10 Commandments of Personal Finance

If any of you are fans of the Freakonomics Radio podcast, you may be familiar with Harold Pollack’s ten rules to be financially literate. I have them printed on a little business card in my wallet, so I can always have a reference on-hand when I need to make an important financial decision. Is this the most embarrassing thing in my wallet? Yes! Has the card in handy before? You bet your bottom dollar!

And so, without further ado, I present to you The Ten Commandments of Personal Finance:

1) Strive to save 10-20% of your income.

Save as much as you are able to do, starting with at least 10%. It may be tough, but trust me, if you aren’t saving any money, every other aspect of your life is going to be a lot tougher.

2) Pay your credit card balance in full every month.

This is a fundamental aspect of building a solid credit score. A good credit score will help you secure low-cost financing for future big-ticket purchases like a house and/or a car. Check out Building a Credit House Pt. II for more good credit habits.

3) Max out your 401(k) and other tax-advantaged savings accounts.

Oftentimes your employer will kick in a matching contribution up to a certain %, which is free $$$ you should be taking advantage of. If you are unsure how to set up an automatic 401(k) contribution from your paycheck or take advantage of your company match, go harass your HR department. That’s what they’re there for.

Other tax-advantaged savings vehicles include the 529 for your spawn’s education and Health Savings Accounts (HSA) that helps you save for both planned medical expenses and emergencies.

4) Never buy or sell individual stocks.

I don’t adhere to this rule, even though I definitely should. My single stock selections are riskier than playing dentist with a crocodile. This ties into rule number 5.

5) Buy inexpensive, well-diversified index mutual funds and exchange-traded funds (ETFs).

One of my favorite anecdotes is that a monkey with a dartboard filled with stocks will outperform most active fund managers. If you don’t have the time or desire to conduct market research to monitor a curated portfolio, then don’t. Over the course of a weekend, you can create a highly diversified, extremely inexpensive portfolio of ETFs and indexed mutual funds that will outperform 95% of active investment advisers. A few different types of index funds – growth, value, international, large-cap, small-cap, and some good bond funds – are a great foundation. As Jack Bogle, the founder of Vanguard says,

“You want to capitalize on the magic of compounding returns without succumbing to the tyranny of compounding costs.”

6) Make sure your financial advisor is a Certified Financial Planner (CFP®).

The Department of Labor recently repealed the Fiduciary standard law, which protected your best interests as a consumer by preventing your Financial Advisor from selling you products that didn’t act in your best interest. Without government protection, you should seek out a CFP® for financial advice because they are obligated by their title and the CFP® board to adhere to the fiduciary standard anyway. Certified Financial Planners must pass an 18-month rigorous curriculum and pass an exam similar to the BAR in order to earn the designation and they are the most qualified professionals to give you sound financial advice. Check out the CFP Board website to find a CFP® in your area.

7) Buy a home when you are financially ready.

For many, a home is the most leveraged, least diversified asset you will ever own. You want to be as thoughtful as possible when you make this purchase. You want to have at least a 20% down payment, which means you can negotiate better terms on your loan and avoid extra costs like mortgage insurance. You should buy a home with a mortgage you can afford monthly payments on in an area that is likely to grow in the future. You should also leave a “strategic reserve” in your savings account in case anything goes wrong after you move in, like a popcorn fire that consumes your microwave or ruptured pipe that replicates Old Faithful in your living room. (True stories.)

8) Make sure you’re protected with appropriate insurance policies.

You need to be insured for a life-changing event – like if that fire had consumed my whole kitchen, or worse. Life insurance helps to support those that depend on you in case you die. Liability insurance protects your car from all the other terrible drivers on the road.

In general, get the largest deductible that you can. First of all, it costs money for the insurer to honor all the smaller claims and you don’t want to have increased premiums for that. Secondly, those with high-deductible insurance know that they’re pretty unlikely to actually use it. This puts you in an insurance actuarial pool that is more favorable than those with low-deductible plans, ie. lower monthly premiums. Remember: insurance should be used to protect against the big, life-altering events, not the little inconveniences.

9) Support the Social Safety Net.

I know, I know, if you’re conservative, you probably just tuned out, but bear with me for a second. What I really mean by this is: pay your taxes. As Americans, it is important that we have each other’s backs to protect each other from the risks that would crush any one of us if we had to face it alone. Unemployment, Social Security, etc. are crucial economic tools that help keep many people afloat during challenging economic periods. A vast majority of those who rely on these programs are honest, good people and it is our responsibility – as financially stable citizens of the United States – to ensure that everyone has access to the social safety net so that they can bounce-back and ultimately contribute back to society. Pay it forward.

10) Remember the 10 Commandments of Personal Finance.

It’s like the opposite of Fight Club’s Rule #1 (and #2).

You can jot these down on an index card or a laminated business card and keep them in your wallet, or place them on the fridge next to your relatives’ Christmas cards. Stick to these rules and your financial stability is bound to improve.

Building A Credit House Part II

Last week in Part I we discussed 4 tools that can help you construct the credit home of your dreams. Now it’s time that we discuss proper maintenance techniques to ensure your home stays secure and upright. In this neighborhood, the broken window theory doesn’t apply.

And so, without further ado, 6 good credit maintenance habits to build your score and show that you’re creditworthy:

1) Make 100% of your payments on time.

Not only with credit accounts but with all other accounts, such as utility bills, loan repayments, etc. Consistently paying creditors on time is the most important factor in determining your credit score. Even one missed payment can have a serious impact. That’s why your payment history makes up about 35% of your FICO score. Bills that go unpaid may be sold to a collection agency, which will seriously hurt your credit and will follow you for the next 7 years… oof.

2) Keep your credit utilization low.

Utilization is your balance when compared to your limit, often referred to as a percentage of the total. Revolving credit utilization (the average of what you use monthly) is one of the most important factors in determining your credit score and makes up about 30% of your FICO score. I recommend keeping your balance under 30% and paying in full each month as soon as you get your statement. I like to keep my revolving credit utilization around 15-20% just to have some wiggle room for emergencies. Just remember that if you don’t use your card and keep the balance at 0, you won’t build any credit score.

3) Keep accounts open for as long as possible.

In general, the longer your credit history, the better. New accounts lower your average account age, which makes up about 15% of your credit score. Unless one of your unused cards has an annual fee, you should keep them all open and active for the sake of your length of payment history and credit utilization.

4) Avoid applying for too many new credit accounts at once.

Applying for new cards required a “hard pull” (or “hard inquiry”) into your credit which will lower your score. Inquiries indicate credit seeking activity and make up about 10% of your FICO score. In general, you don’t want too much credit seeking activity so try to moderate seeking new lines of credit. Limit applications to one or two cards at a time and keep a six-month buffer between each series of applications, especially when you are first starting out. Apply for one or two and if rejected, wait six months and try again.

5) Vary the credit that you utilize.

Creditors want to know that you can mix your credit up and stay reliable with your payments. Total accounts make up about 10% of your credit score. This considers the types of credit being used and reported such as revolving accounts (credit cards) and installment loans (check out Credit Builder Loans if you want to build or improve your score). Your total number of accounts may include both opened and closed accounts.

6) Learn how to check your credit scores and reports.

Check each of your credit reports annually for errors and discrepancies. It’s like your report card – you want to make sure it looks as good as possible. A credit report is a record of how you’ve used credit in the past. Your credit scores estimate how you’ll handle credit in the future, using the information in your credit reports. You’ll want to monitor both to watch for errors and to see your credit-building efforts pay off.

Several personal finance websites, including NerdWallet, offer a free credit score, as well as educational tools such as a credit score simulator. Some credit card issuer print FICO scores on customers’ monthly statements and allow online access as well. Some offer free scores to everyone – cardholder or not: Discover offers a free FICO score at CreditScorecard.com and Capital One offers a free VantageScore at its CreditWise website. More card companies are offering these services as they compete for your business. It really is the best time for us to be consumers in the financial sphere.

So there you have it! I hope that now you feel more comfortable with starting to build your credit home and ensure that it stays standing for the years to come.

Building a Credit House Part I

Building solid credit is analogous to building a house. You need a strong foundation, good maintenance habits, and dedication to make sure that your final product is worth living with. You also need a certain bit of know-how to make sure that the credit home you build is structurally sound and won’t come crashing down. Unfortunately, for those with very little or no credit history, it can seem nigh impossible to get that initial foundation set, especially when no one will give you credit in the first place.

Well, grab some eye-protection because in this two-part series I am going to help you build the credit house of your dreams. Today, I’ll introduce you to 4 tools that can help you construct the base for a solid credit history: secured credit cards, a credit-builder loan, a co-signed credit card/loan, and authorized user status on another person’s credit card.

Secured Credit Cards

A secured card is covered (secured) by a one-time upfront cash payment that you make, which is usually the same amount as your credit limit. For example, a secured card with a $200 credit limit requires a $200 upfront payment.

You can use this card like any other credit card – buy stuff, make payments ON TIME or before the due date, accrue interest if you don’t make payments in full – which makes it a great tool for practicing healthy credit habits.

This is a great option for when you’re starting from scratch, but it isn’t meant to be used forever. Secured Credit cards are designed to build enough credit for you to ultimately get an unsecured card that doesn’t require a deposit and features those incentivizing BONUSES.

Tip: When choosing a secured card, make sure you look for one with a low annual fee and make sure it reports to the three major credit bureaus: Equifax, Experian, and TransUnion.

A Credit-Builder Loan

As the name suggests, this tool is designed to help people build credit. Credit-builder loans typically range from $500 to $1,500 and are offered to people who need to build up their credit score, but already have a stable financial situation. There are three main types of credit-builder loans: Standard Secured, Secured by Loan Funds, and Unsecured. I go more into depth in the article, Credit-Builder Loan Basics.

For those without a credit history, you can achieve a credit score in the mid-to-upper 600s or even low 700s depending on the length and size of the loan. If you’re starting with bad credit, the loan should increase your score by about 20-25 points. If you make all the payments on time and keep the rest of your accounts in order, this can be the perfect tool for building a credit history.

Tip: Make sure your loan duration is at least 7 months as it takes about 6 months to get a FICO (credit) score.

Co-Signed Credit Card/Loan

Share the responsibility (liability) of a line of credit or loan with someone you (hopefully) trust! Co-signed loans/cards may be an option for those who don’t qualify for loans/cards on their own. You can utilize your co-signer’s credit history as a vote-of-confidence for you own credit-worthiness. Just remember that this is a huge responsibility for the co-signer with credit history. They are now liable for debt repayments, may not be able to get other credit, and the loan/credit card will affect their credit score. These obligations are negotiable as part of the initial terms that must be agreed upon and should be carefully considered.

Tip: Choose a relative or significant other with both a great credit score and stable finances, if possible.

Authorized User Status

If you are a particularly silvery-tongued individual, you may be able to convince a family member (or lover) to add you onto their credit card as an authorized user. As an AU, you enjoy access to a credit card and build credit history without any legal obligations to actually pay for the charges. I suggest you come to a mutual agreement with the primary cardholder on how you’ll use the card before being added. If they expect you to fork over some dough for the charges you rack up, please be a good user and do so.

Tip: Make sure the card issuer reports authorized user activity to the 3 credit bureaus; otherwise this tool will be pointless.

 

When used correctly, these tools will substantially expedite building the foundation for the credit home of your dreams. However, this process does take some time so remember to be patient, stay dedicated, and always wear eye protection. Click here for Building a Credit House Part II, where I detail good habits and maintenance techniques to make sure that everything stays standing.