The world of investing and personal finance can be a very intimidating place. It has a daunting number of components and can seem excessively complex. Because of this, in today's difficult and unpredictable economy Americans of all ages are struggling. But perhaps no demographic currently struggles more with their money than do young adults, many of whom are enormously unprepared to manage their personal finances when they join the workforce. A Pathway to Financial Independence for Young Adults is a great resource designed to help you make sense of your finances. Each chapter is filled with useful advice, clever graphics, and easy-to-understand examples. Unlike traditional financial guides, which can be extremely complicated and tedious to read, this book explains personal finance using clear, practical language with an emphasis on truly understanding how to manage your money. So if you are a young adult and beginning to really think about your finances, this book can help you. If you have credit card debt and want to know how to get out of it, this book can help you. If you do not have much experience with investment or retirement accounts, this book can help you. And most importantly, if you want a logical yet effective text to assist you in planning your financial future in a step-by-step progression, this book can help you. A Pathway to Financial Independence for Young Adults is a must-read for anyone interested in understanding how to climb the pathway toward money mastery.
A Pathway to Financial Independence for Young Adults
Understanding How to Manage Your MoneyBy Drew F. CataneseAuthorHouse
Copyright © 2010 Drew F. Catanese
All right reserved.ISBN: 978-1-4520-0854-7 Contents
Introduction...................................................ixChapter 1: What Is Financial Independence?.....................1Chapter 2: Debt................................................5 Credit Card Debt..............................................8 Debt and How to Pay It........................................9 Action Plan...................................................12Chapter 3: Savings.............................................15 Why Save for Emergencies?.....................................18 Pay Yourself First............................................21 The "Christmas Bonus" Factor..................................22 The "No Raise" Lifestyle......................................23 Pay All Bills Every Month.....................................24 How to Save...................................................25 The "Cinderella" Cram.........................................27 Blame Thy Neighbors...........................................28 Action Plan...................................................29Chapter 4: Investing...........................................33 Why We Invest.................................................37 What is "Investing"?..........................................38 Compound Interest.............................................39 Stocks........................................................54 Bonds.........................................................55 Stocks vs. Bonds..............................................57 Stocks for the Long Run.......................................60 The S&P 500...................................................60 Dow Jones Industrial Average..................................62 Money Managers and Stock Brokers..............................63 Mutual Funds..................................................65 ETFs vs. Mutual Funds.........................................67 Real Estate (and REITs).......................................68 Gold and Silver...............................................71 Non-Financial Investment Vehicles.............................73 Annuities.....................................................74 Certificates of Deposit.......................................77 Dollar Cost Averaging.........................................78 Asset Allocation..............................................79 Portfolio Management..........................................82 Action Plan...................................................83Chapter 5: To Buy Or To Rent?..................................89 Buy a Home to Stay Put........................................92 Paying for a Home.............................................93 Emergency Savings and Down Payments...........................96 Aim For a Home You Can Actually Afford........................97 FICO scores...................................................98 Schools, Crime, and Sidewalks.................................100 Action Plan...................................................101Chapter 6: Retirement..........................................103 Understanding "Traditional" Retirement........................106 Retirement Basics Today.......................................108 Annual Income Requirement.....................................109 Individual Retirement Accounts (IRAs).........................111 Traditional IRA...............................................112 Roth IRA......................................................113 401(k) and 403(b).............................................115 What does "Being Vested" mean?................................117 Target-Date Retirement Funds..................................119 Action Plan...................................................121Chapter 7: Final Action Plan...................................123Acknowledgements...............................................129About the Author...............................................131Endnotes.......................................................133
Chapter One
What Is Financial Independence?
What is financial independence?
Financial Independence is a function of two factors:
1) The amount of money you need in income each year to maintain your chosen lifestyle
2) How much money you have saved and invested to generate that income indefinitely
Essentially, this means that:
To be financially independent you no longer live paycheck to paycheck.
To be financially independent you must be smart about your current investments.
To be financially independent you must be smart about your future investments.
To be financially independent you must do what you enjoy in life.
To be financially independent you must understand how to be financially independent!
How can you become financially independent? It is something that every person can achieve if they understand how and follow some basic yet powerful steps. As you progress through this guide, always keep in mind that your ultimate goal is to be financially independent.
Remember, too, that ignorance is not bliss when it comes to your finances. Financial independence is about taking control of your own finances and not letting others-like credit card companies and banks and lenders-control it for you.
To be truly financial independent, you need to understand and implement the strategies put forth in this book. While each of the following ideas is discussed in depth during the course of this guidebook, the basic ideas remain startlingly simple:
1) Get rid of debt.
2) Live within your means.
3) Save diligently.
4) Invest smartly.
5) Retire grandly.
This is financial independence. So do not waste another minute. Time is money! Begin reading now in order to know how to put your money to work for you. You, too, can gain true financial independence.
Chapter Two
Debt
Debt is one of the worst evils in existence. Today, millions of people in the United States have some form of debt. There is credit card debt. There is mortgage debt. There are student loans. There are personal loans. There are "pay-day" loans. And there are many, many other forms of debt. Financially speaking, all of these are terrible for you in terms of your overall monetary health.
In today's world, we have the ability to swipe things on a credit card; this essentially distills down to an "I'll pay it later" mentality and leads many citizens to much financial distress. The main culprit for this is the unfortunate fact that if people do not have the money accessible today to pay for something, they likely will not have the money to pay for that thing in a few weeks either when their credit card bill is due. The symbiotic correlation of rising debt and diminishing savings continues for so many people in our country.
This chapter will discuss a few ways to help you free yourself from debt and its many damaging faces. Simply put, if you owe others money (which is the definition of debt) you can never be truly financially independent. This is one of the basic hindrances of financial security and independence. Thus, not owing anybody anything is one of the basic building blocks of personal financial. In a step-by-step process, here we will examine how to be free from monetary obligations to others as we pave the way for greater savings, investing, and retirement.
One other thing to note, though: This chapter on debt is relatively short. Yet it is without question one of the most important topics covered in the entire book, which is why it occupies a prominent spot here at the beginning. But the reality is that in essence, this whole book is about getting out-and staying out-of debt, in order to be free to use your money in better ways. In particular, realize that many of the strategies in the "Savings" chapter are very applicable as ways to help you free yourself from debt and could easily have been included in the "Debt" chapter as well. So keep reading, but remember to think of this whole book as one solid unit on financial independence and that only by implementing many of the strategies discussed herein can you finally become financially savvy and independent.
Credit Card Debt
For most people with outstanding debt (excluding home loans, which are discussed later in this book), credit cards are the main culprit. According to the "Experian Marketing Insight Snapshot" in March 2009, more than 85% of American households own at least one credit card. And roughly 60% of households have more than four credit cards.
These statistics lead us to even more frightening realizations. The average debt in the United States is growing at an alarming and nearly unstoppable rate. Today, the average American household has over $8,000 worth of credit card debt and no clear idea how to pay it off
Some households even have tens of thousands of dollars of credit card debt. This is a startling statistic indeed. But perhaps even worse is the fact that during the last twelve months, 15% of American adults (or nearly 34 million people) have been late making a credit card payment. That means that almost one sixth of our country had trouble making a credit card payment last year. It has become an epidemic as virulent as any sickness we have ever witnessed in the United States.
Further, credit card debt is no longer just for working adults; younger and younger people are finding themselves under water when it comes to their monthly expenses, leading many to just "charge it" and postpone the payment of a bill. An astounding 84% of college students own at least one credit card while half of those students own four or more credit cards. At first glance, this statistic is not overly shocking, until you include the information that only about a third of college students have a job or a regular source of income. This leads to the acknowledgement that for every college student with a job that enables him to pay his bills, there are three college students with no job yet they still have a credit card.
Because of all this, the average college graduate has nearly $20,000 in debt, with a substantial portion of this being credit card debt. And astoundingly, young Americans (ages 18-29) now have the second highest rate of bankruptcy among all demographics, indicating that this generation is more likely to file bankruptcy as young adults than were young Boomers at the same age.
So what should you do if you have lots of credit card debt? It is hard to justify saving for retirement or a college fund or investing in the stock market if you owe $10,000 in credit card debt with exorbitantly-high interest rates and cannot afford to buy groceries.
For those people who have no debt, you should be congratulated. Move on to the "Saving" chapter! But for those with debt, especially credit card debt, read the next section about prioritizing your payments and begin the process of freeing yourself from debt and achieving financial independence.
Debt and How to Pay It
For many people, knowing what order to pay off certain debts can be a very confusing topic. Since most people have a finite amount of money coming in each month as income, until debt gets under control it can be hard to know whether you should you pay your car payment before your mortgage, or your credit card balance before your health insurance. This section helps explain a good starting point for knowing what to pay when.
To illustrate this, in most circumstances you should adhere to the following order of payments:
1) Any bill you owe to the Internal Revenue Service (the IRS) must always be paid in full and on time no matter what else you must cut back on. This includes your yearly income taxes and taxes at the state or municipal level (including property taxes or car taxes). Be especially careful if you are self-employed because how you pay your taxes can get quite tricky (you might want to consult a certified tax professional to help with your specific situation). Remember that the government has the ability to garnish your wages or withdraw money from your bank account without your permission. So in short, if you owe any taxes or liens to the government, pay those first.
2) After the IRS, any debt you have with extremely high interest is next in line to be paid if you want to free yourself from debt. For many, this means their credit card debt. Strive to pay the balance in full every single month. If you cannot and already have too much debt, the key is to pay more than the minimum balance to avoid finance charges and the ridiculously-high interest rates that some cards charge. Make it a priority to allot $50 or $100 more than the minimum balance until it is paid off. This might take a year or two or three. But the damaging effects of high interest can ruin your credit score and your financial health. Recently-passed credit card laws now state that any payment beyond the minimum balance must be applied to the highest interest portion of the account. Therefore, the more you pay above the minimum balance, the better off you will be.
3) After the government has been paid and you pay your credit card balance (in full if possible, more than the minimum if not), pay for those things that are necessary for life. This includes many of your fixed monthly payments, such as your mortgage payment, your car payment if you have one, payments for food, and your utilities payment.
4) If you are still short on money and need to prioritize, get rid of extraneous expenses that are not necessary for living but instead are actually "luxuries." This includes cable for your television, an extra phone line for your children, the high-cost plan for your cell phone that tallies thousands of minutes a month (go basic instead), or the shiny convertible that you use to cruise around the neighborhood on sunny Saturday afternoons.
5) Finally, consult the "How to save" section in the following "Saving" chapter of this guide for ways to minimize your monthly expenses and make your income stretch further.
Unfortunately, when finances are tight, 59% of people would pay their credit card bills last. A majority claim to pay their mortgage payment first and their utilities next, disregarding the exorbitant interest rates wreaking havoc on their financial health. This is a bad idea. The higher the interest you are paying each month, the worse it is for you.
Therefore, although it may seem contradictory, if you do have a large amount of credit card or personal debt (this does not include your mortgage or car payments) you should always strive to get this paid off as quickly as possible. Building an emergency savings account and saving for retirement or college can come later.
In the end, not everyone fits the same mold and we all have different budgetary needs. In your situation is particularly complex or you think you might need additional professional help, call a debt specialist or see a certified financial planner, both of whom can help you personally get on the right track and figure out a solid financial pathway to alleviate your debt.
Do your absolute best to free yourself from credit card debt. The sooner you do this, the sooner you will have more disposable income to put toward savings and investments that can actually make you money instead of dragging you down.
Action Plan
A clever investor once said "All debt is bad. Credit card debt is worse." These words could not be more accurate. If you have credit card debt, it is important to adhere to the suggestions in the preceding pages and develop a plan for paying it off, even if it takes you a few years. Never settle for having credit card debt; it has truly ruined the lives of thousands of families across the country.
After you have paid off your credit card debt, though, you can begin saving for an emergency (as outlined in the next section) and planning out your investments and retirement. This is where the fun begins!
In the meantime, prioritize who you are paying and strive to pay more than the minimum balances whenever possible. After you free yourself from the chains of debt, never purchase something that you cannot afford to pay for in full at the end of the month (a home is an exception - see the "To Buy or to Rent" chapter later on for more details about affording a home). If you always follow this guideline, you will always be able to live within your means and not have the heavy burden of living each day knowing that just one more expense could send you to financial ruin.
Chapter Three
Savings
Personal saving is one of the most basic-yet most essential-aspects of personal finance. And what is very sad is that during the last two decades the average U.S. family's savings rate has been less than 1%. This means that for every $100 the average U.S. family makes, they save less than $1. This puts many people in very dire straits indeed. What happens if you have no money saved and you lose your job? How will you pay your bills? How will you pay for food? How will you pay rent?
In the news recently, there has been much talk about the economic downturn. It is no secret that this recession has exposed the financial problems of millions of Americans. Some of these problems include huge amounts of credit card debt, subprime mortgages, and little retirement savings.
For example, nearly 50% of our country has less than one month's living expenses saved and almost two-thirds of Americans have less than three months' living expenses. And an even greater percentage of Americans couple these meager savings with massive credit card debt and other forms of high-interest loans. If these numbers do not shock you, they should. With adequate savings, however, you can avoid many of the financial dangers that befall such a large portion of the United States.
According to financial scholar Luke Setzer, in his short yet powerful essay entitled, "Saving for Greatness," your savings "affect the way you stand, the way you walk, the tone of your voice - in short, your physical well-being and self-confidence. A man without savings is always running. He must.... He sits nervously on life's chairs because any small emergency throws him into the hands of others."
A person with little or no savings often subconsciously goes through life feeling defeated or overcome, scared of the next financial crisis or money-related problem! Having no savings, therefore, leads to credit card debt and monetary ruin. Conversely, a person with adequate savings often walks with his head held high, knowing that he can weather any storm or obstacle thrown his way.
Something that few people realize, however, is that saving has nothing to do with the amount of income you receive from your job. Many high-income individuals like doctors and lawyers have no savings to speak of, while some traditionally "blue-collar" workers live every day with a smile on their faces, confident that if something happens they have adequate savings and will not have to go into debt to get through life's setbacks.
Many financial planners and advisors recommend that all individuals have a fully-funded emergency savings fund in order to protect against life's many curveballs
In order to learn ways in which you can start building up a six-month emergency savings account, read through the rest of this chapter. Apply the concepts and practices discussed herein, and before too long you will be well on your way toward financial independence.
Why Save for Emergencies?
Before you can be expected to just blindly start saving, it is important to understand why to save. The motive behind maintaining an emergency savings fund is simple: there are numerous situations that arise in life that you simply have no control over. Should these situations befall you and you need an immediate source of cash flow, it is essential that you have the money. As discussed in the preceding "Debt" section of this guide, far too many Americans do not have adequate savings and so must charge too much on their credit cards, which have incredibly high interest rates. Then, at month's end, they cannot pay the balance due. This forms a downward spiral of debt that is nearly impossible to get out of. Therefore, once all credit card debt has been paid off and you are budgeting well enough to be able to pay your bills in full every month, the top order of business is creating emergency savings. It is one of the fundamental building blocks in your overall personal finance foundation.
(Continues...)
Excerpted from A Pathway to Financial Independence for Young Adultsby Drew F. Catanese Copyright © 2010 by Drew F. Catanese. Excerpted by permission.
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