Tag: Save That Money

The Pitfalls Of Sudden Wealth

Sudden wealth can take many forms, including selling a business, winning the lottery, reaching a legal settlement, or the result of an inheritance.

Receiving a large windfall, especially when tied to the death of a loved one, can trigger powerful and conflicting emotions that may lead to risky financial decision making.

Below are some common pitfalls of sudden wealth and ways to overcome them.

Pitfall #1 – Hasty decision making

Do you ever hear of lottery winners going broke only a few years after they won a large sum of money? How is that even possible?

I think it’s because these ordinary people all of a sudden became extraordinary. They become euphoric and lose all sense of reality.

No matter the source of the windfall, it can oftentimes trigger those visceral emotional responses and all logical thinking goes out the window.

The best course of action to take after a windfall is to do nothing – at least for a while. Take a step back and figure out your priorities and create a plan.

Determine what decisions you have to make in the short-term, like tax planning, and what decisions you can wait to make, such as how to maximize the impact of your newfound wealth.

Pitfall #2 – caving to the pressure

Once friends and family learn that you’ve received a large sum of money, they may have an expectation that they are entitled to it. Depending on your relationship with those people, it can be hard to say no.

Once you start giving money away though, it’s difficult to reverse course.

The easiest solution is to rely on a third party to act as a gatekeeper, such as your financial advisor or attorney, to intercept the flood of requests and take the emotion out of the decision-making process.

Pitfall #3 – Withholding information

A windfall can prompt people to be more close-lipped about their finances. Some feel uncomfortable about their new wealth, others feel isolated from their former peers, and still, others are wary of those seeking handouts.

This instinct to withhold information often extends to your financial adivsor as well.

However, during every big transition, especially sudden wealth, it is critical to provide your advisor with a full picture of your financial situation. Your advisor will serve as a partner to assist you through the decision-making process and help you to spot issues before they become problems.

Pitfall #4 – Failing to update plans

After receiving a financial windfall, it is crucial to review the financial planning framework you previously had in place.

Financial plans will almost always need to be revisited, along with insurance policies and estate plans.

Your financial advisor can lead this team — financial advisor, lawyer, accountant, and insurance agent — to create a plan for your future that stays true to your priorities and goals as your financial situation changes.

The Basics of a Credit Score

Your credit score is a three-digit number that lenders use to determine whether or not you are a trustworthy borrower.

Many lenders use the Fair Isaac Corporation (FICO) model for credit scores, which grades borrowers on a point range, with a higher score indicating less risk to the lender and a more favorable rate for you.

Take for example this credit savings illustration available at myFICO.com.

Borrowers with excellent credit scores — between 720 and 850 — save as much as $9,601 in interest over the life of a 60-month, $25,000 car loan compared to borrowers with scores ranging from 500 to 589. That is real money saved!

While the above example shows the effect of differing FICO scores on a hypothetical auto loan, the same principle applies to any other line of credit — credit cards, personal loans, mortgages, etc.

That’s why it’s important to know what factors are taken into consideration when calculating your credit score so you can take proactive steps in building good credit and qualifying for the lowest rates possible.

Payment History

Repaying past debts is the largest factor that makes up your credit score. Payment history amounts to 35 percent of your score and includes both revolving credit, such as credit cards, and installment loans, like mortgages. In short, payment history is used in credit formulas to determine future long-term payment behavior. Making on-time payments is one of the best ways to improve or maintain a high score.

Amounts Owed

The amounts owed factor accounts for 30 percent of your credit score. The formulas used to compute scores tend to see borrowers who reach or exceed their credit limit as a higher risk. Keeping card balances low can positively impact your score. Utilizing a high percentage of available credit will do just the opposite.

Length of Credit History

Opening a credit account early can pay off in the long run. The length of credit history factor, specifically the age of your first account, makes up 15 percent of your credit score. As time goes on, account holders with a positive history will have more data that influences their credit report.

New Credit

New credit amounts to 10 percent of your credit score. Opening new credit accounts on a whim can negatively impact your financial health, as it is a sign of greater risk. A 20-percent store discount for opening a new credit account may sound great, but it could make getting a loan, or a lower interest rate, more difficult. Only open new credit accounts when necessary to give your score a small boost.

Credit Mix

The fifth and final factor that contributes to your financial health is your credit mix. Credit mix is comprised of the various accounts you currently have open. This can include but is not limited to, credit cards, installment loans, and finance company accounts. Credit mix makes up the final 10 percent of your overall credit score.

Knowing the factors that affect your credit score can help you build and maintain a high credit score which will allow you to borrow from lenders at lower rates, saving you money in the long run.

If you are using credit cards to build credit, make sure you are using your available credit wisely, paying off the balances at each cycle, and only opening new lines of credit when absolutely necessary.

Are your spending habits making you happy?

It is safe to say that most of you are familiar with the concept of “keeping up with the Joneses”. If you haven’t, here is how one source eloquently puts it:

“Keeping up with the Joneses” is an idiom in many parts of the English-speaking world referring to the comparison to one’s neighbor as a benchmark for social class or the accumulation of material goods. To fail to “keep up with the Joneses” is perceived as demonstrating socio-economic or cultural inferiority.

The desire to compare ourselves to our peers is part of human nature — we wouldn’t have sports, corporate ladders, or eating contests if it weren’t.

But measuring our own financial success against that of our peers and letting their spending behavior influence our own can spell major trouble for our finances. And the amount of consumer debt in our society is evidence of this fact.

It seems as though more and more of us are willing to pull out the plastic without regard to our budget. As Will Rogers said, “Too many people spend money they haven’t earned to buy things they don’t want to impress people they don’t like”.

So what can we do to pay less attention to how the Joneses are doing and focus instead on our own financial health and the things in life that will truly make us happy?

Stop comparing yourself to others

Since we never know what anyone else’s financial picture really looks like, it’s important not to see their apparent success as our own failure.

Remember, we don’t know their story and it’s highly possible that our peers are living beyond their means.

Learn to live within your means

Regardless of our income, without a little discipline, it is easy to spend all of it on frivolous things. And if you haven’t built financial margin into your life, one little hiccup in income could result in losing those things and possibly more.

Nearly eight out of ten families in the United States are living paycheck to paycheck. That means one missed paycheck and the bills are going unpaid.

I am willing to go out on a branch to say that the Joneses are likely living paycheck to paycheck and are financing their lifestyle in a way that puts them in danger of losing everything. In turn, the Joneses are likely just as stressed about money as we are.

To relieve some stress, start by tracking spending habits to figure out where money is going. You might be surprised at what you find. Then take action to improve your situation.

Find your own happiness

Don’t let anyone else dictate what should make you happy. Material possessions cannot fill an empty heart.

Instead of spending mindlessly, put your energy into your family and your relationships. That’s where the real value is.

Road Trip: Rent or Not

I’m on an impromptu road trip this weekend to North Carolina. Unfortunately, my Grandmother passed away on Monday and the viewing is today.

I didn’t have a lot of time to plan and one of the decisions I had to make was whether to rent a car or take my own.

There are two factors to consider when deciding to drive your own car versus renting a vehicle for a road trip.

The Pure Mathematics

The first is to crunch the numbers. 

If you rent you’re going to have to pay the rental company a fee to use their car. The cost will vary depending on how long you are renting and the type of vehicle you choose. The longer you will be renting and the smaller the vehicle, the lower your rate will be.

The rental car company will try to up-sell you on items like insurance, GPS, and XM radio. This can add $60 to $100 per day to your daily rate! I never take the insurance the rental car company offers.

I prefer to call my insurance company to let them know I’ll be renting a vehicle and request they add rental car coverage (specifically loss-of-use coverage) for a limited amount of time. I also decline the GPS and XM radio options. We have cell phones that can do both things for free.

But what about the cost of driving your own car? You likely own your car so it doesn’t cost anything to drive it. Even if you have a loan, I wouldn’t consider the loan payment in the cost.

Instead, you’ll need to calculate the “wear and tear” costs. This would include things like oil changes, tires, and other parts. A long road trip will speed-up the deterioration of your car’s parts that would normally only be replaced every few months or years. A good rule of thumb to calculating these costs is to multiply the total miles of the trip by $0.20.

Of course, there is the cost of gasoline. You’ll have this cost whether you rent or dive your own car. However, make sure you know how much gas the rental car company wants you to return the car with. If you’re responsible for dropping it off with a full tank, but don’t, they’ll charge you to fill it up. I’ve made this mistake before. It cost me $10 per gallon!

The Psychological

The second  factor to consider are the things that are more phycological in nature and less about cold hard numbers.

For example the condition of your car. If you have a new car, you might be hesitant to put a thousand miles on it for a road trip. It’s new and you want to keep it that way!

On the other hand, if you have an older vehicle, you might worry if it’ll make the trip at all. If it broke down, you’re in for the cost of towing AND repairs. Yikes!

There’s also the WOW factor of getting to drive a different car for a few days. It’s new and it’s exciting! Especially when you’re on your way to somewhere warm and opt for the convertible!

These psychological factors are harder to substantiate because they aren’t based on fact. They’re based on our feelings. They are still important to take into account though.

The Verdict

I can’t say there is a definitive right or wrong answer. The math may say one thing but the emotional drives may say another. 

Just like my trip to North Carolina. The math was clearly in favor of taking my own car. But my car is a few thousand miles shy of 100,000 and my emotions said to prolong hitting that milestone for as long as possible. Even though hitting 100,000 miles a few months earlier than planned would have zero impact on the reliability of the car.