I was having a lovely conversation with my co-worker yesterday when he started complaining about his credit card debt. I just about dropped my mouth to the floor. What!? Here is a smart and successful person treating credit card debt like it’s no more serious than a $5 latte. For the sake of workplace friendships I kept my mouth shut but figured I might as well share the speech I desperately wanted to give him with all of you.
Although this is a trading blog there are a few things I think you should take care of before you even think about investing in the market. If you would really like to get your personal finances in tip top shape it may be worth speaking with a financial adviser who can give you professional, more extensive guidance.
- Have enough cash in your account to cover all of your bills that are coming due. You should be able to cover your credit card, rent, electric, car, etc. with cash on-hand. And, you really should always have a little left over in the account once all the checks are paid, just in case.
- Contribute to a “rainy day” fund. Put away some cash in a high interest savings account (I use American Express personal savings) that can be accessed in case of emergency, job loss, etc.
- Contribute to a retirement fund. A 401K plan or Roth IRA will give you tax benefits, and most employers match at least a portion of the amount you put in. You might as well contribute as much as your employer will match, as that’s pretty much free money up for grabs.
Circling back to point #1. please, please, please, avoid credit card debt if you can. There are some cases where it might be necessary, i.e. a medical emergency, but it can almost always can be prevented. Thanks to insane interest rates (which could be over 20%), accruing interest on your credit cards means you’re flushing a ton of money down the toilet.
Not only are credit card interest rates high, they work as compound interest. This means that interest charges are added to the base amount, so your debt can grow exponentially. If you have a $100 debt and it accrues 10% interest every month, then the first month you will be charged ten dollars (100 x 0.10). With compound interest, that ten dollars is added to your original debt, so now you have $110 of debt. The second month you are again charged 10% interest, which this time comes out to eleven dollars (110 x 0.10), so now you have $121 of debt. For more details on credit card interest rates check out this Motley Fool article, Interest Rates 101.
The easiest way to avoid this debt is to not charge it in the first place. As my dad says, “never charge anything you don’t know you can pay for.” In this case, I am a big fan of budgeting. For example, when I moved into my own apartment for the first time in New York (talk about $$$$$) I set up an estimated budget for myself. Based on my salary, rent, and how much I wanted to save, I gave myself a certain amount of money to spend on eating out, groceries, clothes, etc. Then, I tracked my credit card bills (in a super cool Excel spreadsheet) for a few months to make sure I could stick to this budget. Once I was confident I was spending within my budgeted means, I stopped tracking. I’d rather spend any extra money on stocks or shoes, not interest expense.