Credit: A Building Block for Building Wealth

 

I recently participated in an Experian #creditchat titled Building Wealth, Not Just Credit: How Credit Fits into Long-Term Financial Success. Its purpose was to explore how credit can be used as a building block for wealth accumulation over time.

Below are the seven questions that were asked and my responses:

What does “building wealth” mean to you, and how does credit play a role in that journey?

Building wealth means gradually increasing your net worth over time by increasing assets, reducing debts, or both. Wealth-building is slow in your 20s/30s but is impressive as investments grow. A good analogy is the progression of prizes on the Who Wants to Be a Millionaire? game show.

 

When you think about credit beyond approval/denial, what role does it play in long-term wealth creation?

Credit provides leverage to use OPM (other people’s money) to buy appreciating assets. Case Example #1: A mortgage. Most people need to borrow money to buy a home that increases in value over time. Case Example #2: Student loans to build human capital to earn a good income.

 

What’s are common myths about credit that actually holds people back financially?

Myth: “Checking my credit score hurts it.” Checking your own credit is a soft inquiry and doesn’t affect your score at all. Not checking your credit history can let errors linger for years. Myth: “I should avoid credit cards entirely.” Actually, avoiding them can hurt your credit history. Responsible use (small charges, paid in full) builds a positive track record.

 

What role does financial education play in helping consumers use credit as a wealth-building tool?

A substantial body of research shows that financial knowledge and skills influence financial decisions that help shape wealth outcomes. Examples of financial education impact include higher credit scores, fewer defaults, and higher savings

 

How can building credit early impact financial success later in life?

Good credit helps people qualify for loans and perhaps a job and lower insurance premiums. Also, it is difficult to travel for business without a credit card, which could hinder your career. Finally, lower interest associated with good credit can save tens or even hundreds of thousands of dollars over time

 

How can having access to credit at the right time influence wealth-building opportunities?

Many wealth-building opportunities are time-sensitive. Credit allows people to act when opportunities appear. Also, credit can accelerate compound interest. The earlier someone acquires an appreciating asset, the longer it has to grow.

 

What is one piece of advice about handling credit for your younger self?

Build a positive credit history by making payments on time and in full and keeping balances low.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Steps to Living a Risk-Reduced Life

 

Health and wealth are key resources for a happy and successful life. People in poor health often die young and spend money that could have been invested on health care costs. 

On the other hand, those who practice recommended health behaviors are more likely to exceed average life expectancy and need a nest egg large enough to insure that they don’t outlive their assets.

Poor health and financial outcomes are often couched in vague risk-based terms such as “you are at increased risk for” (heart disease, cancer, outliving your assets, etc.). People see “you’re at increased risk for” warnings and tune them out. Why? Risk warnings are rarely personalized.  We are told that we are “at risk for’ so many things that many people simply “freeze” and do nothing.

While nobody can live a risk-free life, everyone can take actions to limit the amount of risk we are exposed to. These strategies are often shaped by life experiences and expert recommendations. Below are 20 risk-reduction strategies that I personally use.

Car Parking- I park my car on the outer edges of parking lots to avoid getting scratches and dents and for exercise.

Credit Cards- Nobody takes my credit card so I pay cash at restaurants without a cash register. Privacy trumps points.

Decision Rules- I avoid answering phone calls from unknown callers and let them go to voicemail.

Debit Card- I have never had one to reduce the risk of someone wiping out my checking account.

Diet- Since having breast cancer, I’ve been a pescatarian and drink less than one drink a week.

Drive Bys- My husband and I do test drives together to find destinations that one of us has to drive to alone.

Driving- I stay home or wait out heavy rain storms to avoid accidents while driving in bad weather.

Fitness- I typically walk 10,000 steps per day and have never smoked or used illegal drugs.

Hand Washing- I wash my hands frequently to avoid the risk of a cold, flu, COVID, etc.

Income Taxes- I use IRS safe harbor rules to avoid the risk of owing an underwithholding penalty.

Index Funds- I invest in a low expense total stock market index fund to track market returns.

Mail Use- I avoid mailing things and instead use automated payments and online bill pay.

Mask Use- I wear a mask in crowds, in airports, and on planes (same reason as hand-washing).

Leave It Alone- If something is not broken or absolutely necessary, I typically don’t fix it.

Screening Exams and Vaccinations- I do these to reduce the risk of bad health outcomes.

Smart Car Features- I drive a car with a back-up camera and alerts when you are backing up and getting close to things.

Solopreneurship- Earnings from my company are a supplement to guaranteed sources of income.

Stress- I avoid stressful events that I have no control over, including potentially difficult clients.

Text Alerts and Secondary Email Addresses- I want to be alerted about bank and credit card account transactions.

Uniball Gel Pens- When I do use checks, I use pens with special ink to reduce the risk of check washing.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Middle-Income Earners Can Be Millionaires

Many people think you need to earn a high salary (e.g., $100,000+) to become a millionaire. In reality, many people of ordinary means (i.e., middle-income earners like teachers and police) become wealthy over time and achieve a net worth (assets minus debts) of $1million or more.

A key factor in their success is financial capability, which includes financial knowledge, decision-making skills, and habits. Below are nine things to know about "middle-income millionaires":

Planning is Key- Research has found that saving with a plan makes people two times more likely to reach their goals. Having a motivation to save also matters. One study found that emergency fund and retirement saving motives significantly increase the likelihood of saving regularly.

Slow Starts Are OK- A negative net worth (debts-like student loans-greater than assets) is not uncommon when young adults are in college. What matters is that proactive action is taken afterward to increase savings and reduce debt so that a positive net worth steadily grows.

Decisions Matter- Wealth and net worth are determined largely by decisions that people make about money (e.g., saving 10% of pay in a 401(k) plan). Two people with the same income, or two siblings raised by the same parents, can have very different financial paths and net worths.

Education Matters- One study found that 88% of millionaires graduated from college and 52% have a master’s, doctoral, or professional degree. One reason is that average salaries rise with higher levels of education. In addition, people tend to marry spouses with similar characteristics.

Automation is Key- One of the best “one and done” financial decisions that someone can make to build wealth over time is to set aside money automatically from each paycheck (or net income from self-employment) for retirement or other financial goals. Payroll deductions for defined contribution plans, like 401(k)s, make adhering to advice to “pay your first” automatic.

Wealth-Building Needs Protection- It is important not to overlook the role of insurance as a wealth-building tool. A growing nest egg can quickly be depleted if a family breadwinner dies or is disabled or a major illness or property damage or a large liability judgment occurs.

Backstops Can Mitigate Risk-Taking- Some investors feel that they can take on more investment risk when they have a guaranteed source of income (think tenured educators or retirees with a pension and/or annuities). Similarly, if one spouse in a couple has a stable income, the other spouse may decide to take a chance with entrepreneurship or by earning a degree.

Investment Expenses Are a Drag- Successful wealth accumulators avoid high expense ratios and front- and back-end loads (commissions) on mutual funds and costly annuities with high surrender and mortality & expense charges. Expenses are a drag on the performance of an investment. The second most important factor affecting investment portfolio returns, after asset allocation, is fees.

Knowledge is Power- Wealth-building is enhanced with financial knowledge (e.g., investment risks and characteristics) and skills (e.g., budgeting). A good rule to follow to build financial knowledge is to learn one new thing every day about personal finance (e.g., blogs, podcasts, newspapers, etc.).

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

Are You Wealthy?

The words “wealth” and “wealth management” are used frequently in advertisements for financial products (e.g., exchange-traded funds or ETFs and cryptocurrency) and financial services (e.g., specific investment advisory firms). This begs the questions “what, exactly, is wealth?” and “how do people know when they, themselves, are wealthy?” 

One online dictionary defines wealth as “an abundance of valuable possessions or money.” Another states that wealth is “plentiful supplies of particular resources” and notes that wealth can be held by individuals, communities, and countries. 

Other sources describe different categories of wealth including financial wealth (income and assets), time wealth (freedom), social wealth (strong relationships and social capital), and physical wealth (good physical and mental health). 

The remainder of this post will focus on financial wealth, specifically three ways to measure it to provide an answer the second question, above. Specifically, three wealth-measurement metrics will be explored and explained.

 

Net Worth Calculation

 

A common way to measure wealth is with a net worth statement. Net worth is calculated by subtracting debts from assets.  For example, $200,000 of assets minus $100,000 of debt equals a net worth of $100,000.

Three categories of assets are cash assets (e.g., bank accounts, money market funds, and certificates of deposit), investment assets (e.g., stocks, bonds, mutual funds, and ETFs), and property assets (e.g., house, car, home furnishings, and electronics). Two categories of debt are current debts (e.g., medical bills, credit card balances, and other debts expected to be repaid within a year) and long-term debts (e.g., car loans, student loans, and mortgages).

A good financial goal to strive for is to increase net worth by at least 5% a year through increased savings and/or reduced debt. Use the Net Worth Calculation Spreadsheet (in Excel) or this “paper and pencil” print worksheet to keep track of your progress. Some people also set specific net worth attainment goals such as $1 million before retirement.

 

The “Wealth Test”

 

In the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko, the authors outline a simple “How to Determine If You’re Wealthy” formula to determine the adequacy of a person’s net worth at any point in life. The formula works as follows: multiply your age times your realized pretax annual income from all sources, excluding inheritances, and divide it by 10.

For example, a couple, both age 50, with a combined annual income of $80,000 should have a net worth of $400,000, calculated as follows: 50 x $80,000 = $4,000,000 ÷ 10 = $400,000. 

The authors state that the figure derived from the formula is what the minimum net worth should be for a particular age and income combination. The more people exceed their formula-based figure, the better.

 

Online Calculators

 

A third metric for wealth considers, not only an individual’s or couple’s age and income, but where they live. After all, there is big difference in living costs between, say, Manhattan, Kansas and Manhattan, NYC.

 

The New York Times What Percent Are You? tool asks users to enter a household income. Then they click “Go” and results indicate where they place, income-wise, in percentile among U.S. residents. For example, household incomes of $30,000, $50,000, 100,000, and $200,000 are in the bottom 29%, bottom 49%, top 21%, and top 5% of incomes, respectively. Users can also hover over the U.S. map to get household income rankings for over 300 metro areas.

 

Another interesting calculator is Wealthometer, where users compare their estimate of the percentage of Americans with less wealth than they have. Users enter numbers for real assets, financial assets, and debt (ideally taken from a current net worth statement) and the number of household members. Results are presented in a bar graph showing the position of the user’s estimate of their comparative wealth with their actual position based on government wealth data.

 

What Not to Do

Some people judge their wealth in comparison to neighbors with expensive cars, clothes, and houses. This is a mistake. The neighbors could be in over their head in debt or, as Stanley and Danko describe in their book “ Big Hat, No Cattle.”

The best way to measure financial wealth is with objective metrics and to always remember that net worth ≠ self-worth.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

How to Cut Health Care Costs

With high inflation currently, many families are closely examining their expenses. One category is health care, which takes a big chunk out of family budgets. This includes expenses for health insurance as well as deductibles, copayments, and coinsurance when medical bills occur. Costs can add up to many thousands of dollars annually.

In 2018, the average American household spent almost $5,000 per person on health care. What to do? Fight back as best you can by controlling any potential health care costs that you can. Consider these 11 money-saving tips:

¨     Ask About Health Care Costs- Request a ballpark price quote. According to an article in the Wall Street Journal, inquiring about costs and mentioning financial concerns may be enough to prompt your doctor to recommend a less expensive treatment or to simply monitor a condition “to see if it gets better on its own.”

¨     Negotiate Drug Costs- Ask questions. The above article also recommends discussing financial considerations about prescription drugs with your doctor. This can lead to receiving a supply of free drug samples that the doctor has on hand and/or a prescription for less expensive generic drugs (see below).

¨     Buy Generic Drugs- Ask your doctor or pharmacist if required prescription drugs are available as less expensive generic drugs. Generic drug savings can average hundreds of dollars over the course of a year. Also make sure that prescribed drugs are on your health care plan’s formulary (i.e., list of covered drugs).

¨     Compare Costs- Call around for prices to compare costs for diagnostic services (e.g., CT scan or bone density test) and lab work. The cost of a single procedure could vary by hundreds, even thousands, of dollars. Hospitals often charge higher prices than free-standing radiology providers and other medical service providers. Use the billing code from your doctor for an “apples to apples” comparison.

¨     Find an App- Use an app to get information about the cost of various medical procedures for people with different types of insurance in different parts of the country. Examples include New Choice Health and Fair Health. Be sure to read their underlying assumptions. New Choice Health, for example, provides a Great Price, Fair Price, and Expensive Price for procedures as well as a list of local service providers and their price range.

¨     Focus on Prevention- Practice good health habits that reduce the risk of costly medical problems. Examples include regular health screening exams (e.g., colonoscopies and mammograms), nutritious food, exercise, washing hands frequently, and flossing teeth.

¨     Get Prescription Deals- Order a 90-day supply by mail instead of buying a 30-day supply from a local pharmacy. The savings are generally 15% to 35% on monthly copayments. Another good way to save on prescription drug costs is to use a website/app like GoodRx and WeRx to search local pharmacy prices and apply available coupons and discounts.

¨     Try to Negotiate Discounts- Ask for a price break if you pay with cash when you are responsible for all or part of a medical bill (e.g., services from an out-of-network provider). Cash payments save a doctor or hospital the processing fee on credit cards. Sometimes, the cash payment may be lower than what insurance provides.

¨     Follow Health Insurance Rules- Read the “fine print” in your health insurance policy regarding referrals to specialists and pre-certification for medical procedures. Not knowing the rules for your health plan can result in denial of coverage for a claim.

¨     Use Free Health Care Services- Take advantage of free or low-cost community health fairs, well-child clinics, flu shots, gyms, and other health and medical services available at your workplace or in your community. Do the same thing for services, such as free rabies clinics, for pets.

¨     Check for Billing Errors- Request an itemized statement of your medical procedures and their costs and review it for errors. Report errors to the service provider promptly and request a revised billing statement. It is estimated that 80% of all medical bills contain errors, often due to incorrect billing codes.