Get a Financial Life: Personal Finance in Your Twenties and Thirties - Softcover

Chapter 1

CRIB NOTES

A "Cheat Sheet" for Time-Pressed Readers

If you prefer CNN Headline News to the newspaper and opt for the Cliffs Notes over actual books, this chapter is made for you. It cuts to the chase and offers you the most important steps toward a good financial start. So if you don't have the patience to read the entire book right now, adopting one or two of these strategies will put you ahead of the game.

Of course, as someone's mother once said, cheaters only cheat themselves. And while this chapter is a good launching point, ignoring the remaining eight chapters is a little like relying on a friend's ten-minute summary of Moby Dick -- you'll get the basic plot line but never understand it in any real depth. Stili, the following crib notes should give you a quick-and-dirty rundown on the basics, l've tried to list them in rough order of importance, but your priorities may depend on your own situation.

1. Insure yourself against financial ruin.

It's not surprising that people don't like to talk about insurance. It's expensive, confusing, and mostly about sickness and death. But if you're interested in getting adequate medical care in case of a serious accident or illness, and would prefer not to bankrupt yourself and your family in the process, there really is no higher financial priority than health insurance.

If you work for a company that offers employees health insurance, you're lucky; participating in your employer's group plan will probably cost you much less than buying a policy on your own, and the coverage you get is likely to be more comprehensive than any individual policy you could afford. You may even have more than one type of health insurance plan to choose from through your employer. When deciding among offerings, make sure you consider not only price but also the type of coverage you will receive. If, for example, you're thinking about joining a type of plan called a health maintenance organization (HMO), inquire about exactly what is covered, ask about the procedure for seeing specialists, and find out what happens if you want to visit a doctor outside the HMO. Although HMOs are generally less expensive, if you come down with a serious illness and want to see a specialist outside your HMO network, you may have to foot the entire bill yourself. Before you sign up for any health insurance plan, talk to coworkers about their experiences with the various options.

If the company you work for does not offer insurance, you'll have to pay for it yourself. If you recently graduated from college, see if you can extend coverage from your parents' plan for a few years. If you're job hunting, at the very least get temporary coverage. If you're employed but your company doesn't offer you insurance, see if there are any organizations you can join (a trade association, for example) that will allow you to purchase health insurance at a group rate. This can be much less expensive than purchasing individual coverage. Since plans vary dramatically from state to state, your best bet if you're on your own is simply to call the major insurers and HMOs in your area and see what they have to offer. Also call Quotesmith (800-556-9393), USAA (800-531-8000), and your local Blue Cross/Blue Shield company for quotes. And if you're having trouble getting coverage because of a medical condition, your state insurance department may be able to provide you with the names of companies that will cover you. (See page 182 for the phone number of your state's office.)

Another type of protection you may want to consider is life insurance, but only if you have children or if someone else is financially dependent on you. If you don't have dependents, you don't need life insurance. If you do, the type you should buy is called term insurance, which is relatively inexpensive. There are several services that will scan their multicompany databases free of charge and mail you a list of some of the least expensive policies. Try the Wholesale Insurance Network (WIN) (800-808-5810), Quotesmith (800-556-9393), SelectQuote (800-343-1985), and Termquote (800-444-8376). One warning: If you deal with a life insurance agent, be prepared to hear a big pitch for a type of policy known as cash value life insurance. Ignore it. While it's more profitable for the agent, it's probably nota good deal for you.

Depending on your current financial situation, you may also want to consider protecting your earning power with disability insurance. A disability policy will pay you an income (typically 60% to 70% of your current salary) if you're injured or very sick, and are unable to work for an extended period of time. Depending on the state in which you're employed, you may already be covered by a mandatory disability insurance program and/or by insurance provided voluntarily by your employer as part of your standard employee benefits package. Even if you are, it's a good idea to find out how much coverage you currently have, whether it's possible to buy more, and what it would cost you. As with health insurance, the least expensive way to buy disability insurance is generally through an employee benefits plan. If it's not available to you through your employer's plan, look into purchasing some on your own, though you'll probably find that it's pretty expensive. Some companies that specialize in disability insurance are Unum Life Insurance (800-227-8138), Paul Revere (800-843-3426), and Provident Life and Accident (615-755-1011). Also try USAA (800-5318000), the Wholesale Insurance Network (800-808-5810), and Termquote (800-444-8376).

For additional tips on purchasing all types of insurance, see Chapter 8.

2. Pay off your debt the smart way.

Whether you're drowning in debt or just have a few manageable loans, more often than not the smartest financial move you can make is to take any savings you have (above and beyond money you need for essentials such as rent, food, and health insurance) and pay off your high-rate loans. The reason is simple: You can "earn" more by paying off a loan than you can by saving and investing. Paying off a credit card that has a 17% interest rate is equivalent to earning 17% on an investment -- an extremely attractive rate of return. (Actually, it's even better than that; it's the equivalent of earning 17% after taxes.) If you want a full explanation of this concept, turn to page 48. Otherwise, take my word for it.

If you can't pay off your high-rate debt immediately, take steps to reduce the interest rate you pay. One of the simplest ways is to apply for a low-interest-rate credit card. For a list of low-rate credit card issuers, send a request and $4 (check or money order) to Bankcard Holders of America, 524 Branch Drive, Salem, VA 24153, or call 703-389-5445. Another good source is RAM Research's CardTrak, P. O. Box 1700, Frederick, MD 21702; the charge is $5.

If you have several different types of debt -- say, a credit card balance on a card with a 17% interest rate, a car loan with a 12% rate, and a student loan at 9% -- pay off the loan with the highest interest rate first. One strategy you may want to consider is stretching out your student loan payments over 15 years instead of 10 years by signing up for the Federal Direct Consolidation Loan program. (To see if you're eligible, call the Department of Education at 800-4FED-AID.) This will reduce your monthly student loan payment and leave you with extra cash. Use this money to pay off your credit card balance faster. Once you've gotten rid of your credit card debt, start paying off your auto loan faster. After you wipe out that loan, too, increase your student loan payments to at least their initial levels.

The only time it doesn't make sense to kill your debt is when the interest rate you're being charged is lower than the rate you can receive on an investment. If, for example, you have a special student loan with a 3% rate, you'd be better off maintaining your usual payment schedule on the loan and putting your cash into an investment that pays you an after-tax rate greater than 3%.

For detailed information on credit cards, auto loans, student loans, home equity loans, and credit reports, see Chapter 3.

3. Start contributing to a tax-favored retirement savings plan.

Okay, okay -- the last thing on your mind is retirement. But if you're lucky enough to work for a company that offers a retirement savings plan like a 401(k), you should take advantage of it.

There are several reasons to participate in a 401(k). For starters, many employers will match a portion of the amount you put into such a plan. That means the company will contribute a set amount -- say, 50 cents -- for every dollar you contribute, up to a specified dollar amount. That's an immediate 50% return on your money! (In fact, if your company offers such a fabulous matching deal, you should probably contribute to the plan even before paying off your credit card debt.) In addition, the federal government allows you to delay paying taxes on the money you contribute to a retirement savings plan. That translates into an immediate tax break of hundreds of dollars each year. If, for example, you contribute $1,000 to a retirement savings plan, you're entitled to deduct the full amount at tax time, reducing your taxable income by $1,000. If you're in the 28% tax bracket, that's a savings of $280. (You are probably in this tax bracket in 1996 if you are single and your taxable income is between $24,000 and $58,150, or if you are married and you and your spouse's combined taxable income is between $40,100 and $96,900.)

Be forewarned that you're likely to come across people who'll tell you you're too young to lock up your money in a retirement savings plan. Ignore them. While it's true that you won't be able to withdraw your money until you reach age 591/2 without paying a 10% penalty, many plans allow employees to borrow against their retirement savings at favorable rates. What's more, your money will grow tax-free in a retirement plan for years. The benefits of tax-free growth could easily outweigh the penalty you'd have to pay for making an early withdrawal. And if you switch jobs, you may be able to move your 401(k) money into your new employer's plan.

The easiest way to start contributing is to contact your employee benefits office and ask to have a set percentage of each paycheck automatically transferred to your company plan. Try to contribute the maximum allowed by law. If you can't afford to stash away this much, at least contribute the maximum amount for which you're eligible to receive matching funds.

If you aren't lucky enough to work for an employer who offers a 401(k) or a similar company retirement plan (and possibly even if you are), you should start investing in an individual retirement account (IRA). The most you can contribute to an IRA is $2,000 annually; if at all possible, contribute this amount every year. The tax advantages of an IRA are very similar to those of a 401(k). But IRAs don't have all the advantages of 401(k)s, so putting money in an IRA is somewhat less pressing than enrolling in your company-sponsored plan. For starters, with an IRA you don't have the benefit of an employee matching program. Also, you can't borrow money from an IRA before you reach age 591/2 the way you can with most 401(k)s; if you need to get at your money, you'll have to pay the 10% penalty. As of this writing, however, Congress is considering modifying the IRA rules so that savers can borrow from their accounts for medical emergencies and down payments on first homes. If this happens, investing in an IRA will be a no-brainer for anyone who isn't eligible for a 401(k). But even if these rules don't change, the advantage of tax-free growth for many years is extremely beneficial; if you have to make an early withdrawal from your IRA, you'll often still come out ahead, even after factoring in the penalty.

If your employer does offer a 401(k) or a similar tax-favored retirement savings plan, you should contribute to that plan before thinking about an IRA. Once you've hit the maximum on your company retirement plan, you can decide whether or not to contribute to an IRA as well. If you do, you'll get the benefit of tax-deferred growth. However, the fact that you're eligible to contribute to a company-sponsored plan may make your IRA contributions nondeductible, depending on your income level.

For more information on tax-favored retirement savings plans and answers to commonly asked questions, see Chapter 6.

4. Reduce your monthly banking fees.

If you're like most people, you don't pay much attention to your bank, despite the fact that it's the center of your financial universe. But by becoming aware of bank charges, you may be able to save hundreds of dollars a year.

Two of the most burdensome bank fees are checking charges and automated teller machine (ATM) fees. To reduce these charges and possibly eliminate them entirely, shop around for a bank that waives them for customers who maintain a specified minimum balance. Some banks require you to maintain the minimum in a checking account only; others will waive monthly checking charges as long as the combined balances in your checking and savings accounts meet the minimum requirement. Either way, look for a bank with a low minimum. While some banks require you to keep as much as $3,000 in the bank to get free checking and ATM use, others require you to keep just $100. Even if you have enough money to meet the higher minimum balance requirements, it still makes sense to find a bank with low balance requirements. That way you won't have to tie up large sums of cash in a bank account that pays a pitifully low interest rate.

Before you switch banks, ask whether yours will waive its minimum balance requirement if you sign up for direct deposit (which would mean that your entire paycheck would be deposited automatically into your checking or savings account each pay period); some banks will. You should also find out if you're eligible to join any credit unions, which are special not-for-profit banks that tend to have lower minimum balance requirements and lower fees all around. For help in finding a credit union, call the Credit Union National Association at 800-358-5710.

For more tips on banking smart, see Chapter 4.

5. Build an emergency cushion with an automatic savings plan.

If you find it impossible to save any money, you're not alone. But once you've gotten rid of your high-rate debt and taken care of Crib Notes 2, 3, and 4, it's time to start. A relatively painless way to do it is to enroll in an automatic savings plan. These plans allow you to have money withdrawn automatically from each paycheck and funneled into a bank account or mutual fund. (See Crib Note 6 for a brief discussion of mutual funds.)

If you're trying to accumulate a balance in a savings account large enough to qualify for free checking, see if your bank offers an automatic savings program. If it does, contact your company's payroll office and ask if you can have a portion of each paycheck -- say, $50 -- deposited into your s...