Kostas, Author at The Broke Professional

Why a credit card is like a machete.

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If you take a look in the purse or wallet of any American, you will most likely find a credit card or two. Or three. Or more. The problem is that while many people have credit cards, many of them do not know how to use them responsibly, or how to use them to their benefit. According to creditcards.com, the average cardholder has almost four cards, while 1 in 7 people have 10 or more cards. With that many cards in circulation in the country, it would be prudent for people to know why they have a credit card and how they can best use it.

Credit cards are a tool. A machete is also a tool. A credit card used responsibly can be a good way to track your spending and possibly earn some rewards. A machete used responsibly can help you clear vines and brush to safely lead your party out of a jungle. A credit card can also destroy your credit score if you are late on a payment or carry a large balance. A machete can also be used by a crazed man in a hockey mask to terrorize unsuspecting campers. See where I’m going with this? A credit card can be your best friend while also being your worst enemy.

A credit card is essentially an interest free 30 day loan, with conditions of course. The main condition is that you pay it back by the due date. This is the problem that many Americans have nowadays, as they charge anything and everything they can and then are stuck with a bill they cannot pay off in full. This is when the high interest rates kick in. Credit card interest rates are regularly in the double digits. Scary. This can be devastating to a family trying to make ends meet. Every effort should be made to pay off the debt. A logical way to do this is to organize your cards by interest rate, and try your best to pay off the highest rate card first, as this is the one that will cost you more in the long run. Credit card debt can be painful, but action needs to be taken to stop the cycle.

Now that the depressing stuff is out of the way, let’s go over some of the benefits of having a credit card. One of the major benefits which is overlooked by many is that a credit card is a major component in having a good credit score. As NSAish as it sounds, a company called the Fair Isaac Corporation (FICO) has full knowledge of our financial habits. They know when we open credit card accounts, get a car loan, are late for a bill or are paying our student loans on time. They use this information to formulate a FICO credit score which is a number between 500 and 850 and represents our risk to any company that gives us a loan. The lower the number, the more risky you are and the less likely you are to get a good rate on a loan or even get one at all. Have a high number, and you can get the best possible rate on a loan. This can come into play when we get a loan for a car or a house, which many of us will do at some point. Having a good credit score will save lots of money over a lifetime, and it is an easy thing to do. One of the major components is how we use credit cards and if we pay them back on time. If you never have made a late payment and don’t tend to max out your cards, you should generally be in good shape. Responsible credit card use is not the only factor in a good credit score, but it is a major one and an easy one to achieve.

While helping your credit score is arguably the main benefit of credit cards, there are others as well. From a financial planning standpoint, credit cards are handy because they can give you a line by line history of where you are spending your money. With this information, it is easy to find problem spending areas and make the proper adjustments. Another benefit is convenience. While this can also be a drawback if taken too far, the convenience of credit cards makes them attractive as you can just pull out the card if you are short of cash or don’t feel like using cash at all.

Finally, credit cards that give you rewards such as cash back are useful as well. These should only be used if you do not have any credit card debt and can be tailor made to your life. If you do a lot of driving for example, a gas reward credit card would be a good choice. If you do a lot of traveling, a travel rewards card can be helpful. While you shouldn’t spend extra just to get certain rewards, getting something back for purchases you already make can be helpful. I’m a big credit card rewards guy so I will definitely go in depth into these in future posts.

Filed Under: Credit cards

Financial Commandment #1: Spend less than you earn

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There are certain rules and sayings that are priceless and will withstand the test of time. Two plus two equals four. Don’t buy vacuums form a guy selling them door to door. Michael Jordan is the greatest basketball player ever (please there is no argument here LeBron and Kobe fans). The list can go on. In my personal finance journey, I have come across some timeless and time tested ideas as well. I have tried to make these ideas the foundation of my personal finance strategy. The first of these “Financial Commandments” is one that everyone has heard but not everyone implements: Spend less than you earn.

The first personal finance book I ever read was The Richest Man in Babylon. I thoroughly enjoyed this book because it was short, it was simple enough being a personal finance newbie, and it also imparted the strongest message for me regarding personal finance: spend less than you earn. The books use of parables about the “virtue” of not spending all that you have in your pocket versus spending everything that you get was really refreshing and was easy to apply to my life.

Not spending your entire paycheck right away doesn’t inherently give you any rewards. It just leaves some extra money in your bank account. In fact, you immediately receive less because you don’t use all that money to buy whatever you want. But what that unspent money represents is very powerful. It gives you the freedom to use it in any way you want. If you want to use it as a buffer in your checking account, that is fine since some people feel more comfortable with that. If you want to eventually transfer it to a savings account, that’s great too (this will lead to a future Financial Commandment). If you just want to give it to your favorite charity, that is wonderful also. The bottom line is, that money you set aside can be used for whatever you wish. It represents financial freedom. And the more financial freedom you have, the more potential you have for a happy financial life.

It’s also worth noting that before the age of credit cards, car loans and home mortgages being the norm, it was actually a lot tougher to spend more than you earn. The cash that you had in your pocket or your basic checking account was all you had. Those were simpler times, and most probably less stressful times finance wise. People had to live within their means because that’s all they could spend. Give someone a tool such as a credit card, and living beyond your means suddenly becomes a lot easier. We can use this as a lesson for us to try our best to live within our means and to only use financial tools such as credit cards and loans in reasonable and affordable ways.

Feel free to comment below on this Financial Commandment and how it has shaped your financial journey.

Filed Under: Financial Commandments

Top 5 things I would do with a million dollars

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Powerball/lottery fever has been going around lately. Recently a group of people won the $448 million Powerball jackpot. Good for them. I hope they use their money wisely and in a way that will benefit their families and communities for years to come. This got me thinking on what I would do with a big windfall. Getting $448 million would be nice of course but there would not be much thinking involved in how to spend it because that amount of money would erase all of the debt we have and leave us with more than we would know what to do with.

Dr. Evil can finally pay off those grad school loans.

So I thought about how to spend a large sum of money that would still require some planning. I also wanted to assume I would continue working and making the same salary I am now. I thought $1 million (after Uncle Sam’s bite of course) would be a good place to start, so here are the top 5 things I would spend it on:

Student loans. This is a no-brainer for me as my student loan payments currently total $1200 a month. Getting rid of these debts alone would be enough for me. One thing to consider would be paying off the higher interest loans only as I do have some loans around a low 2% interest rate. I could instead invest this money in an index fund and most likely make more than a 2% return. There is also the maximum $2500 tax deduction from paying student loan interest. But I’m leaning towards the huge psychological and income boost of getting rid of all the loans. This would cost me around $140,000 leaving $860,000 left to spend.
Siblings’ student loans. Took me a little while to decide on this one because I wouldn’t know what to do with my life after student loans! I decided to pay off my siblings’ student loans because having a family free of debt will help everybody and their loans aren’t anywhere near the value of mine. Around $100,000 or so between all 3 of them. And also I think this would be a much better gift than the inevitable hitting me up for cash requests. This would free up money for them for the rest of their lives! This would leave $760,000 to spend.
Charity. Now that the family house is in order, I would give a healthy amount towards charity. I’m not exactly sure which charity but the problems that are dear to my heart include people going hungry and people getting sick and dying because of poor living conditions. So it would likely be a good charity for one of these causes. I would also like to give back to my community in some way. I would spend around $100,000 for this, leaving $660,000 to spend
Invest. With over half a million left to use, I would then turn to investing. I currently have a Roth IRA with Vanguard and a 529 with the state of Maryland. I would focus on these since I’m already contributing up to the match in my company’s 401k. The Roth IRA would get most of the pie because of much lower expense ratios and superior investment choices. I would invest $300,000 in the Roth IRA and $100,000 in the 529, leaving $260,000 to spend.
Mortgage. I’m actually not too worried about getting rid of the mortgage completely since eliminating student loan debt will free up more than enough money. Also I don’t believe in tying up too much wealth in a house because townhomes (which is what I have) don’t generally appreciate as much as typical single family homes, and it would be a pretty illiquid place to keep the money. I would still like to build some equity though and have a nice down payment to use upon selling the house, so I would put $220,000 towards the mortgage, maybe using it to build some improvements on the house as well.

Wait I still have $40,000 left to spend? Guess my education wasn’t that great after all. Seriously though, I think it would definitely be a good idea when receiving a windfall to leave some money to spend on yourself. Always wanted to go on that African safari or European tour? Ever wanted to buy that luxury car and not have to worry about a monthly payment? This is what I’d use that remaining $40,000 for because sometimes you just need some money to spend on whatever you want. Personally I would use it for vacation or three since I’m not really into fancy cars.

Well now that my million is gone, I would say I’m in a very good financial position. Student loans paid off for me and family, healthy investment accounts, good amount of equity in the house and some fun vacations ahead. Not bad at all. What would you spend a million on? Please comment below and share the wealth!

Filed Under: Financial know how, Investing, Student Loans

Net worth: How can we use it?

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One things I really like about knowing your net worth is how clear it makes the current state of your finances and how many different ways you can improve it. It is essentially a live autopsy of your financial health, and with the information on hand you can determine where to make changes in your life.

Just like any good football team, it is essential to have a strong offense and defense. Being too strong in one aspect over the other usually will not produce good results. You can look at the value of your assets as your offense and the value of your liabilities as your defense. If you have a healthy amount of assets but some high interest credit card and student loan debt keeping the amount of your liabilities high, that is a less stable position to be in than having a little less in assets but cutting out the credit card debt. By looking at your net worth, you can see how a combination of making a little more money to increase your assets and getting rid of a little more debt to decrease your liability can make a big difference in the long run.

When some people find the value of their net worth, based on a number of psychological biases and assumptions, they try to decide of their net worth value is “good or bad”. As I mentioned in my last post, the absolute value of your initial net worth is not important. In fact, that number doesn’t mean too much because a couple who is just out of school will most likely have a high negative net worth while a child with five bucks in his pocket has a positive net worth. Obviously the highly educated couple is in a better position to increase their net worth for the long term than the child currently is. What is important is to keep your net worth going up consistently.

As a final point, most people who graduate any type of professional school, myself included, will most likely have a large negative net worth. The combination of high student loan balances and being in the early stage of your earning career will likely push some net worth’s into the negative six digits. While this may be discouraging to see, it is important to know that by paying off high interest student loans first and starting to make some real money, that net worth value will start to grow quickly. As an example, my net worth upon graduating 4 years ago was around -$150,000. That looks like a big hole but in just 4 years my current net worth is now -$90,000. By optimizing my income potential and paying off high interest student loan debt, my net worth increased $60,000 in 4 years. My goal is to break even (a whopping net worth of 0!) in about 5 years.

The power of paying off student loan balances and using that extra money to pay off your next balance is very potent in increasing your net worth. I will discuss different student loan payment strategies and how to find the right one for you in future posts.

Filed Under: Financial know how

Net Worth: What’s it worth?

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There are many metrics you can use to determine your financial health. You can track the amount of money you have currently in your checking account, the money in your savings account or a combination of both. You can also track the amount of money in any investment accounts, the amount of student loan debt or even the value of your car and house. All of these numbers can be useful and people put more emphasis on some over others. The number I believe is most useful, however, is your net worth, which is a combination of everything.

What is a net worth anyway? Definitions vary depending on who you ask, but the basic definition is that your net worth equals the value of your assets minus the value of your liabilities. Now there is some disagreement on what makes up an asset or a liability. Is the equity of your house an asset or is your mortgage a liability? Should your house even be in the equation because you can’t really tap the value until you sell or take out a home equity loan? Should the value of your car be included since it is always depreciating in value? Should your small business expenses be included? The list can go on and there are calculators such as this that can guide you: http://www.bankrate.com/calculators/smart-spending/personal-net-worth-calculator.aspx

Personally I include checking accounts, savings accounts, and investment accounts as my assets, and credit card debt and student loan debt as my liabilities. I believe this is an easy and effective way to see how you’re doing financially. While it can be fun (or frustrating) trying to figure out what is an asset or not, I don’t believe the details are really that important. What is important regarding net worth is that you use it consistently from month to month to track how you are doing financially. If your net worth is consistently going up over a 6 month period, that is a sign that you’re moving in a positive direction. If your net worth is going down consistently, that might be a sign to examine it more closely and see what changes you can make. What’s important is that you use it as a barometer to see how you’re doing compared to last month, and decide to stay the current course or adjust.

Now that we know what a net worth is and how it can be calculated, in my next post I’ll go over how we can harness this knowledge to produce an actual change in our finances.

Filed Under: Financial know how

Lifestyle inflation: Keeping up with the Dr. Joneses

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Most of us have heard of the term “Keeping up with the Joneses”. And hopefully most of us know that it is not a horribly mediocre reality show. It refers to a type of lifestyle inflation in which we accumulate more and more things to keep up with our friends and neighbors, despite not being necessarily able to afford such things. This practice is what undoubtedly gets many people into financial peril, leading to a paycheck to paycheck existence, and sometimes even worse. Keeping up with the Joneses is detrimental to your financial health, so recognizing this practice in your own life is certainly a step in the right direction.

I remember a conversation a few years a back with one of my friends who was a resident physician at the time. He mentioned an event at his hospital where some doctors were teasing another doctor because he drove a Toyota Camry and not a luxury car. It wasn’t even an old or beat up car it was a brand new Camry but they still were teasing him about it. Even though they were just having fun with a colleague, my friend said this lifestyle inflation is very common among MD’s. There is a certain amount of prestige in being an MD, and many doctors take that to believe that they “deserve” fancy luxury cars and houses for example.

Do you “deserve” this?

This type of thinking extends even those who aren’t doctors, as society has engrained the idea that all doctors should be driving a luxury car. If not, something must be wrong and that can unfortunately change the perception of some patients towards their doctor. The bottom line is that unless you can truly afford a luxury car, you are not entitled to one even if you are a doctor. When we start believing that we are entitled to certain things because of our position and don’t even run the numbers to see if we can afford it, that’s when this type of lifestyle inflation can creep up on us and cause havoc on our financial lives.

I will go into more detail in future posts about when you can be sure something such as a car is affordable, but as a general rule if you find yourself buying something because of outside pressure and do not run the numbers, you are playing the dangerous game of keeping up with the Joneses. This can lead to lots of debt and stress which can wreak havoc on the lives of you and your family.

Filed Under: Self Building Tagged: joneses, keeping up, lifestyle inflation

Put the “person” back in personal finance

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Welcome to The Broke Professional! This is the first post on my first blog. Lots of firsts. Allow me to introduce myself. My name is Syed and I am a broke professional. I also know that I’m not the only broke professional out there. Getting a professional degree is great, but in the past few years it has become a little less great mainly because of rapidly increasing tuition leading to large student loan debt balances after graduation. Having a large negative net worth after finishing school is becoming commonplace nowadays.

Before going into much more detail, let me give you some background information about myself. I am currently working as an optometrist for a national corporation. I graduated optometry school in 2009 with all the potential in the world along with what seems like all the student loan debt in the world. Receiving my first paycheck as a doctor was a great day, but it came with a sudden realization: I’m going to be paying off my student loans for a very, very long time if something does not change. This really spurred me into action to learn as much as I could about money, student loans, investing, taxes and everything in between. I devoured and applied as much knowledge as I could since becoming a professional. The bottom line is I really wanted to optimize my education by learning the best way to handle my new-found money.

Naturally, discovering something as revolutionary as changing my financial health led me to talk about it with other optometrists and other professionals in general. What I have found is that many of my peers do not have much interest in getting to know about their finances, let alone try to improve them. For example, many doctors and professionals I have spoken with have not taken the time to contribute any money to their company’s 401k retirement plan, despite knowing that they can receive a matching contribution from their company. This seemed more like a psychology issue that a strict financial knowledge issue so i started learning as much as I could about money and psychology and found some very fascinating things. This is one area I will try to emphasize in my posts as well.

Why do we handle money the way that we do and what can we do to improve our situation? This will be the overall theme of my blog and I hope it will lead to much discussion and, most importantly, implementation of ideas that produce real results in people’s lives. This site is not only for working professionals but for anyone with interest in personal finance.

One last point I would like to make is about the actual phrase “personal finance”. Right there in the name it says finance is personal, meaning everyone’s situation is different and there is usually no one size fits all answer for everybody. There are certain principles that hold true for everyone such as don’t spend more money than you have and try to maintain positive social relationships. But most financial decisions need to be tailored to each individual situation. I don’t have all the answers, but I will try to provide as much objective information and direction as I can, but it is only through discussion and looking honestly at one’s own situation that a person will find the right answer for their problem. This is a principle I try to apply to myself as much as I can and I hope others will also.

Filed Under: Self Building