We have all had that feeling. That sinking feeling. We nonchalantly walked to the mailbox (or our inbox), opened the mail, and one of the envelopes/emails was a big bill staring us in the face. Maybe it was a medical bill, a bigger than expected credit card bill, our property tax notice. Our monthly house payment just went up, or that first college tuition bill is due. Gulp! It was something that knocked the wind out of us and made us scramble to check our account balance and do the monthly algebra to figure out how to cover that big payment.
Sometimes life is that way – full of fun and not so fun surprises – and it’s certainly true we can’t always anticipate what is around the corner. But other times, with a little forethought and some crafty execution, we can avoid that moment that sets us back on our heels. That sinking feeling is no match for our hero:
Sinking Fund Basics
What in the blazes is a sinking fund, I can hear you asking. Ok, that would be me asking that. I’m not sure you use the phrase “what in the blazes” that often…or ever. Regardless, however you do ask, you are asking a great question. Thanks for asking.
A sinking fund is money that you set aside in advance with the goal of accumulating funds prior to needing them. A sinking fund is typically created with a specific use in mind. You can have a sinking fund for an upcoming vacation, a large bill that you know is coming, a home renovation, or just about anything. We can fill in some more of those blanks later, but right now let’s make sure the concept is clear.
If, for example, we have our eye on a piece of furniture that costs $800 and we want to buy it in by the end of the year, we can use a sinking fund to save up the money for it. A little math tells us that if we are in May and we are going to buy it in December, we have 8 months to save up the money to buy it. If we save $100 each month and set it aside in our sinking fund, we will have the cash to pay for it by December.
The concept is very simple, but like a lot of simple concepts, it is applying simple things in clever ways that can make them genius. Sinking funds, if used properly, can save you hundreds of dollars a year. How? Read on.
Auto Insurance Example
Applying the sinking fund concept to car insurance is a great example of using a sinking fund to save money. You know your car insurance premium will come due every six months. It’s like clockwork, if a clock could mark off six months for you. (Shouldn’t that be a calendar, not a clock? I digress.) You know exactly what months your car insurance will be due. Let’s say you get your car insurance renewal and the bill is $1,500. That’s not money you typically pay – only twice a year, right?! – so you have that sinking feeling and decide maybe you won’t pay the $1,500 that month. After all, the kindhearted insurance company will allow you to pay that bill in monthly installments. That would be $250/month. You relax because that takes the pressure off for this month.
But wait, maybe there is a better way. Let’s wind the clock (or calendar) back six months and use a sinking fund instead.
It’s November and you just paid your car insurance. Oof, that $1,400 bill hurt, but you covered it. You decide to set up a sinking fund to make it easier to pay that next insurance premium in May. You look at your bill of $1,400 and you divide it by the 6 months you have until your next bill comes due to give you $233.33 per month. You contact your bank or credit union, and you open a new savings account and you nickname it “car insurance sinking fund” in your bank’s online app. You then proceed to set up an automatic transfer of $233.33 on the 10th of every month starting in November from your checking account where you paycheck is deposited to your new car insurance sinking fund. The new account will keep the funds separate so you are not tempted to spend them, and the automated transfer means you won’t have to remember to move the money. You just put your new car insurance payment on autopilot. By the end of January, you have three months saved and $699.99 sits comfortably in your sinking fund. When May 1 rolls around and you get your new insurance premium notice you see that our kindhearted insurance provider has seen fit to raise your premium to $1,500. That’s okay because your sinking fund sits ready with just under $1,400 in it. Not quite enough to cover your bill, but at least it is most of the way there.
Hold on! You see something in the fine print you haven’t seen before. Your insurance company offers a discount if you pay the entire amount in one payment to renew the policy. The discount is 6% and you avoid a $3 installment fee for each of six monthly payments. Your 6% discount lops $90 off your bill and avoiding the $18 of installment fees means your $1,500 bill just became a $1,392 bill. Seeing that you have $1,400 in your sinking fund, you transfer the money to pay the bill in one payment reaping the discount, saving the fees, and using your sinking fund to avoid that sinking feeling of having to come up with $1,500. It’s a win all around. This is the “financial peace” you keep hearing about, but not experiencing.
At this point after you are done patting yourself on the back, you may want to project your next bill and slightly adjust your monthly transfer into your sinking fund. If your premium increased $100 this time, you might want to bump up the amount you use to fund your sinking fund by another $30/month just to give you a little cushion. The goal is to cover the whole bill, so if you have a little left after you make the next payment, it gives you a little head start on the next round of deposits into your sinking fund.
Here a Fund, there a Fund, Everywhere a Sinking Fund
Now that you have seen the magic of the sinking fund, you start to get more bright ideas of how to apply it. After all, if it works for car insurance, it can work for all sorts of things, right? Life insurance? You bet your life. Property taxes? Bet the farm on it. Vacations? Yes, you can get away with that. Home improvements, saving for a new car, Christmas presents, year-end charitable giving. If you can plan in advance for it, you can create a sinking fund to do it.
There are a few tips that make sinking funds easy to use. First, some banks have the concept of subaccounts or buckets. These buckets allow you to segment money within a single savings account. That can be handy because you can create buckets on the fly without needing to contact your bank to set up a new account. The downside is that you might be tempted to comingle your sinking fund with other money in your savings account. One reason sinking funds work is because you move the money and don’t touch it until you need to make your payment. If you might be tempted to dip into the bucket for other uses, you might be better to have a separate account for your sinking fund.
Second, use the automatic transfer like in the auto insurance example. Moving smaller amounts that accumulate over time into the amount you ultimately need is great. Automating that process so you don’t have to remember to move the money is even better. When life gets busy – is it ever not busy? – automation can save you some brain cycles and lower your stress, so I highly recommend using automated monthly transfers to fill up your sinking fund.
The way we have structured this, you are transferring money from a checking account to a savings account where your sinking fund(s) live. Savings accounts have limits on the number of transfers you can make out of the account, so make sure you stay within those limits. Unless you have a dozen or more sinking funds and half of those have payments due in any given month, you are probably fine, but it is good to be aware of the limit so you don’t run the risk of incurring fees for too many transfers out of your savings account.
Conclusion
Sinking funds work. You may not be able to do them for everything right away, so start with one use and bump up the number of sinking funds over time. Once you have a system in place, it will allow you to take advantage of discounts and it will lower the stress of seeing those big numbers on some of your bills. Using sinking funds saves me several hundred dollars a year. I avoid installment fees and I take advantage of discounts offered by making a single payment. Best of all, sinking fund means no more sinking feelings when big bills arrive.
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This is a question I get all the time. What is financial coaching? I like to explain financial coaching by comparing it to a familiar dynamic of a sports coach. What does a sports coach do?
Let’s start with the mindset. A sports coach wants to win and wants every player he or she coaches to reach their potential. To win, the coach keeps a positive and encouraging mindset while finding ways to challenge each player individually. What does a coach work on with a player? It depends upon that player’s situation and position. In football it would make little sense for a defensive line coach to work on punting or passing with a defensive end. Those are not skills a defensive player needs. Similarly, the quarterback really doesn’t need to spend time kicking field goals. Instead, a quarterback coach will work on drills particular to that position, so passing drills would be part of a workout. A coach also works with a player based on his or her particular needs. A coach might help one quarterback learn how to read a defense while helping another quarterback improve mechanics of his throwing motion. The differences in the plan for each player are tailored to the needs of each player. The coach wants to help the player grow and improve, so the plan is as individual as the person.
Financial coaching follows the same approach. There is not a one size fits all template. For a young couple in their twenties, the coaching might include financial planning for children’s college funds, counsel on paying off student loans, and starting to understand some investing basics. If two couples of the same age have different circumstances – say a single nurse compared to a husband and wife dentist team – then the coaching would be as different as the people, their circumstances, and their goals. Just in the sports world, if a player is new to the sport, it would be appropriate to cover the basic rules and philosophies around the sport.
The same concept carries over to the financial world. If someone is not accustomed to handling money, like a new college grad or a widow whose husband managed their money, a financial coach should lean in to the basics and help these folks understand money management concepts. Budgeting, sinking funds, and planning for bills become important topics.
For those who might be more experienced in handling money, there could still be specific problem areas or hot spots. Take Carl and Ellie for example. The sweet couple from the movie “Up” were always saving for a trip to Paradise Falls when an unexpected expense would arise prompting them to repeatedly break their trip money jar to handle the emergency.
Carl & Ellie needed an emergency fund
A financial coach could work with Carl and Ellie on a strategy for creating a separate and larger emergency fund so their trip fund could stay intact when they have a flat tire or have a medical emergency. A teacher looking to afford a house but concerned that she will never be able to save up for the down payment could benefit from a coach reviewing her budget and providing tips on auto drafting into a house fund account. A family wanting to start a college fund. A thirty-year old trying to figure out how to get rid of student loans. A family tired of living paycheck to paycheck. A widower unsure if his savings will last through his golden years. A 17-year-old wanting to go to college debt-free. Each of these people could benefit from the insight and personal focus a financial coach provides.
My role as a financial coach is to be firmly rooted in principles of personal finance. Sure, I know the math and can walk you through calculations and what if scenarios. The real value I bring is understanding that finances are personal. That means our conversations are confidential and tailored to your needs. That means I pay as much attention to where you are in life and to what your circumstances and goals are as I do to the math. It means one size does not fit all.
Tired of the “One Size Fits All” financial plan?
The foundational money principles that I teach are based in biblical truth and common sense. They are the same principles I have lived by all my life. They are the same values that undergird how I manage my own finances. While those principles are time-tested through countless generations, as a financial coach I help you apply those principles to your season in life and your circumstances. Just as a good sports coach helps a player improve their game so they can win in the end, that’s exactly what I do as a financial coach. I will help you learn to Manage Your Dollars With Common Sense.
To learn more about working with a financial coach, check out my website or blog. Initial consultations are always free to make sure I am a good fit for you as a financial coach before moving forward.
You find yourself needing to stretch your dollars a little further each month to fight inflation, and you wonder where your paycheck has gone (and how it keeps disappearing so quickly!) You decide that maybe you’ll try something different. Maybe you’ll try…a budget! Yes, you are going to give it a go and drive into being more intentional about your spending.
Now what?
Before we get into budgeting mechanics, let’s talk about what a budget is and isn’t. A budget is simply a spending plan. It allows you to plan your spending ahead of time so you can be more deliberate about where your money goes. A budget is not a a set of rigid rules to constrict you, but rather boundaries to serve and protect you. Much the way the boundary for a child might be “don’t chase a ball into the street without first looking both ways” to protect them, a budget provides healthy boundaries to help you get the most out of your money. By working through your budget before a month begins, it allows you the freedom to prioritize your spending instead of emotionally spending as you go. It should be freeing not constricting.
Budget Basics
Here are some good mechanics to follow when building your first budget.
Do a monthly zero-based budget. A zero-based budget means you list your income at the top from all sources and work on your spending plan until you have accounted for every dollar of income for that month. By working on your budget until you have a place for each dollar to go, you will end up with zero dollars to allocate at the end of your budgeting process (thus “zero-based”). Build your budget prior to the start of the month so you are prepared with your spending plan on day one.
Find a method or tool that works for you and stick with it. You can use Excel or Google Sheet, a pencil and pad of paper, or an online tool like Mint or EveryDollar (my favorite). There are a lot of free tools out there. I like EveryDollar for its simple interface, its zero-based budgeting approach, and because it allows you to copy the previous month’s budget as a starter for next month saving a lot of time. Anyone can use the free version to create a monthly budget. There are advanced features that you can access from the paid version, but you can build and track a budget effectively without them. Whatever platform or tool you pick, commit to it for at least three months so you can focus on the budgeting and not on evaluating tools. Once you select a tool, you are ready for the nitty gritty of budgeting.
Budgeting Steps
List your income from all sources. If you are married with two incomes, have a side hustle, a rental property, or a tax refund coming your way, list all of those sources of income for the month at the top of your budget. Add up these sources and you have the limit on the money you can spend for the month.
List your basic expenses first. If you remember Maslow’s Hierarchy of needs from school, that is the basis of your budget. If you don’t remember it or wonder who Maslow is, don’t worry, you don’t need to know to budget well. Abraham Maslow was an American Psychologist said humans work to get their physical needs met first. Following that thinking, budget first for food (groceries, eating out), clothing (new clothes, dry cleaning), shelter (mortgage payment or rent, utilities like electricity, water, natural gas, house maintenance, homeowner’s insurance), and transportation (car payment, gasoline, tolls, car maintenance). With those basics in place first, you’ll make sure you can eat, sleep, keep the lights on, and go to work.
Prioritize the rest of your spending. With the basics covered, you can move on to other spending categories. Do you give money to a charity or your church? Write it down under a “giving” category with a line for each charity. Think through your month and pull up recent bills to see where you spend your money. Do you have kids in activities that require you to pay registration fees or expenses? Write it down under “Kids Expenses.” Do you have travel? Does someone you know have a birthday approaching and you want to buy a gift? Do you want to budget for your morning coffee before work? The great thing about a budget is you control it. If you love to go to the movies, go to sporting events, see plays in a local theatre, load up on your favorite hobby materials at a local craft store — it is all in bounds and up to you. The trick is to remember you are not in Congress, so you can only spend up to the amount of money you make each month, not a penny more. As long as you plan to spend within your income, how you allocate your money is up to you. At the end of this article, I have some suggested categories and a list of resources to help you think through the line items for your first budget. Take a look to help jog thoughts on where you need to allocate money in your budget.
Make adjustments. After you thing you have everything listed and are to zero dollars left for the month (yea!), you are likely to remember something you didn’t add in your budget. Ah, yes, the HOA fees are due. We forgot to budget for that trip to visit Aunt Carol at the end of the month. Or maybe you forgot to list that new streaming service you just signed up for last month. Whatever it is, go ahead and add it with the amount. Now you get to look through the rest of the budget to find enough money to get your bottom line down to zero again. You might decide to take $20 out of your restaurant money and $30 out of your grocery money to get that $50 line you forgot to add in the beginning for you babysitter you need once a month for your guys or girls night out. Whatever it is, expect that you will have a few forgotten items that you need to adjust for once you think you are done.
Follow your budget. You, yes you, put this budget together. It represents your thoughts and your priorities about where you need to spend your money. You took the time and effort to put the budget together, now take the time to make it effective by following it. Your budget is only as good as your ability to let it guide you through your month. If you take your budget and put it on a shelf and never look at it, it’s of no use to you. Do yourself a tremendous favor by looking at your budget on a regular basis, maybe every few days, and tracking your spending against it. Take it with you or check it before you head to the grocery store so you know how much money yo u have for this trip to the store. Use that advanced thinking and planning to spend within your budget for each category. Doing so provides the boundaries to keep you financially safe, which was your intention when you decided to start budgeting in the first place.
Track your spending. To track your spending, pull up your bank account online and record the transactions every few days under the proper spending category. Tools like the premium version of EveryDollar (subscription required which costs $79.99 annually as of this writing), will allow you to connect directly to your bank and pull in your expenses. Some even have a feature where they will “remember” your recurring expenses and know, or example, that your Chick-fil-a expenses go to your “Eating Out” category on your budget. This can be the most tedious part of the budget process. If you don’t have the patience or discipline to track every expense, it may be well worth the money to you to buy the premium version of EveryDollar or find a tool that connects directly to your bank and allows you to pull transactions into your budget.
Tips
If you are new to budgeting, here are a couple of tips that will help you as you get used to the budgeting process.
Access your previous month’s bank statement as you set your first budget. Looking through your online or paper transactions will help prompt you on the ways you spend your money. Using your statement and the categories below will help you make a solid first budget.
You won’t be good at budgeting the first month…or the second month. Most people find that things start to get easier in month three. If you missed a bill in your budget or a whole category, add it, rebalance your budget to get to zero, and move on to next month. You’ll naturally get better as you go.
Ready for some good news? The short-term payoff for all this work is found money. Most people find several hundred dollars of spending they can eliminate once they start budgeting. I recently helped a woman find over $1,000 a month when I guided her through the budget process. That’s real money, folks!
Budget Category List
This is not exhaustive, but it should be helpful in getting you started. There is nothing magic here. How you organize and group your expenses is up to you. I put car payment under debt, but it could also go under transportation. The important thing is to list all expenses and not spend more than you make.
Budget Category
Example Expenses
Housing
Mortgage, rent, HOA fees, property taxes (if not escrowed), home maintenance
When you were growing up, you likely spent some time talking with your friends about being a millionaire. Maybe the conversation was around what would do if you had a million dollars. The word “millionaire” for my generation conjures up images of Thurston Howell III, the wealthy tycoon from Gillian’s Island. Or Bill Gates. Or hundreds of other actors, athletes, or business leaders who made it big. The truth about the average millionaire is actually quite different. While the star football player and the A-list actress may be millionaires, the average millionaire in the United States looks shockingly ordinary. But don’t take my word for it. Instead, let’s take a peek at a 2019 study about millionaires and compare the statistics from that study to seven widely-held beliefs about millionaires.
Belief #1 – Wealthy people use debt in their favor to make more money.
Fact Check – Millionaires are less likely to carry debt compared to the general population. In a random sampling of 2,000 millionaires, only 6% carried credit card debt compared to 40% in the general population. Similarly, only 18% of millionaires have a car loan vs almost double that with 35% of the general population. The numbers were more dramatic with student loans (2% vs 22%) and loans from family and friends (1% vs 8%). The only debt percentages that were close between millionaires and the general population are business loans (2% for both groups), home equity loans (10% for millionaires and 9% for general population), and mortgages (30% vs 34%). The study suggests that millionaires engage in debt less often than the general population does. Almost two-thirds of millionaires have ever taken out a car loan compared to almost three-fourths of the general population (65% vs 73%). Millionaires avoid credit card and student loan debt with only 27% ever holding credit card debt (vs 66% of the general population) and 29% ever holding student loan debt (vs 47% of the general population). Those numbers seem to point out a general aversion to debt except for big purchases like a house and car.
For millionaires who go into debt, it appears they pay off their debt and stay out of debt. In the study, 70% of millionaires don’t have a mortgage, and 82% don’t have a car loan. The statistics point to a pattern of millionaires avoiding debt and paying off debt when it is incurred. Instead of using debt as a tool, debt is avoided, debunking the common belief that debt is a wealth-building tool.
Belief #2 – Most wealthy people come from wealthy families.
This belief hinges on our definition of “wealthy,” but let’s look at this in terms of income class. Millionaires in the study broke down their childhood economics this way:
Income Class
% Millionaires Households in Childhood
Lower Class
4%
Lower-Middle Class
27%
Middle Class
48%
Upper-Middle Class
19%
Upper Class
2%
Income Class of Millionaires’ Household During Childhood
If we define Upper-Middle Class and Upper Class America as “wealthy” then only 21% of current millionaires came from wealthy families. What we actually see is a nice bell curve that skews slightly toward the lower income levels. The stats show that millionaires are more likely to have come from a family below middle class (31%) than to have come from a family above middle class (21%). The majority of American millionaires came from middle class households or below (79%, in fact). Almost 8 out of 10 millionaires were not born or raised with a silver spoon in their mouths. That debunks belief #2.
Belief #3 – To become rich, you have to take big risks with your money.
Investing in and employer-sponsored 401(k) or a Roth IRA is the most commonly used wealth-building vehicle and was used by 80% of the millionaires in the study. While the investments inside of those vehicles could have more or less risk, 401(k) and IRA investments as a form of investing are not super risky. The next most popular vehicles are Exchange Traded Funds (ETFs), single stocks, traditional IRAs, and saving accounts. Again, the specific investments within the 401(k) or IRA would be the greatest measure of risk, but in general, investing in the stock market will yield positive returns. Since 1926 the S&P 500 has returned an average of 12.01% per year. That might seem surprising, especially when you consider the Great Depression and a 37% drop in 2008 are included in that average. Prior to 2022, that S&P 500 lifetime return was 12.33%. While there is risk in the market, it is hard to call IRA and 401(k) investing as “risky” investments. If the unproven cryptocurrency is what folks have in mind, that is not how the millionaires in the study made their money. Old-fashion retirement plans and savings accounts led the way and serve to debunk the high-risk myth about millionaires.
Belief #4 – The majority of millionaires inherited their money.
With a reported 79% of millionaires receiving no inheritance, that statistic alone debunks the belief that most millionaires inherit their money, but let’s dig in a little deeper. Of the 21% who did receive some type of inheritance, the percentages skew a little to the lower end but are split fairly evenly between $1 and over $1 million. 5% received under $100K and 3% received $1 million or more. Another 3% received an inheritance of between $500K – $1M. We can fairly say that the 6% of people inheriting $500K+ had a quicker path to millionaire status, but 6% is a good distance away from a majority of millionaires inheriting their money to become millionaires. To dig one shovelful deeper, 47% of millionaires had neither parent graduate from a trade school or college. Statistically, that means that the lifetime income of those individuals is lower than households where one or both parents graduated from a trade school or college. That would mean there is less potential money to leave as an inheritance. This further supports the idea that by and large, millionaires don’t inherit their wealth.
Belief #5 – You need a six-figure salary to become a millionaire in today’s economy.
A full 33% of millionaires never had a six-figure salary in all their working lives. That alone shows us that it is possible to become a millionaire on a five-figure income. Another related widely-held belief is that you have to be a doctor, lawyer, or company executive to be a millionaire. While the large income that accompanies some professions might be able to create wealth faster, the most common millionaire professions are Engineer, Accountant, Teacher, Manager, and Attorney. There is a decided white collar feel to the list and, yes, lawyer comes in at number five, but it is behind teacher at number three. In 2019 the national average elementary or middle school teacher salary was $53,800 according to the US Census Bureau. With the median household income being $69,021, it should be encouraging to know that an teacher paid on par with the national average can still become a millionaire with good financial discipline.
Belief #6 – Most millionaires have a million-dollar home.
The image of a Versailles garden surrounding a lavish pool on a large secluded plot of land with a mansion is an attractive one, and it is a fantasy image often associated with millionaires. Let’s see what happens when we fact check that against our millionaire study. According to the US Census Bureau, the average new home in the US is 2,660 square feet. The millionaire study showed that the average millionaire house is slightly smaller than that at 2,600 square feet. In the study, 65% of millionaires live in a house 2,999 square feet or less. While a well-constructed house of that size could certainly fetch a million-dollar price tag in some high-rent neighborhoods, 79% of American millionaires live in a neighborhood with the average household income of less than $100K. With the average US household income coming in at $69,021, we see that the majority of millionaires (51%) live in neighborhoods of $75K or less household income. Statistically, these neighborhoods are very average and don’t jump out as a statistic setting millionaire houses apart from the general population. Most millionaires live in areas in stark contrast to more affluent neighborhoods nationally. For the more posh example, Los Altos, CA on the western edge of Silicon Valley has a median household income of over $250,000, and the median household income is $234,427 for Highland Park, Texas. These are not the neighborhoods of the average millionaire. That’s a lot of numbers to read through, but they all point to this truth: most American millionaires live in average-sized houses in average neighborhoods, not high-income gated communities. That debunks the millionaires living in million-dollar mansions myth.
Belief #7 – You have to be lucky to get rich.
This belief is just as hard to debunk as it is to support. Let’s look at a cross-section of statistics about millionaires to see if we uncover any patterns. Most millionaires made good grades in school with 51% being “A students” and 35% being “B students.” That seems to favor being studious over lucky, but let’s press on for a better picture of the average millionaire. In school, 40% were in sports, 17% in band, and 22% were not an any extracurricular activities showing that most folks were active in some form. Education appears to play a role because 36% of millionaires have a 4-year college degree and 38% have a graduate-level degree. First-generation college graduates accounted for 46% of all millionaires. That desire for education shows initiative to get a degree and hard work and determination to see it through, but those qualities may also describe the 13% of millionaires who don’t have a college degree. Saving money is a habit for millionaires as 71% of them save at least 11% of their income every month. That sounds more like financial discipline than luck. For shopping habits, 34% of millionaires have shopped in a thrift store in the last year, 93% use coupons some or all of the time, and 85% of millionaires use a written shopping list and stick to it sometimes or always. The grocery budget of an average millionaire is $412/month which is under the average family grocery budget of $582/month. Restaurants take in only about $200/month of spending from the median millionaire which is $51 less than the average US household spends on eating out each month. These shopping and spending stats paint a picture of a frugal planner. We can’t say conclusively that luck did or did not play a part, but there is a pattern of intentional living that should not be ignored. Seeking opportunity through education, spending less, and saving more are hallmarks of today’s millionaire.
Conclusion
Why take the time to examine characteristics and habits of today’s millionaires? I’m a data nerd, so there is that bit of fun for me, but I also had a simple point in digging into the topic. It is not because we should hold up millionaires as holding some sort of better-than-the-rest-of-us status as people. Quite the opposite. Using the arbitrary standard of a million-dollar net worth as a milestone and looking at the facts, not public perception, it becomes clear that the path to being a millionaire is not as distant as it might seem if you listen to the thoughts of the world around you. Some people might see it as unattainable. That lack of belief then becomes their reality – I can’t succeed with money, so what’s the point of saving, or watching my spending? Why go through the effort to budget if I don’t see a path for moving forward financially?
Succeeding financially – be it a millionaire, a multi-millionaire, or just creating some breathing room in your financial life – is something attainable by everyone. The path looks different for each person, but it is a well-proven path. It starts with understanding some financials principles, working to develop positive habits with money, and controlling the things you can control.
I sincerely believe that armed with solid principles and a desire to change, anyone can forge a better financial future for themselves and their family. Once established, solid consistent financial habits can make a difference to your family for generations to come. I have a passion for walking alongside people who have the desire to improve their financial world. I’m happy to take time to meet with you to understand your current situation and put together a game plan for how to help you move forward. The consultation and game plan are complimentary. If we talk and there is a way I can help, I’ll also show you how I can engage with you as your financial coach to guide and encourage you as you execute on your game plan. With or without my help, the path to a positive financial future is available to you. Who knows, you might be the next millionaire?
You look at your pile of bills and sigh. Relief seems nowhere in sight. No one is riding in on a white horse to make things better. In fact, each month any small step of progress is erased the next month with an unexpected expense that makes the hole deeper. It’s getting depressing.
Now what?
I’m not going to sugar coat it. Getting out of debt takes time, intentional focus, and is hard work. But you already know that. If it was easy, the debt would already be gone. I want to give you some hope and a pattern to follow that will help you catch your breath, get your head above water, and eventually empower you to pay off your debt completely. Take a moment to think ahead to how good it will feel when you don’t owe anyone money. Take some deep breaths and let’s dive into a proven plan you can follow that works.
Save a small emergency fund of $1,000. “No, you don’t understand, I want to pay off my debt, not save money.” I understand. The best way to make sure you can stay on a path to paying off debt is to start by providing some margin between you and the ups and downs of life. An emergency fund is your buffer to make sure the small hiccups don’t derail you. Finances are more about behavior than math, and our behavior is often influenced by our emotions. If you are rolling along paying down debt and a $500 car repair smacks you between the eyes, it can throw you off balance. The panic of seeing your progress slip away as you figure out how to scrape together $500 is why you need that emergency fund. With $1,000 in the bank, you might wobble a bit, but you pull money from your emergency fund and keep on going. Without that money, you may find your progress stalled and your spirit crushed. All that momentum you worked so hard to generate before the repair bill hit is not stopped if you have built the cushion in advance.
Use a debt snowball to pay off your debts. Remember earlier when I stated that finances are more about behavior than math? This next step may offend your calculator, but it is the best option for any humans trying to pay off debt. In a debt snowball, you pay the minimum payment on each debt and put all extra money toward paying off your debts from smallest balance to largest balance regardless of interest rate. Math nerds will tell you to pay off higher interest rate debt first. It will save you a small amount of interest in the long run, but paying off debt is more about behavior than math. If you trade that tiny amount of interest for a heaping dose of success and encouragement, your probability of being debt free skyrockets. Let’s walk through an example to see why good math is not going to help you get out of debt as much as good sense.
Paying off debt is more about behavior than math.
We’ll start with two friends, Chris and Sam who each have identical incomes and the same amount of debt. Incidentally, the amounts here are based on current average US debts and rates for each category. The credit card rate assumes an excellent credit score:
Description
Debt Amount
Rate
Min Payment
Federal student loan
$27,000
6.36%
$248
Private student loan
$10,574
5.8%
$116.33
Car loan
$41,665
7%
$700
Credit card
$5,589
15.16%
$136.78
Example debt list based on current US averages for amount and rate by category
Chris and Sam each have $84,828 of debt which is starting to feel unmanageable. Paying $1,201 in minimum payments each month has not moved the needle for either one of them. Chris and Sam make a pact to get debt free, but they take slightly different approaches.
Sam has heard that you should pick the debt with the highest interest rate first and pay it off because it will save more interest in the long run. Sam decides to throw extra dollars at the credit card first, the car loan second, the federal student loan third, then finally the private student loan.
Chris favors a method called the debt snowball. The principle is to pay off the lowest balance first regardless of interest rate. Chris will attack the credit card first, private student loan second, federal student loan third, and car loan last. We’ll examine the wisdom of these two approaches.
Chris and Sam have tightened their respective budgets and taken part-time jobs leaving each of them an extra $1,200 a month to put towards debt. After five months, Chris and Sam celebrate! They have paid off their credit card. Only three debts to go! Chris takes the payment he was making on the credit card with the extra $1,200 and now pays extra on the next smallest balance, the private student loan. Sam takes the same extra amount and applies it toward the next highest interest rate, the car loan.
Seven months later Chris meets up with Sam to celebrate, but Sam is confused. Chris has paid off the private student loan and has only two debts to go! Sam is a bit puzzled with another 13 months to go until the car loan is paid. Chris is upbeat and feels “halfway there!” This is the critical point where the interest rate approach may fail Sam. Sam feels defeated. The facts are that Sam and Chris have each paid the same amount on their identical debts, but Chris has something extra to celebrate having knocked out a second debt while Sam is wondering if the approach should have been more like Chris’. Chris is beginning to believe while Sam is filling with doubt.
People need encouragement, and math doesn’t supply that, but success does.
If Sam continues the quest to pay off debt despite the discouragement of feeling behind, that debt free day will come at the same time as it will for Chris, forty months into the process. The reality is that people need encouragement, and math doesn’t supply that, but success does. Paying off a debt and having one less bill to pay comes with a sense of accomplishment and relief. It allows for a celebration, a measure of success that the mathematical formula didn’t account for when purely calculating interest. That progress is a positive reinforcement that people need to keep going. The math tells us that Sam and Chris are in the same spot having each paid $28,813 in the first year, but Chris has gotten more of an emotional payoff than Sam. For many people, that visible progress (or lack of it) can make the difference between continuing to pay off debt and giving up discouraged by the lack of progress. Chris is more likely to forge ahead buoyed by success, and Sam is at risk for calling it quits.
If we fast forward and assume that Chris and Sam stay the course, 25 months into the plan Sam pays off the car loan (two debts to go!) and Chris pays off the federal student loan debt in month 27. Chris has one debt left (yea!) and is rounding third heading for home while Sam is still making two payments each month. If they both see their respective plans to a successful conclusion, each will completely pay off all debt in 3 years and 4 months. That’s a big “if.” I’m pulling for Chris and Sam to both make it, but emotionally, Sam is less likely to see it through. If both do make it the full 40 months, Sam will have ridden more of an emotional roller coaster but will have paid $443 less in interest than Chris. Chris traded that .5% of interest savings for faster wins cementing commitment to the plan.
There is much more to cover around the mechanics of budgeting and generating extra money to help get out from under a pile of debt. Those are topics for another time. For now, if you are mired in debt and don’t know which way is up, take the small step of saving a $1,000 to give you a buffer against the emergencies in life, and use the debt snowball to build momentum to pay off your debt. It is an approach used by millions of people. For more details on the debt snowball, check out these links from Ramsey Solutions.
For assistance in assessing where you are in your financial life or to have someone walk alongside you as you work towards freedom from debt, click the button for a complimentary consultation to help you move in the right direction.
You just worked your way through four (or more) years of studying, testing, learning, and growing with great focus and intensity. You put yourself out there — scary isn’t it? — and you landed your first “real” job out of school. Life is grand as you settle into your new normal.
Now what?
Financially, you are likely to be making and managing more money than you ever have in your life. Your parents may or may not have been good role models for how to handle money. Just like with other aspects of your life, you get to make your own decisions about what you do with the money you are earning. Being wise with your money right out of school will help establish patterns — good or bad — for how well money serves you in the future.
Follow these steps to build a solid financial foundation for yourself:
Assess Where You Are. You may have been living in an apartment or a dorm and living the college life, but now, you have more bills and responsibilities. Understanding the current state of your finances is important. Do you have any debt? Do you have money in savings? Are you good at tracking expenses? Are you comfortable with choices at your new job around insurance, retirement savings, and health care options? Be realistic about what you know and don’t know. Make a list of financial areas or topics you would like to understand more now that you are on your own.
Educate Yourself. Have conversations with co-workers, parents, and friends about how they deal with money. Treat these as inputs, not directives. Remember, your friends likely have as the same degree of experience with money as you do, so listen to what they have to say, but weigh their words against people who have already worked through the financial events that are still in your future. Learning from people a generation or two ahead of you can save you lots of valuable time (and mistakes) when handling your money. For Christians, the Bible has plenty to say about money, so you could benefit in learning biblical principles around money.
Pay Off Your Debt. Based on 2016 statistics from the Institute for College Access & Success, most (over 66%) college graduates finish school with student loan debt. You are statistically average if you graduated with $37,574 of federal student loan debt according to figures compiled by the Education Data Initiative for 2021. When you include data from private lenders, that figure approaches $55,000 per person. That means most graduates are starting life $40-50K in the hole. Letting that debt hang around means blunting your sharpest financial tool, your income. Paying back student loans will take time and deliberate effort. If you are thinking some or all of that debt will be forgiven, think again. Only 2.5% of Public Service Loan Forgiveness (PSLF) applications have been approved since November 2020. Only .65% of federal student loans have been forgiven through PSLF. Just $253.8 million was forgiven as part of the Teacher Loan Forgiveness. Student loan forgiveness can and does happen, but the path is narrow. You have about the same chance of being born with red hair (2%) as you do having your student loans forgiven. Student loan debt is not the only kind of debt, but it is quite common. Car loans, personal loans, and credit card debt can also saddle recent grads with demands on their paychecks. Pay off your debt as quickly as you can. It’s not a pet, and it won’t go away on its own.
Create An Emergency Fund. The best buffer between you and financial trouble is an emergency fund. This is money you set aside for…wait for it…an emergency. That might be a blown tire, and unexpected car repair, or a layoff. Building a cushion between and life’s financial surprises will keep a one-time expense from throwing you off course. Even before you pay off debt, you should build up a small $1,000 emergency fund. After your debts are paid, use the money you were previously using to pay your debts and redirect that into a savings account or money market account. Build this emergency fund up to cover three to six months of expenses (not income, but expenses). If you are in a high-risk position or market, six months may be best. If you are in a low-risk position and could find a job in your field quickly if you lost your current job, you might build just three months of savings. Regardless, putting that buffer in place before investing will help you from being being financially derailed by an emergency.
Start Retirement Saving. Now. After you are out of debt and have a full emergency fund, use 15% of your take home pay to invest in retirement. Depending upon your profession, there are a variety of options that may be available to you. 403(b), 401(K), Roth IRA, traditional IRA, solo 401(K), SEP IRA, and other options like Teacher Retirement System (TRS) or the military’s Thrift Savings Plan (TSP) may be available. I’ll cover retirement options in another post, but regardless of the vehicle, the principle is to invest early and regularly to grow your future retirement nest egg. It may seem like you don’t need to think about retirement when it is several decades away, but outside of your income, your greatest wealth-building tool for the future is compound interest. Saving early and taking advantage of compound interest is one of those rare times when time really is on your side.
Learn To Budget. Your largest wealth-building tool is your income. Most people have a general notion of where they spend their money, but once they do a budget they are surprised to see what amount of money is spent in what places. Doing a budget may sound constricting and limiting, but in reality it provides you full control over where your money goes. When people budget for the first time they typically find several hundred dollars they can redirect towards a goal. That “found money” could be used for your savings, paying off debt, or investing. Budgeting is a learned skill, so be okay with not getting everything right the first month. Stick with it. After three to four months, your skills will grow and your accuracy will improve. Combined with investing at a young age, budgeting is the most powerful tool you have.
Give. This one may sound counterintuitive, but giving money to causes you believe in enhances your quality of life. Whether you give as part of a “pay it forward” cycle, to connect with and support a cause, or because it makes you feel good, generous people tend to live longer healthier lives. Being generous to others also teaches us to be less centered on ourselves and focus on others. Giving money connects you to a purpose bigger than yourself. The mental health benefits of being a giver can start with small regular gifts and expand as your income grows. Giving can have tax benefits, too, but the primary reason to give is to develop generosity.
Those are some great starting points. If that list feels too daunting, take it one step at a time. Commit to taking stock of where you are and determining a single next step. Perhaps you decide to work on generosity and give a small financial gift each month. You could commit to learning about money management or start a budget. Whatever it is, be intentional about learning to make your money work for you.
If you would like help taking stock or where you are or what a good next step is as you spend your first few years in the workplace, we provide a complimentary consultation and can work with you on determining next steps.
You just accomplished a goal you had in front of you for the last six months, year, five years, or lifetime. Obstacles were overcome, challenges were risen to, and the struggle has finally turned into success! You fought the good fight, slayed the dragon, and you have reached the metaphorical mountaintop. You did it. You did it! YOU DID IT! Way to go!
Now what?
Don’t be surprised if it feels a bit different than you expected. Many times when you move from a time of intentional focus on a goal to actually achieving that goal there is a letdown. Author and psychology expert Tal Ben-Shahar calls this feeling arrival fallacy. In essence, as you work towards a goal and are convinced you’ll achieve it, your brain starts to adjust to your new reality before you get there so when you reach the goal, it is often not the peak mountaintop experience you expected.
So how do you move forward and get out of your arrival fallacy mini-funk? Here are some ideas to get you moving in the right direction:
Celebrate success. At times we are so focused on a goal, when we achieve it, especially when experiencing the letdown we just discussed, we are exhausted. Take time to celebrate. It can be private or public, with friends and those who supported you, or simply treating yourself to something. Celebrating success is important. It can wipe out some of those blues and it serves to remind yourself that your goal was worth it.
Take stock of your life. Reflect on the journey to accomplishing your goal, and be grateful for what you learned and how you changed along the way. Dig into some of the following questions:
What was the biggest obstacle you overcame and how did you do it?
Knowing what you know now, what would you have done differently? (Don’t use this to second guess yourself, but to grow from the experience and add to your toolset for your next adventure.)
How have I grown from the experience? It could be skills you gained, principles you have learned, relationships you have formed or distanced from as part of your journey. Even bad experiences can pay you back later if you learn how not to do something.
Examine your purpose. Why was the goal important to you? Is it a step in a larger journey that reflects who you are and what you value? The busy buzz of life keeps us from doing important reflection, and nothing is more beneficial than recalibrating on your purpose. We can all get off course when we are not intentional, so reminding yourself who you are and what you are all about can be key to understanding what is next.
The conventional wisdom will tell you to set a new goal. That’s not a bad idea – goals can certainly be a great tool in motivating us to move forward. In setting a new goal, be careful not to fall into the striving trap. What is that? The striving trap is like a monkey through swinging from tree to tree through the jungle, constantly in motion, but never really getting anywhere of value. It can be tempting — even euphorically intoxicating — to be constantly in motion. However, we were made as human beings, not human doings. That is why knowing your purpose is so important. There is a rhythm of work, rest, and play that should be maintained. Always resting is laziness. Always playing is irresponsible. Always working is missing out on life.
So set goals, sure, but make sure they align with your purpose. You may find that now is a time to rest and rejuvenate for a short season. You may discover that in reaching your most recent goal, some important relationships have been set aside and need to be rekindled. You may find that the intensity it took to accomplish your goal sucked some of the joy out of life, so you need some time to relax and play. Setting a new goal may be best for you, but don’t be a mindless monkey just trying to stay in motion. Crack open a coconut, peel back a banana, hang out in a barrel full of, well, friends and then see what is is next. Staying true to your purpose and being intentional about next steps will help make your life not just successful, but meaningful.
When you have kids it is important to teach them about money. Where it comes from (working for it), the value of it, and how to handle it. In this post, I’ll give a quick rundown on how to start talking to your children about money.
From an early age, a child will observe a parent making perhaps a hundred or more transactions a year. These all leave an impression, and some of the impressions are not accurate. You go to a store, you insert a plastic card into a machine, and you walk out with food, toys, or electronics. The impression is that you didn’t exchange anything for what you received, so it is important to teach children that money is exchanged for the things you buy, both products like groceries and services like haircuts and medical care. Money has a value that can be used to buy the things you need and some things you want. Explaining the difference between a need and a want is key, but that is part of a larger discussion for another time.
So money has value, but how do I know how much money it takes to buy something? Great question. Items in stores and services are listed with a price, and that price is generally considered to be what the item is worth. You may agree and decide to exchange money for it, or you may not agree that the value is fair and look somewhere else for the item you need, but the price is the rate of exchange that assigns value to something.
So you give the clerk money and in return get a product based on a price. But how did you get money in the first place? Ah, yes. Money comes from work. You can own a business and work for yourself or you can work for a company or business someone else owns, but the bottom line is that work earns money. Money comes from work, and the amount of money earned is determined by the amount of work and the societal value placed on the work performed. [I’ll pause here. My mother, wife, and children are all teachers. Teaching is one of the most important professions to any society. I find teacher pay to be less than adequate for the work they do and the service they perform for the children they teach, their families, and society as a whole. I can list other professions that I feel are over or under paid, but the reality is that there is a relationship between perceived value and pay. Don’t send me angry emails, I’m on your side.] As your child gets older, opening their eyes to how different careers are valued is important as is the lesson that they should do something they enjoy. The intersection of those circles can help their long-term financial and emotional health.
For now, I’ll get back to what a younger child might need to know about money. Raising our girls, we focused on the three things you can do with money. Spend it, save it, and give it. Everything else flows out of one of those three areas, so keeping it simple for younger children, say ages 3-6, is best. We actually had a bank with three chambers to teach the spend, save, give principle. When the girls earned money from doing chores, we would try to pay them in smaller amounts so they could break up the money. In the beginning, we divided it evenly just to make it easy, but as they grew older, more went into the spend, and less into the save and give to mirror what an adult would do. The spend money was more fluid and could go for games or fun things they wanted, the save money could be used for purchases that required them to build toward over time or take on a trip to buy souvenirs, and the give money could be given to our local church or a charity like the Red Cross for disaster relief. Letting our children handle money from and early age, make purchases at the counter, and deal with change were all part of giving them confidence and reinforcing the value of money.
In the future, I’ll do a further breakdown of different ways to help your children learn to handle money at different ages. This is just a quick encouragement to be intentional in teaching your children about money. Is it not the center of the universe, but it is a reality of adult life, so teach a child how to handle money is an important part of parenting to prepare them for their life ahead.
The principles you teach your children now will last a lifetime. Working with your children and helping them learn to handle money now will give them the confidence and tools they will need to be successful handling money in the future.
When you hear something is done in the background, it can sound a little shady. A backroom deal is one that was brokered in secret and may be illegal or dishonest to reach an agreement. A back alley is an unsavory place where a fight or a drug deal happens. Is it any wonder when we hear the term “backdoor Roth” that it makes us think twice about the legality of such an arrangement? No one wants to run afoul of the long arm of the IRS when it comes to filing taxes correctly. So with that in mind, let’s explore what a backdoor Roth IRA is and see if it is on the up and up.
Basic Limits on Roth IRAs
If you are a high income earner, the IRS disallows some forms of retirement investment. I’ll skirt the discussion about why disincentivizing retirement saving is a bad idea and instead I’ll stick to the facts. In 2025, just as in 2024, you lose the ability to contribute directly to a Roth IRA if you file singly and make more than $150,000 for the year or you are married filing jointly and make over $236,000 per year. Beyond those income thresholds the ability to contribute is decreased and then eliminated completely. That’s an unfortunate part of the IRS tax code because Roth IRA contributions grow tax free which is more advantageous in retirement than having to pay taxes on Traditional IRA withdrawals.
But wait! There is a loophole in the tax code. It sounds too good to be true, and that phrase should set off alarm bells in your head. If it sounds too good to be true, it probably is. In this case – and feel free to factcheck me – this loophole is a fairly easy way for high income earners to still get tax-free growth for life from their IRA contributions. The approach is called a “backdoor Roth IRA” and despite the shady sounding name, it is completely legal.
Who Should Consider a Backdoor Roth IRA?
If you are earning more than the Roth IRA income limits listed above but you still want your money to grow tax free, the backdoor Roth should be something you strongly consider. It is not a complicated process, but you do have to have your ducks in a row to get the maximum benefit from a backdoor Roth.
Standard IRA Contributions
For those unfamiliar with IRAs, let’s quickly walk through how IRA contributions work. An IRA account has a maximum amount you can contribute each year. In 2025 as in 2024, you can contribute $7,000/year into an IRA. If you are over 50 years old or turn 50 this year, your contribution limit rises to $8,000/year because you get to take advantage of a $1,000/year catchup contribution. That $7,000 or $8,000/year is a total per person, so if you are a married couple, you and your spouse can each contribute $7,000 (or $8,000 if you are over 50) into your own IRA account as long as you have a household income over that covers the contribution amount. If only one spouse works, but makes more than $14,000 in income, both IRAs can be fully funded.
Contributing an IRA account – Roth or traditional – is a simple process. You can have pre-tax money deposited directly into a traditional IRA or post-tax money deposited into a Roth IRA. Simply set up a transfer to the IRA account, decide how to invest the money within the account and you are done. The backdoor Roth takes a few extra steps, but it is well worth the effort.
How a Backdoor Roth IRA Works
For individuals whose income puts them over the Roth IRA contribution limits, the backdoor Roth is the way to go. Here are the steps to follow:
First, if you don’t already have a traditional IRA account and a Roth IRA account, open one of each. You can do this at the broker of your choice. Fidelity, Charles Schwab, and Vanguard are just three of many options available on the market. For ease of managing the accounts, I recommend using one broker for both the Traditional IRA and Roth IRA account. When you have your two IRA accounts open, make a contribution to your traditional IRA account. You can contribute the maximum for the year ($7,000 for most people as detailed above) in one transfer or you can make multiple contributions over the course of the year. The amount doesn’t matter, but as you will see later, timing does matter.
After your traditional IRA contribution is made, you can perform a Roth conversion on that money. Most brokerage services allow you to do this Roth conversion by completing a form online. You tell them how much money to convert, and those funds will be moved from your traditional IRA account to your Roth IRA account. Any time you perform a Roth conversion, you need to be aware of two things. First, because you are moving from a pre-tax account to a post-tax account, you have to pay the taxes on any gains at the time of the Roth conversion. You need to make sure you have money to cover taxes on those gains. Second, you cannot undo this conversion.
This is where timing is your ally. When you make your traditional IRA contribution, do not invest that money, just leave it in a cash position. Why? By leaving it in cash, the chance that you will have gains on your money is very low. You may make a tiny bit of interest, but that is why the timing is important. It is best to perform the Roth conversion a day or two after your funds hit your traditional IRA account. By performing the conversion immediately after the contribution is made, you should have no gains on the money – thus no taxes due. If you let that money sit and potentially grow in your traditional IRA in an investment rather than in cash, when you do the conversion, you’ll need to pay taxes on the money you have earned. It is wise to do that conversion immediately, invest the money once it is in your Roth account, and let that investment grow 100% tax free.
Limits and Considerations
As of this writing (January 2025), the IRA has not set any limitations on the number of Roth conversions you can perform. If you contribute $1,000 a month for seven months to fully fund your IRA, you could contribute monthly from January through July and perform a Roth conversion after each contribution. Seven contributions, and seven conversions of $1,000 each will max out your Roth contribution for the year. You could also make one contribution to max out your traditional IRA at $7,000, then do one Roth conversion and be done for the year. If you are able to do so, that allows that money to grow tax free for a longer period of time.
As with any retirement contributions, be sure to keep records of traditional IRA contributions and your Roth conversions. You’ll want to have these at tax time to have a clean paper trail of your Roth conversion to show that you did a backdoor Roth conversion, not a Roth contribution. As silly as it may seem, you cannot contribute directly to a Roth if you exceed the income limits, but anyone can use the backdoor Roth conversion to move money into a Roth IRA.
Keys to Roth Conversions
For you high earners to get the most out of your Roth IRA conversion, make sure you follow the best practices:
Contribute only into your traditional IRA account, never directly to your Roth IRA.
Make sure your traditional IRA contribution goes to cash, not into an investment. This will limit or eliminate taxes you need to pay on any gains.
Perform the Roth conversion as soon as you see the money in your traditional IRA account. Once again, this limits or eliminates any possible gains where you would owe taxes at the time of the conversion.
Window of Opportunity
One final note on the Roth IRA and IRA contributions in general. You have until April 15 (or the IRA tax filing deadline each year) to contribute to your IRA for the previous year. That means that even if you don’t have an IRA account today, you have time to open your traditional and Roth accounts and follow the backdoor Roth process described in this article. With IRA contributions limited each year, this is a golden opportunity to “double fund” your retirement within this window, making contributions for 2024 and 2025. I urge anyone who is able to take advantage of this opportunity to save for your retirement.
This article is designed to help you maximize your retirement investing. If you have resolved to make progress on your financial goals this year, start the process with a financial checkup. Schedule a free no-obligation consultation to see where you are on the financial roadmap and build a plan for a better future for you and your family.
For tips on Managing Your Dollars with Common Sense, read the Loose Change blog or reach out to KJ Financial Coaching to break out of your paycheck-to-paycheck rut.
When you find the perfect gift for someone you love, gift giving can be pure joy. When you are pressed for time to find gifts for all of your friends and extended family members out of obligation, it can be a real chore. No matter how your holiday season gift giving went – joyful or painful – one thing may still ring true in January. The bill is due.
According to financial site NerdWallet, only 31% of people who use credit cards to purchase holiday gifts pay off the full balance when the first bill arrives. For the majority of Americans – almost 7 in 10 – those gifts end up being a more expensive than expected when late fees and finance charges are added. Even as late as October – a full ten months after last year’s Christmas – 28% of Americans are still paying off their Christmas gifts from last year. Ho ho holy cow! Way to take the happy out of the holidays and make the Christmas aftermath much less merry.
We’ve all heard that insanity is continuing to do the same thing while expecting different results. Why not take a different approach this year to generate different results? To formulate a better plan, let’s unpack where things went wrong so we can correct them.
Diagnosing the Pieces of the Problem
Let’s start with the calendar. If we are buying gifts for Christmas, let’s admit that the date doesn’t exactly sneak up on us. It might feel like it arrives way too quickly, but last time I looked, December 25th is the date for Christmas every year. That means if we are caught off guard by Christmas, it is our own lack of preparation that got us there. Let’s make a resolution to plan ahead next time.
What else doesn’t feel too great? That big bill at the end and the 70% chance of finance charges comes to mind. According to my in depth analysis, 100% of finance charges are added to purchase made with a credit card. To avoid the finance charges, avoid using debt for gifts.
Is there anything else we can improve? How about the high stress of paying for all of those gifts at once? When it comes to buying gifts, Americans procrastinate. The National Retail Foundation tells us that in 2023, holiday spending was over $964 billion! Maybe we should spread that out a little bit. NerdWallet tells is that the cost of holiday shopping is a significant stress for 55% of shoppers. Spreading thing out over time might make that more palatable.
I think we have a list of holiday stressors to tackle this year. Now let’s see where we can go with some solutions based on better planning, changing how we pay, and when we pay.
Stress Less for the Holidays This Year
What if, instead of jamming all of that holiday spending into the last month or two of the year, we spread it out over the entire year? And what if you saved a little bit of money each paycheck along the way?
The Holiday Spending Report tells us that the average holiday spender plans to spend about $925 on gifts this year so let’s us that as our base. If you get paid twice a month, dividing the amount equally across paychecks means saving a mere $38.54 per paycheck to pay for all those holiday gifts. That sure seems like a mole hill compared to the almost $1,000 mountain when the expense hits all at once. You can increase or decrease that number, but the process will work the same. Divide the total budget for gifts my the number of paychecks to get an amount to take out of each check.
What do you do with that money? Stash it in a separate account so you are not tempted to spend it. This is a trick that the IRS uses. Money is withheld from your paycheck and you have to then file your taxes to justify the amount and either pay more or get a refund, but it is money that you don’t have to spend from each paycheck. In our holiday budget case, you need to set up the system yourself, but there is a way to put it on auto pilot.
Simple Four Step Plan
First, set up a separate account. All banks or credit unions have a club account or a secondary savings account you can use. Some banks like Ally allow you to set up what it calls buckets. Buckets provide a way to set aside money inside of an existing account for a specific purpose without the hassle and complexity of opening another account. This means you can create a bucket called Holiday Gifts and use that to stash you holiday money.
Second, look at the timing of your paychecks and schedule a recurring transfer into your new bucket. Let’s say your paycheck is deposited into your checking account on the 1st and 15th of the month. You would set up a recurring transaction on those dates to transfer $38.54 from your checking into your Holiday Gifts bucket in your savings account (or into your club or secondary savings account). It is the same out of sight out of mind concept the IRS uses to grab money from your check before you can spend it.
Third – and this is really important – leave that money alone. Simple concept, but be sure you don’t dip into your holiday fund when that perfect pair of shoes goes on sale, or the tire blows out on the car. If you use that as an emergency fund, it will be the sad montage in the movie Up where the young couple keeps saving just to repeatedly break the piggy bank and drain their trip fund.
Finally, and this is the fund step, when the end of the year rolls around and you have been on Santa’s good list by not touching the money, you will have $925 in cash to spend on gifts. It may seem like a Christmas miracle, but in fact it is just good planning and execution. That pile of cash is not permission to overspend, it is a way to make sure you don’t have the same gift giving hangover next holiday season that you had this year. Having the cash on hand growing throughout the year also means if you find a great deal on a holiday gift in July and you already have the money, go ahead and buy it and shove it on the top shelf of your closet. Just remember that it is there so you don’t forget to give that gift when the holidays roll around. Not that I have ever done that.
PRO TIP – Using https://camelcamelcamel.com/ to examine pricing patterns can save you money when you purchase gifts on Amazon.
This article is designed to help you get on top of your money and lower your holiday stress level. If have resolved to make progress on your financial goals this year, start the process with a Financial Checkup. Schedule a free no-obligation consultation to see where you are on the financial roadmap and build a plan for a better future for you and your family.
For tips on Managing Your Dollars with Common Sense, read the Loose Change blog or reach out to KJ Financial Coaching to break out of your paycheck-to-paycheck rut.
‘Tis the time of year for resolutions. We promise ourselves to do more of thing 1, stop doing thing 2, and for the first time in our lives we will absolutely make thing 3 a priority this year.
Then reality sets in and we often abandon these well-intentioned goals. In fact, January 10th is this year’s “Quitter’s Day,” a dubious name bestowed upon the second Friday of January marking the date by which many people have already left their resolutions behind.
I am all for changing and challenging yourself to improve. I have set resolutions in the past. Some years I have even been in the small minority of people who accomplish their goals. I still have a piece of paper with my 1989 resolutions and rows and rows of tally marks where I tracked my successful completion of a number of my resolutions. Through that experience and some wisdom gained since that time, I have the following tips about resolutions.
Tip 1: Give yourself grace. If you expect perfection, you will fail. We are imperfect people who have weak moments, faulty memories, and get tired and sick from time to time. In my experience, if I set the bar to perfection – do this thing every day without fail – then one slip or one missed day means I lost. Game over. It is demotivating. Once I learned enough about myself to give myself a little grace – do this thing 5 days out of 7 this week – I could strive for a daily habit, but if I fell short a time or two, I was still winning. The overall impact was that I was doing something 5 times a week that I wasn’t doing in the past. It was progress over perfection, and it was far more encouraging. It allowed me to build and keep momentum longer, and if I missed, I could restart knowing that I hadn’t already lost. It is a mind game to be sure, but the progress I made when there was a little bit of grace was far more than when I had to be “perfect” in my execution.
Tip 2: It’s not about the resolution. Okay, this one took me a long time to learn, but once it clicked, it made a big difference. Resolutions are not ends to themselves. They are a means for change, and that change is the important part. Once I understood that, I stopped making resolutions. Instead of aiming to hit a resolution, I focus on who I want to become.
That difference might look like this, for example. I can set a resolution to fully fund my IRA this year. I am over 50, so for me that would be $8,000 contributed to an IRA in 2025. Hitting that goal could be great, but it could also be either unattainable or too limiting. What if I only contribute $7,000? Did I fail? What if I have a $100,000 windfall and contribute $8,000 in the first month and blow the rest of the money? Did I succeed? The answer to both questions might be “no.”
If the intention behind the resolution was to become a person who is adept at saving money, saving $7,000 might be a big success. By the same logic, saving only 8% of a $100K windfall doesn’t seem to fit who I was aiming to become if I lavishly spend the other $92,000. If I want to be a person characterized by saving money, I should fund the IRA then turn around and find other ways to save and invest another portion of that windfall. It is not just a matter of hitting a goal, it about becoming who you want to be.
Tip 3: Statistics don’t matter. 61% of Americans made financial resolutions in 2024. Only 25% of people are still on track to hit their resolutions after one month. Fewer than 10% of people accomplish their resolutions for the year. 0% of that matters. What other people do or don’t do is not relevant to you. If you have decided in your gut to change, you can. One of my favorite quote is a bit lengthy, but powerfully captures this idea. It is from noted speaker Les Brown
If you want a thing bad enough to go out and fight for it, to work day and night for it, to give up your time, your peace and sleep for it.
If all that you dream and scheme is about it, and life seems useless and worthless without it.
If you gladly sweat for it and fret for it and plan for it and lose all your terror of the opposition for it.
If you simply go after that thing that you want with all your capacity, strength and sagacity, faith, hope and confidence and stern pertinacity.
If neither cold, poverty, famine, nor gout, sickness nor pain, of body and brain, can keep you away from the thing that you want.
If dogged and grim you besiege and beset it, with the help of God, YOU WILL GET IT!
– Les Brown
Don’t let the fact that others around you do or don’t succeed impact your success. If you are willing to set your sights on change and pursue it with voracity, you can change. Your change is up to you. If only 1% win, you determine if you are the 1% or the 99%.
Tip 4: History don’t matter. Please don’t tell Mrs. Bay, by dear sixth grade history teacher, but history doesn’t matter. If you have found it hard to achieve meaningful change in your life, that doesn’t mean you can’t change. I had never ridden a bike until the day I did. The fact that I had never ridden a bike didn’t define my future. History doesn’t define your future unless it stunts your belief that you can do something different or become someone different. Everything you have done was done for the first time at some point. That point became a line of demarcation marking the moment you went from “haven’t done it” to “have done it.” Failing once is not failing forever.
That’s a lot of philosophy for the new year. I share it because it has helped me as I have targeted growth areas in my life. As I change and grow, moving from striving for goals to becoming more of who I would like to be has been a freeing experience. I focus on developing character rather than checking off resolutions. If goals and resolutions are a path to your becoming who you want to be, certainly use them to your advantage. I have found focusing on the becoming to be more rewarding than checking a box and still not being who I want to be.
For tips on Managing Your Dollars with Common Sense, read the Loose Change blog or reach out to KJ Financial Coaching for help becoming a person characterized by managing money well.
Every weight lifter needs a spotter in case they can’t quite manage that last rep. Every mountain climber needs a safety harness and ropes in case they lose their grip. And every consumer needs a safety net in case they run into hard times like a big medical expense or a job loss. Financial experts who rarely agree on anything offer universal support for building a safety net to deal with emergency expenses. We can agree that everyone needs a safety net, but the real question is “Who is holding your safety net?”
Before we answer that question, let’s gain some perspective by looking at how equipped America is today to handle unexpected expenses. The data doesn’t paint a flattering picture. Here are three fast facts from Bankrate’s 2024 Annual Emergency Savings Report:
About 1 in 4 people in our country have no emergency savings. That means they have no safety net at all. That is a scary place to be when one big expense can knock you off your feet. 1 in 3 people would borrow to handle a $1,000 emergency, again showing that many people are working with a very thin margin, even if they have a little money saved.
It is a safe bet to say that more than 35% of people treat their credit card like a safety net. In fact one of reasons many people sign up for a credit card is to have access to additional spending power “in case” they need it. But does it really make sense to use a credit card as a safety net?
Is Your Credit Card a Good Safety Net?
For the disciplined spender, especially one who is early in their career, the argument of using a credit card as a safety net has some merit. If I have a credit card in case I need to use it for an expense I cannot cover, I feel more secure. That is not a bad thought, but it does have one flaw. Most people don’t limit themselves to using credit cards for emergencies. The convenience and habit of using a credit card gets in the way of using it for “emergencies only.” In fact, an MIT study concluded that using a credit card actually accelerates spending. Ultimately, if you are spending more on a credit card, you are saving less for an emergency situation.
Long-term data bears out that thinking. In 1970 only 16% of American families had a bank-issued credit card. Most people who had a credit card at that time typically had a card associated with a retail store. A little over a generation later in 1998, 68% of American families had a bank-issued credit card. In 1970 when credit card use was low the personal savings rate (money saved after expenses and taxes were paid) hovered around 12-13%, but by December 1998 that number had dropped to 5.5%. Current numbers are even worse with the September 2024 personal saving rate falling to 4.6%. There are other factors like inflation that contribute to the decline of the savings rate, of course, but don’t undervalue the allure of wielding more spending power than you can support with your cash or income. Putting money toward payments and often late fees and finance charges saps cash flow which would have historically gone towards savings.
Why does that matter? As Americans put more of their purchases on credit cards, they overspend compared with debit cards or cash spending which drops their personal savings rate. A lower rate of savings means less ability to handle emergencies, which means reaching for a credit card to bail yourself out, even to pay for a small emergency. It is a cycle that people claim to want to break — remember 59% of people are unhappy with their level of savings — but it appears people are unable or unwilling to make a change. After all, swiping a credit card at the checkout is just so doggone easy to do.
Perpetuating credit card use as a safety net is not a good approach for the long term. If you can’t afford a $1,000 emergency and you put it on a credit card, that payment can easily compound with a late fee and an interest charge. With interest rates often running in the 19-29% range today, that $1,000 compounds quickly, and your credit card safety net turns into a tangle of ropes that restrain you financially. Your credit card company is benefiting more in the event of an emergency than you are. If you can’t trust Visa or American Express to provide your safety net, who then can you trust?
Trust. That is the perfect word. Safety is fundamentally a matter of trust. You wear a safety belt or a helmet because you trust that it will be able to help in case of emergency. The last thing you would expect or want is to be taken advantage of during a time of crisis, and while a card might bail you out in the short-term, it does come with a cost. That cost is either interest to pay off the debt, opportunity cost of not stashing away that money into savings, or realistically both.
Be Your Own Safety Net
When you are answering the question of who holds your safety net, the best answer is found in your mirror. You. No one will look out for your own interests better than you. You can trust that you will have your best interest at heart. You won’t charge yourself interest if you need to pay for an emergency. You are plainly the best choice for holding your own safety net, but how do you make that dream world a reality?
There are four habits that will help you build your own safety net and frankly all of them are very boring and completely effective.
Pay yourself first. I’m a Christian, so I believe in paying God first, so my giving actually comes first, but the next portion of money after charitable giving should go to your savings. It’s the standard airline safety speech approach. In the event of an emergency, put your own oxygen mask on first, then help others. You can’t help your kids, family members, or other passengers if you are passed out on the floor from lack of oxygen, can you? Likewise, you can’t help others if you are not in a position to weather the emergency yourself. By paying yourself first, you can put yourself in the mindset of only spending what is left. If you decide to save 10% of your income, then you will make spending decisions based on the remaining 90%. By saving and “paying yourself first” you will prioritize savings rather than throwing the last crumb of your paycheck into savings. Developing that one habit is the biggest factor in becoming your own safety net.
Do a monthly budget. I told you this is boring. I like to say that budgeting is the flossing of the personal finance world. Everyone knows they should do it, but no one wants to. If you use a budget to plan your saving and spending, you can avoid the biggest mistake people make with money. They unconsciously overspend on expenses like groceries, eating out, streaming subscriptions, and coffee. When you plan your spending and track it, you will see where your money really goes, and you can make adjustments. Until you see your actual expenses in total each month, you will live by “feelings” which doesn’t aid the end goal of savings. Feeling like “we eat out a couple times a week” can easily turn into $1,000 of restaurant spending for a family. Americans on average spend over $2,137 a year on coffee away from home, yet few couples would admit to spending $356/month on their coffee runs. A properly tracked budget would expose those expenses and allow you to decide if you want to save money, or drink Starbucks. I’m just saying that a $100 Keurig might lower your coffee spending and increase your savings rate. It’s all about tradeoffs. If you are new to budgeting, check out this article that helps you with the basics.
Automate your savings. Boring again, but at least this tip lets you use technology. When you get your paycheck, not only can you pay yourself first, but you can automate that transaction. Most employers allow you to split a direct deposit check into multiple accounts, so you can transfer the majority of your check into your checking account and have a portion of your check go directly into a savings account. If you don’t have that option, you can automate the transfer within your bank or credit union by setting up a recurring transfer to coincide with your paycheck. If your paycheck is deposited every two weeks, the following day you can have an amount of your choice transferred to your savings account. Whether by direct deposit or automated transfer, you won’t spend what you don’t see in your checking account, so your saving will grow, and you won’t even miss the money that went into savings.
Using sinking funds to prepare for large recurring expenses. As much as I understand the emotion of dreading the expense of holiday spending, the coming of Christmas or Hanukkah is not an emergency. If you can see it on the calendar and track it year after year, it is not an emergency. That goes for homeowner’s insurance payments, car insurance payments, homeowner’s association dues, and property taxes, too. I won’t go into it here, but I have an entire article devoted to explaining sinking funds. Using a sinking fund takes the sting out of big expenses and allows you to continue to save money without skipping a beat.
Save Yourself
I know changing habits is not easy, but you can develop your own safety net by using the steps listed in this article. While you might be tempted to rely on your credit card to bail you out of an emergency, I urge you to trust yourself more than your credit card company. Save first, save regularly, and mind your spending. Soon you’ll be in the 41% of Americans who are comfortable with their savings. You will breathe and sleep easier knowing that you have a buffer between you and life’s curve balls.
For tips on Managing Your Dollars with Common Sense, read the Loose Change blog or reach out to KJ Financial Coaching to break out of your paycheck-to-paycheck rut.
You have heard the phrase “with great power comes great responsibility.” Consider the amazing power you carry with you every day. You carry a phone that can call anywhere in the world. That phone gives you instant access to a wealth of information on almost any topic on (or above) our planet. It is phenomenal power that we casually have at our fingertips daily and often use to play word games and complete puzzles. Hey, I play those games too, but let’s be honest and admit that we are really not using the power we have to its fullest potential.
Putting our cell phones aside for a moment, another staple in purses and wallets across America is the credit card. We can tap into more purchasing ability than we currently have in cash (more power!), but do we really understand the power – and responsibility – offered by that thin plastic card in our wallet?
Carrying a credit card is like always having a tiny little banker in your pocket. That banker is willing to make you very short-term loans all day every day. How wonderful! How cool! It is convenient, but with that great power, are you ready for the accompanying responsibility? It is good to consider that the convenience we gain may come at a cost.
Are Credit Cards a Good Deal?
Let’s examine the deal that your pocket-sized mini banker has in store for you. To make sure I found a typical example of a current credit card offer, I used my phone with its access to a great wealth of information to search for the best credit card deals. A NerdWallet article led me to some cards that were declared to be the best for me. I am familiar with tag line “What’s in your wallet?” from Capital One, so I picked the Capital One Venture Rewards Credit Card. That’s a terrible reason to pick a financial product but hit any college campus and you’ll see scores of students getting a credit card because it came with a free t-shirt. It doesn’t take much to convince us to get a card.
As I started to read the card terms, the NerdWallet site told me all the good news up front – I can get 2x-5x in airline miles, 75K bonus miles after $4,000 of purchases and other perks, all for a $95 annual fee. I’m not one for annual fees, but that seemed like a reasonably good deal so far based on all the perks. The rates and fees were buried under a section I had to expand about product details. When I followed the link, I learned the terms our Capital One mini-banker wanted to set:
Yikes! This pocket banker wants to loan me money at 20% interest (or more!) unless I pay it back in 25 days or less. That seems pretty steep. By the way, that 25 day cycle is intentional. Your bill is due on a different date each month, so your chance of missing a payment goes way up. It also allows the card company to have 14 billing cycles per year instead of 12 monthly cycles. This should be your first hint that the deck is not stacked in your favor.
Let’s look at this this credit card offer a different way. If I walked up to you in a grocery store and offered to pay for all your groceries using a very short-term loan, would you do it? The terms are to pay me back in less than a month, but if you don’t want to pay be back all the money, that’s okay. Instead, for any money you decide not to pay back, you will pay me a $40 late fee + $1.20 for every $1.00 I paid for your groceries. There is no way you are making that deal. You are assuming all the risk, and I am reaping all the rewards. That same deal is exactly the one you are making several times a day, likely dozens of times each month, with a credit card. You are taking out high-interest very short-term loans with the understanding that you need to pay each one back in full in under a month or you will owe late fees and interest.
If you have the money, why not just pay for the groceries and be done? That mini loan sounds like a terrible deal. If you pay me back one day late – in 26 days instead of 25 – you still owe me an extra $40 late fee + $1.20 for each $1 you borrowed. If you take out small very short-term loans for gas, groceries, your phone bill, your electricity — everything — eventually you are likely to miss a payment. Not you, of course. You don’t slip up like that, but most other people do. According to the Motley Fool, in 2023 the average American paid $1,657 in credit card interest payments. That means either people forgot to pay on time or weren’t able to pay their full bill. That $1,657 represents $138/month of interest. That isn’t terrible, but it does mean what’s in my wallet is less money. Take that $138/month per cardholder for the entire country and you might think you’d be talking about a pretty impressive sum of money. You would be right.
In the 12 months ending on March 31, 2024, Capital One made $51.1 billion dollars. Yes, billion with a “B.” They know what a great business it is to collect your interest payments and late fees, so they do everything they can to expand their business. In fact, they spent over $4 billion in marketing and advertising to make sure their card finds its way into your wallet. They pay Jennifer Garner between $3-4 million each year to smile and make you feel smart for carrying a Capital One credit card.
My point is not to single out Capital One. A Consumer Financial Protection Bureau report from October 2023 tells us that credit card companies charged more than $105 b-b-b-billion in interest and more than $25 billion in fees on a total outstanding balance of (take a breath) over $1 trillion. So… $1,000,000,000,000 of credit card debt. Those are staggering numbers!
With great power comes great responsibility. I’m not sure we as a nation of consumers are hitting the mark on that “great responsibility” part. That little banker in our pocket loaned us money – truckloads of money – and we paid back most of it. Even with our best intentions to pay off the balance every month, $1 trillion is still unpaid. So we pay late fees ($25 billion) and interest ($105 billion) each year. Image if the government operated that way. Oh wait, it does.
Hidden Cost of Credit
Credit cards seem like a great idea, one of pure convenience. Even if you tell me that you always pay off your balance each month (and good for you if you do!), you should still be aware of a few hidden costs of credit.
You spend more with credit cards – MIT Sloan School of Management published a study that concluded credit card use activates the brain’s reward center resulting in the average person spending more with a credit card than when using their own money. Even if you pay your balance every month, you spend more when you are using other people’s money for the purchase.
Paying increased prices – Credit card processing fees can typically run between 1.5% and 3.5% of a transaction’s value. Because the transaction fee is paid by merchants out of their sales, businesses tend to build that cost into the price of their products and services. The more credit card fees they pay, the higher the price of their products and services.
Reverse Robin Hood effect of Rewards– I’m not trying to be a social crusader here, but facts are facts. Credit card points and cash back are perks offered by credit card companies to entice people to sign up for and use their cards. Those reward points are funded by the late fees and interest payment mentioned above, and the bulk of that revenue from fees and late payments is provided by folks who are unable to pay their entire balance. Said more bluntly, people who can’t make their credit card payments are funding your credit card airline points and cash back. It’s the opposite of Robin Hood. That might give you pause about accumulating points on the backs of people less well-off than you. It certainly was a reward buzz kill for me.
It is harder to budget with credit – With a credit card you are buying something today that you won’t pay for until next month. That makes it very hard to budget. Are you budgeting for your actual spending – for the card swipes – or are you budgeting this month to pay for your purchases from last month? And if your August electric bill is on your September credit card statement and is not due until October, getting a clear picture of your expenses each month gets muddied in the process. If you pay as you go, budgeting is far easier to do.
Benefits of Flipping the Script
So how do you make sure the answer to the question “What’s in your wallet?” is “cold hard cash?” Brace yourself for a radical thought. What if you didn’t have to ask your tiny pocket banker for a loan every time you bought something? That’s possible if you pay for things out of your existing funds. Countercultural, but possible.
As an experiment, could you take the credit card(s) out of your wallet and leave them at home for, say, a month? What would happen? Reverse everything you read above this paragraph. If you are the average American, you’ll save $138/month of interest putting $1,657 back in your pocket for the year. Statistically, you will spend less money because your brain knows you are spending your money, which makes you take greater care in what you purchase and how much you spend. Budgeting becomes easier because you budget for what you spend that month, not for what you spent last month or have to pay off this month. No interest to pay, no late fees to fret over each month. No ugly credit card bills in the mail that make you scratch your head wondering how you spent so much last month.
Having a credit card isn’t wrong, any more than having a pet snake is wrong. Neither is something you should do without careful consideration. Do you know how to properly handle a snake? Do you understand the ramifications of owning a snake? If you are not thoughtful and careful of how you handle it, you might get bitten.
The struggle to get ahead is real and life is expensive, but there are alternatives to your tiny pocket banker. There are debit cards, digital accounts, and good old fashion cash. In a future article, I’ll handle whether it is truly possible to live without a credit card. You may not care to try or even to know that answer, and that’s certainly fine, but don’t buy into the myth that credit is essential to daily life. Life without a mini banker in your wallet is a life with fewer concerns, fewer fees, and a life where interest is the attention you pay to something, not money you owe Capital One.
If I told you that you could save over $500/hr. for less than a day’s work, would you be interested? This is not a pyramid scheme, a low-budget late night cable ad, or anything other than a tease to pique your interest about how you can legitimately save some money. The only thing sensational about this is the savings potential you have from doing some research and acting on it.
You may have noticed that some of your bills – even those that should be roughly the same every month – tend to creep up over time. I get it, things cost more, inflation is real, and life gets more expensive every day. However, don’t just go with the flow when providers raise prices. A savvy consumer – that’s you – knows that you have the power to make choices in our capitalist society, so use that power to your advantage and choose well.
In this article, I’ll give you an overview of how my research and choices saved me $2,965 in the past year. It took about 5 1/2 hours over the course of the year (so less than 30 min per month). You won’t get rich by saving a couple thousand dollars, but I’d rather have that money in my pocket at the end of the year than have it vanish by overpaying for services I use. In essence, my efforts paid me $531/hr. Not bad. Your savings certainly might vary, but I found the time to be a good investment for my family’s budget. I’ll detail the actual amounts saved when I was intentional about investing a little time into saving some decent money. Let’s jump right in with the first money-saving tip.
Tip 1 – Call Your Internet Provider
When I said that your costs tend to creep up over time even on bills that should be fixed amounts each month, this is the one I had in mind. About 2-3 times a year, my provider sneaks a fee increase into the schedule. I have automated much of my bill paying, so when they tick up a fee by $2.02 every few months, it makes me have to update my bill pay. It also annoys me and reminds me that I am paying more. In my neighborhood, I have limited access to internet providers, but I would certainly switch if I had another viable option. I’ve looked every year and I don’t have a good option, so I did the next best thing. I had a conversation with my neighbors, and they shared that they just moved to a better rate on their internet plan. It was $21/month less than my plan for a faster speed with the same provider I have. They told me the plan name, I thanked them and headed back to my house.
Armed with that information (thanks, neighbor!), I placed a call to my friendly Spectrum support person. I explained that I wanted the plan my neighbor was on, relayed the plan name, and patiently waited. They were actually quite accommodating, and other than having to brush off some upsells from the support rep as they pushed the “We can get you home phone, TV, AND internet for only $30/month more” angle, they switched me for the next year onto the new plan. That 30 minute call saved $21/month, which means an extra $252 per year for the next year. That’s a $504/hr. return on my phone call. We are off to a great start.
I have made this same call in the past, so I have a few additional thoughts. I always brace for a bit of haggling. You may have to put up with the “new customers only” script from the provider, but I stand ready to counter that with how long I have been a loyal customer and surely they would treat their long-time customers at least as well as new ones. I expect to be transferred to a manager for approval and to weather the storm of options where they upsell me which runs counter to my goal of saving money. Some calls I have been completely stonewalled, but in this case – and several other times – one call gets our monthly price dropped.
Tip 2 –Review Your Electricity Plan
Okay, this one is not something everyone can do, but if you can, it’s worth the effort. Texas deregulated the consumer electric market in 2002. What that means for many Texans is that you have the power to choose your own electric provider. If your community is served by municipalities, cooperatives, or investor-owned utilities they may have opted out of provider choice. For example, Frisco zip code 75035 is in an area that is mostly deregulated, but 75036 in west Frisco is serviced by CoServ which is a cooperative. If you live in a CoServ neighborhood, you have to go with a CoServ plan. If you want to know more about deregulation of electricity in Texas, Amigo Energy (a former electric provider of mine) has a nice article on the subject.
If you are not sure if you can pick your provider, go to the PowerToChoose.org website and type in your zip code. The site is run by the Public Utility Commission of Texas which is the group that regulates public utilities in the state, so it is an impartial source. There are other sites with competitive information, but be aware that they may get kickbacks from providers, and you might not be able to see all your options. Even the PowerToChoose site can have a delay in what they show as a price and the current plans actually available by a provider.
I’ll add the details to a future article, but switching electricity plans saved us $589 last year. The research took me about an hour, so that is $589/hr of savings on my time for the year. I tend to be a little plodding in my research, and I read the fine print on a few electric plans, so you might be a little faster to make a choice. Regardless, the time was well spent to save roughly $50/month on our electric bill.
Tip 3 –Shop Around for a Better Mobile Phone Plan
I happen to know someone who had three phones on a family plan for mobile service for the mom and two kids. The cost was roughly $120 per month. When the oldest child was on her own and removed from the family mobile plan…the price went up $11/month. What?! Less value, more cost?! I was offended so I dug in to see what I could do.
A quick look at the usage data revealed some telling information. In the past year, the two phones on the plan never exceeded 18 Gb of data combined. Rarely did either phone exceed 10 Gb. The plan was for unlimited data, but there were less expensive plans that would cover the high speed data they actually used.
With usage data in hand (data is your friend!) it was a quick matter of shopping around for the right provider and plan. Moving the two phones on the plan from T-Mobile to Mint Mobile lowered the monthly cost from $131 to $46. Nice! And in a crazy twist on the story, Mint uses the T-Mobile network, so compatibility and quality were exactly the same. Mint has a 3-month trial for $15/month ($45 up front) for any of their plans, including the Unlimited plan. After 3 months they will recommend a plan based on your usage, even if it is a less expensive plan. Nice again! If you like, you can even sign up for the comically named Unnecessary Plan which is 60 Gb of high-speed data.
There are a few catches on this one, but this family was happy to make the change even with these fine print details. It took some time to research and then the switch took a little effort, but I’ll put the savings per hours at about $478/hr for two hours of research.
Catch number 1: The T-Mobile plan came with “free” Netflix with no ads. That “free” service perk was costing the family $85/month when Netflix sells it directly for $15.49/month. If the family was willing to put the ads back into the equation, the Netflix subscription drops to $6.99/month. Regardless of the choices with Netflix, it was clear that a switch was in order. In this case adding the cost of ad-supported Netflix, the savings amounted to about $78/month after tax or $956 for the year.
Catch number 2: To get the best Mint pricing, you prepay for an entire year. That may be a sticking point for some folks, but this family saw the value in paying upfront. In this case, two phones on the 15 Gb plan would be $35/month for 3 months, $25/month for 6 months, or $20/month for 12 months. The per phone cost for the year would be $420, $300, or $240 based on the period of time you prepay. Multiply times 2 phones and it made far more sense to prepay $480 for the entire year for two phones than it did to draw it out and pay $880 for the same service by paying 3 months at a time. These are prices before fees and taxes, but those details don’t change the winner of this rate comparison.
Tip 4 –Shop For Your Homeowners/Renters Insurance Policy
Before you click on the way too easy link to renew your homeowners or renters insurance policy, do some rate shopping. While you can easily get quotes online from most major carriers, this one can be a little tedious because you have to answer a series of questions about your home or apartment. Roof material. Square footage. Number of bedrooms. Type of flooring in what percentages in the house. If you take the time to do this on multiple sites or go to one broker site that will do some of the comparison for you, it can result in some cost savings.
I rate shop every year and have saved money on several occasions. I am willing to change carriers, but I stick to insurance companies with a good track record of payout and customer service. I’m sure I could get an even lower rate if I use a cut-rate carrier, but I’m not willing to trade a low price for getting lowball service and potentially getting claims denied.
This time when I shopped around, I ended up sticking with the same provider, but reviewing the policy offers from other companies pointed out that I was paying for a clause in the policy that didn’t make sense for my needs. It was an escalating value clause that increased the amount of money the policy would pay me to replace the contents of my house over time. The coverage I had was plenty to pay for the replacement cost of our furniture, electronics, etc. so when I renewed, I requoted the price without that clause. The requote lowered the policy cost by $354. It took me about 45 minutes, so my savings rate was $472/hr. Certainly not chump change, so I pocketed my savings and moved on to the next savings tip.
Tip 5 –Use a Sinking Fund to Pay Your Car Insurance
Alright, we are almost on rinse and repeat now. I encourage you to shop around with different providers before you renew your car insurance. However, this tip is to prepay for the 6-month policy when you renew or get a new policy. The savings will vary based on coverage, number of vehicles, and certainly the number of teenage drivers on your policy (yikes!), but for me the difference between paying the policy monthly and paying for 6 months upfront was $297. Six months later, I did the same thing, but this time I saved $372 dollars.
If you get a lump in your throat at the idea of prepaying for car insurance because of the amount, ease into it using a sinking fund. A sinking fund is a fancy term for paying yourself in advance before you pay someone else. It works great on big bills like car insurance. Whether you create a separate account at your credit union / online bank, create a new “bucket” online within an existing account, or manually track the extra money, paying into a sinking fund can make saving money almost automatic.
For more detailed information on sinking funds and how I use them, see my prior article entitled “Eliminate Sinking Feelings with Sinking Funds.” In this case, an hour of research saved me no money, but the sinking fund saved me $669 for the year for the hour I invested. That is the best return on an hour yet!
Tip 6 –Audit Your Subscriptions
This one is easy, but it can get away from you. Look at all your subscription services and think through which ones you truly use and which you can do without. Hula, Disney+, Amazon Prime, Netflix, Sling, Peacock, Paramount+, Apple TV+…the list grows daily. The fact for us was that we used some services a lot and some very little. We decided to cut those underused subscriptions and focus on the ones we really used. We even tend to rotate through some services. For example, if you are fans of a show that is exclusive to one service, subscribe, watch through all the shows you want on that platform, and then cancel. When a new season comes out, you can let a few shows build up a backlog and then subscribe and watch through them. If you rotate between different services, this can save you from wasting your subscription dollars paying for content you don’t watch.
There are two tips, one that is great that my wife does and a second that is more extreme and not for the faint of heart. Many of the streaming services offer holiday discount pricing around the November/December timeframe. Hulu tends to have a black Friday sale for $1/month (okay, $1.07 per month), which is a nice discount from their normal rate of $7.99 for the base plan. That can save you a nice $80 per year with little effort.
The second tip is more hardcore, so sports fans please don’t throw things at me for this one. I am an avid college football fan, but I care less about other sports. I get Sling during college football season and then drop it the rest of the year. That saves about half year off the Sling subscription. Some people need their ESPN all year. I get it. That used to be a “must” for me, but as I focused on raising a family and watching fewer sporting events, it was something I could part with for a chunk of the year. Watching corn hole and billiards championships in late June was just not worth the price for me, so I focused on when I used the service and paid just for those months. You can do the same with March Madness or the NBA/NHL playoffs and only pay for the months you actual watch the sports of that season. If you have sports on all the time, this is clearly not the path for you. The point is to be intentional about getting bang for the buck.
Dropping the services we didn’t use saved us another $145 for the year for about 15 minutes of thought and 5 minutes of clicking “Cancel” on a couple subscription services. That’s $435/hr.
Summary
To summarize, here is the report card for savings in a year.
Savings Type
Annual Savings
Time Spent (min)
Savings / Hour
Internet plan
$252
30
$504
Electricity provider
$589
60
$589
Mobile phone plan
$956
120
$478
Homeowner’s Insurance policy
$354
45
$472
Auto insurance
$669
60
$478
Streaming services
$145
20
$435
TOTAL
$2,965
335
$531
Actual savings achieved by an actual human who actually followed the tips presented here
That’s certainly not chump change! Some years I saved a little, and other years I have saved a lot. What I published here are my actual savings since last year. If you are intentional year after year, you can see how this could result in more substantial savings over time. I urge you to pick a couple of tips from this list and give it a shot. Use the access you have to information to take control of your recuring bills and put some money back into your own pocket for a change.
Links
Check out the Mint plans and get a $15 credit if you sign up using the link provided. Full disclosure, I will get a credit if you sign up from the link, but I only promote products I use and believe in, so you should know I am happy with my service and the lower price.
PowerToChoose.org is the site I use to start looking for electricity providers. It will also tell you if you are able to choose your provider or not based on your zip code.
For more ways to win with your personal finances, subscribe to get future articles.
For more tips on Managing Your Dollars with Common Sense, read the Loose Change blog or reach out to KJ Financial Coaching to help you get out of your paycheck-to-paycheck rut.
It’s April which means it is Financial Literacy Month! But you already knew that. We are in mid-month now and I know you have been busy decorating your house in the customary Financial Literacy Month (FLM) style. The US currency wreaths. The budget balloons. The “pin the debt on the consumer” game for the kids!
OK, maybe it is not America’s most celebrated holiday (yet), but it certainly does provide ample opportunity to think about how we can all get better at managing our finances. So, if you don’t already have your own favorite FLM tradition, here are a few ideas to get you started no matter your age.
For Young Kids
Play store using play money to teach buying and selling.
Start a chart of chores kids can do around the house. Some chores might be expected because they are expected to do work to contribute as part of the family, but other “stretch goal” chores might have a dollar amount attached to them.
Teach your kids about budgeting using the three buckets of Spend, Save, and Give (or Share if you like them all to start with “S”). You can easily use three containers that you create yourself, or you can buy a three-part bank from Amazon. As an Amazon Associate, I earn a small percentage if you buy from this link. All of my affiliate funds go toward the creation or purchase of financial educational materials.
Open a bank account for your child and explain the concepts of saving for a long-term goal.
For Teens
Play a game of financial “Would You Rather” using questions like these:
Would you rather get a free 2 week trip anywhere in the world each year or drive your favorite car for free all year?
Would you rather get $1 million today or $100,000 every year for the next 20 years?
Would you rather run a business or run a charity if you knew it wouldn’t fail?
Would you rather have a well-paying job you hate or a low-paying job you love?
Discuss with your teen a financial goal you set in the past or would like to set. Talk about what you did to achieve the goal or how you plan to achieve it. See if your teen has any goals they want to set for the next year, especially if you are also working toward some goals. Look for ways to encourage each other towards those goals.
Talk about the power of compound interest with your teen. If you aren’t clear on what that is or don’t know a good way to explain it, give this link a look. It explains the math and has a video about a third of the way down the page that walks through two examples for you.
Have a discussion with your teen about what they want their future to look like. This could include what line of work they want to go into, what type of lifestyle they want to have, and some key future goals they might want to set like getting their first job, owning a house one day, or contributing money to a cause they care about deeply.
For Adults
Audit your expenses to see where you can save. Good places to start:
Insurance policies (car, homeowners or renters) – shop around to see if there is a better deal
Eating out – pull up your credit card and bank transactions online and add up your actual eating out expenses for the past month. Most people are floored at how much they spend compared to how much they think they spend eating out each month.
Groceries – do the same exercise for your grocery bill. If you are not such what is average, check out this chart from the USDA published in February 2024 that you can use to calculate what they think is a typical grocery budget. Hint, for a family of 4 it is roughly $1,000 per month. There are ways to reduce that number (perhaps that is a good goal for Financial Literacy Month!), but first make sure you know what you are spending today.
Make a budget. Budgeting is a lot like flossing. You know you need to do it, but you don’t do it nearly as much as you should. I have learned that most people don’t like making a budget. I’m a people and I don’t always want to make one, but I can tell you it will pay off in the long run. If you want help getting started, check out this article.
Review your retirement investments and see if you need to make any adjustments. Are you on track for retirement? How much do you need to retire? You can use this retirement calculator to get a rough idea of what you might need to save and when you can pencil in that retirement party. If you want to do some extra credit reading, here is a quick article about retirement basics as well as an article I wrote about Roth vs Traditional IRAs.
For All Ages
Set a goal and track it on a graphic in your home. If you are single, set a goal (pay off debt, save for a specific purchase or trip, or save toward retirement) and track it on chart on your fridge. If you have kids and you are saving for a car, have your kids draw a car on graph paper where each square is a portion of the money (perhaps $100) you plan to save. Each time to save that amount, color in squares to show your progress.
Find ways to earn extra money to reach your goal faster. For adults that could be food or grocery delivery, doing side work in your field, or working overtime. For kids that could be mowing lawns, cleaning pools, or babysitting. For the younger crowd it could mean doing extra chores or running a lemonade stand in the front yard.
Host a garage sale. You’ll get rid of some of the clutter in your home and you’ll make a little extra cash to put toward your financial goals.
Conclusion and Offer
No matter how you plan to celebrate Financial Literacy Month, I urge you to learn about a financial topic and take a small step toward improving your financial future.
That’s the conclusion, now here is the offer. Personal finance is a passion of mine. In particular, I love empowering people to learn about how to handle money and help them create and execute a plan to move toward a brighter financial future. I considered creating a business where I would provide fee-based financial coaching services, but God has really put it on my heart to trade in the business plan and for community outreach. Translation: I provide financial coaching for free.
I have learned a lot through the years, and I am happy to share that knowledge and wisdom with others. While there are a lot of fine people providing financial services for a fee, I believe you shouldn’t have to pay to learn some foundational skills that will help you improve your life.
If you are ready to apply the knowledge and wisdom you receive, I’m happy to share it with you. In this equation, you have nothing to lose, and I have nothing to gain so it removes any money pressure from the relationship. I know that if you don’t have any skin in the game, you may not follow through, which means we are both wasting our time talking. With that in mind, my ask is that you be invested in yourself enough to incorporate the information from our time together into a plan to help you move forward. If you are unwilling to do that, please don’t be offended when I politely decline to work with you. I am taking time out of my week to help, and if you aren’t willing to apply the help, I know we both have better ways to spend our time.
I can be of service to you as you are learning and planning your financial future and if you are ready to build and execute a plan of action, please reach out and I’ll see how I can help. I have a website where you can schedule an appointment using any of the big red buttons on the page (they are hard to miss). If you are a cautious soul — something I know a thing or two about — check out the free content near the bottom of the main page to get a sense of my approach and to read articles I have posted.
Happy Financial Literacy Month! Now go do something to make your financial life better so you will have a reason to smile when you celebrate this time next year.
In the financial world you can find all kinds of advice. Some people will sell you a life insurance policy as an investment. That’s like using a parachute for a tablecloth: It may work to some degree, but that’s not what a parachute is designed to do. A parachute really has a better and higher use than saving your table from getting dirty. Your parachute tablecloth would be a huge hassle to use, and you would be right to question the sanity of someone selling you a parachute to cover your table.
Yes, there is a lot of bad advice on the market. There are companies with an entire sales force that is financially incented to sell you bad products. In an effort to counter the confusion and poor advice, I am writing a series of articles I call “Do The Math.” The goal is to take an impartial look using real scenarios and honest calculations to point you in the right direction. No sleight of hand or crafty ways to steal your money.
This is my nerdy side showing and I don’t mind saying so. I get excited by getting to the heart of a situation using math to promote understanding of a topic. I hope my fervor for proving what path is best will help you in your financial life. I have nothing to gain, and you have nothing to lose. With this article, I’m unpacking IRAs – Individual Retirement Accounts.
History and Types of IRAs
Let’s start with the origin of the IRA. In 1974 the Employee Retirement Income Security Act (ERISA) created Individual Retirement Accounts (IRAs) as a way to encourage employees without a pension plan to save for retirement. The original IRAs are beneficial because they allow employees to contribute money before paying taxes on it. IRAs were created with a cap on the amount of money a person can invest in them each year – currently $6,500 for most people – and a potential benefit of paying taxes when the funds are withdrawn. The thought is that funds will be withdrawn in retirement and the owner of the IRA might be taxed at a lower tax rate in retirement than during employment years. These pre-tax IRAs – we call them Traditional IRAs now – also come with a required minimum distribution (RMD). The RMD is a required amount of money that must be withdrawn after the IRA holder turns 72. If you die with money remaining in your Traditional IRA, those who inherit the money will pay taxes on it. That is the Traditional IRA in a nutshell.
Fast forward two and a half decades and the Taxpayer Relief Act of 1997 created a new form of IRA called the Roth IRA. The Roth allowed money that had already been taxed to be invested and withdrawn tax-free. Roth IRAs have income limits meaning on the surface, if you make too much money, you can’t invest in a Roth IRA. In 2022, “too much money” meant over $144K as a single filer or over $214K if married filing jointly. There is a legal loophole that people making more than those limits can use to invest in a Roth IRA, but that is a tip for another time. Roth IRAs also have a maximum contribution limit of $6,500 per year (which bumps up to $7,500 per year for people over 50). The Roth IRA is not subject to RMDs, so there is not a minimum amount of money that must be withdrawn based on age. Both Traditional IRAs and Roth IRAs have penalties if you take money out money before age 59 1/2. Is anyone else amused that the IRS makes laws based on your half-birthday? Finally, if you die with money in a Roth IRA, your heirs don’t pay any taxes because you paid taxes on the investment on the way into the account. That’s the Roth IRA.
Roth vs Traditional IRA
People in the financial world love a good debate, so they instantly sharpened their No 2 pencils and starting working to determine if a Traditional IRA is better or a Roth IRA is better. Some people swear by one, others advocate for the other, and still others will say use both or it depends. So what is the optimal way to invest in an IRA? This is where we…
I’ll work through three scenarios in case one size truly does not fit all, and I will build a model for each one. We can let the math tell us which option is best in each scenario. If we get a consistent pattern, we’ll declare one the clear winner. If results are mixed, we may have a draw on our hands, but I’ll do my best to point out the factors that swayed the results in one direction or the other. Below are three examples that I picked to look at variables like maximizing contributions, longer or shorter investment periods, and different income brackets to see what variables made a difference in the results. Here we go!
Scenario #1 – Max Out Your IRA
In this scenario, we have two investors. Ruth Roth makes the maximum contribution allowed by law each year into her Roth IRA account. Trevor Traditional makes the maximum contribution allowed by law each year into his Traditional IRA account. (Hint they are doing the same things, only the type of IRA is different.) Let’s see who retires happier.
Ruth and Trevor are both 46 years old now, so their maximum contribution is $6,500. (If they were 50 or older, they could contribute $7,500 per year.) As loyal investors, they have been making the maximum contribution since age 22. Back then the maximum contribution was only $2,000 but it has steadily been raised to the current $6,500 per year. All of that will be in our model. Assuming they have exactly the same investments that have performed at the S&P 500 average since 2000, they would have earned about 8.29% on their investments. To make the model simple, I give them that same average rate on their investment each year.
Ruth’s Roth
I’m going to try to stack the deck against Ruth in this example by making Ruth a high-wage earner. With a high income, her taxes are high. For our example, Ruth and Trevor will both make over $589,101 this year. You might think this is awesome – and it is! – but for our example the point is to make Ruth pay a lot in taxes before she makes her Roth IRA contribution. Because Roth only takes after-tax money, and because she makes such a great income, her money is taxed at 37% before she can contribute to her IRA. We are going to say she has been making enough money her entire career to be in the 37% tax bracket. That is highly unlikely, but let’s go with it because it increases her taxes paid. Again, we are trying to stack the deck against Ruth Roth. Only the IRS and I could be so diabolical. The maximum contribution has gone up over time for IRAs, but if we take this year as an example, Ruth has to make $10,317 of which $3,817 will be paid to the IRS so she can contribute the remaining $6,500 in after-tax dollars to her Roth IRA account. Yikes! She might start dumping tea into Boston Harbor in revolt.
Trevor’s Traditional
Trevor, on the other hand, has chosen the Traditional IRA to avoid paying all those nasty taxes before he makes his contribution. Crafty Trevor! He can contribute pre-tax dollars directly into his IRA (ha!) saving himself the $3,817 in taxes that Ruth had to pay (ha ha!). He believes this is a genius move and reminds Ruth about it every chance he gets.
Both Ruth and Trever have now invested $6,500 this year. Making identical maximum contributions each year from age 22 and getting exactly the rate of the market over that time, they now have identical balances of $337,996.97. Trevor has paid no taxes and Ruth has paid $70,476 in taxes on her contributions for the 25 years they have held their IRAs. Trevor is clearly in the lead here, but like the tortoise and the hare, the race is far from over.
Retirement Time!
Using our time machine, we fast forward to 2043 when Ruth and Trevor have a retirement party on the same day. They turn 65 and say adios to the working world. Assuming the IRA contribution limit remains fixed to keep the model simple, Ruth has now paid $152,405 in taxes on her contributions. Trevor has paid nothing. Trevor is clearly “winning,” but his tax bill is about to come due, but at a lower rate.
Ruth is able to withdraw her Roth IRA money tax-free – she already paid her bill in advance at a higher rate. I’m going to make a wild assumption here to try to stack the deck in favor of our friend Trevor. Trevor, buddy, you get to withdraw your money at a much lower 12% tax bracket. As single people, that means Trevor and Ruth are each making less than $44,725 each year. That is highly unlikely considering they were each pulling in over half a million dollars annually, but let’s pretend they paid a tax wizard to do some crazy good things to lower their official income to that level and keep them in the 12% tax bracket. It is an extreme version of why some people favor the Traditional IRA. The assumption is that being in a lower tax bracket will make the Traditional IRA a better deal. Let’s see if it worked.
Assuming that Ruth and Trevor live long enough to withdraw every penny from their respective IRAs, let’s look at the numbers. Both Ruth and Trevor contributed $259,000 over their working lives. As you recall, Ruth’s tax bill was $152,405 on that amount. Trevor will pay taxes on his contributions just like Ruth did, but he is taxed at the lower 12% rate. Taxes on his contributions equal a mere $31,140. Wow, he is still well ahead in our scenario and there is only one last figure to calculate. Ruth is done paying taxes. She paid her taxes on the money going in to her account, and with a Roth all money comes out tax free. Trevor is taxed 12% on his contributions and on his gains. Both of them have investment growth of $1,609,774. Nice! Trevor now has to pay 12% to Uncle Sam for each withdrawal. Assuming no more growth in the money, Trevor’s tax ball on his gains is (drum roll, please) $193,173. Here is our final score card:
RuthRoth
TrevorTraditional
Contributions
$259,500
$259,500
Growth
$1,609,774.15
$1,609,774.15
Total in IRA Account
$1,869,274.15
$1,869,274.15
Tax Rate
37%
12%
Taxes on Contributions
$152,405
$31,140
Taxes on Growth
$0
$193,173
Total Taxes
$152,405
$224,313
Total Money Withdrawn
$1,869,274.15
$1,644,961.25
Ruth Roth vs Trevor Traditional
When you look at this example, three things stand out clearly. First, even at a much higher tax rate during her earning years, by paying the taxes up front, Ruth saved almost $72,000 in lifetime taxes. Second, even with a lower tax rate, paying taxes on the growth of his money and the contributions means that Trevor paid significantly higher taxes. He was taxed on $1.8M instead of $259K. That made his tax bill larger. Third, because Trevor was paying taxes on the account as he withdrew money, he actually was able to only benefit from $1.64M instead of $1.87M. Not chump change for sure, but he got $224K less than Ruth did in retirement.
Scenario #1 goes to Roth. This example had textbook maximum contributions over a long period of time for high wage earners and a a very low retirement tax rate. Let’s look at a more realistic example of two people who started contributions later and then stopped well before retirement.
Scenario #2 – Delayed Contributors
Here we have Ralph Roth and Tracy Traditional as our two IRA owners. Early in their respective careers they each thought they didn’t make enough money to contribute to an IRA, so they didn’t. At age thirty, Ralph and Tracy each realized they were not saving for retirement and opened an IRA, Ralph a Roth and Tracy a Traditional. They each contributed the maximum allowed for the next twenty years. At age forty-nine, they stopped contributing so they could start to save up some money for their kids college. While they intended for this to be a temporary move, the truth is that life happened, and they never made another contribution to their IRAs again. This example spotlights a shorter period of contributions and significant investment growth.
Let’s see how it plays out after a few more details. Ralph and Tracy spend the first five years of their IRA contributing life in the 24% tax bracket and then they jump to 32% for the last 15 years. That just means that Ralph’s taxes are lower for 5 years and higher for 15. The last contribution is at age 49, and Ralph and Tracy both retire at age 66. For this example, I had their investments grow faster than that first example, but it is still within reasonable levels. I selected a growth rate of 11.94% per year. Some might think this is outrageous, but 11.94% is the average return on the S&P 500 since 1929. I intentionally included 1929 – the year of the great stock market crash and all the years of the Great Depression – but I excluded the three years from 1926-1928 leading up to crash where the market grew an average of over 30% per year. So yes, 11.94% is a fair number given my slightly conservative historical approach.
Here is the tale of the tape for Ralph and Tracy:
Ralph Roth
Tracy Traditional
Contributions
$130,000
$130,000
Growth
$3,412,244
$3,412,244
Total in IRA Account
$3,542,244
$3,542,244
Tax Rate
24-32%
12%
Taxes on Contributions
$56,146
$15,600
Taxes on Growth
$0
$409,469
Total Taxes
$56,146
$425,069
Total Money Withdrawn
$3,542,244.08
$3,117,174.79
Ralph Roth vs Tracy Traditional
Well, it looks like Roth wins again. Ralph paid $368,924 less in taxes and as a result is able to withdraw $425,069 more than Tracy. The IRS should send a giant thank you to Tracy. Maybe they would if they weren’t so busy counting her tax dollars.
Scenario #2 – Roth wins. Roth is looking good. Let’s see if there is any way we can have Traditional come out on top.
Scenarios #3 – Worst Market Ever
In our final example, it’s not the end of the world, but you can see it from here. Okay, it’s not that bad, but this scenario is highly unlikely to happen, but I am only creating it to prove a point. Reggie opens a Roth, Toto a Traditional IRA and both contribute…blah blah blah…you know the drill. This time, I use the same numbers as in Scenario #2 with one significant twist. Their investments only grow by a tiny 4.5%.
Let me pause to put this growth rate into perspective for you. The gold standard benchmark for the stock market is the S&P 500, an index comprised of the 500 largest companies in the US. The index tracks the returns on those companies which tend to be stable companies that have grown over a long period of time. I pulled data from 1926 forward and never has the stock market had a loss over a 10 year period. It came close in 2008 with a paltry .67% gain over 10 years, but it was still in the black. The lowest return over any twenty year period since 1926 is 6.5% in 1948. That twenty year span included four consecutive down years in the Great Depression, a terrible 1937 with 35% losses, and some lean years with steady losses leading up to World War II. Exactly ten of those years (half of the time period!) had losses. Even with all of that headwind, the S&P returned 6.5% over that 20 year span. The average 20 year period returned 12.35%. The worst performing 37 year span is from 1972-2008 when the S&P 500 returned 11.2%. I tell you that to provide context around our next scenario where I have the S&P 500 returning 4.5% over 37 years. That is a ridiculously low number from a historical perspective. Laughably low. Seriously bad. It is about a third of what history tells you we can expect. You get the picture, but to prove a point, let’s go with it.
Here is the tale of the tape:
Reggie Roth
Toto Traditional
Contributions
$130,000
$130,000
Growth
$320,340
$320,340
Total in IRA Account
$450,340
$450,340
Tax Rate
24-32%
12%
Taxes on Contributions
$56,146
$15,600
Taxes on Growth
$0
$38,441
Total Taxes
$56,146
$54,041
Total Money Withdrawn
$450,340.29
$396,299.45
Reggie Roth vs Toto Traditional
Ah ha! We found it! If the market only performs at 4.5% (one-third of it’s average 37-year return) AND you are a high wage-earner AND you fall into a 12% retirement tax bracket (which would be a huge lifestyle drop from your working years) then a Traditional IRA comes out ahead on taxes by $2,105. The likelihood of all that happening is…well, sign me up for a lottery ticket if I can hit those odds because then I won’t need an IRA.
But we did it! We found a scenario where the Traditional beats the Roth. The key is really terrible returns because the taxes on the growth are minimal compared to the taxes on the contributions.
Let me put your mind at ease. If you invested in an S&P 500 index fund, this scenario will not be your future. Scenario #1 and #2 provide you with more typical returns and in those the Roth came out ahead by a few hundred thousand dollars. I suppose you could make a giant income and invest very, very poorly and pull off this negative unicorn event, but realistically with good investments that track the market (or anywhere close to it) and some normal tax rates during your earning years and afterward, the Roth will come out ahead.
Winner – The Roth IRA
So congratulations are in order for the Roth IRA. It wins. Go open a Roth IRA. But wait, not everyone qualifies to contribute to a Roth IRA. There is an income limit. If you make above a certain amount, the IRS won’t let you contribute directly to a Roth IRA. In 2024, if you file as a single filer to the IRS, you can make up to $146,000 and still contribute to a Roth IRA. If you have a modified adjusted gross income above $161,000, you cannot contribute. Between those two numbers, the amount you can contribute drops the more you earn. For married filing jointly, those limits are under $230,000 and over $240,000. To see more specifics, look at these tables on the Charles Schwab site.
That would really stink, if you earn too much and cannot take advantage of the Roth based on the numbers we just ran through. There is good news! If you earn too much to contribute to a Roth IRA, you can do what is called a backdoor Roth IRA where you contribute to a Traditional IRA and then immediately convert those contributions into a Roth IRA account. More on that in another article, but for now just know it is an option. It is 100% legal and allows everyone to benefit from the Roth IRA regardless of their income. For now, math has won the day again and shown us that the Roth IRA is superior to the Traditional IRA in almost all but the most edge case scenarios.
The Fine Print
To be fair to our old pal the Traditional IRA, there are some other factors to consider when you pick an IRA. In all our scenarios, the IRA holders contributed the most they could in years they made contributions. By maxing out their contributions, it compounded the growth of their investments faster. Maxing out a Roth means having the money for the contribution ($6,500 this year for most folks) AND having money to pay the taxes. In our scenarios, that means having $6,500 + enough money to cover your taxes. For you nerds (like me) who want to know that exact dollar amount you need before taxes, you can use this formula to calculate it:
$6,500 / (1 – <your tax rate>)
For example, if you are single filer making $70,000 per year, your tax rate is 22%, so your number would look like this:
$6500 / (1-.22)
$6500 / .78
$8,333.34
To max out the Roth at a 22% tax rate, you need to make $8,333.34 in order to pay taxes of $1,833.34 and still contribute $6,500. For the Traditional IRA, you only need to make $6,500 to contribute $6,500 because the contribution is pre-tax. If you are committed to maxing out your IRA, that difference means you have to earn more money to contribute fully to the Roth. You have seen the difference it makes on the back end when you retire, but it is fair to point our that you do need extra money up front to cover the taxes. If you don’t max out your IRA or if you use the taxes to subtract from your annual contribution, you will contribute less money to a Roth and that will make the Traditional a better deal because you are compounding less money over time in the Roth. If you plan to max out your IRA contribution each year, the Roth is the clear winner.
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Welcome! You are a month into a new year. Many of us kicked off the year with celebration, reflection, and promises of things we wanted to do better moving forward. Often reflection leads us to resolve to eat better, exercise more, lose weight, and be better at handling our money. For those wanting to improve their financial situation, there is one very important mistake to avoid. While it is easier said than done, it can make a big difference when it comes to hitting your financial goals.
Before I get to the financial talk, let’s take a quick trip down analogy alley. When you get in the car to run an errand, take a trip, or visit a friend, you have the end point in mind. You know your route or you have a navigation app on your phone to tell you the steps to take to reach your destination without wasting gas and going way out of your way. While there are endless detours and paths you could take, the most efficient way is to follow the plan you laid out as long as your plan is a good one.
Reaching your financial goals works the same way. To get to your goal the fastest way possible, set a plan, and follow the plan. The number one money mistake is failing to plan. Imagine getting in your car and heading off in a random direction with only a vague idea of where you are going to shop and eat. After driving aimlessly for an hour, you pass by a store and suddenly decide to shop there. You’re not sure what you are shopping for, how much you will spend, or how long you have, but you are happy to be there. After a spending spree, you decide you are hungry and return to your car only to find that your wandering habits drained your gas tank. You don’t have enough gas to get to your favorite restaurant without gassing up the car. You fuel up and drive to dinner so you eventually get to your goal, but it took much longer and cost more money than you ever thought it would.
Walking though life without a financial plan means the path to your financial goals will take you longer and be much more expensive than they could have been. In fact, if you aren’t careful, you may run out of gas and not get there at all.
If the term “financial plan” sounds formal and intimidating, let me simplify it. A short term financial plan is simply a budget. A longer term plan involves setting goals, saving, and investing, but without taking the time to plan and track how you use your money each month, you are wandering around wasting time and money. Because your long-term goals will be the result of a series of short-term decisions, let’s focus on the short-term plan, the budget.
A budget is a spending plan for how you’ll use your money each month. It is a common sentiment that budgeting is important. Most people also agree that flossing their teeth is a good idea, but in both cases, knowing something is important and making a habit of doing it are two different things. Some people love the control that budgeting gives them, but for others creating a budget sounds hard. It doesn’t have to be hard, but it is a discipline to be mastered.
According to Debt.com, there are a lot of reasons people don’t budget. Most focus around discomfort. Most new things are uncomfortable, but if you stick with them they will prove to be easier over time.
I’ll counter these objections and discomfort with some personal coaching stories. The first benefit of budgeting is the “found money” effect. Everyone I have coached has found at least a few hundred dollars per month of extra money when creating their first budget. One client found just over $1,000 per month that could be redirected toward her goals. Most people feel like they receive a raise when they start to financially plan for their month in writing. When you really start to plan and track your spending, you may be surprised at where your money goes. The grocery store, restaurants, coffee shops, and tollways are some of the gremlins that take your money when you aren’t paying close attention. Before you realize it, your bank balance is uncomfortably low. Planning your spending can keep the gremlins at bay and keep more money in your account.
FOUND MONEY is a benefit of budgeting – Photo by cottonbro studio on Pexels.com
After the “found money” is identified and redirected toward your goals, the second benefit of a budget is having a plan of attack for spending for the month. The choices are yours on how to allocate your money when you budget, but once you make those decisions, work your plan. Don’t let the emotion of the moment, hunger at the grocery store, or fear of missing out override your well-reasoned plan. If you are married, prepare the budget together and treat it as a spending pact. Disagreements on the budget between spouses represents an opportunity to align priorities and often results in a better marriage while working through differences together.
Having a plan doesn’t just give you a reason to say “no” it also gives you permission to say “yes.” If you have the money to do so, give yourself ways to enjoy your spending. Pamper yourself if you have the means to do it, but don’t go overboard. A spending plan allows you to have a category for a nail salon visit every month or a budget item for the home improvement store visit or a hobby you enjoy. Instead of these being spontaneous purchases that may put you in the red, planning an amount to spend gives you permission to spend without blowing up your plan.
There are a lot of other reasons to create a spending plan every month, but the last one I’ll hit on here is that a spending plan can support your long-term goals. Do you want a new car, but you never seem to have money when the time comes? Create an item in your budget to squirrel away a certain amount of your paycheck every month. Using recurring transfers, you can even automate the process and move the money to a savings account before you are ever tempted to spend it. Using this approach and saving in advance for your goals can save you money on the initial purchase, save you finance charges and interest payments monthly, and can ensure that money is there for your long-term goals when you need it. Whether it is an insurance premium payment, saving for a car, or investing toward retirement, your budget is a key tool to give you structure to your savings.
The old adage is that failing to plan is planning to fail. Don’t fall for the popular notion that everyone lives paycheck to paycheck. Planning your spending with purpose before the month begins, tracking your actual spending, and sticking to your plan will put you three steps ahead of the crowd. Plan your spending and your really planning to hit your financial goals.
For help putting together your spending plan, contact me to set up a consultation. I can help you assess your financial situation and step you through setting up your first budget. You don’t have to go it alone when you are improving how you manage your money.
KJ Financial Coaching 