In her latest book, The 10 Commandments of Money, personal finance whiz Liz Weston offers strategies for coping with the latest twists and turns in the economy. As she explains, her tips aren’t exactly new, since they are based on the same back-to-basics principles she’s always espoused, but “people are more willing to listen these days,” as she puts it. Her philosophy revolves around simplicity. “Life is complicated enough without trying to turn your money into rocket science,” she says.
“For awhile there, when the economy was booming, I was starting to feel like a crank for telling people things like, ‘Ya know, real estate prices can go down as well as up’ and ‘You probably want to have some bonds in your portfolio, even if you’re not 80.’ …But being vindicated isn’t much fun when so many people have lost their homes and their jobs,” says Weston. US News recently spoke with Weston about five of her commandments:
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1. Put 20 percent of your after-tax income towards savings or debt repayment.
Weston: If they follow the whole 50/30/20 budget—50 percent of after tax income for “must haves,” 30 percent for wants, 20 percent for savings and debt repayment—the answer is yes, [it is possible for everyone]. The whole point of this budget, which was created by bankruptcy expert Elizabeth Warren, is to create a balanced life, so that you’re taking care of your daily expenses, having a little fun AND putting aside money for the future (plus paying off your past).
The problem many people face is that their must-haves have taken over the lion’s share of their budgets. They’re spending far more than half their after-tax income on shelter, transportation, food, utilities, insurance, child care, minimum loan payments—all the stuff you can’t put off without serious consequences. When those expenses eat up much more than half your budget, it’s really hard to create balance.
It’s not easy to wrestle those expenses back under the 50 percent mark. But when you do, suddenly you have more money to save, and more money for fun. You probably aren’t going to get there overnight but you can get there over time, and it’s worth the effort. The alternative is living a life that’s perpetually out of balance.
2. Start planning for an emergency now, by putting aside $500.
Weston: That doesn’t seem like much, but it’s enough to get you off the paycheck-to-paycheck carousel and to cover a lot of the small emergency expenses that pop up, like a minor car repair. Once you save $500, you’ll realize you can start saving more.
Before you do, though, you should make sure you’re starting to save for retirement and paying down toxic debt. Those things have to take priority over building an emergency fund, which can take years. In the meantime, you should make sure you have some access to credit, since an open line of credit or space on your credit cards can help you out in a real emergency, or when a big-enough emergency wipes out your savings.
3. Learn the difference between good debt and bad debt.
Weston: Good debt is debt that, in moderation, helps you get ahead somehow, typically by increasing your earning power (federal student loans) or allowing you to invest in an asset that can grow in value over time (mortgages). Good debt typically has a low, fixed interest rate and the interest you pay may be tax deductible. Of course, anyone can turn good debt into bad debt by overdosing on that debt, but used correctly good debt can be an important tool in growing your wealth.
Bad or toxic debt is any debt that’s eroding your financial well being. Toxic debt has high or variable rates, isn’t tax deductible and isn’t an investment in any kind of future wealth. Credit card debt, payday loans, bounced check fees and title loans are all examples of toxic debt.
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4. Take out a smaller mortgage than the maximum the bank approves.
Weston: Thirty years ago, you could pretty much assume that a lender wouldn’t give you a bigger loan than you could afford. Five years ago, you could get an unaffordable loan if you were able to fog a mirror.
The pendulum has swung back to where it’s harder to get a too-big mortgage, but certainly not impossible, so you need to be careful to limit how much you borrow for a house.
To make sure you have enough money for the other expenses of life, I’d try to limit your monthly mortgage payment to 25 percent or less of your gross income. And if you can’t afford the payment using a fixed-rate, 30-year mortgage, you probably can’t afford the home.
5. Take a counter-intuitive approach to your insurance needs.
Weston: A lot of people get insurance exactly backward. They’ll insure their cell phones, then cheap out on car insurance and buy only the minimum liability coverage. You don’t want insurance to cover what you could pay yourself out of pocket. Insurance should be reserved for catastrophic expenses—those you couldn’t easily cover on your own.
A lot of insurance is sold, rather than bought. That means someone who stands to profit is convincing people to buy coverage, rather than the people realizing they need insurance and seeking it out. The people who are persuaded to buy coverage this way often don’t understand the alternatives—and sometimes, neither do the insurance salespeople. So people wind up, for example, buying expensive cash-value life insurance and getting too little coverage, instead of buying the cheaper term insurance and getting enough coverage.
Kimberly Palmer is the author of the new book Generation Earn: The Young Professional’s Guide to Spending, Investing, and Giving Back.