Posted in Personal finance

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?

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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. 

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Posted in Budgeting, Personal finance, Savings

Five components of a personal finance system

There are many articles on how to be frugal, how to save more, earn more and invest for high returns.

All this is good advice, and the Internet is full of such articles, blogs, videos, courses.

However the key to saving money and investing for growth is action and the discipline to implement the good practices.

If you go through most of the articles, some common themes emerge such as:

  • Pay yourself first
  • Do a proper budget or at least allocate money to your various expenses
  • Big tax refunds are not cause to celebrate
  • Get out of debt
  • Regularly invest a little
  • Use Robo advisors
  • and so on…

Yet lot of people (some say 78% of Americans) live paycheck to paycheck, and will not be able to cough up $400 cash in times of emergency.

With so much of good advice and technology out there, why then we still have the problem with more than 50% of the population? What is different with the 10-20% who manage to create and keep wealth?

I think the answer lies in being organized, intentional and disciplined. As Dave Ramsey said “Personal Finance is more behavior than numbers”.

It requires a system to be organized and manage your money. Once the system is in place and you get into the habit of it, you will automatically resist impulsive behavior.

In this post, I will highlight some of the systems that I follow to organize this area of my life. And remember, the more organized and intentional you are on personal finance, it impacts rest of the areas of your life as well. Cliche, right? Yes but difficult to implement.

There are 5 parts to the system:

  1. Automate
  2. Cap
  3. Archive
  4. Remind
  5. Learn

Just for fun, lets rearrange and call this the CARLA system (Cap, Automate, Remind, Learn and Archive). Really the order does not matter.

1. Automate

Automation is the heart of any system. And with most of the financial products employing high end technology, there is no reason to avoid automation.

A simple automation makes the “Pay yourself first” a breeze like operation.

For example, in my case, the first bi-monthly paycheck (pre and post tax) simply goes to my mortgage and investments (retirement, 529 plan, HSA, investments). I just cannot see it in my checking account by the 2nd or 5th of the month.

How do I run my expenses and pay my bills then? Another automation.

All my bill payments are set on the one and only credit card that I use. It is completely automated so I don’t need to remind myself to pay electricity, water or phone bills. The same credit card is used for first half of the month to buy essentials.

By the same system, the second bi-monthly paycheck pays off the credit card bill in full.

A portion of that also goes into savings for short term goals (provided the credit card was not overused – we will talk about caps in next section).

Advantages:

  • Naturally implements the Pay Yourself First.
  • Automated bill payments, so no chance of forgetting and running into credit problems.
  • Earn points on the credit card, as all expenses are charged to the one.
  • The credit card is automatically paid off within the month.

Risks

  • Need to control expenses as the credit card balance should not overshoot the projected amount.
  • Unexpected debits to the checking account (checks issued, or charged by institutions) may cause overdraft scenarios if not careful or kept track of such expected transactions.

The Starter Kit explains how to setup a system from scratch.

2. Cap

One of the toughest part of personal finance behavior is to cap your spending. No amount of technology or automation can address this adequately. There are budget apps, reminder apps, envelope system but at the end of the day, if you are armed with a credit card, there is no stopping you.

There are two ways to address this:

  1. If you are using a credit card, then absolutely you will need a budgeting and expense tracking app. I use YNAB (You Need a Budget) but I have heard people liking Mint or Personal Capital. In these apps, you can set limits for spending under each category like Food, Transportation, Utilities and Fun. Here is a referral link to YNAB.
  2. However a more effective way and not to run into debt, you can automate to transfer the estimated monthly expenses to another checking account, and use the ATM/debit card of that account. As soon as you see the account is drying up, you know you have to rein in your spending. As you do this more, you will slowly understand the pattern and be able to make or adjust estimates.

Advantages:

  • Having a cap of expenses is non-negotiable in the pursuit of good personal finance habits.
  • You know exactly where each dollar is going and how to optimize or reduce the outflow.

Risks:

  • The first approach definitely has the risk of running into credit card debt, and not able to pay in full.
  • The second approach is safer but if you are not keeping track, can hit you with overdraft fees or embarrassing card decline at the checkout counter.

Yet another simple budgeting mechanism is described in Budget – Grow the tree upside-down .

3. Archive

A good archiving system is also key to good personal finance habits. Not only habit, but it keeps you stress-free. Remember the scrambling during tax filing season, looking for bank statements, dividend results, interest certificate etc.

Moreover we have multiple sources of information, statements coming through email, snail mail, website downloads, or even previously archived repositories.

A simple system I follow consists of a uniform folder structure across multiple sources of information.

There are 4 aspects of personal finance that you need to keep track of.

  • Banking – Accounts, statements, credit cards, interest certificates.
  • Investments – Portfolio Statements, dividend statements, recommendations, documents from financial advisers.
  • Taxation – Everything related to your taxes year wise. Returns, documents sent to CPA, CPA communication, IRS communication and so on. For each year, I have the following folders.
    • Year
      • Source documents – Everything I sent to the CPA
      • Processing – All drafts and iterations I had with the CPA
      • Final – Final copies of the filed return and acknowledgements etc.
      • IRS – In case there are any direct interactions with IRS after filing (notices, response, tax due, tax paid etc.).
  • Insurance – Insurance policies, forms, statements, estate planning documents.
  • Bills and Receipts – Miscellaneous bills and receipts if they do not fall into above categories.

With the above organization, you can simply create the archival system in all your information sources.

  1. Gmail – create these as labels or email folders.
  2. Evernote – you can create notebooks and store documents as notes under each notebook.
  3. Google Drive – create folders. You can save attachments from gmail directly to these Drive folders.
  4. Laptop local drive – Sometimes it is best to store in the local drive than cloud. That is, if you are uncomfortable storing documents containing sensitive information (SSN, date of birth) into the cloud. Be sure to periodically back this up into external hard drives.
  5. Physical documents – Paper statements can be either scanned and stored in above places, or simply dropped into file cabinet drawers, with appropriate labels. The labels should follow the same categorization.

Once you have the uniform structure across all these platforms, storage and finding information is easy.

Advantages: 

  • Easy to file and find.
  • Following same structure in all systems that you use.

Risks:

  • None at all.

4. Remind

So you have automated, capped and archived personal finance. But what about still those actions to be taken, follow-ups to be done and making sure time sensitive things do not fall through the cracks?

I don’t want to describe personal productivity or time management here, but an essential part of managing personal finance is timing. There are taxes to be paid quarterly, investments to be made, or simply a phone call to be made.

Choose whatever system works for you as reminders, be it an app on your phone, or calendar on the laptop.

For me, plain gmail works as it has a snooze facility, by which I can redirect any email to come back to my Inbox at the time I need to take action. In my opinion, it is an important tool in time management as now I can remember to take action at the right time. It just pops in my Inbox on that Sunday prior to the week I need to take action on that. 

Another good platform for keeping track of your laundry list is Trello. I use it quite extensively and the concept of board and cards, helps keep things visually clear.

Advantages: 

  • Even if you automate everything, there will be things for which action needed to be taken timely.
  • Remain stress free and auto-magically respond or follow-up with people at the right time. Sometimes this surprises people as they may have promised to do something (or get back to you) and you follow up on the agreed date. 

Risks: 

  • Unless you stick to one system (Trello or Gmail), you run the risk of multiple apps keeping track of your to-do lists and confuse you enough not to take action or update new items.
  • You may run the risk of irritating some people who do not like to be followed up, especially if they wanted to forget what they promised.

5. Learn

I cannot emphasize this enough and with the plethora of information on the Internet, whatever I say will sound like cliche.

However as with any field, it is important to keep yourself up-to-date with advances in personal finance topics. 

One of the simplest ways is to dedicate a couple of hours every week, to read about different topics, blogs and videos of personal finance. You can subscribe to magazines like Money or Kiplinger. Or simply come back to this blog as I normally post every week.

Advantages: 

  • Learning is always good, and opens up new opportunities for you.
  • You build your own system and strategy as you read and learn techniques others have used.

Risks:

  • Don’t get obsessed by personal finance reading, as it can get repetitive very easily. You may end up wasting lot of time reading the same message in different ways.
  • You may take wrong action or jump into investments without fully understanding the consequences, or simply following some author’s thumb rule from a book.

These are the Five essential elements of a good system that can be setup with minimal infrastructure. It worked for me and I hope you find it useful. 

My CARLA system (Cap, Automate, Remind, Learn and Archive) – a system to automate, manage and grow personal finance. 

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Posted in Budgeting, Investing, Personal finance, Savings

The Starter Kit

If you are just starting off with organizing your personal finance, or restarting from scratch, here is a step by step way to get started.

Most of the times, we get started haphazardly, the first account in the local bank or the ad-hoc insurance policy or even the next stock tip forces us to open a  brokerage account.

However there is a need to get started in a more planned way.

When I moved to the US couple of years back, the below is how I setup my money system. I had a similar one running in India for a long time and it has given me very good results.

Here is the starter kit that you need to get organized and get started. 

Since it is built in a systematic manner, it will help you automatically organize and keep your finances in order.

A checking account

This is the first step as you need a place to deposit your income, be it direct deposit from your employer or you get checks at the end of the month.

Get a simple checking account at a Credit Union which provides you with a basic ATM and Debit card. Try to find a credit union or bank which has very low fees. Obviously they will have some like overdraft fees that we will anyway avoid, but others like ATM access are something unavoidable, so shop around a little.

This is where all your income will come in and get deposited. 

A credit card

We are going to be responsible spenders, right? If not, do not get this and use your debit card from your checking account.

The key to being a responsible spender is to make a budget, stick to it and pay off the credit card bill in full every month. Lets just assume you agree to all of this. 

There are many credit cards in the market with various features like cash back, travel rewards etc.

As a starter kit, you will just get one from the same bank or credit union where you hold your checking account. The reason is ease of payments and setting up automatic transfers from your checking account to pay it off at end of month. 

The bonus will be of course if  the card also has generous cash back benefits or other similar perks. But get a free one and not one with annual fee loaded just for extra perks.

The credit card will be your main expense vehicle. It gives you automatic fraud protection, insurance and easier account tracking. 

Budgeting

If you do not do any further, you have setup the very basic system. You earn money which get deposited into the checking account, you spend with your credit card (on a budget!!) and your checking account pays it off every month.

But this sounds like living paycheck to paycheck or Living on the Edge, right?

We are going to do better – save and invest. 

First what we need is a planner. As the above system of checking account and credit card gets working in a flow, you will start getting an idea of how much you are spending every month.

For the next 2-3 months, track your spending to categorize your money into only 4 parts.

  • Food and Dining
  • Utilities and Transportation
  • Clothing and miscellaneous
  • Surplus

You will automatically get motivated to squeeze the first 3 categories and increase your surplus every month. 

Check out this post on how to budget: Budget – Grow the tree upside-down

The above technique will help you generate surplus for both savings and investment, make it your goal to only increase it and not fall back to paycheck to paycheck cycle.

Savings Account

There are unexpected events or expenses that will always come up. You need to be prepared for it and the only way is to build up a cash cushion.

One essential comfort zone

This is similar to Dave Ramsey’s first 3 baby steps, where you start with saving $1000, then get out of debt (hopefully you have none if you started with this) and finally build a cushion of 3-6 months of expenses.

I use an online savings account like CapitalOne 360, Ally Bank or Synchrony. There are many others, and online banks provide little more interest on your deposits than brick-and-mortar banks, or the one where you have your checking account.

Setup an automatic transfer of your Surplus from your checking account to this Savings account. Set this up for beginning of the month, so that your budget works with just the right amount needed (to pay off the credit card at end of month). 

Investment Account

Get to this step only when you have a running budget, able to generate surplus consistently and stacked up 3-6 months of expenses in your savings account.

From here on, you become a pro in personal finance as you are about to invest and grow your net worth. 

There are two main investment accounts, a retirement account and brokerage account.

Contact your employer for a 401k (Pretax or Roth) account and contribute to it, if there is a match. If this exhausts your projected surplus, no worries you have got started.

If there is still surplus, good news. Open a brokerage account in one of Schwab, Vanguard or Fidelity. Preferably open a Roth IRA account if your income is within eligible limits.

Roth IRA rules

Then invest in one or two broad index funds with very low expense ratio (< 0.05).

Here is a classic 3-fund portfolio from Vanguard index funds.

  • Vanguard Total Stock Market Index Fund (VTSAX)
  • Vanguard Total International Stock Index Fund (VTIAX)
  • Vanguard Total Bond Market Fund (VBTLX)

Similar portfolio can be constructed from Schwab Funds too.

https://www.wallstreetphysician.com/three-fund-portfolio-using-schwab-index-funds-etfs

Managing and growing the investments

You have done a great job in the above steps and at par with average disciplined investors.

In investment world, “average” is what wins. If you get average returns of 8-9% over a very long time (decades), there is nothing more you need to do. 

To know how to structure and maintain your investment accounts, read this blog post

Investing in the High Five portfolio

Conclusion

The above is a simple 5-step process to take you from a personal finance newbie to a disciplined investor and saver. Taking action in a systematic way is the key to financial bliss.

If you need motivation to get started, read this:

Shun that perfection

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Posted in Personal finance

Shun that perfection

One of the lessons we learn in our early childhood is to be perfect in whatever we do. We were told if you are not perfect, you will not be able to compete in the real world. 

While it may be true for some disciplines like music, medicine and mathematics (the only subject in our times in which we could score a perfect 100/100), personal finance needs an opposite attribute.

There is nothing perfect about investments, budget and savings.

Things change rapidly like the stock markets fall when a leader in some nation sneezes, or unexpected events in life happen.

While the perfectionists among us keep waiting for the sun, moon and the earth to align to begin to invest or budget. Some of the common quotes which I am guilty of uttering at many times in my financial life.

“I will invest once I get the next raise” – when and who guarantees that today?

“I will save from next fiscal year” – hello, which fiscal year and which month does it start?

“I am too scared as the markets are going down”  – which means I will invest when they are up, exactly at the wrong time.

The end result is that the perfectionist gets a perfect ZERO in his/her investment and savings goal. 

You have to unlearn the perfections and not apply them at all in personal finance.

What is important is to get started and be consistent. 

Anyone who has not yet started or planned own finances should do this in below 3 steps.

  1. Budget – Keep it simple by following the methods described in : Budget – Grow the tree upside-down
  2. Invest – Slowly build the 5 account portfolio. Start today with at least one of the accounts : Investing in the High Five portfolio
  3. Save – Save for your important goals even if you allocate just $50 to one goal today : One essential comfort zone

Perfect plan? Now execute it imperfectly by just getting started.

Write one goal each of budgeting, saving and investing for this week. 

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