Category Archives: Debt

How the Economy Works by Ray Dalio

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“Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income.” Ray Dalio

Ray Dalio is one of most successful hedge fund managers and founder of Bridgewater Associates. He credits much of his success to guiding principles that he has used to make decisions both in his professional and in his personal life.

How the Economic Machine Works – “The economy is like a machine. At the most fundamental level it is a relatively simple machine, yet it is not well understood,” explains Ray Dalio.

Economic principles discussed:

  • Economy – The economy is simply the sum of all transactions repeated again and again over a long period of time. Money and credit account for the total spending in an economy.
  • Transactions – the exchange of money or credit between a buyer and seller for goods, services or financial assets.
  • Markets – “All buyers and sellers making transactions represent the market. For example, we have wheat markets, stock markets, steel markets, oil markets and so on.The combination of all of these sub-markets is the entire market, or the entire economy.” Ray Dalio
  • Governments – the biggest buyer and seller of goods, services and financial assets. The government consists of two parts: the central government that collect taxes and spend money; and, the central bank which controls the amount of money flowing through the economy. It does this by influencing interest rates and printing more money.
  • Central Bank – The Central Bank can only buy financial assets, not goods and services. To support the economy, the Central Bank buys Government bonds which gives the Central Government the ability to buy goods and service.
  • Price – the result of total spending / quantity sold.
  • Credit – Credit “is the most important part of the economy because it is the biggest and most volatile part”. Credit can be created out of thin air — in fact, in 2016, the US$50 trillion of the US$53 trillion in the economy was credit, as opposed to ‘real’ money. Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income. Credit is bad when it finances over-consumption and borrowers are unable to pay the debt back.
  • Lenders – lend money to make more of it. When lenders believe borrowers will repay, credit is created.
  • Borrowers – borrowing is pulling spending forward which relates to borrowing money to buy something you can’t afford, such as a house, a car, a business or stocks. Borrowers promise to repay the amount borrowed (the principal) with interest. Borrowing creates cycles.
  • Debt – Debt allows you to consume more than you produce when it is acquired, and forces you to consume less when you have to pay it back. “When credit is issued it becomes debt. It’s a liability for the borrower, and an asset for the lender. It disappears when the transaction is settled.
  • Interest Rates – When interest rates are high, borrowing is low. When interest rates are low, borrowing is high.
  • Spending – one person’s spending is another person’s income. Total spending is the sum of money spent plus of credit spent.
  • Income – one person’s spending is another person’s income
  • Monetary Cycles – economy expansion and recession cycles.
  • Inflation – inflation is when prices rise. When spending is faster than the production of goods, it means that we have more demand than supply, which results in inflation.
  • Deflation – when spending decreases, prices tend to decline.
  • Expansion – growing markets and increasing transactions
  • Recession – Economic activity decreases, and if unchecked this can lead to a recession.
  • Bubbles – when the price of assets far exceed the value of the assets
  • Debt Burden – When incomes grow in relation to debt, things are kept in balance. But a debt burden emerges when debt growth exceeds income growth. This debt to income ratio is the debt burden.
  • Productivity – innovation and hard working raises productivity, which equates to the amount of goods and services produced.

Three rules of thumb for life

Source: Ray Dalio

According to Dalio, there are “three rules of thumb” with which to navigate the economy, be it in your own businesses, organisations you work at or your personal finances.

  1. Don’t have debt rise faster than income (because debt burdens will eventually crush you).
  2. Don’t have income rise faster than productivity — it will eventually render you uncompetitive.
  3. Do all you can to raise productivity — in the long run that’s what matters most.

References:

  1. https://www.nofilter.media/posts/ray-dalios-economic-machine-12-minute-summary
  2. https://www.amazon.com/gp/product/1501124021/ref=as_li_qf_asin_il_tl_nodl?

Credit Report Information 101

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Your credit history is one of the factors that lenders use to assess your creditworthiness so it is important to understand what information has been reported to your credit file. 

Ancient Greek playwright Sophocles wrote, “Wisdom outweighs any wealth.” While this statement certainly rings true, it’s also true that wisdom can play a major role in building wealth—particularly when it comes to effectively managing your finances and credit.

Consumers with excellent credit scores  tend to pay less for major purchases. In short, your credit is your financial calling card, it can both open and close doors. Credit reports have also become essential tools beyond the financial world. Nowadays, your housing or employment status could be decided by your credit history; and maybe even your love life.

Thus, it is important to be prepared for anything on your horizon by understanding how your credit and credit score can impact financial progress and wealth building. The three major credit reporting bureaus — TransUnion, Equifax and Experian — maintain credit reports. The reporting companies issue credit reports to creditors, insurers and others as permitted under law for the purposes of evaluating your financial responsibility.

Tablet - 3 Bureau Reports & Scores

Here is an example of how the system works:

Apply for a Credit Card – When you apply for a new credit card, the creditor requests a copy of your financial history, or credit report, from one or more of the credit reporting companies.

The Creditor’s Assessment – The creditor may use your credit report, a score, and other information you provide (such as income or debt information) to determine whether to approve your application and what rates to offer.

The Creditor’s Decision – If you are issued a card, the creditor reports that account to the credit reporting companies, and then updates it, including your balance and payment activity, about every 30 days.

Your Credit Profile Updated – The credit reporting companies update your credit report as they receive new information from creditors and lenders. Your credit profile changes based on your financial activity. The next time you apply for a credit card or loan, the process repeats.

Managing Your Credit Report

Your report is divided into six main sections. When you open a new account, miss a payment or move, these sections are updated with new information. These sections are:

  • Identifying Information (name, address, birth date and Social Security number)
  • Employment
  • Consumer Statement
  • Account Information
  • Public Records
  • Inquiries

Negative records – Late payments create a negative record. Generally, negative records will stay on your report for up to 7 years (up to 10 years for certain bankruptcy information). Positive records can remain on your credit report longer.

Your Credit Report is updated in most cases every 30 days – Your credit report is updated with new information reported by your creditors. Most creditors report new information approximately every 30 days, to reflect your account balances and payments you make.

Check every 6-12 months – Not all creditors report to all three companies; the companies obtain their data independently, so your credit reports from TransUnion, Equifax and Experian could substantially differ. That’s why it’s important to check your three credit reports every 6-12 months to ensure that the information is accurate and up-to-date.

Check Your Credit Report regualarly…checking your own credit will NOT harm it.

Correcting inaccuracies – Under the Fair Credit Reporting Act, consumers are protected if there is inaccurate information on their credit reports. If you find inaccurate information on your credit reports, you can contact the associated creditor or lender directly. You can also dispute the inaccuracy with the credit reporting companies.

Know the system – Managing your credit and maintaining a good credit history can lead to better rates on major purchases. It’s recommend that you check your credit reports every 6-12 months, or at least 3 months before a major purchase, in order to identify potential inaccuracies and any signs of identity theft.

Routine check-ups, along with paying your bills on time, keeping your credit card balances below 35% of their limits, and correcting any inaccuracies will help ensure your credit reports are viewed in the most favorable light.

Finally, if you believe you’re a victim of fraud, you can activate automatic fraud alerts and the credit bureaus will place an initial alert on your credit report. This alert encourages lenders to take extra steps to verify your identity before extending credit.

References:

  1. https://www.creditonebank.com/articles/10-famous-quotes-about-finances-credit

Budgeting 50-30-20 Strategy and Cash Flow

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Managing your money and tracking your finances is essential in building wealth, but it doesn’t have to be complicated or painful process. It can be as simple as creating a budget. And, a budget starts with listing of your income and your expenses.

One simple strategy for tracking your personal cash flow (income and expenses) is the 50-30-20 budgeting strategy. With this budgeting strategy, you divide your income into three broad categories: necessities, wants, and savings and investments, according to those ratios.

—- 50% of your income should go toward things you need

This category includes all of your essential costs, such as rent, mortgage payments, food, utilities, health insurance, debt payments and car payments.

If your necessary expenses take up more than half of your income, you may need to cut costs or dip into your wants fund.

—- 20% of your income should go toward savings and investments

This category includes liquid savings, like an emergency fund; retirement savings, such as a 401(k) or Roth IRA; and any other investments, such as a brokerage account.

Experts typically recommend aiming to have enough cash in your emergency fund to cover between three and six months worth of living expenses. Some also suggest building up your emergency savings first, but, you don’t just want to save this money.

You want to invest it and make it work for you. That means contributing to your employer’s 401(k) plan if they offer one or saving in other retirement accounts, such as a Roth IRA or traditional IRA.

—- 30% of your income should go toward things you want

This final category includes anything that isn’t considered an essential cost, such as travel, subscriptions, dining out, shopping and fun.

This category can also include luxury upgrades: If you purchase a nicer car instead of a less expensive one, for example, that dips into your wants category.

But think about what matters to you before spending this money. As research shows, how you spend is oftentimes more important than your overall income or the amount you spend in total.

Money experts suggest you spend on experiences, such as trips or classes, rather than things. “All of the best psychological research on money and happiness tell us that spending money on experiences brings more (and more lasting) happiness than spending money on material objects,” says Ron Lieber, New York Times columnist and author.

There isn’t a one-size-fits-all approach to money management, but the 50-30-20 plan can be a good place to start if you’re new to budgeting and are wondering how to divide up your income.

References:

  1. https://www.cnbc.com/2021/06/25/best-free-budgeting-tools-2021-how-to-make-your-own-spreadsheet.html
  2. https://www.cnbc.com/2021/05/11/how-to-follow-the-50-30-20-budgeting-strategy.html
  3. https://www.cnbc.com/2019/07/22/use-the-50-30-20-formula-to-figure-out-how-much-you-should-save.html

The Three C’s of Credit

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Borrowing (using credit) allows people to purchase goods and services that they can use today and pay for those goods and services in the future with interest.

Credit can be a powerful tool that helps you improve your finances, get access to better financial products, save money on interest, and can even save you from putting down a deposit. The benefits of a positive credit report and good credit score are extensive.

The biggest benefit of good to excellent credit is saving money. When buying a home, for example, good credit can easily save you tens or even hundreds of thousands of dollars in interest on a 30 year mortgage. Essentially, a lower interest rate means you pay less money. A higher interest rate means you pay more money.

Conversely, credit can be detrimental which entraps and burdens people financially. Access to credit may make it easier to pay for basic needs and cover emergency expenses, but it also simplifies buying expensive products you might want but not need. Psychologists have found that people often use credit unwisely due to natural human impulses.

Additionally, the interest rates on consumer credit are often staggeringly high and can force consumers to pay back several times the initial value of their purchases. The average annual interest rate on credit cards can be as high as 21 percent– more than five to eight times higher than the typical interest rate on a 30-year mortgage, which hovers around 2.5 to 4 percent.

Interest is what you pay for using credit or “someone else’s money”.

As you can see, using credit has both financial benefits and costs. At times, it can be a means to purchase assets with borrowed capital, but it can be also an indication that something has gone wrong with your money management and financial planning (spending too much and/or saving too little relative to your income). There are ways to use debt or credit sparingly and manage the use of credit.

People choose among different credit options that have different costs. Lenders approve or deny applications for loans based on an evaluation of the borrower’s past credit history and expected ability to pay in the future. Higher-risk borrowers are charged higher interest rates; lower- risk borrowers are charged lower interest rates.

Credit or loan providers may include banks, credit unions, car dealers, credit-card companies, or department stores. And, some things people often use credit or a loan to purchase vary but may include a house, car, college or travel.

The three C’s of credit (capacity, character, and collateral), assess the riskiness of lending to that individual based on these character- istics, and then decide whether or not to approve or deny the loan request.

Lenders expect all the money they lend to be fully repaid with interest. Thus, when deciding whether to make a loan or offer credit, lenders want to know the likelihood that the individual will repay the money. Thus, lenders want financial information about a person before lending that person money.

The three questions lenders generally want answered before granting a loan are factors known as the “Three C’s of Credit”: Capacity, Character, and Collateral:

  • Capacity: What is the individual’s ability to repay the loan?
  • Character: What is the individual’s reliability to repay the loan?
  • Collateral: What assets does the individual own that could be sold to repay the loan?

Each “Three C’s of Credit” factor attempts to provide a measure to help a lender answer each question about a borrower. The results vary from person to person, with a wide range of possibilities.

  • Capacity: The amount of debt a borrower has relative to his or her income is an indication of “capacity,” that is, that person’s ability to repay debt. For example, an individual with debt payments that are a large percentage of his or her monthly income would be less able to take on more debt than someone with debt payments that are a smaller percentage of his or her income.
  • Character: A credit score is an indication of “character” because it indicates a person’s reputation for paying bills and debts based on past behavior. A credit score is a number based on information in a credit report, which indicates a person’s credit risk. Credit scores are often called FICO scores. FICO is an abbreviation for Fair Isaacs Company—the first company to develop credit scores. Credit scores generally range from 350 to 850, with 350 indicating low reliability and 850 indicating high reliability. A low credit score indicates that a person has not been responsible with credit in the past.
  • Collateral: Collateral is property required by a lender and offered by a borrower as a guarantee of payment on a loan. Also, it can be a borrower’s savings, investments, or the value of the asset purchased that can be seized if the borrower fails to repay a debt. For example, a borrower who owns many other assets such as stocks, bonds, or real estate would be able to sell some of those assets to repay a loan if necessary. As such, lenders will see the loan as less risky than a loan to someone with few or no assets.

The three C’s affect each other by having a favorable rating on one C may help you have favorable ratings on others; for example, capacity may make collateral more likely. Lenders use this type of background information to make some lending decisions.

Borrowers who repay loans as promised show that they are worthy of getting credit in the future. A reputation for not repaying a loan as promised can result in higher interest charges on future loans, if loans are available at all.

Loans can be unsecured or secured with collateral. Collateral is a piece of property that can be sold by the lender to recover all or part of a loan if the borrower fails to repay. Because secured loans are viewed as having less risk, lenders charge a lower interest rate than they charge for unsecured loans.

Lenders make credit decisions based in part on consumer payment history. Credit bureaus record borrowers’ credit and payment histories and provide that information to lenders in credit reports.

Lenders can pay to receive a borrower’s credit score from a credit bureau. A credit score is a number based on information in a credit report and assesses a person’s credit risk.

“Debt is a trap, especially student debt, which is enormous, far larger than credit card debt. It’s a trap for the rest of your life because the laws are designed so that you can’t get out of it. If a business, say, gets in too much debt, it can declare bankruptcy, but individuals can almost never be relieved of student debt through bankruptcy.” Noam Chomsky

References:

  1. https://www.stlouisfed.org/~/media/education/curriculum/pdf/making-personal-finance-decisions-complete-unit.pdf
  2. https://www.self.inc/blog/benefits-of-credit

Historic Inflation Worries Americans

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Worries by Americans over historic inflation level and higher retail prices are now larger than concerns about the coronavirus pandemic, according to recent polls from Monmouth and AP-NORC.

The U.S. consumer price index rose 0.8% in November from October. The Labor Department said consumer prices grew last month at an annual rate of 6.8%, which is the highest in 39 years since President Carter administration. The growth in prices were led by cars, food, gasoline, electricity and fuel oil.

As the bulk of Americans cite inflation and paying their bills as their top concerns, President Joe Biden’s job approval ratings fell to new lows with 69% disapproving of how he is handling inflation, according to an ABC/Ipsos poll.

Additionally, inflation concerns could potentially cost the President and Democrats’ their coveted social and environment legislation. It is believed that adding additional fiscal spending to already exploding government debt that adds juice to the economy might worsen inflation critics assert.

Most economists agree that the Build Back Better bill would add to inflationary pressures in the short run, however, they differed over its effects on inflation over the long term. Furthermore, most economists see inflation coming down sometime next year, but the debate is over how soon and by how much.

The bill will probably increase demand over the next few years, Harvard University professor Doug Elmendorf said. “That will tend to push up GDP and employment and inflation — which is not the policy impulse we need right now,” he added. Elmendorf served in the administration of former Democratic President Bill Clinton

References:

  1. https://www.barrons.com/articles/two-thirds-of-americans-polled-disapprove-of-how-biden-has-handled-inflation-51639331904
  2. https://www.bloomberg.com/news/articles/2021-11-17/top-economists-see-biden-s-spending-plan-adding-to-inflation

Planning and Achieving Financial Freedom

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Financial freedom can be an elusive—and hard-to-define—goal.

Financial freedom is often said to be in the eye of the beholder. To some it may mean freedom of debt and being able to fund your lifestyle with your cash flow; to others it may mean early retirement on a Caribbean island. Whatever your financial goals or definition of financial freedom, there are ways and things you can learn to help you get your financial house in order.

Once you’ve decided that financial freedom is one of your top goals, you can start taking steps to achieve it. Thus, the first step toward achieving financial freedom is to define exactly what it means for you. You can’t generally achieve something that you haven’t defined. So, once you’ve defined what financial freedom means to you, you can start taking steps toward your goals.

“What then is freedom? The power to live as one wishes.” Marcus Tullius Cicero

Just because you have money does not mean you have financial freedom. There have been numerous people, especially professional athletes and entertainers, who have earned millions of dollars and subsequently lost it all through reckless spending and debilitating debt. Thus, even if you have a lot of money, if you don’t know how to manage and make your money work for you, it will more than likely disappear.

Financial freedom typically means having enough savings, financial assets, and cash on hand to afford the kind of life you desire for yourself and your families. It means growing savings and investments to a level that enables you to retire or pursue the career you want without being driven to earn a wage or salary each year. Financial freedom means your money and assets are working hard for you rather than the other way around…you’re working hard for your money.

In other words, financial freedom is about much more than just having money. It’s the freedom to be who you really are and do what you really want in life. It’s about following your passion, making choices that aren’t influenced by your bank account, net worth or cash flow, and living life on your terms.

Track your expenses

It’s difficult to know how to save money if you don’t have a good idea of where your money is going. Carefully track your spending habits for a typical month. Doing this will help you to become more conscious of your discretionary expenditures. It will also reinforce what expenses are essential and remind you to plan for unexpected expenditures, like medical emergencies and car repairs. Therefore, it is vital to understand and to know where your money is going.

Make a budget

Once you’ve taken inventory of your expenses, next step is to create a budget. While budgeting can sound like a cumbersome task, you may want to start by using a budgeting calculator to get a feel for how you are currently spending your money and how you’d like to change your spending.

One popular budgeting method is the 50/30/20 rule. The 50/30/20 rule is a way to divide your post-tax income based on your needs, wants and savings. The rule states that people should spend 50% of their income on their needs. This includes health insurance, housing, transportation, and groceries. Then, the guideline states that people should spend 30% of their income on wants or non-necessities such as entertainment, travel, and more. Finally, the last 20% of a person’s income should be saved or invested. This might include retirement savings and building a stock portfolio.

Once you have created a budget, don’t put it in a drawer and forget about it. Instead, make it a working and living document that you check and refer to often. Spend a half-hour per month reviewing how your actual expenses match your budget and make adjustments as necessary.

Automate your savings

Automating your savings and investing is one of the easiest steps you can take to ensure that you are on the path to financial freedom. You can set automated contributions to your employer-sponsored investments, including your 401(k) contributions and employee stock options.

When your savings and investing are automated, your money will continue to grow without you having to think about it. This will help you to reach your financial goals easily and quickly.

Have some percentage (10% to 20%) of your paycheck automatically deposited into a separate account—whether it’s a savings account, a 401(k) or an IRA. Money that isn’t easily accessible is not easily spent.

Unfortunately, many Americans are not saving enough to maintain their current standard of living during their retirement years. It was found that about 21% of Americans have nothing saved for retirement, according to the Northwestern Mutual’s 2018 Planning & Progress Study.

Start investing early

Follow the adage, the best time to start investing was twenty years ago; the second best time is today. You should start investing in a tax deferred account, preferably with your employer matching a portion or all of your contribution.

Planning for retirement is a marathon and not a sprint. Even if you are starting small, the most important thing is to get started. Therefore, it will likely take decades to reach your goal. Therefore, it is important to remember why you want to achieve financial freedom. Keeping your purpose, goals and the bigger picture in mind will help you navigate the day-to-day financial decisions.

Once you become financially free, you have more choices of how to live your life and spend your days.

When you decide that you want to start working toward financial freedom, it is important to remember that you will not become financially free overnight. However, according to certified financial planner David Rae, in a 2018 article in Forbes magazine, there are eight hierarchies of financial freedom that you can work towards:

  1. Level 1: Not Living Paycheck to Paycheck – The first level of financial freedom is building up an emergency fund and paying off any credit card debt. Unfortunately, living paycheck to paycheck is the reality of millions of Americans. According to the Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2017, some 40% of households could not cover a $400 unexpected expense.
  2. Level 2: Enough Money to take a sabbatical from your work – Accumulating enough money to be able to take a break away from work can be rewarding. This does not mean you have to quit your job, but it sure is a good feeling to know you can.
  3. Level 3: Enough to be Financially Happy and still Save – it’s about enjoying your life and having the money to do it. There can be peace when you are earning enough to save, doing the things you enjoy and still having extra at the end of the month.
  4. Level 4: Freedom of Time – Many people desire more flexibility with their schedules. Freedom of time and financial independence go hand in hand. Together, they are about following your passion, or spending more time with family, and not going completely broke doing it.
  5. Level 5: Enough for a Basic Retirement – Think about what your bare minimum retirement would look like. By knowing your bare minimum retirement, and knowing that you have enough money saved to at least cover some standard of living in your retirement, will also influence other life choices you may make along the way.
  6. Level 6: Enough to Actually Retire Well – Knowing you are on track to accumulate a nest egg to support that lifestyle is a big win. Well done to those who have accumulated enough assets, or passive income streams, to be in a position to retire well.
  7. Level 7: Enough for Dream Retirement – It would feel great knowing that you are on track to have enough money to retire and be able to live your dream life. What is stopping you from getting there.
  8. Level 8: More Money Than You Could Ever Spend – Having more money than you expected to spend is great. Building enough wealth so that you could not possibly spend all of it is another.

Bottomline is that if you want to be financially free, if you want to be able to live the lifestyle of your choosing while responsibly managing your finances, you need to become a different person than you are today and let go of the financial mindset that has created your current financial predicament and has held you back in the past.

Attaining financial freedom, which means having enough savings, investments and cash flow to live as you desire, both now and in your later years, requires a continuous process of growth, learning and emotional strength. In other words, whatever has held you back and provided you comfort in the past or kept you less than who you really are will have to be replaced. You will have to become comfortable for awhile being uncomfortable. And in return, the financially empowered, purposeful, and successful you will emerge — like a butterfly shedding its cocoon.

References:

  1. https://www.richdad.com/what-is-financial-freedom
  2. https://smartasset.com/financial-advisor/financial-freedom
  3. https://www.forbes.com/sites/davidrae/2019/04/09/levels-of-financial-freedom

Americans in Debt

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“U.S. adults carrying debt hold an average of $23,325, exclusive of mortgages

Most Americans carry some form of personal debt. In fact, 77 percent of Americans have debt, according to the 2018 Northwestern Mutual Planning and Progress study.  And, if you have significant levels of debt, you need a financial plan to manage your debt and get out of it. That’s because debt can cost you money, potentially a lot of money for a long period of time.

In fact, if you take the time to tally how much you’re paying in interest over the life of your debt, it might just be the motivation you need to finally make a big push to pay off your debt so you can spend that money on something you enjoy or can invest in your long term financial freedom.

The Northwestern Mutual’s 2021 Planning & Progress Study showed that among U.S. adults aged 18+ who carry debt, they hold an average of $23,325 excluding mortgages. This represents a downward trend of over 20% since 2019.

While overall debt is on the decline, 30% of Americans’ monthly income on average goes towards paying off debt other than home mortgages.

Far and away, the top source of debt after mortgages is credit cards, accounting for more than double any other source, according to the study:

  • Credit card bills – 19%
  • Car loan – 8%
  • Education loans – 7%
  • Home equity/lines of credit – 4%

Debt under control, or controlled by debt?

“78% of Americans say debt has impacted their ability to achieve financial security.”  Northwestern Mutual’s 2021 Planning & Progress Study

When prioritizing debt versus savings, the interest rate on your debt is a key consideration. The higher the rate, the more you stand to save by paying off the debt.

But also consider the type of debt. A debt can be “secured” or “unsecured”. A secured debt is backed by an asset, also called collateral. Auto loans and mortgages fall into this category: Both allow the lender to repossess the asset if you stop paying the loan. In other words, they can take what you bought with the loan and sell it to get their money back.

With debt consuming nearly a third of monthly budgets on average, many people also say that it has negatively impacted their ability to pursue other financial milestones. Because of Americans personal debt:

  • 29% delayed making significant purchases
  • 18% delayed saving for retirement
  • 14% delayed buying a home
  • 8% delayed having children
  • 7% delayed marriage

Having to pay down debt also carries weight in the way people feel about their long-term financial stability – 78% say that debt has impacted their ability to achieve long-term financial security.

“The latest numbers show steps in the right direction compared to previous years, but we continue to see debt hindering many Americans from having the financial freedom to make other important decisions in their lives,” said Christian Mitchell, executive vice president & chief customer officer at Northwestern Mutual. “Having a plan of action to manage debt and stay on top of payments is critical to achieving future financial goals.”

Although debt is holding some back from major decisions, there are positive indications that people are looking ahead to manage and reduce their debt. Two-thirds (66%) of those with some debt say they have a specific plan to pay it off, and have a timeline for doing so:

  • 45% only expect to be in debt for 1-5 years
  • 20% say for the next 6-10 years
  • 14% say between 11-20 years
  • 9% say for the rest of their lives

The cost of debt can add up quickly. Thus, it’s important to manage the amount and reduce the cost of your debt, and get it paid off. That way you can put that money to work for you financial freedom or toward something more fun, like your next vacation or retirement.

“Rather than lamenting you have too much debt, imagine how much better your life would be with less.”

There’s almost no better way to reduce your expenses and save money than unloading credit card debt. Ridding yourself of this high-interest debt offers returns that few investments can match over multiple years. Even though the S&P 500® has long-run average annual returns of 10%, most people should only expect to earn about 6% a year on average because they’ll hold a mix of assets (including bonds) that lowers their overall risk (and expected returns).

Here are several recommendations to assist you manage your debt and to think through what’s best for you and your money, according to Northwestern Mutual:

  1. COME TO GRIPS ABOUT SPENDING – Debt can pile up for all kinds of reasons. Paying it down should be pretty straightforward — but for that to happen you have to be honest about your spending. Putting your spending into perspective can help you manage and develop a plan to get yourself in better financial shape.
  2. GIVE IT A POSITIVE SPIN – Rather than lamenting you have too much debt, imagine how much better your life would be with less or none. Then set specific financial goals with a focus on debt reduction and elimination.
  3. AUTOMATE YOUR PAYMENT PLAN – Put as many of your credit card and/or loan payments on auto-pay from your checking or savings account. That way, you’ll be sure to avoid any unnecessary late fees.
  4. PRIORITIZE, PRIORITIZE – If you can’t pay all your debts each month, prioritize what you can pay. Give high priority to debts secured by a house or car, necessities like utilities and debts you can’t discharge, including student loans and unpaid federal taxes. Then tackle unsecured debt like credit cards. You’ll want to identify the credit card with the highest interest rate and pay that one off first. That way, you’ll save yourself money by avoiding unnecessary and excessive interest rate charges over the life of your debt.
  5. PAY AS YOU GO – It may seem old fashioned, but avoid paying with plastic and start using cash, check or debit card instead. Sure, it will take a little extra planning to make sure you have sufficient cash in your wallet, but doing so can help you clearly connect to where your money goes each day. It may also help you avoid impulse purchases and other unwise spending.
  6. MAKE MORE OF YOUR INCOME – Many people believe they don’t have enough money to put toward debt reduction. Ask yourself: Do I really need a latte every morning, or special cell phone services? Sticking to a budget isn’t easy, but if you save small amounts, you’ll be able to pay off your debt that much faster.
  7. DON’T LOSE SIGHT OF RETIREMENT – Paying off debt isn’t a free pass to put your retirement savings on hold, especially if your 401(k) at work offers a company match. Even if you’re paying off a high interest rate on your credit card debt, the employer match on your retirement savings makes your retirement plan contribution the better deal.

When it comes to your retirement, you want to make your money work for you. That’s where investing becomes most important. Sometimes, saving and investing makes more sense than paying off debt. With the interest rate on your debt below 6%, you may want to pay off that debt on schedule rather than making extra payments.

As an added incentive, the tax advantages of investing through retirement accounts like 401(k)s and IRAs can help your money go further over time than it would by paying off debt early.

Plus, you can only contribute so much each year to retirement accounts. Every year you don’t contribute is a missed opportunity to save. With many workplace plans, you also miss a chance to earn matching contributions—i.e., free money—from your employer. And thanks to compounding, the earlier you save, the more your investments could grow over time.

Personal debt has its purposes and financial benefits until it becomes unmanageable and you have trouble paying it off. In the worst case scenario, debt can result in you going bankrupt if you’re unable to make your monthly credit card or mortgage payments.

The pandemic has put some Americans behind and has allowed others a chance to gain some ground on their debt. Specifically, 34% say it will take them longer than expected to pay off their debt because of the pandemic, while 23% expect to be able to pay it off sooner.

When it comes to paying off debt or saving money for emergencies, retirement and other goals, your financial priorities will depend on several factors. These include the types of personal debt, their interest rates, your disposable income and your long-term goals. You can weigh your options, depending on how much debt and how much money you already have saved for the future and invested to for the long term.

References:

  1. https://news.northwesternmutual.com/2021-08-25-Northwestern-Mutual-Study-Finds-Americans-Personal-Debt-Has-Dropped-More-than-20-Over-the-Last-Two-Years
  2. https://news.northwesternmutual.com/planning-and-progress-2021
  3. https://www.prudential.com/financial-education/how-to-pay-off-debt-and-save
  4. https://news.northwesternmutual.com/2018-08-14-New-Data-Personal-Debt-On-The-Rise-Topping-38-000-Exclusive-Of-Mortgages
  5. https://article.smartasset.com/financial-advisor-secrets-1/

Financial Planning and Investing

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“Take control of your finances, savings and wealth building with a financial plan.”

Whether you have short-term financial needs — such as planning for an upcoming vacation or holiday spending — or long-term plans like retirement, financial planning can help you organize your finances by evaluating your expenses and income. Yet, a 2020 Northwestern Mutual study found that 71% of U.S. adults admit their financial planning needs improvement.

Futhermore, the Northwestern Mutual research finds a third (32%) of Americans say their financial discipline has improved during the pandemic, and 95% say they expect their newfound habits will stick after the health crisis subsides.

Among the financial behaviors that people say they’ve adopted as a result of the pandemic and expect to maintain going forward are:

  • Reducing living costs/spending (e.g., cancel subscriptions, eat out less, etc.) – 45%
  • Paying down debt – 34%
  • Increasing investing – 33%
  • Regularly revisiting financial plans – 29%
  • Increasing use of tech/digital solutions to manage finances – 28%
  • Increasing retirement contribution/savings – 25%

A financial plan can show if you’re on track to meet your money and savings goals. Financial planning can include strategies for paying off debt, starting an emergency fund, saving up for a large purchase like a house, or building wealth.

Investors who stick to a financial plan have an average total net worth that’s 2.5 times greater than those who don’t follow one, according to Charles Schwab. Financial planning helps you understand where you are today. It also creates a roadmap to get you where you want to be in the future.

Investing is key to building wealth.

Time is on your side and key when it comes to building your wealth. That’s the magic of compound interest. Compound interest is interest earned on interest. Basically, it’s the reason why investments earn more money over time.

But before you start investing, it’s crucial that you’re financially prepared. Consider these four signs you’re ready to invest:

  • Have a long-term financial plan and strategy.
  • Have an emergency fund.
  • Research and prepare to invest.

Investing all depends on tim ane in the market and your unique financial situation. These signs are a good step to getting your finances in order. But consult a financial professional for comprehensive investment advice.

As a result of the personal finance challenges experienced by Americans during the pandemic, the 2020 Northwestern Mutual study found that  there was mounting interest in personal  financial planning that may be here to stay. “Personal finance is a lifelong journey; it’s not something you look into once and say, ‘OK, I checked that box,’ and move on,” explains Matthew Pelkey, OppUs’ director of financial education. “Just the simple act of looking into things you can do to be more deliberate in your financial life will give you that agency over your finances — and create the habits that are really what produce good financial health.”

Financial planning can equip you to handle life’s many unexpected financial twists and turns. Although, it will vary, depending on your stage in life. You don’t need to know everything — but knowing and planning for the essentials will provide a solid foundation. Always remember the adage:  “Failing to plan is planning to fail.”

  • References:
    1. https://news.northwesternmutual.com/planning-and-progress-2020
    2. Strategic Business Insights, MacroMonitor 2018-2019 Report, February 2019.
    3. https://www.opploans.com/oppu/articles/financial-planning/

    The Debt Ceiling and Congressional Brinkmanship

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    “I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.” Warren Buffett, Chairman and CEO, Berkshire Hathaway

    Around October 18, Treasury Secretary Janet Yellen and the U.S. Treasury Department have warned Congress that the government will no longer be able to pay all its bills unless the $28.5 trillion statutory debt ceiling is increased or suspended.

    Source: Congressional Research Service, Congressional Budget Office, and the Treasury Department. Data as of 05/01/2021.

    Moreover, Secretary Yellen believes the economy would fall into a recession if Congress fails to address the borrowing limit before an unprecedented default on the U.S. debt.

    While the U.S. has never failed to pay its bills, economists say a default would tarnished faith in Washington’s ability to honor its future obligations on time and potentially delay Social Security checks to some 50 million seniors and delay pay to members of the U.S. armed services.

    “If you ask the question of Americans, should we pay our bills? One hundred percent would say yes. There’s a significant misunderstanding on the debt ceiling. People think it’s authorizing new spending. The debt ceiling doesn’t authorize new spending; it allows us to pay obligations already incurred.” Peter Welch (D-VT), U.S. House of Representatives Democratic Caucus Chief Deputy Whip

    Increases to the debt ceiling aren’t new. They’ve occurred dozens of times over the last century, mostly matter-of-factly, a tacit acknowledgement that the bills in question are for spending that Congress has already approved.

    One thing separating today’s debt debate from those of the past is the larger-than-ever national debt, according to Fidelity. Publicly held US debt topped 100% of GDP in 2020 and is expected to reach 102% by the end of 2021.

    And the debt is projected to increase significantly in the future. The Congressional Budget Office (CBO) projects a federal budget deficit of $2.3 trillion in 2021—the second largest deficit since 1945.

    Source: Congressional Budget Office, as of February 11, 2021.

    Failure to address the current challenge could shake global markets even before the Treasury has exhausted its available measures to pay bills. A U.S. debt default, whether through delayed payments on interest owed on U.S. Treasuries or on other obligations, would be unprecedented.

    The effect would be one of perception. And, perception can be tied to the reality that someone isn’t going to be paid on time, whether it be government contractors, individuals who receive entitlement payments, or someone else. The damage to U.S. credibility would be irreversible.

    Even if a default were only technical—if payments other than interest on debt were delayed—the United States could no longer fully reap the benefits bestowed on the most reliable debtors.

    Interest rates would likely rise, as would financing costs for businesses and individuals. Debt ratings would be at risk. The government’s own financing costs, borne by taxpayers, would increase. Stock markets would likely be pressured as higher rates made companies’ future cash flows less predictable. Such developments occurring while economic recovery from the COVID-19 pandemic remains incomplete makes the potential scenario all the more important to avoid.

    Let it be said that no one doubts the ability of the United States to pay for its obligations, according to Vanguard. There is a minimal credit risk posed by the United States is supported by its strong economic fundamentals, excellent market access and financing flexibility, favorable long-term prospects, and the dollar’s status as a global reserve currency.

    The House has passed a measure that would suspend the debt ceiling through mid-December of 2022, and the bill now goes to the Senate. Republicans in the Senate oppose any effort to raise the borrowing limit and appears intent on making Democrats address it as part of their sprawling investment in social programs and climate policy under reconciliation.

    Senate Democrats could lift the debt ceiling without the GOP votes through reconciliation, although that would come with downsides. Under reconciliation, a simple majority of senators can pass a very small number of budget bills each year. The process is sufficiently complex that it would probably take a couple of weeks and distract Democrats from their negotiations over Biden’s “Build Back Bette” agenda.

    Thus, the Democrats resist raising the debt ceiling through reconciliation if it means potentially sacrificing other policy goals. And, the rules for reconciliation would require Democrats to specify a new limit for the national debt which would expose them to potentially uncomfortable GOP political attack ads.

    Republicans insist that since Democrats control both the executive and the legislative branches and are in a socialistic tax-and-spend binge, they should bear sole responsibility for dealing with the debt limit, which is rearing its ugly head again because the suspension included in a two-year 2019 budget deal expired on July 31.

    Democrats argue that Republicans should share the burden of this unpopular chore, since (a) much of the debt involved was run up under Republican presidents and (b) Democrats accommodated Republicans on debt-limit relief during the Trump presidency.

    For long term investors, it’s clearly in the best interest of the country to resolve any debt-ceiling issues, according to Fidelity. And, it’s important to understand that there will always be times of uncertainty. It’s important to take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation.

    References:

    1. https://investornews.vanguard/potential-u-s-debt-default-why-to-stay-the-course/
    2. https://www.cnbc.com/2021/10/05/debt-ceiling-us-faces-recession-if-congress-doesnt-act.html
    3. https://nymag.com/intelligencer/2021/10/democrats-can-raise-debt-ceiling-via-reconciliation-bill.html
    4. https://www.fidelity.com/learning-center/trading-investing/2021-debt-ceiling

    7 Investing Principles

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    The fundamentals you need for investing success.  Charles Schwab & Co., Inc

    1. Establish a financial plan based on your goals

    • Be realistic about your goals
    • Review your plan at least annually
    • Make changes as your life circumstances change

    Successful planning can help propel your net worth. Committing to a plan can put you on the path to building wealth. Investors who make the effort to plan for the future are more likely to take the steps necessary to achieve their financial goals.

    A financial plan can help you navigate major life events, like buying a new house.

    2. Start saving and investing today

    • Maximize what you can afford to invest
    • Time in the market is key
    • Don’t try to time the markets—it’s nearly impossible.

    It pays to invest early.  Maria and Ana each invested $3,000 every year on January 1 for 10 years—regardless of whether the market was up or down. But Maria started 20 years ago, whereas Ana started only 10 years ago. So although they each invested a total of $30,000, by 2020 Maria had about $66,000 more because she was in the market longer.

    Don’t try to predict market highs and lows. 2020 was a very volatile year for investing, so many investors were tempted to get out of the market—but investors withdrew at their peril. For example, if you had invested $100,000 on January 1, 2020 but missed the top 10 trading days, you would have had $51,256 less by the end of the year than if you’d stayed invested the whole time.

    3. Build a diversified portfolio based on your tolerance for risk

    • Know your comfort level with temporary losses
    • Understand that asset classes behave differently
    • Don’t chase past performance

    Colorful quilt chart showing why diversification makes long-term sense. The chart shows that it’s nearly impossible to predict which asset classes will perform best in any given year.

    Asset classes perform differently. $100,000 invested at the beginning of 2000 would have had a volatile journey to nearly $425,000 by the end of 2020 if invested in U.S. stocks. If invested in cash investments or bonds, the ending amount would be lower, but the path would have been smoother. Investing in a moderate allocation portfolio would have captured some of the growth of stocks with lower volatility over the long term.

    4. Minimize fees and taxes; eliminate debt

    • Markets are uncertain; fees are certain
    • Pay attention to net returns
    • Minimize taxes to maximize returns
    • Manage  and reduce debt

    Fees can eat away at your returns. $3,000 is invested in a hypothetical portfolio that tracks the S&P 500 Index every year for 10 years, then nothing is invested for the next 10 years. Over 20 years, lowering fees by three-quarters of a percentage point would save roughly $13,000.

    5. Build in protection against significant losses

    • Modest temporary losses are okay, but recovery from significant losses can take years
    • Use cash investments and bonds for diversification
    • Consider options as a hedge against market declines—certain options strategies can be designed to help you offset losses

    Diversify to manage risk. Investing too much in any single sector or asset class can result in major losses when markets are volatile.

    6. Rebalance your portfolio regularly

    • Be disciplined about your tolerance for risk
    • Stay engaged with your investments
    • Understand that asset classes behave differently

    Regular rebalancing helps keep your portfolio aligned with your risk tolerance. A portfolio began with a 50/50 allocation to stocks and bonds and was never rebalanced. Over the next 10 years, the portfolio drifted to an allocation that was 71% stocks and only 29% bonds—leaving it positioned for larger losses when the COVID-19 crash hit in early 2020 than it would have experienced if it had been rebalanced regularly.

    7. Ignore the noise

    • Press makes noise to sell advertising
    • Markets fluctuate
    • Stay focused on your plan

    Progress toward your goal is more important than short-term performance. Over 20 years, markets went up and down—but a long-term investor who stuck to her plan would have been rewarded.

    References:

    1. https://www.schwab.com/investing-principles