2011 Spending in Review

Happy New Year everyone.  I thought I'd take a post to look at my expenses for this previous year and use it to help give me a good idea of how much I should be spending in the future.  Also, for those of you still looking to get your first credit card, it may help to see which credit cards I use most often and what returns I get through their cash back programs.

End of the Year Losses

Merry Christmas everyone and thank you for supporting me in reading my blog.  While you open those expensive family presents you bought each other (which hopefully you have budgeted), I thought I'd end this year with an educational post about what almost everyone does near December 31st: take capital losses to offset any capital gains or some income.  The reason why you would want to offset capital gains or income is to save on taxes.

Why You Should Manage Your Personal Finances

I've been regularly posting on my blog for more than half a year already, yet I think I have neglected one of the most important topics that need to be addressed: why should you even bother learning about personal finance?  Of course, some of us may automatically say "obviously, it's to have more money."  But that isn't the real reason. There is a reason why we even want money in the first place—so that we can pursue our interests and find what makes us the happiest.  Everything always comes down to seeking happiness and how it comes to each and every one of us is almost completely unique.

Retirement

I thought I'd spend a post talking about retirement in general, before moving on to specific ways to help save money for retirement.  I also have posts on retirement saving strategies and retirement investment strategies.

Weekday Vegetarian

I don't have time these two weeks to make a very formal post about a new topic, so I thought I'd share a very motivating TED talk I have heard in the past and taken to heart.  It is about vegetarianism and the guy talks about a unique way of thinking about your health.  I started it about a year ago after watching this video and I really believe in its benefits.  In a previous post, I mentioned how buying in bulk can help you better budget.  Buying groceries are a better alternative to eating out at a restaurant and with weekday vegetarianism, you can help your budget (the environment, and your health) even more.  Click read more to see the video.

Types of Credit Cards

I have posted on several occasions about the benefits of getting a credit card, but there are a lot of credit cards out there.  I stress reward credit cards because I am blogging about making money and an easy way to make money is to get paid for your normal expenditures.  There are a few different types of credit cards though which I will go through.

All About Inflation

I'm not sure how many young adults really grasp the idea of inflation.  Most people who impulsively spend probably don't need to worry as much about inflation as those who save, but hopefully you have read some of my other posts and agree that it is beneficial to budget and keep some money for the future.

The unfortunate thing is that inflation will eat away at your savings.  I'll first explain some of the basic reasons why we have money before going into detail about inflation.

The Individual Retirement Account

The Individual Retirement Account (IRA) is a general term for retirement plans that give tax advantages for retirement savings.  I posted a very funny and educational video about it in September but I haven't really said much about ways to save for retirement other than the 401k.  So here I will talk about the two most common IRAs: traditional IRAs and Roth IRAs.

The Market

What do people mean when they talk about "the market?"  When they say the market is up 200 points, what exactly are they referring to?  If you hear this terminology, but never knew exactly what it referred to, this is the post to read.

Banks Rethinking Debit Card Fees

A few posts back when I mentioned Bank of America's plans to introduce a $5 debit card usage fee, a huge consumer backlash came about.  People across the country were talking about closing their Bank of America checking accounts and it seemed as if there was a mass exodus from national banks to more local credit unions.  J.P. Morgan Chase has been testing a similar $3 debit card fee in a few states but plans on abandoning the idea.  Wells Fargo had been implementing an almost identical $3 fee that it has also decided to cancel.  TD Bank conducted a customer survey and found that about 75% use debit cards for convenience and that almost all of them would discontinue their account if a fee was imposed.  U.S. Bank has also come out saying that they do not plan on adding any fees.

Annuities

Most people have heard of life insurance.  However, not everyone knows about the other side of the coin, annuities.  While life insurance protects against an early death, annuities protect against living too long.  So why am I blogging about annuities on a young adult centered site?  It's because annuities can be a very important consideration for your retirement nest egg in the future and generally too few people pay attention to them.

Optionshouse: The Cheapest Way to Invest

Time Value of Money

Ever hear the phrase that time is money?  I thought I'd make a post for the general public who might not know much about such a topic while we learn everything about it in business school.  In this sense, there is an actual price associated with the value of money over time.  If given the choice between $1 today and $1 in a year, nobody would ever pick the latter. Intuitively, getting a $1 today and keeping it until a year from now will be the same as the latter choice, except that you have the option to spend it on something within a year if you find an opportunity.  From a financial perspective, you could also put the $1 into a bank account today and accumulate interest for a year, receiving more than $1 in a year.

New Debit Card Fees

Anyone with a Bank of America account should already be aware that the company is planning to institute a $5 monthly debit card fee starting in 2012.  They will roll it out slowly, selecting a few states at a time but no specific information is available yet.  This fee does not include use of ATMs but whether you use your card at the cashier once or 100 times, you will be charged $5 for that month.  This is essentially a $60 fee assuming you use your debit card at least once a month.  Wells Fargo and Chase are already testing debit card fees in certain locations and this may prompt them to also institute a global debit card fee for their own cards too.  However, I believe there will always be some banks offering free use of their debit cards and the promotion of this feature will become more prominent in the years to come.

The Passing of an American Visionary

This night saw the unfortunate passing of Steve Jobs, one of the greatest visionaries and businessmen in the world.  We all knew it was coming but I'm sure it is a shock that it was so soon.  I really appreciated his Stanford 2005 Commencement Address and thought I'd share it for anyone interested.  The speech is really moving and it's hard to hear that he is now gone.

Credit Card Overview

I thought I'd go through a quick list of my credit cards, the pros and cons I have found with each one, and what their purpose is for my spending habits.

IRA Music Video

Here's another amusing video about IRAs, or individual retirement accounts.  You might have seen it if you clicked on similar videos for the previous post.

Haven't Made A Budget Video

This is one of funniest educational videos I have ever seen.  It was recently blogged on Get Rich Slowly and I couldn't resist sharing it here.  It is basically a story about a guy trying to get a girl and realizing that she wants someone financially responsible.

If you aren't sure about some of the terms they use in the video (like ETF or 401k), you can try to find the posts I made about them in my history on the right hand side.  Anyway, enjoy!

Best and Worst Ways to Raise Cash

There was a similar post on investopedia.com, so I thought I'd reblog with some of my own input on this idea.  We'll take a look at several ways to raise emergency cash and the consequences of doing so.

The best method to raise cash is to keep an emergency fund, which I posted about recently, and not needing to raise cash.  Some good storage places for your emergency fund is a high yield online savings account or a money market account.

Creating an Emergency Fund

An article recently quoted an FCC survey citing that 64% of Americans would be unable to get $1000 for an emergency.  To me, it isn't that alarming, but hopefully college students understand the importance of having an emergency fund available for easy access.  It is quite risky living paycheck to paycheck without access to cash, which is probably more common as a college student.  However, we also probably have access to parents in times of emergency but it is especially important to have our own fund.  Once we graduate and live in the "real world," we will have to deal with these issues independently.

Credit Card Rewards So Far 2011

Save on Electricity

Most college students probably won't have to worry about this for a while, but if you care for the environment or already pay your own electricity bills, here are some tips to cut down on your usage (and of course, costs).

Encourage Healthy Eating Habits

Sometimes, what's good for our health is also good for our wallets.  Here are some tips for what healthy choices you can make that also cut down on costs.

In general, shopping at grocery stores instead of eating out will cut down your food expenses and also be healthier.  Learning how to cook on your own will allow you to control what goes into your food so that you can more carefully monitor how much sodium and sugar you get.  Fruits and vegetables are high in fiber and can help you feel more full more quickly.  Some of the most nutritious foods are quite low in cost such as bananas, carrots, potatoes, whole-wheat flour, and dried beans.  There are people who think fruits and veggies are too expensive, but these same people might spend $3 on a pound of candy rather than $1 on a pound of bananas.

Textfree

This post is probably not as applicable for my peers, so I understand that the majority of people won't benefit as much from this post (which is why I'm putting it up in the middle of the week), and my blog doesn't get much traffic anyway.

But, if you aren't a frequent texting fiend (which most high school and college students are) and you have a wifi device (such as an iPod touch) with easy access (such as on a college campus), then you could save $10-30 a month by dropping your text plan and signing up for text free (or your parents could save it in which case most students would probably stop reading here).  It is an app in the apple store which lets you text any phone number through a wifi connection.  The savings is fairly significant, accumulating up to a few hundred dollars a year.

Taking Advantage of Bonuses

Often times, there are a lot of great deals you can take advantage of as a new customer.  I wanted to specifically look at some of the bonuses you can get at banks.  There are often lots of incentives if you open a new checking account or a credit card.  While lucrative, you often have to pay attention to the fine print.  For credit cards, make sure you aren't getting a card with an annual fee.  I can't even count how many offers I get from airline credit cards every year, but all of them have annual fees.  There are options out there that don't have an annual fee, but still give great introductory bonuses.  Some of them depend on fulfilling another criteria.  For example, the Chase Freedom card has several promotions floating about.  You can either get $50 with the card after your first purchase or $200 if you spend $500+ on it within the first 3 months.  If you plan on spending $500 in the next 3 months, why not get the card and get 40% of that back?  Bank of America also has a $50 cash back offer (after spending $100 within 60 days) with one of their new cards which also gives 2% back on groceries and 3% back on gas.  Of course, this all assumes that you are responsible with credit cards already and you won't be tempted to overspend.

Sell-off as U.S. Rating Drops

I apologize for not updating this past week.  I've been pretty busy but apparently, so has the market.  I am trying to get some more personal finance posts up but until then, I thought I'd point out the current stock market's performance.  Over the weekend, the S&P downgraded the U.S. credit rating to AA+ from AAA.  Nothing has fundamentally changed these past two days, but with the market today, the S&P is down more than 6% and this is on top of a 5% drop last Thursday.  Equities are getting to look very attractive.  Professor Siegel came on Bloomberg earlier today and said that unless you believe there is going to be a double dip recession, stocks are looking very cheap.  Will the market continue to drop another 5%?  Potentially.  Could this be the bottom and everything will rebound from here?  Possibly.  In the short term, it is almost impossible to time the bottoms in the market, but for those people who are looking to put away some cash for the long-term, now is a great time to get in, even if its just a little bit.

Your Credit Score

I've mentioned the FICO Credit Score a few times in my previous posts, but I recently took a look at my credit score and thought it would be helpful to share with everyone what are some of the positive and negative factors that go into your score.  I'll list out the main ideas and then paste the details that came with my report below.

1. Always make your payments on time and never miss any if you can avoid it.  Make sure you don't miss consecutive payments which is often worse than missing a few stand-alone payments (separated by a few months).

2. Make sure you have a few accounts with access to credit, but avoid signing up for too many (or signing up for several in a short amount of time).  I'm not sure what too many is, but it is probably safe to say that double digits is pretty high (if you wake up one day with 10 or more cards).

3. Make sure your credit lines report your credit limit.  If you have a credit card but it doesn't report your credit limit, then it's hard for future lenders to gauge how much credit you have been trusted with in the past.

4.  Establish a credit history early, at least a few years before you plan on applying for loans.  Short payment histories are negative, since it doesn't provide very accurate or reliable information on your payment habits for lenders.  Below, it says shorter than 3 years is way too short and shorter than 7 years is risky.

5. Avoid running a high balance on your lines of credit.  Lenders will worry that you are living beyond your means.  Running a low balance frequently is the best for your score; running no balance may be negative since it doesn't provide additional information on your repayment habits.

6.  Avoid applying for credit before applying for credit.  When you need a loan, make sure you don't apply for credit cards the prior year since lenders worry that you may be trying to take on too many new accounts at once.

The Case for Generics

Everyone probably thinks of drugs when hearing generics versus brand names, but it certainly applies to other products.  When going down the pharmaceutical aisle, though, it is easy to see the discrepancy in price between generic drugs and brand name drugs, even though they are the same compounds in the same quantities.  Are brand name products really worth the price?

The answer really depends on your comfort with the company.  For some people, brand name products may be worth the extra price if that company has established a good reputation with the customer.  If you don't have confidence in the quality of a generic producer, it may make sense to pay for brand names.

Annual Credit Report

It is important to check your credit report at least on an annual basis.  Each year, you are allowed to view your credit report for free at https://www.annualcreditreport.com/cra/index.jsp.  Make sure that you take a look at your report regularly to see if anyone has been using your name to get credit.  A lot of banks offer credit protection services for a fee where they will monitor your credit report to alert you about identity theft.  These services also give you a look at your credit score in case you are curious.  A lot of them also include a one month free trial so that you can check it out and not get charged for that first month, but you have to remember to call them before the month ends or else they will bill you for the next month (and you need to give them a credit card when you sign up).  I personally don't use one at the moment, but I do check my report on an annual basis.  I believe the government recommends checking it semi-annually, or twice a year, although you would have to pay for the second view.  Identity theft is said to be a very serious issue.  Although I have never been a victim of it and I haven't heard of anyone becoming a victim of it, I would rather stay on the safe side and do the minimum by checking my credit report.

Size Does Matter

People often either underestimate or overestimate the power of bulk purchases.  On one hand, people buy things from vending machines individually, such as soda and chips, which often comes at a 100+% premium (they say it's for the convenience of not going to the store, but buying in bulk is even more convenient when you only have to walk to your pantry or closet instead of downstairs to your dorm vending machine).  On the other hand, some people buy more or cook more food than they can eat and sometimes the food they do have expires or goes bad, resulting in money in the trash.  It is important to know when to buy in bulk when you plan out your spending.

Let's Head Southwest

Looking at my budget so far this year, transportation accounts for 32% of my spending!  And you have to take into consideration that I never drive so gas isn't even a factor in that spending.  Of course, it is understandable that as a college student across the country, flying should take up a considerable amount of my budget, but perhaps it is a large factor in many other demographics.

I'm going to spend this post talking about my favorite discount airline, Southwest.  An important thing to know is that they don't sell tickets anywhere but their website.  This means if you use travelocity, expedia, or some other flight booking website, you will miss out on Southwest tickets.  But before we get into the pricing, let's take a look at how Southwest differs from some other airlines.

Only Death and Taxes

Possibilities of Good Credit

What are the benefits of a good credit score?  First of all, what does qualify as a good score?  The line drawn might differ depending on who you ask, but a 740 or higher would put you in the top third of Americans.  It will get you some of the lowest rates on home and auto loans.  However, a good credit score also gets you lower rates on credit cards and better cash back deals.  Also, when purchasing a car and looking for financing, dealers will typically be locked into preset rates for financing; but, you could talk about finding better loan offers elsewhere to leverage in negotiating the sticker price.  If you are looking for a vacation home or (more likely for college students) a place to rent, a high score usually is a sign of a responsible tenant which will help again in your negotiations for price.

Buying Direct

There is an alternative method to buying stocks from a broker.  Investors can try to buy stocks directly from a corporation through a DSPP (Direct Stock Purchase Plan).  For some companies, the commission that you pay is $0.  This allows investors to slowly add shares of a company to their portfolios over time without having to build up a sum of money to purchase all at once (otherwise, you'd be paying a very large percentage of your investment in commissions).  There is usually a fee to sell shares, but hopefully, the stocks you pick for buying direct are for the long-term.  Some companies do have fees to buy shares, but they are generally less than broker's depending on the company.  Most of the ones who offer a DSPP are blue chip stocks like P&G or Microsoft.  You can find a company's DSPP plan if they have one on their website under the investors tab.  Or you could probably google search it.

The 411 on the 401k

What's a blog post about retirement doing in the middle of the stock series?  I thought it would be good to take a break from brokers and stocks and some internships students get during the summer offer a 401k enrollment.  Although many college students probably think they are too young to think about retirement, some of these decisions should be looked into early on, especially since most of the benefits of retirement plans come from untaxed or deferred tax on growth of your earnings.  This means that the earlier you get a retirement plan and invest, the more money you will earn and the more you'll save in taxes over your lifetime.  I'll just be introducing the 401k and talk about other retirement plans such as IRAs later on.

TradeKing Review

Have you already decided on a broker yet?  If not, let me make a recommendation for TradeKing.  As I discussed in my earlier post, when I started I went out to look at discount brokers.  I wanted to minimize the cost of commissions for trades so I first compared prices.  I'll say upfront that TradeKing is definitely not the lowest out there.  I believe Optionshouse has cheaper commissions for both stocks and options (more on this financial derivative later) but TradeKing had a better reputation of customer service as well as a referral bonus.

Your Orders, Sir?

This is going to be a very brief introduction to the types of orders you can make in order to purchase stocks and other similar securities like ETFs or mutual funds.

First off, if you look at www.google.com/finance or any other financial webpage, you can usually see the real-time (or close to real-time) prices of the stock market during trading hours (9:30am-4pm EST).  If you can imagine it, try picturing yourself walking in a supermarket.  As you go down one aisle, the stock aisle, you see all these different products and the price tags of each one changing every couple seconds by some cents.  This is kind of what the stock market is like during trading hours.  Prices fluctuate up and down.  Usually, big changes happen in between market hours so prices open (the price the stock begins the trading day with) at a much higher or lower price than the previous close (the price stocks ended yesterday's trading day).  Sometimes, when big economic reports or earnings reports come out, you can see a large spike or drop in a stock price in the middle of a trading day.

So how does this affect you?  Obviously, the price you buy or sell stock is very important.  There are several different types of orders that you can use with your broker: market, limit, stop, stop limit, market on close, and some other more complicated ones.

How To Buy Stocks?

I've talked a lot about why you should invest in stocks, especially if you are looking over a long time horizon, but you may not know too much about the process.  There are a couple ways to actually purchase stock, but I will mainly look at the primary method for most ordinary investors: a stock broker.

The two types of stock brokers are full-service brokers and discount brokers.  I am personally most familiar with discount brokers, but I will mention what I do know about full-service.  Full service brokers often charge a higher premium for their work and generally offer more in terms of research, financial advice, retirement planning, tax tips, etc.  Full service brokers include Edward Jones, Goldman Sachs, and Merrill Lynch.

Discount brokers, on the other hand, charge a much cheaper commission and offer a much simpler product.  The most important difference is the price: discount brokers are usually around 1/20th the cost of full-service brokers.  This makes them much more attractive for investors who do not want full financial planning service and instead want to just put some money into stocks, bonds, etc.  Discount brokers include TradeKing, Zecco, Optionshouse, Fidelity, and Scottrade.

The Feeling is Mutual

So you've read about why you should invest in stocks and the handy ETF security, but you're probably wondering what those mutual funds that you hear here about really are.  A mutual fund is a pool of money collected from investors and put into different stocks and other securities of different asset classes.  Sound familiar?  It should.  Mutual funds are very similar to the ETFs we just talked about.  However, instead of tracking a specific index, mutual funds are actively managed by money managers.  The main goal is to give smaller investors access to professionally managed, diversified portfolios which would be more difficult to create with a smaller amount of money.  By pooling together money from many people together, the fund makes it easier to invest it many securities.  However, students and investors should be aware of the fees that mutual funds have which often eliminate much of the gains you can make from such an investment.

Best of May

The Best of May
1. How to Budget
2. Why Budgeting
3. Diversifying Your Risk
4. Credit Card Recommendations
5. Introduction to Bank Accounts

I thought I would take a post to go back through the best of May, at least in terms of viewers.  I know that it is biased for posts that were made earlier on since they had more days available on the website to be read, but I sincerely believe some of these most read posts are what people are looking for in terms of learning something new about personal finance.

The ETF

We have talked about the benefits of diversification before.  This technique should be used in your overall portfolio and within each asset class in your portfolio (meaning you should have a mix of stocks, bonds, etc. and diversification within stocks, within bonds, etc.)  If not, you might end up with the diversification they have in the cartoon.

So since we are on the topic of stocks, I am going to be introducing the exchange traded fund (ETF) which is an easy way to diversify your stock holdings.  The ETF is a security that tracks an index (a basket of different stocks or other assets) but trades like a stock.  You get the ability to buy it like a stock or short sell it and some of the advantages include lower fees than mutual funds (which we will talk about later).

What's in a Stock?

So you were convinced enough by my earlier post on why stocks to put some money in?  But you don't know what to look for in a stock?  Especially in bear markets when the economy is going down and stocks as a whole drop in price, it is important to pick good stocks.  In bull markets, it is still important but a little less so since generally stocks as a whole will go up.

There are several features that you should pay attention to when picking a stock.  These include the P/E (price over earnings) ratio, market capitalization, and return on equity.

The Short Sale

Okay, so the stock market might not be as random as this cartoon, but it does show that sometimes the market moves irrationally.  Again, I would like to reemphasize holding stocks for the long-term since most of the short-term fluctuations in price are unpredictable.  You will definitely experience a lot more volatility the first few months after purchasing a stock than when you look at time horizons of several years.

We went over last time that you can make money off the dividends and the capital appreciation of the stock.  Of course, this assumes you are purchasing a stock outright.  There are ways to make money when stocks fall as well.  I wouldn't recommend this method because of a few reasons, but it is a tool every investor should be aware of.  First of all, let's start with the basic proposition for how to make money on the change in price of stocks.

Why Stocks?

The stock market is a pretty popular place to put your money.  If you have ever seen the news, a section is usually dedicated to how the stock markets moved that day and many people have investments in various companies.  But first of all, why does the stock market exist?

Companies usually get listed on the stock exchange as a way to raise money.  Individual investors have the opportunity to give companies money in the hopes that the company is able to use that money in a solid business plan to make more money.  However, this is only in the case of an IPO (initial public offering) where a company first sells shares to investors.  During the normal day-to-day trading on the stock exchange, however, people buy or sell shares of stock to one another.  There are instances where the company may initiate a stock repurchase to buy back its shares when they think their shares are undervalued, or priced too low, but for the most part the counter-party to a trade is another investor (or fund manager, etc.).

What's Your Grade?

What is the grade of your bond and how does that affect your investment?  The grade is an indicator of a bond's credit quality.  Just like how individuals have a FICO score for credit card companies to check the quality of a person, the grade of a bond is a way for you to check the quality of an institution's ability to pay back debt.  Standard & Poor's and Moody's are the two big names in the credit rating scene.  You can see from the handy chart that the more A's the better, kind of like in school.  The speculative and highly speculative ranges are known as the junk bond ratings where you are essentially taking a bet on getting your money back, but you will definitely get a larger return than from higher rated bonds.

These ratings are based on the issuer's financial condition.  However, it is important to remember that it is only one factor going into your decision to invest in a particular bond.  Some other factors to consider is the yield on the bond, whether or not it pays a coupon, if it is tax-exempt, or if payments are inflation adjusted.  The bond rating is useful for a quick check but as always, you should always do thorough research on the securities you are looking to purchase.  I may come back to discuss more about bonds, but hopefully the next few posts will look more at stocks.

The Name Is Bond...

Okay, so it's not really about James Bond, but I couldn't help but resist the cheesy pun.  It was either a picture of this or Barry Bonds, or I could have gotten a very boring picture of a certificate which is the type I will be discussing in this post.

So if you haven't already read the first post on bonds, I would recommend going there first.  This post will just take a more in depth look at what bonds are, the different types of bonds out there, and why you should consider investing your money in them.

As I mentioned in my first post, bonds are thought of as "safe" securities.  It is a type of debt investment: you are giving your money out as a loan and expect to be paid back in full with some interest for your trouble.  Bonds are used by governments, states, companies, municipalities.  This is where most of the risk lies with bonds, and like I mentioned in the other post, the payment of your bond depends on the reputation of the bond issuer.  With corporate bonds, these can be quite risky (some of the riskiest bonds are called junk bonds, implying that you would essentially be buying junk since it isn't that likely that you would get paid, but these bonds often have the highest returns).  In technical terms, these bonds are given a low rating.  I will make another post about the ratings later on and what you should watch out for, so for now assume that the bonds we deal with are guaranteed and safe.

Why "The Smart Nickel"

I'm going to spend a post just talking about my blog to give my readers a better idea about my goals and what I hope to achieve as well as why I decided to go with "The Smart Nickel" instead of "The Smart Billion Dollars."

I sincerely believe that it is not impossible for anyone to generate at least a 5% return on their money.  With credit cards and their cash back, it is even possible to earn back 5% of what you spend.  But hopefully, my blog is able to convince many college students the importance of saving for the future and the potential your money has to grow itself over time.  So the nickel comes from the possibility to make a nickel on each dollar, which may not sound like very much but it adds up.  And that's how I made the name, but please continue to learn about the goals of this post.

Update

Hello all my readers.  I apologize for not updating very frequently the past few days.  Unfortunately, the power brick for my laptop seems to have stopped working and I will be unable to go to a store to get a new one for a while.  Until then, I'll have limited access to the internet so I probably will not be able to post very often.  Hopefully, after I get that fixed up, I'll be able to continue with the stocks and bonds series and talk more about investment management.  Feel free to check back infrequently until then.

Diversifying Your Risk

Now that you have learned a little bit about stocks and bonds and since we are on the topic of risk, let me go on to probably the number one issue you should address before starting: risk management.  You often hear that the stock market is risky and it is much better to put your money in a safe bank account.  However, I would argue that prepared correctly, the stock market is actually much better suited to guarantee a more prosperous future for you.  The main tool that you use to manage the risk you take on is diversification.

Let's take a simple exercise.  If I offered you the chance to play a game where I'll flip a fair coin, and if it lands heads you win $20 and if it lands tails you get nothing and the game costs $5 to play, how many times would you want to play it?  Probably as many times as you can.  Why?  Because the expected value of the winnings is $10 (50% * $20 + 50% * $0) and the cost to play is only $5.  Although technically, you should play the game even if you were only allowed to play once, it is much more assured that in the long-run you will make $5 on average each time you play.  Playing the game once is risky, but the payoffs when you do win should more than make up for the losses if you play many rounds.

The same can be thought of for stocks.  If you put your money into one stock and it happens to do poorly, you would have lost a lot of your savings.  However, putting your money into multiple stocks diversifies the risk, as if you were playing the coin flip game multiple times.  There is a more logical mathematical proof of decreasing the risk because variance of the outcome goes down as you increase the number of stocks you own, but I won't go into detail unless a lot of readers want to hear about it.  The main idea is to, like the old saying, not put all your eggs in one basket.

The main takeaway is that you are probably as diversified as you can be by having 30 or more unique assets that are different in terms of market capitalization, industry sector, and asset class.  I will go over these more in detail later on, but hopefully my example was clear enough to demonstrate how preferable it is to have a diversified portfolio when thinking about investing since you limit your exposure to the extreme cases and try to aim for a guaranteed return.  We will next take a look at how, as a whole, stocks have given a very consistent return on investment over the long-run.

Risk Versus Reward

With any asset, there is always a trade off between risk and reward.  Often times, it feels like you are trying to walk a tightrope balancing the two of them.  First of all, let's define risk and reward.

Risk is the variance in possible outcomes.  For example, a stock that may shoot up from $10 to $20 one day and then drop down to $5 the next day is much riskier than a stock that stays at $8 over the span of a certain time period.  Or you can think of lottery tickets as being extremely risky while coupons are not.  With lottery tickets, your winnings can vary from $0 to $1,000,000+ and with a coupon, you know for certain what you are getting for certain.

Reward is pretty obvious.  In most cases, it either is or can be exchanged into money (for comparison purposes).  It is what we seek to gain from certain actions.  When you think about investing your savings, you are seeking the highest return possible (or highest growth in your assets) which is your reward.

So what is the relationship between risk and reward?  They are usually positively correlated: as you find something that gives a higher reward, it usually carries a higher risk.  The simplest example is stocks versus bonds.  There are some stocks that can increase 300% over the course of a year while others drop 90%.  Bonds, on the other hand, earn you maybe 1-3% for certain over the course of some specified time frame.

So what combination is right for you?  You should probably take a risk tolerance test online (or I might just post one up on this blog later on) to see what risk profiles you should be looking at.  Generally, younger students should take on a riskier portfolio that a retiring senior since young adults don't have to worry too much about short term fluctuations.  It also depends on how well you handle emotions and stress.  Would you be able to sit through losing half of your money on the possibility of doubling it?

As you'll see in the next post, stocks in general have the most potential and have proven to be consistently the most rewarding in the long run.  For the ambitious who want to make the most of their money, they will probably want to have an aggressive portfolio of mostly stocks, but I'll talk more about asset allocation later as well.  You should think about what time horizon you are looking to keep your money invested and find the right risk tolerance level before choosing a specific allocation.  I'll continue to give more examples as we continue discussing risk management and stocks and bonds.

Stocks and Bonds, What?

So you have some money saved up, probably from disciplined budgeting, and perhaps it's in your bank account.  What do you do with it now?  You are earning a little bit of interest, but you really want to see your hard-earned money grow, have it reproduce more of itself for you and take a little bit of the responsibility for your financial stability.  What can you do with it?  There are actually a lot of options available to you.

I'm fairly certain almost everyone has heard of stocks and bonds, but probably many college students don't know what they are or how to utilize them.  Please read the disclaimer at the bottom of my website as nothing I say will constitute financial advice.  I will try to state mostly facts and observations as well as give my own opinion, but if anyone reading this blog is actually thinking about putting money into any of the places I will mention, please do your own research to make sure any investments you make are right for you.  For this post though, I will be mainly defining a lot of these asset classes.

First of all, what are stocks and bonds?  First, let's look at the question of equity versus debt (stocks are a form of equity and bonds, debt).  Equity is ownership in something.  When you buy a stock, you are becoming a partial owner of the company and purchasing ownership.  Debt, on the other hand, is similar to the loans we have talked about for credit cards and banks.  When you buy bonds, you are loaning money to the entity on the other side.  If you buy government bonds, you give the government money and get a bond (a certificate that says the government owes you some amount of money) in return.

What is the difference in how these assets earn you money?  With equity, the value of your ownership depends on the performance of the company.  If you take some time to follow the stock market, you will see that it fluctuates day to day.  You can earn money through two avenues: capital appreciation of the stock (you buy the stock at one price and sell it at a higher price) or dividends (similar to interest you earn on debt).  For debt, you earn interest either when you get your principle back at the end of the term or as a stream of payments up until the end of the term.  It is kind of similar to how you pay interest on your credit card balance if you don't pay it off in full, except when you buy a bond, you are the one getting paid as the lender.

Bonds and debt securities are considered safer securities than stocks and equity because you are guaranteed your money back (depending on how reputable the bond issuer is).  Stocks do not have to guarantee a dividend and the value of a company can drop pretty steeply with some bad news.  However, with greater risk often comes greater reward, which I will discuss more in depth in my next post.

How To Open A Bank Account & Recommendations

If only I could find a bank where something like this community chest card event actually happens...  But more realistically, on to the actual point of this post.

So let's say you've done some research and you've found a bank that looks like a good match with your goals (and if not, I have recommendations throughout).  How do you go about opening one?  You can either open an account online or in person.  I would recommend opening one in person if it is your first time since you can ask any questions you may have.  Just make sure that you have brought enough money with you for the minimum opening balance or you have a check you can use to deposit.

When you open an account online, you simply go to the bank's website and find where to apply for the checking account.  You can usually use the website's search engine or Google it.  I would try to find student accounts if you are a student, particularly because banks are usually more lenient with maintenance fees if they do have any. Then you go fill out some personal information as well as a method to make the opening deposit and then you're done.

In terms good banks, I know that Bank of America often has a lot of maintenance fees and you have to jump through a lot of hoops to waive it (such as only use the ATM to deposit and withdraw AND sign up for online statements).  I would also make sure to keep an eye out for opening offers (some banks offer money when you open an account with them).  Just Google searching checking account offers leads me to see an ING Direct Checking offer of $50.  I got a $50 bonus when I opened my U.S. Bank Checking account and a free iPod Touch when opening my Bank of the West checking account (I actually opened Bank of the West solely for the iPod Touch, but their service has been great).  So make sure you stay on the lookout for these offers since it can be some easy money in your pocket (or your new bank account).  Another quick note is that these offers I got were over the summer so I'm not sure how time sensitive these things are.

Also make sure that you get your first order of checks for free with a checking account.  This was the case for U.S. Bank, Bank of the West, and PNC Bank, but I'm not sure if it is standard for all banks.  These three are the only banks where I have experience with their checking accounts.  I have also looked at Bank of America, but their fees usually persuade my to look elsewhere.  I have heard good recommendations for Wells Fargo though.

In terms of savings accounts, I like Discover Bank because I have their credit card and because it pays the highest interest rate I know of.  The thing about Discover Bank though is that it is solely an online savings account so there is no physical bank for you to go to.  This means that you must have a checking account or savings account at another bank in order to withdraw your money (I only use the ACH transfer to my checking account but I believe you can wire transfer as well for a fee).  They have no monthly minimum balance and no fee and the APY is 1.15% currently.  It isn't that much but it's higher than most of the other savings accounts I have seen so when interest rates do go back up, I expect Discover to stay on top.  A close second, however, is Capital One which has a 1.1% APY and a bonus 10% on interest you have earned in the quarter if you have their credit card or maintain a $10K balance.  I would recommend these online savings accounts, especially for students and young adults in my generation since we are usually more comfortable with handling money online.  If you aren't, then a normal savings account at a bank is fine as well, but I generally don't find too many with a leading interest rate on the account.

What To Look For In A Bank Account

Now that you know a little bit about how banks work, let's go over the key features you want to pay attention to when selecting a bank account.  You can use Google's site to compare some popular checking and savings accounts.

Like credit cards, you will have to pay attention to a certain rate when looking at savings accounts (although some checking accounts have one at times too).  This is your interest rate that you will be earning on your balance with the bank.  It is called an APY (annual percentage yield), similar to the APR (annual percentage rate) on credit cards.  This number is typically around 1% for savings (but there are some banks who offer something like 0.35%) and next to nothing for checking accounts nowadays.  Normally, the savings interest rate is much higher, but the government is currently keeping interest rates low to encourage consumer spending.  And obviously, the higher the APY on your account, the better since you will earn more interest.

One minor thing to keep in mind is how often your interest is compounded if the bank you are looking at is advertising a higher interest rate but does not specify that it is the APY.  Compounding is the magical way of earning money exponentially since your interest earns interest, then your interest's interest earns interest, and then... well you get the idea.  Of course, it takes a while for this effect to become significant and almost all banks compound interest daily.  The APY is calculated as the effective rate using a compounding period of one year, so it should be a good comparison tool across banks.  You may be interested, however, in how often the the bank pays out interest as well (most pay out monthly I believe).

Another major feature to pay attention to is a monthly fee.  Sometimes, banks charge a monthly fee on your account unless you maintain a certain minimum balance.  If you are about to open an account and they mention that there is a monthly fee,  I would ask first if there are student accounts available.  Most of the time, these accounts don't have any monthly fee or any requirements.  One such bank I know this case applies to is Bank of America.  Make sure to avoid paying monthly fees on either your checking or savings accounts, simply because there are alternatives out there which don't have such a fee.  There may be other fees such as an overdraft fee and other fees that you should look out for so make sure you read through the fine print.

The last feature to pay attention to is the minimum amount to open an account.  For checking accounts, this is usually either $1 or $100, but it can vary.  Savings accounts usually have slightly higher minimums to open, either $100 or $500.  Obviously, you have to make sure that you have enough money to put into the account to open it.

I will mention some of my recommendations for checking and savings accounts in the next post.

Introduction to Bank Accounts

Now that we've learned a lot about budgeting, where should you put your money?  Hopefully, you have decided to save at least 20% of your income (may be less depending on how large your income is and how much your needs take up), but where should you put those savings?  The most common place is the bank.

I don't think I have ever met someone who wasn't familiar with what a bank is, but there may be some of the smaller details you have never thought about.  So for those of you who are starting to become fully financially independent, a bank is probably one of the best places to store your money when you are not going to be using it in the near future.  There are two specific types of bank accounts: checking and savings.  A checking account is used for a lot of transactions (when you need to withdraw money from an ATM or write a check to pay your bills) and savings accounts are used to put away money for long periods of time so that you can earn interest.  Interest is essentially the bank paying you to leave their money with them and the main motivation for why you should save money: your money will be making money for you.  Also, with a checking account, you usually get a debit card and a checkbook with a set of free checks.

I will go over the nitty-gritty details about how to choose a bank and what features to look out for next time, but for now let's just talk about how commercial banks work.  The typical bank makes money by lending it out to people so it plays both the role of the borrower and the lender.  For people who need to take out a mortgage loan or any other type of loan, a bank assesses their credit risk and offers them the loan at a specified interest rate.  Where does the bank get this money?  There are a lot of technical details with how banks manage money with each other and the government, but essentially a lot of their holdings come from people like us who deposit our hard earned money into the bank.  Usually, loan interest rates are much higher than savings account interest rate because the bank earns money on this difference.  What determines interest rates?  That takes a couple economics courses worth of material that will probably put you to sleep, but in general it is determined by how much money is available in the economy which is determined by the government to some extent.

One important thing to note is that banks do not hold all the money they receive from us.  It was implied by the fact that banks lend out money but banks normally only have a percentage of our deposits in cash with them.  If we theoretically all went to the banks and demanded all the money in our accounts at once, the bank would be unable to give it to us because they don't have enough cash on hand to satisfy all the liabilities.  These circumstances have happened in the past, called bank runs, especially in times of crisis.  An important thing to look for when choosing a bank is to make sure that it is FDIC insured.  FDIC is the federal government agency that insures your account with the bank so that you will be guaranteed to get your money from the government if the bank ever fails.  The current insurance amount is $250,000 per depositor, per insured bank for each account ownership category, and most of the big banks are FDIC insured.  If your local bank is a little smaller, I would double-check to make sure that it is FDIC insured so that it will be one less worry on your mind.

One final thing to note about savings accounts is that there is a monthly limit on how many transfers you can make from the account.  The current limit is 6 outgoing transfers per month, and I don't believe it will change in the near future but it is possible it will change some time from now.  There is usually a fee charged if you go over this limit, but I usually just move the total sum of my credit card debt from my savings to a checking account in one transfer and then pay off each card separately.  Just keep in mind that with a savings account, there is a limit to how many times you can move money out of it (although not into it) while a checking account has no such restrictions.

Budgeting Tools

If you haven't read the post about why budgeting is useful, I would recommend going here first.  If you already understand the benefits of budgeting and just want to learn effective and efficient ways how, then go here.  And finally, if you just want to see some of the programs you can use then you are in the right place.

First of all to review, what do you need to take into consideration when you create a budget?  We can split our overall categories of spending into needs, wants, and savings.  Needs include basic necessities to live such as food, rent, utilities, and other products for which you can't avoid paying.  Wants are extra things we buy to satisfy some of our desires, but ultimately they are not necessary to live.  Obviously, there are some gray areas: does eating at a fancy restaurant count as a want or a need?  These issues don't need to be exclusively addressed since categorizing your monthly or yearly expenditures is supposed to be more of a guide than a strict limit.  You would also need to pay attention to your income.  If you have a job, how much is your paycheck normally and how often do you get it?  It may be good to set your budgets biweekly if your paychecks arrive biweekly so that it is easy to see what you need to adjust.  Generally, you don't want to budget to spend more than your income since you will run out of money very quickly by doing so.  If you are currently not employed but receive an allowance from parents, use that as your income to measure how much you can spend.  As a college student, this is good practice before getting a real job and managing a steady flow of income each month.

After taking into consideration what goes into a budget, what tools should you use?  One popular tool I have heard a lot about is Mint.com.  It is an online tool developed by the makers of Quicken to help manage your personal finances online.  You enter your bank, credit card, and investment information and it organizes everything in an easy-to-view format.  Whenever you pay for something with a credit card, the transaction will automatically appear on your mint account.  However, I have read a lot of reviews online talking about its security and I am still hesitant to input all my information into one location.  One very comprehensive review can be found here.  You can see the Mint video on their homepage and they way they describe how people usually keep track of their financial information is actually very accurate for me: statements and spreadsheets.  While Mint.com does look very useful in tracking all your information and making it less tedious since transactions are imported automatically, I still would not feel comfortable using it.

Excel is the main tool I use to keep track of my expenses on my computer.  I don't have an extremely comprehensive mastery of all the excel functions, so anyone should be able to use excel to at least budget.  I usually use three columns to list each item: Date, Merchant, Amount.  In the fourth column, I label the overall budget I have for all my expenditures and (for this example let's say I have a budget for $4000) type in the box below "=4000 - SUM(C:C)" which is set to automatically calculate how much budget I have left after subtracting the total of all the numbers put in the amounts column from $4000.  Obviously you can change the number from $4000 to anything you want, and I've included a screenshot below in case anything I said wasn't clear.

As you budget, you can just look at the number below Budget in the D column to see how much is left.  You can create different spreadsheets for different budgets, but I may update later with some more sophisticated formulas you can take advantage of.  The downsides to using Excel over a powerful tool like Mint is that it can be painfully tedious if you aren't that interested in budgeting in the first place.  You would have to remember to budget and write down the amounts that you spent somewhere so that you don't forget them by the time you get home to your computer.  However, there is no threat of someone getting access to all your bank account and credit card information.  Also excel is fully customizable so that you can manually add in categories for your spending and use it to display handy graphs to give you a visual representation of the data.  I may try to go over some of this excel functionality in a future post.

I'll leave it at that for now.  Overall, you can choose between some more sophisticated programs or budget manually.  There is some trade-off between security and convenience (you could also make your own sophisticated program but that would take a lot of technical skill).   Also, the SpendingLite app I mentioned earlier may be the easiest thing for people with an iTunes handheld.  I may revisit this topic later if there is a lot of interest in it, but hopefully you feel like you will be able to do the basics of budgeting and add that to your personal finance toolbox.

Budgeting App: SpendingLite

I thought I'd quickly share a very handy budgeting tool I personally use.  The downside is that it is an iTunes app so if you don't have an Apple handheld (such as an iPod Touch or iPhone), you won't be able to access it but I'm sure there must be similar apps for other smart phones.  Anyway, the app is called SpendingLite and it is completely free.  There is a paid version that gives some minor functionality improvements (such as saving data and adding different types of income) but the free version provides the majority of the value of the program.  It is extremely simple to use.  You have a big income button and expense button when you want to record.

You can also select the category of your expenditure and view your expenses in a nice bar graph or pie chart for the day, week, month, year, or any period of time you choose. money you receive or spend.  

Hopefully these screen shots are helpful.  Again, the main reason you would want to budget is just to get an idea about where your money is going and how your expenses look relative to your income.  If you find that you are spending more than you earn every week, there may be some reason to look into it.  I'll talk a little more about some other tools that can help your budgeting next time.

How To Budget

I've now talked about why you should budget, so now let's talk specifically about how to budget before going on to budgeting tools.  I found a really good article at this other blog called Get Rich Slowly, which you can take a look at, and I like their breakdown of necessities and discretionary items which I will mention again.  And although it is insightful to further break down these categories, generalizing them into three overarching sections can help simplify your budget and make it more easy to read.  It references the Balanced Money Formula which breaks down your after-tax income into three categories: 50% needs, 30% wants, and 20% savings.  I've copied the helpful picture below.

They define needs the same way I do necessities: your rent, food, health care, transportation, insurance, clothing.  Wants are cable TV, cell phones, books and magazines, vacations, and food and clothing beyond the basics.  Again, they also recommend that this is a guideline instead of a bible.  For example, I would probably move the phone bill to necessities in my budget.  

Also, the 50-30-20 budget breakdown can be adjusted to your desires.  For me, savings would probably take up more than 20% simply because I don't have many wants besides my needs.  Right now, about half my income is spent on necessities, albeit I do go out and eat at a nice restaurant once in a while, and the other half I usually just save.  I try to take advantage of free internet and free food events (which I will probably have a post about later as well) so my formula is pretty different.

The main takeaway is to shift the weights to match your goals.  Your basic rent and insurance premiums probably do not change month to month, so after a while you should be able to see what percentage it is of your income.  Find out if your needs takes up 30% or 50% or 70% of your income and learn what excess income you have to allocate to wants and savings.  If you plan on making a large purchase in the near future (a house or a car), you may want to have savings take up the majority of what's left of your after-tax income after your needs.  If you don't plan on purchasing anything big for a while, perhaps you can spend more on your wants and save a little less (but hopefully after reading about how much your savings can grow, you will be a little more enticed to save).

So, figure out your goals in terms of your plans for large purchases over the next few years.  As a college student, it may be a while before you start really thinking about buying a house and a car but it shouldn't be too far off.  Remember that budgeting is simply a guide to let you know how strong you are setting up your financial position for the future.  If you want to celebrate during Christmas and spend most of your income after your needs on high-end restaurants and a shopping spree, go for it as long as you are okay with it.  But you should always try to save at least a little of your paycheck for emergencies to have some margin of safety. With later posts, whatever money you do save should be able to grow significantly to help you out when you do need it and you should be able to feel secure with your finances.