Ten Indicators of Financial Stress

President Calvin Coolidge once said “There is no independence quite so important as living within your means.” Unfortunately, debt problems often creep up on people gradually until they get to a point where it is difficult to make even minimum payments on credit cards.

Therefore, it is useful to have a list of “red flags” of debt problems to use as a reference point. 

Below is a list of ten common financial stress indicators that debtors often experience:

¨     Dipping into savings to pay debts and/or routine household bills

¨     Having household expenses and/or debts grow faster than income

¨     Taking out new loans before previous loans are repaid

¨     Charging more each month than the amount made in debt repayments

¨     “Juggling” the payment of bills from month to month

¨     Using a checking account overdraft or credit card cash advance to pay expenses’

¨     Having late fees assessed on loan and credit card payments

¨     Using credit for items that used to be purchased with cash

¨     Having a consumer debt-to- income ratio (total of monthly consumer debt payments divided by monthly take-home pay) of 20% or above

¨     Having negative information (e.g., late payments, judgments, and collections) in a credit report

If one or more of the above situations are happening to you, reach out for help. Contact creditors to request payment concessions or a non-profit credit-counseling agency that can help you draft a “livable” budget and negotiate with creditors on your behalf.

Most importantly, do not try to “borrow your way out of debt;” it simply cannot be done. In addition, do not ignore a growing debt problem and the ten financial stress indicators listed above. Like untreated cancer, debt problems will only continue to get worse and take over your life.

Take-Aways from FPA

Last week, I attended the 2019 Financial Planning Association (FPA) conference which contained inspirational messages and personal finance updates for financial advisors. Below are six key take-aways for consumers:

¨     Prepare Yourself to Succeed- Preparation is how people get things done. It provides a sense of control. Being prepared will give you the greatest opportunity to achieve whatever you want to do in life. Luck happens when preparation and planning meet opportunity.

¨     Consider a New Word- Many people don’t relate to the word “retirement,” at least the vision of it with 100% leisure time. People may retire from long-time careers, but they don’t retire from life. The word “retire” is derived from a French word meaning “to retreat.” Possible replacement terms for it include “rewirement,” “refirement,” “renaissance,” “reinvention,” and FIND (Financial Independence, New Directions).

¨     Live Inspired- Live the life now for how you want to be remembered and as if every day is September 12, 2001, when people hugged their families close and vowed not to take their lives for granted. Every day is a gift. Actively seek to experience “Elijah moments” where you can change the lives of others for the better.

¨     Be Realistic About Work in Later Life- About 80% of workers say they will work in retirement but only 25% actually do. Thus, retirement often happens sooner than expected. An award-winning research study found that, after age 61, people retire about a half year early for each year of work planned afterward.

¨     Avoid Financial Stress - Heart attacks are the #1 cause of death in the U.S. Financial worries raise the risk of heart attacks 13 times. Heart attacks are also associated with stock market drops. Conversely, philanthropy is positively associated with longevity. People who make charitable gifts live 2 to 5 years longer than others.

¨     Start Investing- Most Americans are not investors in any meaningful way. Two common barriers are difficulty understanding investment terminology and not having any money. People also believe that the stock market is more risky than it actually is. Good habits make a difference. Start small with any amount of money.

Ten Key Personal Finance Recommendations for College Students

I recently guest lectured about personal finance for a class of non-finance majors at Rutgers University. Below are ten key “evergreen” recommendations that I shared with the students:

Develop a Spending Plan (Budget)- Tweak income and expense numbers until positive cash flow is achieved. Include savings for future financial goals and/or emergencies as a “fixed expense.” Use apps like mint.com to keep track of spending.

Don’t Spend What You Don’t Have- Avoid costly debt by living below your means. Shop inexpensively for clothing and home furnishings at thrift shops and look for “deals” with online coupons and promo codes.

Pay Yourself First- Save early and often and do it automatically, if possible, through an employer-based credit union or tax-deferred retirement savings plan. If your employer matches your savings, save at least the maximum match amount.

Appreciate the Awesome Power of Compound Interest- Compound interest is your BFF if you are investing money and building wealth over time. It is your worst enemy if you are making minimum payments on credit cards and paying interest.

Make the Most of a Precious Resource: Time- Save for multiple financial goals concurrently, instead of sequentially, so that retirement savings begins in your 20s instead of waiting until after you pay off student loans and/or buy a house.

Protect Your Identity- Shred documents with sensitive personal identification information (e.g., bank and credit card account numbers), keep credit and debit cards in sight at all times, and limit the amount of personal data that is shared online.

Build an Emergency Fund- Try to save 3 to 6 months expenses, even if it takes several years to build up to this amount. In the meantime, any savings for emergencies is better than none.

Keep Track of Your Net Worth- Calculate your net worth (assets minus debts) regularly. It is not uncommon for students with college loans to have a negative net worth. Over time, it will increase with regular savings and debt repayment.

Write Down Your Financial Goals- Include an estimated cost (e.g., $8,000 for a “new used” car) and a time deadline (e.g., December, 2021). Then “do the math” to calculate the savings required each month or pay period.

Never Stop Learning About Personal Finance- Devote at least 15 minutes a day, or longer on weekends, to learning something new about money management. Information sources include web sites, Twitter chats, seminars, and mass media.

Five Important Credit Concepts

I just finished several lectures about credit for my Rutgers University class. Understanding the wise use of credit does not have to be difficult. While there are many credit-related terms such as APR, debt-to-income ratio, and FICO score, there are only a handful of “evergreen” credit concepts. Below are five things that everyone needs to know about credit:

¨      Credit Is OPM (Other People’s Money)-When people use credit, they are earmarking their future income to pay for today’s spending. A 20% debt-to-income ratio effectively means that one day’s pay is already “spoken for.”

¨      People Spend More Money with Plastic- When people swipe a credit (or debit) card, they are disconnected from the “loss” they feel when they take cash out of their wallet to pay for something on the spot. Using credit “hurts” less.

¨      Lower Monthly Payments Come with a Cost- When people make lower monthly payments by stretching out the time to repay a loan (e.g., a 5-year car loan vs. a 3-year loan), they pay more interest over the life of the loan. Other common ways that people lower monthly payments are interest-only loans and paying the minimum payment due on credit cards.

¨      Your Credit Past is Your Credit Future- When people use credit, their payment history is their “financial reputation” and shapes future opportunities such as new loans, the interest rate charged on loans, auto insurance premiums, and rental housing options. More than a third (35%) of a FICO credit score is based on past debt repayment history.

¨      High-Risk Borrowers Pay More for Credit- When people have a credit score lower than the mid 700s (depending on a lender’s risk criteria), they pay more for credit than “prime” borrowers and are offered fewer credit-related opportunities. Risk-based pricing by lenders mean that a low credit score costs extra. Often, lenders use tiered interest rates and will not quote an interest rate on a loan until they’ve examined a prospective borrower’s credit history.

Financial Planning Tips for Retirement

One of the most significant financial transitions in a person’s life is the decision to retire. When it comes to retirement planning, there are no “one size fits all” solutions. A lot depends on a person’s goals (e.g., traveling and hobbies), and lifestyle decisions (e.g., where to live and whether to work), as well as available resources such as an employer pension. Other important factors to consider are health status, inflation, and family responsibilities (e.g., caring for aging parents).

Some people can live happily on half of their pre-retirement income while others require 100% (or more!). For many people, 70% to 80% of the amount earned prior to retirement is a realistic income replacement percentage. Inflation will increase expenses over time, however. Therefore, a reasonable annual inflation rate should be factored into retirement savings calculations. Below are six retirement planning tips to consider:

¨      Understand the 4% Rule- One frequently cited guideline is to withdraw 4% of retirement savings annually and adjust it for inflation. Extending the 4% rule, someone should save $300,000 for every $1,000 monthly withdrawal needed in retirement ($300,000 x .04 = $12,000/year or $1,000/month). This guideline assumes at least 50% of a portfolio in stock.

¨      Prepare a Retirement Budget- Track current living expenses for several months. Then identify those that will end or decrease in retirement (e.g., commuting costs and mortgage payments) and those that are likely to increase (e.g., travel, medical and dental expenses, and health insurance premiums).

 

¨      Prepare for Non-financial Aspects of Retirement- Consider the three pillars of retirement life: leisure activities, work, and volunteerism. Experts caution against retiring without giving thought to the type of lifestyle desired and activities that will fill the time that a job once occupied. A successful retirement requires much more than money.

¨      Calculate a Retirement Savings Goal- Use an online calculator like the Ballpark Estimate. Five key variables in retirement savings calculations are: age at retirement, amount of annual income needed (as a percentage of pre-retirement income), growth rate on savings, estimated life expectancy, and amount of money currently saved.

 

¨      Get Help- Check out retirement planning worksheets and online calculators. Monte Carlo analysis is a simulation of possible investment outcomes used to predict the likelihood of sustaining a certain withdrawal rate for, say, 30 years.

 

¨      Take Action- Enroll in an employer retirement savings plan and save as much as possible. Start small, if necessary, and gradually increase the amount of money saved, especially when income increases or a household expense ends.