Wisdom Wednesday: Treat Your Personal Finances Like a Business

Photo from H&R Block

Since becoming adept in my studies of Business, Accounting, Finance, and Economics, I have made it a point to look at my personal finances with business acumen.  Before looking at numbers, I had to first think about why I am making my personal finances one of my life’s ongoing focuses.  Here’s what I came up with:

“To live a secure life, with the freedom to live in comfort, where I want, and continually experience the joys of time with friends, family,with professional and personal endeavors that feed my passions.”

This might seem kind of corny, but any legitimate business will have a charter indicating its purpose.  If a company does this, why shouldn’t we?  People start businesses to better their personal financial position, which hopefully is geared towards living their eventual dreams.  Dreams don’t usually happen overnight, and that’s why you need a mission statement. 

Next, you need to think about profitability in terms of your personal life.  One way to look at it is to consider your savings your actual earnings & profits (E&P).  E&P is a tax term, but can also be equated to net income and retained earnings.  During your working life, you should aim to have a constantly increasing bucket of retained earnings.  These first take the form of your three to six months of emergency savings, then your retirement accounts, home equity, and other investments made further down the road of life.

Increasing revenues, or income, should also be a big focus for individuals and businesses.  A firm may invest in new product development and the individual might want to invest in higher education or a certification.  Either way, both are looking at the big picture.  If you love your job and the pay increases are holding you back from meeting your personal goals, then look for ways to make yourself more valuable to your employer.  Alternatively, maybe you can start a second job, or “side hustle” to bring in more income.  Either way, you need be looking at ways to increase your income to stay on track and build wealth.  You might also need to consider if you are paid fairly compared to others doing similar work in your market.  Look for resources like Glassdoor for comparative salaries in your geographic area.  Always be on the lookout for opportunities to grow your career and income.

Sometimes you will have “storms” in your life, which will sideline your ability to save.  Other times you will have wants that might have you dip into savings, but this is okay if you are progressing on an annualized basis.  Taking time and money for a wonderful vacation, to start a family with kids, care for parents or loved ones who are ill, or renovating your home to improve your quality of life are all common and valid reasons to temporarily sideline savings.  This concept can be related to a business taking money and having team building days, or company picnics and award parties.  In the grand scheme of both life and business, taking some time and money to do fun things improve the overall quality and give you the motivation to keep going when you get back to work.

Ultimately, you cannot measure the quality of your life by your net worth, but you can definitely make your life less hectic and more predictable, giving you the flexibility to try new things and live out your dreams.  Life is short, but money can be shorter if you don’t plan for the future and monitor your progress.  Live in the present, plan for the future, and be prudent for the sake of making the really important things happen in life.  Stay safe, happy, and focused!

I want to hear why you work, sacrifice, and save!  What motivates you to get up and work each day?  If you are fortunate enough to not need to work anymore, what are you doing with your time? 

Credit Scores: Playing the game

If you’ve been following my posts, you probably realize I’m not very excited about debt.  Like most things I’ve ever wanted in life, a great credit score is something that I wanted for years and today don’t care to use very often.  I used to be all about getting the best interest rates, but today it’s about saving as much as I can to build wealth and realize my next big dream of owning a house I designed, on a good sized lot, away from people.  Well, far enough away that my Great Danes barking near the house won’t both my neighbors. 

Image from wsj.com

I learned a long time ago, building credit is a like a game.  It’s you against your creditors.  If you minimize your balances and carry almost no credit card debt, don’t open new accounts often and always pay on time, you will build a great score after several years with minimal interest paid, and you win.  If you’re impatient, run up your cards near or over their limits, and pay late, you’ll suffer financially and you lose on interest and fees and your score is lower. My advice is to never open a card account if you don’t have self-control.  I do admit having self-control with credit and the self-control to stick to a budget is pretty much the same thing. 

Throughout the years, I have found it much easier to spend on credit.  Every automobile I have purchased was on credit, although through each car acquisition, I had more down and a priority to pay off the load as fast as possible.  Now that I have enough saved to go out and buy a car with cash, I wouldn’t dream of parting with my hard-earned cash.  I’ll continue to enjoy my paid-for truck for years to come. 

What makes up your credit score?

Generally, there are five attributes that are counted in your credit score (listed in order of importance):

  • Payment history:  Do you pay on time? (35%)
  • Amounts owed:  How much of your credit lines are utilized? (30%)
  • Length of credit history:  How old is your oldest account and the average age accounts? (15%)
  • New credit:  How many new accounts do you have and can you manage them? Inquires? (10%)
  • Types of credit used:  What is the mix of cards, installment loans, and mortgages? (10%)

For more detail on what makes up the average credit score, check out this old CNBC post as it is still relevant today!

Each attribute is weighted more than the other because paying on time is more important than your credit mix, but it all adds up.  This is why you can build a decent score in as little as two years, but it will take seven or more, and take multiple loan types, to show you really know how to handle your debt load.

To have the best scores, you should rarely apply for new credit.  Once you find a great credit card, if you use one, stick with it.  Don’t try to open up new cards in search of better rewards.  Also, if you do open a new credit card, do not close the old one unless it has an annual fee.  Try to keep the card active by charging something every few months and paying it off before interest accrues.  I have a lot of good card accounts that I have obtained over the last 20 years, and keep open just because of age and the high limits help me ensure that even if I have a balance of $5,000 or so one month, my utilization is only around 2-3% of my total credit lines.  Always keep your purchases well below your limits.  If you keep getting close to the limit but pay it off before interest is due, apply for a credit line increase to help keep your score high.  Remember the credit is like having money.  The more you have, the less you need, and the more attractive you are as a borrower (until you borrow too much!).

As far as credit mix, having auto loans, student loans, and mortgages will all help your score.  Mortgages are considered “good debt”, which is debt that shows you are really responsible and making sound financial choices.  Also, it usually means you have equity and assets, which means if you don’t pay your creditors, they can try and put a claim towards your assets and gives them a little more assurance you will pay them back.  Most people who own homes are responsible and want to keep their home, therefore why credit card companies love homeowners.  If you have not assets, besides retirement assets, you are judgment proof and if you default, creditors will have no asset to try and claim, so all they get to do is put a bad mark on your credit and make it impossible for you to borrow until you clean up the mess or it ages off your report in a decade.

Earlier, I mentioned that I don’t strive to have the best credit cards or brag about my credit score.  As I’ve learned through the years, showing how much you can borrow through flaunting lavish houses and flashy cars is not the best use of credit.  Instead, build credit to get the best mortgage rate and know that insurance companies look at credit scores when setting auto premiums.  When you do borrow, do it strategically.  For instance, I really am tempted to pay down my mortgage, but my interest rate is so low, that I feel good having a beefy emergency fund and plunking a large amount of my paycheck into retirement.  Based on historical, long-term returns, I will come out ahead having my cash compounding at 8-12%, rather than at 3%, which is what I get while I pay off my mortgage. 

I do agree with Dave Ramsey that you can pay your house off quickly and then shove boat loads of cash into investments afterward, and probably come out about the same, and there is more risk involved with holding a mortgage, but I do insure against potential chaos with a large emergency fund. If I had kids depending on me, I might change my strategy, but being single, I feel pretty good about my risk levels. 

How do you feel about the use of credit scores in consumer lending?  Is it a fair practice?  Do you think that creditors should look at other factors besides a score? Leave me a comment! I’d love to hear from you.

Learning to Behave, Financially

Personal finance bloggers give a lot of advice on what to do to save money or how to set up a budget, but it is a well-known fact that personal finance success is mostly reliant on your behaviors and patterns.  We all know that we should be saving some money for retirement and that a “rainy day” is coming sooner or later, but how can we put mind over matter?

Start small.  You may be gung-ho on getting your financial life turned around, but it often isn’t realistic to implement your plan in one day, one week, or even one month.  Instead of planning to do it all from the start, incrementally work your way towards success.  For example, if you eat out for lunch every day, start bringing your lunch one or two days a week.  If you spend substantially less than when you eat out, such as bringing a $3.00 frozen meal instead of spending $10.00, transfer $7.00 to your savings, or allocate that amount to your debts.  If you equate your behavior to actual money in the bank, you are likely to keep it up as you see your progress. 

Track your progress.  How many times have you made a perfect budget only to get so busy that you don’t track what you spent money on?  Let’s face it; not all of us are accountants with a love to tracking every cent that comes in and out.  Automate by using Mint or Everydollar, which sync bank and card accounts using a phone app and a web login.  Couples can stay in sync on income and spending by merging finances.  If a couple can get on the same page with money, you likely can conquer most other marital spats that come up over the years. 

Personally, I love tracking changes in my net worth over time.  If you have software that lets you download your finances, you can do this in Excel or run a report.  I use Quicken, but I am a dinosaur and now have to pay for Quicken, and I will give a crash course in a post later this month!  An alternative is to list all your assets on the top of a page or spreadsheet and list all your debts below.  Add up both assets and liabilities, and then take the difference of the two.  This is your net worth. Hopefully your assets are more than your liabilities, but I too once had a negative net worth.  It takes time and focus, so don’t let this number stop you before you start.

Net worth Report from Quicken Desktop 2020

Set attainable goals.  Instead of only making one big, fat, hairy goal, break it down into baby steps.  We all want to have a net worth of one million dollars when we are just getting started, but it takes years of good behaviors.  If you set out to save a million dollars for retirement, work backwards to figure out how much you will need to contribute at a historical rate of return that matches your investment risk levels.  Most retirement fund websites have calculators that you can plug in the number of years you have to work and the amount you want to retire with.  If you are paying off debt, list them out and make a game plan.  When you pay one off, celebrate a little and look forward to the next win!

Reward thy self.  If you set savings or debt reduction goals, and you meet them, be sure to splurge a little on one night out or a new clothing item.  You should set a limit for yourself, say $50, for a monthly treat, or maybe as much as a few thousand when you meet a major goal such as saving up three months of expenses or paying off all your consumer debt.  Of course, don’t go into debt or reduce your emergency fund to have fun, make sure you earmark new cash for this purpose.  Just as you sacrifice to complete a degree or get your kids through school, changing money behaviors is just as much of an accomplishment.  Change your behaviors slowly and they will become habit, which will show in the long run.

What’s your worst money habit?  Leave me a comment on my blog page!