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How South Dakota Is Making the Rich Richer and You Poorer

The Pandora Papers that were recently released confirmed that the ultra-rich will do almost anything to skirt taxes, but a shocking revelation from the documents was that the elites don’t need to go as far as we thought to do it. They can shelter their money right on American soil in South Dakota.

Realizing that the super-rich don’t need to send their money to places like the Cayman Islands or the Bahamas to avoid paying their fair share of taxes is disheartening, but what’s even worse is that the South Dakota laws that help the wealthiest people in the world avoid paying taxes, were set in motion by ones that hurt everyday Americans. This is how South Dakota became a favorite of the ultra-rich and a burden on everyone else.

The Prologue

It all started back in 1927 with the passing of the McFadden Act. Before this act, banks could either be chartered by states or by the federal government. Basically, a bank’s charter dictates how they’re allowed to operate. Before 1927, federally chartered banks were only allowed to operate out of one building, which meant that they couldn’t open any branches. Many states, however, had far less limiting restrictions on a bank’s ability to open branches. The passing of the McFadden Act allowed federally chartered banks to operate under the branch guidelines of their state, meaning if their state allowed it, they could open more branches. 

Still, interstate banking, or allowing banks to cross state lines, was a big no-no, but that didn’t stop banks from figuring out how to do it. Banks wanted to expand their operations into different states because this diversified their operations. If you were only allowed to bank in a single state and that state faced an economic crisis, your bank had to cross its fingers that it would be able to weather the storm. By diversifying across states, the other banks could help float the parent company while one bank was struggling. This is the same thinking behind diversifying your investment portfolio.

To diversify across states, banks created bank holding companies. These holding companies could purchase banks across many states and since these banks were considered independent of each other, doing this was not a violation of the law. This loophole and other concerns with the business practices of bank holding companies led to the passing of the aptly named 1956 Bank Holding Company Act. This act defined what a holding company was and stipulated that for a holding company to expand its banking operations into another state, it needed approval from the Federal Reserve Board. 

Getting approval from the Federal Reserve board was tricky because the act required the Board to get the opinions of state banking regulators in the state where the holding company wanted to expand operations. Since state and community banks fought to keep new and bigger competition from entering their territory, this act made expanding a holding company’s banking operations into a new state nearly impossible.

How South Dakota Became a Finance Mecca

Marquette National Bank v First of Omaha Services Corp

Fast forward to the late 1970s and all of these banking regulations were putting a strain on banks. Without being able to expand, banks had to abide by the usury limits in their state while inflation was soaring.

Usury limits are interest rate caps on the loans commercial banks make to customers, like you, and are set by each state. Banks make money by taking the money their customers deposit and then lending it out and charging interest on those loans. If inflation is higher than the interest rate a bank can charge, the value of the cash they’re lending will decrease by more than what they can earn in interest on their loans. In this economic climate, banks were losing money every day.

Without the ability to expand operations to other states with higher usury limits, banks were stuck trying to juggle rising inflation and stagnant interest rates, but a supreme court decision in 1978 would shift the banking landscape. 

That supreme court case was Marquette National Bank v First of Omaha Services Corp. This case allowed a bank to charge an interest rate based on the usury rate in the state where the lending decision was made, not the state where the money was being lent. For example, if you live in Kentucky and take out a loan from a bank operating out of South Dakota, the interest rate you’re charged is based on the usury limit of South Dakota, not Kentucky.

By 1980, South Dakota was passing legislation to eliminate their usury limit, which meant banks operating out of South Dakota could charge rates above the rate of inflation (or really any rate they wanted as long as people were willing to pay it) and start making a profit again. The only problem that remained was the difficulty banks had with getting approval to cross state lines. 

The Arrival of Citibank

After the Marquette National Bank v First of Omaha Services Corp court case, banks were looking for opportunities to expand their lending operations, and credit cards were a great way to do it. Credit cards could be issued from a state like South Dakota with no usury limit and used by people everywhere. 

Citibank had heavily invested in expanding into credit cards, but because inflation was outpacing New York’s usury limits, by 1980, they had lost over $1 billion on their expansion. That’s when Citibank contacted the South Dakota governor about moving its credit card operation to the plains state. This would allow Citibank to charge interest rates on their credit cards that were higher than the rate of inflation and make their credit card operations profitable again. But Citibank still needed the OK from South Dakota to move their operations.

While the governor of South Dakota claims that he didn’t abolish the usury limit to attract the finance industry, he needed jobs to come to South Dakota as desperately as Citibank needed to make their operations profitable. So, when the CEO of Citibank called the governor of South Dakota and asked if they would invite Citibank into the state, he agreed. 

Not only did the governor say yes, he actually had Citibank draft the legislation that he quickly got passed through the state government. (Are your conflict of interest alarm bells ringing? Because mine are!) With South Dakota’s lack of usury limits, their willingness to let it new banks, and incredibly low wages compared to other states like New York, more big banks began flocking to the region in hopes of using high credit card interest rates to boost their profits.

Summoning the Super-Rich

Soon after abolishing usury limits, South Dakota also abolished the rule against perpetuities. This allowed for what are referred to as dynasty trusts. The super-rich love these because they can be used to pass money down from generation to generation, forever, while avoiding federal estate taxes. 

On top of being able to avoid federal estate taxes, up until 1986, South Dakota was the only state that allowed dynasty trusts and had no state income tax. As a little icing on their tax cake, South Dakota also does not tax capital gains. This allows trust beneficiaries to avoid paying state taxes on trust income and any distributions they receive.

In addition to its generous tax laws, South Dakota also has extremely favorable privacy projections for trusts. It is the only state that has automatic total seal privacy for all court matters involving trusts. That means that all court documents and proceedings are automatically sealed from the public indefinitely. Most other states make court documents on trusts public except for Delaware, which seals the documents for three years.

This cocktail of tax benefits and extreme privacy laws have made South Dakota one of the biggest tax havens in the world, housing nearly half a trillion dollars in trusts. 

What This Means For You

The lack of banking regulations in South Dakota created a thriving credit card industry, and now over half of American adults are in credit card debt. At the start of 2021, the total US consumer debt burden was nearly $900 billion, and with an average credit card interest rate of around 17%, Americans will spend $153 billion in credit card interest this year alone. 

The astronomical interest rate credit card companies charge makes credit card debt one of the worst types of debt a person can have, and we have South Dakota to thank for it. Once they abolished their usury limits, other states, like Delaware, followed suit to attract credit card companies to their states as well. This led to a booming credit card industry, incredible profits for banks, and crippling debt for many Americans.

Who knew a seemingly unimportant state had been working for the last 40 years to negatively impact the majority of Americans’ wallets while lining the pockets of the world’s wealthiest.

References

EXPLAINER: How US states help rich foreigners shield assets

Interview: Bill Janklow

How South Dakota became a haven for both billionaires and full-time RV-ers

A BELLWETHER OF MODERN TRUST CONCEPTS: A HISTORICAL REVIEW OF SOUTH DAKOTA’S POWERFUL TRUST LAWS

The Repeal of the Glass‐​Steagall Act: Myth and Reality

Interstate Banking

Bank Holding Company Act of 1956

The Ascendancy of the Credit Card Industry

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How Many Credit Cards Is Too Many?

The average person has 4 credit cards. Some of you probably loathe the idea of stuffing that many cards into your wallet, while others of you can’t believe the average is that low. Regardless of your preferred number of credit cards, there are upsides and pitfalls to having multiple cards. Here’s when you should apply for more cards, and when you shouldn’t because you have too many.

When You Should Apply for More Credit Cards

Improve Your Credit Score

Your credit score is used to assess your creditworthiness when you apply for more credit, like a loan or a credit card. The higher your credit score, the lower the interest rate you’re offered, so before applying for credit it’s important to get your credit score as high as possible. To do that, you can work on improving these 5 factors that are used to calculate your total credit score

  • Payment history (35%) – your ability to pay your minimum balance on time every month
  • Credit utilization (30%) – the amount of your available credit you’ve used
  • Length of history (15%) – how long you’ve been using your oldest credit card
  • New credit pulls (10%) – how often you apply for new lines of credit
  • Credit mix (10%) – your mix of revolving credit (like credit cards) vs installment credit (loans)

Where opening a new credit card can help is with your credit utilization, which is the amount of credit you’ve used vs the limit you’re offered. The lower your utilization, the better. Someone who has a $2,000 limit and maxes out their credit card every month would have a utilization rate of 100%. In this scenario, they could greatly improve their credit utilization by applying for another credit card and increasing the amount of credit they’re offered. If they got a second card with a $2,000 balance and still only spent $2,000 each month, their credit utilization would improve to 50%, which would improve their overall credit score.

While adding a card will improve your credit utilization, it will also require a new credit pull, which is a negative for your credit score. Since your credit utilization is factored into your overall credit score three times as much as your pulls, it is usually worth it to take a small dip in your score for a pull to get a larger gain from better credit utilization. However, if you’ll be having your credit score pulled for other reasons soon, like because you’re applying for a mortgage, for example, you may want to hold off on adding even more pulls. To avoid a new credit pull and still improve your credit utilization, contact your existing credit card company and ask for an increase on your limit. 

Take Advantage of Perks

When it comes to taking advantage of perks, you can never have too many credit cards. Some cards offer great sign-on bonuses, others offer travel rewards, and some give you cashback. To get the most out of your spending, you’ll need to sign up for multiple credit cards.

If you’re looking for an influx of points to help offset the cost of an upcoming trip, go for a card that has a big sign-up bonus. To qualify for these bonuses you usually need to spend a certain amount of money within the first few months, so make sure you can meet the spending minimum within the allotted time frame before you sign up.

Adding another credit card can also allow you to take advantage of the best perks on multiple cards. Let’s say you love to travel, so you have one credit card that gives you the best rewards for flights and hotels, and offers no foreign exchange fees. Then you also have a credit card that gives you a higher cashback percentage in other high spend categories for you, like groceries and transportation. Having multiple credit cards that give you the best rewards in all of your high spend categories gives you the biggest bang for your buck.

When You Shouldn’t Apply for More Credit Cards

You’re In Credit Card Debt

While adding a new card to your arsenal can be extremely beneficial, it can also be a bad idea if you’re already in credit card debt. The only way to reap the benefits of your credit card rewards is if you fully pay off your credit card every month. If you aren’t doing that, you should focus on paying off your balance before adding another card to the mix. Credit card companies charge astronomical interest rates on the balances you carry, so the cost of carrying a balance will far outweigh the rewards. The worst thing you can do in this situation is to get another credit card and run up even more credit card debt.

It Stresses You Out

Another reason to avoid getting a new credit card is that you’re happy with your credit score and don’t want to overcomplicate things. Having multiple credit cards so you can take advantage of the rewards each offers is great, but it also means you have to keep track of which card to use on which purchases. Some people love finding deals and have a credit card for each spending category. Other people can’t stand the thought of keeping track of which card to use for what. If that’s you, there’s no point in adding a card if you’re never going to use it.

While 4 is the average number of credit cards someone has, it isn’t the ideal amount for everyone. For some people, having more than 4 cards is better, and for others, 4 is way too many. In general, adding a credit card can help your credit score but should be avoided if you’re in debt, and you can increase your rewards with more cards but it also complicates your spending. To figure out if you have too many credit cards, ask yourself these questions.

  1. Am I in credit card debt?
  2. Is having multiple credit cards stressing me out?

If the answer to either of these questions is yes, you have too many credit cards.

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When to Claim 0 on Your W-4

w4 form with pen

Since March 2020, we’ve started asking questions we never thought we would have to, like how could a 2-week quarantine turn into an 18+ month extravaganza, how the f*** does a boat get stuck in a canal, and why am I spending my days at this job when they don’t pay me enough? These questions and the new WFH norm have changed our views on remote work and the importance of spending time with the ones we love, which has led to what’s being dubbed the Great Resignation.

Americans are quitting their jobs in record numbers in search of better pay, more flexibility, and more fulfilling careers. As we begin to find new jobs that pay us more, let us attend zoom meetings with our camera off, and don’t give us the Sunday scaries, there’s one question we’ve asked before that’s going to pop back up. WTF am I supposed to claim on this W-4 tax form?

What Is a W-4?

Your W-4 is a tax document you fill out that tells your employer how much money to withhold from each paycheck to cover your income taxes. As you go through your W-4 form line by line, you can claim certain exemptions. The number of claims you make, also known as your withholding allowance, along with your salary and your pay frequency, is used by your employer to estimate your annual tax bill so they can withhold the required amount from each paycheck to cover it. 

How Much Should You Claim on Your W-4

W-4 forms are complicated, which leads many people to base their withholding allowance off of popular advice that says you should claim 0. The logic behind this is that claiming 0 on your taxes is a good idea because it will give you the largest tax return, which is true.

That’s because the lower the number of claims you make on your W-4, the larger the amount that will be withheld from each paycheck and vice versa. Since so much money is withheld from your paychecks throughout the year when you claim 0, you usually end up overpaying on your taxes. When tax season arrives, you reconcile this with the government and they pay you back all of the extra money you’ve given to them throughout the year.

If you claim more allowances on your taxes than you qualify for, or a higher number, the opposite will happen and during tax season you will owe the government the money that you didn’t pay them throughout the year. Even worse is if you pay far less than you should throughout the year, you could face additional penalties come tax time.

While you definitely don’t want to pay too little in taxes and face penalties, you also don’t want to claim 0. The extra money you pay the government all year is essentially a free loan to them. They can use your extra money to pay off their debt and invest in the country all year and then pay you back interest-free during tax season. Instead of letting the government take full advantage of your money, you could be using it to improve your financial situation instead.

What to Do With Your Extra Cash

Update your W-4 form (this can be done anytime during the year) to claim the allowances you should be claiming. No more, no less. When your new tax structure takes effect, make a note of how much additional money you’ll be getting each pay period. For example, if you used to make $2,000 every two weeks and now you make $2,100, the difference of $100 is what you need to figure out what to do with.

Build an Emergency Fund

Emergency funds are the foundation of healthy finances, so if you don’t have one, building one is where you should start. Your emergency fund will help you navigate any financial hardships without having to get yourself into more financial trouble. Since the only time you’ll use the money in your emergency fund is for, well, emergencies, it’s mostly just going to sit there, so why not earn a little extra money on it? To do that, put it into a high yield savings account. They pay you much higher interest than traditional savings accounts for doing the exact same thing. Just make sure the one you choose is FDIC insured.

Invest It

When it comes to investing, time is of the essence. As the saying goes, time in the market beats timing the market, which means you need to start investing as much as possible, as early as possible. You have several options when it comes to investing your tax savings. You can increase your 401k contribution, open a Roth IRA, or avoid the restrictions of retirement accounts altogether by using a taxable brokerage account. Just remember to automate your contributions into a Roth IRA or brokerage account (they’re already automated for 401ks) so you actually invest your tax savings instead of spending it. By investing the money you used to lend to the government for free, you can earn around 10% per year instead of 0.

Pay Off High-Interest Debt

When it comes to whether you should pay off debt or invest your extra money, investing is almost always the best option. The exception is when you have high-interest debt. 

The average annual return on the stock market is 10%, so if you have any debt with an interest rate higher than that, you should pay that debt off first. Most credit cards charge much higher interest than 10%, so if you have any credit cards that aren’t fully paid off, prioritize paying those off before investing.

Save for Other Things

Need a new car, want to go on a vacation, or simply want to have more money to spend on Christmas gifts this year? Start a sinking fund for any large purchases you have coming up. 

To set up your sinking fund, figure out the total amount of money you’ll need and when you’ll need it. Then determine how frequently you’ll contribute to your sinking fund. Will it be monthly, every 2 weeks when you get paid, or some other interval. Then, take the total dollar amount and divide it by the number of contributions you’ll make until the day you’ll use the money. For example, if you need $1,000 for a vacation in 1 year and you’re contributing to your sinking fund monthly, that’s $1,000/12 months = $83 monthly contribution to your sinking fund. High yield savings accounts are also great places for sinking funds and they’ll help you earn a little extra money towards your goal.

So when should you claim 0 on your W-4? Never. Doing that just ties up money you could be using to build your financial foundation, earn more money by investing, pay off high-interest debt, or save for other fun things. So when you get that new job that’s more fulfilling and actually pays you what you’re worth, start practicing some smarter financial habits alongside starting your new job. The first of which should be claiming what you qualify for on your W-4.

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Why Literally Everyone Needs to Hire a Money Coach

Here’s the deal. Whether you’ve paid for one or not, you’ve had a money coach. Your earliest coach was probably your parents or someone else who took a parental role in your life. Starting at an incredibly early age, their actions, directly or indirectly, began forming your beliefs about money. Maybe you watched them struggle to make ends meet or work their asses off to give you everything you wanted. Maybe they spoke directly to you about business and investing or helped you manage your allowance. Maybe money was a taboo subject that nobody ever discussed at home. No matter what your situation was, many of your views about money were formed by your very first “money coach” in early childhood.

Unfortunately, most of our first money coaches had bad money habits and taught us pretty terrible financial lessons. They taught us that money is scarce and hard to come by. They taught us to be fearful of investing and that it’s only for the rich. They talked badly about anyone who spent extravagantly and flaunted their wealth. They told us that all debt is bad and to avoid it at all costs. 

All of these teachings became ingrained in our brains and formed the foundation of our money habits, and unless you were one of the lucky ones who was taught about wealth building and you’re set to inherit generational wealth, you probably need to hire a qualified money coach and learn some new money lessons. Here are some tips to help you find the best money coach for you.

What a Money Coach Does

Money Coach vs Financial Advisors

Money coaches are different from financial advisors or wealth managers. The primary goal of a money coach is to educate you on your options and build your financial literacy. Financial advisors and wealth managers do something similar, but they also usually manage your money for you. The problem is that the fees financial advisors charge to do that can add up to hundreds of thousands of dollars, and if you haven’t built at least $1 million in assets, you don’t need to hire a financial advisor, you need to learn how to build your wealth and make smart financial decisions.

Instead of managing your money, a money coach gives you the tools you need to make smarter financial decisions and transition to building wealth passively. They take a comprehensive look at your financial situation and educate you on the various ways you can improve it. Whether your goal is to save up an emergency fund, decide whether to pay off debt or invest, or learn how to better manage your investments, a money coach can outline your options and give you the tools to make the best financial decision for your individual circumstances.

And if you’re thinking, can’t I get all of this information for free on the internet? The answer is yes, you totally can. You can also find lots of free information on how to paint landscapes on the internet but that doesn’t make you an artist. Piecing together your financial journey with free information online will work, but only at the expense of hundreds or thousands of hours of your time and several costly mistakes along the way. Hiring a money coach is like buying the fast pass at Disney, it takes you straight to the front of the line so you can enjoy the ride.

Understanding Your Financial Goals

One of the biggest mistakes people make with their finances is that they invest and save without knowing what their goals are. Without knowing your financial goals, you’re pretty much crossing your fingers and hoping you’re doing the right thing. 

It’s obviously a huge problem if you aren’t saving or investing enough because you may not be able to cover an emergency expense or have to put off retiring. But saving and investing too much is also a problem. All of the money sitting in your savings is being devalued by inflation, so over saving just reduces your money’s value over time. Over-investing will end up making you a lot more money in the future thanks to the exponential growth compound interest will create, which can’t be bad, right? Wrong.

Sure, retiring with extra money so you can do more things and leave a larger inheritance sounds great, but it comes at the expense of missing out on experiences you could be buying today. While it isn’t a fun thought, you might not even make it to retirement. Do you really want to forego having fulfilling experiences now so you can have too much money when you retire? I doubt it.

On top of saving and investing errors, prioritizing paying off debt is another common mistake people make. There are definitely instances when it’s better to prioritize paying off debt, but in most cases, you shouldn’t. Getting a clear picture of your entire financial situation so you can determine your financial priorities, establish concrete goals, and develop actionable plans to reach them is one of the most important reasons you should work with a money coach.

How to Choose a Money Coach

Now that you know the benefits of hiring a money coach, you need to be able to choose the best one for you. These tips will ensure you end up with a qualified coach that can help you reach your goals.

Check Their Credentials

A lot of money coaches started off documenting their own personal finance journey and then used what they learned to teach others. While it’s important that money coaches practice what they preach, it’s also important that they know all of the financial tools available to you, not just the ones they’ve used. 

There are so many different aspects of personal finance, saving, debt payoff, investing, wealth preservation, and more. You want someone who’s informed about all of these aspects so they can tailor the information they give you to what you need, not just tell you what worked for them.

Before you pick your coach, ask about their credentials. Do they have a finance degree? If not, have they taken courses in financial coaching? Have they worked in the finance industry or as a financial advisor? You wouldn’t hand your money over to a financial advisor that didn’t have credentials (I hope) so don’t pay to get your financial education from a money coach that doesn’t have credentials either.

Match Your Needs with Their Expertise

As I mentioned above, there are a lot of different aspects to personal finance, and as cliche as it sounds, personal finance is personal. You may have no debt, but are living paycheck to paycheck and want to learn about budgeting. You may have thousands of dollars of credit card debt and student loans that you don’t know how to manage. You may feel secure financially, but don’t know how much money you’ll need to retire. You may be so fearful of investing that you’ve been putting it off and need help managing your fear and getting started. Maybe you just graduated and are looking for tips on salary negotiation. 

Depending on your situation, you’ll need different things. If you want help budgeting, find a coach that specializes in it. Looking to start investing? Find a money coach that has an investing course. There’s no one size fits all approach to personal finance, so find a coach that offers exactly what you’re looking for.

Pick Someone You Like

On top of vetting your coach’s credentials and offerings, make sure to pick someone you like. If their offerings match what you need but their approach makes you uncomfortable, how open do you think you’ll be with them about your money? Probably not very open. 

Money is a difficult subject for most people to talk about, but to get the best advice from your money coach, you’ll need to be vulnerable and open about your financial situation. To make sure you can do that, pick someone you think you’ll mesh well with and can deliver information to you professionally and in a way that you can absorb.

Why You Need to Hire a Money Coach ASAP

Even if you can see the benefits hiring a money coach will have, you may still want to put it off until later. The problem with that is that being able to build wealth easily is all about front loading. The earlier you start building wealth, the easier it becomes. That’s all thanks to compound interest, which allows you to earn interest on the money you deposit AND on any interest you’ve already earned. This creates exponential growth for your investments, but it takes decades to start making really huge gains. Because of that, it is incredibly important to start investing asap. If you put in the effort now, you could reap huge rewards, I’m talking hundreds of thousands of dollars of passive income a year rewards, with almost zero effort later.

So while most of us start off with less than qualified money coaches who teach us terrible money management habits, all hope is not lost. Find yourself a qualified money coach that can help reframe your relationship with money, build your financial literacy, and help you set financial goals and develop plans to achieve them. Once you do, you’ll feel confident about your finances and start building wealth in no time.

Ready to hire a money coach? Get my Get a Grip on Your Finances Course or schedule a one-on-one financial consulting call with me!

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Should You Put Money in a High-Yield Savings Account?

When I first came across a high-yield savings account (HYSA), I thought it was a scam. I’m a firm believer in the saying, if it sounds too good to be true, it probably is. So when I found a savings account that said it would pay me 25x the rate I was currently getting just for putting my money in it, I figured there must be a catch. After doing a full-blown investigation to determine if high-yield savings accounts are, indeed, too good to be true, this is what I learned.

What Is a High Yield Savings Account?

A high-yield savings account or high-interest savings account is a type of savings account that pays you a higher interest rate for keeping your money in it. Traditional savings accounts, like the one you open alongside your checking account, pay around .01% interest on the money you keep in them. HYSAs pay far more than that but have fluctuating interest rates. 

When the Federal Reserve Committee (the Fed) lowers interest rates, the interest rate HYSAs pay you also decreases. When the Fed raises rates, HYSA rates rise as well. In the last several years, HYSA rates have fluctuated between .4%-2.5% while traditional savings account rates have remained at .01%. Even though the Fed reduced rates to help stimulate the economy during the Covid recession, HYSA rates are still significantly higher than traditional savings rates and when the Fed begins to increase rates in the next few years, HYSA rates will increase also. 

But all this information on rates begs the question, how can HYSAs pay you more than traditional accounts for doing the same thing?

How Does a High Yield Savings Account Work?

All savings accounts work the same way. A bank pays you a fraction of the interest they earn from lending out the money you deposit with them. That’s right, banks don’t actually keep your money safe in a special mini vault until you want to use it later. Instead, they lend it out to other people in the form of mortgages, auto loans, personal loans, etc., and charge interest to their borrowers on those loans. Your bank then pays you a fraction of their interest earnings to incentivize you to use their bank. 

The difference between traditional savings and HYSAs is that traditional savings accounts pay you a smaller fraction of the interest they earn than HYSAs, mostly because traditional banks have more expenses. Many of the banks offering HYSAs are online-only banks with no brick and mortar locations, and they don’t offer debit cards or access to withdraw your money from ATMs. Because of this, they’re able to save tons of money on rent, frontline worker salaries, and ATM machines. This gives them more wiggle room to pay a higher interest rate to their depositors, AKA you.

How to Choose a High Yield Savings Account

Make Sure It’s FDIC Insured

The first step you should take to make sure the HYSA you’re interested in is legit is to verify that the bank it’s with is FDIC insured. The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the US government that protects depositors’ money in the event of theft or bankruptcy.

What that means is that if your funds are hacked/stolen or your bank runs out of money and shuts down, the federal government will compensate you in full for up to $250,000 in your savings account. It’s essentially free insurance to protect your money if your bank fails. Since the bank isn’t keeping your money in a mini vault and is instead lending it out, and the prevalence of hacking is on the rise, it is critically important that you save your money in a HYSA with a bank that is FDIC insured.

Check Balance Minimums & Fees

One of the best uses for a HYSA is to hold your emergency savings, but what happens if something comes up and you need to pull all of your money out? You don’t want to get hit with fees for dropping below your minimum balance requirement when you’re already dealing with a financial emergency. 

When evaluating your HYSA options, choose an account with a $0 minimum balance requirement. Also, check on the fees you may be charged for other types of transactions. On top of their interest earnings, banks make a killing from charging additional fees. There may be a limit on the number of withdrawals you can make each month or limits on other transactions. Depending on how often you need to move money in and out of your account, you could be charged a fee if you exceed your designated number of transactions. All of these fees add up and unnecessarily eat into your savings. It’s best to select an account with as few fees as possible.

Focus on Functionality, Not the Best HYSA Rate

As you learned earlier, HYSA interest rates fluctuate, so different banks have different rates at different times. One bank may offer you a slightly higher interest rate today, and another bank may do the same next quarter. Since these rates usually only differ by a tiny fraction of a percentage, the minuscule increase in earnings you’d receive by switching to the savings account with the highest rate every quarter isn’t worth the hassle. 

Instead of focusing on getting the highest rate, shift your focus to finding an account that offers the functionality that is best for you. Some accounts offer debit cards, while others don’t. Some offer incredible organizational features so you can easily save for multiple goals and track your progress. Some have no frills and just offer one simple account to hold all of your money. Whatever account fits your personality and goals best is the one you should choose, not the one with a .05% higher interest rate.

So while HYSAs seem too good to be true, they actually… aren’t! They simply do offer significantly higher interest rates than traditional accounts with no hidden catch. They’re the best place for you to keep your emergency fund and to save for other long-term goals like a down payment on a home or a new car. Just make sure you choose an account that’s FDIC insured, has a $0 minimum balance and low to no additional fees, and has all the bells and whistles you need to help you reach your goals. Once you find the best account for you, you should 100% put your money into a high-yield savings account.

To find out how much you should have saved for an emergency, get my FREE Emergency Savings Calculator!

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Best Practices for Redeeming Your Credit Card Points

So you’ve racked up some credit card points and are wondering WTF you should spend them on. Is it best to save them up and spend them all at once on a vacation? Or should you use them up every month to pay off lots of little things? Is the answer the same if you have a card that earns you points vs one that earns you cashback? 

These are just a few of the questions you probably ask yourself about your credit card because, well, credit cards are CONFUSING! There are endless options to select from when choosing your credit card and once you’ve finally decided on one, then you have to keep track of spending categories, payment dates, balances, and manage your perks. It’s exhausting. 

But it’s also well worth it because the perks can be absolutely amazing! The most well-known perk offered by credit cards is cashback or points and once you’ve figured out the best way to accumulate them, you have to figure out the best way to spend them. Here’s how to do that.

Earning Cash Back vs Points

Before we break down how to spend your credit card rewards, you need to understand the difference between earning points and earning cashback. Although they’re similar, they do have some key differences.

Cash Back Credit Cards

Cashback credit cards give you cashback on your purchases. It works like this. Let’s say your credit card offers 1% cashback. When you use your credit card to buy something, you pay full price for the item and after that, your credit card company pays you cashback on 1% of your purchase’s value. This essentially gives you a 1% refund on your purchases. 

The great thing about cashback is that its value is in dollars, so 1% cashback means you earn $.01 back for every dollar you spend. Since you’re earning cash at cash value, you spend it the same way you would spend the money in your checking account. 

Points Credit Cards

Points accumulate similarly to cashback where you receive a certain portion of your purchase amount back in the form of points. This is usually stated differently to you than cashback is, though. Your credit card will say something like you’ll get 2 points for every dollar you spend. 

The major difference between earning points vs cashback is that the value of your points will vary based on how you spend them. For example, travel cards often offer you more value for your points when you use them to book flights or hotels than when you use them in other categories. In this case, the value of your points may be $.01 each if you use them to book a flight, but only work $.005 each if you use them to shop for a new couch online. To get the most bang for your buck, you have to spend your points in the categories that value them the highest.

When to Redeem Your Credit Card Rewards

The Best Time to Redeem Your Credit Card Rewards… Technically

The question you’ve been waiting for. Is it better to redeem your points on small purchases consistently or save them up and spend them in bulk? 

Technically, it’s better to redeem your points or cashback regularly, thanks to inflation.

Inflation eats away at the value of your credit card rewards the same way it eats away at your cash and savings. If you’re getting cash back from your credit card, your cashback is being devalued by inflation the same way the cash in your savings is. If you’re getting points for your purchases and prices are rising due to inflation, you’ll need more and more points to cover those purchases. Either way, inflation is eating away at your credit card rewards.

To get the most out of them, spend them asap. Use them to cover purchases every month and lower your bill. 

Using Your Credit Card Rewards for Big Purchases

While technically it’s better to redeem your credit card points as soon as possible, it’s also really not a big deal if you don’t.

Let’s say that you want to take a trip to Europe, so you open a high yield savings account and start saving the several thousand dollars you’ll need for your trip. The entire time you’re saving up for your vacation, inflation will be devaluing the money in your savings account. Whether you’re saving cash in a savings account or saving up your credit card rewards to spend on a large purchase doesn’t matter. The cash in your savings and your credit card rewards are both being affected by inflation. 

So don’t waste your time and energy trying to find the best time to spend your credit card rewards. If you prefer to use them monthly to lower your bill, do it! If you like to save them to use for large purchases, do that! The difference is negligible and it’s definitely not worth agonizing over. 

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3 Simple Ways to Protect Your Money from Inflation

hands protecting money in a piggy bank from inflation

This week the Fed announced that it would be leaving interest rates near 0% until 2023 in hopes that cheap borrowing will incentivize companies to expand and create jobs, and get more Americans back to work. But the announcement also stoked the fire fueling the rising fear of inflation. Cheap borrowing, stimmies, increased unemployment benefits, and city reopenings have created a spending frenzy and the biggest rise in consumer prices in nearly 13 years.

According to the Fed, inflation is projected to be at 3.4% this year instead of the 2% annual inflation rate we’re used to. While prices in 2021 are rising faster than usual, inflation is nothing new. Once it dips back down to a more normal level it’s still going to continue to eat away at the value of your money. The good news is that you can protect your money by doing just a few simple things. These are the three best ways to protect your money from inflation. 

Use a High Yield Savings Account

Your emergency savings is the foundation for healthy finances, but any cash you hold is constantly being gobbled up by inflation. To protect the purchasing power of the money in your emergency savings, you should put it in a high yield savings account. 

High yield savings accounts, or HYSAs, pay you a higher interest rate than traditional savings accounts for keeping your money in them. In some cases, HYSA rates are a staggering 25x higher than traditional savings rates. That 25x higher interest rate is what will help combat the effect inflation is having on the purchasing power of the money in your savings. 

To help you choose the best HYSA for you, here are some things you should consider during your search. 

  • It’s FDIC insured – if your bank fails and doesn’t have the money to pay back all of the money you deposited with them plus the interest you’ve earned, the FDIC will make sure you’re compensated in full. 
  • Transfer times – many HYSAs are offered by online banks separate from your checking account. That means it can take several days for the money in your HYSA to transfer to your checking account if you need it. It also means that you may not be able to access your money at an ATM or be issued a card for your account. Make sure you’re comfortable with the limitations of your provider.
  • Account functionality – different accounts provide different functionality. For example, some let you segment your money into multiple buckets to save for different goals while others only let you keep one lump sum. It’s more important to choose an account with functionality that you like rather than the account with the highest interest rate. The interest rate of your account will fluctuate and sometimes it will be higher than the competition and other times it will be lower, but you’ll always be stuck with the same functionality.

Invest Your Money

Once you’ve hit your emergency savings goal, it’s time to invest. When deciding what to invest in to combat inflation, you need to pick investments with average rates of return that are higher than the rate of inflation. 

The stock market and real estate are two popular investments that average higher returns than inflation. The average return on the S&P 500 is 10% per year and the average home appreciation is 4% annually not including rental income. With rental income included, the return on an investment property would be higher than 4%. 

If the returns on your investments are higher than the rate of inflation, you’ll be preserving your purchasing power and building additional wealth. 

Ask for a Raise

This is one of the most overlooked strategies for preserving your purchasing power. Most people don’t think about the fact that if you make the same salary for several years while prices increase at a rate of 2%+ each year, you’re actually getting poorer. To prevent that, you’ll need to at minimum get a cost of living raise equal to the rate of inflation each year. To make sure you can, at minimum, maintain your lifestyle, here are some pointers on how to ask for a raise if you aren’t offered one. 

Prepping for Your Raise

  • Keep a list of your accomplishments – This is critical if you really want to shine in front of your manager because of something called the recency bias. This is a bias people have toward giving more importance to recent events than historic ones. That means your manager could be evaluating your entire year of performance-based only on your achievements over the last month or two. It also means that you’re prone to forget about everything you achieved 6, 9, or 12 months ago also. By keeping an ongoing list of your achievements, you can refresh your memory and your bosses about the larger impact you’ve had over the year.
  • Use numbers – Improving efficiency is a great accomplishment, but if you can say you improved efficiency by 25%, that’s even better. When evaluating your performance, do your best to track measurable results. Oftentimes you’re going to need to do extra digging to find out how much of an impact you’ve actually made, but it will be worth it come evaluation time. And as a bonus, these numbers look great on a resume.

Making Sure Your Raise is Adequate

  • Calculate your raise as a percentage – to maintain your lifestyle, you need to get a raise that’s equal to the rate of inflation. If you’re told your raise as a salary number, calculate what your percentage raise is to make sure it’s adequate. For example, if the Fed is correct about 3.4% inflation this year and you started the year making $50,000, you’ll need to make $51,700 in 2022 to cover the cost of inflation. (50,000 x 1.034 = 51,700)
  • Make sure your performance raise is really a performance raise – If you wowed your boss with all of your accomplishments over the last year and you’re getting a performance raise it’s going to need to be higher than the rate of inflation. If it’s not, I hate to break it to you, but you’re actually only getting a cost of living raise.

Inflation, whether rising or “normal”, is never your friend. It is constantly making it harder for you to afford the same lifestyle and making it even harder for you to build wealth. By taking these few small steps to fight the effect inflation is having on your money, you’ll be able to preserve your wealth and make it easier to build more, no matter what the Fed’s report says about inflation. 

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6 Ways to Kickstart Your Financial Journey

cup of coffee with money bag foam to kickstart your financial journey

Where the f**k do I start? That’s the million-dollar question when you finally come to the realization that you need to get your financial shit together. And it’s hard to figure out because there is so much contradictory information out there about whether you should pay off debt or invest, what the best investments are, how to budget, and so much more. Trying to sift through everything and decide who’s right is overwhelming and exhausting.

Because of the information overload, many people grasp onto the low-hanging fruit, like budgeting. But saving $3 here and there isn’t going to have much of an impact on your financial future, and it definitely isn’t going to help you weather the next recession. So what should you do instead? Focus on making big financial wins and building your financial scaffolding. 

By building a solid financial foundation and structure, you’ll be able to better navigate financial hardships in the future, and by reducing a few extremely costly fees you can save hundreds of thousands in the long run instead of $3 every grocery trip. Even better is that all of these things require much less time and effort than penny-pinching.

Here are the 6 things you should do when starting your finance journey to create big financial wins and build your financial foundation.

1. Take your financial inventory

Taking your financial inventory will give you a snapshot of your current financial situation. This is probably the scariest step to take because once you have a clear picture of your financial situation, it’s hard to ignore it. It’s also impossible to change your situation without understanding what you’re working with, so taking a financial inventory is step number one.

To do it, list out all of your savings, debts, and investments, and how much you have of each. Then calculate your net worth using this formula. Don’t feel bad if your net worth is negative! Many people, including me, had negative net worths when we started out. Now your job is to use the next 5 steps to turn that number positive.

2. Start saving

Once you have your financial snapshot, the next thing you need to do is start building your foundation. The best way to do that is to start an emergency savings. 

Your emergency savings goal should be to have 3-6 months of expenses saved in a high-interest savings account. You can use my free savings amount calculator to get an idea of where you should fall within that range. 

Once you know how many months of savings you’re shooting for, you need to calculate your monthly expenses. To do that, list out all of your bills, loan payments, subscriptions, insurance payments, grocery costs, etc. Then add all of your expenses up and add a 25% buffer to your total. Multiply that number by the number of months you’re planning to save and you have your savings goal.

Your next step is to open a high-interest savings account with an FDIC-insured bank and set up automatic contributions into it. Once you’ve done that, you’re well on your way to building your financial foundation.

3. Do an expense overhaul

Expense overhauls are the easiest way to save money without having to budget. The first thing you should do is go through all of your expenses and cancel any subscriptions you don’t use. 

Step two is to call your providers and negotiate your bills. This works for things like your insurance, cell phone bills, and some streaming services. You can ask them if they have any promotional offers, and threaten to cancel if they don’t lower your bill. These companies also frequently change their policies, so sometimes you’ll find out that you’re paying a high price for one of their old plans and can easily pay less by switching to one of their newer offers.

While this process can be tedious and intimidating, you can get it all done in a couple of hours and could end up saving several hundred dollars each month. When my husband did this last year, we ended up saving over $200/month with just a few hours of work. Once you’ve negotiated your savings, you can reap the rewards for an entire year before having to do it all over again.

4. Pay off your credit card

If you haven’t been paying off your credit card in full every month, it’s time to start. Credit card debt is one of the worst types of debt you can have because it’s sooooo expensive. The average interest rate on a credit card is 18%. That means you pay 18% extra per year for everything you buy on your credit card but don’t pay off.

Since the average credit card interest rate is higher than the average return on the stock market, it’s unlikely that you’ll be able to invest your money and receive a higher return than 18% to offset your losses. So when deciding whether or not to invest or pay off credit card debt, the answer is to pay off your debt.

Since you’ve already taken your financial inventory, you know exactly how much credit card debt you need to pay off, and now you need to set up a plan to do it. Credit card interest is added daily, so make your payments as frequently as possible. The easiest way to do that is to set up automatic payments on days when you know you’ll have money to cover them, like payday. You can also call your credit card company and try to negotiate your interest rate down. This will reduce your interest expense while you’re paying off your balance. 

5. Start investing

When it comes to investing, the earlier you start, the better. That’s because of compound interest. Compound interest grows your wealth exponentially over time, but to really reap the benefits, you have to wait decades. 

If you invest $450 every month for 30 years and receive a 10% return, you’ll end up with over $1 million, but only $162,100 of it will have been contributed by you. You can thank compound interest for the other $865,882. 

To make that much money from compound interest, though, you have to give it time to work. It took 30 years for that much money to accumulate in our example. If you shorten your investment period down to 15 years, you’ll only have $188,531 in total. That means over 80% of your $1 million earnings are made in the second half of your investment years. The more time you can leave your money invested, the more it will grow for you, which is why it’s so important to start investing today!

6. Check your fees and get them waived

Fees are your enemy when it comes to all things finance because they take away your hard-earned money. The good news is that you can get a lot of fees waived. 

When it comes to account fees, there’s often an easy way to get your fee waived, like by signing up for paperless statements. If you can’t find information online on how to get your account fee waived, call your provider and ask if there’s a way you can do it. If you’re ever charged a fee for over-drafting your account or not maintaining the minimum required balance, you can also contact your provider and ask them to waive the fee.

Another type of fee you need to look out for when investing is called an expense ratio. These are the management fees funds charge so they can cover the expense of operating the fund. In general, actively managed funds have higher fees than passively managed funds, and they usually don’t perform well enough to compensate for the extra fee you pay. Choosing to invest in funds with higher fees can end up costing you hundreds of thousands of dollars more than you would have paid if you had invested in a fund with lower fees. When choosing funds to invest in, select the ones with expense ratios under .5%. If they’re under .2%, that’s even better. 

By focusing on these 6 areas of your finances, you can make significant financial gains without constantly stressing about every dollar you spend. There’s no need to bargain shop and penny-pinch if you’re making larger financial wins and building a solid financial structure. That’s how you set yourself up to weather financial hardships and have a fantastic financial future.

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Six-Figure Mistakes You’re Making with Your Money

woman stressed about money mistakes

There are an endless number of mistakes you can make with your finances. Some are small like forgetting to put in your discount code at the grocery and paying full price for items you could have gotten at a discount. Others are big. Like hundreds of thousands of dollars, big. These are the ones that will make or break your financial future. If you can skip making these, you’ll end up with, well, hundreds of thousands more dollars over your lifetime. 

To keep you from falling into a giant money pit, here are the biggest financial killers and how to avoid them.

Debt Mistakes

Getting Into Credit Card Debt

Credit card debt is the absolute worst type of debt you can have because credit cards charge you outrageously high interest rates when you hold a balance on them. The average credit card APR or annual percentage rate is about 18%, but many run into the upper 20s or even low 30s. That means you’re paying 18% more every year for anything you buy on your credit card and don’t pay off. For comparison, the average interest rate on a mortgage in the US is around 3%, which is 15% less than the average credit card. 

On top of their extremely high rates, credit cards charge interest to your balance daily, unlike a mortgage that charges you monthly. That means every day you’re charged more interest on your initial balance plus any interest you’ve already accumulated. The act of charging interest on previous interest charges is called compounding, and it increases the amount of interest you end up paying. To minimize compounding’s effect on your balance, you should make payments on your credit card as often as you can. And by as often as you can, I mean more than once a month.

The amount of money you’ll lose to credit card interest will vary based on your balance, interest rate, and how long it takes you to pay it off, but it’s easy to get yourself into six-figure debt by holding a balance on your credit card and only making your minimum payments. To avoid getting yourself into this situation, make sure to pay your credit card balance off in full every month. If you already have a balance on your card, make a plan to pay it off in full and make payments as frequently as possible. 

Having a Bad Credit Score

You may have heard the debt myth that keeping a balance on your credit card helps your credit score. This is just plain wrong. As I detailed in-depth above, keeping a balance on your credit card is one of the worst things you can do for your finances. 

Now that we’ve busted that myth, let’s discuss what does affect your credit score. Making your payments on time has the biggest effect on your credit score. The second biggest factor that’s considered when calculating your credit score is your credit utilization. In simple terms, your credit utilization is the percentage of your available credit you’ve used. If you’re close to maxing out your credit card, you’ll have a high credit utilization which will negatively impact your overall score and vice versa. The remaining three things that impact your score are your length of credit history, the type of debt you have, and how many new inquiries have been made into your credit history.

Credit scores range from 300-850 and you should strive to keep your credit score at least above 640 because anything below that is considered subprime and borrowers in that category get charged the highest interest rates. A person with a credit score near 620 will end up paying $65K more on a $200K mortgage than a person with a credit score over 760. Scores over 700 are considered good and these borrowers are often offered lower interest rates, and borrowers with scores of 800 or higher are considered excellent and are offered the lowest rates.

Having a low credit score means you’ll be charged the highest rates on your loans and end up paying tens of thousands of dollars more in interest. On top of the interest charges on your loans, your credit score is also factored into your utility charges and affects what housing is available to you. With all of these factors, over your lifetime, a poor or mediocre credit score can cost you over $100,000.

To keep your credit score up, make sure you make all of your minimum payments on time every month. This includes your credit cards, loans, utilities, rent, etc. Also, keep your credit utilization as low as possible. If you want to improve your credit utilization you can open a new credit card, but I don’t recommend this unless you’re already paying off your credit card in full every month. Lastly, keep your old credit cards open even if you don’t use them anymore. This will keep all of your old credit history intact.

Investing Mistakes

Investing in High Fee Mutual Funds

Compound interest from your debt may be enemy number one, but investing fees are a close second, and mutual funds are notorious for having super-high fees.

The reason many mutual funds charge high fees, or expense ratios, is because many of them are actively managed. That means their fund manager tries to pick the stocks they think are going to outperform index funds that track the market. The fund manager charges you more for all of the time it takes them to research stocks and find the top performers.

This wouldn’t be a problem except for the fact that after you factor in their fees, most actively managed funds underperform compared to the market. In 2019, 71% of large-cap US actively managed funds underperformed the S&P 500, and 81% have underperformed their target over the last 5 years. So while these funds promise larger fortunes in exchange for their higher fees, they rarely hold up their end of the deal, which can cost you hundreds of thousands.

Passively managed funds, on the other hand, have much lower expense ratios than actively managed funds and on average charge .2%. Investing in a fund that charges .2% will end up costing you $37,964 in fees over 30 years if you invest $450 per month and receive a 10% annual return. If you instead invest the same amount into an actively managed fund with an expense ratio of 1%, you’ll end up paying a whopping $174,788 in fees. That’s $136,824 more you’ll pay in fees with a slim chance that you’ll see higher returns. So the moral of this story is to skip the high fee funds.

Not Investing

There are lots of reasons people put off investing. It’s way less fun than splurging on your favorite things. The messaging about investing makes it super intimidating. Or maybe you think you need to pay off all of your debt before you even think about starting to invest. The problem with allowing any of these scenarios to hold you back from investing is that compound interest needs a lot of time to work on building your wealth, so the sooner you start, the better.

While compound interest is your nemesis when it comes to debt, it is your savior when it comes to investing. Over several decades compound interest will grow your wealth exponentially. If you invest $450 every month for 30 years and receive a 10% return, you’ll end up with over $1 million, but only $162,100 of it will have been contributed by you. You can thank compound interest for the other $865,882.

To make that much money from compound interest, though, you have to give it time to work. It took 30 years for that much money to accumulate in our example. If you shorten the investment period down to 15 years, you’ll only have $188,531 in total. That means over 80% of your $1 million earnings are made in the second half of your investment years. The more time you can leave your money invested, the more it will grow for you, which is why it’s so important to start investing today!

So while we tend to sweat the little things, it’s really a few smart choices that can make the biggest impact on our financial future. By staying out of credit card debt, maintaining a good credit history, and investing ASAP into low fee funds, we can end up with hundreds of thousands more dollars in our pockets over our lifetime. 

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Do You Have Too Much Saved In Your Emergency Fund?

During the pandemic, saving money has been a hot topic. This is no surprise considering the staggering job losses that affected millions of Americans in early 2020, and the unprecedented number of women dropping out of the workforce due to the stress of juggling work and household duties 24/7. With all of this suffering and uncertainty, Americans turned to their emergency funds for stability, and from March to April of 2020, the US savings more than doubled from 12.7% to 32.2%

This jump in the savings rate of Americans was well overdue considering most Americans would have had trouble covering an unexpected $400 purchase pre-pandemic, and having an emergency fund is the best way to create financial stability. However, the pandemic has also caused many personal finance experts to change their recommendation for emergency savings amounts from 3-6 months of expenses saved, to 6-12 months of expenses saved, which is just too much. 

While saving too much might sound like an oxymoron, it is actually possible and can harm your financial health. Here’s why you need an emergency fund, but should ditch the new savings recommendation and only stash 3-6 months of expenses in it.

Why You Need An Emergency Fund

One word, liquidity. In fancy terms, liquidity means how quickly you can convert an asset into cash at its fair market value. In layman’s terms, it means how quickly you can sell something you own for what it’s actually worth. 

Let’s take your house, for example. If you own your home, you can sell it whenever you want, but you’ll have to jump through some hoops before you can get it listed for sale and find a buyer. On top of that, other market conditions will determine how quickly you’re able to attract a buyer. If you need cash ASAP, selling your house at a discount might be the only way to get it. All of these hurdles between the time you decide to sell your house and when you actually receive the cash for it make your house fairly illiquid. 

Stocks on the other hand are much easier to sell and are therefore more liquid. There are billions of shares traded on stock exchanges each day, so if you need to sell your stocks, you can usually do it almost immediately. This quick turnaround from when you decide to sell your stocks to when the cash gets into your pocket makes stocks liquid assets.

Since cash is, well, already cash, it is the most liquid asset. Your emergency fund is extremely liquid because it’s full of a bunch of cash. If you need money in a pinch due to a job loss or an unexpected expense, your emergency fund will give you immediate access to the cash you need. This financial cushion is what makes your emergency fund so important. It is your protection against having to jump through hoops to find cash or sell your assets at a loss in an emergency situation. 

Why You Shouldn’t Save Too Much

Two words this time. Inflation and opportunity cost. 

Inflation

In fancy terms, inflation is a loss of purchasing power due to a general increase in prices. In layman’s terms, prices increase overall in the US by around 2% every year, which means you can buy less with the same amount of money every year. 

Because inflation causes your money to decrease in value, the more of it you have lying around, in this case, in your emergency fund, the more you’ll be impacted by it. This is why saving up to 12 months of expenses is a bad idea. If you saved $60k to cover a full year of expenses in 2020, by 2030, you’ll only be able to buy 70-80% of what you were before and need over $77k to cover the same amount of expenses.

To protect your money from losing its value to inflation, you need to receive a return on your savings that is greater than the rate of inflation. Unfortunately, that’s impossible right now with interest rates being so low, but saving in a high yield savings account (HYSA) is your best option. These offer higher returns than traditional savings accounts and will protect you more from inflation. 

Opportunity Cost

On top of inflation eating away at your savings, there is also the opportunity cost of what you could have earned if you had invested that extra 6 months of savings instead. Investing $30k (6 months of expenses based on our earlier example) into an index fund like the S&P 500 would be worth over $81k after 10 years, assuming you receive the average return on the stock market of 10%. By investing that extra $30k instead of saving it, you could earn over $50k instead of losing 2% every year. Since the opportunity cost of saving an extra 6 months of expenses is so high, it’s best to save 3-6 months and invest the rest.

How to Determine Your Savings Goal

Now that you’re convinced you only need 3-6 months of expenses saved, you need to figure out where you fall within that range. To do that, take a look at the variables affecting your cash flow, as well as your risk tolerance. 

Cashflow

As a general rule, the more responsibilities and expenses you have, the more you should save, and the more variable your income or cash inflows are, the more you should save. For example, a person with a mortgage and kids should save more than a renter with no kids, and someone who is paid on commission should save more than someone earning a salary.

For a recommendation on how many months you should have saved based on your cash inflows and outflows, download this Savings Amount Calculator.

Risk Tolerance

While the Savings Amount Calculator can quickly give you a savings target, you should also factor in your risk tolerance when deciding how much to save. If your recommended savings amount is 3 months of expenses but only saving that much makes you uneasy, you can always increase your savings goal. In general, the lower your risk tolerance, the more you should save, and the higher your risk tolerance, the less you should save.