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Personal Finance

For an organization that keeps announcing it hasn’t made a decision yet, the Federal Reserve sure gets a lot of media attention. And yes, the discussion of when and if the Fed is going to raise interest rates can get a little tedious, but it still probably deserves some of your attention because interest rates are woven so deeply into the fabric of household finances.

The following is a look at what’s up with the Fed, what it may mean to you, and what you should do about it.

Recent Fed meetings — much ado about nothing

For over a year now, there has been rampant speculation that the Fed is getting ready to raise short-term interest rates. By way of background, the Fed lowered rates to unusually low levels as a response to the Great Recession. Low interest rates help stimulate growth by making borrowing cheaper, and they also support asset prices from housing to the stock market.

At the same time, rates can’t stay near zero forever. When interest rates are too low, it can encourage inflation. It also leaves the Fed with very little room to lower rates the next time the economy enters a recession.

By the way, as you have probably noticed if you’ve been looking at savings account or CD rates over the past five years, current monetary policy also leaves savers with precious little interest earned on their deposits.

Officially, the Great Recession ended over six years ago, meaning the current economic expansion is already longer than the average post-World War II expansion. So why hasn’t the Fed begun raising rates?

Consider market rates while the Fed calms investors

For much of the past six years, the economic recovery seemed fragile and halting. More recently though, the Fed seems overly concerned with not upsetting stock market investors. Following meeting after meeting, the official release from the Fed has referenced waiting for employment and inflation to get stronger. And yet, job growth has been strong for over a year now. Inflation has been running above the Fed’s stated target since the end of January. Yet after each Fed meeting, the word on raising interest rates is essentially “not this time.”

The bottom line, though, is that whether or not the Fed takes action, if employment and inflation continue to rise, market interest rates are likely to follow. What are market interest rates? These include investment yields on the bond market as well as the type of interest rates you encounter frequently in everyday life, such as deposit rates at banks and rates charged to borrowers on things like mortgages and credit cards.

Here’s where interest rates could affect you

Specifically, what does all this mean to you? Here are some examples of how you might be affected by rising interest rates:

  1. Buying a home could get more expensive. Recent years have seen record low mortgage rates, but any lender making long-term loans is going to be very sensitive to signs that inflation is on the rise. When mortgage rates start to rise, they can move very quickly.
  2. Selling a home could get more difficult. On the other side of the ledger, if mortgage rates make buying more expensive, would-be buyers will have less money to put into the price of the home — and that could come out of your end of the deal.
  3. Even renting could become more expensive. Higher interest rates could affect your housing costs even if you don’t plan on owning a home. Landlords are affected by higher mortgage rates, and you can expect them to pass on whatever costs they can to their tenants.
  4. Credit card debt could get more expensive. Carrying a balance on your credit card is very costly — such balances are charged an average of 13.49 percent, according to the most recent Federal Reserve figures. If inflation continues to rise, expect that number to go up too.
  5. You could finally start to earn some income on your deposits. The plus side of higher rates is that people who have been earning next to nothing in savings accounts and other deposits could finally start to earn a decent rate of interest again.

Some of the impact you can’t do anything about, but there are ways you can prepare for rising interest rates nonetheless.

What should you do about rising rates?

Since interest rates may start to rise with or without the Fed’s intervention, here are some things you might want to do to be prepared:

  1. Refinance while you have the chance. Mortgage rates have been rising generally since April, and could go even higher if inflation continues to firm up. If you haven’t taken advantage of the opportunity to lock in a lower mortgage rate, now may be your last chance. If you can afford a higher monthly payment, consider refinancing to a shorter mortgage to get an even lower rate. This will cost you less interest in the long run because you will be paying interest over fewer years. Also, if you have an adjustable rate mortgage, it might be a good idea to refinance to a fixed-rate loan before rates rise much more.
  2. Be decisive about buying a home. No one should rush into buying a home; but if you have thought it through and were planning to move ahead, you might want to bump it to the top of your list of priorities. Getting in before mortgage rates rise could save you money for years to come.
  3. Shop actively for savings account and CD rates. When interest rates start to rise, some banks are going to react sooner than others. When it comes to savings account and CD rates, you want to look for the banks that raise rates first and farthest. A rising rate environment is a time when some active shopping for bank rates can really pay off.
  4. Keep CD maturities short. Speaking of CDs, keep maturity dates on the short side so that you can roll them over more frequently as rates rise. You might consider a CD ladder so that you will have money coming available for reinvestment regularly. An alternative is to look for CDs with relatively mild penalties for early withdrawal, so you can continue to earn the higher rates of CDs with a longer term and yet break out of the CD at a reasonable cost should rates rise sufficiently.
  5. Pay down credit card balances. You should be trying to do this anyway, but think of rising interest rates as added motivation.

The bottom line is that when interest rates rise, savers win and borrowers lose. That is yet another reason you should strive to get yourself more on the saver side of the equation.

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It’s the heart of the baseball season and, whereas 20 years ago talk about the sport would have centered on the All-Star Game, the trade deadline, and how the pennant races were shaping up, now the chatter is filled with terms like “Wins Above Replacement” and “Defense-Independent ERA.” For better or worse, advanced metrics have taken hold in baseball.

What is interesting about the transformation of so many sports nuts into statistics geeks is that Americans don’t generally apply the same quantitative rigor to their household finances. That’s a shame, because finance is far more suited to statistical analysis than baseball, and the right set of numbers can give you a clear, objective view of your financial condition. For example, here are a dozen metrics that could give you some valuable financial insight:

Wage growth. Obviously, how much you make is important, but the rate of change tells you where you are headed. If your wage growth is not keeping pace with inflation, then you are headed in the wrong direction. In contrast, if your wage growth is up in the high-single digit percentage range, you should be on your way to a wealthier future, even if you still have a ways to go at the moment.

Total compensation growth. While your wages have the most immediate impact on your lifestyle, don’t neglect the importance of benefits — things like 401(k) matching contributions, healthcare benefits, and other extras your employer might provide. People tend to take these benefits for granted when they have them, but they certainly miss them when they don’t. So, you should factor benefits into the value of any compensation package. Nationally, the total compensation growth rate fell to a low of 1.4 percent shortly after the Great Recession, but recently recovered to a six-year high of 2.6 percent, which is still somewhat meager.

After-tax growth. While pre-tax compensation measures how much you earn, it is after-tax compensation that really affects your lifestyle. If after-tax growth is lagging badly behind pre-tax growth, think about what you could do (e.g., tracking deductions better, moving to an area with lower taxes) to stop taxes from taking an ever-growing bite out of your income.

Spending growth. It’s bad enough if you have trouble making ends meet now; but if your spending is growing faster than your after-tax income, then you are on course for real trouble.

Savings growth. This is a reality check for the income and spending growth measurements. If income appears to be growing faster than spending, you should check to see if this is showing tangible results in the form of an increasing rate of savings growth.

Current net worth. An important measure of your financial progress is to tally up the current net value of everything you own. Two things to remember about doing this. First, the “net” part of this is very important — you have to subtract the amount of debt you owe from the value of any assets. Second, when you consider the value of any tax-deferred retirement savings, keep in mind you are likely to have to pay taxes on those savings when you ultimately access them.

Net worth growth rate. Financially, where you are now is often less important than where you are heading and the rate at which you are getting there.

Debt-to-income ratio. Having some debt can be a normal part of financial management, but the larger that debt grows to be relative to your income, the more you risk it getting out of control.

Debt-to-asset ratio. On a net worth basis, there may be little difference between having virtually no assets or debt on the one hand or having a large asset value offset by an equally large debt burden. However, the latter is riskier, because a setback in the value of your assets could suddenly leave you with a significantly negative net worth.

Retirement savings rate. The percentage of your income you put aside for retirement savings may start out small early in your career, but you should strive to get it into the double digits by the time you reach 30.

Projected retirement income. Use a retirement calculator to project what retirement income your savings program would produce. This will give you a glimpse of the lifestyle you are on track for at your current pace.

Projected retirement income gap. If your projected retirement income does not seem adequate for the lifestyle you want, measure how far it falls short and start to figure out how to close that gap.

No one statistic is the answer to assessing how healthy your finances are. Instead, these statistics are pieces of a mosaic giving you a glimpse at part of the picture. If sports fans these days can spend so much time obsessing over statistics, a little quantitative examination of your finances now and then shouldn’t be too big a burden.

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A few days ago I shared four personal finance “rules” I’ve broken. So-called rules sell books because they provide a way for an author to be declarative and have solid opinions, even when these rules have been around for a long time, repeat already well-known concepts, or aren’t appropriate for everyone.

Start saving for retirement when you start working.

And sometimes, the ideas are good in theory, but difficult in practice. And difficulty shouldn’t be an excuse. Sometimes you have to make difficult choices. For extraordinary results, you have to do things differently than most other people.

I’m sure you’ve heard all the motivational sales techniques. The bottom line is you can teach good financial behavior to students all you want, but it’s not going to have a positive impact on financial behavior. Imagine yourself without the financial help of friends and family, and perhaps without the financial support from a family throughout your entire life growing up. Now, after a receiving a degree from college because you knew that higher education is the surest path to life-long financial success regardless of the degree, you followed your passion and are in an entry-level position — perhaps even in a nonprofit organization where you are paid effectively much less than minimum wage for 80-hour work weeks.

You can’t consider your needs in retirement. It’s just not going to happen when you’re not even earning enough to pay for your food and housing. Urgent needs take precedence, and thinking about the future is a luxury that only some people have. You can’t look for other, more lucrative work because you only have time for your current job and sleep, and not much sleep at that. And when shiny, happy motivational people try to get you to see that all you have to do is change your “mindset,” you want to punch them. And you’re allowed to feel this way, because most of the time, the shiny, happy motivational people are so far removed from your situation that they have no capability to understand your life and empathize with you.

Well, that’s where I was when I was twenty-three and twenty-four years of age. As I mentioned the other day, I couldn’t save ten percent of my income, and I couldn’t think about retirement. No words from a financial advisor or a motivational speaker could change the fact I couldn’t afford my all-ready bare-bones existence. Getting out of that situation wouldn’t have been possible without a safety net, which in my case, was living with my father for free for a few months to change my life’s direction.

Spend less than you earn.

This is perhaps the core tenet of personal money management and getting started on a path to financial security and eventually financial independence. It makes mathematical sense. You only grow when you have a surplus. A business that never has profit will eventually fail. A person whose financial position deteriorates every month will eventually crash and burn.

Just out of college working in nonprofit, I could barely make this work; in fact, most of the time, I was simply unable to reduce my spending below my income, simply because I needed sustenance and shelter. So I had to break the same money rule I was reading about every day on the Motley Fool discussion boards. And I did not feel good about that. I mentioned that I only had time to work at my job and sleep; I took up much of that time available for sleeping to try to freelance. I offered my services as a web developer to a few companies, and probably worked too much for too little money.

Now that my situation has significantly improved, I’m once again breaking this rule. That’s after a decade of being mindful of my financial situation, from both income and expense perspectives. With a new job working fewer hours and making much more money, and while keeping my expenses low, I not only was able to meet my expenses, but I had time to focus on my own projects, which eventually resulted in being a proprietor of a multi-million dollar business.

Particularly in the last few months of last year, my income from working has been significantly down from before I sold that business. And I’ve been spending more than I’ve been earning from work. The good news, and why I can break this rule today, is that I can afford not to work. I have investments that should last me for the rest of my life, and these investments also generate income.

I haven’t been using this income so far, and I’ve been depleting my savings instead. Starting with this month, I’m changing that approach. I will continue to write for Consumerism Commentary and earn money as a writer, and I will supplement that working income with income from investments, at least until I’m free to work on some more lucrative projects. And I consider myself very fortunate to have this flexibility.

Keep six months’ worth of expenses in your emergency fund.

This rule comes in many forms. The “six months” idea seems to be the most popular, but I also like the idea of keeping a months’ worth of expenses in liquid savings for every percentage point of unemployment. Emergency savings should, among other things, keep you going in the event of the loss of a job. In times of high unemployment, it could take longer to find a job. And the more time you spend unemployed, the harder it will be to get a new job, as unemployment carries a pretty significant stigma among hiring managers.

My situation today permits some flexibility for me. And my situation at the beginning of my career would have prevented me from having any emergency fund. Many people will argue that you can start an emergency fund with as little as a dollar a week. This is true, and it’s probably affordable for just about anyone with a job, even minimum wage. But it’s going to take a long time to build a complete emergency fund with a dollar a week, especially if your living needs still exceed your income.

I’ve seen the popular year-long project in which you start with saving a dollar the first week a year and double that amount every week until the end of the year. This is a great idea if you have the capacity. But exponential savings can quickly climb to a requirement that’s unattainable for someone like the twenty-three year-old me.

Have life insurance valued six to ten times your annual income.

This might be a good rule for some people, but even as written, it’s pretty vague. There’s a big difference between carrying insurance at six times your income versus ten times your income.

I don’t carry any life insurance. The only reason I would possibly buy insurance now would be because it’s apparently cheaper to start now than wait until I’m older and my living situation warrants it. But that’s not a great reason; it’s like buying a second refrigerator just because it’s on sale and you expect your current refrigerator to stop working sometime within the next thirty years.

I have no children, no wife. There’s no one relying on my ability to earn income. That will probably change one day, but even if it does, because of my good fortune in business, I would have other options for caring for my loved ones after an untimely demise.

Rules are made to be broken. Well, that’s what they say. It’s a meaningless cliché, and in fact, rules are not made to be broken. But the personal finance rules you often read about, if you read financial blogs or books, or if you watch television shows, or if you’ve ever listened to a financial speaker who prefers the sound of his or her own voice, are usually nothing more than guidelines. Sometimes they are ideals. And in many cases, the reasons for not being able to “obey” are beyond your immediate control.

So please, when you read about rules of personal finance, keep your neurons engaged. And don’t feel guilty or inadequate if you feel you can’t meet someone else’s goal. And feel free to disagree and argue. Gurus like it when people don’t argue, and just go along with their words of wisdom. They will dismiss those who disagree, and accuse adversaries of “just not getting it.” They will call you jealous of their success rather than defending their views, because their views don’t always stand up to criticism, and calling names or attacking character is easier than discussing ideas intelligently.

What rules do you break?

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Thumb through any book about personal finance, money management, and investing written by an expert, and you’re bound to come across a number of rules dictating financial behavior. Sometimes the author-dictators believe their rules are unbreakable and chastise those who might think differently, while other writers leave room for flexibility. In general, the more powerful a brand behind the writer, the more likely he or she will ridicule and disparage those who are willing to put up an argument. That happens to be how cults succeed, as well; if you disagree, you’re shunned and embarrassed, but if you want to share in the glory of the brand, albeit in the shadow of the leader, toe the line and preach the truth.

Don’t get me wrong. People have created these rules over the years not to trap the public, but to provide some guidance. In most cases, the rules are good starting points, and the best way to communicate guidelines and to convince an audience to pay attention is to call them “rules.” Readers and listeners need to understand there are consequences for making bad decisions, but in order to make good decisions, there needs to be some sort of framework. That’s what these so-called rules provide.

But rule following doesn’t eliminate the need for reasoning. Now, not everyone is capable of financially-smart reasoning, and in the attempt to spread good messages and sell books, rule following can be an adequate replacement for self-awareness, contemplation, higher levels of cognition and understanding, and decision-making based on anticipating outcomes. Everybody needs guidance at some point in their lives, but mindless rule-following most often results in enrichment of the gurus who claim they have all the answers, and the answers are absolute.

There have been times in my life I have been willfully neglectful of the rules I’ve been reading about for years, and while my approach worked for me, it might not work for you. I bet many Consumerism Commentary readers have broken some of these same rules and not only lived to tell the tale, but thrived financially in spite, or in many cases because of those decisions.

Never buy a new car.

You should never buy a new car because the biggest depreciation is immediate. As soon as you drive off the lot, the car loses a lot of value. It’s better for someone else to pay for that, and smart people buy gently used cars.

I broke that rule when I bought a new 2004 Honda Civic LX in June 2004. And I made that purchase before I was done paying off my undergraduate student loan. (I earned that degree in 1999.) Civics were and are very economical cars to own, and the market knows that. Therefore, the price for “gently used” was close enough to “brand new,” and I needed to make sure my vehicle was as reliable as possible, so I made the purchase. The price differential wasn’t significant to me, and I paid the car loan off early.

Never rent a house when you can afford to buy.

In my early adult years, there was a lot of pressure to buy a house, and the housing boom seemed like a sure thing. Everyone was bragging about how the value of their homes was skyrocketing in value and preaching about how everyone should buy real estate as soon as they could. It’s probably a good thing I didn’t have the money for a down payment at that time, because things got out of hand quickly. Real estate is not a guaranteed investment, and on average appreciates in line with inflation.

There is a mantra I still hear from time to time that renting is “throwing money away.” It’s not. It’s saving on major cost-of-living expenses that go into owning a home. And while you’re not building equity in an asset (by paying off a mortgage and waiting for asset appreciation), that asset is generally useless for anything but providing shelter until you sell it. And then you just buy another. There’s no need to lock up all your financial assets in a house.

Save at least ten percent of your income.

A good rule of thumb like this can just lead to frustration. When I first starting working out of college at my first major job (that is, not a substitute teacher, not a student-worker in my college’s library, but a good position at a nonprofit organization), the thought of saving ten percent of my income was unconscionable. I couldn’t even afford my rent, commutation, and grocery expenses. I ignored my student loan repayment because I needed to eat. The boss brought in a financial advisor and began offering a 403(b) plan — a 401(k) for nonprofit organizations — and I couldn’t spare anything from my paycheck to make a contribution.

It’s just as well — the fees on that 403(b) plan were outrageous.

And now that I’m in a different situation, financially independent, I’m not really in saving mode, even though I am earning money from working. Unless I start a new business, I’ll be in asset depletion mode.

Don’t use credit cards.

There are certainly some people who should never use credit cards. It can be argued that even people who use credit cards wisely, paying off the balance every month and earning cash back or other perks, are damaging their financial health through the psychological phenomenon of spending more for every abstraction layer further away from cold hard cash. Yes, there are times where I’ve spent money I wouldn’t have had I not had a plastic or electronic form of payment — most notably whenever I’ve ordered anything online. But overall, making conscious decisions about spending, training yourself to wait when there’s an urge to make an purchase based on an impulse, can help control that urge.

Not everyone has self control or a sense of financial consequences. I’m not saying I’m immune to the psychological effects of spending with credit cards, but it my informed judgments based on self-analysis, I see credit cards as a tool for organizing spending and earning benefits. Just yesterday, I received a $525 check from American Express in return for Membership Rewards.

In addition to these four rules I’ve broken, here are four more rules I break either today or have broken in the past. What personal finance rules do you willingly break?


Why Socrates and Plato Are the Only Financial Gurus You Need

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Why Big Wins Are the Best Way to Boost Your Saving Rate

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The Words You Choose: Are Certain Expenses “Investments?”

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Moved Bank and Investment Accounts to a Living Trust

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The Psychology Behind Financial Wellness

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As far as I’ve come with my ability to manage my own finances, I often fall back into the comfort of unmanaged chaos. The comfort comes from the lack of work and the lack of worry, which often win the day over meticulous planning and consideration. I’m cushioned at the moment; I know that I ... Continue reading this article…

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You Can’t Control Everything About Your Money

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