Category Archives: Saving Money

Analyzing Personal Finances with Ratios

Financial ratios are a common tool to measure the financial health of a company.  The price-to-earnings (P/E ratio) is a ratio that is commonly referenced by the financial media.  The P/E ratio is a quick measurement for valuing a company that measures the current share price to its per-share earnings.  A company that has a high P/E ratio is normally linked to a stock that investors have high expectations for growth.  The average P/E ratio of the market is in the 25 times earnings range. A value stock will have a low P/E ratio.  Ford (F) comes to mind because it has a P/E ratio of 5.

Another common ratio is EBITDA ratio.  This is giving me a flashback to Accounting 101.  The EBITDA ratio measures revenue with earnings.  EBITDA stands for earnings before interest, taxes, depreciation, and amortization.  It is believed by many financial managers that EBITDA determines the true financial health of a business.

For a business to be successful, its management needs to take stock of its financial health.  For an individual or household to be financially successful, they too should take a deep dive and look at their metrics.  Are there financial ratios that are relevant to personal finance?

There are many different aspects to being successful in personal finance.  There are, however, far fewer variables when it comes to personal finance than the financial management of a corporation.  With that, there are far fewer ratios to measure.

What should an individual investor measure to determine if their personal finances are healthy?  For a business to be successful, it needs revenue.  On the personal finance side, income is needed.  Too much debt is negative for both businesses as well as for an individual.  One sign of a healthy company is that it has many assets on its balance sheet.  That is also true for individuals and the foundation of acquiring many assets starts with having a high savings rate.

Income

Income is what drives your personal finances.  Income is a key factor for those who are working to earn a paycheck.  It is equally important for retirees who require income-producing investments to sustain their standard of living.

To save money, income is needed.  How much should people be saving?  In the 1980’s, Americans were saving 10% on average.  That percentage has decreased over the decades.  American’s are, however, trying to get their savings back on track.  They are currently saving more than 5% on average.

While saving 10% is better than the current rate, it is not as high as it should be.  In the Richest Man in Babylon, a savings rate of 10% was suggested.  I do not know the average lifespan from 5,000 years ago, but I know that it was not as long as people are living today.

To find out if you are saving enough, the saving-to-income ratio is a helpful tool.  To determine the saving-to-income ratio, divide household savings by the average household income.  Savings include everything that is in a 401K, IRA, brokerage account, savings account, and checking.  Real estate holdings such as your house should not be used.  Income includes all earnings from a job, business, and side-gigs.

For example, Sarah is a 25-year-old math teacher.  She has $20,000 in savings.  Her salary as a school teacher is $40,000 per year.  Sarah would have a saving-to-income ratio of 0.62.  Sarah would have a high savings-to-income ratio for age.

A good savings-to-income ratio for a 30-year-old person would be 0.1.  The saving-to-income should increase with age.  At mid-career, a person should have a 1.7% savings-to-income ratio by age 40.  At age 50, with retirement in sight, the savings-to-income ratio should be at 4.5%.  If a person is still employed at age 60, the savings-to-income rate should be in the 8.8% range.

Debt

The second factor consider is to measure debt.  As a member of the financial independence community, I view all debt as bad.  For a more mainstream approach to measuring debt, the debt-to-income ratio is a good measure.

Start with total debt.  Include both good and bad debts.  Calculate the totals for the monthly student loan, credit card payments, mortgage payments, and any other outstanding debt that you might pay every month.  Next, calculate the total monthly income.  To determine debt-to-income ratio: total monthly debt/income.

For example, Jim has $2,000 in monthly debt payments.  His household income is $10,000.  That would equal a Debt/Income Ratio of 0.2%.  That would be considered a reasonable amount of debt.

A household should never exceed a Debt/Income Ratio of 0.36%.  Anything above 0.37% is considered the danger zone.  It is considered the danger zone because of that ratio measures if there is enough household income to cover monthly debts and other obligations.  When the ratio of 0.36% is exceeded, there is less money to cover other expenses as well as for savings.

Savings

The last ratio is an important ratio for retirement planning.  Every personal finance blog, forum, and publication states that people need to be saving more for retirement.  How much exactly should people be saving?

The Saving Rate-to-Income Ratio is a helpful tool to determine how much a person should save for retirement.  An employer match on a 401K plan should be counted.  If an employee contributes 8% of their salary to their 401K and the employer provides a 4% match, the Savings Rate-to-income would equal 12%.

A good starting rate for a young employee who wants to retire early (younger than age 65) would want to start at 12% and try to increase their Savings Rate-to-Income Ratio by 1% per year.  If an employee is satisfied with a more traditional age of 65, the 12% rate should be adequate if it is followed for 40 or more years of employment.

That 12% does not include interest, dividends, or capital gains.  It does not include Social Security withholdings.  The 12% Savings Rate-to-Income also does not include any contributions that an employee makes to a defined benefit plan.

Conclusion

Financial ratios are a useful tool to measure and track how healthy a household’s personal finances are.    With financial ratios, they do not tell the whole story.  They should be used as a helpful tool.  They are useful to gain a snapshot to determine if income is sufficient, debt is at a manageable level, and if savings are high enough to cover future living expenses.

When you calculate the income, debt, and savings ratios, the results might be eye-opening.  If these ratios reflect that your personal finances are not as healthy as you thought, the good news is that they can be improved.  As you work to earn more, pay down debt, or save more, your efforts will be reflected in the ratios.  A 45-year-old should have better ratios than a new college graduate.

Calculate these ratios every six months.  A good time to run them is when you review your asset allocation.  These ratios are for tracking the progress you are making.  As you work to make improvements, your efforts will be reflected in these metrics.

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Successful Personal Finance Traits

I have always felt that how a person manages their finances is a good reflection of their overall life.  People who are successful with their money always seem to look for ways to improve everything they do.  People who are good at managing their personal finances share a few common traits.  Those traits are not the ability to demand an above average market salary, have an above average IQ, or have graduated from a top-20 university.  The traits that are required to be wildly successful with your personal finances can easily be looked over.

Tuning Out The Noise

There are ads everywhere.  Marketers use TV, radio, print, and digital to push their products and services to the world.  People who are in good financial shape are masters of tuning all of that noise out.  They can delay gratification.  They are conditioned to identify all ads as spam.  People who are struggling with their finances always seem to fall into the must-have-it trap. Most people who are doing well financially do not even notice the noise.

Happiness

They know that spending money on things that are marketed to provide happiness is a lie.  The short-term high of buying new stuff wears off quickly.  They see the live life for today crowd as being short-sighted.  Tomorrow might never come, but if it does, it is better to have the resources to support oneself.

Organized

People who are good at managing their personal finances are organized.  Obviously, they are good at managing their bank account, paying bills on time, and keeping up with their investments.  They are neat, structured, punctual, and live a more orderly life.  If someone looks like a wreck, odds are, so do their finances.  Sure, there is always the eccentric millionaire, but they tend to exist more in fiction than in reality.  People who are organized financially tend to carry that virtue into all of their affairs.

Value

The people who are good at managing their personal finances have diverse interests.  They do not waste their time shopping and buying stuff they do not need.  When they do spend money, it is about buying quality products or meaningful experiences.  They understand the concept of spending a little more for a quality product than spending less on an inferior product that will wear out and have to be replaced.  They have developed the knack for when it is the time to be cheap and when it is the time to be frugal.

Intentional

Sure, people who are getting ahead in this world know how to read financial statements, but they are analytical in everything they do.  People who are good at managing their personal finances are intentional.  They do not rush to decisions or fly by the seat of their pants.  They think before they act.  Being analytical does not require the use of advanced statics.  Don’t fall victim to analysis paralysis.  A simple practice that anyone can apply is to make a pro and con list when it comes to making a financial decision.  If the pros outweigh the cons, move forward.  If the cons outweigh the pros, hold tight.

Balance

There will be many ups and downs in life that can lead people to make poor financial decisions.  The focus always needs to be on the big picture.  While money is extremely important because it is our life’s energy, it truly is just currency.  Most people have many responsibilities in their lives.  Health, family, community, and other areas of life are equally important.  Yes, we hear about the workaholic who has poor health and family issues.  Most of the people who I have met in the financial independence community are masters at living a balanced life.  By having a balance in their life they are in harmony with the universe.

Freedom

I have had sit-down discussions with many people who are in the financial independence community.  Some have their own blog and others just participate by being active on different financial forums.  While they all come from different backgrounds, they all seem to generally get it.  They better understand life, know that money cannot buy happiness, yet understand that many wonderful things come to pass for those who reach financial independence.  Their general understanding is that money equals freedom and freedom equals happiness.

This group has broken the chains that bind most people to their poor habits and financial woes.  They do not use leverage as a get rich quick scheme nor are they fearful of debt.  Their debt ratios are healthy.  They also know how to use debt in ways that can be extremely lucrative like credit card churning.

Be Present 

Everyone is on his or her own journey toward financial independence.  A person might be fresh out of college and ready to start a rewarding career where they have to manage their own personal finances for the first time.  Someone might be at mid-career where they are entering their high earning years and are trying to ramp up savings.  Another person might be near retirement or already retired and has to manage their personal finances during the drawdown period.

Conclusion

No matter where you are in life or what your financial situation looks like, always strive to get better.  Read blogs, listen to podcasts, or participate in constructive forum topics.  Learn from what others have to offer.  Create a blog and share how your own struggles were turned into victories.  By being active, I learn new ways to increase savings, pay down debt, and to improve earnings almost every day.

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Financial Planning for New College Graduates

You did it.  You earned your college degree.  Congratulations on this major life accomplishment. Now it is time to learn about financial planning for new college graduates.

Hopefully, you have a job lined-up in your field of study.  If not, don’t get overwhelmed.  Start applying and interviewing.   Before you know it, you will be working, growing your career, and earning a paycheck.

The good times are not over, but it is time to enter the real world.  By starting this next chapter of your life on the right track, you will be able to better ensure a sound financial future.  Right now, time is on your side.

As a new college graduate, I am sure the last thing on your mind is retirement.  Retirement might be many decades away, but the actions you take in the coming years will shape your financial future.  Below are the key steps that will help you to establish a plan that will guild you on your journey toward financial independence.

Step 1 – Save 15% of your salary.  Start this process of saving with your first paycheck.  It might sound like a high percentage, but this is just the first step.

Step 2 – Sign up for your employer’s retirement savings plan.  If you work in the for-profit universe, it is called know as a 401K.  At a not-for-profit organization, it is called a 403B.  If you work for the Federal Government, it is a Thrift Savings Plan (TSP).  On your first day of work, go to the Human Resources office and sign up to contribute 15% of your salary to their retirement savings plan.  Increase the amount that you contribute to your retirement plan by 1% every year.

Step 3 – If possible, only Invest using low-cost mutual funds and index funds.  Avoid trying to pick individual stocks or trying to time the market.  Identify an asset allocation that best matches your age and risk tolerance.  Historically stocks have produced higher returns than bonds. Stocks, however, are more volatile.  On the other hand, bonds are less volatile but do not keep up well with inflation.  Establish a plan that uses both stocks for growing your wealth and bonds to retain your wealth during bad economic times.

Step 4 – Establish a plan to pay off your student loan debt.  Don’t fall victim to the mindset of the masses when it comes to student loans.  You attended college and earned a degree.  Hopefully, you paid attention in class and are ready to put your degree to work for you as an employee.  You attended class, possibly lived in a dorm, and most likely ate your meals in the cafeteria.  It is time to pay back what you owe.  Avoid self-pity and feelings of entitlement.  Those ill feelings will just hold you back on many levels.

Step 5 – Get a part-time job.  For those who have the entrepreneurial spirit, start a side business.  You are young and full of energy.  Now is the time for you to be working and building a solid financial foundation.  Getting a part-time job will allow you to earn extra money.  Working a couple of evenings during the week and picking up some hours on the weekend will greatly help to increase your earnings. That extra money can be used to pay off your student loans, establish an emergency fund, or open a Roth IRA.

Step 6 – Put off attending graduate school.  Unless you work in an industry that requires a graduate degree to obtain entry-level employment, put off attending for a couple of years.  Find an employer who offers tuition assistance as part of their compensation package.  That will allow you to work in the day and take graduate classes in the evening or on the weekend.

Step 7 – Write a financial plan.  A financial plan is a map.  It allows you to identify where you are at from a financial standpoint.  A financial plan is also a map that can be used as a guide to where you want to be in the future.  It helps to have a guide than to go it alone.  Financial planning is too important of a topic to not have a plan and just fly by the seat of your pants.  A financial plan is a living document that needs to be reviewed annually.  The great feature of a financial plan is that it can be amended as your plans and goals change.

Step 8 – Establish a budget.  Calculate how much you will earn every month from your job.  Write out your budget based on percentages.  Know how much of your salary will go towards housing, food, entertainment, and every other expense.  Be sure to write a budget that is practical in terms of expenses and prudent in terms of savings. In other words, always try to reduce expenses and to increase savings.

Step 9 – Keep your transportation costs low.  Transportation costs are simply an expense in your budget.  Use your budget as a guide to determine how much you can afford to spend on a car.  Keep your transportation costs at 11% of your budget.  Your budget will determine if you can afford a fancy new car or a used economy model.  Try to keep in mind that a car does not determine your identity.  It is just what enables you to travel from Point A to Point B in a timely manner.

Step 10 – Keep your housing costs as low as possible.  If you are renting, try to find a roommate or two.  Having a few roommates greatly reduces the amount you will have to pay for rent every month.  As you advance in your career and if you have a family, you might consider buying a house.  Use your budget as a guide to determine how much house you can afford.

Step 11 – Be sure that you are properly insured.  If you are under the age of 26, you should be able to remain on your parent’s health insurance.  If not, ask your employer about when you are eligible for coverage under their plan.  You are young and most likely healthy, but one trip to the emergency room could ruin you financially if you do not have proper health insurance.  Also, be sure that you have the proper amount of insurance for your car, home or apartment, and life insurance if you have a spouse or children.

Step 12 – Avoid Debt. Keep your debt to a minimum.  Avoid payday loans and credit card debt at all costs.  Having a high credit score is important because it will allow you to get the most favorable interest rates if you do have to borrow money.  To ensure you do not take on too much debt, monitor your debt with the Debt-To-Income Ratio.  Always try to keep your DTI under 16% and never exceed 36%.  In life, sometimes debt is unavoidable.  Most people will have to take out a mortgage to purchase a house.  Some people will have to take out a car loan in order to have a means of transportation.  When doing so, use both your budget and DTI to determine how much you can safely afford.

Conclusion

There you have it.  You are finished with college and ready to take on the world.  Don’t put off applying these steps.  You can start implementing some of these steps on your first day of employment.  If you start out with a well-established plan, you will be well ahead of your peers.  Use these steps as a guide and you will surely become a financial success story.

Do you agree with these suggestions?  Do you think that anything is missing from this plan?  What would you add or do differently?

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Debt: Reaching Step Zero

The first step in correcting a problem is to admit that there is a problem.  Prior to admitting that there is a problem, there is another step.  That is when a person reaches their breaking point and cannot go on living the way that they are living.  That is often referred to as step zero.  Step zero is when a person says to themselves “this crap has to stop”.  It is the breaking point.  It is the point where a person becomes willing to take corrective action.  They become willing to try a different approach of living because of a psychic change.

Have you reached the point where you realized that your way of managing money is not working?  Are you spending more than you earn?  Does all of your earnings go towards paying bills?  Do you have creditors calling you who want to be paid?  Do you have to borrow money when an emergency occurs?  Do you find yourself spending money that you do not have in order to keep up with your friends, neighbors, or relatives?  Do you feel broke even though you work hard and earn a good income?  Do you contribute any money to your retirement savings accounts?

Have you reached step zero? Do you want to change how you manage your finances?  Do you want to take control of your life?  Do you want to break away from the bondage of debt?  Are you at a point where you are totally dissatisfied with how you are living because of debt?

The good news is that there is hope.  It can get better.  It is all up to you.  It is based on your willingness to change.

Now that you have admitted that your way of managing your finances does not work, how should you start the mending process?

Measuring the Damage

Start by measuring the damage that you created.  Before you can move forward, do an analysis of what you owe.  My favorite tool to assess debt is the debt-to-income ratio.

To calculate your Debt-to-Income Ratio, see the formula below:

Debt-to-Income Ratio = Monthly Debt Payments/Monthly Income x 100

Example: $1000 in Monthly Debt Payments/$3000 in Monthly Income x 100 = DTI of 33%

What is considered a bad DTI Ratio?

If your DTI Ratio is higher than 36%, you are in the danger zone.  The higher your DTI Ratio is, the less money you have to cover your living expenses.  A healthy DTI Ratio is less than 16%.

Where to Start

After you know your DTI Ratio, it is time to start paying down that debt.  Start with paying off all of your bad debt.  Pay off all of your payday loans, credit cards, and auto loans.  Next, start to pay down your student loans, mortgage, and business loans if they exist.

Stop the Bleeding

Stop buying stuff you do not need on credit.  Identify what you need and only pay cash for those needs.  A few examples of needs are food, clothing, medical supplies, transportation costs, and housing expenses. Wants are fancy cell phones, cable TV, designer clothes, eating at restaurants, or any other expense that is not required to live.

Income

If you are part of a dual-income household, learn to live off of one salary.  Use the higher of the two salaries to pay for all of the household living expenses.  Use the lower of the two salaries to pay down debt.  After your debt is paid off, you can start to focus on saving money.

Get a second job.  Find a side gig to earn money to pay down debt.  If you spend your free time working, you will be less likely to spend money on stuff you do not need.

Create a budget.  A budget is a plan that allows you to break down where your earnings will be allocated based on a percentage.  For example, 25% for housing, 11% for transportation, 20% to pay off bad debts.  Once you have a budget established, all you need to do is follow it.

Recreation

Even though you have debt, you still have to live your life and have fun.  Find ways to enjoy what your local community has to offer.  Instead of going to high priced movies or amusement parks, go to local parks or free museums.  Instead of going to a high priced gym, exercise outside by walking.  Instead of going on a luxurious vacation, take a staycation.

Guilt & Shame

There is no use in feeling bad about having debt.  You have identified the problem.  Now is the time to move ahead and to make positive changes.  Having ill feelings is not a solution.

Focus on the positive and on everything that is possible once your debt is under control.  Try to take small steps and to monitor your progress.  Don’t strive for perfection.  If you have a slip, don’t beat yourself up.  Pick yourself back up and keep striving for progress.

Conclusion

Debt is similar to hiking.  Once you walk 5 miles into the woods, you have to walk 5 miles to get out.  Now that you have decided that a change is needed, it is up to you.  At this point, there is no use in looking for someone or something to blame for your debt.  You cannot change the past.  You can just pick up what is left and apply a solution.  If you learn from the situation, it was not a waste.  As you move forward, you can also use it to help other people who are struggling with their own financial issues.

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Travel Hacking: Round Two

Travel hacking is a great way to travel for free.  Travel Hacking is the practice of opening premium rewards credit cards to capture the generous initial bonus points that these credit cards offer to new cardholders.  The hack is based on getting the bonus points, closing the card before the annual fee is due, and never paying interest or carrying a monthly balance.

I first learned about travel hacking from reading The Millionaire Educator.  It sounded interesting.  It was not until I attended a Rockstar Finance Meet-Up in New York City that I really got turned on to this practice of traveling for free.

In my post Travel Hacking: Round One, I wrote about my first experience with Travel Hacking.  The first card that my wife and I opened was the Chase Sapphire Preferred Card.  We used the bonus points from this card to buy two round-trip tickets from Newark, NJ to Dublin, Ireland.

As the result of my first experience, I have decided that travel hacking will be a major part of my financial plan.  My wife and I take at least two vacations per year.  Even though I am frugal, we still have the monthly household spending to earn enough points to pay for two trips per year.

The second card that I opened was the Chase Preferred Ink Business Card.  Unlike the Chase Sapphire, the Chase Preferred Ink Business Card is a business card.  In order to qualify, having a small business like a blog or an Etsy store would qualify.  For sole proprietors who do not have a tax id, they could use their Social Security number when signing up for business credit cards.

Another benefit that the Chase Preferred Ink Business Card offers is that it does not count against the  Chase 5/24 rule that Chase has for opening new cards.  Chase only allows individuals to open 5 cards in a 24 month period from any issuing bank, you will not be approved for new Chase credit card.  That also applies for anyone who is an authorized user.  Since it is a business card, it is not counted as being part of the 5/24 rule.

The Chase Preferred Ink Business card offers a very rich benefits program.  After the cardholder spends $5,000 in 3 months, they receive 80,000 bonus points.  When you redeem those points through Chase Ultimate Rewards, 80,000 points are equal to about $1,000 towards travel.

When you open the Chase Preferred Ink Business Card, there is a $95 annual fee.  Unlike the Chase Sapphire Preferred card, that fee is not waved for the first year.  Based on the value of those 80,000 travel points, it is easy to justify the $95 for one year.

On additional spend, cardholders earn 3 points for every $1 in spending.  The 3 points for every $1 in money spent is good for up to the first $150,000 charged.  After that, cardholders earn 1 point for every $1 in spending.

My wife and I used this card for all of our monthly expenses.  We try to put all of our monthly reoccurring bills on the card.  We also use it when we go out to eat at a restaurant or fill up our car at the gas station.  It took us two months to reach the $5,000 in spend to equal the 80,000 points.

So, how did we use these points?  My wife’s birthday is in December.  She does not know it, but I booked a Western Caribbean Cruise.  While going on a cruise is exciting by itself, this cruise departs on December 23rd.  What makes that exciting is that winter is in full swing in Pennsylvania at that point, so we will even appreciate the cruise more.

I wish that I was able to report that I was able to book the cruise for free.  Unfortunately, that was not the case.  Hopefully, I will be able to share a post about taking a free cruise with you in the future.  I have not reached that level of travel hacking success yet.

What I did apply the points towards was our flight.  I have never booked a flight from Pennsylvania to Florida in December.  When I went to book this trip, I was shocked to find out how inflated the prices are this time of year.  After giving it a little bit of thought, it makes sense due to the holiday traffic and snowbirds who are flying south for winter.

The normal cost for a ticket from the Scranton International Airport to Tampa is around $300.  This flight cost $625 per person.  Our flight to Ireland was less expensive.

The total amount of points that were required to cover our two tickets were 112,000 in Chase Points.  At this point, I had 88,000 in chase points from the Chase Preferred Ink Business Card.  My wife and I also had 30,000 in points from our spending on the Chase Sapphire Preferred Card.  By combining the points from the two cards we were able to cover the airfare.

With the remainder of our points, we booked our hotel.  The cruise departs on Sunday, December 23.  We are flying down the day before.  I was surprised, but we were able to pay for one night at a 3-star hotel for only 6,000 points.  That was the only value that I have found so far on this trip.

Even though the flight was expensive, it ended up being free for us since we took advantage of our points from the Chase Preferred Ink Business Card.  Otherwise, we would have had to shell out over $1,200 for a 3-hour flight from Pennsylvania to Tampa, Florida.  It might seem expensive, but I am sure that I will be happy to be cruising the Western Caribbean instead of dealing with at best a wintery mix at home in Pennsylvania.

I am excited about the money that I will be saving on travel as the result of travel hacking.  Even though it sounds fun, be warned that travel hacking is not for everyone.  Travel hacking is only for those who are ridged and hyper-focused when it comes to managing their personal finances.

If you struggle with paying off your credit card bills every month, travel hacking is not for you.  If you do not have enough in normal monthly spend, travel hacking is not for you.  If you have to try to generate artificial spend to try to earn points, travel hacking is not for you.

Please keep your eye out for my next post in this series on travel hacking.  The next post will be about the Chase Southwest Rapid Rewards Premier Business Card.  I look forward to sharing about how I am getting free flights and to share with you about where we are planning on visiting next.

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