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Personal Finance

Fundamentals of budgeting for beginners

December 8, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Budgeting is a simple concept, yet many people fail to follow.

What best describes your household budget:

  1. A series of mason jars with money stashed for different expenses?
  2. You simply spend until you start getting overdraft notices when you try to use your debit card?
  3. A theoretical concept with few details that you expect will get easier when you win the lottery?
  4. A carefully-planned, electronically-monitored program that helps you meet your current and future needs?

If number 4 is your answer, then good for you - you are probably in the minority of people with disciplined, well-executed budgets. It's a shame so few fit into that category because efficient budgeting can not only help you use your money better, but it can help grow your wealth and your savings account. A better financial standing can ultimately save you on credit card interest and other borrowing costs, and help you invest your savings more effectively.

The following is a comprehensive overview of budgeting basics to get you on the path toward meeting your financial goals.

Match income and expenses

Budgeting is a way of planning for the flow of money in and out of your bank accounts - usually a checking account, since that is the best suited to regular transactions.

Think of it as an old balance scale. On one side, you have your income and any other money you expect to receive. On the other side, you have expenses and any other money you expect to pay out of your account. The primary objective is to make sure the expense side does not outweigh the income side.

That might be fairly simple if it were a one-time, static comparison, but of course income and expenses are occurring in all the time. That's why another fundamental component of budgeting is planning not just how much you will receive and spend, but when these transactions will occur. Getting the timing to line up is crucial.

Look at recent transactions

If you are starting from square one, the best way to do this may be to look at your check register for the past few months. You can see what amounts flowed in and out, and at what intervals those flows occurred. Now try to project that same pattern forward for the next few months. Once you do that, you will have the beginnings of a budget.

How to deal with expenses that happen irregularly

What makes this a little more difficult is that income and expenses don't always come in regular increments. You might receive an annual bonus, or do project work with variable earnings. Certain expenses, like a dental bill, may only come up now and then. In addition, the cost of seasonal items might be considerably greater in the winter than in the summer, like a heating bill.

Think through these types of things, and try to anticipate them. This is one of the values of budgeting: It helps you see things coming even when they are not routine, month-after-month expenses.

Budget for future needs

The type of budgeting described so far helps you deal with expenses as they come up, but another benefit of budgeting is to anticipate future needs far in advance. For example, if you start setting a little aside for your next car each month, it will cut down on how much you need to borrow when your current vehicle finally needs replacing. Then, of course, there is the big one - creating room in your budget to save for retirement.

Budgeting makes future needs easier to meet because you can spread their cost out over a longer period of time, rather than having to scramble for the money when the need is imminent.

Don't expect to get this all right the first time. An essential part of budgeting is regular monitoring. This is so you can see where you went wrong and adjust accordingly. Budgeting is always a work in progress, rather than a one-time project.

Should you use budgeting spreadsheets and apps?

There are a variety of tools you can use to help automate your budgets. A simple Excel spreadsheet can work, but there are also several web-based programs and apps, many of them free. The advantage of these is usually a managed interface that will help guide you through the budgeting process. Also, being able to access and update tools on a smartphone or other mobile device can help you manage your spending in real time. Just be mindful of security because this also make a lot of sensitive material vulnerable to loss or theft.

You can use state of the art technology, or you an use an old paper ledger. However you do it, making a budget and sticking to it can help grow your money and shrink your financial anxiety.

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7 investment factors that distinguish investing vs. speculating

December 6, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Investing entails the acceptance of risk in the pursuit of a worthwhile return. Speculation involves the same thing, and that commonality often leads people to confuse investing and speculation. In fact though, they are very different things, and if you are to become a successful investor, it is important to be able to distinguish the two.

Investing vs. speculation

Here are some of the things that distinguish investing from speculation:

1. In-depth information

Successful investors thoroughly research their targets, whether they be companies, government bond issues, or commodities. They understand the supply and demand dynamics that will drive market growth, and they understand the competitive forces and cost factors that will determine the ability to profit from that growth.

Speculators, on the other hand, don't look in depth at the underlying vehicle, but simply put their money on a belief that it will go up or down.

2. A detailed outlook on the future

Understanding current conditions is good, but a further step entails being able to make some calculations about how those conditions will develop in the months and years ahead. This may take the form of things like a multi-year earnings projection for a stock, or quantifying the interest rate sensitivity of a bond.

You need to have thought through both what you expect to happen and how your investment will react if you are right. Without specifying how you will succeed, you are just speculating that things will work out in your favor.

3. Consider valuation

Taking into account valuation is a critical component of investing. It means comparing the price now with the likely future value of the investment based on its underlying fundamentals. This is critical, because markets often anticipate the future. If what you pay for an investment already reflects an assumption of its future success, there will be little upside for you even if things go in your favor.

On the other hand, speculators just hope that if things go well, the price will go up.

4. A flexible time frame

True investments can take some time to succeed - economic fundamentals usually evolve gradually, and sometimes it takes markets a while to recognize value. Having the flexibility to wait for all of this to play out increases your chance of success. In contrast, narrowing down the time frame in which it can happen takes you down the road towards guesswork.

5. An awareness of a differing perspective

Understanding how your view of an investment differs from the market consensus is very important, because if you don't see things differently, there is less potential for you to profit. This is why buying into highly-popular investments takes on an increasing element of speculation. You haven't really thought through why the investment should go up any further, you just like what everybody else likes.

Your differing perspective can involve any or all of the things discussed above: the information you have, your outlook on the future, valuation, or the time frame over which you are willing to hold onto the investment.

6. Recognition of the downside

Speculators tend to be focused primarily on the rewards of winning. But a true investor also understands the probability and downside potential of being wrong.

7. Extent of reliance on others

The "greater fool theory" means that you don't care if you overpay for an investment, because if it keeps going up a greater fool will come along and pay you more for it. Depending on the irrationality of others rather than on investment fundamentals is one of the hallmarks of speculation.

Investing vs. safekeeping

Though true investing should be less of a risky proposition than speculation, it is important to understand the distinction between investing and safekeeping. Investing involves being conscious of the risk of loss, and trying to manage it in proportion with the potential upside. Safekeeping involves eliminating the risk of loss, at the expense of any real upside.

For example, savings accounts and other insured deposits should be fully protected against loss, but they offer little in the way of upside - especially when interest rates are low. However, if safekeeping is what you want, it is important to recognize that as your priority and ensure that your money is placed accordingly. This means making sure you stay within FDIC insurance limits, and not mistaking truly safe vehicles for somewhat low-risk investments, like government bonds for example, which still carry some risk of loss.

The distinction between investing and safekeeping is in the trade-off between potential upside and potential loss. The distinction between investing and speculation is essentially the difference between making a reasoned business decision and placing a bet.

More from MoneyRates.com:

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10 Big Scams That Put Your Holidays In Jeopardy

November 23, 2016

By Sheena Leano | Money Rates Columnist

The holidays are the peak time for shopping and gift-giving and scammers are already on the prowl for their next victim. Consumers face nightmare scenarios like expecting a package that never comes or seeing fraudulent charges on their credit card, putting their celebrations and savings accounts in jeopardy. But consumers can fight back to prevent con artists from ruining the festivities and save the holidays.

1. Counterfeit products

10 Big Scams That Can Jeopardize Your Holidays - 1. Counterfeit Products

If you’ve seen a coveted gift like an iPad, makeup palette or purse for a rock-bottom discount online, beware as you’re probably not getting the real thing. Scammers often use inferior materials or shoddy electronics that could make these gifts unsafe for your intended recipients. For example, fake makeup or fragrances can contain toxic ingredients like arsenic or cadmium, according to the FBI.

How to avoid scammers: Buy directly from the manufacturer’s store or from authorized sellers of brand name products. If buying from a third-party, check ratings and reviews before your purchase to see if other people have been scammed.

2. Charity scams

10 Big Scams That Can Jeopardize Your Holidays - 2. Charity Scams

The holidays put shoppers in a giving spirit, but some scammers take advantage of this goodwill with fake charities. They may cold call unsuspecting people or approach them in front of stores or on busy streets. Instead of going to great causes, donations go straight into the tricksters’ wallets and you don’t receive any tax deductions as a result.

How to avoid scammers: Check out Charity Navigator’s list of fake charities before donating. Look up the name of the charity on Guide Star’s website detailing information on nonprofit organizations to determine if it’s legitimate and the funds are going to where they should.

3. Gift card fraud

10 Big Scams That Can Jeopardize Your Holidays - 3. Gift Card Fraud

The National Retail Federation estimates 56 percent of consumers will purchase gift cards this holiday season, but this popularity makes them very vulnerable to scammers. Thieves can steal physical gift cards from the store, write the card numbers down or use a magnetic strip reader and then place the cards back on the display. They can also scratch off the PIN code associated with the card. Once a customer purchases and activates the card, thieves can check the gift card balance online and transfer it to a different card or drain the account.

How to avoid scammers: Inspect the card for signs that the card has been tampered with, such as a scratched off PIN, before leaving the store area. Purchase gift cards that are secure behind a glass case instead of an open display where thieves can grab cards. Keep the receipt in case you or your gift recipient notice strange activity to increase your chance of a refund.

4. Data breaches

10 Big Scams That Can Jeopardize Your Holidays - 4. Data Breaches

Retailers are a big mark for cybercriminals, especially during the holidays, leading to data breaches. It’s hard to forget the data breach that hit Target in late-2013 that impacted millions of customers during the peak holiday shopping season. Breaches can expose financial data like debit and credit card numbers and personal information, such as names and home or email addresses.

How to avoid scammers: Use cash or a credit card instead of a debit card when shopping. Credit card companies typically provide fraud protection for consumers. In the event of an unauthorized purchase with a credit card, you are only liable for up $50, Federal Trade Commission states. If you used a debit card, you may be liable for all the money stolen from your account. 

5. Email phishing

10 Big Scams That Can Jeopardize Your Holidays - 5. Email Phishing

Phishing is not new, but con artists are always changing their approach to swindle victims and steal their identities. Emails can claim you’re the winner of a giveaway or you owe money to a debt collector or the government. These emails may appear like they’re from authentic people or organizations, but the websites they link to are designed to take your information or install malware.

How to avoid scammers: Whatever the phishing scam, do not respond to requests for money or your personal information and stop yourself from clicking on links or opening attachments. You can forward suspected scam emails to spam@uce.gov or file a complaint with the FTC if you believe you’re a victim. In addition, you can report these fake messages to the real organizations they’re impersonating.

6. Card skimming

10 Big Scams That Can Jeopardize Your Holidays - 6. Card Skimming

Card skimming is a simple yet financially devastating scam affecting ATM and debit cards. The New York Times reported 2015 had the highest number of ATM fraud incidents recorded by FICO Card Alert Service. Thieves will install a card skimmer inside ATMs to steal card numbers and a camera to take images of PIN codes. Increasing this threat, there is now new skimming technology that involves a probe that connects to the ATM’s internal circuit board to more easily steal card information.

How to avoid scammers: Use ATMs that are located inside banks, which make it harder for thieves to manipulate the machines. When entering your PIN, block the pad with your hand. Make it a habit to monitor your debit card and transaction activity to report losses immediately. You are liable for just $50 if you report ATM or debit card fraud within two business days of learning about the loss, the FTC notes. But if you report it after 60 calendar days, you can lose all money stolen from your ATM or debit account.

7. Fake social media giveaways

10 Big Scams That Can Jeopardize Your Holidays - 7. Fake social media giveaways

Giveaways hosted on social media sound too good to be true - and many times they are. Travel + Leisure recently warned readers about a fictitious giveaway on Facebook targeting Southwest Airlines. Scammers made a Facebook post designed to look like it came from Southwest Airlines and promised a free trip and gift card to the lucky recipient who shared, liked and commented on the post.

How to avoid scammers: Determine if a giveaway is posted by the actual brand and not a fake page. Facebook and Twitter both feature a blue checkmark next to brand names to verify their pages.

8. Ransomware/malware infections

10 Big Scams That Can Jeopardize Your Holidays - 8. Malware

A malware infection on your computer or phone can make it easy for hackers to take sensitive information or even take control of your device. Ransomware is a scary type of malware where cybercriminals can lock you out of your computer or threaten to release stolen information unless you pay a certain amount of money.

How to avoid scammers: Install security and firewall software on your device and only use secure browsers and websites.

9. Phony IRS phone calls

10 Big Scams That Can Jeopardize Your Holidays - 9. Phony IRS calls

The IRS regularly warns consumers of a scam where con artists pretend to be from the organization and call victims claiming they have a refund or that they owe money. The scammers may demand payment in the form of prepaid cards or wire transfer.

How to avoid scammers: Remember the IRS will not call, email or text you about personal tax problems. Legitimate communication from the IRS will usually take place via mail. If you received a fake phone call, report the incident to the Treasury Inspector General for Tax Administration.

10. Package thieves

10 Big Scams That Can Jeopardize Your Holidays - 10. Package thieves

The increase in online shopping during the holidays keeps mail carriers - and thieves - busy. The USPS alone anticipates delivering 750 million packages during the 2016 holiday season, up 12 percent from last year. Thieves follow carriers’ trucks to snatch up packages as soon as they are delivered or drive around neighborhoods looking for unattended packages.

How to avoid scammers: Schedule a delivery when you know you’re home or pick it up from a carrier location. You can also have the package sent at your office if that’s more convenient. If you have a security system, set it to record so you can catch the thieves.

Not all Grinches come in the color green. As this list shows, fraud and scammers come in many forms. Look out for these scams to have a safer and more enjoyable holiday.

More from MoneyRates.com:

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3 ways debt controls you (and how to take back control)

November 21, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Debt can seem overwhelming, but the key is to take control. Show your debt who's the boss by putting a plan in place to deal with it. The following are some examples of common debt problems and how to deal with them.

1. Too much credit card debt

There are many causes for this, but in many cases it just creeps up on people. A little bit of borrowing seems harmless, then an unexpected expense seems to justify a little more borrowing, and the next thing you know using credit just to make ends meet becomes a habit.

If your credit card debt keeps growing month after month, you have a problem. Don't wait until you reach your credit limits before you start to address that problem.

How to curb credit card debt

Establish a budget and use cash on shopping trips

The first thing you have to do is make rules about when you can and cannot use credit. Set up a budget, and leave your credit cards at home if you can't avoid using them compulsively.

Look into transferring balances to a low interest credit card

Next, prioritize your credit card debt, and try to shift the balances to the cards with the lowest interest rates. You might also consider transferring your balances to a card with a zero-interest promotional offer, but be wary of transfer fees that can undermine this money-saving move. Use a calculator to determine the amount of lower interest credit card savings you could benefit from before transferring over your balance.

Create a timetable for paying down balance

Finally, work out a timetable for paying down your debt. A big cause of financial mistakes is the feeling of not being in control of events. Setting out a timetable for repayment, however long it takes, is an important step towards seeing how you can take control of the situation.

2. Excess student loan debt

It used to be that credit card debt was the first major financial pitfall that young people fell into soon after leaving school, but now they often don't even make it that far before acquiring a serious debt problem. Student loan debt has mushroomed in recent years - the total amount outstanding has doubled in the past seven years.

Not surprisingly, a 2016 poll sponsored by the National Foundation for Credit Counseling (NFCC) found that almost 66 percent of adults said student loans impacted their finances in a negative way. Many of the NFCC survey participants (41 percent) did not feel confident in repaying a student loan worth $30,000.

Strategies to pay back student loans

Carefully consider taking on any more student loan debt

To get control, look to stop compounding the problem. A weak job market has driven many people back to college in recent years, but it can be an expensive refuge. Any degree you pursue should be researched as an investment, and based on an assessment of the job market, wage levels and what qualifications are necessary.

Take advantage of grace periods during loan repayment

The NFCC advises that to start coping with your debt, you should recognize the flexibility that is built into many student loan programs. These loans often have grace periods of six or nine months after graduation before you have to start repaying them. Use those grace periods to start saving up some money to make your monthly payments a little easier once they start.

Find a repayment plan that works for you

Also, while the standard repayment period for federal student loans is 10 years, you may qualify for a longer period or payments based on how much you earn. These alternatives can help payments fit into your budget, but be advised that they will result in you paying more interest over the life of the loan.

3. Overextended on a mortgage

This is a common problem because people have such high expectations for what they want from a house. Paying for your dream house may look manageable on paper, but unexpected expenses or other setbacks can quickly make a mess out of those plans.

Mortgage repayment tips

Consider mortgage refinancing

First, explore options for making your mortgage more manageable. This can include refinancing to lower your interest rate or restructuring the loan to spread payments out over a longer period. Talk to your current lender because they might be most receptive to finding a workable solution, but also shop around to see if better rates or terms are available elsewhere. Utilize a loan calculator to find out if you should refinance your home mortgage and compare your current and new mortgage rates.

Downsize to a less expensive home

The main thing about coping with this problem is to be decisive. Payments in the early years of a mortgage are mostly interest rather than principal. In essence, continuing to make payments on a mortgage you ultimately won't be able to afford is just throwing money away because you won't be building much equity. If you can't find a payment plan that works, sell out and find a cheaper home before you waste any more money.

The common denominator to all of the above is that the longer you take to confront these problems, the worse they will get. Solving these problems may take a long time, but the immediate need is getting a plan in place.

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How investors can identify stock market cycles

November 18, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Stock market cycles are something of an enigma - if investors generally know they exist, why don't they get out at the peaks, and buy back in when the market is down? The better you understand the dynamics of market cycles, the better you can take advantage of them rather than being victimized by them.

What makes up a stock market cycle?

Historically, U.S. stocks have averaged a return of about 10 percent a year, but they have not gotten there in a straight line, producing 10 percent year-in and year-out. Instead, there have been extreme market highs and lows cycling around that theoretical straight line. Often, the stock market will average better than 10 percent on its way to a peak, but then make up for that by experiencing a period of negative returns.

Of course, the market can go up and down a little from one day to the next. However, each of those fluctuations is not considered a market cycle.

How to define a bear market for stocks

It is better to look at a cycle as comprising both a meaningful rise and a meaningful fall - otherwise known as a bull and a bear market. Some people use a 10-percent loss to define a bear market, others 20 percent.

A useful way to consider whether the market has really gone through a cycle is if it suffers a fall from which it takes at least a year to recover. Knowing when to invest, such as through an online broker, is critical and being more knowledgeable of stock market cycles can help.

7 ways to identify a stock market cycle

Of course, if everyone knew a bear market was coming, they would get out of the market in advance and that bear market would occur earlier, or at least the bull market would lose some of its steam. Instead though, people tend to pile into markets just as they are nearing their peaks, and panic out of them only after prices have fallen.

Why do people find market cycles so hard to recognize? There are several factors that help disguise them:

1. Length varies

There is no standard length to a market cycle - they can be just a couple of years in duration, or can last over a decade.

2. Valuations differ

Valuations such as price-to-earnings (P/E) or price-to-sales (P/S) ratios help measure how cheap or expensive stocks are, but these valuations reach different extremes from one cycle to the next. For example, there is no set pattern that establishes a P/E of 30 as indicative of a peak, or a P/E of 10 as marking the market bottom.

3. There are cycles within cycles

Besides the stock market in aggregate going through peaks and valleys, there are smaller cycles affecting different types of stocks - value stocks may cycle in an out of favor relative to growth stocks, or smaller stocks relative to big ones. Individual industry sectors may also experience their own cycles.

4. Interest rate conditions are an x-factor

A key variable that helps make every cycle different is the interest rate environment. Low bank rates are good for stocks, so low or falling rates tend to support a bull market. On the other hand, high or rising rates tend to make stocks more vulnerable to a setback.

5. The relationship with the economic cycle is complicated

The market cycle should not be confused with the economic cycle. The market represents what investors are willing to pay for companies, while the economic cycle represents the underlying growth rate of the economy. Although market and economic cycles have an influence on each other, they do not always line up neatly.

6. The sidelines are lonely during a bull market

Getting out at a market peak is easier said than done psychologically. When it seems everyone is making big money in the market, people find it very hard to sell out and wait for the next bear market.

7. The bottom is a scary place

When the market crashes, the prevailing emotion swings from greed to fear. Stocks may be cheap, but people perceive that further disaster is just around the corner. Thus, few people are able to take advantage of market lows.

All of this should tell you that it is folly to try to time a market cycle perfectly. However, having an independent investment discipline that is not driven by the popular attitude towards the market can help you buy more when stocks are cheap, and sell more when stocks are expensive.

Remember, even though market cycles can be functions of fundamental economic conditions, their greatest extremes tend to be driven by psychology - either excessive fear or excessive greed. If you can avoid participating in those emotional extremes, you should be able to smooth out some of the rougher edges of market cycles.

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