CRIB NOTES
A Cheat Sheet for Time-Pressed Readers Who Need Help
Now
If you're overwhelmed by the idea of delving into chapter after chapter
on personal finance, this section's for you. The advice below cuts to
the chase and puts you on the road to a solid financial life. Adopting
even one or two of these strategies will leave you ahead of the game,
whether the economy is soaring or suffering.
Of course, as someone's mother once said, cheaters only cheat
themselves. And while this chapter is a good launching pad, ignoring the
remaining nine chapters is a little like relying on the
Cliffs-Notes version of Macbeth: You'll get the basic plot
line but never understand what all the fuss is about. Still, the
following will give you the basics. I've tried to list them in rough
order of importance, but your priorities will depend on your own
situation.
1. Insure yourself against financial ruin.
There's been lots of talk recently about the health insurance crisis,
but not much action. As a result, nearly 20 million people (18 to 34
years old) are uninsured. If you're one of them, you need to figure out
a way to get some coverage. And even if you're insured through your job,
you need to be smart about the choices you make. The right health
insurance will protect you in case you have a serious accident or
illness and guarantee that you don't bankrupt yourself or your family if
you are beset with major medical problems. For that reason, health
insurance should be your number one financial priority.
If you work for a company that offers employees health insurance, you're
lucky; participating in your employer's group plan will almost always
cost you much less than buying a policy on your own. You may be given
more than one type of plan to choose from through your employer; make
sure you consider not only the price but also the extent of the coverage
you will receive. If, for example, you're thinking about joining a type
of plan called a health maintenance organization (HMO), inquire about
exactly what is covered, ask about the procedure for seeing specialists,
and find out what happens if you want to visit a doctor who doesn't
participate in the plan. Before you sign up for any plan, talk to
coworkers about their experiences with the various options.
If the company you work for does not offer health insurance, you'll have
to pay for it yourself. If you recently graduated from college, see if
you can extend coverage from your parents' plan for a few years. (Some
states will let you stay on your parents' insurance until you turn 26;
New Jersey is the only state that will give you until age 30.) If not,
see if there are any organizations you can join -- a trade association,
for example -- that will allow you to purchase health insurance at a
group rate. If you're job hunting, at the very least get so-called
"temporary" coverage that will protect you from true medical disasters.
If all else fails, you'll probably need to purchase a policy on your
own. Go online to compare prices for individual policies -- either
temporary coverage or longer term -- from sites like eHealthInsurance
(www.ehealthinsurance.com) and Net-Quote (www.netquote.com), as well as
your local Blue Cross/Blue Shield company (www.bluecares.com).
For additional tips on purchasing all types of insurance, see Chapter 8.
2. Pay off your debt the smart way.
More often than not, the smartest financial move you can make is to take
any savings you have (above and beyond money you need for essentials
like rent, food, and health insurance) and pay off your high-rate loans.
The reason is simple: You can "earn" more by paying off a loan than you
can by saving and investing. Paying off a credit card that has a 16%
interest rate is equivalent to earning 16% on an investment,
guaranteed -- an extremely attractive rate of return. (Actually
it's even better than that; it's the equivalent of earning 16% after
taxes.) If you want a full explanation of this concept, turn to p.
34. Otherwise, take my word for it.
If you can't pay off your high-rate debt immediately, take steps to
reduce the interest rate you pay. Start by simply calling your credit
card company and asking them to lower the rate. Also, see if you can
qualify for one of the lower-rate cards listed on websites like
www.credit.com, www.cardtrak.com, and www.lowcards.com.
If you have several different types of debt -- say, a credit card
balance on a card with a 14% interest rate, a car loan with an 8% rate,
and a student loan at 5% -- pay off the loan with the highest interest
rate first. One strategy you may want to consider is asking your student
loan servicer to stretch out your student loan payments over 15, 20, or
even 30 years instead of 10 years. This will reduce your monthly student
loan payment and leave you with extra cash, which you can use to pay off
your credit card balance faster. Once you've gotten rid of your credit
card debt, increase the payments on your auto loan. After you wipe out
that loan too, increase your student loan payments to at least their
initial levels.
The only time it doesn't make sense to kill your debt is when the
interest rate you're being charged is lower than the rate you can
receive on an investment. If, for example, you have a special student
loan with a 3% rate and no other debt, you'd be better off maintaining
your usual payment schedule on the loan and putting your cash into an
investment that pays you an after-tax rate greater than 3%, if you can
find it.
For detailed information on credit cards, auto loans, student loans, and
home equity loans, see Chapter 3.
3. Start contributing to a tax-favored retirement savings plan.
You may be scared to part with your money right now, or you may just
think retirement is so far away, why bother? But here's the reality.
Saving money in a retirement plan is one of the smartest things you can
do when you're young. If you're lucky enough to work for a company that
offers a retirement savings plan like a 401(k), you should take
advantage of it. There are several reasons to participate in a 401(k).
For starters, many employers will match a portion of the amount you put
into such a plan. That means the company will contribute a set amount --
say, 50 cents -- for every dollar you contribute, up to a specified
percentage of your salary. That's free money, equivalent to an immediate
50% return! (In fact, if your company offers such a fabulous matching
deal, you should probably contribute to the plan even before paying off
your credit card debt.) In addition, the federal government allows you
to delay paying taxes on the money you contribute to a retirement
savings plan until you withdraw that money. That translates into an
immediate tax break of hundreds of dollars each year. If, for example,
you contribute $1,000 to a 401(k), you will reduce your taxable income
by $1,000. If you're in the 25% tax bracket, that's a savingsof $250.
Be forewarned that you're going to hear horror stories from people who
lost huge amounts of money in their 401(k)s. But the benefits of
matching and tax-deferred growth are so huge that this is still the best
deal out there. And, if you're really nervous, there are ways to invest
in your 401(k) without losing any of the money you contribute. (Learn
all about this in Chapter 6).
Although you won't be able to withdraw your money until you reach age 59
without paying a penalty, many plans allow employees to borrow against
their retirement savings at favorable rates. If you switch jobs, you may
be able to move your 401(k) money into your new employer's plan (or
transfer it into something called an individual retirement account; see
below).
Your employer might have already signed you up for its 401(k). If not,
contact your employee benefits office and ask how you can have a set
percentage of each paycheck automatically transferred into your company
plan. Many companies allow you to do this online. Try to at least
contribute the maximum amount for which you're eligible to receive
matching funds.
If you aren't lucky enough to work for an employer who offers a 401(k)
or a similar company retirement plan, you should start investing in an
individual retirement account (IRA). The most you can contribute to an
IRA as of 2009 is $5,000 annually; if at all possible, contribute the
maximum amount every year.
IRAs don't provide matching contributions, so putting money in an IRA is
somewhat less pressing than enrolling in a companysponsored plan that
offers a match. Also, unlike a 401(k), an IRA does not permit borrowing.
That said, certain IRAs known as Roth IRAs do offer a special benefit:
You are allowed to withdraw the money you contribute to them at any
time. (You're not allowed to withdraw the interest you earned on the
money you contributed until after you turn 59.)
Bottom line: Max out your company's 401(k) up until the matching limit
if you have one. If not, go with an IRA.
For all your questions on tax-favored retirement savings plans, see
Chapter 6.
4. Build an emergency cushion using an automatic savings plan.
If you find it impossible to save any money, you're not alone. But once
you've gotten rid of your high-rate debt, taken care of Crib Notes 1 and
2, and started on Crib Note 3, it's time to begin stashing away three
months' worth of living expenses in a safe spot.
Your safest choice is a bank savings account. You can have the money
automatically withdrawn from each paycheck and funneled into your
savings. That's a relatively painless way to force yourself to
accumulate money.
A second choice is a special type of investment called a money market
fund. Money market funds have historically been considered almost as
safe as bank savings accounts and tend to pay higher interest rates. To
find a money fund, check out websites like www.bankrate.com and
www.imoneynet.com, which provide a list of the highest interest rates
currently being offered. You can set up an automatic transfer from your
checking account once or twice a month so it's as easy as saving in a
bank savings account. (For virtually everything you need to know about
money market funds, see Chapter 5.)
No matter what type of automatic savings plan you choose, focus on your
goal of at least three months' worth of expenses. To figure out that
amount, use the worksheet (Figure 2-2) in Chapter 2.
5. Consider investing in stock and bond funds.
Once you have your three-month savings cushion in place, you can
continue putting money into low-risk bank accounts and money market
funds, or you can choose to get more aggressive with your investments.
The advantage of stocks and bonds is that they've historically tended to
earn more for investors over long periods of time, allowing them higher
returns to stay ahead of inflation. (For a discussion of inflation and
why you'll need to worry about it, see Chapter 5.)
The downside of stocks and bonds is that they're riskier than money
market funds. Translation: You can lose money by investing in them. Only
you can decide how much risk you're willing to take for the chance to
earn higher returns over time, but one common approach has been to put
about half of the holdings you don't plan to touch for many years into
stocks, one-third into bonds, and the rest in money market funds. This
is a mix you may want to consider for your retirement savings plans,
although some experts recommend putting somewhat more into stocks for
IRAs and 401(k)s.
If you do decide to put some of your money in stocks and bonds, do so by
investing in stock mutual funds and bond mutual funds. A mutual fund is
a type of investment that pools together the money of thousands of
people. It's headed by a fund manager, who invests the entire sum in a
variety of stocks, bonds, and/or money market instruments. (To find out
exactly what these are, you'll need to read Chapter 5.) Avoid investing
in funds with a load, which is the commission that some mutual fund
companies charge each time you put money in or take money out of a fund.
They don't perform any better on average than no-load funds, so there's
no point in paying extra for them. I recommend that you consider only
no-load mutual funds with low expenses. Expenses are the annual fees
charged by the fund and can take a huge bite out of your investment
returns if you're not careful.
Although stock funds are considered somewhat riskier than bond funds,
they have also performed somewhat better over long periods of time. If
you decide to invest in a stock fund, I recommend you consider a type
known as a stock index fund. "Index" means it tracks the performance of
a recognized basket of stocks, such as the Standard & Poor's 500
Index.
Two companies that offer index funds with no loads are Vanguard
(www.vanguard.com; 800-662-7447) and T. Rowe Price (www.troweprice.com;
800-541-6066). Vanguard has some of the lowest fees and the largest
selection of index funds, but you'll generally need at least $3,000 to
open an account there if you want to invest in its index funds. (It also
has a special fund that only requires $1,000 to start; see p. 132 for
more details.) T. Rowe Price has higher fees (still lower than the
industry average) but allows investors to get started with a minimum of
$50 a month automatically siphoned out of a checking account.
Bonds are generally less risky than stocks but riskier than money market
funds and you can still lose money with them. Holding bonds as well as
stocks will help to diversify your investments, reducing your overall
risk. Vanguard and T. Rowe Price offer noload bond funds as well. While
there are several different types of bond funds, a reasonable approach
would be to choose a bond index fund that invests in government
securities or highly rated corporations.
To learn more about bond funds, stock funds, index funds, and investing
in general -- you guessed it -- you'll have to read Chapter 5.
6. Find out your credit score and improve it.
A credit score is a number that tells lenders whether or not you're a
good risk. It's basically a mathematical representation of your
financial behavior, and it's contained in files at three national credit
agencies: Equifax, TransUnion, and Experian. These files, which include
information received by the agencies from your various creditors, are
called your credit reports. You're legally entitled to one free report
from each of the agencies every year. You should get them at
www.annualcreditreport.com and check to make sure all the information
included about you and your financial behavior is accurate.
You can think of your credit score as the SAT score of your financial
abilities; the only difference is that unlike your SATs, your credit
score is being recalculated all the time -- and will have a huge impact
on your life forever. If you want to qualify for a low-rate credit card,
car loan, or home loan, and if you want to rent an apartment, get
insurance, or change cell phone plans, your credit score will matter. To
find out your credit scores from all three agencies (they often vary),
go to www.myfico.com. It costs about $50 for all three. (See Chapter 3
for details.)
Once you've collected all this information, take steps to make sure your
score is as good as it can be. The higher your score, the more likely
you are to get a lower interest rate on a loan. The biggest component of
your credit score is your track record for making on-time payments,
followed by the amount of credit you're using and the length of your
credit history. One of the easiest, most foolproof ways to keep your
score in good shape is to pay all of your bills automatically, which you
can do online.
7. Think about buying a house or apartment.
Despite all the havoc in the housing market, at some point in the next
few years you may start to feel that it's time to purchase a home of
your own. Deciding that it makes sense to buy involves more than simply
comparing your monthly rent with the monthly mortgage payments you'd
make as an owner. A whole range of financial factors, including the tax
break you'll get from buying, the fees you'll pay when you buy, and how
long you plan to live in the new home, should enter into your decision.
For a discussion of some of these factors and ways to analyze your own
situation, see Chapter 7.
If you do decide that it's time to buy, you may wonder if it's really as
hard as they say to get a home loan, also known as a mortgage, these
days. The answer depends on your situation. One of the toughest
obstacles is coming up with the down payment required by the lender. You
will likely need to have an amount equal to at least 10% of the purchase
price of the home to qualify for a mortgage. In addition to that cash,
you will need a good credit score and to be able to prove that your
salary is high enough to make the monthly mortgage payments. Mortgage
lenders also want to make sure that your other debts are manageable.
Once you are ready to buy, your next step is to look at sites like
www.hsh.com, www.bankrate.com, and www.freeratesearch.com to find the
best mortgage deal you can get. It's also a smart idea to check with
your local bank or credit union -- sometimes the best home loan deals
are right in your own backyard.
But what if you're eager to buy and can't come up with the full down
payment or don't have great credit? All is not lost. One option, for
example, is to look into the Federal Housing Administration (FHA) loan
program. FHA loans require only a 3.5% down payment and they're usually
easier to qualify for, but you may end up paying somewhat more in
interest and fees over the long run. Contact a lender or your local
Housing and Urban Development office (www.hud.gov) for more information
on FHA loans. You can also call your state housing office to see if it
offers any low down payment mortgage options for which you're eligible.
The advantage of these state programs is that they typically charge a
lower interest rate than you can get on a bank mortgage. (For the
website and phone number of your state housing office, see pp. 186-87.)
If you don't qualify for any of these programs, don't give up. Make it
your goal to spend the next one to two years improving your credit score
(by paying all your bills on time) and saving up for that down payment.
You'd be surprised how quickly you can build your credit record.
For more housing-related tips for buyers and renters, see Chapter 7.
8. Get smart about income tax.
Want to stretch your paycheck further? One way is to decrease the
portion that goes to Uncle Sam by taking as many tax deductions as
you're eligible for. Deductions are specific expenses that the
government allows you to subtract from your income before calculating
the amount of tax you're required to pay. Taking advantage of these tax
deductions is simple.
The easiest approach is to take the standard deduction, which is simply
a fixed dollar amount ($5,700 for singles or $11,400 for couples in
2009) that you subtract from your income. But you might pay even less if
you itemize your deductions instead. Itemizing means listing separately
the specific items that are deductible under the tax laws and then
subtracting their total cost from your income.
If you choose to itemize deductions, you'll have to fill out a tax form
called a 1040 (also known as the long form). You'll then have to list
your deductions on an attachment to Form 1040 called Schedule A. Among
the types of expenses you may be allowed to deduct are state and local
taxes you've paid (or sales taxes you've paid), charitable donations,
and certain moving, job-hunting, business travel, and educational
expenses. To figure out whether you should take the standard deduction
or itemize, look at the list of deductions beginning on p. 273.
The only way to find out if you can save money on your taxes by
itemizing instead of taking the standard deduction is to fill out a copy
of Schedule A and see if the amount you're allowed to deduct is greater
than the standard deduction. Even if you find that you won't save money
by itemizing this year, this exercise will help get you better
acquainted with some common types of deductions, and may help you plan
things in a way that could reduce your tax bite next year.
One warning: If you don't earn a lot, you will be tempted to fill out
the 1040EZ form, which is, well, easy to fill out. The problem is that
you may miss out on some money-saving deductions. Although it may take a
little more time, you should take a look at the more detailed forms like
the 1040 and Schedule A so you don't pay more in taxes than you have to.
If you earn very little or have children or educational expenses, you
may also qualify for valuable tax credits, which subtract money directly
from the amount you owe the IRS.
Whether you owe money to the IRS or not, you will need to file your
taxes. Make sure you do it. If you earn less than $54,000, you can file
online for free at the IRS website. Otherwise, try www.taxcut.com and
www.turbotax.com, which will let you download the forms for roughly $40
to $50.
For specific ways to cut your tax bill, see Chapter 9.
Copyright © 1996, 2000, 2009 by Beth Kobliner
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