4 Signs You're Financially Clueless
If you're among the many Americans who are falling behind with finances, you're not alone. I've pinpointed some of the most obvious signs that it's time to increase your knowledge in money management. Before you start reading, take our quiz and put your knowledge to the test!
Quiz: How much do you know about your personal finances?
(Put your mouse over the quiz and scroll down. There are five questions.)
Looks like many of you scored well on our quiz. Here's the breakdown for answers -- how did you do, compared to other readers?
Question 1 -- 61% correct; 34% incorrect; 6% skipped
Question 2 -- 99% correct; 1% incorrect
Question 3 -- 67% correct; 28% incorrect; 5% skipped
Question 4 -- 96% correct; 4% incorrect
Question 5 -- 81% correct; 19% incorrect
The average score was 80%! To take our more difficult quiz, scroll down to the bottom!
1. You're putting off retirement to pay down student loans
I know what you're thinking. Student loan debt is arguably the biggest financial obstacle the millennial generation is facing these days. Some 40 million Americans are in hock to student lenders to the collective tune of over $1 trillion.
Since bankruptcy relief is only available in the strictest of circumstances, the vast majority of borrowers are stuck making their payments. Those who can't keep up end up in default, which can be extremely damaging to your credit. So what sense does it make for 20-somethings to think about saving for a future that's 30 or 40 years away when they want to get the student debt burden off their shoulders now?
The answer is pretty simple. Unlike a college education, you can't finance your retirement. The longer you wait to start saving, the less time your money has to grow. Not only that, but the earnings you could see from investing your extra cash could easily outstrip the interest you're paying on your loans.
Here's an example to illustrate my point. Let's say you owe $30,000 with a 6 percent interest rate and you're on a 10-year repayment plan. Your regular payments are $330 but you're paying an extra $200 a month to get rid of them faster. If you did that, the loans would be gone in about 5 1/2 years and you'd pay about $5,000 in interest versus $10,000.
Now, assume you took that $200 a month and invested it in an Roth IRA for 10 years while still making the regular payments on your loans. After a decade, you'd have zero loan debt and about $35,000 in your retirement account, which puts you in the black by a margin of $25,000. If you put the money into your 401(k) with an employer match, your fledgling nest egg could be even bigger.
Tip: If you don't have access to a 401(k), you can still begin building your retirement savings if your employer offers a high deductible insurance plan with a Health Savings Account. The money you contribute to these accounts grows tax-free and withdrawals made after age 65 are penalty-free, regardless of whether it's used for a medical expense.
2. You're still using a regular savings account
If you've been working on building up an emergency fund to cover any out-of-the-blue expenses that come up, give yourself a pat on the back. According to a recent survey from NeighborWorks America, 1 in 3 adults say they have nothing saved at all. Nearly half of those surveyed said their savings would only last three months or less.
Saving for rainy days is a step in the right direction but that doesn't mean you have to settle for sticking your money in a regular savings account. Interest rates, as meager as they currently are, tend to be higher for things like CDs, money market accounts and high-yield savings accounts so it's to your benefit to see what else is out there.
Getting the best rates may mean moving some of your money to an online bank, but there are some other advantages to making the shift. Online banks tend to charge fewer fees, which is good news if you have an occasional problem with overdraft. Unlike bigger banks, which have strict minimum balance requirements, most online banks won't penalize you if your account sometimes runs low.
Tip: Federal Regulation D limits you to six withdrawals a month from a savings account. If you go over that amount, your bank may charge a penalty or convert your account to checking instead.
3. You're spending too much of your income on housing
As a general rule of thumb, financial experts recommend spending no more than 30 percent of their income on housing costs. If you're paying on a mortgage each month, meeting that standard may not be difficult since your income factors into how much you can borrow. If you rent, on the other hand, staying under the 30 percent limit is a lot more difficult these days.
Renting is an especially big money-suck for millennials, who may not be in a position to buy because of their student loan debt. Elite Daily's 2015 Millennial Consumer Survey found that 96 percent of young adults spend as much as 50 percent of their pay on housing costs. Saying goodbye to half your paycheck each month makes no sense at all from a financial perspective but the trend continues.
So what can you do? Moving to a less expensive area is one option, but it's not always feasible. You could move back home with Mom and Dad temporarily, but it may not be an option, depending on your situation. Taking on a roommate, on the other hand, instantly cuts your rent cost in half, along with your utility bills. Living with someone else may not seem ideal but it frees up extra cash that you can use to attack your debt or increase your savings.
Tip: If you don't like chasing after your roomie for their share of the bills, use an app like Venmo to split expenses. You can send money back and forth to one another right from your mobile devices and it's free if you link up your bank account or a qualifying debit card.
4. You have no idea what your credit score is
Credit scores are important for a couple of different reasons. First, they're used to determine whether you can qualify for loans or lines of credit, which is important if you're planning on buying a car or applying for a mortgage. Second, they influence what kind of interest rates you'll be approved for. FICO scores range from 300 to 850 and the higher your score is, the more attractive you are to lenders.
If you don't know what your score is or even how it's calculated, you're doing yourself a major financial disservice. Paying your bills on time accounts for 35 percent of your score and even one late payment can knock points off. Running up your balances, applying for multiple credit cards in a relatively short period of time or closing down accounts you're not using all negatively impact your score.
Tip: Certain credit card issuers, including Discover and Capital One, offer customers free access to their credit scores each month. If you regularly use Mint to manage your budget, you can also check your score using the app.
Millennials are notoriously leery about using credit cards but if you're paying your balance off on time each month, that's a pretty fast and easy way to beef up your score. If you choose a rewards card, you could even earn some cash back or travel miles in the process.
Quiz #2 below is more difficult: how did you do?
(Again, there are 5 questions -- scroll down when your mouse is on the quiz.)
Update 4/24/15: It looks like the hardest question was #5 -- only 56% got it right. The average score was about 74%.
Question 1 -- 74% correct; 26% incorrect
Question 2 -- 74% correct; 16% incorrect; 9% skipped
Question 3 -- 95% correct; 5% incorrect
Question 4 -- 72% correct; 14% incorrect; 14% skipped
Question 5 -- 56% correct; 26% incorrect; 19 skipped
If you took any of the financial literacy quizzes, don't be shy about sharing the results. Leave a comment below, telling us how you did.