In this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are joined by Foolish analyst Nathan Hamilton, who shares the story of his personal journey to maximize his credit score -- now impressively over 800. Find out why a better FICO score matters and how you can use the rules and formulas by which the credit rating agencies calculate your score to your advantage.
A full transcript follows the video.
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This episode was recorded on April 11, 2017
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert here at the Motley Fool. In this week's episode we're joined by a Fool who is going to share the path he took to achieving an impressive 814 credit score. We're also going to answer your question about how much to invest in each sector and play a rousing game of "Can I Throw It Away Already?" All that and more on this week's episode of Motley Fool Answers.
It's time for Answers, Answers and today's question comes from Christian on Twitter. His handle is @ChristianMPT. He writes, "Any suggestions or resources for what percentages to invest into each industry sector? I feel overweighted in tech."
Robert Brokamp: Well, Christian, let me start by parsing out the terms. Actually, sector and industry are different. Sector is sort of the big umbrella term, and most people consider the sectors that have been identified by the Global Industry Classification Standard. It's a joint project of Morgan Stanley and S&P, and there are 11 sectors.
Underneath those sectors is where you get industries and sub-industries. There's actually 24 industry groups and 157 sub-industries.
Southwick: Wow! OK.
Brokamp: So I'm going to assume you're talking sectors -- the big 11. You're not unique in probably being overweighted in tech. First of all, if you're a Motley Fool reader or listener, you probably already have a lot of tech because we like tech stuff. But it's also the sector that has the biggest weighting in the S&P 500 -- 22% of the S&P 500 is in tech.
However, just because you have many stocks in the same sector doesn't necessarily mean you're overly concentrated, and I'm going to cite an excellent article that came from a guy named Adam McCullough from Morningstar. He looked at the top 10 holdings in the major sector ETFs and found that some are more concentrated than others in terms of their correlation.
When you look at, for example, the real estate sector ETF, all top 10 holdings are correlated, because they're all sensitive to interest rates. If interest rates go up or down, they all move. However, when you look at something like consumer discretionary, even though all these stocks might be considered consumer stocks, they're very different. For example, the No. 1 holding in consumer discretionary is Amazon.
Brokamp: Then Home Depot. Then Comcast. Then Walt Disney.
Southwick: Because Amazon ... well, that could also be a tech stock.
Brokamp: Exactly. So just because you have a lot in tech doesn't necessarily mean that you're overly concentrated. You have to look at the individual companies and see if they're in similar businesses. Do they often perform similarly?
But if you're looking for a general rule of thumb, I would say that once you get up to about 30% in one sector, you might be pushing it. You might want to cut back a little bit. And I say that particularly with 2008 in mind, which was the worst year for the stock market since the Great Depression.
A lot of people were very focused in financial stocks, particularly people who were retired, because they were looking for the dividends that came from those stocks. But that was the industry that got hit the hardest. So probably once you hit 30%, it's time to start thinking about maybe diversifying a little bit more.
Southwick: I believe it was Aristotle who once said, "Show me the credit score and I will show you the man." Or maybe no one said that, but someone could have. Your credit score is a number between 300 and 850, and it's based on your history of debt, managing your credit and paying bills. It's a very important number, and Nathan Hamilton, an analyst here at the Motley Fool, joins us today to talk about how he was able to achieve a credit score of, da da da duh, 814.
Nathan Hamilton: 814.
Southwick: I think you can do better, though.
Hamilton: I could. I could get up to 850.
Brokamp: That's true.
Southwick: Yeah, you could. So thank you for joining us, Nathan ...
Hamilton: Absolutely. Glad to be here.
Southwick: ... and sharing your story. So first off, talk to us a little bit about why a credit score matters so much.
Hamilton: I guess, simply put, it's the most important number in our financial lives that most of us don't know about. Not being grandiose, there, but research shows that 60% of Americans don't know their credit score. That's the majority of people out there.
Southwick: So out of the three of us, do you know your credit score?
Brokamp: I do.
Southwick: I don't.
Brokamp: I mean, I don't know the exact number, but it's in your neighborhood.
Southwick: I'm sure I'm in your neighborhood, too.
Brokamp: I would be surprised if you're not.
Hamilton: Well, after this episode let's go check it ...
Southwick: Go check it. All right, let's.
Hamilton: ... and you can take a look. [Why is it important?] Say with a mortgage. A poor credit score versus an excellent credit score has a 1.5 percentage point difference. That sounds like a small number, but if you look at 30 years with a 30-year mortgage, that's tens, maybe hundreds of thousands of dollars that you could save just by having a better credit score, budgeting well, and saving.
Brokamp: There are all kinds of people who have some sort of influence on your financial life that will be looking at it. Insurers. Potential employers can be looking at your credit record. There are studies that show that people with lower credit scores do get into more car accidents, for example. If I had to know just one thing about someone, and make a prediction about what their financial life is going to look like, I'd choose their credit score because it shows whether they're a person responsible with money.
Southwick: Now you, however, maybe didn't get off with the best start with money.
Hamilton: I did not.
Southwick: But before we get to how you got to 814, tell us about where you started.
Hamilton: I guess my story is probably similar to a lot of people. I got my first credit card. I wasn't too informed.
Southwick: Did you get it in college because of the free t-shirt?
Hamilton: It may have been.
Southwick: A frisbee or something like that.
Hamilton: I think I wanted to buy a new computer and get something that I wanted but didn't need, essentially. So after opening my first credit card, it was pretty much a few months before I was incurring interest charges. Had racked up debt -- I think several thousand dollars within that time frame and just pretty much went on a spending spree.
Hamilton: Yeah. It was very nice, but I don't remember what I bought or anything.
Hamilton: But I do remember the feeling I had of being in debt at that point. And I made a decision to never take on credit card debt again, just because of the high interest charges. To never pay those interest charges.
So to get out of debt, what I did is essentially opened up a balance transfer credit card. For people that may not be familiar with it, it's just essentially taking your balance from one card and moving it to another card where there's a 0% introductory APR for a certain number of months (12, 15, 18, 21 months). I did that twice. So I opened one card, didn't incur interest. Kept on paying the balances down on time. I wasn't able to pay it off during the promo period. Opened another balance transfer card. Closed down the old one and kept on doing that until the debt balances were paid down.
Southwick: The idea of opening up new credit ... we've been doing this show long enough for me to know that it's actually not bad, but it sounds bad. Like to be saying you opened up a credit card to pay off another credit card sounds like a bad idea, but it's not.
Hamilton: But it's not. No, because if you look at my credit [history], [I think] I've held, over my entire life as a borrower, 19 credit cards.
Hamilton: And some of them I will sign up for bonuses and I'll use the card infrequently. Some are just ones that I use as my standby go-to. I normally carry just one to two cards in my wallet to keep it simple. But over time I have used credit cards for various different purposes.
And there will be a slight ding [in your credit score] when you apply for new credit -- five to 10 points depending upon the scenario. But if you look over the long term, if you're opening another account, and establishing a payment history of paying on time, and you're managing your debt well, that's more data that credit score models can use to assess your risk as a borrower.
Southwick: And talk a little bit about credit utilization and how that impacts your FICO score.
Hamilton: So as part of paying down the balance transfers, credit utilization is looking at how much debt you borrow versus what you have available on your revolving credit limit. And with your FICO score, you want to bring that number down. By paying off debt quicker, you're impacting 30% of your FICO score by doing so.
So that's one thing. When you look at the balance transfer cards, why does it make sense to do that? You're establishing a payment history, which counts for 35% of your score. You're bringing down your credit utilization ratio, which impacts 30% of your score. Those are the two single biggest factors driving your FICO score and where many people should focus for improving it.
Southwick: So should I also call up my credit card [company] and try to always max out my credit limit, or does that backfire?
Hamilton: In certain scenarios.
Southwick: Oh, OK.
Hamilton: So if you're prone to spending that credit limit increase, absolutely don't do it.
Southwick: I'm not. I'm not prone. I'm not prone to spending too much.
Hamilton: But if you manage your finances well and you want to improve your credit utilization ratio, absolutely. Dial up your credit card company. Go online. It's simple to request a credit card limit increase, and I don't see any reason to not do so if you're good at managing your finances and not taking on that additional debt.
Brokamp: One thing you mentioned is that the most important thing is just paying your bills on time.
Hamilton: It is. It's simple.
Brokamp: And how have you managed to do that to make sure? You have an actual system that you follow.
Hamilton: Yes, and I've started this one in the last year or two. If you look at credit cards, they're super convenient. It's easy to get into debt. They say on average that people spend about 18% more with a credit card versus, say, a debit card. So in my brain I had to say, "How do I budget better?"
What I've done is I've broken down my budget into 10-day increments, so the 10th of the month, the 20th of the month, and the end of the month, and I've set up an allotted amount that I spend within that time frame. I pay the balance off. Go to the next 10 days. Pay the balance off and set alerts on your account. When your balance goes above a certain threshold, you're notified and it says, "Okay. You're not meeting your budgeting goals."
Southwick: So you have some recommendations that you want to leave our listeners with if they want to improve their credit score. What's the first piece of advice you have?
Hamilton: The first one is if you are in debt (just like I was when I was 21 and spending whatever amount of money on whatever purchases I still can't recall), just pay down that debt quick, because bringing down your utilization ratio, like I said, is going to impact 30% of your score.
The second thing you can do is never miss a payment, and that comes down to budgeting and spending within your means.
Southwick: And then as far as specific credit cards, what do you suggest?
Hamilton: In the case where you do have debt, balance transfer credit cards are going to make sense. And there's so many on the market. If you look at it, there's over 1,700 credit cards in the U.S.
Hamilton: And for people looking for balance transfer cards, they definitely need to narrow down the options out there. If you go to fool.com/creditcards, we do have our picks of the best balance transfer credit cards. If you don't have debt, maybe it makes sense to look at earning rewards, because you're paying your balance off monthly. You're not incurring interest charges. You might as well earn, say, 1.5% to 2% cash back or travel rewards for those everyday necessity type purchases.
Southwick: So in addition to, obviously, paying your bills on time and credit utilization, what else should people keep an eye on when it comes to keeping a credit score looking high and awesome?
Hamilton: Getting above 800.
Southwick: Yeah, getting above 800.
Hamilton: As we mentioned before, credit inquiries are going to have an impact, but they do roll off after 12 months, so they roll off of your FICO score. They are reported on your credit report ...
Southwick: That's just if you open up new credit? Or if you get a mortgage?
Hamilton: Yes, open a new account. If you apply for a mortgage. There are certain instances, like applying for a new cellphone or ...
Hamilton: Yes, rent. Anything like that where there is a hard inquiry you want to keep track of, but as I mentioned, they roll off after 12 months.
Hamilton: The other part of it is having a good mix of credit accounts. So be it a student loan, be it a mortgage or credit cards (whatever type of money you can borrow), the FICO-scoring models will take a look [at whether you] have a good mix of accounts, assess it, and say, "Okay, you're a good borrower. We're going to give you a higher score."
Southwick: Is there anything wrong with opening all these said credit card accounts and then just leaving them dormant and just snipping them?
Hamilton: If you're incurring an annual fee for not using the card, it makes sense to close it down. But if they are no-annual-fee credit cards, there's no harm in keeping them open. What it does is it establishes your average account age. To get the best score out there, you really want to have an average account age of five years. And keeping your cards open in those scenarios will definitely make sense.
Southwick: Another thing we often tell people is if they want to improve their credit score, to check in on their credit reports and make sure there's nothing inaccurate. Do you want to talk about that a little bit?
Hamilton: If you go to what I believe is FreeCreditReport.com or My Annual Free Credit Report ... you can look on Google and there are websites where you can get your free credit report. Now the important thing to remember is that's your credit report. It's not your actual credit score.
Southwick: Right. It's what your score is based on. So that information in your credit report is what FICO crunches. It's the data FICO crunches to give you your credit score.
Brokamp: It's actually AnnualCreditReport.com. More and more services, I found, are actually offering your credit score for free.
Southwick: Oh yeah, Credit Karma.
Brokamp: And Bankrate. That said, some of those are not the actual FICO. It's basically their educated guess ...
Hamilton: Their guess ...
Brokamp: At what your credit score actually is.
Hamilton: Yeah. It's directionally right when you look at those free credit scores -- all of those offers you see out there -- but it's not a FICO score. But you can get a free FICO score, and what I recommend is some credit cards offer it. Some banks offer it. And there may be a good chance that if you are with some of the major banks out there, check with them. You already have access to a free FICO score through your existing relationships.
Southwick: Cool. Well, Nathan, thank you for joining us today ...
Southwick: And if you, our listeners, want to learn more about raising your credit score, or to see what credit cards the Motley Fool believes are the best for people with excellent credit (because you listen to the show, so I'm sure you have) ...
Brokamp: You've got it all going ...
Southwick: ... head to fool.com/creditcards to learn more.
Southwick: It's that beautiful week in Washington, DC between winter and summer. You might know it as spring. We know it as the brief period where you have neither the AC nor the heat running. It's literally like seven days.
Brokamp: That's about it.
Southwick: So we're all embracing spring. Throwing open the windows and hopefully tossing things out. Maybe not necessarily out the window but whatever. So Bro and I are going to play a rousing game of "Can I Throw It Away Already?" to help you with your spring cleaning. The first one -- old tax returns.
Brokamp: Here's the guidance from the IRS, and I think it's actually quite funny. First of all, keep stuff for three years unless situations four, five, or six apply to you. What's situation four? Keep them for six years if you underreported your income, and it's more than 25% of what you should have. Keep it forever if you've committed fraud.
Southwick: Is that right?
Brokamp: So if you've committed fraud, just keep those records around. Generally speaking, I would say three years is what the IRS tells you, because that's the amount of years they have to audit you. But I think seven years is a better guideline just as a good rule of thumb.
Southwick: Bills, bills, bills, bills. I've got my phone bill. I've got all these bills, such as stubs.
Brokamp: I would say the average utility type of bill, keep it for a year, and that's about as long as you need it.
Southwick: Photos of me that aren't flattering. This is going to be from the '90s.
Brokamp: These don't exist.
Southwick: That's very sweet. They do exist. For now, anyway. All right. Receipts from household purchase items. Are you talking about blenders?
Brokamp: No, I'm talking about ...
Brokamp: Anything that if your house were to burn down, you would want proof that you owned it. So big appliances. Refrigerators. Oh, also anything that would be under warranty. That said, if your house burns down, you're going to lose some of those receipts, so some of the important stuff ...
Southwick: Yeah, that's going to go.
Brokamp: I actually recommend you take pictures of all that stuff so you have digital copies, and the really important stuff keep in some kind of fireproof safe, which is what we have at our house.
Southwick: Pay stubs?
Brokamp: Pay stubs generally for a year. That last pay stub is the most important, because that tells you everything you need to know in terms of what you've been paid. How much in taxes you paid, but also how much you contributed to retirement accounts. You may remember in a previous episode a fellow was contributing to both his traditional 401(k) and his Roth 401(k), but this 401(k) provider didn't separate the two contributions. We suggested he go back to his pay stubs. So if you're doing anything funky with your retirement accounts -- actually anything related to retirement accounts -- it's actually better to keep some information, at least on an annual basis forever.
Southwick: Your childhood diary?
Brokamp: If you hadn't gone through puberty yet, it's adorable. If you've gone through puberty, it's embarrassing.
Southwick: It's so bad! It's the worst!
Brokamp: My 25-year-old daughter has posted some stuff she wrote when she was like 12 on Facebook, and it's really cute. But I could just imagine. I found my diary, once, [from] high school, and it was just embarrassing.
Southwick: It's just all feelings, right? Isn't it?
Brokamp: It's all feelings.
Rick Engdahl: Just don't keep one. Don't ever keep one. It's not worth it.
Brokamp: It's like if my kids ever found it, oh!
Southwick: Yeah. I found mine the other day, and I was like, "Oh, I'll just pull a random date and read it." I literally wanted to go back in time and punch myself in the face. It was so bad! It was just bad!
Engdahl: I think we have a new fun segment on our hands.
Brokamp: Girls, just bring your diaries in. Today's entry -- Duran Duran has a new song out.
Southwick: He's dreamy. All right. The pile of paperwork you signed when you bought your house.
Brokamp: You want to keep it for as long as you own the house, because it will have information about what you paid and stuff like that. That will be information you need when you sell it to calculate any kind of gain. If you owe any taxes on it. Generally most people don't, but you want to keep that around.
Once you've moved from the house into another house, keep that information for about seven years and then get rid of it.
Southwick: Account statements, like the ones from my broker and 401(k) and all that stuff.
Brokamp: Anything that establishes the cost basis of anything you've bought, that you eventually will sell and have to report on your tax return, keep it. If it's your IRAs, generally speaking you don't have to worry about it unless you're making non-deductible contributions to a traditional IRA. Keep that information. But anything for a taxable brokerage account, keep that information because at some point you're going to sell those investments, and you're going to need some way to calculate your cost basis.
Southwick: Receipts for home improvements.
Brokamp: Keep those, because those also will factor into the cost basis of the house when you eventually sell it.
Southwick: You actually would consider that? Like you would look at that and think about it?
Brokamp: Yeah, because for most people you have a home sale exclusion of $250,000 per person and $500,000 per couple. That means you can gain that much on your house and not worry about taxes. But who knows about future tax law, and living in Washington, D.C., if you've owned your house for a long time, it's possible. So all that stuff would be factored into the cost basis of calculating your gain.
It's also for any appraisal, so if you're going to get a home equity loan or a reverse mortgage (anything where they're going to appraise your house), you want to say, "Actually my house is worth this much more than you think it is, because we improved the kitchen, or we did this or that."
Southwick: So home improvements over what amount of money? Thousands? A couple of thousands?
Brokamp: For me, we just have this big file of everything we've done to the house. So it pretty much just gets thrown in there. But if you've painted the mailbox, it's probably not necessary.
Southwick: Well, casa Southwick is going to get a whole lot cleaner, here. Thank you very much. I'm going to go throw some stuff away, and maybe even my diary.
Engdahl: I have a question.
Engdahl: Is there any reason any of this cannot be electronically stored instead of paper stored? Can I just take a picture of everything?
Engdahl: Or does some of it have to be, for legal reasons, actually in paper?
Brokamp: Not that I know of. Even with the IRS, now, they are strongly encouraging people to do everything digitally so I think it's possible. As long as you have two places to store that information. So you have it in a computer and then maybe a backup drive.
Engdahl: Even tax returns? Stuff like that?
Brokamp: I think it's fine. I mean, I've been filing my taxes electronically now, for years. I have printed them out just because I'm that type of guy, but the IRS ...
Brokamp: ... does not say anything about making sure you have a print copy.
Engdahl: I've always printed them out because I thought I was supposed to be that kind of guy. But I'm not, and I'd be happy to not print them out, if that's legal.
Southwick: We're giving you permission to not be that guy.
Southwick: All right, that's the show. Our email is [email protected] You can connect with us via Twitter. We're @AnswersPodcast. Also if you're on Facebook, come join our private Facebook group. It's a friendly space where you can chat with Motley Fool analysts and hosts about stocks, money, etc.
Thanks to Bill who sent the promised postcard from the promised land of Jordan. It finally arrived! Yay! Also thanks to Robert Brokamp who bought me 10 boxes of Little Debbie Oatmeal Creme Pies.
Brokamp: You're worth every one of them.
Southwick: The show is edited spring-cleanily by Rick Engdahl. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.