How to talk with your partner about finances.

Money can be a scary subject. Something about money brings a taboo feeling to many couples and is often a topic that does not get addressed until it’s too late. Financial stress is one of the leading causes for divorce in the United States; marriage.com has money rated as the second leading cause of divorce, specifically “lack of financial compatibility.”  The lack of financial compatibility leads to stress, the stress leads to miscommunication, and the miscommunication leads to resentments due to a lack of understanding.

It’s no wonder why financial stress is a leading cause of many relationship problems. Our expenses continue to rise year over year, while at the same time the average household income has been staying about the same and the amount that the average American has saved has decreased for the past few years. According to the US Census Bureau, the average household income in the United States was $63,179 in 2018. With an average monthly household income of $5,265, less than 81% have one month’s total household income saved for emergencies without having to borrow from family, tap into credit, or take money from retirement.  People are struggling with their finances and that is causing financial stress on many relationships.

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First and foremost, realize that you and your partner are on the same team. Sometimes it might not feel like it, but you are both probably wanting your money to provide similar things. Come to the table with this position in mind. Your partner is not the enemy. You need transparency in your finances, and there are a few easy places to get started.

Understanding your partner’s money background

I have heard this called money scripts as well. At the heart of the first step is to understand what money means to each of you and how you approach your money.  Each of us has had a completely unique and different set of experiences while growing up. Every individual comes to the table with different expectations on how money should be handled.

If you find that you have opposing views regarding how the household funds should be managed, you may want to start with finding a place in the middle that you can both agree on and build from that place once you begin to see successes.

Accept that you cannot change the background, but you can create a safe place to explore options, find common ground, and make incremental changes toward a new shared vision of money.

Ensuring that you have the same goals

Sit down and take the time to fully understand what your money represents for each of you and your lifestyles. When interviewing couples and talking about finances in my initial interviews, I often discover how many couples, new and old, have completely different views of what their money is for and how they plan to use it. Once you start talking about your finances together, you may find that you are on completely different planets regarding what each of you wants to do with your money. You may find that one of you has only short term aspirations and no long term planning other than that they may eventually want to buy a house or retire while also stating that the money in savings is going to a vacation later this summer, while the other of you has only long term money plans but no short term plans.  These views represent extremes, though the point is that there is room for disagreements regarding long-term and short-term planning.

Create a budget

Once you know what you are working for as a cohesive unit and have discovered the financial goals you want to achieve together, it is time review your budget and make the adjustments needed to put you on a path to working together toward a common money goal.

More than anything COMMUNICATION

Very few things build resentment faster in a relationship than having to make compromises and not talking about it. Sure, in a relationship we sometimes have to make sacrifices. If you’re not you should look in the mirror and realize that your partner probably is. When it comes to your finances and you are planning to build a long-lasting life together, you need to talk about what your money is doing and what it represents to each of you in a calm empathic manner. Truly understand where your partner is coming from. Schedule regular financial check-ins with each other, talk about each bill you’re about to pay, talk about purchases you want to make and your goals as they continually evolve through your discussions. One of the best exercises that I can recommend is having a financial date night. Make it a big deal and lay everything on the table on a regular basis. Without open, honest, empathic communication, the potential problems will only accumulate.

Now I never said that it was going to be easy and for most it will not be an overnight success. That said, start by taking the first step, scheduling some time to bring the conversation up and sitting down to listen to each other. It’s going to pay off.

How do you talk about money with your partner? Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

How to Teach Your Kids About Money

Looking at how important financial literacy skills are for navigating through life, it is almost appalling at the lack of required curriculum financial literacy has in our children’s schools. Speaking with several teachers about financial education over the last few weeks, most all have expressed concern about our children graduating with a serious lack of knowledge around money, credit, and investments. As a parent, it is imperative that you teach your children the important financial lessons that they will not learn anywhere else other than by trial and error.  Children are constantly exposed to financial transactions in the exchange of goods and services and may have an unclear understanding of the value of money without a proper explanation of the basics. Preparing our children for financial security can start at any age and can also teach us a few important financial lessons and skills at the same time. 

Learning good money habits at a young age helps your children to make good financial choices later in life. By learning to budget now, they will have a ‘leg up’ on others when it comes time to budget for being on their own, building credit, and saving for retirement. 

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Make saving fun

One of the greatest ideas on teaching your children to save came from a friend of mine who gave his daughter a few large glass jars for saving her money opposed to a standard piggy bank. He explained that the jar allowed his daughter to see the money as it grew. He labeled each jar for different things that she was saving for. She had four jars, which were labeled: Ice Cream Dinner, American Girl doll, Hamster, and Savings. This not only let her decide where she wanted to spend her money when she received it but they also created a rule that she had to put a minimum of ten percent in a savings jar, where it would be saved for her when she was older. 

Teach them about the how the coins and dollars add up

Learning how to add up money can be confusing and frustrating for a young child. Help them understand the basic concepts of money by introducing the different coins and the value each one has [or how much each one is worth].  Take the time to review how money adds up. Show them how each coin adds to the next and how collectively they add up to a dollar, and how a dollar adds up to twenty.  We often found the most fun was to quiz. I would write 2¢, 55¢, $1.32, along with other amounts on a piece of paper and let her find the coins that would add up to this amount. When she got it right, there was great reinforcement, and we took the time to review.   Knowing how change and dollars add up to will help when they begin to encounter purchasing.

Provide them chores

Make them do chores to earn the money that they put in their money jars. Learning early in life that work and money are connected is an important foundation.

Help them create a budget with goals

Having your child create their own budget can give them an idea of what they can afford and how much things actually cost. This will come in handy when your children want to buy something, but they realize that they need to plan to save up for it. This helps them understand the value of money and learn not to take things for granted.

Open a bank account with your child

Most banks understand the importance of teaching children financial literacy at an early age and offer accounts designed specifically for children and young adults. Once they have a small amount saved in their savings jar, take them to the bank to open the account. Encourage them to ask questions by going over a few before you leave home. Ask the banker to provide a ledge and review the account opening process with you child. Having been a banker for several years, these moments are often the best part of our day. Opening a bank account allows your child to feel like an adult and take the next steps in their financial literacy with pride.

Include your children in financial decisions and transactions

Don’t let money be a secret in your house. Talking about money often feels like a taboo subject in some households I have observed over the years. A great way to help kids understand money is to teach them how to use money. Next time you go to the grocery store have it planned out in advance. Have cash and coins available and take the time to let your child count out the money and present it to the cashier.  Have a little bit of every denomination available. For example, if your average grocery bill is $90.00, bring four $20’s, a $10, a $5, five $1’s, three 25¢, two 10¢, a 5¢, and five 1¢. This will be more than ample for them to understand the amount of money it takes to purchase daily goods.

If you have the opportunity to take them with you when making major purchases, such as a house or car, do it. Let them learn and encourage them to ask questions. This will allow them to have a different perspective on purchases.  Take them to your next meeting with your retirement advisor. Show them that you are saving money and they will want to emulate you by doing the same.

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Play the investment game with your children

If your kids are past the age of piggy banks, consider giving them a glimpse at the stock market. Rather than investing real money, though, you can invest in virtual stock markets. You can make it a game by using websites such as Investopedia and Howthemarketworks.com, which offer free online stock market simulators.. Allocate each of your family members a million dollars of pretend money and see who can create the best returns over a set period of time, offer a prize or put a wager of chores on the line. When the prize is high and the game becomes competitive, you might be amazed at how much your children begin to research and study to win.  It is a fun way for parents to teach their young adults about the exhilarating highs and the demoralizing lows of risk in the financial markets without spending a penny.

Teaching children about money, including lessons on spending, savings, and investments, also provides a nice reminder to parents about the importance of financial literacy and preparation for the future.

It’s never too early to teach your children about money.

How do you teach your children about money? Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Why Should I Rebalance My Portfolio?

Figuring out your asset allocation is usually one of the first steps in figuring out how you are going to distribute your funds within the capital markets of the investing world. Creating an asset allocation ensures that your investment strategy matches your risk tolerance, investment time horizon, and goals, and that these are in line with your risk reward potential. However, when an asset allocation is not upheld over time with regular rebalancing, you may find that your portfolio had significant gains in one area, which have grown to a point where any shifts in the market could have a significant effect on the entire portfolio. The problem would be if this effect is negative and outside your original risk tolerance. Essentially, rebalancing your portfolio will ensure that your well diversified portfolio is not overly dependent on any one stock, bond, fund, or other asset.

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How often should I rebalance?

When it comes to how often you should rebalance, you may get competing advice. Most advisors suggest rebalancing at least once a year, while others suggest doing so quarterly or when the market has moved into a correction or the value is out of balance by more than 10% in any one area.  Whatever timeline you choose is up to you. There is no right or wrong answer; however, once you create your plan and choose you method, stick with it. Discipline is one of the most important variables for producing positive long-term results. Periodic rebalancing helps in removing some of the emotional side of investing. It will prevent you from trying to time the market; you will not find yourself holding off on buying a decreasing asset waiting for the bottom of the market or riding a bubble to the very top.

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There are cases against rebalancing, as well. When you look at one asset against another you would often have to ask yourself why you would sell off a well-performing asset to purchase one that is not preforming as well. This means that rebalancing your portfolio offers a certain amount of market contrarianism. Rebalancing is, in a sense, betting against the market trend, by selling a little of what has done best lately in order to buy a little of what has done worse. But when looking at it from a technical perspective, if you were rebalancing on a regular basis and you were rebalancing at the height of the market in February of 2020, you would have been selling stocks that were performing extremely well and purchasing bonds. A month later you would have found yourself with an opportunity to sell bonds and purchase stocks at a new lower price than the month before.

When looking at different strategies for rebalancing discuss your options with your financial professional and your tax advisor. There can be different tax consequences depending on the type of securities and accounts you are trading.

Do you rebalance? If so, what is your method?

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

The Importance of Being Financially Diversified With Your Investments

In building an investment portfolio you will need to take several things into consideration. One of these is that investments involve trade offs. There is always a risk that comes with investing our money. One way to mitigate that risk is by diversification. Diversification is the practice of distributing the risk involved in investing across different types of investments, including across different types of asset classes, products, geographical locations, and times. This helps increase the odds of investment success throughout the volatility of the markets. Diversifying your investments allows you to have investments that react differently to similar market or economic events. In this way, diversification helps you get the most out of your investments by reducing the amount of risk that you are exposed to in any one type of class of investment. In essence you should never “put all of your eggs in one basket.”  

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A few ways to diversify your portfolio include:

Asset Class Diversification  

Asset class diversification, or asset allocation, refers to the spreading of the portfolio funds among different asset classes. Participating in asset allocation means having a mix of assets within your portfolio, having a mix will assist in lowering your overall risk exposure more so than would than owning only stocks, bonds, or another single category of assets.

Product Diversification  

Index funds, annuities, mutual funds, life insurance, and exchange trade funds, are just a few products that are available to investors. When you peel back the fancy wrappers of these products, they are all basically a combination of cash, bonds, and stocks. All of these products have their place in most individuals’ portfolios, and very few investors should ever rely on a single asset product. Other asset products include, tangible assets, such as real estate, precious metals, and other commodities, which can contribute to the overall portfolio diversification.

Geographical Diversification

Global diversification often helps in lowering the risk in your portfolio by increasing your exposure to the global markets. By doing this, you allow your portfolio to take advantage of the different countries’ economies, which often concentrate in different market sectors than those domestically. Globalization and inter-connectivity are here to stay and are going to increase. The United States only represents five percent of the world’s population, and, despite having being the world’s largest national economy, it still only accounts for twenty percent of the world’s total income according to the United States Trade Representative. Owning stock and bonds from companies outside of the United States will allow you to have a broader diversification should the United States have an economical slow down while other areas of the world thrive.

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Time Diversification

Look at time diversification as dollar cost averaging. The strategy behind dollar cost averaging consists in making regular contributions of a set dollar amount towards the same fund or stock over a long period of time regardless of the market conditions. When dollar cost averaging is used over long periods of time, it tends to reduce investment risk, reducing average costs per share over time and allowing the investor to purchase more shares in an economic downturn.

Most financial professionals will agree that, although having a diversified portfolio will not mitigate all risk of loss, diversification is the most important part of producing long-term financial gains while minimizing the risk to your portfolio.

How do you protect yourself against investment loss? How do you protect yourself against inflation?

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

What is Investment Risk?

Because investment involves trade-offs, there is always a risk that comes with investing our money. If you hold cash in your mattress, you will never earn interest and risk losing purchasing power to inflation or, even worse, your home being burglarized or burning down in a fire. On the other hand, if you lend someone money there is a risk that the borrower will not repay you when the time comes. Likewise, when you purchase an investment there is a risk that the bank, government, or company may not be able to pay you back or even that it may go out of business, leaving you high and dry.

In general, the greater the risk the investor assumes, the greater the potential reward and the greater the anticipated rate of return we expect. The key is to determine the suitability of various types of investments and how they weigh your logical decisions verses your emotions if and when your investments experience volatility.  Risk is inherent any time we invest our money with an expectation of growing our investment, and risk is characteristic in all business activities over time. Because of this, good risk management is essential when building your investment portfolio. 

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Thinking about financial risk often prompts us to become short-sighted when thinking about where and how to invest our hard-earned savings. When the market is having record days and all-time highs, such as during a bull market, we often become overly confident and discount the real possibilities of a future downturn. On the flip side of that, we often become overly cautious in the wake of a significant market downturn or when there is uncertainty in the economy. Either condition can have disastrous consequences on your investment portfolio over time.  In fact, many investors do not properly gauge their personal feelings of risk. As a result, they lose a large portion of their investment in a sudden downturn, pull their money at the bottom of the market and avoid reinvesting as the markets recovers from losses, causing irreversible damage to their overall financial well being.

When you are making investment decisions, always consider the different types of risk that you may encounter, this will help you in creating an effective strategy where you can balance your logical head and your emotional heart in order to survive the financial ups and downs that come with investing.  Knowing some of the different types of risk is the first step in helping you maneuver murky waters of investment risk.

When experts talk about risk, you will hear them referring to systematic risk, a type of risk that affects all investments, and unsystematic risk, a type of risk that affects some businesses and not others.  Some of the most common types of risk include:

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Market Risk

Almost all types of stocks and bonds involve some degree of market risk. This is the risk that investors may lose some of their principal invested due to volatility in the market overall. This is a type of systematic risk investors’ face. An investor cannot avoid market risk through diversification. Should the entire market fall, all investments would likely decline as well.

Inflation Risk

Also known as purchasing power risk, inflation risk is the effect of rising prices due to inflation, resulting in less purchasing power as time goes on. In savings accounts or other cash alternatives, such as certificates of deposits or government treasuries, you may see that your investment may not keep up with the rate of inflation. The purchasing power of your invested dollar will be less than it was before you invested.

Reinvestment Risk

When interest rates decline, it is difficult for investors to reinvest the proceeds of their investments when they come due in products like certificates of deposits (CDs), bonds, and treasuries or when preferred stock is called by the company, and still maintain the same level of return at the same level of risk. Think of it this way, if you purchased a five year CD in 2015 at an interest rate of 5% and you wish to reinvest your principal and the interest you earned in another CD in 2020, you will be looking at a rate closer to 1% for the same level of risk you took in 2015.

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Credit Risk

Also known as default risk, credit risk involves losing all or part of your principal due to a company or government failing. Credit risk is related to debt securities and varies by product and the credit rating of your investment.

These are by no means all the types of risk you may face, but these are some of the most common risks you may experience.  It is important to know the different types of risk when building your portfolio and how you feel about each to know how you will navigate them before they happen. It is important to gauge your personal risk tolerance. This will help you when it comes to creating a diversified and disciplined investment strategy.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Why Investing is a Must for Everyone

Many investors, both new to investing and seasoned having spent lifetimes investing, don’t always realize the different roles that investing their money and saving their money play in their financial strategy when planning for their future. Investing and savings each have a very important place in every person’s individual portfolio, but each has an entirely different role to play in your overall money strategy. Your savings has a different purpose and plays a different role in your financial strategy than that of investing your money. Making sure you are clear on this fundamental concept before you begin your journey to building wealth and finding financial freedom is vital because it can save you  heartache and stress down the road.

Investing is not about getting rich. It is about building a financial future where you will be able to support yourself for the rest of your life once you stop working. Having the funds available to support your lifestyle during retirement can mean the difference between living life on your terms and living life in fear  that an emergency could arise that would ruin your ability to live comfortable.  All of this is can be addressed when creating your personal money portfolio. 

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Every money portfolio should be individually tailored in a unique asset allocation for every individual or family. For you, this will be based on your investment time horizon (the length of time that you will need money, also known as the rest of your life) and your risk profile (the measurement of how your head and heart can deal with the volatility of the cycles of the economy). Knowing these two considerations will help you create an asset allocation that will be right for you. This allocation should be reevaluated on a regular basis, at least annually.

To keep this simple, let’s put capital market into three groups. These three groups are made up of cash, bonds, and stocks. There are many different vehicles out there that offer different ways to invest your money (mutual funds, exchange trade funds (ETFs), annuities, life insurance, and more), but when you pull back the fancy wrappers on these products, you will find that at their core, these are cash, bonds, stocks, or a combination of the three. (We will take a journey down that last road another time.)

Let’s define cash in the simple sense: cash is any debt security (checking account, savings account, money market account, certificate of deposit, bond or treasury) that is payable immediately or within the next 12 months. Essentially you are lending your bank, your credit union, a corporation, or a government entity money on a very short term basis. Once you figure out the asset allocation of your portfolio, the cash amount should be set to an amount equal to your living expenses for the next three to twelve months plus anything extra that just makes you feel safer. There is no right or wrong answer here; it is whatever makes you the most comfortable and what can be supported by your risk profile.  

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Bonds are very similar to cash. They are longer term loans to a bank, credit union, corporation, or government entity, which these entities have to pay back over a time period greater than twelve months.  Creating a bond portfolio, laddering mid- and long-term CDs or treasuries for different maturities and rates finding a professional management company to do the work for you are all good options for creating your bond portfolio. This is the money that you will need in the next two to ten years. These are conservative investments that are earning you a little more interest or yield than cash and have a little more volatility than cash, as the immediate prices change with interest rates. You should keep a set percentage of your total portfolio in these types of investments. These investments will help supplement your income if needed over the next two to ten years. Should you not need the income you will reinvest it based on your asset allocations when they become due.

Stocks on the other hand are an entirely different animal. Here you are observing that the owners of companies earn all of the money. In buying a stock you are buying a small fractional piece of a company and are entitled to that fraction of the company’s earnings or growth. Stocks have high volatility in the short term, moving unpredictably in their day-to-day pricing. Over the longer term a well-diversified stock portfolio will provide a more predictable rate of return.  The money that you are looking to invest in the stock market should be the money that you want to access after a time period greater than 10 years. This money is earmarked for the long term, the money that you invest here is money that you are not going to worry about or touch on a regular basis.

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If you set up your portfolio on a percentage basis, having a set percentage of your assets allocated to each asset category you or your advisor should be rebalancing the portfolio based upon the guidelines that you set up. What that means is that you will periodically buy and sell assets within your portfolio to maintain the original level of allocation. If you originally set up your portfolio in the following manner: 10% cash, 30% bonds, and 60% stock and the stock market had several good quarters where the prices of your stocks went up while bonds and cash remained at their same price levels your portfolio percentages could have changed to something like: 7% cash, 18% bonds, and 75% of the value in stock. At this time you would rebalance, selling a percentage of your stocks and allocating those funds to your cash and bonds to mirror the original allocation set. The same is true if the stock market takes a large drop in value and your new allocation becomes: 20% cash, 40% bonds, and 40% stock. At this time you would sell some of your bonds and invest some of your cash to buy stock. This practice will assist in reducing the downside risk in extreme an extreme market volatility environment.  

 If you are looking for ways to invest it is probably easier than you imagined. You could be able to start investing at work tomorrow.  Begin by looking at your company’s 401(k), 403(b), 457(b), or whatever your company has available for you. Know what type of retirement plan your employer offers and learn about that plan. Talk to a financial professional about your plan, and know what that plan offers so you can know how best to diversify your options within that plan to match your predetermined asset allocation. Also, employers that offer retirement plans will often match a percentage of your income, if you are investing in the plan.

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If you are working for a company that offers a 401(k) or some type of retirement and your employer is matching contributions to this plan, you should maximize your contribution. If you are not investing at least as much as the employers’ matching contribution, you are saying no to free money. 

Pay yourself first, make your savings and investments automatic. Then enjoy the benefits of compound interest, market growth, and knowing that you are taking steps to invest in a better financial future.  

Achieving financial freedom, whatever that means to you, is not complicated. It takes time, knowledge, and discipline. There is no right or wrong way to invest, it is all personal preference. What matters most is that you start sooner rather than later. Begin your journey today to make your tomorrow more financially secure. Talk with a professional, do your due diligence, and read up on how to make the best plan for you.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

What Is Inflation and How Does It Hurt Our Pocketbook

Every year in a normal economy you see the cost of almost everything around you become a little bit more expensive. This is inflation.

Inflation affects all of us. It can reduce the value of our savings, our earnings, and our purchasing power.

In simple terms, inflation is the general increase in the prices of goods and services over a given time.

The most widely used measure of inflation in the United States is created by the Bureau of Labor Statistics, the premier research division of the Department of Labor, which finds, creates, and publishes economic data. The Bureau’s report on inflation is called the Consumer Price Index (CPI), which is a measure of the amount of change in prices of a certain “basket” of consumer goods and services, such as costs for medical services, food, and transportation. Changes in the costs of these goods and services are usually measured over the past twelve months.  Below you can see the goods and services used to measure the CPI and the changes of the products over the last twelve months as of April 15, 2020.

Category12-month percent change, Mar 2020Category12-month percent change, Mar 2020
All items1.50%All items less food and energy2.10%
Food1.90%Commodities less food and energy commodities-0.20%
Food at home1.10%Apparel-1.60%
Cereals and bakery products0.10%New vehicles-0.40%
Meats, poultry, fish, and eggs2.30%Used cars and trucks0.10%
Dairy and related products3.70%Medical care commodities1.30%
Fruits and vegetables-1.90%Alcoholic beverages1.40%
Nonalcoholic beverages and beverage materials1.40%Tobacco and smoking products5.40%
Other food at home1.40%Services less energy services2.80%
Food away from home3.00%Shelter3.00%
Full service meals and snacks3.20%Rent of primary residence3.70%
Limited service meals and snacks2.80%Owners’ equivalent rent of residences3.20%
Energy-5.70%Medical care services5.50%
Energy commodities-10.40%Physicians’ services1.40%
Fuel oil-20.10%Hospital services4.40%
Gasoline (all types)-10.20%Transportation services-0.70%
Energy services-0.50%Motor vehicle maintenance and repair3.40%
Electricity0.20%Motor vehicle insurance1.10%
Natural gas (piped)-2.90%Airline fare-10.60%
12-month percentage change, Consumer Price Index, selected categories, March 2020, not seasonally adjusted
Information provided by the U.S. Bureau of Labor

The number given by the Consumer Price Index is essentially how much purchasing power your dollar is losing (or gaining) from one year to the next. In some years, the CPI is higher,  while in others it can be negative. Over the last thirty years the average inflation rate in the United States has been about 2.5%. If this were the rate year after year, this would mean that our cost of living would double roughly every 25 years.

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When inflation is positive or higher than expected, consumers and savers are in a losing position. While the cost of living is rising, the value of your same dollar and interest earned are falling behind what that dollar and interest value could have bought one year ago. The longer that time goes on the more that we are losing.

If you were to put $250.00 into your average savings account at 0.2% right now and let it compound annually for the next ten years you would have $255.56 at the end of that time. Yet, if you are spending $250.00 at the grocery store and the inflation rate was 5%, that same basket of groceries would now cost you $427.59. The money that you had sitting aside in a safe place actually lost $172.03 in value.

Inflation is one type of risk that can hurt our pocketbooks and eat away at our savings.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

The Magic of Compound Interest

Compound Interest is an important concept to understand in helping you build your wealth.  Understanding compound interest will help you understand why it is important to get the best interest and yield on your accounts. It’s not magic it’s math, and it helps you grow your wealth.

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Compound interest is what can make your deposits grow faster, similar to the “snowball effect.” When you roll a snowball down the hill, the snowball continues to grow upon itself and ends up growing so big it becomes a giant avalanche. Compound interest works relatively the same way, earning money on your initial deposit and on the interest that you earned, as well.  This cycle of compounding your investment and the interest that you earn leads to significant increases in the balance over time. The compounding of interest can happen in several manners depending on the compounding period, which can be measured daily, monthly, quarterly, or annually. In most cases interest is calculated on a monthly basis. This is typically the case with savings accounts and certificates of deposits (CDs). When shopping rates, look at the annual percentage yield (A.P.Y.), it is the true rate that takes the compounding into account on an annual basis.

In the example below, the initial deposit is $10,000 with an annual compound interest rate of 5%. The money is left in an investment account for fifty years. After the first year you have made $500 in interest and have a total amount of $10,500. That $10,500 is earning interest the entire second year and now you made $525 in interest with a total balance of $11,025. This happens year after year, and at the end of the fifty years you have $114,674 without ever adding to the principle investment.  That is the magic of compound interest.

Compound Interest AnnuallyTotal
Year 1$10,000 x 5% = $500$10,500.00
Year 2$10,500 x 5%= $525$11,025.00
Year 3$11,025 x 5% = $551.25$11,576.25
Year 4$11,576.25 x 5% = $578.81$12,155.06
Year 5$12,155.06 x 5% = $607.75$12,762.81
Year 10$15,513.25 x 5% = $775.66$16,288.91
Year 25$32,251.00 x 5% = $1,612.55$33,863.55
Year 50$109,213.33 x5% = $5,460.67$114,674.00

Compound interest works in your favor, especially when you are able to deposit funds and leave them to grow. Combining compound interest with periodic deposits to your account, perhaps on regular intervals, helps you build savings for your future even faster.

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Let’s take a look at the magic of compound interest while continuing to contribute to the principle of the investment. We can deposit the same $10,000, in the same investment account earning a 5% yield and compounding monthly. With this example, we add an additional $250 each month to the account. Compounding monthly we will need to divide the interest rate by twelve for the amount being paid on a monthly basis. Because we are earning a 5% yield on an annual basis, we will be earning 0.41667% on a monthly basis. After the first month we would earn $41.67 in interest and deposit an additional $250, bringing the total balance to $10,291.67. Doing this for next five years would result in having an account worth $29,832.11. After fifty years, the account balance would be $788,357.98 with a total contribution of only $160,000 ($10,000 initially and $150,000 in monthly deposits) over the fifty-year period.

Saving $250 Per Month With Compound Interest MonthlyTotal
Month 1$10,000 x (5%/12) = $41.67 + $250$10,291.67
Month 2$10,291.67 x (5%/12) = $42.88 + $250$10,584.55
Month 3$10,584.55 x (5%/12) =  $44.10 +$250$10,878.65
Month 12 Year 1$13,276.02 x (5%/12) = $55.32 + $250$13,581.33
Month 24 Year 2$17,024.96 x (5%/12) = $70.94 + $250$17,345.89
Month 36 Year 3$20,965.70 x (5%/12) = $87.36 + $250$21,303.06
Month 60 Year 5$29,462.35 x (5%/12) = $122.76 + $250$29,835.11
Month 120 Year 10$54,812.29 x (5%/12) = $228.38 + $250$55,290.68
Month 300 Year 25$182,679.29 x (5%/12) = $761.16 + $250$183,690.46
Month 600 Year 50$784,837.82 x (5%/12) = $3,270.16 + $250$788,357.98

No matter how you choose to save for your future, the most important thing that you can do now is to open an account and start contributing to it on a regular basis, whether you’re starting a savings account, retirement account, or a standard investment account, this will allow you to take full advantage of compounding interest rates. The sooner you begin investing, the larger you balances will be when you reach retirement age. Compound interest rates will work in your favor over the long run. 

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

How to Establish Credit

Most major financial landmarks in life, such as buying a car or a house, will require the use of credit, but when you have little or no credit, there are often more “no’s” than there are “yeses” from lenders. Starting to build your credit is not the easiest thing to do when there are more rejections than approvals, it is difficult to know where to start.

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When starting out, it is important to ensure that you are starting out clean. There have been several cases over the years that I have seen when someone who thought that they had no credit actually had some credit from a joint account they held with a parent or from years of student loans they have been paying. There have been those that have very bad credit riddled with collections from utilities or rent that went unpaid. The first thing you need to do is check your credit. There are several ways to do this but the easiest is to head over to www.annualcreditreport.com, which provides a free credit report from each of the three major credit reporting agencies once per year. You should verify that the information you find on your credit report is correct and accurate. If it is not, for instance, if you have fraudulent charges on your report, you will need to dispute the charges, most likely with both the creditor and the credit reporting agency.

Once you have an idea of what your credit looks like there are several ways to go about building credit.

Retail Cards

Retail cards, such as credit cards for department stores and gas companies, are often the easiest credit cards to obtain as they are limited to the retailer that you choose and usually come with lower spending limits, hence less risk for the issuer. However, these cards often come with high interest rates if you are not paying them off every month and carrying balances month over month, and they can have you paying much more for a product or service than it is actually worth.

Secured Credit Cards

One of the best ways to build or rebuild your credit is to start with a secured credit card. Secured credit cards are safeguarded by money you provide to the lender, usually in amounts of $300 or greater. This money is placed in a savings account and locked until the card is closed. The lender issues you a credit card with limits equal to the amount of money you provided. When charges are made to the card, monthly payments are still required and interest accruing. The initial secured payment that you provided the company is to be used only in the event that you default on making your payments, which would show negatively on your credit report, as well.

Many of the companies that issue secured credit cards have programs where they will evaluate your payment history on a regular basis and consider graduating you to an unsecured card when you meet their specific guidelines. The great thing here is that you are building credit and should not have to pay fees or undue interest provided you make the payments in full each month.

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Secured Loans

A secured loan can have several advantages, including helping you build your credit faster than you could with credit cards alone. The process is very similar to that of a secured credit card, where you provide the lender with cash in advance. For a secured loan, the security amount is usually $3,000 or greater. This amount is placed in a savings account that you cannot access until the loan is paid in full. In the meantime, the lender gives you a percentage of the held amount, usually around 90%, and you establish a set payment plan of a few years to pay the loan back in regular monthly intervals. One of the greatest advantages of this type of loan is that it will show as an installment loan, a loan for a fixed amount of money repaid over a set time period, when reported to the credit agencies. This will add to your overall credit mix and help you increase your credit score.

Going the way of a secured loan is in essence paying for the privilege to establish your credit. These loans also often come with a hefty interest rate or loan origination fees.

Become an authorized user

Another option and often one of the simplest ways to build credit, is to be added as an authorized user to a friend or family member’s credit card account. This allows you to associate your name and information with that of the credit your friend or family member is using. However, not all lenders report authorized users to the credit reporting agencies, so there is a chance that being an authorized user may not be helping you build your credit.  Before taking this approach, make sure the credit card company reports all authorized users to the credit reporting agencies.

This option may be risky, so use extreme caution if you choose to become an authorized user. In becoming an authorized user, ensure that you friend or family member uses their credit responsibly and always makes their payments on time. Should their account become delinquent or go to collection, that negative action will also reflect on your credit.  On the other hand, you need to practice responsible credit behaviors as well. Having a clear plan in place to inform the card holder of the purchases made and how you will reimburse your friend or family member for purchases is also important so that you don’t hurt someone else’s credit.

Have a Co-signer

If you’re having a hard time accessing credit for a purchase, you can ask a friend or family member to co-sign a loan. Similar to the authorized user option, you are using your friend or family member’s good credit standing to help you get approval for a loan; however, in this case, their credit now counters the risk to a lender on your behalf. In essence you are requesting this person to put their credit reputation on the line for you. Should you default on the loan, this person is now responsible for the full repayment of any outstanding balances and fees that may accrue. Any missteps on the repayment of this loan by you can negatively affect your co-signer’s ability to obtain financing in the future and can cause irreparable damage to their credit history and your relationship.

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Once you have a few types of credit under your belt, it’s important to carefully monitor your credit reports for changes, understand what is on your credit report, and know how your credit score comes together. This is a good way to monitor your credit-building efforts and see how these efforts are paying off in terms of building your credit while actively protecting yourself from fraudulent activity.

When starting out, it is imperative to begin making your payments on time as agreed from the beginning. Reports of late payments and other missteps will stay on your credit reports for up to seven years. A few late payments or an account that becomes a collection account when building your credit can cause you years of work and frustration trying to clean it up.

As you make payments you’ll progressively build your credit and it is possible to make significant progress on establishing your credit quickly. As building your credit is not quick project, incremental improvements month by month will provide you better financial options in the future.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Understanding Your Credit Score

Your credit score can affect many aspects of your financial life.

The three main credit reporting agencies, Equifax®, TransUnion®, and Experian™, create and generate your credit reports. You credit score is a number, typically ranging between 300 and 850, that indicates how likely you are to repay your debts. The three major credit reporting agencies calculate your scores based on their own models, but these are not the scores that most lenders are looking for. There are several independent scoring companies, each with its own model for how they convert your credit report information into a score that indicates the level of risk that you may default to a creditor. Today, a vast majority of major lenders use the FICO® Score, a credit score created by the Fair Isaac Corporation, when making decisions on whether to lend to you. The score holds so much weight that it can affect the interest rates that you may pay on loans, your insurance rates, and even your ability to rent a home.

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Understanding your credit report and how your credit score is compiled is a good place to start. Let’s break down your FICO® Score, as it is currently the most widely used credit score format that the top lenders are using.

The Fair Isaac Company considers five categories when calculating your FICO® Score: your payment history, how much you owe, your length of credit history, the credit mix that you keep, and your new accounts.

Your payment history (35%) — Thirty five percent of your FICO® Score comes from how you have managed your past payments to your creditors. This section of the reporting will take into consideration the payments you have made to creditors. Creditors, including credit cards, retail accounts, installment loans, auto and mortgage loans and many others, report to the major credit reporting agencies and that information is used to tabulate your score. To maintain, improve and build your credit score, it is important to make your payments on time every time. This keeps your accounts in good standing and helps create more depth in your payment history.

Missing payments or making payments late will have a negative effect on your score. The more frequent the missed or late payments are, the greater the impact they will have to your overall score. Public records and collection accounts, such as bankruptcies, tax liens and civic judgements, can lower your rating in this category dramatically and can have serious long-term repercussions on your overall score.

Your payment history is the section given the most consideration in determining your score, and it is the most important factor a lender assesses when determining the level of risk it will undertake when issuing you credit.  

Amounts Owed (30%) — Thirty percent of your score is based on how much you owe your creditors. There are several factors that come into play in the amounts-owed part of the scoring. Simply owing money does not always negatively affect you score, though when your credit utilization ratio (the total dollar amount of revolving credit, usually credit cards and personal lines of credit, you currently owe divided by the total available credit limits of the accounts) is high, it can indicate that you are overextended and are more likely to default if you come into a financial hardship. 

For example if you have on credit card with a limit of $10,000 and owe $6,500 on that card you would have a credit utilization ration of sixty five percent. The higher your credit utilization ratio the great the impact it will have on your overall score. A good rule of thumb is to have a credit utilization ratio of thirty percent or lower.

Length of credit history (15%) — You can still have a high credit score if you haven’t had a long history of credit, but you’re doing well on all the other categories. Your length of credit history makes up fifteen percent of your total score. Typically, the longer you have had credit accounts the more positively this will impact your overall score. The average time that each of your accounts has been open will help to determine  your overall length of credit history.  Having a longer credit history provides more information to base lending decisions on for potential lenders.

Credit Mix (10%) — When it comes to credit mix, think about diversity. Having a variety of types of credit accounts can have a positive effect on your credit score. It is not necessary to have every type of credit account available, but a few different types of credit will show that you can manage a mix of account types. It will be okay if you are just starting out or do not have a variety of forms of credit. Your credit mix is ten percent of your combined FICO® Score.

New Credit (10%) – Last but not least, the final ten percent of your FICO® Score is made up by evaluating your new accounts and account inquiries. It has been shown that opening numerous new accounts in a short period of time can indicate a financial problem and may indicate a greater likelihood of future default. It is not just a new credit account that will impact you but also the credit inquiries. When you are shopping for new credit, the lender will report an inquiry regardless of whether they issue credit. These inquires will remain on your credit report for the next two years and can negatively affect your credit score for the next year. Consider this whenever seeking to obtain new credit.

 Knowing more about how your credit score is calculated can help you maintain or build a better score. Think of your credit score as a way of explaining your combined history of credit to a lender who knows nothing about you. Your credit score is simply a risk score, a risk of how likely you are to repay a lender. The higher the score the more likely you are to repay them. A lower score may indicate the opposite, and this can make it more costly for you to borrow money (riskier loans charge higher interest rates). Having a higher credit score can help you save thousands of dollars over the course of your lifetime.

In the case of credit scores, knowledge can be power. Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.