making monthly debt payments, you are working for your creditors and not for yourself. Understanding the financially healthy use of credit is truly one of the first steps in becoming financially liberated, and beginning to work towards securing our own futures. 

For more information, try The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey. This is a great book on paying off debt, and becoming financially secure.

Millionaire Habits: Building a budget

A 2007 survey by Princeton Survey Research Associates International revealed that only 40 percent of Americans have a monthly budget. Research conducted by Thomas Stanley and William Danko, however, in The Millionaire Next Door reveals that the vast majority of American Millionaires are very disciplined budgeters. The lack of a disciplined household budget can truly come back to bite us, especially during the holiday season. 

The average American consumer will spend $688.87 during the 2010 holiday season, according to 24/7 Wall Street, a website that provides market analysis and commentary for investors. This estimate has increased by about 1% from last year. Now, I'm not one to bah-humbug the Christmas Season. I believe spending quality time with your family, buying gifts for your children, and truly enjoying the trappings of the holidays can make it one of the most special times of the year, and a truly wonderful investment in quality time with our families.

Unfortunately, the vast majority of American consumers will finance their holiday plans using credit cards, and will be left with a holiday debt hangover come January 1st. If this sounds like your family, and you are feeling desperate for guidance on eliminating credit card debt, I highly recommend Dave Ramsey's The Total Money Makeover: A Proven Plan for Financial Fitness.

Financing the holidays with a credit card can often be traced back to failing to plan for the expenses in our household budget. Spending on our credit cards and carrying a balance into the new year can cost us dearly. If we were to spend the US average of $688.87 during the holidays, and add this total to the average existing household credit debt in America, which currently stands at $3,752.00, we would be left with a credit card balance of $4,440.87.

Since this is a post about budgeting, I will save the effect of making only minimum payments on a credit card for future posts (suffice it to say, its a very bad idea).

Speaking personally, before I developed a detailed budget, I had no idea how much I was making, spending or saving. I thought that I was doing well financially, that I didn't "need" a budget. But, as I started to learn more and more about personal finance, I decided to develop a personal budget to take stock of where I was relative to my peers and relative to my long term financial goals. The experience was eye opening. Not only was I paying out almost half of my monthly income in debt payments, but I actually had a negative net worth (assets minus liabilities). 

Building a budget truly must be our first step towards financial independence. Without a personal awareness of our net worth, our assets, our liabilities, our recurring payments etc. we can never be financially free. 

If you are like I was a few years ago, and don't know how to start a budget. I would highly recommend the free website Mint.com as an excellent place to begin taking stock of your personal financial situation. We cannot begin to invest until we know what the best investment for our personal situation will be, whether it will be reducing recurrent payments, paying off credit cards, or investing in the future.

The Millionaire Mind: How the wealthy live

I recently read The Millionaire Next Door: Surprising Secrets of America's Wealthy In this fascinating book, the authors, Thomas J. Stanley Ph.D., and William D. Danko Ph.D. study and analyze in depth the lifestyles of America's wealthy, and identify several characteristics common to those with a net worth in the millions of dollars.

Essentially, the research presented in The Millionaire Next Door indicates that those Americans with the greatest financial resources are, in a word, frugal. The authors make an extremely compelling argument for the fact that these people are not frugal because they are wealthy, but they are wealthy because they are frugal. The millionaires interviewed by the authors rarely came in to a financial inheritance, won the lottery, or struck it rich through luck. Rather, the wealthy as studied in The Millionaire Next Door came to their financial station in life through hard work, deferred gratification, and making their families and their financial well being their priorities.

Some interesting facts and statistics as revealed by the authors of The Millionaire Next Door follow:

1. The average age of the American millionaire is 57.
2. The vast majority of American millionaires are married, and have an average of 3 children.
3. 2/3 of American millionaires are self employed.
4. 1/3 of American millionaires are retired.
5. 97 percent of American millionaires are homeowners.
6. 80 percent of American millionaires never received an inheritance, and are first generation affluent.
7. The vast majority of American millionaires live well below their means and are meticulous budgeters.
8. Only a very small minority of millionaires own or lease a current year automobile.
9. 80 percent of American millionaires have at least an undergraduate college degree.
10. Millionaires, on average, save 20 percent of their household income.
11. The vast majority of American millionaires identify themselves as frugal.

What can we beginning investors and students of personal finance glean from these facts as revealed by peer reviewed academic research in The Millionaire Next Door? I believe this book, which studies the wealthy from a sociological point of view, offers we students of personal finance a few clear signposts along our path to financial well being:

1. Education is one of the most important investments we can make in ourselves and our future.
2. Budgeting is a critical tool in our ability to live below our means, reduce debt, and increase wealth.
3. Saving for the future is non-negotiable, and we should aim to save 20 percent of  our before tax income.
4. Understand the difference between our needs and our wants. Status symbols are hazardous to our wealth.
5. Home ownership is an investment in your future, but in some circumstances you may be better off renting.
6. The most important factors in increasing net worth are time, patience, and consistency.

New Beginnings: Investing in financial literacy

In life, it is often the well traveled path that offers the least resistance. But although this seemingly safe trail through the wilderness of life may offer what seems like clear direction, it is inevitably in one's best interest to understand where the path will lead.

I refer, of course, to the conventional financial "wisdom" that has led many hard working and intelligent people down the primrose path to financial hardship or ruin.

We have learned through the media, advertising, and our daily social interactions that hyper-consumption is good. When we think about what it means to be wealthy, the first things that come to mind are private jets, flashy cars, yachts and mansions. We tend to believe that the wealthy are somehow different from the rest of society. In one respect, I believe this is true.

The wealthy understand the nature of compounding returns. Simply put, the wealthy invest in themselves, their families, and their futures while the rest of us pour time, resources, and money into liabilities that provide short term pleasure or gratification, but not long term dividends.

It is my contention that the real difference between the wealthy and the rest of us comes down to financial literacy, and it is my goal to share my journey toward a more fiscally responsible and financially sound future with you, the reader.