Lesson 1 Budgeting and Saving
Lesson 2 Investing
Lesson 3 Choosing bank accounts

personal finance

Introduction

Do you keep a budget each month? Do you allocate part of your income toward savings, investments, and a retirement account? Is your retirement account through your employer, or do you have your own? Do you have a Roth IRA that you max out each month? Do you even know what I’m talking about? (If you do, that’s awesome; if not, don’t worry — you will soon enough!)

For just about everyone, taking control of your personal finances is essential to live the life you want: getting an education or helping your children get an education; purchasing a home; paying off debt; and being able to buy material things you really want or need, to name a few important things you may want to do in life. This is why I’m on a mission to develop a core curricula for all personal finance concepts that will help you take control of your financial future.

This isn’t to say that you aren’t currently in control, because you very well may be! Perhaps these ideas won’t be as useful to you, and in fact, you may have some additional things you do that are not covered here. If so, I would love to incorporate them to share with everyone else. Please email me anytime at katie.kormanik@gmail.com.

What I’m releasing now is non-exhaustive, but over time I will continue to build on it to accommodate those in as many different situations as possible. Please fill out this personal finance questionnaire to help me determine which content would be helpful to include.

So let’s dive in to topic #1: budgeting and saving.

Lesson 1: Budgeting and Saving

“The key to becoming wealthy is the ability to convert earned income into passive income or portfolio income as quickly as possible.”
Rich Dad Poor Dad

I couldn’t agree with this statement more. (And I recommend reading this book!) Earned income is literally your income from your employer, which is taxed at about 30-35%. Passive income is money you earn from investments, which is taxed at 15% (and often your investments will grow by 5-15% per year depending on what you invest in). The first step to converting earned income to passive income or portfolio income (purchasing a home) is budgeting.

It goes without saying that you should spend less than you make. Out of each paycheck, at the bare minimum you should allocate enough for:

  • Living expenses: rent, food, household items
  • Saving: amount that goes in your savings account for emergencies so you have liquid assets
  • Investments: stocks, bonds, mutual funds, retirement accounts (we’ll cover investments in Lesson 2)

This spreadsheet can help you keep track of your finances. Use it to decide how much you will save and invest after taking mandatory expenses into account. After inputting the amount you’ll spend, save, and invest each month, you’ll see your final checking account balance. The goal is for that balance to always be close to $0, but never negative. (It’s usually good to have some cushion just in case you have automatic withdrawals from your checking account or you need to withdraw cash, so maybe make sure the balance never goes below $100 or $200.) You can then plan months or years ahead to make sure you’re saving enough to meet your financial goals (whether that means paying off mortgage each month, saving to purchase a car, etc.).

In the video below, I demonstrate how I use this spreadsheet for my own personal finances.

The key here is to spend as little as possible so that you can put as much as possible into savings and investments. For many people, the most important thing is discipline. Keep track in your head of how much you’re spending; if you can’t do that, withdraw cash each week and only spend that.

Lesson 2: Investing

Disclaimer: This is not professional financial advice. However it provides ideas on how you can get started with investing and make sound investment decisions.

Investing is critical to maximizing the amount of money you have over time. Mutual funds can grow up to 20% annually (though usually between 6% and 15%), while the interest rate of savings accounts (at least in the US) are only 1% or less, and 1% is actually pretty high. A lot of banks have interest rates of 0.05% or less. (We’ll cover checking and savings accounts in Lesson 3.)

Check out what happens when you invest $1000 per year in a mutual fund that grows at 8% annually versus putting $1000 per year into a savings account with an interest rate of 0.05%.

Investment simulation

After 20 years, you will have invested $20,000. But with a mutual fund where your money grows 8% each year, you’ll more than double your money after 20 years. Whereas with a savings account with a 0.05% interest rate, you’ll make a whopping $100. Whoop-dee-doo.

You can play around with this spreadsheet to calculate how much money you’ll have after x years under a specified interest rate and amount you invest or save per year. Columns C and D allow you to compare the difference between how much you’ll have under different interest rates. Simply change the % in cells C1 and D1. You can also change the amount you’ll save or invest per year. For example, if you invest $5500 per year in a mutual fund that grows 8% annually, after 20 years you’ll have invested a total of $110,000 but have approximately $271,826. (And if this investment is in a Roth IRA, it will grow tax-free! More on saving for retirement in Lesson 4.)

The video below explains how figures in the spreadsheet are calculated and how you can use it.

Okay, that sounds all well and good, but you may have three questions:

  1. How do I know that a mutual fund I choose will grow 8%?
  2. Which mutual fund should I choose?
  3. How do I invest in a mutual fund?

I’ll answer them one by one.

How do I know that a mutual fund will grow at least 8%?

The answer to this question is simply: you don’t. But in general the market rises over time. Check out the following mutual funds over the last few years:
mutual funds

This trend is consistent for just about every mutual fund. In many cases, any money you invested 5 years ago would be worth almost double today. In general, any mutual fund is better than simply putting your extra money in savings (although it is important to have some money in savings in case of emergencies).

Which mutual fund should I choose?

The first step is to determine what kind of mutual fund you’re looking at. One tool is the Morningstar Style Box which categorizes funds according to size (small, medium, and large capitalization, where “capitalization” is the total worth of the company, equal to the number of shares multiplied by the price of each share) and style (value vs. growth).

The Morningstar style box categorizes stocks and mutual funds by size and style. This image depicts a classification of a blended style and a large size.
The Morningstar style box categorizes stocks and mutual funds by size and style. This image depicts a classification of a blended style and a large size.

A fund’s category on each of the two axes is determined based on the stocks that compose it.

  • Size: Large-cap stocks account for the top 70% of the capitalization of their geographic area; mid-cap stocks are the bottom 10%-30%, and small-cap stocks are the bottom 10% of capitalization.
  • Style: Morningstar says, “In general, a growth-oriented fund will hold the stocks of companies that the portfolio manager believes will increase earnings faster than the rest of the market. A value-oriented fund contains mostly stocks the manager thinks are currently undervalued in price and will eventually see their worth recognized by the market. A blend fund might be a mix of growth stocks and value stocks, or it may contain stocks that exhibit both characteristics.”

For more on the style box, see Morningstar Style Box, Morningstar Investing Glossary

To analyze a fund’s performance, compare its 3-year, 5-year, and 10-year returns to a benchmark that’s in the same category. Morningstar does this for you on their site: www.morningstar.com.

The following video demonstrates how to analyze a fund on their site.

How do I invest in a mutual fund?

Once you know which mutual fund(s) you want, you’ll need to open a brokerage account. Anyone can do this with online brokers like Scottrade, Fidelity, Charles Schwab, TD Ameritrade, or E*Trade. Just keep an eye out for fees.

Once you open your account, you’ll be able to make elections decisions, meaning which mutual fund(s), stock(s), etc. to invest in. You can link your regular bank account (checking or savings), transfer money into your Scottrade account, and then choose which mutual fund(s) or individual stock(s) to buy.

The screenshot below shows how you would purchase $500 worth of AMAGX on Scottrade.

Scottrade

In the budget you designed (see Lesson 1), you should have determined how much you will put in investments each month. So be consistent every month and don’t take it out until you need the money for a larger financial goal, like buying a house.

Buying stocks

I recommend that the majority of your money go into a mutual fund, as it’s very likely you’ll consistently make money over time. But you may also want to invest some money into individual stocks. Many people choose to invest in companies they believe in. Or sometimes, you might choose stocks based on big company moves, like a merger, acquisition, or IPO (initial public offering). For example, in September 2014 Vail Mountain Resorts (MTN) purchased Park City Mountain Resort in Utah. (The “ticker” symbol — in this case “MTN” — is the nickname/abbreviation for the company that the stock market knows it by. Google “MTN” to see how the stock price has changed over time.) After this purchase, MTN’s stock price jumped 11.7%. ($1000 would have become $1117.)

MTN's stock price jumped after it purchased one of the largest resorts in Utah.
MTN’s stock price jumped after it purchased one of the largest resorts in Utah.

For an IPO example, Alibaba (BABA), China’s largest e-commerce site, went public on September 19, 2014. Many jumped on the opportunity to buy shares once it went public. But before you jump on the IPO bandwagon, pay attention to the initial offering price (the share price early investors can pay before the stock debuts for the general public) versus the offering price to the general public.

“The vast majority of shares in a hot IPO such as Alibaba are sold to well-placed institutional investors prior to when the shares debut on a public stock exchange. … Investors who didn’t get in on the IPO ahead of the initial pricing — which is to say the vast majority of investors — will have to pay whatever the going price is generated by demand after the stock begins trading publicly.”
Alibaba IPO Poses More Than the Usual Risks To Retail Investors, Fox Business

In the case of BABA, early investors were able to buy at about $68 a share, and the general public was able to buy on at around $93. So while investors bought at this higher price, early investors sold at a 37% gain, resulting in the stock price dropping for the next month.

$5000 in 2005 would be worth $100,000 today.
$5000 in 2005 would be worth $100,000 today.

If you’re lucky enough to place your bets with a company that does well, you can have huge returns. Just look at the life of major companies like Apple (AAPL), Facebook (FB), or Google (GOOG). (Wouldn’t it be nice to have invested $5000 in Apple in 2005, which would be worth about $100,000 today?!)

HP YHOO

However, compared to mutual funds which have a diversified portfolio of stocks of different classifications (recall the Morningstar Style Box), stocks are not as reliable. Just look at Hewlett-Packard (HP) and Yahoo (YHOO).

Remember that when you invest in individual stocks, you’re taking a risk. In general, it’s wise to invest the majority of your money in mutual funds.

When you’re logged into your online brokerage account and ready to buy stocks, most likely you’ll have to pay a transaction fee. The cost per transaction (no matter how many shares you’re buying or selling at once) varies by broker. Scottrade charges $7 per transaction, E*Trade charges $9.99.

Investment accounts to save money

Roth IRA: Seriously consider opening a Roth IRA, in which your pre-tax dollars grow tax-free. Technically, this is a type of retirement account, but it’s a good idea for anyone to open one even if you’re not necessarily planning for retirement because there are ways you can still use the money before you retire. Here are the basics:

  • You can contribute up to $5500 per year (provided you fall within the income limits)
  • You can withdraw up to the amount you’ve contributed anytime, tax-free and penalty-free
  • You can withdraw up to $10,000 (contributions + unearned income) to purchase a home without penalty or tax as long as your account is at least 5 years old
  • Anyone with earned income in the US can open a Roth IRA
  • You can contribute for the previous year up until April of the following year

On Scottrade and other online brokerage accounts, you can open a Roth IRA, transfer up to $5500 per year into your account, and elect your investments. Let’s say you put the money into a mutual fund that gives 8% returns each year. After 40 years, assuming you contribute the full $5500/year and don’t take anything out, you’ll be able to withdraw $1.5M tax-free. (See this Roth IRA simulation.) However, if you had invested the same amount ($220K) in a regular investment account, the $1.32M of unearned income will be taxed at 15%, and you’d make about $200K less. Read more about Roth IRAs here.

Lesson 3: Choosing bank accounts

I chose my first checking account based on which bank my parents used. I quickly realized that it wasn’t the best option for me after incurring hundreds of dollars of fees for EVERY. LITTLE. THING. (Think monthly maintenance fees, paper statement fees, overdraft fees, etc.) Finally, I did some investigating on what types of checking, savings, and credit accounts would be best for my situation and transitioned.

I’ll be transparent about what I use and why, simply to help guide your decisions but not to recommend that you do the same (unless you truly believe this might be a good option for you).

Checking and Savings account
I wanted a simple checking account (i.e., no hidden fees, no unreasonable restrictions and regulations) that I could use for my direct deposits and online payments. I rarely go into a physical branch, and I wanted everything to easily be done virtually. I also wanted high interest rates on checking and savings balances. I settled on Ally Bank, which was voted one of the least evil banks by CNN Money.

Some perks I enjoy include:

  • Checking (“Money Market”) account APY (annual percentage yield) of 0.85%
  • Savings account APY of 0.99%
  • Full reimbursement of ATM fees from any ATM
  • eCheck deposit option (deposit checks by taking photos from their app)
  • Easy online banking
  • Quick and 24/7 phone response time if I need to call with a question

Most other banks have APYs of 0.01% for checking accounts. So, while a $10,000 balance in a checking account at Ally will generate an additional $85 in interest, $10,000 in a Wells Fargo checking account will only generate $1. Wells Fargo’s “high-yield” savings APY is 0.03%. Can you say “cheap”?

One drawback to Ally Bank is that sometimes big corporate checks don’t go through with mobile deposits. So I have a backup Chase checking account that I use whenever I need to deposit these kinds of checks. As long as I keep a minimum of $1500 in the account, there are no fees.

Credit card
Choosing a credit card can be just as difficult or more so. It’s important to have a credit card to build credit (this helps you get approved for loans and get lower interest rates), plus it can have perks if you’re responsible. It can also get you in deep doo-doo if you’re not.

Use the Google form below to determine what kind of credit card you might consider for your situation.

If you’re interested in a rewards card, this spreadsheet is a tool to help you easily compare the annual monetary benefit you would have from each card. You simply type in your monthly expenses and credit card information (annual fee and rewards rates). Then you can approximate how many rewards dollars you’ll earn each year.

For example, if you spend $1000 per month, the Capital One Venture Rewards card is the best. But if you only spend $500 per month, the Capital One VentureOne rewards card will rein in the biggest reward.

You also have the option to itemize your expenses since some credit cards offer different rewards depending on what you purchase.

Before you make your decision, keep in mind some things to watch out for when choosing a credit card:

  • High rewards rates but impose a maximum on the amount you can spend to get that reward (e.g., 6% cash back on groceries, up to $6,000 spent annually)
  • $0 annual fee the first year that increases in subsequent years
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