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The subject of personal finance is very
broad, but as a
beginning, I would like to discuss what I
consider the
foundation of personal finance: security.
Security
Security to me means that I am prepared for the
"hit by a
bus" scenario.
I have life insurance to provide for my wife and
children.
Health, disability, auto and home insurance
policies also
provide me additional protection in their
respective areas.
I also have a list of where these policies are,
who my
agents are, phone numbers and basic policy
information
(#s, amounts, costs, etc.) I keep this
information both in a
file at my house and in a safety deposit box at
the bank (a
friends home will also work - think: "house
burns down"
scenario). Also my wife and my brother and
sister-in-law
who live nearby also know where these things
are.
I also try to maintain an emergency fund of cash
in a bank
account or money market account (with checks) so
that I am
prepared for a financial disaster, layoff, or
natural
disaster. It took several years to build up this
cash fund.
I started with a goal to have enough cash for 6
months of my
normal financial needs (mortgage, food,
insurance,
transportation, etc.). Now I am trying for 12
months'
worth. I do this by saving a little each month,
and
"investing" a portion of all "found" money
(gifts,
inheritances, tax returns, anything
unexpected).
I have a will and update it each year around New
Year's to
reflect any changes in my life during the past
year (new
children, new home or business, etc.). Most
people don't
need an extensive will, the forms you buy at
your office
supply store will do. But in some states if you
die without
one, watch out. What happens to your money and
even your
children could be entirely up to some state or
court
appointed official.
Stability
The next level of personal finance is
stability.
Stability to me means that first of all I live
within my
means. I don't spend more than I earn. Otherwise
I am
spending my savings, investments, emergency
money, or
getting into debt. I have a lot of debt, but
most of it is
real estate which is producing some income. I
try to avoid
credit card debt and purchase everything with
money I
already have. I don't buy things expecting that
next month
I will have more money or I will get a big raise
or
promotion. You can't sell me a car based on a
monthly
payment amount; I want to know the final
price!
In order to make sure that I am living within my
means, I
created a simple budget and I track my expenses
using Simple
Joe's Expense Tracker. I can tell how much I
have spent in
each budget category and I know when to keep a
closer eye on
certain types of expenses, or when and where I
can cut
expenses and what I can live without in order to
stay within
my budget. Counting pennies is pretty tedious,
but tracking
where the dollars go can be eye-opening.
Another aspect of stability is avoiding or
eliminating debt.
Debt in itself is a form of stability; you
always have to
make those payments until it is all paid
off.
Some recent reports show that the average
American is $7,000
- $20,000 in debt. Most of it is consumer debt:
credit
cards, store accounts, rent-to-own, auto loans,
etc. And
those types of consumer debt usually charge a
higher
interest rate than any savings account, CD, or
money market
account; even more than most high-flying risky
investments.
This means that $1,000 in debt at 18% is costing
you 9 times
what your $1,000 savings account at 2% is
producing.
Consumer debt is a dangerous spiral that is very
hard to get
out of.
The first problem is, as mentioned before,
living within
your means. Don't get further into debt to
support an
extravagant lifestyle. Or even if you are
frugal, if you
are using credit cards and debt to finance your
purchases,
you either need to stop purchasing luxury items
or find a
way to increase your income to support these
purchases/payments.
You may even have to lower your
standard-of-living because
you have racked up considerable debt and need to
free up
some money to pay it down. But don't wait to
start. Those
minimum payments are often designed to keep you
paying 18%
interest for 40 years! That's longer than most
home loans.
You could even end up paying more than 10 times
the original
cost of the item just in interest payments. Is
that new
stereo really worth that much?
To help people get themselves out of debt we
created the
"Pay Off My Debts" tool in Simple Joe's Money
Tools. It is
also available as a stand-alone product called
Simple Joe's
Debt Eraser. These tools help you create a Rapid
Debt
Reduction Plan which shows you how much to pay
on each debt
each month in order to save as much on interest
charges as
possible and pay off your debts as soon as
possible.
These tools can help you systematically
eliminate your debts
whether you owe $1,000 or $100,000. The key is
to start
living below your means and start focusing on
paying off
your debt.
It doesn't make much sense to be worried about
whether or
not your 401k earns 8 or 9% this year, if you
are paying 21%
on your credit card debt.
A third aspect that starts in the stability
category and
transcends to the next personal finance level,
growth, is
the concept of investing in yourself. By this I
mean
spending time to educate yourself in personal
finance
matters, as you are doing right now and spending
time
gaining more knowledge and improving your skills
or even
developing new ones.
As an employee, this can have a direct relation
to who gets
laid off during the next round of cutbacks. If
you have
some skills or have demonstrated some abilities
that are not
possessed by your co-workers and these skills
make you a
more valuable employee, you are less likely to
get the
pink-slip.
Also while you are making yourself more valuable
to your
current employer, you are also making yourself
worth more to
future employers. It is much easier to land a
job if you
have some special skills that are in high demand
or even if
you bring some special knowledge or experience
that you
fellow job-seekers may have overlooked or failed
to invest
in.
Being in the computer industry, I have to spend
hours each
week reading trade magazines, exploring web
sites, and
reading emailed newsletters to keep abreast of
what is new
in my field. If I stopped learning just five
years ago, I
would have missed out on the Internet
revolution, email, web
sites and the majority of the income I now
enjoy.
Keeping myself informed and up to date takes
time and
resources, but it helps me protect my current
income and
expand my skills to help me earn income in other
areas.
This increases my stability by allowing me to
not have to
rely on one client, employer or source of
income. A chair
with four legs will always be more stable than a
stool with
only three.
Growth
The next level of personal finance, as I alluded
to before,
is growth.
Once you are secure and stable, you can begin to
think about
building your wealth. Not that you have to
figure out how
to become the next Bill Gates or Warren Buffet.
But you
have to start building the "nest-egg" that you
will rely on
when you retire.
And don't think that Social Security has you
covered, or
that your 401k will grow back to what it was a
couple years
ago. Or that your current employer is going to
re-institute
the generous pension plans of yesteryear. 401ks
are much
cheaper to administer and you, the employee,
take the hit
when the market goes down, not the employer.
My father is nearing retirement age and I think
he has a
good plan. He has done some research and
estimated what his
expenses are going to be when he is retired. He
then took a
look at his potential sources of income during
his
retirement.
He figured that Social Security would cover
about a third of
what he wanted to live on. Only a third! And he
has worked
his entire life. Would you like to instantly
have to live
on only one third of what you currently make?
Retirement is
suppose to be the golden years, so where's the
gold?
Luckily throughout his career, my father has
worked for
companies that have had pension plans and he had
worked long
enough at each company to be eligible for some
pension
money. This is rare these days because today the
average
worker will change jobs and companies at least
five times
during his/her career. Also, as I mentioned
before,
companies are switching to lower cost 401k plans
that do not
guarantee you any fixed payments.
In my father's situation, his pension money
would cover
another third of the retirement income he
wanted. So now he
had to either figure out where the last third
was going to
come from, or start cutting out expenses during
retirement,
like not visiting his children so much. None of
us liked
the sound of that.
So my father started learning about the stock
market and
investing in stocks and mutual funds. He made a
plan for
growing his wealth and then educated himself as
to how he
could accomplish his plan.
I wish I could say that he is doing better than
he is, but
luckily he has some time still to put his plan
into action
and ride out any market downturns. (He can do
this because
he has the security of insurance and emergency
money, and
the stability of little debt and a strong set of
skills.)
By learning about how stocks, bonds, mutual
funds, index
funds, options, futures, commodities, real
estate and other
financial tools work you lay the foundation for
growing your
wealth. You may start with just $100 in a bank
CD, but as
you learn more and become more sophisticated,
you can invest
in more and more opportunities.
You will learn about how risk and reward are
related, that
as the risk increases so does the size of the
potential
reward. Just like at the race track, you'll make
more on
the long shot, but the odds are against it. Also
you can
learn how to tilt the odds in your favor and
protect
yourself against risk.
For those who are just starting out in the
growth phase or
who want to dabble a bit before completing the
other levels
of personal finance, my suggestion would be to
look into
index mutual funds. Especially no-load index
funds (no
initial/sales fee).
These funds are made up of the same stocks that
make up the
popular market indexes like the Dow Jones, S&P
and
NASDAQ100. The costs are low because management
is simple
and as a mutual fund you can invest a little at
a time.
Also they are easy to follow since you see them
on all the
news shows and in the newspaper.
Protection and Management
The final level of personal finance is the
protection and
management of your wealth. Most people never
develop wealth
enough to need this level. But some of the
concepts can be
applied to any amount of wealth you possess,
$10,000 to
$10,000,000.
Part of the protection harks back to your will
as we
discussed on the first personal finance level:
security.
With any significant wealth or valuable asset
(your home,
car, heirlooms, 401k, IRA, business, etc.) you
will want
some way of disposing of that asset upon your
death.
Whether it is go to go your family, favorite
charity, or
local church, if no one knows about it, "it
ain't gonna
happen".
As you start to accumulate wealth in excess of
$350,000, you
may want to consult an attorney about creating a
trust. A
trust is an entity that can own property and
pass that
property to anyone you name in your will.
Usually the trust
is designed to provide income to children from
the assets
that are placed in the trust.
The trust can survive you so that your assets
and income may
be passed on to your children or next-of-kin
without
excessive taxation and legal entanglements. Some
states
will take up to 55% of your assets as taxes when
you pass
away.
Protection also relates back to insurance. Now
it may be
time to look at a multi-million dollar umbrella
policy that
will protect you from lawsuits designed to part
you and your
wealth. You may now be a bigger target, so
purchase a suit
of armor.
The management aspect comes into play where you
may start to
concern yourself with taxation, ownership,
distribution of
income and possibly endowments to charities or
other
non-profit institutions.
You may hire a person or company to manage your
wealth, or
you may choose to do it yourself. Most people
who have
earned their wealth through the "sweat of their
brow" have
already become adept at managing their assets.
Some
continue to personally manage their wealth
because of the
enjoyment or challenge it gives them.
Others are ready to turn it over to a
trustworthy manager
(who only gets paid a percentage of your
increase) and
travel the world, or sit on a beach and count
the waves.
Whatever your dreams for retirement (and why
wait until you
are 65), understanding the different levels of
personal
finance and spending the time and resources to
educate
yourself will pay off whether you live next to
Bill Gates or
Homer Simpson.
About the Author
© Simple Joe, Inc.
David Berky is president of Simple Joe. One of
Simple Joe's best
selling products is
href="http://www.simplejoe.com/moneytools/index.htm">Simple
Joe's Money Tools - a collection of 14 personal
finance and
investment calculators. This article may be
freely
distributed so long as the copyright, author's
information
and an active link (where possible) are
included.
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