Step 2: Mastering Your Personal Finances

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11 Rule Maker Steps

By Phil Weiss

When we mean to build,
We first survey the plot, then draw the model;
And when we see the figure of the house,
Then must we rate the cost of the erection.
-- Henry IV, Shakespeare

All right, you've read Step 1 -- The Rule Maker Philosophy -- and you're intrigued. Maybe you haven't been happy with your approach to money and investing. You now recognize how shocking it is that so few of us got any financial education in our schools. You may even accept that our nation's ignorance about money is fueling some misbehavior in the financial industry. Finally, you just might be saying to yourself: "Hey, this is as good a time as any for me to take charge of investing my savings."

Excellent. The place to start, though, isn't with stocks. Nor with bonds. And definitely not with commodities or options or gold coins -- all pitched at you in low-grade advertisements in the newspaper and on the radio. Nope, to tackle your financial circumstance with the panache of a Fool, you'll need to begin at the beginning... with your personal finances. After all, if you have a heavy load of credit-card debt or a demanding 15-year mortgage to manage or tuition payments due in the next twelve months, you shouldn't be investing in stocks. You have other fish to fry.

Truth to be told, though, we'll only talk in very general terms here about personal finances because the subject is already thoroughly covered in The Fool's School as well as in Step 2 of the 13 Steps to Foolish Investing. Some of it does bear repeating, though... so voila:

1. Develop a plan for regular savings.

Set aside and save a portion of each of your paychecks. For most Fools, this should be around 10 percent of your annual income. As your salary rises from $25,000 to $50,000, you should begin putting away more than 10 percent each year. To get there, you might have to cut down a bit on the $325 spent on new compact disks, the $250 on cheap beer, and the $650 on swank new clothing, but think of this as paying now for your future endeavors. The savings of your todays, compounded at 10-15% annually, will dramatically expand in the decades ahead. Did you know that $1 of savings per day invested in a stock-market index will grow into $575,000 in fifty years, if the market performs as it has this century? No worse, and no better, just average performance from stocks and a buck of savings a day.

You can save more than a dollar a day, can't you?

Now when you're saving this money, Fool, the best way to do it is through some type of direct deposit into a savings account. Keep it out of your checking account. Put the funds out of sight and outta mind. Oh, and, recognize that if you have a disproportionate amount of personal debt, then you should concentrate on paying that down now, rather than setting it aside as savings.

2. Erase all credit card debt.

Yep, just like we said. Get rid of that credit-card debt. The rate of interest paid on most credit cards is in the area of 18 percent -- and the unfortunate truth in America is that right now the average adult is carrying $5,800 in credit-card debt from one month to the next. Worse still, the interest on that debt isn't tax deductible -- whereas, for example, your mortgage payments are.

Given all that, we see no logical defense for investing in stocks when you have unpaid, high-rate debt. You would have to consistently earn something in the range of 20 to 24 percent per year in the stock market just to break even on the credit payments. Remember that you'd have to pay capital-gains taxes on any investment profits before transferring the money to pay down debt. Ya can't beat your credit-card debt with investments in stocks -- pure and simple. Pay the debt down, methodically and relentlessly. In fact, encourage your kids, your colleagues, your fellow Fools, encourage everyone but your mortal enemies to pay down their credit-card debt.

And here's one way to get started today: contact your credit-card company and attempt to restructure this debt, bringing the interest rate lower. You can often get your card provider to drop rates from, say, 18% to 12% in just five minutes of chatting them up. Threaten to take your business to another card provider, if they hesitate. And if this fails, go ahead and consolidate your debt at lower rates via some of those new card offers from other banks. Be aware that the bank often drives up rates from, say, 7% to 20% after six months, though. So, you'll really want to pay down your debt, if you have to flit from card to card.

That really is the point here -- use the card-switching alternatives only as justification for eliminating your debt load... not preserving or extending it. In your quest to pay down loans, order the debts from highest to lowest interest rate, and begin at the top of the list. Fool, remember:

The best investment out there has a guaranteed annual return of at least 15-20%, which is free from all local, state and federal taxes. It doesn't make sense to put a dime into the stock market until you've maxed out on this particular gold mine. The name of this greatest of all investment techniques is 'paying off your credit cards'.

3. Get the rest of your debts in order.

We know this stuff is getting boring, "Debt this... blah blah... debt that." You came here for investment ideas! And many of you have already cleared out your debt. Very Foolish. So particularly for those of you with $2,000 or $10,000 or $500,000 saved and waiting to find its way into cash-rich companies, we're going to race to the end of this, Step 2. There are only a few, but important, short lessons that remain before we get into stocks.


When setting up your savings plan, make sure that you are properly insured (not overinsured) with long-term disability coverage. Then ensure that you can meet all of your payment obligations on your home mortgage, your car, your student loans and/or tuition. Get ready for a controversial point!

When paying your mortgage, we think you should aim to exceed the minimum payment whenever possible. Our bias here is toward getting rid of your mortgage sooner rather than later, and we think the discipline of paying down the house quicker will have you looking to buy a little less house upfront. Real estate has not been the best investment of the 20th century; common stock has. We expect that to continue into the next century, and so we'd recommend buying a little less house than needed, paying it down quickly simultaneous to moving savings into the stock market.

Now, we do recognize the benefits of investing alongside tax-deductible mortgage bills. Once all deductions are included, many are paying less than 5-6% on their mortgage debt -- a rate that has historically been walloped by the stock market. So why are we recommending increasing the amount you pay of your mortgage? To protect you against the extreme downsides -- the loss of a job, the death of your family's main income provider, the ten-year collapse of the stock market. The more debt you have, the more vulnerable you are to the extremes. And, unfortunately, all of us will be visited by extreme negatives at some point in our lives.

To close, are we saying pay all of your mortgage down before investing in a 401k plan or directly into common stocks? No. But we are suggesting that you buy a little less than a mansion, that you abide a discipline of paying slightly more than the minimum on your mortgage payments, and that you only invest into stocks what you can afford to put away for more than five years.

Hey, these ideas are controversial, and as we said in Step 1 -- we don't think you should blindly follow what we're doing or proposing here. Ask questions on our message boards, ask others what they're doing with mortgage and other low-rated debts, and steer your ship on the course that makes most sense to you.

All right. That was simple. You're ready to save, or you've already been saving. On to stocks? Well, before we get to discussing the allocation of your savings into investments, we want to address what sort of money we think should be invested in the stock market -- and what shouldn't. Because the Rule Maker approach to the stock market demands making long-term investments in businesses -- not looking for a gimmicky, quick profit on trading - we hereby challenge you not to invest into stocks any money that you'll need in the next five years.

Do you need capital for a downpayment on a house in two years? Need some cash for your son's bar mitzvah next year? Need moola to cover an outstanding loan from your Great Uncle Bjorn? You shouldn't invest into the market any money that you've earmarked for oncoming bills. Just remember that while the stock market has grown at an average yearly rate of 11% this century, it has also been nearly cut in half a handful of times along the way. You don't want to be stuck having to sell a holding at the worst possible time just to cover bills!

Step 3: Allocating Your Savings Money »