Confused about money? You're not alone. Throughout history, thoughtful people have differed about what money is and what it does. "Time is money," said Benjamin Franklin. "Money is like muck," opined Francis Bacon, "not good except it be spread."
But what do you need to know about money? Just 10 things:
1. Know what you've got and what you want.
By now, Irene Freeman can summarize consumer money problems in one (albeit compound) sentence:
People in financial trouble don't know how much they have; they spend more than they earn, and they've never figured out how money fits into their everyday lives.
As president of Consumer Credit Counseling Services in San Diego, Freeman advises hundreds of people each year to start with a plan that covers three things: what you want, what you spend and what you've got.
Financial planning is like planning a trip. What you want--your financial goal--equates to the destination. What you spend--your budget--is how you'll get there. And what you've got--assets minus liabilities--shows how far you've come and how much farther you have to travel.
Without this financial road map, you're likely to meander through life never quite getting where you want to go.
2. You don't need cash for emergencies.
Age-old financial-planning wisdom says you ought to have six months' to a year's worth of earnings squirreled away in a bank account just in case your financial house caves in.
While it may make you feel warm and cozy to think you've got money in the bank, that cozy feeling can cost a fortune--especially if, like most people, you also have credit card debts.
The reasoning boils down to simple mathematics.
In today's market, you're going to earn 2% to 3% on your savings--and part of that is going to be taken away by income taxes. Meanwhile, you'll probably pay 10% or more on your credit card debt. That means you're losing at least 7% on every dollar that's kept in the vault rather than used to pay off your credit cards. On a $5,000 debt, that sets you back $350 to $400 annually.
The better option is to use your emergency fund to pay off credit cards, then use your credit cards if you're ever faced with an emergency. Untapped borrowing power is the same as money in the bank when it comes to handling financial crises, said Tim Kochis of Kochis & Fitz, a personal financial consulting firm in San Francisco.
The only time that advice doesn't ring true is when you can earn more on your investments than you pay on your borrowings. If your money is invested in a bank account, that's hard to do.
3. Being penny-wise isn't always pound-foolish--but it can be.
There are plenty of good ways to cut expenses, from refinancing your home mortgage to comparison shopping and clipping coupons.
But penny-pinchers should be careful not to alter their buying habits simply because something looks like a bargain, said Amy Ost, academic associate at the College for Financial Planning in Denver.
For instance, buying in bulk from clubs and warehouse stores has become a trend. On the surface, it seems you can save a bundle by buying your Raisin Bran in 64-ounce packages at 10 cents an ounce rather than in 20-ounce packages at 20 cents an ounce. But a surprising number of people waste food when they buy in large quantities, simply because they can't eat it fast enough to avoid spoilage, Ost said.
If you're shopping at warehouse-style supermarkets, limit your buying to foods that keep well--or that you eat in quantity. Saving $3 on a 20-pound bag of apples doesn't do any good unless you're ready to eat a whole lot of applesauce.
"Sale" shopping can also be costly, because many people focus more on the price than whether they need the item, credit counselor Freeman said. She warned shoppers never to leave home without a list of exactly what you need, specifying how much you can afford to pay for it. And never deviate from the list.
This strategy is particularly important during the holidays, when merchants vie for your business with flashy displays and promises of cut-rate prices. Impulse shopping--what most people do at sales--is the most penny-wise, pound-foolish of all.
4. A penny saved won't buy diddly. But several dollars wisely invested become a fortune.
Saving even a small amount each month is important for two reasons: It can help you accumulate a substantial nest egg for retirement, and it gets you into the healthful habit of spending less money and setting aside more.
Think of it this way: If a young person saves $1.50 a day, that adds up to about $50 a month. Put that in long-term Treasury securities paying 6% and in 40 years you'll have about $100,000. Invest it in the stock market, assuming a relatively conservative average return of 8%, and you'll have more than $175,000; at 10% interest, you'd accumulate more than $300,000.
If you start saving late--or invest poorly--building a nest egg is far more difficult, says Ost.
Consider someone who starts saving at age 35 instead of age 25. That same $50 monthly investment amounts to just $50,226 in 30 years, assuming it's invested at a 6% rate of interest. Increase the interest rate to 8% and this investor nets $74,517, Ost said.
Worse yet, if the money is in a 2% passbook account, your savings--about $25,000--won't even buy a new Hyundai in 2023.
5. You already know everything you need to invest wisely. You just don't know what you know.
If you're like most people, you find the concept of investing a bit intimidating. Whenever you get near financial professionals, they throw some term at you, like subordinated debenture, inverse floater or price-earnings ratio. And you walk away thinking you were out of your depth.
In fact, a dictionary of financial jargon would show that the most complicated terms are reserved for the most miserable investments. "If the broker can't explain it to you in 10 minutes, forget it," said Frank Glaser, a seasoned Los Angeles area investor.
Indeed, investing is easy--and you already know how to do it, according to Peter Lynch, one of the nation's most successful investors. You simply need to apply what you know.
Lynch is the former manager of Fidelity Investment's Magellan Fund and the author of two books on investing, "One Up on Wall Street" and "Beating the Street." If you invested $1,000 in Magellan when Lynch started managing it in 1977, you could have cashed out with $28,000 when he retired 13 years later.
His secrets: Invest in stocks. Invest in stocks you know. And "never invest in any idea you can't illustrate with a crayon."
To show just how simple it is, "Beating the Street" tells the true story of Ms. Morrissey's seventh-grade social studies class at St. Agnes School in Arlington, Mass. Ms. Morrissey set out to teach the class about investing. She had the students split up into groups and pretend to invest $250,000. Her rules were simple: Each portfolio needed at least 10 different stocks, with at least one or two that paid a decent dividend. Students could not invest in a company unless they knew what it did. And once they picked some good prospects, they had to research the firms' fundamentals--earnings, debt, growth and so on.
Over a two-year period, the students' portfolios gained 70% in value, compared to a total return of 26% for the Standard & Poor's 500 index.
What did they buy? Walt Disney, because they liked its movies and theme parks. Pentech, because they used the company's markers. Nike, Gap and Limited, because they liked their clothes and shoes.
You get the idea.
6. No matter how old you are, you have to do your homework.
To say that investing is easy doesn't mean there is no work involved. Good investors, like the students at St. Agnes, do their homework.
That means identifying companies or mutual funds that interest you because you like their business, their products or their strategies, then poring over their financial histories with a fine-toothed comb.
The process is a great deal easier if you use a handful of readily available tools. If you are investigating an individual stock, your tools should include Value Line investment surveys, your brokerage firm's research reports and financial articles and analyses of the company. Aside from the brokerage reports, you generally can get all this information at a public library.
You'll also want to hit the library if you're researching a mutual fund. Look for Morningstar mutual fund reports, magazine articles and rankings of mutual funds. Most financial magazines publish at least one comprehensive comparison of funds each year.
Your final bit of research on a mutual fund should be the fund's own financial documents, including a prospectus and annual report that spell out the fund's risks, rewards and fees.
If investing still sounds tough, contact the National Assn. of Investors Corp. in Royal Oak, Mich., and ask about their home study course. NAIC can be reached at (313) 543-0612.
Or buy a book. Either of Lynch's is a good choice, and so is "Kiplinger's Invest Your Way to Wealth."
7. The last person to look after your best interests was your mother.
"He kept saying, 'Trust me,' " lamented Lanell Mabry. "I never talked to him when he didn't say, 'Trust me. I'll look after you.' "
Mabry, 67, told a broker she needed somewhere safe to invest her modest savings--an investment she could tap quickly if she needed money to care for her 93-year-old mother. The Prudential-Bache broker put her into a partnership that paid him and Prudential a fortune, but left Mabry twisting in the wind.
The Temple, Tex., woman fell into a relatively common trap. She didn't do her own research because she thought she could trust somebody else to look after her financial affairs.
"Consumers have to realize that somebody who is selling you something is doing it for a purpose, and that purpose is to make money on the sale," said Joseph Goldstein, associate director of the Securities and Exchange Commission's enforcement division in Washington.
"Be skeptical of what strangers tell you over the phone," Goldstein counseled. "They are not your mother, your father or your friends. They are not going to do something special for you. What they want from you is your money."
That's particularly important advice now, because so-called affinity fraud--preying on members of religious organizations, ethnic minorities or any other identifiable group--is proliferating. You could be taken by a member of your church. A business associate. A classmate. A cousin.
While there are plenty of honest brokers, insurance agents, financial planners and the like, an investor's best protection against a scam--or simply bad financial advice--is his or her own knowledge of what the investment is and how it works.
If you don't understand it, don't invest, Goldstein said.
8. Financial regulators can't protect you. They can only prosecute after you've become a victim.
Many consumers go to the SEC, the National Assn. of Securities Dealers or state securities regulators after they've lost their money, crying, "Why didn't you protect me?"
Regulators have a simple, if unsatisfying answer: "We can't."
Financial regulators can promote reasonable laws--such as requiring disclosure and prohibiting misrepresentation. And they can establish a reasonable means of overseeing compliance with those laws. If the laws are broken, they can prosecute.
But regulators cannot make you read the disclosures. They cannot prevent you from investing in things you don't understand. They can't make you hang up on telephone con artists. And they can't stand over the shoulder of every broker and salesperson to make sure they follow the rules.
"It's analogous to traffic laws," said Marianne K. Smythe, a former SEC enforcement director who is now a partner with the Washington law firm Wilmer, Cutler & Pickering. "There are speed limits and traffic lights and a reasonable number of policemen, but when the light changes, you still need to look around to make sure that no one is speeding your way."
Said Smythe, "It does no good to say 'I was in the right' from your hospital bed."
9. You don't need to be an economist to figure out which way the wind is blowing.
When will employment pick up? When will interest rates rise? How do you know if the time is right to refinance debt or make a major purchase?
Many people think that only economists and market professionals can answer these questions. In fact, if you keep your eyes open and apply one of the most pervasive economic laws--that of supply and demand--you can do a pretty good job of predicting trends yourself.
Supply and demand is something familiar to every consumer. Consider pumpkins:
Just before Halloween, everybody is out combing supermarkets and pumpkin patches for the perfect Jack-o'-lantern. Because there are so many buyers (demand) and a limited number of perfect pumpkins (supply), the price skyrockets.
But on Nov. 1, demand for pumpkins plunges well below the available supply. The value of even the most pristine gourd falls to a few pennies a pound.
Similarly, when everybody wants to buy a particular company's stock, the price will rise until the number of buyers willing to pay that price is equal to the number of people willing to sell for that amount.
Likewise, when a lot of people are borrowing and few are saving, loan rates tend to rise. When everybody's saving and few are borrowing, loan rates fall. There's simply more money available than there is demand for it.
How do you know where supply and demand are shaking out at any given time? Read the paper; talk to friends and relatives. When most everybody starts talking about spending rather than saving, get ready for interest rates and prices to climb.
10. Education costs a lot, but it also pays.
Every parent has heard the horror stories. The cost of a college education is rising far faster than the rate of inflation; some predict it will cost $100,000 or more to send a child to a private college in 2000.
Nonetheless, education pays off.
The average college graduate earns about 30% more than a high school graduate, Department of Education statistics show. Over a career, that difference adds up to more than $600,000. If you include the money you could earn by investing the additional income over the years, it adds up to millions of dollars.
Moreover, experts say that having a college diploma may be pivotal in the coming decade's labor market. That's because the job categories that are expected to expand most are those that require two- or four-year degrees.
How Americans Spend Their Money
On average, Americans spend nearly every dollar they get their hands on, laying out more to keep roofs over their heads than anything else.
Income taxes: 9.2%
Apparel & services: 5.0%
Health care: 5.0%
Social security, pensions and insurance: 8.1%
Miscellaneous (including charity tobacco and education): 9.7%
Savings and investment: 2.6%
Source: Bureau of Labor Statistics