It wasn’t that long ago — perhaps your mother’s or grandmother’s time — when women couldn’t get bank loans or credit cards, and employers could pay them less, explicitly for being women. While women have made considerable strides in attaining financial equity over the past 60 years, this history still plays a role in their current experiences and finances.
A January 2024 NerdWallet survey of more than 2,000 U.S. adults, conducted online by The Harris Poll, asked Americans about the gender financial divide and found remnants of that recent past.
“A lot has changed since the 1960s and 1970s, but these decades and what came before them still impact our financial lives,” says Kimberly Palmer, personal finance expert at NerdWallet. “Acknowledging how our financial experiences differ across gender, race and even age can help us understand what we can do in our personal lives and household budgets to improve our financial outlook as well as the role that governments, companies and institutions can play.”
Key findings
Men are seen as having an easier time finding well-paying jobs, but women are more optimistic about their current roles. More than 2 in 5 Americans (44%) say men have the easiest time finding a well-paying job, while just 11% think women do. However, employed women are more likely to feel optimistic about keeping their current job over the next 12 months, with 81% saying this versus 76% of employed men, according to the survey.
Men were more likely to receive a pay raise over the past year. More than 1 in 4 men (27%) say their salary or pay rate increased over the last year compared with 21% of women, according to the survey.
Both men and women are more likely to say the most financially successful person they know is a man. Just 16% of Americans say the most financially successful person they know is a woman, compared with 37% who say it’s a man, according to the survey. That includes 42% of men and 33% of women who say a man is the most successful person they know.
Women were cited as better money managers. Close to 3 in 10 Americans (28%) say women are better at managing money on a daily basis than men. Just 15% say men are better at it, according to the survey.
Financial Outlook
Overall, 72% of Americans say they’re optimistic that their financial situations will improve over the next 12 months — roughly equal shares of women (71%) and men (72%). But beneath the surface, there are some disparate perspectives. Here’s a look at several, along with advice for consumers on navigating personal finances.
Current job security and job-seeking
Women have become major players in the labor market over the past several decades. In 1953, about 34% of women participated in the labor force. That figure peaked at 60% in 1999, and had dropped to 57% in 2023, according to the Bureau of Labor Statistics.
But being more prominent in the workforce doesn’t mean getting the best jobs is easy. In the NerdWallet survey, more than 2 in 5 Americans (44%) say men have the easiest time finding a well-paying job (just 11% think women do).
The ability to maintain employment once you find it is key to financial security, and in this regard, women are feeling good. About 4 in 5 employed women (81%) are optimistic about continuing to work in their current job over the next 12 months, compared with 76% of employed men, according to the survey. That divide was larger among generations: just 59% of employed Generation Z (ages 18-27) expressed optimism about their current jobs, compared with 79% of employed millennials (ages 28-43), 84% of employed Generation X (ages 44-59) and 88% of employed baby boomers (ages 60-78).
Stay competitive in your field. Even the best employees aren’t guaranteed their job will be there forever. Keep your resume updated and look at open roles occasionally to stay abreast of what employers are seeking. Then, if the economy takes a turn and you lose your job, you can quickly pursue new opportunities.
Recent pay increases
The Equal Pay Act of 1963 barred employers from wage discrimination based on sex. While the gender pay gap has narrowed since that time, it hasn’t closed.
On average, women’s paychecks continue to fall short of those of their male counterparts. According to the BLS, women who are in the 25-34 age group earn about 90% of men of the same age, on a weekly basis. Looking at 35- to 44-year-olds, women earn even less (84%) than men. Lower earnings mean women generally have less of a buffer to rely on when times are tight.
More than 1 in 4 men (27%) say their salary or pay rate increased over the last year compared with 21% of women, according to the NerdWallet survey. That divide expands among Gen Xers, where 40% of men say they had a pay bump and 25% of women say the same.
“Given those pay disparities, it’s harder for women to funnel money into savings and investing accounts, since on average, they are starting with less. With the power of compound interest, those discrepancies can add up over time, creating even greater wealth gaps between men and women by the end of their lives,” Palmer says.
Ask for more from your employer. Only 8% of Americans — roughly equal shares of men and women — negotiated for a higher salary at their current job, according to the survey. Whether it’s time for your annual review or you’re considering a new job, be prepared to negotiate for more money and/or perks. A 2021 study by researchers at the University of Southern California found participants often avoided negotiating compensation, but those who did wound up getting larger pay packages.
Financial Security
Roughly equal shares of men (61%) and women (63%) say they’re optimistic that the financial companies they use care about their financial well-being, according to the survey. But it wasn’t always that way. There was a time when women in the U.S. couldn’t take out loans or have their own credit cards, particularly if they were unmarried. The Equal Credit Opportunity Act of 1974 changed that, barring discrimination by lenders based on gender or marital status.
Access to credit can be a lifeline when unexpected expenses arise. So can an emergency fund. The survey reveals that a smaller share of women believe they won’t have to tap such a fund in the coming year: 65% of men are optimistic they won’t have to dip into their emergency savings in the next 12 months, while 58% of women express the same optimism.
But millennial women are concerned: About 1 in 5 (17%) of this group say they’re “very pessimistic” about having to use those emergency funds over the next 12 months compared with 8% of millennial males, according to the survey.
The ability to build an emergency fund can feel like a luxury, one that may be afforded less to folks with less wealth. And while the gender pay gap is notable, the gender wealth gap — which takes debt and assets into account — is even more pronounced, according to the St. Louis Fed.
Indeed, just 16% of Americans say the most financially successful person they know is a woman, compared with 37% who say it’s a man, according to the survey. That includes 42% of men and 33% of women who say a man is the most financially successful person they know.
Bolster your emergency fund. A robust emergency fund is the bedrock of financial security. It can insulate you from a variety of financial shocks. If you’re starting from scratch, build your fund incrementally, beginning with a goal of $500, for instance. In the long term, aim to have several months of essential living expenses set aside in a high-yield savings account.
Money management and advice
Having money and knowing what to do with it don’t always go hand in hand. The survey finds nearly twice the share of Americans think women are better at managing money than are men.
Close to 3 in 10 Americans (28%) say women are better at managing money on a daily basis than men. Just 15% say men are better at it. Men are fairly evenly split in this assessment — 21% say women are better at the task and 22% say men are. Women are a bit more biased — 35% say that women are better at it and 9% say men are.
The perspective that women are better at daily money management doesn’t necessarily translate to people seeking out their guidance: 15% of Americans say the person they most often turn to for financial advice is a woman and 25% ask a man.
Gen Zers and millennials are slightly more polarized, with 35% of Gen Z women and 24% of millennial women saying they most often ask a woman for financial advice. Compare that with just 15% of Gen Z men and 10% of millennial men who say the same.
“Own” the financial factors within your control. You can’t control how society adapts to significant cultural shifts (such as allowing women access to financial equity). But you can find ways to take authority over the money you have, learn how to manage your money daily and give yourself the best possible chance to earn more and reach your long-term financial goals.
“Setting financial goals that are realistic and manageable can make it easier to stay on track with your spending and saving habits,” Palmer says. “Sharing those goals with friends and family who can offer support and their own tips also helps. We’re in it for the long run, so think about where you want to be in several decades, and begin taking steps to reach that destination today.”
Methodology
This survey was conducted online within the U.S. by The Harris Poll on behalf of NerdWallet on Jan. 18-22, 2024, among 2,085 adults ages 18 and older. The sampling precision of Harris online polls is measured by using a Bayesian credible interval. For this study, the sample data is accurate to within +/- 2.5 percentage points using a 95% confidence level. For complete survey methodology, including weighting variables and subgroup sample sizes, contact [email protected].
Disclaimer
NerdWallet disclaims, expressly and impliedly, all warranties of any kind, including those of merchantability and fitness for a particular purpose or whether the article’s information is accurate, reliable or free of errors. Use or reliance on this information is at your own risk, and its completeness and accuracy are not guaranteed. The contents in this article should not be relied upon or associated with the future performance of NerdWallet or any of its affiliates or subsidiaries. Statements that are not historical facts are forward-looking statements that involve risks and uncertainties as indicated by words such as “believes,” “expects,” “estimates,” “may,” “will,” “should” or “anticipates” or similar expressions. These forward-looking statements may materially differ from NerdWallet’s presentation of information to analysts and its actual operational and financial results.
The average savings account interest rate as of February 2024 is only 0.46%, according to the Federal Deposit Insurance Corp. Cash App’s savings yield, however, is competitive with some of the best high-yield savings accounts available. Putting your money in a high-yield product that earns 4.50% can help your savings grow much faster over time. Here’s an example:
According to a compound interest calculator, if you have a $1,000 balance in an account that earns 4.50%, you would earn just under $47 in interest after a year. That same $1,000 in a basic savings account that earns only 0.5%, for example, would earn only about $5 in that same time frame. Neither amount makes you instantly rich, but the extra money adds up over time.
The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.
Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:
Learn investment and tax strategies to help you achieve financial security and prepare for a prosperous retirement.
How can you balance saving for emergencies and investing for the future? What strategies can you employ to maximize your tax benefits and build a secure financial future? NerdWallet’s Kim Palmer and Alana Benson discuss investment strategies and tax planning to help you understand how to navigate your financial journey effectively. They begin with a discussion of investment strategies, with tips and tricks on understanding different investment accounts like 401(k)s and IRAs, leveraging compound interest, and the importance of starting investments early. Then, Alana discusses tax planning and filing in-depth, covering the intricacies of different tax forms like W-4s and W-2s, the significance of estimated taxes for freelancers, and strategies for managing capital gains taxes.
Kim and Alana delve into retirement planning and the challenges of active versus passive investing. They provide a framework for prioritizing your finances, emphasizing the creation of an emergency fund, taking advantage of employer 401(k) matches, and understanding the role of asset allocation based on age and risk tolerance. Additionally, they tackle the decision-making process in personal finance, such as choosing between paying off debt and investing, and the pros and cons of having a financial advisor.
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Episode transcript
This transcript was generated from podcast audio by an AI tool.
Sean Pyles:
Hey listener, we’ve got a special episode in store for you today. Our investing and tax Nerds recently hosted a webinar going deep into how you can level up your investing and tax strategy. So we packaged that up into a podcast episode for you. The Nerds talk about what you need to know about different investing accounts, how to get help with your taxes and more. So here’s the webinar.
Kim Palmer:
Welcome everyone. I am Kim Palmer. I’m a personal finance writer at NerdWallet where we help people make smart decisions. One important note, we are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. NerdWallet Inc is not an investment advisor or broker and does not provide personal financial advisory services. Today we are excited to talk to you about the basics of investing and taxes and we think we have some helpful info to share with you. You can always find more at nerdwallet.com or on the NerdWallet app. Our goal today is to kick off a helpful discussion about investing and tax information and tools. Alana Benson writes about investing topics including stocks, funds, and ethical investing. And now I will hand it over to Alana.
Alana Benson:
Thanks Kim. Hi everyone. Thank you for joining us today. So before we start, I just want to say a couple of things that often get forgotten when we’re talking about investing. So first, investing usually comes second to some other goals. If you’re having a hard time paying for necessities or you don’t have an emergency fund, it’s really important to focus on those things before we even start worrying about investing. Second, instead of scrimping, try to increase your income. So I didn’t start investing until I was in my late 20s, and that’s because one, I didn’t work at NerdWallet yet, so I literally didn’t know anything. And two, I was making around $25,000 a year, so I didn’t have much expendable income. And when you don’t have extra income, it’s really hard to prioritize investing and it just might not even be a good idea to do that.
When I started making more money, it was suddenly a lot more possible for me to invest for retirement. So if it’s possible for you and you want to be investing more, look for jobs that will pay you more or look into side hustles, but cutting back on your streaming services probably will not save you enough money for retirement. And finally, if you don’t have the money to invest now, that’s totally fine. Some people have serious money anxieties and others just don’t have the cash. Whatever your reason is, don’t stress too much about it. Just keep learning and when you’re able to, you can start investing. So why do we invest? What is the point of all this? And the answer is that it’s because we like money and that’s okay. There’s no shame in admitting it, I like money, most people like money. It’s because money isn’t just money. It’s not like Scrooge McDuck diving into pools of money and buying Maseratis. It’s not that.
It’s about not being stressed about your money all the time and it’s about being able to buy everything that you need and some stuff that you want comfortably without having money stress take up all of your energy. Money allows us to thrive instead of just survive and investing helps you make more money than you could ever possibly make just by working at a job. So okay, what actually is investing? This whole process is very strange. Okay. Investing is the process of money that you already have making additional money for you. And this works through what’s called compound interest. Compound interest means that your gains get a little bit bigger every year and that’s also why starting when you’re younger gives you a huge advantage and more money in the long run. So for example, you just start at that little number one in the box up there. Say you buy an investment for $100, if it goes up the average stock market return of 10%, it could then be worth $110, meaning that you’ve made $10.
Then that $10 that you earned also starts earning compound interest on top of the $100 you initially invested. That doesn’t sound like much of a profit, but imagine if you were doing it with way larger amounts of money over a way longer period of time. Now that 10% is an annualized rate, which means that you’re not going to get 10% every single year. In all likelihood, some years you’re going to finish up, some years you’ll finish down. But over the course of decades when you average all that out, you tend to get about 10%. The way you actually start investing is through an investing account. And there’s a couple of different types, but the type of investment account you have is actually really, really important because a lot of them have some pretty significant tax benefits that you want to take advantage of. So you’ve got your 401(k)s and these are offered through your employer. You add money to it and sometimes your employer matches it. So it’s basically free money. If you have a 401(k), you’ll likely choose your investments from a pre-selected list or a fund that will automatically adjust itself over time.
So this means 401(k)s are typically very hands off. IRAs on the other hand are investment accounts that you open up yourself. IRAs can be opened online through brokerages and actually at a lot of large banks, they also do that. So it’s likely you can open up an investment account just through your bank. Unlike with a 401(k), IRAs you’ll have to choose your own investments in those accounts. You may have heard about a thing called a Roth IRA or a Roth 401(k) and it’s good if you know the difference. So with a Roth, you pay taxes on your money now just like any other money that you earn and then the money you have invested inside that account grows tax-free and you can take it out tax-free in retirement. With a traditional IRA or 401(k), the money you contribute today is pre-tax.
So that is you get to deduct it from your income taxes this year. So it’s like a nice little treat this year, but then when you cash it out in retirement, you’ll owe income taxes on it. This is really, really important. I’ve seen a lot of people make this mistake. Your investment account is not an investment, so a Roth IRA, a 401(k), not an investment. So if you have a Roth IRA, that’s great, but that doesn’t mean you’re actually invested in anything. So you fund your investment account and then you buy investments from there. But I’ve heard of people opening a Roth IRA, putting in a bunch of money and then wondering why it didn’t grow over the last 10 years. So you have to purchase investments for your money to actually grow and if you don’t do it, you’ll miss out on all of those years of growth, so very important.
And there’s a couple different types of investments that you can choose from once you open and fund your investment account. So you’ve got stocks, I’m sure everyone’s heard of that, these are shares of ownership in companies and the way you make money from them is if they go up in value and some pay you a cut of the company’s profits on a regular basis. Then you’ve got bonds. This is when you loan money to companies or the government and they pay you interest. Funds, now these are very exciting because they’re basically just baskets of stocks and bonds that you buy all at once. So a fund is still a stock or bond based investment depending on the type of fund that you get. And there’s a lot of different kinds such as index funds or exchange traded funds and mutual funds, but they’re all collections of investments that you buy at one time.
And I think funds are pretty awesome because if you own a stock and that company goes out of business, you lose all of your money. But if you invest in a fund that covers 100 stocks and that same stock goes out of business, your investment is buoyed up by the other 99 companies. So again, all of these investments, stocks, bonds and funds, you buy them from your investment account and then you own them in there. All right, so let’s talk about the stock market, it’s this weird nebulous term that’s hard to understand. But the stock market is just where people buy and sell investments, but now people just trade investments online. So the stock market is made up of several what are called market indexes. Now these are basically just predetermined lists of companies and the performance of that overall list can tell us a lot about the health of the US economy.
So for example, the S&P 500, something you probably have all heard of, that’s just the list of 500 of the largest publicly traded companies in the US and it includes companies like Apple and Amazon. So when we say the stock market is down today, that means that on average most of those companies aren’t doing well. And you can’t invest in the literal stock market, but you can invest in funds that include all the same investments. So these are called index funds because they track a market index. So again, if you have an S&P 500 index fund, it should perform pretty closely to how the S&P 500 itself is actually performing. The S&P 500 goes up 10% a year on average and 6.5% after inflation. And this is just an average, so some years the market goes up more, some years it goes down less, but when done well, investing can potentially mean doubling your money every few years for doing basically nothing, which is my favorite way of earning money, by doing nothing. It’s great.
So let’s talk strategy. This is all about the way that you invest, when you put your money in and when you take your money out. So passive investing is where you buy that S&P 500 index fund and you keep adding money into it until you retire. It’s very boring, but it’s effective. So it can give you that 10% return on average over the long haul, but a lot of people want to make more than that 10%, and they do so by actively buying and selling stocks, crypto options and other high risk investments. They try to predict when they’ll be low, then they buy them and then they turn around and try to sell them when they’re high. So these people are called active traders or day traders. Only 20% of active traders make money over a six-month period. That is not a lot of people.
There have been a lot of studies over the years that show that active investing is a way less lucrative fashion than boring old passive investing with that index fund. Plus active investing is a lot more work, you have to do all kinds of research and you keep an eye on the markets and you can hypothetically earn more by actively trading versus passively earning the same amount as that historical return of 10%. But most people end up making less when they actually try it, and that’s because people are really bad at predicting things. And in order to make money on the overall stock market over the long term, you have to be really good at predicting things all the time. So maybe you make it big on one stock, but the odds of that happening again and again are very low. So let’s put all of this information together, the accounts, the actual investments and the strategy.
Here’s how financial advisors suggest you prioritize your money when you’re starting to invest. So the first thing you want to do is you’re not actually going to invest at all. The first thing is that you’re going to have an emergency fund. So this is money that you won’t actually put in the stock market, and that’s because when your money is invested, its value can change day by day. So say you have $1,000 and you want to use it for an emergency fund, but you invest it, when you have to fix something on your car suddenly, you go to check your money and its value could be $600 instead of $1,000 and that’s not good. If you put it in a high yield savings account, you can access that money at any time without risking its value. Plus right now the interest rates are really high.
So your money could be earning 4 to 5% just by sitting there. So next, you want to get that 401(k) match if it’s available to you because it’s free money. After that, it’s a good idea to look into IRAs. Both IRAs and 401(k)s have what’s called a contribution limit, which is just the maximum amount of money you can put in each of them every year. If you’re able to max out an IRA, then it’s a good call to move back to your 401(k). And the reason you switch around like that is because of the way the tax benefit works. So it’s likely more beneficial to invest in an IRA over a 401(k) if you’ve already gotten your match, if you have to choose between the two. Then if you max out your 401(k), you can move to a standard brokerage account. And this is not a list of everything you have to be doing right now.
You might be thinking, “Whoa, maxing out an IRA is $6,500, I cannot afford that”, and that is totally fine. So I like to picture it as a waterfall. So when you fill up your emergency fund, then you can start working on getting that 401(k) match. Only after that bucket is full should you then move on to investing in an IRA and so on. And wherever you’re at in your bucket filling journey is okay. It’s just nice to know what to do next when you’re ready for it. So we already talked about what accounts to invest from and the investments you can buy, but then do you just start buying a bunch of index funds or stocks or bonds? How do you know how much of each investment to get? And that is all about risk tolerance. And to understand that we have to understand how risk works over time.
If you’re investing for retirement and you’re in your 20s now, that means you have a ton of time for your investments to grow and then drop dramatically and then rise back up. So financial advisors would say you can afford to take on a bit more risk, AKA invest in riskier investments, because you have time for your investments to bounce back. Now, if you’re investing for your retirement and you’re 65, you don’t want to risk all the money you’ve been investing for years and years because you’re going to actually need to use it to pay for stuff in retirement pretty soon, so you want to protect it. And figuring out how much of each investment you should have is a fancy term called asset allocation, but it just means how much of your portfolio is in which of these investments.
And age is just a number, but typically when you’re younger, you may be able to afford to take more risk because you have more time for the stock market highs and lows to even out. So stocks, and okay, remember index funds and mutual funds are often made up of stocks so those count too, but those tend to carry more risk than investments like bonds. And an example of a 20-year-old’s investment portfolio, which includes all of your accounts so your 401(k), your Roth IRA, all of that together, that could be 100% stocks. And that’s fairly risky, but those 20 year olds are not going to retire for a long time. Now, a 65-year-old might have way more bonds because they don’t want to risk all that money they’ve earned over time. And one thing some investors do to mitigate risk is to slowly shift their asset allocation from high risk investments to low risk investments over time.
And again, I’m not a financial advisor and this is not personalized investment advice, but how much of each investment it’s good to have will usually depend on how much risk you are willing to take. And an investment portfolio can be really simple or really complicated. So you could have that one S&P 500 index fund and you purchase it from a Roth IRA, and that’s just all you do. Just if you want to keep it really simple or you can make it more complicated. So maybe you explore several stock-based funds such as international stocks and healthcare stocks and technology stocks, and you could invest in those types through a fund. So instead of buying 30 technology stocks, you just have one technology stock fund, then a small slice in bonds, and then an even smaller slice is crypto or other high risk investments. Though financial advisors have varying opinions on the safety of crypto.
So keep in mind, this is just an example and not necessarily what you should do personally, but it is really helpful to look up asset allocation portfolios through an online brokerage and see what they recommend for your specific age and when you plan on retiring. You can also talk with a financial advisor who can help guide you through those decisions. And investing is great because it can help you earn wealth, which you could spend on a boat, but more than likely one of your biggest investing goals will be retirement. And the sad truth is that in some things like retirement, they just cost so much that you’ll probably never afford them just by putting money in a savings account. And that’s why we say we have to invest for retirement. And the truth is that most people just aren’t saving enough for retirement.
So you’ll probably have a lot of expenses and you have to pay for that in retirement and some of it’s necessary like food or housing or medical care and some of it is travel or bucket list stuff, but you may not be working anymore or at least not as much as you were. And once you factor in inflation, it’s likely that a dollar today will be worth way less when you’re in retirement. And saving for retirement has gotten even more difficult because you can’t necessarily afford to live on social security. Medicare doesn’t always pay for your health needs and pensions aren’t really as common as they used to be. And because of all this, it’s really important to start investing for retirement sooner rather than later.
And if you’re early in your career, it might seem silly to worry about retiring right now, but if you start investing sooner, you actually spend less on retirement than if you start investing later in life overall and that’s because of compound interest. So our retirement calculator shows that if you start putting away $100 per month, that could grow to nearly $400,000 in 35 years. And it’s always good to know how much you should be trying to invest. When you have a long-term goal in mind, you want to know what that number is. So a retirement calculator can be a big help to figure that out, including NerdWallet’s retirement calculator. No shame, I’m going to plug it, but some financial advisors recommend saving 15% of your pre-tax income for retirement. So okay, let’s break that down. What does that look like?
So if you make $100,000 a year, again just because easy math, that would be $15,000 annually that you’re trying to save for retirement. But if you had a 5% match on your 401(k), you’d already be saving $10,000 a year between the $5,000 you make and the $5,000 your employer puts in. And then if you contributed another $5,000 to your Roth IRA, you’d already meet your target goal of saving $15,000 a year for retirement. You should also think about how much you can make during those peak earning years. If you’re younger, what career are you looking to have? You can look up what those wages tend to look like on a site like Glassdoor or ask someone in your life who is in that career path, and maybe do that tactfully because you’re asking about money. But figuring out what you want to be when you grow up may not be something you want to think about right now.
But to be honest, I studied English in college and no one told me about my job prospects. I figured that I would have to write a super famous book or be a teacher and you don’t have to have everything figured out now, but it doesn’t hurt to see how much a potential field could earn and figure out what careers are open to you. And just keep in mind that relationship between your earnings and investing like we talked about in the beginning. And if you’re later in your career, it is harder to take advantage of compound interest, but some of those investment accounts have those catch up contributions that we talked about so you’re able to contribute more after a certain age. Thank you all so much for listening to me talk very fast for a long time, and now I will hand it back over to Kim to talk about taxes. Thanks so much.
Kim Palmer:
Great, thank you so much, Alana. That was great. Someone actually asked in a pre-submitted question, “Why do I have to pay taxes?” Well, here is why. Taxes are used to pay for a lot of different things like clean water, roads, schools, healthcare, and the military. And your tax return is due every year in mid-April to the IRS. We’ll talk a little bit later about what to do if you need an extension, but in general that is the deadline. But first, let’s back up a little bit. When you file taxes, there is so much paperwork. One really important one is the W-4. That is the document that your employer asks you to fill out when you start a new job. And it plays a really big role in telling your employer how much in taxes to take out of each paycheck. It asks you things like your filing status, dependents, how much tax to withhold, and if you get a really big tax bill or a big refund, then you might want to go back and revisit your W-4 just to make sure you’re withholding enough but not too much.
There’s also the W-2, which is a document that your employer sends you to summarize how much in total they took out of your paycheck the previous year, and you’ll need to reference all those numbers when you file your tax return. If you are self-employed or you work a side hustle, then taxes won’t be automatically withheld from your paycheck, and that means you might have to pay something called estimated taxes, which is typically four times a year. In January, you’ll get something called a 1099 form that outlines how much money any company paid you, and then you’ll use that information when you file your return. And then finally, the 1040 is the main form you use when you file taxes, and we’ll drop a link in the chat for more about that. Okay, so you have all of your forms set. How do you actually file your taxes?
You can do it yourself through the IRS. You can use an online tax prep software or you can use a tax professional like an accountant or a tax preparer. If you do it on your own, you can either use paper forms or get access to brand name tax prep software through an IRS service called Free File. But it’s important to know that only people who make below a certain income qualify for the Free File program. If you use tax software like TurboTax, H&R Block or NerdWallet Taxes powered by Column Tax, many of these providers use a Q&A style to help you do your taxes and some even offer paid upgrades that connect you directly to a tax professional. If your finances are really complicated and you want some extra help, then you can also work with a tax preparer such as a certified public accountant.
You do want to make sure to ask them lots of questions and check their credentials before you agree to share your financial information. And you also want to check to see if they have a prepared tax identification number, which is an ID that’s required for anyone who files tax returns for compensation. The US does not have a flat tax system, and that means that portions of your income can be taxed at different rates. There are currently seven tax rates for federal income taxes that run from 10% to 37%. And which tax rate applies to you depends on your income and your filing status. So you might hear people say, “I’m in the 12% bracket” or “I’m in the 22% bracket”, but being in a tax bracket doesn’t mean you pay that tax rate on everything you make. And in reality, people’s income can fall into several different tax brackets depending on how much they make.
Portions or chunks of your income are taxed at different rates and some of those different taxes are then added together. So for example, some of your income could be taxed at a rate of 10%, another chunk could be at 12%. The more you make, the higher the tax rate might be on some of your income. And depending on the state where you pay your income taxes, you might pay a flat rate or a progressive rate similar to the federal structure. A small handful of states have no state income tax. If you want to pay less, you can look for tax breaks. Tax credits and tax deductions are two tools that can help you potentially minimize your tax bill, but they do work in different ways. Tax deductions reduce your taxable income. As a simplified example, a $25,000 tax deduction on $100,000 of taxable income means that only $75,000 of that income will get taxed.
Tax credits directly reduce your tax bill by the value of their credit. So this means if you owe $2,000 in taxes and you’re eligible for a $1,000 tax credit, you’ll end up owing $1,000. Tax credits tend to be more valuable because they have the potential to pack a bigger punch, so you definitely want to try to take all the tax credits you qualify for, and you could even get money back if a credit is refundable. Common tax credits include the earned income tax credit, the child tax credit, the lifetime learning credit, and the American opportunity credit and savers credit.
All right, I alluded to this at the beginning, but what happens if you’re not going to be ready by mid-April? What do you do? If you know you won’t be able to file on time before tax day, you can file for a free extension with the IRS and that gives you until mid-October to file your return. But you want to make sure that at least 90% of what you think you’ll owe in April is covered by an estimated tax payment or your withholdings. Otherwise, the IRS can hit you with a penalty for late payment. The failure to pay penalty is really no joke. It’s 0.5% of your unpaid taxes each month your payment is late plus interest. If you file late and you did not file an extension, you could also get hit with a failure to file penalty, which is 5% of your unpaid taxes each month that your payment is late. There is some good-ish news, if you file late but you don’t owe anything, you won’t get penalized but that doesn’t mean you’re not still obligated to file.
If you don’t, the IRS could file a return on your behalf and you might miss out on a refund if you’re owed one. And if your tax bill is so high that you can’t pay it off, you do have options. You can set up a long-term or short-term payment plan with the IRS.
I know that was a whole lot of information and taxes can seem scary, but we break down lots of popular tax questions and terms on nerdwallet.com. We have some time to address some pre-submitted questions from the audience ranging from about Roth IRAs to the pros and cons of having a financial advisor. And I do want to give a reminder here as we answer these questions that we are not tax or investing advisors. We are writers who focus on these fields and what we say is not investing or tax advice. So with that said, let’s dive into these questions. A question that came to us in an email was: how do you choose between paying off credit card debt and investing in saving for emergencies?
I really love this question because I think it speaks to some of the biggest challenges of personal finance, navigating these choices. And the answer is it’s really up to you. Many financial advisors say that the first step is to create a starter emergency fund, and you can read more in our article that we’ll link to, Should I Pay Off Debt Or Save? And you’ll see most people think about saving $500 to $1,000 first and then after that to consider contributing enough to a workplace retirement plan if they have access to one, and then contributing 3% to 5% of income to an IRA or a Roth IRA. And then financial advisors say people can consider focusing on paying off high interest debt and amp up investing efforts once they have paid that off. And now Alana, I’ll turn over to you. Perhaps you can answer the questions about Roth IRAs.
Alana Benson:
Absolutely. So a couple folks were wondering, before we went over everything, what a Roth IRA is and how does it work and when is it worth it to open one? So we already covered this a little bit, but again, it’s an individual retirement account and it lets you contribute money that you’ve already paid taxes on. So think about when you get your paycheck. That money has already had taxes taken out of it. So once you hit age 59 and a half and you have held the Roth IRA for at least five years, you can withdraw your contributions and any earnings, which is a fancy word for money that you earn from investing, without paying taxes again. And whether it’s worth it is up to you, especially if you’re trying to decide between a Roth IRA and a traditional IRA because it’s about when you pay those taxes and if you have a traditional IRA, you do get that tax break right now.
So that’s a personal decision. But you can also take out money tax-free from your Roth IRA later in life. So if that’s something that you are really trying to parse out, it might be good to talk to a financial advisor because they can help you with that question. We had two other questions. The first one is: how do you calculate how much money to put in your Roth IRA if you make over the maximum amount? So we didn’t actually cover this, so Roth IRAs do have income limits, but there is something called a Backdoor Roth that lets you contribute money first to a traditional IRA, pay taxes on it and then roll that money into a Roth IRA. And then our last question is: what are the pros and cons of having a financial advisor and how do you find one?
This is such a good question. The pros and cons really depend on your situation. The catchall term ‘financial advisor’ is used to describe a wide variety of people and services, including investment managers, financial consultants, financial planners. First and foremost, you always want to verify a financial professional because financial advisor doesn’t require people to be vetted. Certain things like a certified financial planner or a CFP, those actually have a very high level of education and have a certification that you can verify online. So anyone that you are talking about money with, you want to make sure that you are vetting them. And some of these people can just talk to you about your finances and some of them can actually manage your investments for you if you want that. Financial advisors, depending on the kind that you choose, can be pretty expensive. A robo-advisor is like an AI version of a financial advisor.
You just set up an account for one and then they charge you a pretty modest fee. And based on your age and your risk tolerance, it will manage your investments for you. An online financial advisor can offer more services and you can actually talk to a human being, but those do tend to cost a little bit more. And then you could go to an in-person financial advisor, depending on their credentials, that might cost even more, but sometimes it’s really nice to talk to somebody that you know and you can grow that relationship with them over time.
Kim Palmer:
Great. Thank you, Alana. And I think, actually, I can squeeze in one more question that we received. How do taxes work with investment accounts? How much do we set aside so we aren’t surprised by a tax bill? Which is a great question. If you’re selling stocks from a brokerage investment account, then you should be aware of three words, capital gains taxes. Those are the taxes you’ll pay when you sell assets for profit. Assets that you have owned for more than a year are subject to long-term capital gains tax, and the capital gains tax rate is 0%, 15% or 20% on most assets. Capital gains taxes on assets held for a year or less are subject to short-term capital gains. If you regularly trade stocks or other investments, you might be subject to short-term capital gains.
Those profits are taxed as ordinary income based on your tax brackets, which we went over before. Your final tax bill depends on a number of different factors. If you don’t want to be surprised, estimate what you’ll owe using tools such as a tax calculator or IRS worksheets. If needed, consider setting aside enough to cover the tax bill or paying estimated taxes and as always, your specific situation will differ and we are not tax professionals. We hope that you enjoyed this webinar and learned something today. If you’d like to get even more clarity on your finances and continue learning with NerdWallet, consider signing up for an account with us at nerdwallet.com. Thank you so much for joining us.
Sean Pyles: And that’s all we have for this episode. To send the Nerds your money questions, call or text us on the Nerd hotline at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Here’s our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. This webinar episode was produced by Alikay Wood, Sheri Gordon, and me. We had editing help from Liz Weston, Sara Brink mixed our audio, and a big thank you to NerdWallet’s editors for all their help. And with that said, until next time, turn the Nerds.
Understanding how interest works is crucial for managing your personal finances effectively. In this article, we will dive into the two main types of interest—simple and compound interest—and explore their differences, advantages, and disadvantages. We will also provide real-life examples and tips for maximizing your interest earnings.
What is simple interest?
Simple Interest Definition and Formula
Simple interest is calculated using only the initial principal balance. The formula for calculating simple interest is:
Simple Interest = Principal x Interest Rate x Time
Principal: The initial amount of money borrowed or invested.
Interest rate: The annual percentage rate (APR) applied to the principal.
Time: The duration for which the interest is calculated, typically measured in years.
Real-life Examples of Simple Interest
Car Loan
Let’s assume you take out a car loan for $10,000 at an annual interest rate of 5% for a 3-year term. Using the simple interest formula, you can calculate the total interest payable over the loan term:
Simple Interest = Principal x Interest Rate x Time
Simple Interest = $10,000 x 0.05 x 3
Simple Interest = $1,500
In this case, the total interest you’ll pay over the 3-year term is $1,500, making the total amount payable (principal + interest) $11,500.
Certificates of Deposit (CDs)
CDs are time-bound savings products offered by banks. They typically use simple interest, with the interest payments made at regular intervals or at maturity. For example, if you invest $5,000 in a 1-year CD with an annual interest rate of 3%, you would earn:
Simple Interest = Principal x Interest Rate x Time
Simple Interest = $5,000 x 0.03 x 1
Simple Interest = $150
At the end of the 1-year term, your investment would be worth $5,150, including the initial principal and earned interest.
Advantages and Disadvantages of Simple Interest
Advantages
Easier to calculate: The simple interest formula is relatively straightforward, making it easy to understand and apply in various financial situations.
Predictable payments: For borrowers, loans with simple interest usually result in predictable and consistent payments, making it easier to budget and manage finances.
Lower interest expense for short-term borrowing: For short-term loans, the total interest paid with simple interest is typically lower than with compound interest.
Disadvantages
Less growth potential: Compared to compound interest, simple interest doesn’t account for accumulated interest, resulting in lower overall returns for long-term investments.
Limited applicability: Simple interest is less commonly used in modern financial products, making it less relevant for most individuals’ financial planning and decision-making.
What is compound interest?
Compound Interest Definition and Formula
Compound interest is calculated on both the principal balance and the interest accrued from previous periods. The compound interest formula is:
Compound Interest = Principal x (1 + Interest Rate / Number of Compounding Periods) ^ (Number of Compounding Periods x Time)
Principal: The initial amount of money borrowed or invested.
Interest rate: The annual interest rate applied to the principal.
Time: The duration for which the interest is calculated, typically measured in years.
Number of compounding periods: The frequency at which interest is compounded, such as annually, quarterly, or monthly.
Real-life Examples of Compound Interest
Savings Account
Suppose you deposit $5,000 in a high-yield savings account with an annual interest rate of 2%, compounded monthly. To calculate the future value of your savings after 5 years, you can use the compound interest formula:
Step
Calculation
Result
1
Principal x (1 + Interest Rate / Compounding Periods)
1.0016667
2
(Result from Step 1) ^ (Compounding Periods x Time)
1.0016667 ^ 60
3
Principal x (Result from Step 2)
$5,000 × 1.1047
4
Final Compound Interest
≈ $5,520.53
In this example, after 5 years, your initial $5,000 deposit would grow to approximately $5,520.53, thanks to the power of compound interest.
Retirement Account
Consider a retirement account, like a 401(k) or IRA, with an initial investment of $10,000 and an average annual return of 7%, compounded annually. After 30 years, using the following formula, your investment would be worth:
Step
Calculation
Result
1
Principal x (1 + Interest Rate)
1.07
2
(Result from Step 1) ^ Time
1.07 ^ 30
3
Principal x (Result from Step 2)
$10,000 × 7.6123
4
Final Compound Interest
≈ $76,123.29
In this case, the power of compound interest has turned your initial $10,000 investment into $76,123.29 over 30 years.
Advantages and Disadvantages of Compound Interest
Advantages
Exponential growth potential: Compound interest allows your investment or savings to grow exponentially, as interest is continually added to the principal balance and earns interest itself.
Rewards long-term investing and saving: Compound interest takes the time value of money into account, encouraging long-term investing and saving strategies.
Disadvantages
Higher interest expense for borrowers: When borrowing money, compound interest can result in higher interest expenses compared to simple interest, especially for long-term loans.
More complex calculations: Compound interest calculations can be more complex than simple interest calculations, particularly when involving varying compounding frequencies or irregular payment schedules.
Comparing Simple and Compound Interest
Visualizing the Difference
One of the most effective ways to understand the difference between simple and compound interest is to visualize their growth over time. You can create graphs or charts to compare the accumulation of interest for both types in different scenarios, such as varying principal amounts, interest rates, and time horizons.
Factors to Consider When Choosing Between Simple and Compound Interest
When deciding between simple and compound interest, consider the following factors:
Time horizon: The duration of your investment or loan term will impact which type of interest is more suitable. Generally, compounded interest is more advantageous for long-term investments, while simple interest is preferable for short-term loans or investments.
Risk tolerance: Your risk tolerance should play a role in your choice. While compound interest offers greater growth potential, it may involve more risk, depending on the underlying investment.
Financial goals: Align your choice with your specific financial goals, such as saving for retirement, buying a home, or building an emergency fund.
Tips for Maximizing Interest Earnings
Choosing the Right Financial Products
To make the most of your interest earnings, consider the following financial products:
High-yield Savings Accounts
High-yield savings accounts offer competitive interest rates and use compound interest, making them an excellent choice for growing your savings over time.
Money Market Accounts
Money market accounts typically offer higher interest rates than traditional savings accounts and also use compound interest. However, they may have higher minimum balance requirements.
CDs
CDs can be a useful option for earning a higher fixed interest rate over a specified term. They often use simple interest, making them suitable for short-term investments with predictable returns.
Bonds
Investing in bonds can provide a steady stream of interest income, with some bonds offering either simple or compound interest, depending on their terms.
Diversification
Diversifying your investment portfolio helps to balance risk and return. Consider a mix of assets, such as stocks, bonds, and real estate, to optimize your interest earnings and capitalize on the power of compound interest.
Regular Contributions
Making regular contributions to your investment or savings accounts can help you maximize your interest earnings. By consistently adding to your principal balance, you can benefit from the exponential growth of compound interest.
Reinvesting Interest
Reinvesting the interest earned from your investments can significantly boost your overall returns. By allowing the interest to compound, you can accelerate the growth of your investments.
Simple Interest vs. Compound Interest: Common Misconceptions
Misconception 1: Simple Interest is Always Cheaper for Borrowers
While simple interest can lead to lower interest expenses for short-term loans, it’s essential to evaluate each loan on a case-by-case basis. Factors such as fees, loan terms, and additional charges can influence the overall cost of borrowing.
Misconception 2: Compound Interest Always Provides Higher Returns for Investors
Although compound interest can offer exponential growth potential, the underlying investment’s performance and risk factors must be considered. It’s also crucial to consider the historical performance, fees, and management of the investment before making a decision.
Impact of Different Compounding Frequencies
The frequency at which interest is compounded can have a significant impact on your investment’s growth or your loan’s interest expense. Generally, the more frequently interest is compounded, the higher the overall returns or costs.
Daily compounding: Interest is calculated and added to the principal balance every day.
Monthly compounding: Interest is calculated and added to the principal balance every month.
Quarterly compounding: Interest is calculated and added to the principal balance every three months.
Annual compounding: Interest is calculated and added to the principal balance once a year.
Historical Perspective
Simple and compound interest have played a vital role in the development of modern financial systems. The concept of interest dates back thousands of years, with civilizations such as the Babylonians, Greeks, and Romans using different forms of interest to facilitate trade and commerce.
The idea of compound interest gained prominence during the Renaissance, with mathematicians like Leonardo Fibonacci developing formulas to calculate compound interest. Over time, compound interest became a cornerstone of modern finance, shaping the way investments and loans are structured today.
Interest Rates and Economic Conditions
Interest rates are influenced by various economic factors, including inflation, unemployment, and central bank policies. Understanding the relationship between interest rates, economic conditions, and the performance of financial products that rely on simple or compound interest is crucial for making informed financial decisions.
Debt Management Strategies
Understanding the difference between simple and compound interest can help borrowers create effective debt management strategies, such as:
Pay off high-interest debts first: Focus on repaying loans with the highest interest rates, as they can quickly accumulate interest and increase your overall debt burden.
Refinancing loans: Consider refinancing high-interest loans to secure lower interest rates or more favorable terms, potentially saving you money in the long run.
Debt consolidation: Combining multiple high-interest debts into a single loan with a lower interest rate can simplify repayments and reduce overall interest expenses.
By understanding the differences between simple and compound interest, you can make more informed financial decisions and work towards achieving your financial goals.
Tips for Borrowers
When borrowing money, it’s essential to understand the implications of simple vs. compound interest on your loan. Here are some tips for borrowers:
Shop around: Compare loans with different interest structures and rates before committing to one. Don’t just look at the interest rate; consider the overall cost of borrowing, including fees, repayment terms, and penalties.
Negotiate: In some cases, you may be able to negotiate your loan’s interest rate, particularly if you have a strong credit score and a good relationship with your lender. Lower interest rates can save you money over the life of the loan.
Extra payments: Making additional or larger payments can help reduce your loan’s principal balance, lowering the total interest you’ll pay over time. However, be sure to check if your loan has any prepayment penalties.
Monitor interest rates: Keep an eye on interest rates in the broader market, as they can impact the cost of borrowing. If rates drop significantly, you may want to consider refinancing your loan to secure a lower interest rate.
Understand loan terms: Read and understand your loan agreement’s terms and conditions, including any interest rate adjustments, payment schedules, and fees. This will help you better manage your loan and avoid surprises down the line.
Conclusion
Simple and compound interest are fundamental concepts in personal finance, influencing everything from saving and investing to borrowing money. By understanding the differences between the two, you can make smarter financial decisions and work towards achieving your financial goals.
In summary:
Simple interest is calculated on the initial principal balance only, while compound interest is calculated on both the principal balance and any accumulated interest from previous periods.
Simple interest is generally easier to calculate and results in predictable payments for borrowers, while compound interest offers exponential growth potential for investors.
Choosing between simple and compound interest depends on various factors, such as your time horizon, risk tolerance, and financial goals.
To maximize your interest earnings, consider high-yield savings accounts, money market accounts, CDs, and bonds, along with regular contributions and reinvesting interest.
Understanding the impact of different compounding frequencies and the relationship between interest rates and economic conditions can help you make more informed financial decisions.
For borrowers, managing debt effectively involves comparing loan options, negotiating interest rates, making extra payments, and understanding loan terms.
By keeping these principles in mind, you’ll be well-equipped to manage your finances and make the most of your financial journey.
When it comes to investing for the future, the magic of compound interest can be a powerful tool. By placing your money in the stock market, you’re allowing it to grow over time with relatively little effort. However, understanding how to allocate your assets properly and diversify your investment portfolio can be a daunting task. That’s where exchange-traded funds (ETFs) and mutual funds come into play.
Both ETFs and mutual funds offer simple and effective ways to diversify your stock portfolio without having to buy individual stocks. They allow you to spread your investment across numerous stock options, reducing your overall risk and increasing your chances of growth.
In this article, we’ll dive deeper into the differences between ETFs and mutual funds, their pros and cons, and how to determine which one is right for your personal investment goals.
What’s the difference between ETFs and mutual funds?
At their core, both ETFs and mutual funds are pools of money invested in an array of stocks, bonds, and potentially other securities and assets. These investments are managed by third-party individuals or corporations, alleviating the need for you to perform extensive research and manual transactions to gain market exposure.
The Key Differences
While ETFs and mutual funds share similarities, there are several key differences that can impact your decision when choosing the right investment vehicle for your portfolio:
Active Management: Mutual funds (except for index funds) are actively managed by qualified financial professionals who monitor and adjust the fund’s assets based on market performance. This can provide a sense of security for long-term investors. ETFs, on the other hand, are typically passively managed and track a specific index or sector.
Trading Flexibility: ETFs can be traded on a daily basis, just like individual stocks, allowing investors more control over their investments. Mutual funds can only be bought and sold at the end of the trading day at their Net Asset Value (NAV).
Investment Minimums: ETFs generally have lower initial investment requirements than mutual funds, as you can often buy a single share at a relatively low price. Mutual funds typically have higher minimum investment thresholds.
Fees and Expenses: ETFs often have lower expense ratios and fewer fees compared to mutual funds. This can be attributed to their passive management style and lower operating costs.
ETF vs. Mutual Fund: Pros and Cons
To help you decide which type of investment is best for your goals, let’s dive deeper into the advantages and disadvantages of ETFs and mutual funds.
ETFs
Pros:
Lower start-up investments: With the ability to buy a single share, ETFs often have lower initial investment requirements compared to mutual funds.
Lower fees: ETFs typically have lower expense ratios, and fewer additional fees like marketing and distribution costs.
Greater transparency and flexibility in trading: ETFs can be traded like stocks throughout the day, and their holdings are usually disclosed daily. This offers more control and transparency for investors.
Tax efficiency: ETFs tend to be more tax-efficient, potentially resulting in lower tax liabilities for investors.
Cons:
Lack of active management: Most ETFs are passively managed, so investors looking for professional oversight may prefer mutual funds.
Potential trading costs: While ETFs generally have lower expense ratios, frequent trading could result in higher transaction costs, offsetting their cost advantages.
Mutual Funds
Pros:
No commissions on trades: Mutual funds can be bought and sold without paying additional commission fees, which may be beneficial for investors who trade frequently. Some brokerages also offer commission-free ETFs, but these may have higher expense ratios than other ETFs on the market.
Active management: Mutual funds are more likely to be actively managed by financial professionals, which can be appealing to investors seeking expert oversight and decision-making.
Automatic investments and withdrawals: With mutual funds, you can set up automatic transactions, making it easier to invest and withdraw funds on a consistent basis.
Cons:
Higher fees: Mutual funds typically have higher expense ratios and additional fees compared to ETFs, which can eat into your returns over time.
Less trading flexibility: Mutual funds can only be bought and sold at the end of the trading day at their NAV, offering less control and flexibility than ETFs.
Potential capital gains tax liabilities: Due to their structure, mutual funds may result in increased capital gains taxes and subsequently, higher tax obligations for investors.
Choosing the Right Investment Vehicle for Your Personal Portfolio
Ultimately, the best choice between an ETF and a mutual fund depends on your individual financial goals, risk tolerance, and investment preferences. Both options provide broad market exposure with relatively low effort and expense, but you may find one more appealing based on your unique circumstances.
Considerations for ETFs:
If you have limited funds to invest initially, ETFs may be a more accessible option due to their lower start-up investments.
If you prefer more control over your investments and the ability to trade throughout the day, ETFs offer the flexibility you’re looking for.
If tax efficiency is a priority, ETFs tend to have a lower overall tax liability compared to mutual funds.
Considerations for Mutual Funds:
If you value the expertise and oversight of financial professionals, actively managed mutual funds may be a better fit.
If you plan to trade frequently and want to avoid commission fees, mutual funds could be more cost-effective.
If you prefer the convenience of automatic investments and withdrawals, mutual funds allow for easy setup and management of recurring transactions.
A Balanced Approach: Combining ETFs and Mutual Funds in Your Portfolio
It’s important to note that you don’t have to choose exclusively between ETFs and mutual funds. Many investors find value in incorporating both investment vehicles into their portfolios to capitalize on the benefits of each. By combining the two, you can create a diversified, balanced investment strategy that caters to your individual needs and preferences.
For example, you might allocate a portion of your portfolio to low-cost, passively managed ETFs for broad market exposure and tax efficiency, while also investing in actively managed mutual funds for targeted growth opportunities and professional management. This approach allows you to take advantage of the unique strengths of each investment vehicle, potentially leading to better long-term returns and a more resilient portfolio.
Understanding the Mechanics of ETFs and Mutual Funds
To fully comprehend the differences, let’s take a look at their underlying mechanics and how they function within the investment landscape.
Creation and Redemption Process
ETFs:
ETFs are created and redeemed through a process involving authorized participants (APs) – typically large financial institutions. When creating new ETF shares, APs assemble a portfolio of underlying securities that mirrors the ETF’s composition and deliver it to the ETF issuer.
In exchange, the issuer provides the AP with ETF shares, which can then be sold on the open market. The redemption process is the reverse of this, with APs exchanging ETF shares for the underlying securities.
This creation and redemption process helps maintain an ETF’s market price close to its NAV. If the market price deviates significantly from the NAV, APs can capitalize on the arbitrage opportunity by creating or redeeming ETF shares, which in turn, helps bring the price back in line with the NAV.
Mutual Funds:
Unlike ETFs, mutual funds do not involve APs or the creation and redemption process. Instead, mutual fund shares are created and redeemed directly with the fund company at the end of the trading day, based on the NAV. As a result, mutual funds are not subject to the same intraday price fluctuations as ETFs and do not rely on an arbitrage mechanism to maintain a consistent market price.
Portfolio Management Strategies
ETFs:
The majority of ETFs are passively managed, meaning they aim to replicate the performance of a specific index or sector. This passive approach results in lower management fees and operating costs compared to actively managed funds. However, there has been a recent surge in the popularity of actively managed ETFs, which attempt to outperform their respective benchmarks through the expertise of portfolio managers.
Mutual Funds:
Mutual funds can be either actively or passively managed. Actively managed mutual funds rely on the expertise of a fund manager to select and manage the underlying securities in an effort to outperform the market.
This active management can lead to higher fees and expenses due to increased research, trading, and operational costs. Passively managed mutual funds, also known as index funds, seek to replicate the performance of a specific index or benchmark, resulting in lower fees and expenses.
Assessing Performance: ETFs vs. Mutual Funds
When comparing the performance, there are several factors to consider, such as historical returns, risk-adjusted performance, and consistency of results.
Historical Returns
While past performance is not necessarily indicative of future results, analyzing historical returns can provide valuable insight into how an investment vehicle has performed over time. Comparing the average annual returns of ETFs vs. mutual funds over various time horizons (e.g., 1-year, 3-year, 5-year, and 10-year periods) can help you gauge their relative performance.
It’s important to remember that individual ETFs and mutual funds can vary significantly in their returns based on their underlying investments, management strategies, and fees. Therefore, it’s crucial to analyze the performance of specific funds that align with your investment objectives rather than relying solely on broad industry averages.
Risk-Adjusted Performance
To effectively compare the performance of ETFs and mutual funds, it’s essential to consider the level of risk associated with each investment. Risk-adjusted performance measures, such as the Sharpe Ratio, can help you evaluate an investment’s return relative to its risk. A higher Sharpe Ratio indicates a better risk-adjusted return, allowing you to compare investments with different risk profiles more accurately.
When comparing mutual funds and ETFs, consider the risk-adjusted performance of each to determine which investment vehicle offers a more favorable balance between potential returns and associated risks.
Bottom Line
When it comes to deciding between ETFs and mutual funds, there’s no one-size-fits-all answer. By understanding the key differences, pros and cons, and how each investment vehicle aligns with your personal financial goals, you can make an informed decision that best suits your needs.
Remember to continually evaluate your investment strategy and make adjustments as needed. As your financial goals and circumstances change, your ideal mix of ETFs and mutual funds may also evolve. By staying informed and adaptable, you’ll be well-equipped to keep up with the ever-changing world of investing and work towards a successful financial future.
While each investor may have their own approach to investing, there are some best practices that have been honed over time by those with years of experience.
That’s not to say that one investing strategy is right and another is wrong, or that any strategy is more likely to succeed than another. When it comes to putting your money in the market, there are no guarantees and no crystal balls. But understanding some basic guidelines that have stood the test of time can be beneficial.
Basic Investing Principles
Following are a few fundamentals that hold true for many people in many situations. Bearing these in mind won’t guarantee any outcomes, but they can help you manage risk, investing costs, and your own emotions.
1. The Sooner You Start, the Better
In general, the longer your investments remain in the market, the greater the odds are that you might see positive returns. That’s because long-term investments benefit from time in the market, not timing the market.
Meaning: The markets inevitably rise and fall. So the sooner you invest, and the longer you keep your money invested, the more likely it is that your investments can recover from any volatility or downturns.
In addition, if your investments do see a gain, those earnings generate additional earnings over time, and then those earnings generate earnings, potentially increasing your returns. This is similar to the principle of compound interest.
2. Make It Automatic
One of the easiest ways to build up an investment account is by automatically contributing a certain amount to the account at regular intervals over time. If you have a 401(k) or other workplace retirement account you likely already do this via paycheck deferrals. However, most brokerages allow you to set up automatic, repeating deposits in other types of accounts as well.
Investing in this way also allows you to take advantage of a strategy called dollar-cost averaging, which helps reduce your exposure to volatility. Dollar cost averaging is when you buy a fixed dollar amount of an investment on a regular cadence (e.g. weekly or monthly).
The goal is not to invest when prices are high or low, but rather to keep your investment steady, and thereby avoid the temptation to time the market. That’s because with dollar cost averaging (DCA) you invest the same dollar amount each time, so that when prices are lower, you buy more; when prices are higher, you buy less. 💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
3. Take Advantage of Free Money
If you have access to a workplace retirement account and your employer provides a match, contribute at least enough to get your full employer match. That’s a risk-free return that you can’t beat anywhere else in the market, and it’s part of your compensation that you should not leave on the table.
Recommended: Investing 101 Guide
4. Build a Diversified Portfolio
By creating a diversified portfolio with a variety of types of investments across a range of asset classes, you may be able to reduce some of your investment risk.
Portfolio diversification involves investing your money across a range of different asset classes — such as stocks, bonds, and real estate — rather than concentrating all of it in one area. Studies have shown that by diversifying the assets in your portfolio, you may offset a certain amount of investment risk and thereby improve returns.
Taking portfolio diversification to the next step — further differentiating the investments you have within asset classes (for example, holding small-, medium-, and large-cap stocks, or a variety of bonds) — may also be beneficial.
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5. Reduce the Fees You Pay
No matter whether you’re taking an active, passive, or automatic approach to investing, you’re going to have to pay some fees to managers or brokers. For example, if you buy mutual or exchange-traded funds, you will typically pay an annual fee based on that fund’s expense ratio.
Fees can be one of the biggest drags on investment returns over time, so it’s important to look carefully at the fees that you’re paying and to occasionally shop around to see if it’s possible to get similar investments for lower fees.
6. Stick with Your Plan
When markets go down, it can feel like the world is ending. New investors might find themselves pondering questions like How can investments lose so much value so quickly? Will they ever go back up? What should I do?
During the crash of early 2020, for example, $3.4 trillion in wealth disappeared from the S&P 500 index alone in a single week. And that’s not counting all of the other markets around the world. But over the next two years, investors saw big gains as markets hit record highs.
The takeaway? Investments fluctuate over time and managing your emotions is as important as managing your portfolio. If you have a long time horizon, you may not need to be overly concerned with how your portfolio is performing day to day. It’s often wiser to stick with your plan, and don’t impulsively buy or sell just because the weather changes, so to say. 💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.
7. Maximize Tax-Advantaged Accounts
Like fees, the taxes that you pay on investment gains can significantly eat away at your profits. That’s why tax-advantaged accounts, those types of investment vehicles that allow you to defer taxes, or eliminate them entirely, are so valuable to investors.
The tax-advantaged accounts that you can use will depend on your workplace benefits, your income, and state regulations, but they might include:
• Workplace retirement accounts such as 401(k), 403(b), etc.
• Health Savings Accounts (HSAs)
• Individual Retirement Accounts (IRAs), including Roth IRAs, SEP IRAs, SIMPLE IRAs, etc.
• 529 Accounts (college savings accounts)
Recommended: Benefits of Health Savings Accounts
8. Rebalance Regularly
Once you’ve nailed down your asset allocation, or how you’ll proportion out your portfolio to various types of investments, you’ll want to make sure your portfolio doesn’t stray too far from that target. If one asset class, such as equities, outperforms others that you hold, it could end up accounting for a larger portion of your portfolio over time.
To correct that, you’ll want to rebalance once or twice a year to get back to the asset allocation that works best for you. If rebalancing seems like too much work, you might consider a target-date fund or an automated account, which will rebalance on your behalf.
9. Understand Your Personal Risk Tolerance
While all of the above rules are important, it’s also critical to know your own personality and your ability to handle the volatility inherent in the market. If a steep drop in your portfolio is going to cause you extreme anxiety — or cause you to make knee-jerk investing decisions – then you might want to tilt your portfolio more conservatively.
Ideally, you’ll land on an asset allocation that takes into account both your risk tolerance and the amount of risk that you need (and are able) to take in order to meet your investment goals.
If, on the other hand, you get a thrill out of market ups and downs (or have other assets that make it easier for you to stomach short-term losses), you might consider taking a more aggressive approach to investing.
The Takeaway
The rules outlined above are guidelines that can help both beginner and experienced investors build a portfolio that helps them meet their financial goals. While not all investors will follow all of these rules, understanding them provides a solid foundation for creating the strategy that works best for you.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
Invest with as little as $5 with a SoFi Active Investing account.
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Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
The Secure 2.0 Act aims to help Americans save for retirement through new policy changes and government incentives, but one provision taking effect next year is working toward something more: narrowing the racial wealth gap.
Section 101 of Secure 2.0 requires companies to automatically enroll eligible employees into 401(k) or 403(b) plans, starting after Dec. 31, 2024, citing auto-enrollment’s effectiveness at boosting the participation rate in workplace retirement plans for Black, Latino, and lower-wage employees.
Participating in a retirement plan through work may be one of the easiest ways to prepare for the future, but historically, participation has varied. A 2023 study by T. Rowe Price found that participation in an employer-sponsored retirement plan was highest for white people at 57.7% but lowest for Black people at 40.5% and Hispanic people at 31.9%.
That auto-enrollment provision is well-intentioned, says Yemi Rose, but it needs to be part of a bigger solution.
“I don’t think anybody’s surprised to say if we automatically enroll people that we’re getting more enrollment,” says Rose, the Maplewood, New Jersey-based founder of OfColor, a startup that supports employees of color in building financial awareness. However, he says that getting enrolled and participating in a retirement plan in and of itself doesn’t solve the hard, more pressing money issues.
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A glimpse into the retirement gap
One driver of retirement inequality could be income inequality. According to the Federal Reserve 2022 Survey of Consumer Finances, white families had an average pre-tax income of $164,550 compared with $70,950 for Black families and $71,550 for Hispanic families.
With less money to begin with, challenges such as inflation, higher interest rates and student loan repayments can put a lot of demand on the dollars coming in, says Greg Ward, a certified financial planner with Financial Finesse based in Charlotte, North Carolina.
He says common financial priorities for communities of color also include providing for family at home or overseas, and saving for their children’s education.
When there’s pressure to meet current financial obligations, skipping retirement savings or dipping into them might seem to offer relief, Ward says.
A 2023 report by the Sloan School of Management at MIT found that Black employees were twice as likely as white workers to take an early withdrawal of at least $1,000 from their retirement savings. Hispanic workers were 21% more likely.
Another Secure 2.0 provision, effective this year, removes tax penalties for some hardship withdrawals, but that’s sticky, too, said Hui-chin Chen, a certified financial planner and managing partner at Pavlov Financial Planning in Arlington, Virginia, in an email interview.
“Flexibility to withdraw may be an incentive to contribute to retirement accounts,” she said. “However, having that flexibility doesn’t mean you should exercise it when you don’t need to. Investing for the long-term in retirement accounts is still recommended.”
Beyond competing financial priorities, a lack of trust in institutions may also cause some to hesitate before participating in a retirement plan.
Chen said that immigrants who have arrived in the U.S. as adults have less time to save for retirement, and they might be more hesitant to take advantage of a retirement system they do not understand.
Rose also says lack of institutional trust can play a role in 401(k) participation rates. A worker might start a job expecting to see a certain amount in their paycheck, and when it’s less than they thought because of 401(k) deductions, they might get upset, he says.
“It’s a confirmation bias like, ‘Oh, my goodness, they’re taking more money from me.’”
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Secure 2.0: part of a bigger solution
Despite reservations about auto-enrollment, Rose says he still went to Capitol Hill to push for Secure 2.0 to be passed.
“In one sense, yes, we have more people enrolled,” he says. “But at the same time, you might also start to see more distributions in the form of a hardship or a loan. So you really have to kind of solve it from both ends.”
Part of that solution is raising financial awareness and literacy in communities of color, especially when it comes to preparing for retirement, he says.
Jamia Erickson, a senior financial advisor at Thrivent, based in Rochester, Minnesota, suggested small steps for those who find it hard to save for retirement by taking advantage of compound interest.
“I know it sounds cliche, but it works,” she said in an email interview. “Even if it’s $25 a month, start contributing to a retirement account.”
And while Erickson said that people shouldn’t rely on legislation when it comes to their future, she does tell people to ask questions of financial advisors and to do their research.
“Retirement planning is highly complex, so you shouldn’t feel like you have to know it all,” she said. “And because it’s such a major part of your life, asking questions will allow you to make more informed money decisions that ultimately help you achieve what you want in life.”
Inside: Learn the roadmap to financial freedom with no money. Surpass debt, embrace millionaire habits, invest wisely & start a victorious journey to become financially independent!
Navigating the road to wealth can feel daunting, especially without a financial head start. But the journey to becoming a millionaire isn’t reserved for the lucky few with an inheritance at their heel.
It’s about strategy, perseverance, and making informed decisions.
Reaching the status of a millionaire is possible. I have done it and many other Money Bliss readers as well.
You have to change your mindset to make this happen. Becoming financially stable is of utmost importance.
Now, if you are serious about making seven figures in your net worth, then keep reading on how to do it.
Foundations of a Millionaire Strategy with No Money
Building a wealthy future from the ground up demands a strong and comprehensive financial plan. This isn’t something super fancy and you don’t need crazy knowledge.
You just have to start and be determined.
Step 1: The Essential First Steps Toward Financial Growth
Before plotting any course, assess your current circumstances candidly. Are you battling debts? Barely managing expenses? Or perhaps saving inconsistently? Acknowledging your starting point is critical.
A financial plan acts as your roadmap. It outlines not only your current standing but also sets the destination: your millionaire goal. This is not a figure plucked from thin air but rather a calculated estimate determined by your aspirations and timeframe.
Structure your plan to encompass these elements:
Income Assessment: Calculate your total annual income, be it from your primary job or any side gigs you maintain.
Expense Analysis: Track every expense. From the daily coffee to the monthly rent, understand where your money is going.
Debt Strategy: High-interest debts can cripple financial growth. Prioritize paying off these debts to alleviate financial pressure.
Savings Plan: Start with achievable goals. Perhaps saving $100 a month initially, then incrementally increasing as your earnings grow.
Investment Consideration: Every dollar saved should be working for you.
Ultimately, keep your plan documented and visible. Regular interaction with your strategy keeps the vision of financial growth at the forefront of your daily choices.
Step 2: Harness a Mindset Crafted for Success
Maintaining a positive mindset can significantly amplify your success with money, empowering you to manifest your financial ambitions with clarity and confidence.
This positivity helps to reframe financial obstacles as opportunities for growth. To cultivate this prosperous mindset:
Practice gratitude by acknowledging and appreciating what you already possess, which can create a sense of wealth beyond the monetary value.
Counteract negative thoughts about money by consciously redirecting them into positive money affirmations, reinforcing your belief in your financial acumen and capabilities.
Focus on your ultimate goals and align your behaviors accordingly.
Step 3: Starting Small: Saving with Limited Means
When funds are scarce, saving can seem impossible. However, even the most modest savings habits can blossom into significant wealth over time. The key is to start – no matter how small, and to remain consistent.
Implement these techniques to save effectively on a tight budget:
Automate Savings: Set up a direct deposit from your paycheck to a savings account.
Savings Challenges: Engage in one of my popular money saving challenges.
Save Raises and Bonuses: Save at least half of any raises, bonuses, or tax refunds you receive rather than increasing your spending.
Micro-Saving Apps: Consider using apps that round up your purchases to the nearest dollar and save the difference.
Saving is habitual. Even with a limited budget, adapting ways to make saving a consistent part of your financial behavior is crucial.
Start with a small percentage that won’t strain your daily living but will quietly accumulate in the background. These mini saving challenges are perfect!
Step 4: Handling Debt: Strategies for Minimizing Financial Burdens
Tackling debt is a pivotal stage on the road to financial freedom and accumulating wealth. Personally, this is exactly what happened to me. Once we paid off our debt, we were able to increase our net worth substantially.
Simply put… When debt is left unchecked, it can blossom into an insurmountable challenge, thwarting efforts to acquire wealth. The cash flow killer.
Consider these tactics to manage and minimize your debt:
Debt Audit: Begin by evaluating all your debts. Take note of balances, interest rates, and minimum payments. Understanding the total sum of your debts is essential for forming a repayment strategy.
Prioritize High-Interest Debts: High-interest debts such as credit cards can quickly grow beyond control. Prioritizing these debts for repayment can save you a significant amount in interest over time.
Debt Snowball vs. Avalanche: Choose the method that will keep you motivated and align with your financial goals.
Negotiate with Creditors: If you’re in financial hardship, reach out to your creditors to negotiate for lower interest rates or modified payment plans. Many creditors prefer to work out a payment plan rather than risk not being paid at all.
Avoid Accumulating New Debt: As you pay off existing debts, it’s crucial not to accrue new ones. Stick to your budget and avoid temptations that could lead to further debt.
Remember, every debt you free yourself from is one step closer to letting your money work for you, not against you.
Step 5: Identifying Skills That Pay: Turning Talents into Revenue
In the evolving economy, capitalizing on your skills can be a powerful way to generate additional revenue streams. The beauty of skill-based earning is that it can fit around a traditional job and can be scaled up or down as your situation changes.
Here are possible avenues to pursue:
Demand for Your Skills: Look at the market and find out if you can outsource your skills
Start Freelancing: Platforms like Upwork, Fiverr, and Freelancer can connect you with clients looking for your specific skillset. Begin with competitive pricing and build up your portfolio and rates as your experience grows.
Teach Others: If you’re knowledgeable in a particular area, consider creating an online course or conducting workshops. With platforms like Teachable or Udemy, you can reach a global audience.
Networking: Leverage social media, professional networking sites like LinkedIn, and community forums. This builds your professional presence and can lead to job opportunities.
Lastly, do not be afraid to ask for a pay raise. Thus, will help you fast-track your path to six figures.
Step 6: Side Hustles and Entrepreneurship: Growing Your Earnings
To build real wealth, especially with no initial capital, earning income from multiple streams can be a game-changer. Side hustles and entrepreneurship are about leveraging your time, talents, and sometimes minimal financial investments to grow your income outside of your primary job.
Almost every millionaire I know has a side hustle or business that helped them to get to that point.
Here’s how you can expand your earnings with side hustles and entrepreneurship:
Make money online: The fastest growing area is knowing how to make money online. Even seemingly mundane skills can be lucrative.
Choose the Right Side Hustle: You can choose to make money or chill and watch TV. Pick on the popular side hustles to get started today.
Start Small Business Ventures: Consider creating a small business. It could start as simple as lawn care services, homemade goods, or consulting. Validate your business idea with minimal investment before scaling up.
As financial expert and entrepreneur Ramit Sethi states, “There’s a limit to how much you can save, but there’s no limit to how much you can earn.”
By actively growing your earnings and establishing additional income streams, you accelerate your trajectory toward millionaire status.
Step 7: Investment 101: Basics for the Beginner Investor
Investing is the escalator to wealth, turning your savings into passive income generators.
For beginners, the world of investing can seem labyrinthine, but with foundational knowledge and strategic baby steps, you can begin to navigate it confidently.
Don’t be afraid of the stock market as you are giving up way too much money! This was the stupid mistake I made in my 30s. Now, my investment portfolio is the primary way I am growing my wealth today.
Here’s what you need to know to get started with investing:
Start with a Retirement Account: If your employer offers a retirement plan, like a 401(k), especially with matching contributions, take full advantage of it. This is often a beginner’s first, and potentially most profitable, investment.
Low-Cost Index Funds: As a beginner, it’s wise to invest in low-cost index funds, which are designed to mimic the performance of a particular market index. They are diversified and typically have lower fees.
Automatic Investing: Set up automatic transfers to your investment account to facilitate regular contributions without having to actively think about it. Don’t forget to select which fund to invest in.
Educate Yourself: Take advantage of online resources, books, and courses to understand the basics of stocks, bonds, and other investment vehicles. This is what I did – invest in my stock market knowledge and it has paid off big time!
Understand the Rule of 72: A simple formula to estimate the doubling time of an investment. For example, at a 7% average annual return, your money could potentially double every roughly 10 years.
Understand Risk vs. Reward: All investments carry some level of risk. Typically, higher risk could mean higher potential returns, but also greater potential losses. Assess your risk tolerance before investing and use those stop losses!
Investing isn’t a sprint; it’s a marathon with compound interest serving as the tailwind to push you forward over time. Learn how to invest in stocks for beginners.
Step 8: Retirement Accounts: Why Maxing Out Early Matters
By maximizing contributions to retirement accounts, you not only safeguard your golden years but also capitalize on tax-advantaged growth, which can be substantial over time.
Just because you are in your 20s or 30s, don’t say I’ll invest later. You are missing the boat.
Here’s why it’s beneficial to start maxing out your retirement accounts as soon as possible:
Compounding Interest: The earlier you start, the more you benefit from compounding interest.
Tax Benefits: Contributions to retirement accounts like 401(k)s and traditional IRAs are made each year, but they come with limits and potential tax-deferred (IRA) or tax-free (Roth IRA) accounts.
Employer Match: Many employers offer a match on 401(k) contributions up to a certain percentage. Failing to contribute at least enough to get the full match is akin to leaving free money on the table.
Higher Contribution Limits: The earlier you start maxing out, the less you have to play catch-up later. The IRS sets annual contribution limits, and consistently hitting those maximums can mean a considerable difference in your retirement savings over time.
By comprehensively engaging with your retirement accounts from an early age, you start an assured path towards the millionaire echelon.
Yes, it is possible to have multiple Roth IRA accounts.
Step 9: Adopting the Growth Attitude: Learning from Millionaire Mentors
The difference between those who accumulate wealth and those who don’t can often be traced back to mindset and mentorship. Adopting a growth attitude and learning from successful individuals can accelerate your path to prosperity.
Millionaires, with their experience and results-driven approaches, often provide valuable insights into effective wealth-building strategies.
Here’s how tapping into the wisdom of millionaire mentors can benefit your financial growth:
Learning from Their Experiences: Millionaires can share their triumphs and tribulations, offering you a roadmap that highlights what to do and what pitfalls to avoid. Cultivate these millionaire habits in your life.
Networking Opportunities: Millionaire mentors often have expansive networks. By building a relationship with a mentor, you may be introduced to key connections that can lead to lucrative opportunities.
Mindset Shift: Interacting with successful individuals can shift your perspective from a fixed mindset to one that embraces challenges, persists in the face of setbacks, sees the effort as the path to mastery, and learns from criticism.
Innovative Thinking: Mentors can inspire innovative approaches to income generation, investment, and savings. They can encourage out-of-the-box thinking that may lead to financial breakthroughs.
Emulating Success: By observing the habits and tactics of millionaires, you can emulate strategies that have proven successful while avoiding practices that may lead to failure. Start these billionaire morning routines to help you.
By adopting a growth attitude and learning from the insights and experiences of millionaire mentors, you sharpen your financial acumen and enhance your ability to create and capitalize on wealth-building opportunities.
Step 10: Community Counts: Surround Yourself with Success
The people you surround yourself with can significantly influence your thoughts, actions, and ultimately, your success. By intentionally building a community of hard-working, success-oriented individuals, you can foster an environment that promotes wealth accumulation.
Here is why it’s crucial to immerse yourself in communities that align with your aspirations:
Shared Success Mindset: In a like-minded success-oriented community, you’ll find individuals who have goals similar to yours and an attitude that is conducive to financial growth. This collective mindset can reinforce your own ambitions.
Peer Learning: Being a part of a community allows for collaborative learning. Exchange insights, experiences, and tactics with peers who are also on a path of financial growth. I love my masterminds!
Accountability: Just as with individual mentors, a community can keep you accountable. Regular interactions with people who take financial success seriously can encourage you to do the same.
Cross-Pollination of Ideas: Varied perspectives in a group can lead to a cross-pollination of ideas, sparking creativity and innovation in your own wealth-building strategies.
Increased Confidence: As you witness others achieving success, it instills a belief that you can do the same. This confidence can push you to take calculated risks that lead to greater rewards.
This adage stresses the importance of being selective with the company you keep, as their attributes frequently rub off on you, influencing your path to becoming a self-made millionaire. Likely you want friends who are millionaires or striving to be, too.
Step 11: Steer Clear of Debt: Remaining Unshackled as You Ascent
The gravitational pull of debt can be a formidable force, impeding one’s ascent toward the zenith of financial independence. But, you can overcome this by using these debt free living habits.
Here are strategies to remain unshackled by debt:
Budget Religiously: A budget constrains overspending and reduces the temptation to rely on credit.
Build an Emergency Fund: A substantial emergency fund can cover unforeseen expenses, diminishing the need to fall back on credit cards or loans that could exacerbate your financial situation.
Spend Less Than You Make: This may sound simple, but this helps you to live within your means and avoid going into debt.
Discern Needs from Wants: Be meticulous in distinguishing true needs from mere wants.
Ultimately, your ability to evade debt not only safeguards your financial stability but also amplifies your capability to invest and save, propelling you firmly on the trajectory toward millionaire status.
Step 12: The Lifestyle Inflation Trap: Keeping Expenses in Check
Success and salary hikes can often lead to lifestyle inflation, a phenomenon where spending increases as income rises, negating the potential for savings and investments. Keeping lifestyle inflation at bay is pivotal to ensuring that growing income translates into growing wealth.
Here’s how you can avoid the lifestyle inflation trap and keep expenses in check:
Stick to Your Budget: Even as your income grows, maintain the budget that facilitates your savings habits.
Identify Trigger Points: Be aware of what prompts you to spend more. Sometimes, seeing others upgrade their lifestyle can trigger the same desire. Stay focused on your financial goals rather than external influences.
Automate Savings Increases: When you receive a raise or bonus, immediately update your automatic transfers to increase the amount going into your savings or investment accounts.
Value Experiences Over Possessions: Studies have shown that experiences bring more lasting happiness than material goods. Opt for a modest increase in experiences rather than expensive goods as your income grows.
Embrace Minimalism: Adhering to minimalist principles can reduce the urge to accumulate non-essential items, keeping spending down and savings rates up.
Avoiding lifestyle inflation doesn’t mean living as frugally as possible regardless of how much you earn. It’s about finding a balance that allows for a comfortable yet modest lifestyle, wherein you can enjoy the fruits of your labor without compromising your long-term wealth goals.
Billionaire investor Warren Buffett exemplifies this principle by still living in the house he bought in 1958 for $31,500 and driving a reasonably priced car. Buffett’s lifestyle choices display an astute awareness of the perils of unnecessary spending and emphasize the importance of consistency in financial discipline.
Step 13: Compounding: The Wonder that Builds Big Balances Over Time
Compounding interest is a powerful tool that has the potential to turn modest savings into vast sums over time.
The principle behind compounding is straightforward: the returns you earn on your investments generate their own returns in the next cycle, leading to exponential growth given enough time.
Here’s how the wonder of compounding works to build big balances:
Start Early: The magic of compounding is maximized by time. The sooner you start investing, the more cycles of compounding your money can go through, and the larger your balance can grow.
Reinvest Your Returns: To truly harness the power of compounding, reinvest the interest, dividends, and any capital gains you receive, rather than spending them. This increases your investment balance, which in turn means more significant potential returns in the next cycle.
Regular Contributions: Make regular contributions to your savings and investments. Consistent additional deposits can significantly amplify the effects of compounding over the long term.
Step 14: Procrastination and Perils: Why Immediate Action is Crucial
Procrastination is often the thief of time and opportunity, especially when it comes to financial decisions. Postponing essential actions like saving, investing, or paying down debt can have compounding negative effects, making it harder to achieve financial goals.
Understand the perils of procrastination and the importance of immediate action:
The Cost of Waiting: In the realm of investment, the longer you wait to begin, the more you miss out on the potential compounding returns. Delayed action can mean the difference between a comfortable retirement and a financially insecure one.
Opportunity Loss: Procrastination can lead you to miss out on time-bound opportunities, such as market dips that are ideal for purchasing investments at lower prices or missing the deadline for a tax-advantaged account contribution.
Paying More on Debt: By putting off debt repayment, you accrue more interest, which only increases the total amount you’ll eventually have to pay. Acting quickly to pay off high-interest debt saves money in the long run.
Increased Stress: Delaying important financial actions can lead to an accumulation of stress and anxiety, which can, in turn, impair your ability to make sound financial decisions.
Potential for Rash Decisions: When you constantly procrastinate, you might eventually rush into decisions without adequate research or consideration, leading to poor financial outcomes.
Recognize this type of behavior and set weekly money meetings with yourself to help you move forward – one task at a time. Grab an accountability partner too!
Step 15: Long-Term Vision: Setting Up For Sizeable End Gains
The journey to becoming a millionaire is often a marathon, not a sprint.
Nurturing a long-term vision for your financial future is essential in guiding your daily decisions and motivating you to stay the course.
To ensure sizeable end gains, you need to establish and maintain a future-oriented mindset:
Set Long-Term Financial Goals: Establish clear, achievable long-term financial goals that align with your desired = future. Whether it’s attaining a specific net worth, owning property outright, or securing a comfortable retirement, these goals should inspire your action plan.
Strategic Planning: Develop a comprehensive financial plan that includes savings, investments, retirement accounts, and estate planning. This plan should act as a living document that you can adjust as your circumstances and goals evolve.
Patience is a Virtue: Recognize that wealth typically accrues over time, and not without fluctuation. Stay patient and avoid knee-jerk reactions to short-term market swings or temporary setbacks.
Regular Investments: Commit to making regular investments, even in small amounts. Over time, consistent contributions can result in substantial wealth through compounding interest.
It’s about creating financial disciplines that compound over time, ensuring that with each day, month, and year, you’re progressively building towards a considerable nest egg.
FAQ: Climbing the Financial Ladder Without a Silver Spoon
Getting rich with no money might seem like a paradox, but it’s a trajectory that many self-made millionaires have pursued successfully. The blueprint involves a combination of mindset shifts, disciplined financial habits, and strategic action.
You have to take proactive steps to increase wealth even when starting from zero.
Starting from nothing and achieving millionaire status requires a multifaceted strategy, encompassing personal development, financial planning, and an entrepreneurial approach to income generation.
Wealth creation is a journey, and starting from zero means that progress may be slow initially.
However, by adopting these steps and maintaining a disciplined and proactive approach, you incrementally increase your chances of accumulating significant wealth.
Ready to Become a Millionaire with Nothing?
Are you ready to become a millionaire with nothing but your ambition, intellect, and unwavering resolve? If your answer is a resounding yes, then it’s time to take the first step.
With every small victory and learned lesson, you inch closer to your ultimate goal.
Your journey starts with dedication, a commitment to yourself that from this day forward, you will work relentlessly toward the life you envision.
Wealth is not just about the money you accumulate but also the knowledge, experience, and relationships you develop along the way. Wealth creation is often not a straight line but a series of strategic moves and consistent behaviors that, collectively, lead to financial success.
Remember, your current financial position is just a starting point – with the right mindset and actions, significant financial growth is within the realm of possibility.
Your next step is working towards becoming financially independent.
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Inside: Escape the cycle of being broke with insightful tactics. Learn to invest, save smartly, spot financial traps, and build secure money habits today.
You are desperate right now. You want to know why I am broke.
I get it. This is a situation I have been in before and just recently when I lost my main source of income.
The feelings of you can’t afford anything may send you down a steep spiral of depression.
So, how do we escape?
Here are the tips I used before and plan to use again.
Top Reasons for Why I am Broke
#1 – The Mindset Traps That Keep You Broke
A mindset that cultivates a sense of scarcity rather than abundance can be a massive roadblock to financial prosperity. When you’re shackled by thoughts like “I am always broke,” you unwittingly set the stage for a self-fulfilling prophecy.
The mental narrative that convinces you wealth is unattainable can keep you trapped in a loop of missed opportunities and poor financial decisions.
You may inadvertently sabotage your potential to earn more, save, or invest wisely by clinging to a defeatist paradigm.
Fixing a broken mindset is about shifting from a state of helplessness to one of deliberate, empowering action.
It starts with self-awareness and is further built through intentional positive affirmations and financial education.
Overcome By: Remember, the mind is powerful—it can be your greatest ally or your most formidable adversary. Change your money mindset.
#2 – Living Beyond Your Means: A Fast Track to Empty Pockets
Living beyond your means is akin to constantly filling a sieve with water, hoping it will someday retain more than it loses—a surefire way to financial drought. It’s a lifestyle where your outflow far exceeds your inflow, and every paycheck evaporates into the ether of consumerism.
With the advent of credit cards and buy-now-pay-later schemes, the temptation to spend money we don’t have has never been greater.
The façade of affluence conceals the grim reality of financial instability.
Acknowledging this trap is step one. Living within one’s means doesn’t imply sacrificing joy or reverting to asceticism; it’s about striking a harmonious balance between the lifestyle you desire and the one you can sensibly afford.
Overcome By: Making choices aligned with your financial reality, finding contentment in simplicity, and prioritizing financial health over transient pleasures.
#3 – Chronic Debt: Borrowing from Tomorrow for Today
Chronic debt is a pervasive issue, ensnaring individuals in a vicious cycle of borrowing today and worrying about repayment tomorrow. This pattern often stems from an urgency to fulfill immediate desires or needs without adequate financial resources.
Alarmingly, the trend of increasing consumer debt signals a culture obsessed with instant gratification as consumer debt is $16.84 trillion in Q2 2023, according to Experian. 1
Being in debt should not be normal.
The onus of breaking free from chronic debt lies in reevaluating your relationship with money. It means slowing down the urge to splurge, meticulously planning for future financial obligations, and carving a path towards debt repayment.
Overcome By: Find the discipline to not only stop accumulating debt but also to aggressively tackle existing debts through methods like debt snowball or debt avalanche strategies.
#4 – You Haven’t Learned to Plan and Budget for a Brighter Tomorrow
The lack of a strategic financial plan and a detailed budget is tantamount to navigating unknown terrain without a map. Without these critical tools, your finances are left to chance rather than choice, leaving you vulnerable to the whims of circumstance.
Budgeting is perhaps the most fundamental step toward taking ownership of your financial future. It gives you a clear snapshot of where your money is going, which is essential for making informed spending decisions.
However, many avoid the budgeting process, perceiving it as restrictive or complex. The truth is that budgeting liberates you from the anxiety that comes with uncertainty. It empowers you to align your spending with your financial goals and to find a balance between today’s necessities and tomorrow’s aspirations.
Overcome By: Choose a budgeting method whether it be the zero-based budget, the 50/30/20 rule, or the envelope system, the key is to find a method that resonates with your lifestyle and stick to it.
#5 – No Emergency Fund to Weather Financial Storms
An emergency fund is an essential bulwark against the financial tempests life invariably hurls your way. Without it, a single unforeseen event—a job loss, a medical emergency, or an urgent car repair—can capsize an already precarious financial ship. The lack of an emergency cushion extends an open invitation to debt and financial strain.
The data tells a stark tale:
A statement from the Consumer Financial Protection Bureau highlights that nearly a quarter of consumers (24%) don’t have an emergency savings account. 2
Additionally, 39% have less than a month’s worth of income saved for emergencies, setting the stage for potential financial disaster. 2
This precarious situation has become more pronounced with the increasing cost of living and high inflation rates witnessed in 2021-2023.
Overcome By: Structured, automatic savings transfers to facilitate the gradual growth of your emergency fund without it feeling like a financial blow. The goal is to build a reservoir robust enough to cover several months of living expenses, providing a comfortable buffer that can help you bounce back from setbacks without the need to borrow money at high-interest rates or liquidate precious assets at inopportune times.
#6 – Lack of Understanding of The Power of Investing
Understanding the power of investing is key to grasping the potential of a seed. A seed, given the right conditions, can grow into a flourishing tree. Similarly, investing allows your finances to grow beyond the confines of stagnant savings.
Yet, many people fail to harness this power due to a lack of understanding or fear of the unknown. This was me for many years until I decided to learn to trade stocks.
A common misconception surrounding investing is that it’s solely the playground for the rich or financially savvy. This myth steers many away from multiplying their wealth via investments, leaving them to rely solely on their primary source of income. Moreover, a lack of understanding often leads to panic during market volatility, resulting in ill-timed decisions to buy high and sell low—contrary to sound investment strategies.
Overcome By: Invest money consistently into a low-cost mutual fund or ETF that tracks the overall S&P. Then, continue your investing education on how to invest in stocks.
#7 – Wasteful Spending Habits
Wasteful spending habits are the quiet thieves of financial security. They nibble away at your earnings, leaving you wondering where your money has gone at the end of each month. This pattern often goes unnoticed, as it’s usually composed of small, seemingly insignificant purchases that accumulate over time.
The danger of wasteful spending is its subtlety.
It’s the daily coffee on the way to work, the meal out because cooking feels like too much of an effort, or the impulse buys during the sale season.
Individually, these do not seem like considerable expenses, but together, they can consume a substantial portion of your budget.
To curtail this financial leak begins with recognizing and acknowledging these habits. Tracking every penny spent can be an eye-opening experience, illustrating just how quickly the ‘little things’ can add up. With this awareness, one can then consciously decide where to cut back.
Overcome By: Adopting a minimalist approach, where value and purpose become the benchmarks for every expense, can help combat wasteful spending. Questions like, “Do I really need this?” or “Will this purchase add value to my life?” can serve as useful filters. Take up a no spend challenge to see your mindless consumption.
#8 – Fail to Recognize the Patterns That Lead to a Near-Empty Wallet
Failing to recognize the patterns that deplete your wallet is akin to ignoring the signs of a leaking roof until it caves in—it’s a disaster in the making. Often, it isn’t one significant financial blunder, but rather a series of small, recurring missteps that lead to the near-empty wallet syndrome.
For instance, routinely underestimating monthly expenses can lead to a perpetual state of surprise when the bills pile up.
Similarly, neglecting to keep tabs on bank account balances may result in overdraft fees that, over time, take a sizable bite out of your funds.
Disregarding the accumulative effects of late payment charges or routinely paying only the minimum on credit card balances can exacerbate financial distress.
Overcome By: To reverse this trend, one must become a detective in their own financial mystery. Start by scrutinizing bank statements and tracking expenses. Look for patterns, like repeated late-night online shopping sprees or habitual dining out, which contribute to the thinning of your wallet. Use budgeting apps or spreadsheets to flag these patterns visually, making it easier to identify and amend them.
#9 – How Fear and Denial Contribute to Ongoing Money Issues
Fear comes in several forms: fear of failure, fear of taking risks, and even fear of facing the truth about one’s financial situation. It can immobilize individuals, preventing them from making necessary financial changes or taking action that could otherwise mitigate or reverse money woes.
For instance, the fear of losing money might dissuade one from investing in potentially lucrative opportunities, leaving them stuck in the low-yield safety of a savings account.
Further, there’s the psychological phenomenon of denial—a defense mechanism that numbs the pain of reality. When faced with mounting debt or budgetary failure, denial kicks in, allowing individuals to live as if the problem doesn’t exist. Unfortunately, ignoring overdue notices or dodging calls from creditors doesn’t make debts disappear.
Denial only deepens the financial hole, often leading to larger, more complex problems.
Overcome By: To confront these challenges, it’s crucial to adopt a stance of brutal honesty with oneself. This means acknowledging fears and confronting financial shortcomings head-on. Professional help, such as financial counselors or advisors, can provide support and guidance to navigate these tricky emotional waters.
#10 – No Clear Financial Goals and Plans
The absence of clear financial goals and plans is like embarking on a voyage without a destination. It not only leads to aimless wandering but also ensures that you miss out on the focus and motivation that well-defined objectives provide.
When you lack clarity on what you’re saving for or what you wish to achieve, there is little impetus to resist the temptations of immediate gratification or to weather the short-term sacrifices that long-term gains often require.
Setting clear and measurable financial goals lays the groundwork for creating effective plans to reach them.
Overcome By: To break this cycle, begin by reflecting on what you value most and where you would like to be financially in the future. Whether it’s achieving debt freedom, owning a home, funding education, or planning for retirement, having specific goals in mind will define the purpose of your financial activities. Craft a plan that outlines the steps needed to accomplish them.
#11 – Laziness is your Game
When you approach your finances with a laissez-faire attitude, it’s akin to ignoring the health of a garden; without regular attention and effort, it’s bound to wither. Financial laziness can manifest in various ways, from failing to review bank statements and ignoring budgeting to neglecting opportunities to cut costs or boost income.
Each act of omission is a step closer to the financial doldrums.
Procrastination or avoidance might seem less painful at the moment, but they ultimately compound the problem. Contrary to what some might think, simple acts of financial diligence, such as cash management or regularly doing household chores, do not require Herculean effort.
Moreover, they set a foundation for sound financial habits that thwart needless spending.
Overcome By: Schedule time for financial management much like an important meeting.
#12 – Keeping up with Others is Breaking Your Bank
The urge to keep up with others—often termed the ‘Keeping up with the Joneses’ or ‘Keeping up with the Kardashians’ phenomenon—is a profound pressure that exerts an invisible, yet powerful, force on financial habits. This social comparison can lead to an insidious form of competition, one that disregards personal financial realities in favor of an illusory social standing.
It’s an impulse driven by comparison, where the benchmark of success is set not by personal satisfaction, but by the possessions and lifestyles of others.
The decision to upgrade to a luxury car, splurge on designer clothes, or redo a perfectly functional kitchen stems not from need, but from a desire to project an image that matches or surpasses those in your social sphere.
Financial guru Dave Ramsey encapsulates this philosophy with his common saying, “Live like no one else will now, so in the future, you can live like no one else can.” This means making money moves that are right for you, not those dictated by social pressures, which can sometimes involve humbler living now for a wealthier future.
Overcome By: Breaking free from the shackles of this social competition requires introspection and a bold reaffirmation of personal values. Adjusting focus towards personal financial goals and aspirations, rather than mirroring others’ spending decisions, is key.
#13 – Need Help Differentiating Needs from Wants
The blurring line between needs and wants is a common financial pitfall that can lead individuals deeper into the morass of money woes.
Needs are essentials, the non-negotiable items necessary for survival—food, shelter, healthcare, and basic utilities.
Wants, on the other hand, include anything that is not vital for basic survival but enhances comfort and enjoyment of life.
The difficulty in distinguishing between the two often stems from habituation. What starts as a luxury, like eating out at restaurants, getting a high-end smartphone, or subscribing to multiple streaming services, can quickly become perceived as essential. This is particularly difficult in a consumer-driven society, where advertising and social media constantly inflate our perception of what we ‘need’ to lead a fulfilling life.
The result? A budget that’s stretched thin on non-essentials, leaving little room for savings or investment.
Overcome By: Regularly reassess expenses and ask the hard questions about whether a purchase is genuinely essential or merely a desire dressed up as a need.
#14 – You Don’t Make Enough Money to Cover Your Expenses
When your income doesn’t cover expenses, the strain can be relentless. This financial imbalance is often the stark root of the “I am broke” refrain. In such cases, every dollar becomes precious, and the financial breathing room feels nonexistent.
The reason is straightforward: if what comes in is less than what goes out, deficits and debt are the inevitable outcomes.
Addressing this challenge requires a two-pronged approach—increasing income and/or reducing expenses. For many, reducing expenses is the immediate reflex, and while it’s an essential strategy, there’s only so much you can save, but no limit to how much you can earn.
Overcome By: Focus on making more money. This could mean asking for a raise, seeking better-paying job opportunities, pursuing a side hustle, making money online, or acquiring new skills that offer higher income potential.
Long-Term Solutions to Build a Secure Financial Future
Building a secure financial future is an aspirational goal for many, but achieving it requires a strategic approach characterized by foresight, discipline, and an understanding of personal finance.
Becoming financially independent doesn’t happen by magic chance; it’s the result of deliberate actions taken with consistency over time.
Here are the foundational blocks for constructing a sturdy financial edifice:
Invest in Financial Literacy: Knowledge is power, and this is especially true in the realm of finance. Educate yourself about budgeting, investing, insurance, taxes, and retirement planning. Reliable resources include books, online courses, podcasts, and workshops.
Set Clear Financial Goals: Define what financial success looks like for you, whether it’s being debt-free, owning a home, or achieving financial independence. Detailed goals provide direction and motivation for your financial plan.
Create a Robust Budget: A flexible budget isn’t a one-time exercise but a living document that should evolve with your financial situation. It should reflect your income, fixed and variable expenses, and financial goals.
Establish an Emergency Fund: This is the bedrock of financial security. Aim to save three to six months’ worth of living expenses to protect yourself from unforeseen circumstances without falling into debt.
Pay Off Debt: High-interest debt is a major impediment to financial growth. Utilize strategies like the debt snowball or avalanche methods to tackle debts efficiently. Once you’re debt-free, avoid accumulating new debt.
Diversify Income Streams: Relying on a single source of income is a risk. Look for opportunities to create additional streams of income, such as side businesses, freelance work, or passive income from investments.
Invest Wisely: Make your money work for you through smart investments. Consider diversified portfolios, retirement accounts, and tax-efficient investment strategies to grow your wealth over time.
Plan for Retirement: The future is closer than you think. Contribute regularly to retirement accounts like 401(k)s or IRAs. Take advantage of employer match programs if available, as they’re essentially free money.
Protect Yourself with Insurance: Ensure you have adequate insurance coverage for health, life, property, and potential liabilities. This helps to guard against catastrophic financial losses.
Breaking the Cycle of Being Broke
Just like becoming broke is often a gradual process—a few uncalculated loans, hasty investments, and numerous credit card swipes. Suddenly, financial stability seems like a far-off dream.
The same goes for breaking the cycle of being broke. It is about moving from living paycheck to paycheck with no savings, drowning in debt, and making questionable spending decisions to become financially stable.
Even though our society may see being broke as normal, it is possible to embrace financial prudence to defy such norms. It’s time to delve into the reasons behind the perpetuation of brokeness and unveil practical steps toward lasting financial freedom.
What do I do if I’m broke?
Finding yourself in a financial predicament where the end of your money arrives before your next paycheck is a stress-inducing scenario.
When faced with the stark reality of being broke, here’s a step-by-step guide to help you navigate through and set the stage for a more stable financial future:
Assess Your Situation: Take stock of all your available assets and resources. This includes checking account balances, any savings, and items you could potentially sell for quick cash. Understanding what you have can help you gauge your immediate next steps.
Prioritize Your Expenses: Sort your expenses by urgency and necessity. Essentials like rent, utilities, and groceries come first. Non-essentials or discretionary spending should be paused or significantly reduced until your financial situation improves.
Reduce Costs Immediately: Eliminate any non-essential expenses. Cancel or suspend subscriptions, memberships, or services that are not vital. Consider cheaper alternatives for necessary expenses, and utilize community resources, such as food pantries, if needed.
Negotiate with Creditors: If you’re struggling to pay your bills, proactively reach out to creditors to discuss payment options. Many are willing to work with you on a revised payment plan to avoid defaults.
Seek Additional Income Sources: Consider taking on a side job, selling unused items, freelancing, or offering your skills for short-term gigs. Even small amounts of additional income can make a significant difference when you’re broke.
Consider Assistance Programs: Look into local, state, and federal assistance programs. You may be eligible for temporary aid to help with food, housing, or utility bills.
Borrow with Caution: If borrowing is unavoidable, be cautious and choose the most cost-effective options such as loans from family or friends, a personal loan with a low-interest rate, or a hardship withdrawal from your retirement account (as a last resort).
Remember, being broke can happen to anyone, so there’s no shame in it.
The key is to take swift, decisive action to mitigate the immediate crisis while also planning longer-term strategies to prevent recurrence. By addressing the issue head-on and adjusting your financial habits, you can initiate the journey from being broke to becoming financially buoyant.
FAQ: Navigating Away from Being Broke
Finding yourself consistently broke at the end of each month is an indicator that there’s a disconnect between your income and your spending habits.
It’s often the result of several factors or behaviors that, when combined, result in a cycle of financial scarcity. Here are common reasons why this might be happening:
No Budget or Poor Budgeting
Overspending
Impulse Purchases
Lack of Emergency Savings
Failure to Track Expenses
Living paycheck to paycheck
High Debt Payments
Remember, understanding why you’re broke at the end of the month is the first step towards financial stability.
Saving money when funds seem stretched to their limit is a challenge that requires creative strategy and discipline. Even with a tight budget, there are ways to eke out savings without significantly impacting your day-to-day life.
If saving a significant amount seems daunting, start by saving your change. Physically save coins or use apps that round up your purchases to the nearest dollar and save the difference. Check out my mini savings challenges.
Saving money when it seems there’s barely enough to cover the bills begins with a commitment to take whatever steps are necessary, however small they may initially seem. Every dollar saved is a step towards financial resilience and a buffer against future financial challenges.
Investing can be a powerful tool for building wealth over the long term, and it’s often considered a key component of achieving financial stability. However, for those who are currently struggling to make ends meet, the decision to invest should be approached with caution.
Investing typically involves committing money with the expectation of achieving a future financial return. It has the potential to outpace inflation and increase your wealth due to the power of compound interest. Nevertheless, it often carries the risk of losing the invested capital, a risk that those in financial distress may not be in the position to take.
Feeling Broke without Money – Time to Make A Change
Feeling broke is a stressful and demoralizing experience, but it’s also a clarion call for change. It signals that your financial health needs attention and that your money management strategies may require a significant overhaul.
However, the situation is not without hope; with determination and the right approach, it’s possible to transform your financial landscape.
The journey away from the precipice of being broke begins with honesty, introspection, and a willingness to adapt. It’s about confronting uncomfortable truths, devising a clear plan, and taking decisive action. From crafting and adhering to a precise budget, cutting unnecessary expenses, to seeking additional income streams—all these steps are essential in the path to financial stability.
Remember, feeling broke isn’t a permanent state. Mindset is everything.
It’s a challenge to be met, an opportunity for growth, and a chance to steer the course of your financial ship towards calmer and more abundant waters. Your future self will thank you for the changes you implement today, so take that first step now.
>>>It’s time to make a change—because you deserve the peace of mind that comes with financial security.
Source
Experian. “Experian Study: U.S. Consumer Debt Reaches $16.84 Trillion in Q2 2023.” https://www.experian.com/blogs/ask-experian/research/consumer-debt-study/. Accessed January 25, 2024.
Consumer Financial Protection Bureau. “Emergency Savings and Financial Security.” https://files.consumerfinance.gov/f/documents/cfpb_mem_emergency-savings-financial-security_report_2022-3.pdf. Accessed January 25, 2024.
Know someone else that needs this, too? Then, please share!!
Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
A college degree can be a major rite of passage and career stepping stone for millions of Americans. Putting one’s education to work can unlock professional rewards and a solid financial future.
However, there’s no denying that the cost of tuition can be daunting. The student loan debt balance has surged 66% over the past decade and, according to the Federal Reserve, currently totals more than $1.77 trillion (that’s trillion, not billion).
Having those payments unfurling before you can be stressful and frustrating, and the effects of student loan debt can be far-reaching. It can seem as if some of your personal, professional, and financial goals will have to wait until you can pay off what you owe. But there are ways to manage those loans and navigate this situation. After all, student debt is what you are going through, not who you are.
Here, you’ll learn more about student loan debt, how it can impact borrowers’ life decisions, and ways to minimize those effects and manage debt more effectively.
Student Loan Debt Statistics
To understand how impactful student loan debt can be, here’s some perspective. Consumer debt in the United States is measured by the Federal Reserve in five distinct categories — home, auto, credit card, student, and other debt.
Using the Federal Reserve Bank of New York data from 2023, here’s how household debt stacks up in the U.S.:
• Mortgage debt (excluding HELOCs, or home equity lines of credit): $12.14 trillion
• Student loan debt: $1.599 trillion
• Auto loan debt: $1.595 trillion
• Credit card debt: $1.079 trillion
Here’s how educational debt stacks up more specifically: In 2023, the average student loan borrower carried $37,338 in federal debt and $54,921 in private debt. 💡 Quick Tip: Enjoy no hidden fees and special member benefits when you refinance student loans with SoFi.
Impact of Student Loan Debt on Life Plans
Given the cost of student loan debt, some borrowers may delay big life decisions, such as buying a home or starting a family until they are further along in their loan repayment or have their debt totally paid off. Here are some specifics about the potential negative effects of student loan debt. Then, more happily, you’ll find tips on managing what you owe.
Homebuying
One landmark study in the Journal of Labor Economics found that a $1,000 increase in student loan debt lowered the rate of homeownership by approximately 1.8% for people in their mid-twenties who went to a public college for four years. This is equivalent to a delay of about four months in achieving homeownership per $1,000 in debt.
Indeed, as student debt has increased, homeownership among younger Americans has decreased. Experts, however, caution that this is a complex situation and not a matter of student debt meaning you can’t buy a house.
It’s true that student loans can raise a person’s debt-to-income ratio (DTI), a critical measure of creditworthiness. And it can slow an individual’s ability to save for a down payment.
That said, there are ways to get a mortgage with a student loan. By managing debt responsibly and building your credit score, you can achieve this goal. It’s also wise to look into the various mortgages available with as little as 3% down or even 0% for qualifying candidates.
Pursuing Graduate School
If you have undergraduate student loan debt, you may decide to delay or forgo enrolling in a graduate or professional degree program. Graduate school can often mean even more debt. According to the Education Data Initiative, the average graduate student loan debt is $76,620 among federal borrowers, with only 14.3% of that coming from the borrower’s undergraduate studies.
That said, an advanced degree can mean increased job opportunities. For example, the starting salary for those who majored in computer and information sciences of a recent graduating class was $86,964 with a bachelor’s degree and $105,894 with a master’s degree. And if you want to go to medical school, law school, or business school (which can lead to fulfilling and lucrative careers), you will need significant additional training. So it’s important to determine if taking out the debt is worthwhile vs. your anticipated earning potential.
Employment and Career Choices
What you’ve just read indicates some of the ways that student loan debt can impact your career plans. There are a couple of other ways that your loan balance might impact your career:
• If you have significant debt and are faced with the choice between your dream job at a lower salary and a basic job at a higher pay grade, you might opt for the one that fattens your bank account even though it doesn’t thrill you.
• Also, some companies (particularly those in the financial industry) may check your credit score as part of your job application. Student loans could build your score if you pay on time, and they could broaden your credit mix. But loans also create the opportunity to make a late payment or miss one entirely. Those are aspects of your payment history, the single largest contributor to your score. If you don’t stick to your schedule and pay what you owe every month, you could wind up with a lower score.
Marriage and Divorce
Student loans can also impact one’s personal relationships. According to a 2023 Student Loan Planner® survey, one in four borrowers said they delayed their marriage plans due to student debt. In addition, more than half of respondents (57%) said their student loans were a source of considerable stress in their marriage or relationship.
Marriage can impact your student loan payments, depending on the types of loans you have and the repayment plan you are on. If you are on an income-based repayment plan, your monthly bill might change based on how much you and your spouse earn and how you file your taxes.
Marriages and money can create complex situations that are hard to fully decode. When looking at the impact of student loan debt on divorce, it can be tricky to unravel the interplay of factors. One survey conducted a few years ago found that 13% of respondents attribute student loan debt as a cause of their divorce. Yet some couples with student loan debt were more likely to delay divorce due to their student loans and how it might impact their ability to repay their debt. So in matters of the heart and the wallet, there isn’t a clear consensus.
Recommended: How Marriage Can Affect Your Student Loan Payments
Starting a Family
According to the USDA and other government statistics, it can cost more than $330,000 to raise a child to age 18. That’s no small amount, and it’s a daunting figure for many. Those carrying a hefty amount of student debt may delay parenthood as they pay off their loans.
One landmark New York Times survey in 2018 found that among people who didn’t plan to have children at all, 13% said it was as a result of student debt. In a more recent study of those with high student debt, 35% said they were waiting to have kids due to the impact of their loans on their finances. Still others may respond to this scenario by adopting strategies to pay off student loans faster.
Saving for Retirement
One of the negative effects of debt on young adults is that their retirement savings can be impacted. A recent study conducted by Fidelity found that 84% of borrowers felt that their loans impacted their ability to save for their retirement.
A study from a few years ago bore this out: Research by the Center for Retirement Research at Boston College found that Millennials who had never borrowed student loans saved twice as much for retirement by age 30 as college graduates who have student debt.
Here’s another bit of intel that supports the fact that student debt can make it harder to save for your future. Fidelity also found that the percentage of student loan borrowers who put at least 5% of their salary into their retirement plan rose from 63% to 72% during the Covid-19 loan payment pause.
Delaying retirement savings can mean playing catch up in your later years. Typically, the earlier you start saving for retirement, the more time your money will have to benefit from compound interest.
It can seem overwhelming to start saving for retirement while you’re still paying off student loan debt, but doing both at the same time can help you meet your financial goals in the future. 💡 Quick Tip: Refinancing could be a great choice for working graduates who have higher-interest graduate PLUS loans, Direct Unsubsidized Loans, and/or private loans.
How to Manage Your Student Loans
As you’ve just read, student loans can impact many areas of your life. But you are not alone in this situation, and your loans will not be with you forever. Focus on smart solutions to help you manage your debt repayment. Consider the following strategies.
Keep Paying
Even when money is tight, it’s wise to pay on time, as much as possible. Timely payments are the single biggest contributing factor to your credit score, an important financial metric. So do your best to keep current on those monthly installments.
Make a Budget
It’s hard to effectively manage your student debt and your finances in general if you don’t know how much money you have coming in and going out. If you don’t yet have a budget or yours isn’t working well for you, commit to reviewing different budgeting methods and finding one that works.
This process of tracking your money and possibly trimming your spending could reveal ways to free up more funds to pay off your debt.
Repayment Plans
There are federal student loan repayment plans that base your monthly payment on your income or ones that give you a fixed monthly payment. Those that are based on your income may help you lower your monthly payment.
It can be worthwhile to consider your options. For fixed payments, you may have a choice between standard, graduated, and extended plans. If you focus on income-driven repayment (IDR) plans, you will likely review the SAVE Plan (which replaces REPAYE), PAYE, IBR (income-based repayment), and ICR (income-contingent repayment) plans. With IDR plans, once you satisfy a certain number of months of qualifying payments, you can be eligible for forgiveness on the remaining balance of your loan(s).
Deferment and Forbearance
If you are finding it challenging to pay your federal student loans, you may be able to take advantage of deferment or forbearance, which are both ways of pausing or lowering your payments for a specific period of time. Perhaps you haven’t yet found a job after graduation or have another situation that is impacting your ability to pay; these programs can help qualifying borrowers out.
The main difference between is that during deferment, borrowers are not required to pay the interest that accrues if they have a qualifying loan. With forbearance, however, borrowers are always responsible for paying the interest that accrues, no matter what kind of federal loans they have.
Forgiveness
Here’s another path to lessening the impact of student loans on your life: forgiveness, which means you may not have to pay back some or all of your federal student loans. For these programs, there are a variety of qualifying factors, such as whether you’re a teacher, government employee, or worker at a nonprofit. Other factors could be that you have a disability, your school closed, or you declared bankruptcy, among others. It’s worthwhile to research your eligibility because the upside could be significant.
Recommended: A Look at the Public Service Loan Forgiveness Program
Refinancing
Another possible way to reduce the impact of student debt on your life is student loan refinancing.
When you refinance your loans you take out a new loan with a private lender. Depending on your credit history and financial profile, you can qualify for a lower interest rate, which could substantially lower the amount of money you pay in interest over the life of the loan (depending on the term you select, of course). Two important notes about this:
• When you refinance federal loans with a private loan, you forfeit federal protections and benefits (such as the forbearance and forgiveness options mentioned above).
• If you refinance for an extended term, even though your monthly payment may be lower, you may pay more in interest over the life of the loan.
To see how refinancing could help you manage your student loans, take a look at an online student loan refinance calculator.
The Takeaway
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
SoFi Student Loan Refinance If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.
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