The Best Money Advice You've Never Heard
Even with an economy that's in near-constant turmoil, most personal-finance experts seem to spout the same old, same old: Stuff as much as you can into your kids' college funds; refinance your mortgage to slash your monthly costs; max out your 401(k) contributions. Perfectly good strategies but sometimes (like now) doing the exact opposite can be the smarter move.1. Open More Credit Cards
Financial experts caution against this practice because each application you fill out lowers your credit scores. In actuality, this credit hit is very small and goes away after about six months, says Maxine Sweet, vice president of public education for Experian, a national credit-reporting agency. Over a longer term, opening cards can have a positive effect on your credit rating. Here's why: Your scores are partly based on the proportion you've already tapped of all your available credit. So with each new card you open, the ratio instantly improves. Let's say you have one card with a $10,000 limit and an $8,000 balance. Your "utilization" of credit amounts to an 80 percent slice of the whole pie. Opening four more cards with $10,000 limits would make your utilization of available credit a far rosier 16 percent ($8,000 out of a total $50,000 available), dramatically improving your scores. Of course, this benefit evaporates if you start running up debt on those cards. Either don't use them or, if you want to take advantage of the airline miles or cash-back deals many cards offer, make sure you pay off the full balance every month. For a healthy credit rating, keep your utilization under 30 percent, advises Sweet.2. Stop Avoiding Income Tax
To encourage retirement savings, Uncle Sam lets you fund your 401(k) and IRA accounts with pretax money -- though you'll have to pay income taxes on those savings when you withdraw them in retirement. "The rationale behind this has traditionally been that your income will be lower in retirement and hence your tax rate will also be lower," says financial planner Mary Quist-Newins, an expert in women's financial issues in Bryn Mawr, Pennsylvania. This is a dubious assumption on two counts. First, many people have no intention of retiring with far lower incomes than they currently enjoy. But more significantly -- thanks to snowballing national debt, among a host of other factors -- most experts concede that future tax rates are unlikely to be as low as today's (which are among the lowest in recent history). Indeed, many observers are predicting that taxes will skyrocket in the coming decades. So you could actually wind up paying more taxes on your savings after retirement -- even if your income is lower. To protect against that risk, invest some of your retirement savings in a Roth account, which you fund with after-tax dollars that can be withdrawn tax-free. Unless you're in a high-income tax bracket (currently, more than $183,000 in adjusted gross income for a married couple), you and your spouse can contribute up to $5,000 annually to a Roth IRA ($6,000 if you're over 50). Additionally, about a third of American companies offer their employees Roth 401(k)s, which are not subject to these income limitations. Important reminder: If your employer offers a company match with its 401(k) plan (whether it includes the Roth option or not), never fail to contribute enough to earn that match. This is free money, after all -- and until the day income is taxed at 100 percent, that fact will always outweigh any tax liability down the road.3. Skip the College Fund
Okay, if you're a hedge-fund manager, you'll want to take advantage of the tax benefits of 529 college savings plans to help pay for those pricey private schools your kids have their hearts set on. But if you're a hardworking member of the ever-dwindling middle class, you have more important financial fish to fry, says Tahira K. Hira, PhD, a professor at Iowa State University who formerly chaired the New York Stock Exchange's Financial Literacy Advisory Committee. After you've accumulated a reserve to have on hand in an emergency (one piece of advice from the standard canon that's as solid as ever, though the usual recommendation of six to 12 months' living expenses is a stretch for most of us), Hira suggests putting anything left over into retirement savings, not college funds. Given the disappearance of company pensions and the precarious state of the Social Security system, your own nest egg may well be the bulk of what you have to live on after you leave the workforce. "You cannot borrow money for retirement, particularly now that leading banks have stopped offering reverse mortgages where you draw monthly income off your equity in your home," says Hira. "But you can borrow for college, whether it's your kids taking student loans or you tapping your home equity." In addition, she notes, kids can work part-time or apply for scholarships to help defray college costs. Indeed, if anything, the lack of a large college fund may enhance their chances of being awarded need-based financial aid. In short, most couples should focus on their own financial futures and explore alternatives to financing their children's education.4. Don't Refinance to Lower Monthly Mortgage Payments
With interest rates still near historic lows, you can refinance your home to a sub-5 percent loan and slash your monthly payment. But doing so could actually cost you big bucks over the long haul. Let's say you're eight years into a 30-year $200,000 loan at 6 percent. Refinancing to a new 30-year 5 percent loan will save you around $250 per month pre-tax -- but you'll be starting the clock at zero again, meaning it will be eight additional years before your mortgage is paid off. That triggers an increase of $23,000 in interest over the lifetime of the mortgage. None of this is to say that you shouldn't refinance. Just forgo the monthly savings for long-term savings. Taking a shorter term -- 15 years instead of 30, say -- will get your mortgage paid off sooner (saving you a lot of interest overall). This is a great option if it's feasible, but for many homeowners it makes the monthly payment unaffordably high. "My advice is to go for a new 30-year term, but keep paying the old monthly amount," says Eleanor Blayney, the consumer advocate for the CFP Board of Standards, a certifying agency for financial planners. "You won't have the extra spending money each month, but you'll pay off your principal sooner." How much will this strategy save you over the long term? In our example, that extra $250 per month "prepayment" of principal would reduce the length of the new loan by 11 years and slash your total interest costs by a whopping $55,000.5. Don't Just Ask Your Agent for Insurance Advice
Sure, he's a nice guy, but your insurance agent has one primary goal: to sell insurance. And since he's almost always paid on commission, he has a powerful incentive to sell you more of it, not less. If you rely on him to tell you what coverage you need, you're probably overinsuring yourself, says Susan Voss, past president of the National Association of Insurance Commissioners. Here are some of the classic traps Voss urges consumers to be on the lookout for: selecting a too-low deductible on your car and homeowners insurance (go for a minimum of $1,000 and $2,500, respectively); insuring jewelry based on an often-inflated appraisal instead of your purchase price; paying for collision and comprehensive insurance on a car that's more than five years old; locking in life insurance beyond the point at which you'll have dependents. Where should you go for insurance advice? Start with your state's insurance commission website (find it at naic.org) and the Insurance Information Institute (iii.org). Or call a few other insurers and ask them for an analysis of your needs. Competition usually results in more favorable terms for the consumer, notes Voss. The proposals are free, and even if you opt to stay with your current insurer you can apply what you learn to your existing policies.6. Quit Obsessing About Getting a Raise
Over the past few years, pay increases have been few and far between for American workers. Not that we'd ever suggest you turn down a bump in salary. But in truth most raises are fairly puny and you can do more for your bottom line by cutting your expenses a little each month. "A penny saved is actually worth a lot more than a penny earned," Blayney points out. "You have to pay taxes on what you earn, but every last cent of what you save goes directly into your pocket." For the average household, federal, state and local taxes claim about 25 percent of earnings. Money saved through belt-tightening? You keep 100 percent of that. And cutting back isn't as hard as you might think. You can pocket more than $3,000 a year, for example, by brown bagging your lunch, skipping the cocktails when eating out, and mowing your own lawn. That tax-free money is equivalent to roughly a 10 percent raise on an income of $40,000. Now ask yourself: When was the last time you got a 10 percent raise?7. Shell Out More for Your Car
It sounds counterintuitive, but going for lower car payments can cost you a lot of money. This is a mistake many drivers make, by focusing on their monthly outlay instead of a car's total cost, says Bonnie L. Doolin, chief operating officer of the New England Credit Union Services. Taking a five-year $15,000 loan at 4 percent interest, for example, might work out to $276 per month, which sounds much more appealing than $436 per month for a three-year, 3 percent loan. But over the course of the loan, the higher monthly payment would actually save you nearly $1,000. And if you're buying a luxury vehicle, the savings from choosing the shorter term could easily be double or triple that amount. Similarly, leasing a car can inflate your bottom line, even though it lowers your monthly cost, because (1) you will always have to make payments and will never own the car outright as you eventually would if you were purchasing it via a conventional loan; (2) you're subject to all sorts of junk fees and wear-and-tear costs, especially if you decide not to lease another vehicle from the same dealer; and (3) you're likely to exceed the often-modest mileage limits, adding high per-mile fees to your leasing costs. "If you can't afford to buy the car with a three- or four-year loan," Doolin says flatly, "that car is too expensive for you."
Originally published in Ladies' Home Journal, June 2012.