A Financial Starter Kit

Everyone has a unique situation, but here are key things everyone should have a grasp on to assist in their planning:

1. Credit Score
2. Debt
3. Checking account
4. Emergency Fund
5. Investments and Investment Accounts

Credit Score

Your credit score is more important than you may realize. I have had friends where their credit score has caused them issues with getting a job (I'm completely serious).

The benefits of a good credit score:

1. Cheaper debt (loans, credit card interest rates)
2. Getting a job!
3. Ability to rent a house or apartment

How it (kind of) works

It's a snapshot of your credit in time. Lenders can't see the history of your credit score, just your current score. So some things in your score change from month to month and can cause variation in your score, like credit usage.

Monitoring

Monitoring your credit score is absolutely critical, especially after the Equifax data breach (opens new window). If you were an adult with any credit history in 2017, you were likely impacted. By frequently checking your credit history with free services like Credit Karma (opens new window), you can make sure that your credit information is correct. I check my score every week or two to make sure that no new accounts or hard inquiries against my account that would indicate someone trying to open an account in my name. Many banks and credit cards offer free credit score checks, as do services like Mint (opens new window).

Also, sometimes there are mistakes in your credit history. If you find a mistake, take the steps necessary to fix the mistake.

Credit Factors

Now that you are monitoring you, start to understand the factors that make up your credit score. The previously mentioned Credit Karma breaks them down for you and how you're performing relative to them. For completeness of reference, here they are in order of impact:

1. Credit card use: High impact! Keep under 30% usage on individual cards as well as across all cards combined for the highest possible score.
2. Payment history: High impact! Pay all your bills on time. This includes car payments, mortgage payments, utilities, you name it.
3. Derogatory marks: High impact! These are bad things like things that go to collections, tax liens, or bankruptcy. There are others that can fall in this bucket.
4. Credit age: Medium impact. Average age of your open accounts. You want to keep your accounts open for as long as humanly possible. Even if you don't use a credit card, keep the account open to keep your credit age up.
5. Total accounts: This is the total number of accounts you've had where credit was involved. Don't race to create a bunch of accounts or it will result in a very low credit age and likely a bunch of hard inquiries on your credit score.
6. Hard inquiries: These are inquiries run by lenders, car dealerships, and credit card companies to check your credit score before making a decision on your account. Keep an eye on when a hard inquiry would be used and avoid unnecessary queries. Example: If you have outside financing for a car, don't fill out the financing sheet at the dealership to see if they can get you a "great rate", they're going to do a hard inquiry.

Debt

Not all debt is bad, but bad debt can be absolutely crippling.

Offers that seem too good to be true

They are too good to be true.

Bad/Expensive Debt

This is not a comprehensive list of all debt that can be bad, but it hits some of the big ones. If you have something with a very high interest rate, find ways to move that debt to something with a lower interest rate so you can pay down the balance more quickly.

Payday loans

These things can get out of hand fast. There is a fee structure that equates to an average of 400% APR. They are seen as predatory in their lending practices by many.

Check out John Oliver's segment on payday loans:

According to John Oliver's research, 75% of people cannot afford to pay their loan back on time and have to get additional payday loans to cover.

Title Loans

These are also considered short term loans like payday loans. Rates average around 300% APR. You put down the title of your vehicle in exchange for a percentage of the value of your car. If you miss a payment or can't pay the fees, your call can be repossessed and sold. According PEW, between 6-11% of people with these loans lose their vehicle.

Reference: PEW Auto Title Loans, Market practices and borrowers' experiences (opens new window)

Carried balances on credit cards

Do everything you can to pay your credit card balance off monthly. Otherwise you're likely to be spending 14%-28% APR on that balance. If you are paying interest plus 1% every month, it will typically take close to two decades to pay off and you'll pay several times more in interest than you'll pay against your initial principle. Credit cards are great tools, but they aren't good for carrying balances.

(Some) Personal Loans

Personal loans vary in their rates greatly. They can be as high as 36% which would make some credit cards blush. Additionally, personal loans can also come with variable rates, meaning you may end up paying a higher rate as your loan matures.

Okay/More Affordable Debt

This is typically debt that is under about 8% APR and you don't have a mechanism for decreasing the interest rate short of paying it off.

Home Mortgage

Assuming you can afford your mortgage, this type of debt is not horrible. Rates vary, but the market for these loans is relatively

(Some) Personal Loans

These can be tools for helping manage things like credit card debt. If you have debt on credit cards that's at 26% and you can consolidate that debt into a personal loan where you're paying, say, 7%, that's likely a move that will save you thousands of dollars and several years off your payment timeline. The reason "some" is listed, rates can be as high as 36% for personal loans.

Auto Loans

If you can't pay cash for a car, this may be your only sensible path forward. I have made decisions to finance cars that I could have paid cash for in order to maintain liquidity, plus I was able to get a good rate at the time (1.74% APR).

Don't be afraid to do something different

There are other ways to get your debt, especially bad debt, paid down.

When I dropped out of college, I had student loan debt, and no job lined up. I was in the red and had to borrow money from my sister to pay my rent. Embarrassed, and with my tail tucked between my legs, I moved back in with my parents. I got a job, and almost everything I made I put towards my student loan debt to pay it off. In hindsight, getting rid of that debt quickly was a great idea. The interest rate I had wasn't that great, and at the time, I don't think my credit was too hot either.

Why I'm saying doing something different, is you may be in a different phase of your life, and making a change to pay off debt may mean that you do miss out on some social things you do, or you live in an apartment instead of a house. Don't let other people's or your own expectations define what you have to do. You don't have to live in a house. Living with a relative or a roommate can help you save more and pay down debt more quickly. There are some options that may seem embarrassing in the short term that pay huge in the long term.

The security of financial independence is important, and paying off your debt can actually help improve your IQ! Study: Financial Stress Dramatically Lowers Your IQ (opens new window)

Checking Account

You will need a checking account for your normal transactions. This is everything from direct deposits for pay to paying off credit cards. Even in todays technology rich world, every now and again, you need to pay by check. At a minimum, try to get a free checking account. Free checking accounts typically have minimum balances or require direct deposits at least once per month to be free. Each bank has their own way of doing it. There are also checking accounts that can earn some interest on your balance. I haven't personally setup a checking account that earns interest, but it's worth looking into. After all, if your money can work for you and grow with little to no effort, that's awesome. Additionally, checking accounts are insured up to $250,000. This means that if your bank goes under, your funds (up to $250,000) will be returned to you through that insurance.

Emergency Fund

Murphy's law: Accept it, things go wrong

Shit happens. Things go wrong. Cars breakdown. Accidents happen. Companies go out of business. Layoffs are a common occurrences. Medical bills can come out of nowhere.

You want it safe, growth is not the focus

Set a threshold for your emergency fund. At first having anything saved will seem like a huge accomplishment, but think about saving 3-6 months worth of living expenses for those times where things go wrong. Keep the money in a FDIC-insured savings account. FDIC-insured accounts are covered up to $250,000. I recommend shopping for savings accounts like you shop for other financial products, look at what's available and pick what's right for you. If you're shopping based on rate, check out sites like Bankrate (opens new window) to get current rates. There are other sites you can use to look around, but I've found Bankrate to be a good first stop.

Investments and Investment Accounts

Accounts: Keep an eye on fees

Most brokerage services online have very similar fee structures for trades. Keep an eye out for fees.

Be in it for the long haul

Assume the money you are putting in isn't something you're going to touch for decades. The stock market will go up and down over time. It's going to be a roller coaster. But like a roller coaster, you'll only get hurt if you get off. Frequent trading can also lead to taxable events.

Invest automatically

Use vehicles like your 401k automatically invest. If you can afford it, you can also setup automatic investing with most brokerage platforms. With some platforms, the trades for automatic investing are actually free. By doing it automatically, you take the emotion out of actually doing the investing. It just happens.

What should I invest in?

Ultimately, you're taking the risk. I've gone from investing in individual companies to investing in a fund that tracks the S&P 500. There are a number of funds that do this. Check out this article from Investopedia (opens new window) on the four best S&P 500 funds.

If you follow Warren Buffet's exact advice from his 2013 Letter to Investors (opens new window):

1. 90% - S&P 500 Index or Mutual fund. His recommendation is frequently the index fund $VFIAX (opens new window) from Vanguard, I've invested in $SWPPX (opens new window), which has lower fees and allows me to automatically invest with E*TRADE.
2. 10% - Short-term government bonds. This could be an index fund like Vanguard's $VSBSX (opens new window)

The verbatim from page 20 of the 2013 letter:

"Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

How serious is Warren Buffett about the S&P 500 advice? He made a $1M bet against a bunch of hedge fund managers that the S&P 500 would outperform any hedge fund or collection of hedge funds over a 10 year period... and he won (opens new window).

When I stopped picking stocks

I used to only buy mutual funds and individual stocks. I thought I was doing well coming out of 2008 and was very proud. One day I decided to track my performance against the S&P 500 and found that I was up 60%, but the S&P 500 was up ***120%***. So, yes, I was doing well, but I had some winners and losers which caused me to seriously lag against the S&P 500. 95% of financial professionals and actively managed funds can't outperform the index over time.

Source: This is how many fund managers actually beat index funds (opens new window)