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    Personal Finance For Dummies
    Personal Finance For Dummies
    Personal Finance For Dummies
    Ebook710 pages11 hours

    Personal Finance For Dummies

    By Eric Tyson

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    About this ebook

    The proven guide to taking control of your finances

    The bestselling Personal Finance For Dummies has helpedcountless readers budget their funds successfully, rein in debt,and build a strong foundation for the future. Now, renownedfinancial counselor Eric Tyson combines his time-tested financialadvice along with updates to his strategies that reflect changingeconomic conditions, giving you a better-than-ever guide to takingan honest look at your current financial health and settingrealistic goals for the future.

    Inside, you'll find techniques for tracking expenditures,reducing spending, and getting out from under the burden ofhigh-interest debt. Tyson explains the basics of investing in plainEnglish, as well as the risks, returns, and options for popularinvestment strategies. He also covers ways to save for college andspecial events, tame your taxes, and financially survive the twistsand turns that life delivers.

    • The bestselling, tried-and-true guide to taking control offinances, now updated to cover current economic conditions
    • Provides concrete, actionable advice for anyone facing greatfinancial hardship
    • Helps you avoid or get out of debt and budget funds moresuccessfully
    • Eric Tyson, MBA, is a nationally recognized personal financecounselor and the author of numerous For Dummies titles, includingHome Buying For Dummies, Investing For Dummies, andMutual Funds For Dummies, among others

    There's no need to stress over an uncertain economy — justread Personal Finance For Dummies and protect your financialfuture!

    LanguageEnglish
    PublisherWiley
    Release dateMay 30, 2012
    ISBN9781118238172
    Author

    Eric Tyson

    Eric Tyson, MBA, is a financial counselor, syndicated columnist, and the author of bestselling For Dummies books on personal finance, taxes, home buying, and mutual funds including Real Estate Investing For Dummies.

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    Reviews for Personal Finance For Dummies

    4/5

    34 ratings8 reviews

    What our readers think

    Readers find this title to be a worthwhile read with great tips and advice. However, some readers feel that it is too heavily focused on the USA and may not be as helpful for readers from different countries. Overall, it is considered a must-read for anyone interested in keeping their finances in order and building wealth.

    What did you think?

    Tap to rate

    Review must be at least 10 words

    • 5/5
      gives you an insight in personal finance , doesn't help much for different countries financial systems. As it was written keeping american finance system in mind
    • 5/5
      Happiness comes when your credit scores is in equilibrium with your life style. Firstly, I'm thankful to the article I bashed into lately, that led me to Trovian Credit Repair, they are professional in fixing credit, they did a wonderful job on my credit score after many years of having bad credit profile. I finally got it fixed from 556 to 805. They are trustworthy, reliable and can handle all credit related issues, please give a try, and thank me later. [email protected].
    • 5/5
      Definitely a must read for everyone interested in keep their finances in order and building wealth! My generation, the millennials, need to read this!
    • 4/5
      Full of great tips and advice, but too heavily focused on the USA in terms of tax, retirement info and recommended companies. Still found it a worthwhile read and gave me useful advice overall.
    • 5/5
      Wonderful book!!!
    • 5/5
      For someone who has their personal finances in order, this will be a boring and basic book. For someone who is just figuring out how to manage their finances, this is a great book. I read this book when I was feeling weighed down by our finances and debt. This book helped me think systematically about what we were doing with our finances, helped refine a plan to retire all our debt, and convinced me the need to save and invest for the future. Since I read this book, I have read a number of other books about personal finance and investing. While several of these books gave me a deeper understanding of the topics, not have contradicted what I learned in this book. Personal Finance for Dummies has all the advice I would hope a parent would pass onto their children about money. Unfortunately, a lot of parents don't know many of the things found in this book or don't think to teach their children how to effectively manage their money.

      2 people found this helpful

    • 4/5
      Eric Tyson has written a great intro to personal finances. This book covers basic financial information such as savings and investing, as well as in depth information on taxes, insurance and debt reduction. Tyson's tone is very conversational and not preachy at all, which makes for an enjoyable read. I think it is a must read for young people even if you think you know all there is to know about money. I didn't expect to learn a lot of new stuff and still I ended up with some useful tips that I will definitely apply to my financial life.

      1 person found this helpful

    • 2/5
      This is an adequate "starting out" type finance book. If you already have $$ though it isn't that useful. A little to skewed towards starting your own business.

    Book preview

    Personal Finance For Dummies - Eric Tyson

    Part I

    Assessing Your Financial Fitness and Setting Goals

    9781118117859-pp0101.eps

    In this part . . .

    I discuss the concepts that underlie sensible personal financial management. You find out why you didn’t know all these concepts before now (and whom to blame). Here, you undergo a (gentle) financial physical exam to diagnose your current fiscal health, and I show you how to identify where your hard-earned dollars are going. I also cover understanding and improving your credit report and scores and how to plan for and accomplish your financial goals.

    Chapter 1

    Improving Your Financial Literacy

    In This Chapter

    arrow Looking at what your parents and others taught you about money

    arrow Questioning reliability and objectivity

    arrow Overcoming real and imagined barriers to financial success

    A recent Center for Economic and Entrepreneurial Literacy (CEEL) financial literacy survey showed that Americans lack basic math and personal finance skills. The national survey, conducted just before the holiday shopping season, found that an overwhelming number of Americans are unable to answer basic financial literacy questions. For example, the survey results revealed the following:

    check.png Sixty-five percent answered incorrectly when asked how many reindeer would remain if Santa had to lay off 25 percent of his eight reindeer because of the bad economy.

    check.png Seventy-five percent of people thought that it would take 15 years or less to pay off $5,000 in Christmas presents if they made the minimum payment on their credit card. In reality, it would take 46 years to pay off those holiday expenses!

    check.png One in three people didn’t know how much money a person would be spending on gifts if they spent 1 percent of their $50,000-per-year salary.

    Sixteen percent of respondents admitted that they didn’t expect to have their holiday debt paid off by the following March. I was tickled to see in CEEL’s press release its antidote to dealing with gaps in personal financial knowledge: "Santa would be well advised to leave Personal Finance For Dummies in stockings across the country, said James Bowers, CEEL’s managing director. Many Americans don’t even have the basic math skills required to balance their checkbooks; forget about understanding complicated mortgages or credit-card statements."

    Unfortunately, most Americans don’t know how to manage their personal finances because they were never taught how to do so. Their parents may have avoided discussing money in front of them, and most high schools and colleges lack courses that teach this vital, lifelong-needed skill.

    remember.eps Some people are fortunate enough to learn the financial keys to success at home, from knowledgeable friends, and from the best expert-written books like this one. Others either never discover important personal finance concepts, or they learn them the hard way — by making lots of costly mistakes. People who lack knowledge make more mistakes, and the more financial errors you commit, the more money passes through your hands and out of your life. In addition to the enormous financial costs, you experience the emotional toll of not feeling in control of your finances. Increased stress and anxiety go hand in hand with not mastering your money.

    This chapter examines where people learn about finances and helps you decide whether your current knowledge is helping you or holding you back. You can find out how to improve your financial literacy and take responsibility for your finances, putting you in charge and reducing your anxiety about money. After all, you have more important things to worry about, like what’s for dinner.

    Talking Money at Home

    I was fortunate — my parents taught me a lot of things that have been invaluable throughout my life, and among those things were sound principles for earning, spending, and saving money. My parents had to know how to do these things, because they were raising a family of three children on (usually) one modest income. They knew the importance of making the most of what you have and of passing that vital skill on to your kids.

    However, my parents’ financial knowledge did have some gaps. I observed firsthand the struggles my father endured handling some retirement money after being laid off from a job when I was in middle school. In subsequent years, this situation propelled me to learn about investing to help myself, my family, and others.

    warning_bomb.eps In many families money is a taboo subject — parents don’t level with their kids about the limitations, realities, and details of their budgets. Some parents I talk with believe that dealing with money is an adult issue and that children should be insulated from it so that they can enjoy being kids. In many families, kids hear about money only when disagreements and financial crises bubble to the surface. Thus begins the harmful cycle of children having negative associations with money and financial management.

    In other cases, parents with the best of intentions pass on their bad money-management habits. You may have learned from a parent, for example, to buy things to cheer yourself up. Or you may have witnessed a family member maniacally chasing get-rich-quick business and investment ideas. Now I’m not saying that you shouldn’t listen to your parents. But in the area of personal finance, as in any other area, poor family advice and modeling can be problematic.

    Think about where your parents learned about money management and then consider whether they had the time, energy, or inclination to research choices before making their decisions. For example, if they didn’t do enough research or had faulty information, your parents may mistakenly have thought that banks were the best places for investing money or that buying stocks was like going to Las Vegas. (You can find the best places to invest your money in Part III of this book.)

    Personal finance at school

    In schools, the main problem with personal finance education is the lack of classes, not that kids already know the information or that the skills are too complex for children to understand.

    Nancy Donovan teaches personal finance to her fifth-grade math class as a way to illustrate how math can be used in the real world. Students choose a career, find jobs, and figure out what their taxes and take-home paychecks will be. They also have to rent apartments and figure out a monthly budget, says Donovan. Students like it, and parents have commented to me how surprised they are by how much financial knowledge their kids can handle. Donovan also has her students invest $10,000 (play money) and then track the investments’ performance.

    Urging schools to teach the basics of personal finance is just common sense. Children need to be taught how to manage a household budget, the importance of saving money for future goals, and the consequences of overspending. Unfortunately, few schools offer classes like Donovan’s. In most cases, the financial basics aren’t taught at all.

    In the minority of schools that do offer a course remotely related to personal finance, the class is typically in economics (and an elective at that). Archaic theory is being taught, and it doesn’t do anything for the students as far as preparing them for the real world, says one high school principal I know. Having taken more than my fair share of economics courses in college, I understand the principal’s concerns.

    Some people argue that teaching children financial basics is the parents’ job. However, this well-meant sentiment is what we’re relying on now, and for all too many, it isn’t working. In some families, financial illiteracy is passed on from generation to generation.

    Education takes place in the home, on the streets, and in the schools. Therefore, schools must bear some responsibility for teaching this skill. However, if you’re raising children, remember that no one cares as much as you do or has as much ability to teach the important life skill of personal money management.

    In still other cases, the parents had the right approach, but the kids do the opposite out of rebellion. For example, if your parents spent money carefully and thoughtfully and at times made you feel denied, you may tend to do the opposite, buying yourself gifts the moment any extra money comes your way.

    Although you can’t change what the educational system and your parents did or didn’t teach you about personal finances, you now have the ability to find out what you need to know to manage your finances.

    tip.eps If you have children of your own, I’m sure you agree that kids really are amazing. Don’t underestimate their potential or send them out into the world without the skills they need to be productive and happy adults. Buy them some good financial books when they head off to college or begin their first job.

    Identifying Unreliable Sources of Information

    Most folks know that they’re not financial geniuses. So they set out to take control of their money matters by reading about personal finance or consulting a financial advisor.

    But reading and seeking advice to find out how to manage your money can be dangerous if you’re a novice. Misinformation can come from popular and seemingly reliable information sources, as I explain in the following sections. (Because the pitfalls are numerous and the challenges significant when choosing an advisor, I devote Chapter 18 to the financial planning business and tell you what you need to know to avoid being fooled.)

    Understanding the dangers of free financial content online

    In addition to being able to quickly access what we want, the other major attraction of the Internet is the abundance of seemingly free websites providing piles of free content. Appearances, however, can be greatly deceiving.

    While there are exceptions to any rule, the fact of the matter is that the vast majority of websites purporting to provide a seemingly never-ending array of free content are rife with conflicts of interest and quality problems due to the following:

    check.png Advertising: Any publication that accepts advertising has a potential conflict of interest because it may not want to publish articles that would upset its advertisers. Such a mindset, however, can stand in the way of telling consumers the unvarnished truth about various products and services. For example, auto leasing companies aren’t very interested in advertising someplace that publishes articles highlighting the negatives of leasing. (Check out the section Publishers pandering to advertisers later in this chapter for more on the power of advertising to influence the financial information you encounter online, on TV, and elsewhere.)

    check.png Advertorials: Too many website owners are unwilling or unable to pay real writers for quality content and instead publish articles that are provided and written by advertisers. These pieces of content are known as advertorials and, in the worst cases, aren’t even clearly labeled as advertisements, which is precisely what they are.

    check.png Affiliate relationships: Many companies now pay referral fees to websites that bring in new customers. Here’s how that practice causes major conflicts of interest. On a financial website, you read a glowing review of a particular financial product or service. And, the site provides a helpful link to the website of the provider of that product or service. Unbeknownst to you, when you click on that link and buy something, the seller kicks money back to the affiliate who reeled you in. At a minimum, such relationships should be clearly disclosed and detailed in any review.

    check.png Insufficient editorial oversight: At most established, quality print publications, there are usually several layers of editors who oversee the publication and all of its articles. This structure helps ensure the accuracy of what gets into print (although bias, such as political bias, isn’t necessarily controlled). Unfortunately, the shoestring budget on which many websites operate precludes these quality control checks and balances. Thus, sites operated by non-experts proffering advice place you at great risk.

    check.png Lack of accountability: In part because of a lack of editorial oversight, there’s also often a lack of accountability for advice given online. This situation is especially problematic on the numerous sites that are run without disclosure of who is actually in charge of the site and/or who is writing the articles. Although such anonymity may be helpful to the site and its content providers, it’s certainly not in your best interests because it prevents you from checking out the background, qualifications, and track record of the providers.

    Recognizing fake financial gurus

    Before you take financial advice from anyone, examine her background, including professional work experience and education credentials. This is true whether you’re getting advice from an advisor, writer, talk show host, or TV financial reporter.

    If you can’t easily find such information, that’s usually a red flag. People with something to hide or a lack of something redeeming to say about themselves usually don’t promote their background.

    Of course, just because someone seems to have a relatively impressive-sounding background doesn’t mean that she has your best interests in mind or has honestly presented her qualifications. Forbes magazine journalist William P. Barrett presented a sobering review of financial author Suze Orman’s stated credentials and qualifications:

    Besides books and other royalties, Orman’s earned income has come mainly from selling insurance — which gets much more attention in her book than do stocks or bonds. . . . The jacket of her video says she has ‘18 years of experience at major Wall Street institutions.’ In fact, she has 7.

    When the Forbes piece came out, Orman’s publicist tried to discredit it and made it sound as if the magazine had falsely criticized Orman. In response, the San Francisco Chronicle, which is the nearest major newspaper to Orman’s hometown, picked up on the Forbes piece and ran a story of its own — written by Mark Veverka in his Street Smarts column — which substantiated the Forbes story.

    Veverka went through the Forbes piece point by point and gave Orman’s company and the public relations firm numerous opportunities to provide information contrary to the piece, but they did not. Here’s some of what Veverka recounts from his contact with them:

    "If you want your side told, you have to return reporters’ telephone calls. But alas, no callback.

    ". . . Orman’s publicist said a written response to the Forbes piece and the ‘Street Smarts’ column would be sent by facsimile to the Chronicle. . . . However, no fax was ever sent. They blew me off. Twice.

    "In what was becoming an extraordinary effort to be fair, I placed more telephone calls over several days to Orman Financial and the publicist, asking for either an interview with Orman or an official response. If Orman didn’t fudge about her years on Wall Street or didn’t let her commodity-trading adviser license lapse, surely we could straighten all of this out, right?

    "Still, no answer. Nada . . . I called yet again. Finally, literally on deadline, a woman who identified herself as Orman’s ‘consultant’ called me to talk ‘off the record’ about the column. What she ended up doing was bashing the Forbes piece and my column but not for publication. More importantly, she offered no official retort to allegations made by veteran Forbes writer William Barrett. I have to say, it was an incredibly unprofessional attempt at spinning. And I’ve been spun by the worst of them."

    You can’t always accept stated credentials and qualifications at face value, because some people lie (witness the billions lost to hedge fund Ponzi-scheme-man Bernie Madoff, who was brought down in 2008). You can’t sniff out liars by the way they look, their resume, their gender, or their age. You can, however, increase your chances of being tipped off by being skeptical (and by regularly reading the Guru Watch section of my website at www.erictyson.com).

    beware_sailing.eps You can see a number of hucksters for what they are by using common sense in reviewing some of their outrageous claims. Some sources of advice, such as Wade Cook’s investment seminars, lure you in by promising outrageous returns. The stock market has generated average annual returns of about 10 percent over the long term. However, Cook, a former taxi driver, promoted his seminars as an alive, hands-on, do the deals, two-day intense course in making huge returns in the stock market. If you aren’t getting 20 percent per month, or 300-percent annualized returns on your investments, you need to be there. (I guess I do, as does every investment manager and individual investor I know!)

    Cook’s get-rich-quick seminars, which cost more than $6,000, were so successful at attracting people that his company went public in the late 1990s and generated annual revenues of more than $100 million. Cook’s techniques included trading in and out of stocks and options after short holding periods of weeks, days, or even hours. His trading strategies can best be described as techniques that are based upon technical analysis — that is, charting a stock’s price movements and volume history, and then making predictions based on those charts.

    remember.eps The perils of following an approach that advocates short-term trading with the allure of high profits are numerous:

    check.png You’ll rack up enormous brokerage commissions.

    check.png On occasions where your short-term trades produce a profit, you’ll pay high ordinary income tax rates rather than the far lower capital gains rate for investments held more than 12 months.

    check.png You won’t make big profits — quite the reverse. If you stick with this approach, you’ll underperform the market averages.

    check.png You’ll make yourself a nervous wreck. This type of trading is gambling, not investing. Get sucked up in it, and you’ll lose more than money — you may also lose the love and respect of your family and friends.

    If Cook’s followers were able to indeed earn the 300-percent annual returns his seminars claimed to help you achieve, any investor starting with just $10,000 would vault to the top of the list of the world’s wealthiest people (ahead of Bill Gates and Warren Buffett) in just 11 years!

    How some gurus become popular

    You may be wondering how Wade Cook became so popular despite the obvious flaws in his advice (see the section Recognizing fake financial gurus for the goods on Cook). He promoted his seminars through infomercials and other advertising, including radio ads on respected news stations. The high stock market returns of the 1990s brought greed back into fashion. (My experience has been that you see more of this greed near market tops.)

    The attorneys general of numerous states sued Cook’s company and sought millions of dollars in consumer refunds. The suits alleged that the company lied about its investment track record (not a big surprise — this company claimed that you’d make 300 percent per year in stocks!).

    Cook’s company settled the blizzard of state and Federal Trade Commission (FTC) lawsuits against his firm by agreeing to accurately disclose its trading record in future promotions and give refunds to customers who were misled by past inflated return claims. (That didn’t stop Cook, however, from getting into more legal hot water — he’s currently serving a seven-year prison term for failing to pay millions in personal income taxes.)

    According to a news report by Bloomberg News, Cook’s firm disclosed that it lost a whopping 89 percent of its own money trading during one year in which the stock market fared well. As Deb Bortner, director of the Washington State Securities Division and president of the North American Securities Administrators Association, observed, Either Wade is unable to follow his own system, which he claims is simple to follow, or the system doesn’t work.

    Don’t assume that someone with something to sell, who is getting good press and running lots of ads, will take care of you. That guru may just be good at press relations and self-promotion. Certainly, talk shows and the media at large can and do provide useful information on a variety of topics, but bad eggs sometimes turn up. These bad eggs may not always smell bad upfront. In fact, they may hoodwink people for years before finally being exposed. Please review Part V for the details on resources you can trust and those that could cause you to go bust!

    Publishers pandering to advertisers

    beware_sailing.eps Thousands of publications and media outlets — newspapers, magazines, websites, radio, TV, and so on — dole out personal financial advice and perspectives. Although many of these service providers collect revenue from subscribers, virtually all are dependent — in some cases, fully dependent (especially the Internet, radio, and TV) — on advertising dollars. Although advertising is a necessary part of capitalism, advertisers can taint and, in some cases, dictate the content of what you read, listen to, and view.

    Be sure to consider how dependent a publication or media outlet is on advertising. I find that free publications, radio, and TV are the ones that most often create conflicts of interest by pandering to advertisers. (All three derive all their revenue from advertising.)

    Much of what’s on the Internet is advertiser-driven, as well. Many of the investing sites on the Internet offer advice about individual stocks. Interestingly, such sites derive much of their revenue from online brokerage firms seeking to recruit customers who are foolish enough to believe that selecting their own stocks is the best way to invest. (See Part III for more information about your investment options.)

    As you read various publications, watch TV, or listen to the radio, note how consumer-oriented these media are. Do you get the feeling that they’re looking out for your interests? For example, if lots of auto manufacturers advertise, does the media outlet ever tell you how to save money when shopping for a car or the importance of buying a car within your means? Or are they primarily creating an advertiser-friendly broadcast or publication?

    Jumping over Real and Imaginary Hurdles to Financial Success

    Perhaps you know that you should live within your means, buy and hold sound investments for the long term, and secure proper insurance coverage; however, you can’t bring yourself to do these things. Everyone knows how difficult it is to break habits that have been practiced for many years. The temptation to spend money lurks everywhere you turn. Ads show attractive and popular people enjoying the fruits of their labors — a new car, an exotic vacation, and a lavish home.

    Maybe you felt deprived by your tightwad parents as a youngster, or maybe you’re bored with life and you like the adventure of buying new things. If only you could hit it big on one or two investments, you think, you could get rich quick and do what you really want with your life. As for disasters and catastrophes, well, those things happen to other people, not to you. Besides, you’ll probably have advance warning of pending problems, so you can prepare accordingly, right?

    Your emotions and temptations can get the better of you. Certainly, part of successfully managing your finances involves coming to terms with your shortcomings and the consequences of your behaviors. If you don’t, you may end up enslaved to a dead-end job so you can keep feeding your spending addiction. Or you may spend more time with your investments than you do with your family and friends. Or unexpected events may leave you reeling financially; disasters and catastrophes can happen to anyone at any time.

    Discovering what (or who) is holding you back

    A variety of personal and emotional hurdles can get in the way of making the best financial moves. As I discuss earlier in this chapter, a lack of financial knowledge (which stems from a lack of personal financial education) can stand in the way of making good decisions.

    But I’ve seen some people caught in the psychological trap of blaming something else for their financial problems. For example, some people believe that adult problems can be traced back to childhood and how they were raised.

    I don’t want to disregard the negative impact particular backgrounds can have on some people’s tendency to make the wrong choices during their lives. Exploring your personal history can certainly yield clues to what makes you tick. That said, adults make choices and engage in behaviors that affect themselves as well as others. They shouldn’t blame their parents for their own inability to plan for their financial futures, live within their means, and make sound investments.

    Some people also tend to blame their financial shortcomings on not earning more income. Such people believe that if only they earned more, their financial (and personal) problems would melt away. My experience working and speaking with people from diverse economic backgrounds has taught me that achieving financial success — and more importantly, personal happiness — has virtually nothing to do with how much income a person makes but rather with what she makes of what she has. I know financially wealthy people who are emotionally poor even though they have all the material goods they want. Likewise, I know people who are quite happy, content, and emotionally wealthy even though they’re struggling financially.

    Americans — even those who have not had an easy life — ought to be able to come up with numerous things to be happy about and grateful for: a family who loves them; friends who laugh at their stupid jokes; the freedom to catch a movie or play or to read a good book; a great singing voice, sense of humor, or a full head of hair.

    Developing good financial habits

    After you understand the basic concepts and know where to buy the best financial products when you need them, you’ll soon see that managing personal finances well is not much more difficult than other things you do regularly, like tying your shoelaces and getting to work each day.

    remember.eps Regardless of your income, you can make your dollars stretch further if you practice good financial habits and avoid mistakes. In fact, the lower your income, the more important it is that you make the most of your income and savings (because you don’t have the luxury of falling back on your next fat paycheck to bail you out).

    More and more industries are subject to global competition, so you need to be on your financial toes now more than ever. Job security is waning; layoffs and retraining for new jobs are increasing. Putting in 30 years for one company and retiring with the gold watch and lifetime pension are becoming as rare as never having problems with your computer.

    Speaking of company pensions, odds are increasing that you work for an employer that has you save toward your own retirement instead of providing a pension for you. Not only do you need to save the money, you must also decide how to invest it. Chapter 11 can help you get a handle on investing in retirement accounts.

    Personal finance involves much more than managing and investing money. It also includes making all the pieces of your financial life fit together; it means lifting yourself out of financial illiteracy. Like planning a vacation, managing your personal finances means forming a plan for making the best use of your limited time and dollars.

    remember.eps Intelligent personal financial strategies have little to do with your gender, ethnicity, or marital status. All people need to manage their finances wisely. Some aspects of financial management become more or less important at different points in your life, but for the most part, the principles remain the same for everyone.

    Knowing the right answers isn’t enough. You have to practice good financial habits just as you practice other good habits, such as brushing your teeth. Don’t be overwhelmed. As you read this book, make a short list of your financial marching orders and then start working away. Throughout this book, I highlight ways you can overcome temptations and keep control of your money rather than let your emotions and money rule you. (I discuss common financial problems in Chapter 2.)

    remember.eps What you do with your money is a quite personal and confidential matter. In this book, I try to provide guidance that can keep you in sound financial health. You don’t have to take it all — pick what works best for you and understand the pros and cons of your options. But from this day forward, please don’t make the easily avoidable mistakes or overlook the sound strategies that I discuss throughout this book.

    Throughout your journey, I hope to challenge and even change the way you think about money and about making important personal financial decisions — and sometimes even about the meaning of life. No, I’m not a philosopher, but I do know that money — for better but more often for worse — is connected to many other parts of our lives.

    Chapter 2

    Measuring Your Financial Health

    In This Chapter

    arrow Tallying your assets, liabilities, and your (financial) net worth

    arrow Requesting (and fixing) your credit reports

    arrow Making sense of your credit score

    arrow Understanding bad debt, good debt, and too much debt

    arrow Calculating your rate of savings

    arrow Assessing your investment and insurance know-how

    How financially healthy are you? When was the last time you took stock of your overall financial situation, including reviewing your spending, savings, future goals, and insurance? If you’re like most people, you’ve either never done this exercise or you did so too long ago.

    This chapter guides you through a financial physical to help you detect problems with your current financial health. But don’t dwell on your problems. View them for what they are — opportunities to improve your financial situation. In fact, the more areas you can identify that stand to benefit from improvement, the greater the potential you may have to build real wealth and accomplish your financial and personal goals.

    Avoiding Common Money Mistakes

    Financial problems, like many medical problems, are best detected early (clean living doesn’t hurt, either). Here are the common personal financial problems I’ve seen in my work as a financial counselor:

    check.png Not planning: Most of us procrastinate. That’s why we have deadlines (like April 15) — and deadline extensions (need another six months to get that tax return done?). Unfortunately, you may have no explicit deadlines with your personal finances. You can allow your credit-card debt to accumulate, or you can leave your savings sitting in lousy investments for years. You can pay higher taxes, leave gaps in your retirement and insurance coverage, and overpay for financial products. Of course, planning your finances isn’t as much fun as planning a vacation, but doing the former can help you take more of the latter. See Chapter 4 for details on setting financial goals.

    check.png Overspending: Simple arithmetic helps you determine that savings is the difference between what you earn and what you spend (assuming that you’re not spending more than you’re earning!). To increase your savings, you either have to work more, increase your earning power through education or job advancement, get to know a wealthy family who wants to leave its fortune to you, or spend less. For most people, especially over the short-term, the thrifty approach is the key to building savings and wealth. (Check out Chapter 3 for a primer on figuring out where your money goes; Chapter 6 gives advice for reducing your spending.)

    check.png Buying with consumer credit: Even with the benefit of today’s low interest rates, carrying a balance month-to-month on your credit card or buying a car on credit means that even more of your future earnings are going to be earmarked for debt repayment. Buying on credit encourages you to spend more than you can really afford. Chapter 5 discusses debt and credit problems.

    check.png Delaying saving for retirement: Most folks say that they want to retire by their mid-60s or sooner. But in order to accomplish this goal, they need to save a reasonable chunk (around 10 percent) of their incomes starting sooner rather than later. The longer you wait to start saving for retirement, the harder reaching your goal will be. And you’ll pay much more in taxes to boot if you don’t take advantage of the tax benefits of investing through particular retirement accounts. For information on planning for retirement, see Chapters 4 and 11.

    check.png Falling prey to financial sales pitches: Steer clear of people who pressure you to make decisions, promise you high investment returns, and lack the proper training and experience to help you. Great deals that can’t wait for a little reflection or a second opinion are often disasters waiting to happen. A sucker may be born every minute, but a slick salesperson is pitching something every second! For important investment concepts and what kinds of investments to avoid, turn to Chapter 8.

    check.png Not doing your homework: To get the best deal, shop around, read reviews, and get advice from objective third parties. You also need to check references and track records so that you don’t hire incompetent, self-serving, or fraudulent financial advisors. (For more on hiring financial planners, see Chapter 18.) But with all the different financial products available, making informed financial decisions has become an overwhelming task. I do a lot of the homework for you with the recommendations in this book. I also explain what additional research you need to do and how to do it.

    check.png Making decisions based on emotion: You’re most vulnerable to making the wrong moves financially after a major life change (a job loss or divorce, for example) or when you feel pressure. Maybe your investments plunged in value. Or perhaps a recent divorce has you fearing that you won’t be able to afford to retire when you planned, so you pour thousands of dollars into some newfangled financial product. Take your time and keep your emotions out of the picture. In Chapter 21, I discuss how to approach major life changes and determine what changes you may need to make to your financial picture.

    check.png Not separating the wheat from the chaff: In any field in which you’re not an expert, you run the danger of following the advice of someone you think is an expert but really isn’t. This book shows you how to separate the financial fluff from the financial facts. (Flip to Chapter 19 for information on how to evaluate financial advice online and Chapter 20 for how to evaluate financial coverage in the mass media.) You are the person who is best able to manage your personal finances. Educate and trust yourself!

    check.png Exposing yourself to catastrophic risk: You’re vulnerable if you and your family don’t have insurance to pay for financially devastating losses. People without a savings reserve and support network can end up homeless. Many people lack sufficient insurance coverage to replace their income. Don’t wait for a tragedy to strike to find out whether you have the right insurance coverage. Check out Part IV for more on insurance.

    check.png Focusing too much on money: Placing too much emphasis on making and saving money can warp your perspective on what’s important in life. Money is not the first — or even second — priority in happy people’s lives. Your health, relationships with family and friends, career satisfaction, and fulfilling interests are more significant.

    remember.eps Money problems can be fixed over time with changes in your behavior. That’s what the rest of this book is all about.

    Determining Your Financial Net Worth

    Your financial net worth is an important barometer of your monetary health. Your net worth indicates your capacity to accomplish major financial goals, such as buying a home, retiring, and withstanding unexpected expenses or loss of income.

    Your net worth is your financial assets minus your financial liabilities:

    Financial Assets – Financial Liabilities = Net Worth

    The following sections explain how to determine those numbers.

    Adding up your financial assets

    A financial asset is real money or an investment you can convert into your favorite currency that you can use to buy things now or in the future. Financial assets generally include the money you have in bank accounts, stocks, bonds, and mutual-fund accounts (see Part III, which deals with investments). Money that you have in retirement accounts (including those with your employer) and the value of any businesses or real estate that you own are also counted.

    tip.eps I generally recommend that you exclude your personal residence when figuring your financial assets. Include your home only if you expect to sell it someday or otherwise live off the money you now have tied up in it (perhaps by taking out a reverse mortgage, which I discuss in Chapter 14). If you plan on eventually tapping into the equity (the difference between the market value and any debt owed on the property), add that portion of the equity that you expect to use to your list of assets.

    Assets can also include your future expected Social Security benefits and pension payments (if your employer has such a plan). These assets are usually quoted in dollars per month rather than as a lump sum value. In Table 2-1, I explain how to account for these monthly benefits when tallying your financial assets.

    remember.eps Consumer items — such as your car, clothing, stereo, and so forth — do not count as financial assets. I know that adding these things to your assets makes your assets look larger (and some financial software and publications encourage you to list these items as assets), but you can’t live off them unless you sell them.

    Subtracting your financial liabilities

    To arrive at your financial net worth, you must subtract your financial liabilities from your assets. Liabilities include loans and debts outstanding, such as credit-card and auto-loan debts. When figuring your liabilities, include money you borrowed from family and friends — unless you’re not expected to pay it back!

    Include mortgage debt on your home as a liability only if you include the value of your home in your asset list. Be sure to also include debt owed on other real estate — no matter what (because you count the value of investment real estate as an asset).

    Crunching your numbers

    Table 2-1 provides a place for you to figure your financial assets. Go ahead and write in the spaces provided, unless you plan to lend this book to someone and don’t want to put your money situation on display. Note: See Table 4-1 in Chapter 4 to estimate your Social Security benefits.

    /tb0201

    Now comes the potentially depressing part — figuring out your debts and loans in Table 2-2.

    /tb0202

    Now you can subtract your liabilities from your assets to figure your net worth in Table 2-3.

    /tb0203

    Interpreting your net worth results

    Your net worth is important and useful only to you and your unique situation and goals. What seems like a lot of money to a person with a simple lifestyle may seem like a pittance to a person with high expectations and a desire for an opulent lifestyle.

    In Chapter 4, you can crunch numbers to determine your financial status more precisely for goals such as retirement planning. I also discuss saving toward other important goals in that chapter. In the meantime, if your net worth (excluding expected monthly retirement benefits such as those from Social Security and pensions) is negative or less than half your annual income, take notice. If you’re in your 20s and you’re just starting to work, a low net worth is less concerning and not unusual. Focus on turning this number positive over the next several years. However, if you’re in your 30s or older, consider this a wake-up call to aggressively address your financial situation.

    Getting rid of your debts — the highest-interest rate ones first — is the most important thing. Then you want to build a safety reserve equal to three to six months of living expenses. Your overall plan should involve getting out of debt (Chapter 5), reducing your spending (Chapter 6), and developing tax-wise ways to save and invest your future earnings (Part III).

    Examining Your Credit Score and Reports

    You may not know it (or care), but you probably have a personal credit report and a credit score. Lenders examine your credit report and score before granting you a loan or credit line. This section highlights what you need to know about your credit score and reports, including how to obtain them and how to improve them.

    Understanding what your credit data includes and means

    A credit report contains information such as

    check.png Personal identifying information: Includes your name, address, Social Security number, and so on

    check.png Record of credit accounts: Details when each account was opened, the latest balance, your payment history, and so on

    check.png Bankruptcy filings: Indicates whether you’ve filed bankruptcy in recent years

    check.png Inquiries: Lists who has pulled your credit report because you applied for credit

    Your credit score, which is not the same as your credit report, is a three-digit score based on the report. Lenders use your credit score as a predictor of your likelihood of defaulting on repaying your borrowings. As such, your credit score has a major impact on whether a lender is willing to extend you a particular loan and at what interest rate.

    FICO, developed by Fair Isaac and Company, is the leading credit score in the industry. FICO scores range from a low of 300 to a high of 850. Most scores fall in the 600s and 700s. As with college entrance examinations, higher scores are better. (In recent years, the major credit bureaus — Equifax, Experian, and TransUnion — have developed their own credit scoring systems, but many lenders still use FICO the most.)

    The higher your credit score, the lower your predicted likelihood of defaulting on a loan (see Figure 2-1). The rate of credit delinquency refers to the percentage of consumers who will become 90 days late or later in repaying a creditor within the next two years. As you can see in the chart, consumers with low credit scores have dramatically higher rates of falling behind on their loans. Thus, low credit scorers are considered much riskier borrowers, and fewer lenders are willing to offer them a given loan; those who do offer loans charge relatively high interest rates.

    Figure 2-1: Lenders use credit scores to estimate how likely people are to default on a loan.

    9781118117859-fg0201.eps

    Source: Fair Isaac Corporation

    The median FICO score is around 720. You generally qualify for the best lending rates if your credit score is in the mid-700s or higher.

    Obtaining your credit reports and score

    Given the importance of your personal credit report, you may be pleased to know that you’re entitled to receive a free copy of your credit report annually from each of the three credit bureaus (Equifax, Experian, and TransUnion).

    If you visit www.annualcreditreport.com, you can view and print copies of your credit report information from each of the three credit agencies online (alternatively, call 877-322-8228 to have your reports mailed to you). After entering some personal data at the website, check the box indicating that you want to obtain all three credit reports, because each report may have slightly different information. You’ll then be directed to one of the three bureaus, and after you finish verifying that you are who you claim to be at that site, you can easily navigate back to www.annualcreditreport.com so you can continue to the next agency’s site.

    When you receive your reports, the best first step is to examine them for possible mistakes (see the upcoming section Getting credit report errors corrected to find out how to fix problems in your reports). Several years ago when I did that myself, I found minor errors on two of the three reports. It took me several minutes to correct one of the errors (by submitting a request to that credit reporting agency’s website), and it took about half an hour to get the other mistake fixed (a small doctor’s bill was erroneously listed as unpaid and in collections).

    You may be surprised to find that your credit reports do not include your credit score. The reason for this is quite simple: The 2003 law mandating that the three credit agencies provide a free credit report annually to each U.S. citizen who requests a copy did not mandate that they provide the credit score. Thus, if you want to obtain your credit score, it’s going to cost you.

    tip.eps You can request your credit score from Fair Isaac, but you’ll get whacked $15.95 for every request (that can set you back nearly $50 to see your FICO score for all three credit bureaus). Save your money. If you want to purchase your credit score, you can do so for less by ordering it from the individual credit bureaus when you obtain your credit report(s) via www.annual creditreport.com — Equifax and Experian, for example, charge just $7.95 to obtain your current credit score.

    beware_sailing.eps If you do spring for your current credit score, be clear about what you’re buying. You may not realize that you’re agreeing to some sort of ongoing credit monitoring service for, say, $50 to $100+ per year, an expenditure I don’t feel is worthwhile.

    Improving your credit reports and score

    Instead of simply throwing money into buying your credit scores or paying for some ongoing monitoring service to which you may not pay attention, take an interest in improving your credit standing and score. Working to boost your credit rating is especially worthwhile if you know that your credit report contains detrimental information.

    Here are the most important actions that you can take to boost your attractiveness to lenders:

    check.png Get all three of your credit reports, and be sure each is accurate. Correct errors (as I explain in the next section) and be especially sure to get accounts removed if they aren’t yours and they show late payments or are in collection.

    check.png Ask to have any late or missed payments that are more than seven years old removed. Ditto for a bankruptcy that occurred more than ten years ago.

    check.png Pay all your bills on time. To ensure on-time payments, sign up for automatic bill payment, a service that most companies (like phone and utility providers) offer.

    check.png Be loyal if it doesn’t cost you. The older your open loan accounts are, the better your credit rating will be. Closing old accounts and opening a bunch of new ones generally lowers your credit score. But don’t be loyal if it costs you! For example, if you can refinance your mortgage and save some money, by all means do so. The same logic applies if you’re carrying credit-card debt at a high interest rate and want to transfer that balance to a lower-rate card. If your current credit-card provider refuses to match a lower rate you find elsewhere, move your balance and save yourself some money (see Chapter 5 for details).

    check.png Limit your debt and debt accounts. The more loans, especially consumer loans, that you hold and the higher the balances, the lower your credit score will be.

    check.png Work to pay down consumer revolving debt (such as credit-card debt). Turn to Chapters 5 and 6 for suggestions.

    Getting credit report errors corrected

    If you obtain your credit report and find a blemish on it that you don’t recognize as being your mistake or fault, do not assume that the information is correct. Credit reporting bureaus and the creditors who report credit information to these bureaus often make errors.

    You hope and expect that, if a credit bureau has negative and incorrect information in your credit report and you bring the mistake to their attention, they will graciously and expeditiously fix the error. If you believe that, you’re the world’s greatest optimist; perhaps you also think you won’t have to wait in line at the Department of Motor Vehicles or the post office!

    Odds are, you’re going to have to fill out a form on a website, make some phone calls, or write a letter or two to fix the problems on your credit report. Here’s how to correct most errors that aren’t your fault:

    check.png If the credit problem is someone else’s: A surprising number of personal credit report glitches are the result of someone else’s negative information getting on your credit report. If the bad information on your report is completely foreign-looking to you, contact the credit bureau (by phone or online) and explain that you need more information because you don’t recognize the creditor.

    check.png If the creditor made a mistake: Creditors make mistakes, too. You need to write or call the creditor to get it to correct the erroneous information that it sent to the credit bureau. Phoning first usually works best. (The credit bureau should be able to tell you how to reach the creditor if you don’t know how.) If

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