Tips to Financial Management

1. Save 10% of everything you earn.

Almost everyone can afford to save 10% of what they earn. If you cannot, find a way to earn more. This is the “pay yourself first” principle, and it means that before you pay anyone, you save 10% of what you make for yourself. This is the foundation of building wealth. You may ask “how can I save 10% when I can barely pay my bills as it is?” If this is your situation, you need to take a hard look at your budgeted monthly expenses vs. your monthly income. If you do not have 10% “wiggle-room” in there, you are not earning enough. Do whatever you need to do to create the wiggle room you need, and remember- the first step is the hardest. A few years from now, you will have a good deal saved and it will get easier and easier to save 10% if you make sound decisions and follow the steps outlined below.

2. Buy your cars with cash

Expensive cars are the #1 worst investment you can make, since they are worth less every year. The more you spend, the more you lose per year. Having a high car payment straps you for cash, and the vast majority of what you are paying goes to interest, not to your car. Sure, an older car will require more maintenance. But by giving up that big car payment, you will have the money to do repairs as they happen. This is a common denominator for wealthy people- they generally will not finance a car. If they do not have the money to pay for a car in full, they don’t buy it. In time, you will be able to afford more. Don’t fall into the trap of caring what other people have. Most of the people driving those shiny new cars are struggling financially and cannot afford them anyway. This is one area where looks really are deceiving!

3. Do not invest in depreciating assets such as mobile homes or cars or boats

This is related to the above tip. Mobile homes and modular homes are lousy purchases because they are worth less and less every year. You purchase a mobile home for $40,000 and 5 years from now it will be worth $25,000- or maybe less! If you don’t own the land, it’s a poor idea. Generally if you can afford a mobile home ($400 per month on the mobile home and $400 per month on the lot) you could afford a condo. A starter condo wont cost you any more but will appreciate over time, and instead of finding yourself out $20,000 on a modular home, you may find yourself $20,000 ahead! This is a $40,000 difference and that may be the difference to a start of wealth and bankruptcy.

4. Keep your monthly recurring expenses as low as possible.

This is tied to establishing a budget. The expenses you most want to avoid in life are those that happen month after month, such as car payments, rent, cable, etc. Expenses that occur every month are your monthly “overhead”. These monthly recurring expenses are your enemy. Try to minimize them when you can. The one time purchases do not concern me as much as the monthly ones. Keep your monthly overhead as low as you can. The only caveat to this is where a monthly expense item helps you become more efficient. But even then, try to minimize your monthly payment.

5. Establish a budget

It is critical that you have a monthly budget and that you know what you have to earn each month to break even. The fundamental rule to becoming wealthy is to earn more than you spend. To do this, you must know what your monthly budget is. Factor in everything, including miscellaneous expenses of $100 per month or so, gifts, haircuts, etc. The trick is to write down every single thing you spend money on. Do this for about 2-3 months and take an average. The results may surprise you. Then, do whatever you have to do to earn a few hundred dollars more per month. Always make sure you earn more than your monthly overhead. Keep in mind that your rent and car payments should not exceed about 40% of what you earn. (I have seen people who make $1200 per month with car payments of $500 and rent of $500. This is simply not doable.) Another rule of thumb is that if your monthly bills (the actual checks you must month in and month out, not including spending money and miscellaneous items) are $1500 , you should earn at least $1000 on top of this number. In this case, $2500.

6. Put your savings into things that will appreciate, such as real estate or stocks.

Real Estate and stocks are probably the 2 most sound, long term investments. Many mutual funds can be started with as little as $500, and then they will take monthly deposits as low as $50. The stock market has historically averaged more than 10% per year appreciation. Invest in mutual funds, not individual stocks. Probably the safest and best overall investment is an index fund of the S&P 500. An index fund is broadly diversified since the fund owns every one of the 500 stocks that make up the S&P 500. This index has been proven to beat about 90% of all mutual funds in terms of performance!

Real estate is probably the single best investment you will ever make. Much of this is attributable to the growing population, which makes real estate more valuable each year due to supply and demand. The other reason is the principle of leverage. If you buy a home for $200,000, you may be required to put about $10,000 down. If the real estate market goes up by 10% your property is now worth $200,000. You have made a return on your investment of 200%! (you started with 10,000 and now you have turned this into $20,000). The principle of leverage is that while the market went up by only 10%, you made 200% on your investment. Why did this happen? Because you borrowed $190,000. You leveraged your $10,000 investment into a $200,000 investment by borrowing. This is why low down payment or no down payment real estate purchases, in an appreciating market can make anyone a wealthy person. A word of caution: Leverage works both ways: if the marked depreciates by 10%, your home is worth $180,000, and you just lost 200%. In the long haul though, real estate has been proven to be, and no doubt will continue to be, the best investment you will make.

7. Don’t buy things that don’t improve the quality of your life.

Prior to any out-of-the-ordinary purchase, ask yourself if this item will improve the quality of your life. I see lots of people who just spend $1000 or more on new wheels for their car. This is a good example of an expenditure that really wont improve quality of life. Compare this to movie tickets, camping gear, school, a car for transportation, etc. These are purchases that may make your life better in some way.

8. Do something to improve your earning capacity

If you are in an occupation where you are making a low hourly rate for your work, invest in yourself, and get some education to improve your hourly rate. While it may be difficult to work full time and simultaneously do something to improve your earning capacity, this extra effort will pay dividends for a lifetime.

9. Have more than one source of income

These are uncertain times. Many employers have little loyalty. As we saw in the most recent recession, when the going gets rough for the employer, they often resort to layoffs. With this in mind, consider having more than one source of income. This is particularly important if you are self-employed. Diversifying into a few different jobs means that if one is slow, the other can pick up the slack. I have a client who does some marketing consulting but also has a massage practice. This is a good example of what I am talking about.

10. Establish good credit

While I advise everyone to avoid debt like the plaque, having good credit is more or less essential to real estate investing. You can find out all the details on how to clean up your credit on this web site.

11. Don’t charge something that you won’t have when you get the statement.

If you are going to use your charge cards, limit your charges to assets that you will have when you receive the statement, like clothing or a computer. Have you ever got your credit card statement and it had a bunch of charges for things that you get no benefit from right now? (e.g. charges for a restaurant, a plane ticket, Broncos tickets, etc). This is frustrating because you now have to pay for something that you did in the past. Pay as you go, don’t mortgage your future. Compare this to charging a computer that you need to start a business, or a pair of skis that you will have for 5-10 more years. These are better things to charge.

12. Debt – avoid it like the plagu e- even student loans.

This should be your main goal. Live simply and your wealth will grow. Don’t borrow just to have things that others have, or to satisfy wants and impulses. With respect to student loans, certainly education is usually a wise investment. However, I have seen many, many clients who have student loan repayments that are more like a ball and chain than a good investment. Be awfully careful whenever you borrow today with the expectation of paying it back tomorrow. This is not to say that you should not take out student loans. But if you do, take the absolute minimum possible. Never take a loan to live off the proceeds. Remember– when you incur debt, you become the servant to the lender. Empower yourself by living within your means.

13. Keep your monthly bills as low as possible. Lean and mean.

Expenses that recur every month, your monthly “overhead,” should be as low as you can make it. This means no car payment, lower insurance payments, rent, cable bills, etc. I am more concerned for someone with high overhead than someone who makes an occasional, expensive one-time purchase such as a nice couch. Do what you can to keep your overhead to an absolute minimum. The exception to this is when an item which has a monthly expense brings a potential to earn more, or to work more efficiently. Examples of this may be a cell phone if you are self-employed. This is may be a monthly expense that makes sense. But if you must take on monthly expenses, keep them as low as possible!

14. Life insurance – treat it as a luxury and avoid it if you can.

I have many clients who can barely afford to eat, but somehow they make a $200 per month life insurance payment. It does not make good sense to sacrifice so much now for a benefit you will never live to see, unless you are protecting young children or a dependent spouse. Insurance salesman claim that it is a great investment since you can withdraw against your cash value if you need to. The truth is, it is a lousy investment. The insurance companies are making a killing on your “investment”. That is why you hear the saying that “you don’t buy life insurance, someone sells it to you.” You will do better to purchase a mutual fund—this way, the only one who profits is you.

15. IRA – do it!

This money will grow faster than most investments because it grows tax free, and the amount of the IRA deposit can be deducted from your income in the year you deposit it. The simple rule is this: invest the maximum allowed by law, every year, in your IRA.

16. Don’t refinance your home and pull out cash.

I have recently met with a client who refinanced her home every 4 or 5 years as it appreciated. She bought the place originally 15 years ago for $80,000. Her mortgage payment was $750 per month. But over the years she pulled out cash by refinancing. Now the property is worth $220,000, and guess what she owes on it? $220,000. Her mortgage payment is now $1700 per month and she still has money woes. Where did that money go from her refinances? She lived off some of it, paid down credit cards 2 or 3 times and who knows what else. Had she exercised more discipline and followed the rules described above, she would still have a $750 per month payment. Houses are meant to be paid off if they are to be a good investment. You get no where by borrowing against your equity.

The temptation to borrow against your equity is great, especially if you have credit card debt. The interest rate on equity loans may be half of your credit card rate—and it is tax deductible. But do so reluctantly and only as a last resort. In limited situations it makes financial sense. But if you follow these rules above, you will never need to refinance again!

CONCLUSION

Keep in mind that these rules may conflict at times. There are exceptions to every rule. For example, charging a vacation may increase the quality of your life, but it breaks the rule of not charging things you won’t have when you get the statement. Or you may have to increase your overhead by taking a student loan in order to invest in yourself. In these cases, you have to exercise your best judgement. But all and all, if you use these rules as guidelines, you will prosper.

Starting a road to financial security requires discipline and the ability to put your pride aside for the moment. Don’t fall into traps of high car payments because you want to impress people with your nice car. Don’t feel badly for taking that extra job that you feel is “below you” for the sake of earning a little more. These are exactly the kind of moves that earn true respect, for they are the harder decisions, the fundamentally sound decisions, and the ones that will put you on the road to wealth!