Five FAQs of personal finance

Throughout my journey with personal finance, and through the mistakes and learning, I compiled a list of Top 5 questions that come to my mind, time and again. 

So I decided to compile these as a FAQ and try to answer them to the best of my knowledge and experience. 

  • Buy vs. Rent
  • How many accounts to have
  • How and where to invest
  • How to save more money
  • How to manage my portfolio

Buy vs. Rent?

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One of the biggest financial decisions in everyone’s life is to buy a house. However there are pros and cons that need to be weighed against renting similar or better homes. There are lots of views and articles on Internet which give both a logical as well as emotional opinion to this question. In my opinion (just another), only You know better whether you are ready to buy a home.

To put it logically from what I know, there are few costs and factors that need to be considered.

  • Save up for a down payment of at least 20%.
  • Consider closing costs, it can easily be in the range of $4000-$5000.
  • Consider any rehab budget if you are not buying a recently updated home. You will pay for it either way. 
  • Aggregate of all monthly expenses of home ownership should be less than the current rent paid. These expenses are: 
    • Mortgage payment
    • Taxes
    • Insurance
    • Maintenance (1% of home value per year)
    • HoA fees
    • Lawn care and utilities
      • if you had paid these apart from rent, you need to make sure the costs are almost identical

Only after you have made the calculation above, and convinced yourself that total monthly housing expenses will be less than the rent, you can consider buying provided there is the cash cushion of down payment and closing costs.

One argument which is floated in favor of ownership is that rents are going to increase per year, whereas the mortgage will remain constant. However please consider that Taxes, Insurance and Maintenance will go up too year after year.

On the other hand, the mortgage will get paid down giving a little more advantage to the ownership since you are building equity and hence net worth.

The other factor is how long you are going to stay in the home to recoup the costs of mortgage interest, taxes, insurance, upgrades, maintenance etc. 

One day (in a few years), you may want to move out and convert this house into a rental.

Will the rental numbers in the area completely cover all the expenses? You certainly don’t want to pay for new house as well part of the expenses for your tenant.

All of these factors should be taken into calculation before making the big decision. 

The following post may help in setting up the calculation, but I suggest do your own homework too. 

How to decide on a purchase – the P.V.T formula

If you are interested in scenarios of managing a mortgage or multiple properties, here are couple of previous posts on the subject. 

The Paid Piper of Hamelin

Don’t twist your ARM, fix it !!!

How many accounts should I have?

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There are many banks and financial institutions who are vying to keep your money, earn fees and lure you into a long term relationship. These marketing flyers and lure of higher interest rates or credit offers make us open many bank accounts indiscriminately.

The more you spread out without a purpose to each account, it will become unmanageable and have overlapping features. There are many cases where people (or spouses after the death of one) forgot about their accounts, and the money lies there idle never to be claimed again.

So bank and brokerage accounts all should be tied to specific goals and purpose in your regular financial picture. Typically the following should suffice:

  • A checking account and a debit/credit card
  • A savings account, if more than one, each should be for a specific saving goal
  • A retirement account (typically 401k or IRA)
  • An investment account (outside the 401k/IRA for medium term investments)
  • A special purpose account depending on needs
    • 529 – Kids’ education
    • HSA – Health Savings Account if you have high deductible insurance

Beyond this, it becomes fancy and unmanageable.

The following post shows a step by step guide to open and manage these accounts.

The Starter Kit

How and where do I invest?

One of the main hurdles of personal finance is to find out how and where to invest. There are many risk-return trade-offs from cash savings to mutual funds to real estate, and even exotic investments like art and commodities.

The simplest investment however is a balanced indexed fund, where there is an automatic asset allocation of stocks and bonds and which can vary according to your age and risk tolerance. These are also called Target date funds. Being an index fund, the costs are extremely low (0.0x%) and you get instant diversification.

Most portfolio should not need more that this. However if you are a little bit more knowledgeable, then you can create your own basket of index funds. For example, the three fund portfolio is very popular. Here is a good link: Three-Fund Portfolio

One of my previous posts mentions the various investment accounts that you can setup. 

Investing in the High Five portfolio

Know yourself and your investments

How do I save more?

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This is one of the questions which has many different ways of asking.

  1. How do I spend less?
  2. How do I pay myself first?
  3. How do I increase my income?

The answer lies in all of the above questions. You have to do all to be able to save for emergency, goals, vacations and fun.

The topic on how many bank accounts to have, takes into account this aspect. It is very important to build a cash cushion along with your investments and lifestyle.

See below posts on why and how to do this effectively.

One essential comfort zone

Budget – Grow the tree upside-down

How do I manage my portfolio and reach my goals?

black mazda steering wheel
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Managing your investments and financial system may not be a complex or time consuming task. It needs essentially three things. 

  1. Automation 
  2. Tracking 
  3. Learning

The following post describes a step by step process for managing and growing your personal finance system. 

Five components of a personal finance system

All it takes is to first setup the automatic payments and investments, then a weekly tracking mechanism and weekly reading and exploring more.

With time, you will start flowing like a pro. 

Shun that perfection

Conclusion

While the list of FAQs above is not exhaustive, these are questions that I have seen people struggle with or make irrational decisions on. Or to put it another way, I have done same mistakes and learnt that if you manage these aspects well, you don’t need to worry any more. 

beard cafe coffee shop connection
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