By BOB CUNNINGHAM
(Note to my readers: My apologies for being a day late with this post. This marks a permanent change to Tuesday morning release of my new post each week. The change is due primarily to professional convenience. Thanks for your understanding.)
This website is, first and foremost, dedicated to coaching people how to best go about the various tasks related to savvy personal finance. Achieving success can be accomplished through a mixture of some sound fundamental principles, combined with the reality that many strategies which are considered advisable by the masses are, instead, more beneficial to others.
What does that all mean? Translated into one expression,
“Unconventional wisdom, in many cases, is better than conventional.”
As you read, listen, watch, and research the world of personal finance, you will encounter some common themes preached by everyone from the most famous gurus to the tiniest out-of-the-mainstream blogs (I’d like to believe I’m somewhere in between, but closer to the latter than the former.)
This blog has been dedicated to assisting you in deciphering what to believe and trust, and what not to. We’ve taken individual topics and broken them down into pieces small enough to digest in a way that allows us to effectively learn just how such habits can affect us, short- and long-term.
What I haven’t really done, until the paragraphs to follow today and next week, is put together a summary of the major points made through this blog’s seven months of existence. So let’s get to it. I’m calling this, “Personal Finance: Fantasy and Reality.” Part I is below, with Part II to run Oct 17.
“Pay Yourself First.” This is arguably the most common adage in the world of money. It simply means that you should set aside money for savings and/or investing before you earmark funds to pay your bills and for everyday expenses. The theory, of course, is that if you get in the habit of doing this, you’re guaranteed to save more and anything is better than nothing.
FANTASY: Saving even the smallest amount on a regular basis will eventually lead to significant holdings, from which you can build on additionally.
REALITY: While it’s true that something is always better than nothing, there has to be a definitive goal for increasing savings regularly, and it should only be undertaken after expensive personal debt, such as credit cards that can have APRs well more than 20 percent, is eradicated. One of the most common mistakes is to save slowly in an account earning less than 1% while simultaneously carrying a balance on a credit card charging 23.9% interest compounded. Spend every extra dime paying off the card, stop charging stuff unless you pay it off entirely by the due date, and THEN ratchet up the savings to blow away what you would have accumulated – and wasted – otherwise.
“You need to save at least 3 to 6 months of living expenses in an emergency account.” The idea is that if you have this kind of a reserve, loss of your job for an extended period won’t put you in the poorhouse – or worse, your parents’ basement.
FANTASY: This is one of my favorite finance fables. Some pretty well-known gurus claim it’s better to have a year’s worth saved. Sure, and it would be better if my retirement savings had one or two additional zeroes, too. In truth, for 95% of the population on this planet it is a complete fantasy to have a liquid cash reserve of $10,000 or more and be willing to leave it alone for a rainy day. There’s a better HD television available. It’s an emergency!!
REALITY: A much savvier plan is a basic reserve fund of $1,000-$2,000 for things such as auto repairs. But actually, I propose to use your credit cards as your emergency fund. As long as you’re disciplined – and let’s face it, discipline is required when utilizing any type of advisable strategy – you can use a credit card to charge a true emergency and then formulate a plan to pay off the card with minimal damage. Saving more than the aforementioned $1K-$2K means you’re not utilizing legitimate funds properly. You should be investing those funds in debt elimination, or a dividend-paying whole life insurance policy, or if you must, low-cost index funds, or even in your work’s 401K plan (more on that next week). All are preferable to letting inflation eat away at the buying power of a tidy sum dedicated to nothing… and earning next to nothing in a regular savings account.
“Avoid credit cards.” Because they are debt instruments, many gurus advise to ignore them entirely, except perhaps for one card that can be used only in a “true emergency.”
FANTASY: Just pay cash for everything, and you won’t need cards. Credit cards only benefit the companies who issue them. They victimize their customers unfairly.
REALITY: Credit cards are great, but ONLY when used wisely and properly. Running up a balance on an account charging such high interest rates is fiscal mutilation. But if you are able to obtain 3-4 cards, each with cash-back allowances (preferably in rotating categories offering as high as 5%), and you use them for everyday regular expenses while ALWAYS paying off the entire balance prior to the next minimum payment being due, you not only avoid unnecessary costs, but also accrue small refunds, and at the same time build a favorable credit history. Plus, your purchase of tangible goods are often insured by the card company, a service not provided by cash or a debit card.
“When strategically paying off credit card debt, pay off the smallest balance first.” As opposed to eliminating the account with the highest APR, many financial advisers propose the “snowball” strategy versus the “avalanche” approach.
As the AFLAC duck often exclaims, “Huh??”
FANTASY: Paying off your smallest balances first, before working on the larger ones, yields quicker results and gives you a sense of accomplishment. This increases your chances of sticking with the program.
REALITY: I won’t argue with psychology because I’m not educated in that area beyond my Psych I college course explaining the difference between Sigmund Freud’s id, ego, and superego. But our goal is to save money on interest, so why would I pay off an account charging 16% before one jacking me for 24%? The latter is going to require a larger minimum payment, so I want that one outta-here ASAP. Look, if you have two accounts of very similar rates (like, within 1% of each other) and you choose the smaller one in order to get rid of it quicker, knock yourself out. But don’t leap over dollars for psychological nickels. Just dedicate yourself to the task with the knowledge that it is what is best for your long-term financial health, and save every dollar you can.
That’s it for Part I. See ya next week for the conclusion of our review.
As always, thank you for reading.
DISCLAIMER: This post represents the author’s opinions only. In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment. Results are never guaranteed. Utilize the information as you see fit, make all money decisions at your own risk.