The Index Card: Why Personal Finance Doesn't Have to Be Complicated

by Helaine Olen

But as Pound Foolish showed, many of our financial problems were not the result of our financial missteps. They were caused by economic trends and recessions and then compounded by the failure of financial regulators to crack down on bad behavior by those who claimed to be offering us help.

Harold came up with the concept of the index card not as some academic experiment but as a practical solution to the kinds of urgent financial problems many of us encounter at some point in our lives. As he explains,

The most important advice was embarrassingly simple. It included the following: Save 10 to 20 percent of your money—or as much as you can, if you can’t put that much aside. Pay your credit card balance in full every month. Invest in low-cost index funds.

Most important: Harold originally suggested that people save 20 percent of their pretax income. It’s a terrific goal. It’s also all but impossible for many of us. Aiming for 10 to 20 percent is a more realistic long-term strategy.

outlined on our index card, you will have the confidence to make your own financial decisions; discover basic financial truths such as that low-fee index funds outperform just about any more complicated investment you can buy and that simple fixed-rate mortgages remain the best way to borrow money to buy your house; be armed with a timeless set of guidelines that you can turn to no matter what financial issues you may face or how drastically the winds of financial change shift; and be sure you never make the same mistake Sam made and let your fears about the financial unknown prevent you from doing anything.

Take car repairs. Do you know anyone who ever planned for a broken-down car? On the other hand, do you know anyone who has ever had a car that didn’t break down?

For all too many of us, wages began to stagnate and fall. Accounting for inflation, the annual median income of American households declined by about $3,000 between 1998 and 2013. At the same time, income inequality has increased. Almost all gains in household income and wealth in the past several years have gone to the top 1 percent of the population, even the top 0.1 percent.

According to economists Marianne Bertrand and Adair Morse, authors of a paper called “Consumption Contagion,” the more the wealthier people at the top of the income ladder spend on high-status luxury goods, the greater the pressure to keep up across the income spectrum. This “trickle-down consumption,”

reduces the savings rates for all too many of us. The result? Our national savings rate has been in the low single digits for twenty-five years. A little more than a quarter (27 percent) of American households have net worths of $5,000 or less. 47 percent of us report that we could not come up with $400 if we needed to without selling something, resorting to increased credit card debt, borrowing from a friend or relative, or taking out a payday loan.

The more little decisions you need to make, the less likely you will be able to get the big ones right. Our money muscle doesn’t strengthen. It weakens from stress and overuse.

How much should we save? you ask. Well, the title of this chapter pretty much says it: Ten to 20 percent of your gross income, the amount listed on your paycheck before taxes and everything else are taken out.

You need to determine what day-to-day spending is necessary and unavoidable, what is a luxury but helps you get through the day, and, finally, what is excess. Only then can you avoid falling prey to spending traps.

Step 1: Monitor Your Spending For three months, keep track of everything you spend money on, no matter how small.

Websites, programs, or apps like Mint.com and Quicken .com will automatically collect and categorize every credit or debit card transaction.

Step 2: Confront Your Spending At the end of the first month, look over your categories, and see how much you are spending in each. The first month will give you a sense of your recurring, nonnegotiable, nondiscretionary expenses: rent or mortgage, health insurance, car payments, gas, child care, and so on.

Step 3: Refine Your Expenses over Time If you monitor only one month of spending, you won’t gain a full picture of where your money goes. Routine but sporadic expenses such as car repairs, doctor bills, and the emergency trip to the cat’s vet are more likely to occur over a several-month period.

Step 4: Create a Plan A realistic spending and savings plan accounts for how much you earn and how much you wish to spend, and it leaves room for flexibility:

While many people call this budgeting, it’s more helpful to think of it as surfing a financial wave.

Step 5: Make Sure to Leave Room for Fun See a movie, attend a concert, eat dinner out with a loved one a few times a month. Remember, starvation budgets work no better than starvation diets.

What constitutes an emergency? An emergency is an expense that is both immediate and absolutely necessary. It almost certainly implies something bad has happened. An emergency is . . . root canal when the car breaks down on the side of the road any important or urgent medical matter when the heater blows in your home—and it’s 22 degrees Fahrenheit outside losing your job—and with it your regular paycheck

To build your emergency fund, start stashing away three months of living expenses in an accessible savings account.

We mean three months of your nonnegotiable living expenses, things like mortgage payments and grocery bills. This will give you breathing room if you suddenly lose a job while also offering a source of cash for the unexpected doctor bill.

Unless you are a crazed shopaholic with the discipline of a dog eyeing a rare sirloin, count on your nondiscretionary expenses such as housing, transportation, and health care as being your largest outlays.

The experts say we should not spend more than 50 to 60 percent of our take-home pay on such expenses.

Helaine likes to call this the non-latte factor. You’ve all heard of the Latte Factor. That’s the term trademarked by the financial guru David Bach, who says if we just give up a $5 small luxury a day, we can retire millionaires. But if that were all it took, most of us would be millionaires already.

Your biggest outlays—like your house, like your car—are your biggest problems. It’s important to get these right in the long run, but these expenses are harder to control in the immediate future. So what to do?

Take all monthly bills and give them a good inspection. It’s unlikely you can eliminate your cell phone bill, but does it really need to be that high? You’ll likely notice fees and charges you don’t understand. Ask someone to explain them to you. It’s almost certain that either you are paying for things you don’t need or you can negotiate for a lower monthly charge. Do you really need to rent that cable modem?

(No.) Can’t you live with a higher deductible on your home or auto insurance? (Almost certainly.)

Scrutinize every line item on that monthly credit card bill. Harold found one exercise to be very useful. Imagine that someone stole your credit card and you had to cancel it. When your new card arrives, would you re-up for every magazine, iPhone app, or whatever else you’re automatically paying for right now? When Harold performed this exercise, he discovered many accumulated items. Some had festered for years, including the $10 monthly charge for a wireless hot-spot service he never us...

According to the market research firm Natural Resources Defense Council, the average American family of fou...

One way to cut back on spending is mind-numbingly simple but very hard to do in our society. Say good-bye to plastic and all virtual money. Studies have repeatedly demonstrated we will spend more—upward of 20 percent more—when we don’t have to handle physical, paper dollar bills.

marketing at Cornell University, consumers will impulsively purchase more junk food at the supermarket when they use a credit or debit card over cash.

AUTOMATIC SAVINGS PLAN So how do you pry that money out of your wallet and get it to start working for you, not against you? Make it automatic.

DON’T PRIORITIZE EMERGENCY SAVINGS OVER CREDIT CARD DEBT

Almost no one goes into credit card debt deliberately. Just ask Harold.

Many of us spend a lot of our lives in debt. Average credit card debt per U.S. household now exceeds $7,000. But it’s actually worse than that. A little more than half of us manage to pay off our credit card bill in full every month.

It’s almost certain the secret to our grandparents’ extraordinary financial discipline was a result of the four Ls: lack of access to credit layaway plans loved ones loan sharks

Hospitals and doctors and dentists—not to mention veterinarians—now offer access to fast credit via CareCredit. And we haven’t even gotten to subprime auto loans, payday loans, pawnshops, rent-to-own, refund loans, loans disguised as convenient payment plans, and other adventures in high-interest lending that capitalize on consumers’ impatience, innumeracy, or simple despair.

Well, the real money for credit card issuers is in making sure people who can’t or don’t pay off their bills in full load up on credit, then charging them for the privilege. As a result, they don’t want you to manage your money responsibly. If you do, they’ll call you a deadbeat. Why? They don’t make any money off you. If you use your card to buy something like an appliance, then pay off your bill at the end of the month, you are costing them money because they can’t charge you any fees.

A “DEADBEAT”: PAY OFF YOUR BILLS EVERY MONTH It feels as if we can never escape. But we can. We just need to try to surmount the temptation, not to mention the need, to use high-interest credit to get by. High-interest debt can grow so fast it will overwhelm your other savings and investments. There is no better way to simplify and gain control over your financial life than by eliminating high-interest debt.

Think of it this way: The average interest rate on credit card balances is around 15 percent. On store-branded cards, it is higher, often between 20 and 25 percent. That’s the rate of return you receive, tax-free and risk-free, when you pay that debt down.

When you receive a statement from a credit card company, it will come with a minimum payment requirement. That minimum payment amount listed on your statement is not a recommendation. Unfortunately, all too many of us take

Why are so many of us paying only the minimum? Many of us probably can’t afford to pay more. But others are likely falling prey to a concept cognitive psychologists call anchoring.

RANK YOUR DEBT Can’t pay all your bills off right away? Then you need to begin by ranking your debt. Sit down with all of your bills. That’s right, all of them. Not just credit cards. But car loans and student loans too. You need to work out the following: 1. What you owe each lender 2. What the interest rate and other expenses are for each loan

within your spending and savings plan. Emotionally, it might be a difficult

It’s okay to acknowledge the mistakes and the roads not taken. But then it is time to take action.

The interest rate you are charged on your credit card is called the annual percentage rate, often shortened to APR. At the beginning of 2015, the annual median rate offered is in the midteens,

You have at least twenty-one days from the day the bill is mailed to pay your bill without incurring interest charges. Pay your credit card in full—like one-third of all customers—and you are indeed receiving an interest-free loan. If you don’t, the interest immediately begins to accrue. And once you miss a full payment, you’ll pay a high interest rate on your balance all the time, until the next time you pay your entire bill.

At the end of three years, these strategies yield very different results. Without paying a penny more, you save almost $1,000 by prioritizing your most costly debt.

Some argue for a different strategy: Make a list of all the debts, and pay them down in order from the smallest to the largest. You can think of this as the momentum method. Does this approach work better? For some people, maybe. A study published in 2012 by two professors at Northwestern University’s