I enjoy weddings. I’m just not sure how much I’d pay for one.
That thought was prompted by reading recently that the typical wedding in the United States costs around $30,000 these days. Now, I’m a little skeptical about that number. After all, there is whole cross-section of businesses dedicated to promoting the idea of big weddings. I think of it as the wedding industrial complex. It is in their interest to promulgate figures that suggest it’s perfectly normal to spend a small fortune on a wedding.
Still, whether or not $30,000 is an accurate figure, the fact remains that many people spend far too much on their wedding. It could be seen as a welcome sign of prosperity, except that these are not prosperous times. No, we are living with an epidemic of people struggling to pay their student loans and failing to save for retirement. So really, it is worrisome to see couples start their lives together by taking on a heaping helping of debt.
There is even an entire category of personal loans called wedding loans. It is worth looking at how those stack up relative to other options for financing a wedding; but also, I can’t resist the urge to follow that up with reasons not to borrow money for a wedding in the first place.
Compare wedding financing options
Here are some of the ways you can borrow to pay for your wedding:
- Credit card. Wedding expenses tend to come up over a period of time, as deposits have to be made, dresses and tuxedos bought, etc. These periodic expenditures make it all too easy to fall back on a credit card as a handy way to pay. But don’t forget that credit card debt is extremely expensive and interest rates are likely to be especially high for young couples with limited credit histories.
- Personal loan. At around 10 percent, personal loan rates aren’t exactly cheap, but they are lower than most credit card rates. Also, debt repayment is structured, which makes it easier for borrowers to stay on track toward timely repayment.
- Home equity loan. If you are lucky enough to already own a home by the time you get married, a home equity loan is a cheaper way to borrow than either credit cards or personal loans. Just be sure you feel confident in your long-term job security, because using your house as collateral really raises the stakes of borrowing for your wedding.
- Line of credit. Another option is a line of credit, which may be either unsecured or secured by equity in your home or some other asset. (Again, secured loans are generally cheaper, but they put your collateral at risk.)
There are pros and cons to using a line of credit to finance a wedding, though. Since you don’t pay interest until you actually use the line of credit, this approach can be well suited for the way wedding expenses don’t all come up at once. On the other hand, having access to a line of credit can make it too easy to make spur-of-the-moment upgrades or additions to your wedding plans, which can send your costs soaring.
Why going into debt for your wedding is a bad idea
So now I get to be the wet blanket and tell you why you should not borrow to pay for your wedding:
- Long-term debt is bad for short-term expenditures. Borrowing for assets like cars and houses makes sense because the useful life of the asset outlasts the repayment period. However, borrowing for short-term events like vacations or a wedding means taking on debt without an offsetting asset.
- Don’t feel you have to prove anything. Make the wedding entirely about your commitment to each other, and not about showing off for friends and family.
- It’s really easy to overpay. Most people don’t have a lot of experience with weddings, so they are essentially sitting ducks for the professionals who make their living in that industry.
- Saving could tell you something about each other. Being disciplined about money will help your marriage work, so why not find out how well you can manage this kind of thing together by waiting and saving up to pay for the wedding?
- Multiple debt layers could become a strain. When you think about it, it often takes 15 years to pay off student loan debt. After you are married, you may want to buy a house, for which you will possibly need a mortgage. Do you really want to create a third layer of debt by taking on a wedding loan?
I don’t have any formal data on this; but given the way celebrity marriages often turn out, I get the impression that there might even be an inverse relationship between the cost of a wedding and the length of the subsequent marriage. Then again, that impression might be skewed by the fact that my own low-budget wedding has led to 29 wonderful years of marriage, and counting.
A very wealthy and successful guy I used to work for once mentioned something about his mortgage to me. I was a little taken aback, and asked why someone with his money would still have a mortgage. His thinking demonstrated that there are several dimensions involved in the decision of when to maintain debt rather than tap into savings.
Cash or charge?
This comes down to the question we’ve all been asked by sales clerks over the years: cash or charge? That choice is available not just when initially making a purchase, but also any time when you are paying off a loan. If you have some savings at your disposal, you could opt to use some of those savings to pay off your loan ahead of schedule.
On the other hand, in the case of my former boss, his thinking was that between the mortgage tax deduction and investment opportunities, he could earn more on his money than the mortgage was costing him. In any case, the choice comes down to a trade-off between borrowing costs and liquidity — the ready access to your money.
Pay now or pay later? Here’s what to consider
So how do you decide on the trade-off between borrowing costs and liquidity? Here are nine key considerations:
- Tax implications. When interest is deductible, as with most home loans, it can lower your effective cost of borrowing and thus make debt more palatable. Keep in mind, though, that not everybody is in a position to take advantage of these deductions. You should be in a position to itemize deductions, and you must have sufficient income from which to take your deductions.
- Cheaper alternatives. Sometimes, the reason to pay off a loan is not to retire debt altogether but to refinance it. For example, credit card rates are very expensive relative to mortgage debt and even personal loans. So, you might pay off a credit card balance by tapping into a cheaper source of debt. Also, if interest rates have fallen since you took out the loan, you have an incentive to refinance.
- Rate spread. The bigger the differential between the interest you have to pay on debt and the interest you could earn from savings, the less cost-effective it is to borrow. So, a wider rate spread argues for paying down debt early. For example, 30-year mortgage rates may seem very low at 3.6 percent, but that is still a lot more than the 0.06 percent the average savings account is earning. This means that you probably would lose by having savings offset by debt, and the worse your credit rating, the more this spread is likely to work against you.
- Investment opportunities. Of course, savings account interest isn’t the only thing you could earn by investing cash rather than using it to pay off debt. The more attractive you feel opportunities like the stock market are, the more likely you will be to use debt so you can invest your cash.
- Early repayment penalties. One factor which can argue against repaying debt early is if there is a penalty for doing so. For example, many mortgages have this kind of penalty, so always check before repaying a loan early or refinancing.
- Liquidity. Your wealth might far exceed your debt, but depending on how you are invested you may not have money readily accessible to use to pay off debt. For example, if you are in relatively illiquid investments like real estate, it might not be worthwhile for you to sell off assets to pay down debt.
- Upcoming cash needs. If you have large expenses on the horizon, you might want to avoid using up your cash to pay down debt early if you would just have to borrow again in six months for your upcoming needs. In that situation, you can’t be sure whether credit will be available to you when the time comes, or on what terms.
- Budget discipline. If you are disciplined about following your budget, you can count on using your savings constructively if you don’t use it to pay down debt. On the other hand, if you are a compulsive spender, you might want to use any extra cash to pay down debt before you are tempted to spend it more frivolously.
- Job security. If you have good job security, you can pay down debt with confidence knowing that your earnings will provide you with the cash flow to build savings back up again. However, if you have concerns for your job, you may want to keep some cash in reserve.
Finally, besides the logical considerations to this decision, it also comes down to personal style. Some people, like myself, are just more comfortable when they are debt-free. In my case, that feeling of being free and clear from financial obligations is worth giving up a little liquidity by using savings rather than debt to pay for things.
I suppose it is bound to happen if you live in a wooden house in a semi-rural area. Our house has become besieged by woodpeckers.
The insistent, get-you-up-out-of-bed nagging of their rapping on the walls reminds me of the inescapable angst of having money worries. The problem is, I know what to do about financial doubts. Woodpeckers are another matter.
Whose house is this anyway?
I can assure you that my wife and I have a clear legal title to this house. The woodpeckers don’t have a hint of a claim on the property, yet here they are. They drill perfectly round holes in the siding for their homes, and then start building additions by clearing out the insulation and whatever else is in the interior walls. After all, what self-respecting woodpecker can live without a man cave and a gourmet kitchen?
The funny thing is, we’ve been in this house for 18 years, and the woodpeckers didn’t show up for the first several years. Maybe it is because the previous owners had a gun, and we don’t. The woodpeckers have caught on. You can’t underestimate the intelligence of these pests. I started caulking their holes, so they started putting their holes just high enough for me not to be able to reach on the ladder. For now, the woodpeckers have the better of me.
Why this reminds me of money worries
What we are finding with the woodpeckers is that you no sooner shoo one off than another one appears. It’s the same with money worries — you face a series of them over the course of a lifetime and, if you are fortunate enough to put one to rest, another one is bound to pop up. Like the woodpeckers, these money worries seem to start tapping away at the quiet every time you try to relax. I’ve found that what makes me happy is to address the problem directly rather than trying to ignore it, because these things just don’t go away. Some examples:
- Job security. This was always the big one for me because, as long as I’m earning a half-way decent income, I’m confident that I can make it work by living within my means. Graduating in the early 1980s when unemployment was 10 percent made me realize very quickly that a good job is not a sure thing, even if you earn good grades and are willing to work hard.
I suspect a younger generation has also acquired a chronic insecurity about employment, since a net total of over 8.6 million jobs were lost in 2008 and 2009 as a result of the Great Recession. My advice is to make sure you are adding value where you work now, but keep half an eye on the job market. Specifically, know what kinds of jobs are in demand, and try to keep your skills in line with what the job market wants.
- Loan repayment. I have a habit of paying off loans early, just because I find it hard to rest with the obligation of owing money to someone else hanging over my head. It’s a real financial woodpecker for me, tap-tap-tapping at my conscience. I even paid my student loan off early, even though that was near the start of my career when there wasn’t much money to spare. I decided that, instead of taking a step up in lifestyle with each raise, it was a higher priority for me to get rid of the debt. That’s not going to be everyone’s choice, but the lesson is to decide what matters to you most and put your resources toward achieving it.
- Too much mortgage. Home buyers get so caught up in trying to qualify for a mortgage that they don’t adequately question whether they need such a big loan. Look, lenders and real estate agents have a financial interest in trying to push you to the upper limit of what you can afford, so you need to be the one that reins things in. It’s no use owning a home if you can’t relax in it, and having ongoing worries about meeting your mortgage payments is going to be another financial woodpecker disturbing your rest.
- Lack of retirement saving. I get that this is tough in part because people don’t want to sacrifice today’s lifestyle for tomorrow’s practicalities. However, ask yourself whether you are really comfortable with this in the here and now. It might be that you will rest easier if you start to take care of the future by adding to your savings, making you happier both today and tomorrow.
Those are some thoughts on how to keep money worries from pecking away at your peace, interrupting your sleep. They are simple and practical approaches, but that rather than tricks is what works when it comes to gaining control of household finances.
Unfortunately, I am less practical and resourceful when it comes to driving away woodpeckers. So, if anyone has any suggestions, I’m listening.
How worried should I be?
That’s a question financial people get a lot when the market is as unstable as it has been over the past several weeks. Actually, it’s a question we ask ourselves in those environments.
Having both asked and answered that question several times recently, let me share some of the answers I’ve come up with.
Down 500 points? No big deal.
The stock market has hit some major downdrafts lately, including days when the Dow Jones Industrial Average lost over 500 points.
Inevitably when this happens, the media post pictures of Wall Street traders tearing their hair out. That’s okay. Baldness is an occupational hazard, and they are compensated well enough to afford Rogaine.
An important thing to remember about those traders is that they have large amounts of money at stake on very short-term market positions. Outside of the financial sector, though, most investors are trying to save for the long term, for retirement. This means accumulating wealth over 20, 30, or 40 years. Have you ever seen what a 3 percent loss (roughly the equivalent of a 500-point drop at today’s level of the Dow) looks like on a 40-year chart of stock market returns? It is barely a ripple, something you wouldn’t even describe as a speed bump.
Bigger problems than market downturns
For long-term investors, then, most day-to-day or even month-to-month fluctuations can be shrugged off. What is more disturbing is that, for all its ups and downs, the stock market has made very little progress over a long period of time.
Since the beginning of this century, the S&P 500 has gained just over 34 percent, or a compound average of 1.90 percent a year. Throw in a couple percent a year for dividends and you would roughly double that on a total return basis. But returns in the neighborhood of 4 percent a year are far below the growth assumptions people make when they are doing retirement planning. This has been going on for more than 15 years now, which is a significant chunk of anyone’s retirement time horizon.
Add to that the low yields on bonds over the past several years and the even lower rates on savings accounts and other bank deposits, and you are looking at long periods of sub-standard returns for most U.S. investors. This is a bigger problem than any short-term market downturn.
Economic reality vs. perception
Markets are one thing; the economy is another. While the U.S. market was going through all the angst of late August, one very positive piece of economic news went almost unnoticed. The official estimate of U.S. gross domestic product was revised upward to 3.7 percent, a substantial improvement over the original estimate of 2.3 percent, and significantly better than the first quarter’s rate of 0.6 percent.
The contrast between the stock market and the underlying economy is even greater in China. For all the attention the dramatic plunge in Chinese stocks has gotten, what is less reported is that their economy is continuing to grow, albeit at a slower rate than in recent years. Squeezing some of the speculation out of the Chinese stock market should be good for investment there in the long run.
Protecting your number one asset
When the investment environment gets worrisome, your attention should turn to your number one asset. This probably is not your portfolio or even your house. It is your job.
Keeping that stream of income coming — and growing it through career advancement if possible — can help pick up the slack when investments are doing little to build your wealth. Keep your skills sharp, and look to add value at your job to a degree that would make it difficult for your employer to do without you.
Control what you can control
Besides attending to your career, the other thing you can control when investment results disappoint is your spending. Lower returns may mean you have to lower your spending expectations, both now and in retirement. Doing this on your own terms is much less painful than having austerity forced on you when you can’t pay your debts. Just ask the Greeks.
One way to think of all this is that you should be concerned rather than worried. Concern means that the situation is serious enough to merit some attention, particularly with regard to safeguarding your career, tightening up your spending habits, and being alert for investment opportunities. Acting out of concern is distinct from merely worrying, which usually involves unproductive activities like checking the market every five minutes or lying awake at night worrying about decisions that are already behind you.
This notion of acting constructively toward things you can control is perhaps the best cure for a worrisome environment. Once you’ve done all you can do, it is easier to stop worrying and turn your attention to other aspects of your life while the stock market’s drama plays itself out.
The worst thing about bad credit isn’t being turned down for a loan or a new credit card. After all, there are worse things than not being able to borrow. The bigger problem with bad credit is that it can cost you money in a number of ways, and that added cost makes it easy for small money problems to become big money problems.
The more you understand about the hidden costs of bad credit, the more motivated you will be to keep your credit clean.
6 ways bad credit can cost you
Here are 6 ways having bad credit can cost you money:
- Higher credit card rates. Credit cards often have different rate tiers for different customers. People with good credit pay lower rates than people with bad credit — and if your credit rating slips after you sign up for a card, the credit card company can charge you a higher rate on future purchases. The irony is that the people who get the best credit card rates rarely actually pay those rates, because they don’t carry balances on their cards over from month to month. In all, the average rate for credit card accounts that have to pay interest is over a full percentage point higher than the average for all credit card accounts.
- Higher loan rates. Credit cards are not the only form of borrowing that gets more expensive as your credit deteriorates. Everything from car loans to mortgages are likely to cost more if you have bad credit. Lenders view part of the interest rate they charge as a cushion against the risk of the borrower defaulting, and the bigger the risk your credit rating suggests you are, the bigger that interest rate cushion will be.
- Larger down payment requirements. In addition to charging a higher interest rate, lenders also hedge their credit risk by making borrowers with bad credit put more money down on their purchases. This can cost you by forcing you to wait longer before making a major purchases, which often results in paying a higher price.
- Higher insurance rates. Some insurance companies offer discounts to customers with good credit histories. This is yet another example of how people who are already in good shape financially get the kind of breaks that can make their finances even healthier.
- A red flag for prospective employers. Increasingly, employers are reviewing credit histories as part of their background checks on job candidates. Credit problems have several negative implications from an employer’s perspective — they suggest a low level of personal responsibility, they could raise concerns about putting that person in a position of financial trust or lead them to believe that the candidate may let dealing with money problems become an ongoing distraction on the job. So, credit problems can make it tough to get ahead because you might miss out on the best job opportunities.
- Limited financial flexibility. Even if you are able to get a mortgage or a credit card initially, poor credit can limit your flexibility to manage your debt in the future. Poor credit could prevent you from reaping the financial rewards of refinancing or taking advantage of cheaper credit card offers.
4 habits that will keep your credit clean
Naturally, living within your means is the key to avoiding credit problems, but you also have to develop good habits for taking care of your financial responsibilities. Here are four habits that will help keep your credit clean.
- Organize your payments. Don’t treat bill paying like a chore that you will get to when it is convenient; you need to have a process to make sure it gets taken care of consistently. Setting aside a specific time of the week for bill-paying and automating some of your payments can help.
- Don’t use automatic bill-paying for everything. Automatic bill payments are a useful tool, but they are best suited to bills that are for a predictable amount of money month after month. For more variable bills, you may want to handle them yourself to make sure an unusually large amount does not cause an overdraft, and so you can spot any overcharges or other problems.
- Make the timing work. Coordinate the timing of your payments so they will arrive by the due date and so they are in sync with your pay schedule to ensure you will have sufficient funds in your account.
- Never borrow without a repayment plan. This is especially important for credit cards, because it is all too easy to use them impulsively. Figuring out how you will repay the money makes you stop and think before you borrow.
You’ve probably heard the phrase “the rich get richer and the poor get poorer.” One way to think about that is that financial conditions have a way of feeding on themselves. Credit problems usually make life more expensive, and thus those problems become harder to overcome. Keeping your credit clean can stop a downward spiral from ever starting.
If you have been able to buy a house or refinance a mortgage in recent years, then congratulations. You have been a beneficiary of the Fed’s extraordinary effort to keep interest rates low. For many others though, monetary policy hasn’t been so favorable — in fact, it has cost them dearly.
Ostensibly, low interest rates are a monetary device to stimulate the economy, but more subtly they also serve to bail out banks and borrowers. Who suffers from that? Primarily savers. Whether you have a short-term savings account or a long-term retirement portfolio, low interest rates have made earning any money on your savings an uphill climb.
Recognizing the various ways low interest rates may have hurt you is not important simply so you can mutter rude things about Janet Yellen when she comes on the television. It can help you make adjustments to adapt to the low interest rate environment and the subsequent fallout that will result when rates return to more normal levels.
Here are seven bad things about low interest rates:
- Low interest rates on savings accounts. Deposit rates are closely linked to short-term Fed funds rates, so the low interest rate policy has been very clearly evident in driving savings account rates down to near zero. This is especially hard on retired folks, who typically invest their money conservatively and had grown accustomed to being able to earn some retirement income on their savings. Virtually wiping out that income for people who often don’t have another means to earn a living is a pretty harsh blow. There is no way to fully make up for the destruction of savings account income that has taken place, but it does underscore the importance of shopping around for higher-yielding savings accounts, and perhaps committing your deposits to longer-term CDs to earn a higher rate of interest.
- Low yields on bonds. Long-term Treasury bonds have been a staple of retirement plan investments, but low interest rates have helped drive their yields to below 3 percent. You might argue that the drop in interest rates created a windfall for bond investors because prices rise as yields fall, but this would be reversed with a return to more normal yield levels. In the meantime, low yields on a significant portion of retirement investment portfolios is going to make it hard to reach the return assumptions on which retirement funding is based.
- Fanning the flames of inflation. The Fed has persistently said it wants to keep interest rates low to encourage higher inflation. I can’t help thinking that encouraging higher inflation is like saying “Beetlejuice” three times — you might live to regret the help that you called for.
- A stock market on PEDs. Performance-enhancing drugs, or PEDs, inflated the statistics of professional baseball a few years back, just as it artificially inflated the physiques of the cheaters who used them. Similarly, low interest rates artificially pump up stock prices — in the long run though, all you have are companies that are more expensive, but not actually more valuable in terms of having boosted their revenue-generating power in line with the rise in stock prices.
- High checking account fees. Checking account fees have risen steadily in recent years, and free checking has become a rarity. Back when interest rates were higher, banks were happy to offer free checking just to attract deposits. With interest rates low, having those deposits on hand is not worth as much to banks, so one recourse is to raise fees. In fairness, it is worth noting that another government policy is also partly to blame for the rise in checking account fees. The Durbin amendment to the Dodd-Frank Act arbitrarily cut the fees banks could charge retailers for debit card transactions. Banks raised fees to make up for this, but don’t hold your breath waiting for retailers to pass their savings along to consumers.
- Low mortgage approval rates. The frustrating thing about the low mortgage rates of recent years is that relatively few people have been able to qualify for them due to tough lending standards. When mortgage rates are no higher than the long-term rate of inflation, it leaves little margin for defaults, so lenders are particularly wary about making loans in that situation.
- A subsidy for banks. Yes, mortgage rates came down quite a lot, and credit card rates came down a little, but neither fell as far as deposit rates. So, the rates banks pay consumers fell by more than the rates consumers pay banks. That means banks win and you lose.
Of course, low interest rates have not been entirely bad, and I can even accept the argument that they were a necessary evil in the depths of the financial crisis. However, the longer the Fed prolongs the era of low interest rates, the more it seems that savers are getting a raw deal.
It’s one of the most awkward questions a friend can ask you: “Will you lend me some money?” Awkward for your friend to have to ask, and awkward for you to have to answer. Saying “no” could adversely affect your friendship. However, saying “yes” could also put a strain on your friendship, and your finances.
If you get asked that awkward question, you should follow up with eight questions of your own before you decide whether or not to lend a friend money.
1. Why does your friend need the money?
Sometimes, there is a clear, one-time need for which a timely loan can get your friend through a particular situation — for example, Bob has found the perfect house but is a couple thousand short on the down payment, or Jane’s son needs dental surgery. Situations which are out of the ordinary and are not likely to recur at least suggest that a loan might be a one-time thing.
Unfortunately, more often when people turn to their friends for financial help, it is because of long-standing money problems. In that case, your loan is likely to be nothing more than a temporary stop-gap, leaving your friend with the same set of problems in a few months, and you with little chance of being repaid.
2. What other debts does your friend have?
If a friend comes to you for money, it may well be because he or she has exhausted all other sources of borrowing — meaning that the credit cards are maxed out, and possibly mortgage, car, or student loan payments are coming due.
If your friend owes money to credit card companies or lenders, you are probably going to have to stand in line behind them before any money you lend gets repaid — which significantly reduces your chances of seeing that money any time soon.
3. Is this an amount you can afford to lose?
Institutional lenders use a variety of techniques to assess loan risks, and they make thousands of loans. So the cost of the occasional bad loan can be absorbed by the money they make from interest on good loans.
You have neither those underwriting tools at your disposal, nor the opportunity to broadly diversify your lending risk. This makes a one-off type of loan especially risky, and you should not lend more in that situation than you could afford to lose.
4. How formal should the arrangement be?
This loan may be an understanding between friends, but that doesn’t mean you shouldn’t formalize it with a signed, written agreement. Aside from protecting your financial interests, it can be important to the friendship to document your understanding in a way that ensures you both remember things the same way after some time has passed.
5. Should you charge interest?
Remember, there is an inflation cost and possibly an opportunity cost to tying up your money. Charging interest need not mean profiting at your friend’s expense. It can simply be a way of recouping the cost of having the money unavailable for a while.
One argument in favor of formalizing the arrangement and charging interest is that, if you don’t, the IRS may deem it a gift rather than a loan. If there is a large amount of money involved (the exemption limit is $14,000 for the 2015 tax year), this may mean having to pay gift tax — and the giver rather than the recipient is on the hook for gift taxes, so this could come out of your pocket.
6. What is the repayment schedule?
Part of the formal arrangement should be a repayment schedule. That way you both know what to expect about repayment terms.
7. Has your friend budgeted for repayment?
Another benefit of a repayment schedule is that it can serve as a reality check. Once you have a repayment schedule worked out, it is fair to ask your friend how he or she intends to find the money for those payments — especially if that friend has been having financial problems already.
8. Which will affect your friendship more: saying no or saying yes?
It might seem to be the path of least resistance to say yes, but saying no means you can both quickly put the incident behind you. On the other hand, a burdensome loan could prove to be an ongoing strain on the relationship for years to come.
Consider the alternatives
If the analytical approach described above seems too hard-headed, consider an alternative besides saying yes or no to a loan: simply giving your friend the money. If your friendship is close enough that you really want to help, giving rather than lending money allows you both to move forward with no strings attached.
On the other hand, if simply giving the money away is not something you can afford, you should think very analytically about lending the money. If things go wrong, a bad loan to a friend could cost you both the money and the friendship.
As I was coming of age, I became aware of too many examples of people who had gotten into trouble with credit card debt. It made me avoid getting a credit card for several years. Eventually, though, I overcame my fear of plastic, and realized it is the user and not the card that should be in control.
A healthy concern about credit card use is not misplaced. After consumers reined in their spending in the immediate aftermath of the Great Recession, they have expanded their credit card debt in each of the last four years, and that debt is on the rise again in 2015. Still, having a credit card does not have to mean having credit card debt. Actually, if you make it a practice to pay off your balance every month, the benefits of having a credit card can outweigh the disadvantages.
This may be more true now than ever before. Here are six good reasons to overcome a fear of plastic, some of which were true 30 years ago when I got my first credit card and some which came into greater prominence in the 21st century:
- You win when you get free use of money. Because there is a lag between when you charge something and when you start paying interest on the amount you borrowed, you effectively get free use of the money for a short period of time. The catch is that once interest starts being charged, it is very expensive — credit card companies charge an average of 13.49 percent on outstanding balances. Still, if you pay your credit card bill in full and on time, you can avoid incurring interest charges. As long as you choose a credit card without monthly fees, then used correctly a credit card can be a convenience that doesn’t cost you anything.
- You win even more when you get free rewards. Not only can you have the convenience of a credit card for free if you pay your balances off promptly, but you can also get cash back or other rewards on your purchases. Credit card companies do this to induce you to use their cards, both for the interchange fees they get from merchants and on the assumption that many people won’t pay the money back right away and so will have to pay interest. It is especially important to avoid carrying a balance on rewards credit cards because they typically carry higher interest rates than non-rewards cards, but if you can pay your balances off on time earning rewards means the card company is paying you for using their credit card rather than the other way around.
- A responsible credit history can help you save on insurance. I was shocked when our auto insurance carrier wanted to raise our family rate a few months ago, even though we have pretty clean driving records. It turns out the deer that jumped into my son’s car a couple years back was not insured, so that accident is counting against us. When I complained, my agent suggested a program they have that offers lower rates for people with strong credit histories. I figured we would qualify, and we did, as a result of which our insurance premiums went down rather than up. Getting a credit card can be an important step toward establishing a credit history.
- You may need a credit history to rent an apartment. Never mind needing good credit to buy a home — you may need it just to rent. Landlords consider your credit history as an important indication that you will pay your rent and meet your other obligations as a tenant.
- Traveling without a credit card is very difficult. When I first started to travel for business, I actually used to get by with carrying a large amount of cash with me to cover the hotel bill. These days though, decent hotels tend to frown on letting you check in without a credit card, and forget about renting a car without one.
- Establishing a digital discipline is becoming essential. The reason some people shy away from credit cards is that they make it all too easy to overspend and get into debt trouble. This was my reasoning 30 years ago; but back then, not having a credit card was enough to avoid the temptation to spend impulsively. Nowadays, with financial affairs increasingly conducted digitally in a variety of ways, you simply have to develop the discipline not to abuse these tools. Otherwise, you will find more than one way to get into money trouble electronically.
If you want a simple decision rule for using a credit card responsibly, try this: Any month you cannot pay off your balance, put the card away and don’t use it until your current debt is paid off. This is a crude-but-effective way of making sure the accumulation of debt does not outweigh all the positive aspects of having a credit card.
My wife and I were talking recently about a June 5, 2015, New York Times article that described the lifestyle of “Millionaires Who Are Frugal When They Don’t Have to Be.” It got me thinking about the word “frugal.” It will probably never be a sexy concept, but neither does it have to seem like a dirty word.
The title of the article seems to conjure a slightly pejorative image — people who are well off but needlessly pinch pennies. The actual content of the article is more favorable. It focuses on people who have settled into a particular niche — the Times describes them as single-digit millionaires. It’s an interesting position. Obviously, they are very well off, but they are not crazy rich enough to afford every extravagance that crosses their minds. Also, people in this position often made their money themselves, so they can remember what it was like to get by with less.
None of the lifestyles described will ever be fodder for a reality show — not only aren’t these people splashy enough spenders, but they seem more focused on living their lives than on demonstrating their wealth to the rest of the world. Still, while I can see the article’s point about frugality, what struck me is that each of the people profiled had some form of indulgence, whether it is an extra piece of property or the occasional trip to Italy.
In other words, these people are not making themselves miserable by living a monk-like existence when they could afford more. They are enjoying their wealth even while being very conscious of not blowing it.
Enjoying a frugal lifestyle
Of course, the people in the article are far from typical. Even a single-digit millionaire has been far more fortunate than the average American. Still, I think there are some lessons in the lifestyles described that show how frugality does not have to mean miserable self-denial.
Here are some thoughts on how to leave room for joy in a frugal lifestyle:
- Budget for some discretionary spending. Living within a budget requires having the discipline not to exceed that budget, but it does not have to mean every expenditure is specifically planned or even logical. Whether it is $50 or $50,000, leave yourself a some room in your annual budget to spend impulsively, indulgently, or however you see fit. That way, you will get to feel a sense of financial freedom, while also knowing that you are staying within the framework of your budget.
- Own up to your splurging. The worst over-spenders I know always have a rationalization every time they splurge on an unnecessary expense. This translates into a sense of denial which prevents them from recognizing how often they do it. Be realistic. It’s OK to splurge occasionally, but recognize it so it does not become a thoughtless habit.
- Make the big decisions count. No offense to one of the guys described in the article, but you can darn your socks all you want, it will still be the big financial decisions that matter. What did you pay for your home, and what mortgage rate did you get? Did you strike a hard bargain on your last car? There are a handful of big decisions that have real big-money impact.
- Enjoy the little things. Building a 25,000 square foot palace can drain even a millionaire’s finances, but buying a little better bottle of wine or a weekend getaway are smaller indulgences that shouldn’t leave a lasting mark. If you learn to enjoy little rather than big indulgences, you can enjoy your money without overspending.
- Maintain some form of income. Take it from someone who is in his second career — it feels great to downshift without completely slamming on the brakes. I enjoy working, and even with some money saved there is nothing more reassuring than seeing some income continue to roll in.
- Get on the same page as the rest of your household. The wealthy couples described in the article all seem to share a philosophy toward money with their spouses, and this is very important to being able to be happy with a modest lifestyle. If you want to drive around in a seven-year-old Toyota while your spouse wants to live like a Kardashian, neither one of you is going to be very happy.
- Keep positive goals in mind. Don’t focus on the denial aspect of financial responsibility; focus on the positive aspects of it instead, such as a brighter future and a stronger sense of control over your life. View financial responsibility as an act of empowerment, not one of denial.
The people profiled in the Times article are living such good lifestyles that I probably would not even have used the word “frugal” in the title. To me, it just seems sensible; but that probably says something about my overall mindset, not to mention why my wife showed me the article in the first place….
Around this time of the year, new college graduates are leaving their schools with a wealth of knowledge. At the end of their four (or six, or eight…) years of college, graduates have typically tackled a wide range of academic subjects, often with an impressive degree of complexity. Unfortunately, one type of lesson many of them are missing as they venture out into the real world is basic schooling in personal finance.
Here are seven personal finance lessons that recent grads might find helpful, because they probably were not taught these things in school:
- Student loans need a repayment plan.
According to the National Foundation for Credit Counseling, the average American college student now has $27,000 in student loan debt at graduation. Make sure you know the schedule of when payments on your loans will start coming due (typically, this is six to nine months after graduation). If it looks like you will have trouble paying, explore options for alternate payment schedules. Most of all, stay in contact with your lender to find a workable solution. If you simply default, it can have drastic consequences which can include having your wages garnished, your tax refunds confiscated, and long-lasting damage to your credit record.
- Credit cards should be for short-term borrowing.
Recent grads are often deluged with credit card offers. This is not necessarily a bad thing. Credit cards can give your finances some flexibility while helping you build a credit history. The key is to understand and live by this rule: Credit cards should be used only for short-term borrowing. If you use them as a cash substitute during the month and pay off your balance at the end of each month, they can be a free resource, and you might even earn some rewards points in the process. However, if you use them to maintain a lifestyle you can’t afford, you will end up with two big problems: That lifestyle will come to an abrupt end when you reach your credit limits, and credit card debt carries a very expensive interest rate.
- The job market may be very different in the next state.
Having trouble finding a job in your area? Use the fact that you are probably not tied down yet to your advantage and look elsewhere. The unemployment rate in some states is more than twice as high as in others, and the job market can vary even more greatly in some professions.
- There is more to a job offer than salary.
When you compare job offers, be sure to calculate the economic value of any benefits that come with those offers. This includes things like how much they might pay toward your health insurance, or what kind of employer match they make on retirement plan contributions. These amounts can be in the thousands of dollars, so differences in benefits could easily tip the balance in favor of one job over another.
- Don’t be on the hook for your roommates.
Pitching in with others is often the only way a recent grad can afford a place to live, especially in expensive urban areas. Just be careful about whose name is on any legal agreements such as leases or utility accounts. You should take your share of responsibility, but make sure it doesn’t all fall on you if the others don’t pay their share. People’s lives can change quickly in the months after graduation, so avoid financial commitments that involve others.
- The right saving account will pay you for doing nothing.
As you handle the wave of new responsibilities that comes after graduation, you might fantasize about getting paid to do nothing. In a sense, the right savings account will do this. Most savings accounts these days pay almost no interest, but a few are paying around 1 percent. Find one of these relatively high-paying savings accounts, and it will keep paying you month after month with no further effort on your part.
- Overdraft protection is a sucker’s deal.
When you sign up for a checking account, your banker will probably offer you a helpful-sounding service known as overdraft protection. Be sure to decline it. In exchange for temporarily covering any overdrafts in your account, the bank will charge you a fee for each occurrence that is often several times the amount of the overdraft itself. This is a deal that is good for the bank but bad for the customer, so opt out.
It is commonplace to say that there is no teacher like experience when it comes to handling money, but imagine if you took that approach to biology, accounting, or whatever your chosen field is. If you had to experience everything first hand, knowledge would never get a chance to progress very far! Learning from others can help you get more out of your own experiences — and when it comes to personal finance, it can help that experience come at a much cheaper price.
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