Let’s begin with two questions:

1. Do you consider yourself financially literate?

2. If so, how did you get that way?

And now, a third question:

3. How important is widespread financial literacy to the health of a modern society?

These questions open a great article by Stephen J. Dubner (See: “Are We a Nation of Financial Illiterates?” Freakonomics blog, NYT).

I challenge you to read his essay and see if you can correctly answer the first three questions he poses. Or, listen to his brief discussion of the topic at “The Takeaway” podcast.

Here’s an excerpt from his article:

I am all in favor of a well-rounded education, but seriously: what good is it if high-school students learn about Flaubert, biology, and trigonometry if they don’t learn how to take care of their money? One bright side to the increasingly dark economic news these days is that more and more people will learn (albeit the hard way) Rule No. 1: Do not buy what you cannot afford.

How or why do know (or don’t know) about personal finance issues? It’s a question worth asking yourself as you work to change your behavior with money. If you need a refresher, check out our recent “back to the basics series”. It covers topics we all should know—or think we know—that directly impact our personal finances.

What about in your life? Who helped you learn about personal finance? Or, what situations forced you to educate yourself? What would you advise someone just beginning to take control of their financial lives? Share your experiences with us here at the blog or in a related Geezeo group.

By Katie McCaskey

Lavish lifestyles presented in the media sell—a lot. From upscale food and drink to designer clothes to seductive toys, gadgets, and cars, few of us are 100% immune. When it comes to money many Americans think that if you “have it”, you “show it”.

In this installment of our back-to-the-basics series we discuss being frugal, or, living below your means. But first: let’s define “cheap”. Frequently, the two are confused.

The way I define “cheap” is simple: being “cheap” is being actively selfish. It’s putting your needs ahead of all else. “Being cheap” is behavior where someone tries to get a product or service “for nothing”. And, it gets ugly. Being cheap is frequently insulting and/or abusive — a one-sided “bargain”. Being “cheap” ignores the foundation of trade as equal exchange.

Being “frugal”, on the other hand, doesn’t mean driving a hard bargain. It’s living life by spending wisely. A frugal person might look for the best “bargains”. And, they might just spend less overall. But a truly frugal person never approaches a financial transaction with the goal of “putting one over” on the other party.

In short, being frugal is a great practice to put more money in the bank. Being cheap is a great way to piss people off.

So, how does frugal behavior increase your bottom line?

First, being frugal requires that you evaluate all your spending. It requires that you prioritize between wants and needs. A frugal person might “want” a new car, but instead chooses a “pre-owned” vehicle.

You think you know what comes next, right? Not so fast…

Some people will take the money “saved” by purchasing the “pre-owned” vehicle and spend it elsewhere. (Admittedly, that’s my toughest challenge!).

But truly frugal people have a greater purpose in mind. What is it? They put all of their reduced-cost savings to better use. This could be by paying down debt, saving, or investing. The point is: a frugal person not only conserves money, but, takes these incremental savings and puts them to better use.

Think of how much more productive you would be - financially speaking - if you took a lesson from frugal people. Too frequently we like to claim we “saved” money. But how many of us can point to specific dollar amounts and explain how it has been put to better use?

I’m learning to be more frugal. It’s both a mindset and a practice. But, I know the reward will be greater flexibility and greater ability to impact the causes that are important to me.

Find more discussion on frugal living by checking out Geezeo Groups.

Related:

Articles by TheStreet.com writer Jeffrey Strain
Open Book: How to be So Money by Farnoosh Torabi

“Simple is as simple does” said Forrest Gump some years ago. So what is “simple interest” and how does it compare with “compound interest”? This back to the basics article will give you the overview.

Simple interest rates are a different method to calculate rates of return. Simple rates are used in stocks, limited partnerships, and mutual funds. Unless stated otherwise, most mutual funds use simple interest rates.

With simple rates, your principal does not compound as illustrated in the Rule of 72. With simple rates the investor earns 100% each time the principal doubles. Check out this example from Left-Brain Finance for Right-Brain People, pg 24:

If you invest $1,000, then six years later sell the investment for $2,000, you made a $1,000 profit or 100% of your money.[...][T]he total profit divided by six (number of years) gives the annual yield of 16.7% (100 / 6 = 16.7%). Or, the profit per year, $167, can be divided by the principal, $1,000, to get the same, 16.7%.

The 16.7% simple yield used in this example is equivalent to a 12% compound yield. That is, in six years, $1,000 earning 12% compound interest grows to $2,000; and, in six years, $1,000 earning 16.7% simple rate of return also grows to $2,000.

Most investments calculate yields using the simple method. Be realistic making comparisons and don’t think the simple rate is always better because it is higher.

For more Forrest Gump-isms on making money, check out this blog entry, “The Forrest Gump Guide to Becoming a Gazillionaire”.

Let’s pause in our back to basics series to consider the power of baby steps. Are yours big enough?

You might not consider “baby steps” a milestone on the path to budgeting, investing, and saving. But, consider how many people give up on budgeting, investing, or saving. They claim it is too difficult, intimidating, or impossible. They give up.

Here’s the secret: small actions DO make a difference. Consider this example from “Eight Steps to Seven Figures” by Charles Carlson:

If you were to improve just .003 each day—that’s only three tenths of 1 percent, a very slight edge—and you kept that up for the next five years, here’s what would happen to you:

The first year you would improve 100 percent.
The second year you would improve 200 percent.
The third year you would improve 400 percent.
The fourth year you would be a better person by 800 percent.
By the end of year five—simply by improving three tenths of 1 percent a day—you will have magnified your value, your skills, and the results you accomplish 1,600 percent.

Yes, there is a financial parallel. Carlson provides an example which I’ll boil down to these two hypothetical situations:

Situation A
Invest $95/month
Annual return: 11.4%
Holding period: 20 years
Total amount at the end: $87,544

Situation B
Invest $100/month (just $5 more than Situation A)
Annual return: 11.5% (just 0.1% more than Situation A)
Holding period: 25 years (just 5 more than Situation A)
Total amount at the end: $173,659

The reward for those baby steps? $86,115.

Do not be discouraged by small amounts. Whatever small changes you’re making will add up. Keep making these small steps. They do add up!

A “back to the basics” series wouldn’t be complete without mention of 72 — not the year, but a simple calculation on how quickly your money will double and re-double. Here’s how Benjamin Franklin used the “rule of 72″ and you can, too.

You’ll recall that TIME is a huge factor in accumulating wealth. People who wait until their fifties to start investing will need to put away 14x (fourteen times!) more money each month than those in their twenties. The habit of putting small amounts aside every pay period is critical.

Secondly, you’ll remember that INFLATION will get us all, and so we need to consider our BREAK EVEN RATE OF RETURN and plan accordingly.

The Rule of 72 is a valuable tool to predict money growth on compound rates of return. This rule shows how many years are needed for a sum to double at various rates. Simply divide 72 by the rate of return (example: 6%). The answer tells you the number of years before your money doubles.

Examples:

$500 earning 6% doubles to $1,000 in twelve years (72/6 = 12). $500 earning 12% doubles in six years (72/12=6). What is the difference between compound and simple interest? Tune in tomorrow. But first, consider this example from “Left-Brain Finance for Right-Brain People” (page 23):

Benjamin Franklin understood compound interest. He left $5,000 to the city of Boston in 1791 with instructions that it should be left alone to compound for one hundred years. The $5,000 grew to $322,000 by 1891.

At that time the city decided to build a school with some of the money. They also followed Ben’s wishes and set aside $92,000 for another 100 years. By 1960, this fund had grown to $1,400,000!

Let’s hope the city of Boston had the foresight to put it away for another 100 years so that Mr. Franklin’s money can produce more gifts.

You probably won’t set aside your money for 100 years or more, unless you plan on being cryogenically frozen. You might, however, consider how compound interest will work for you and your heirs. Use the Rule of 72 to help you figure out how fast money will grow.

More. That’s the short answer to “How much should I be saving for retirement?” You could immediately tell me if you are able to break-dance. Could you immediately tell me your break-even savings rate?

Most of us have heard the doom and gloom surrounding the pitiful national savings rate, disappearance of pensions, and evaporating supplemental Social Security payments. Let’s not even mention the changing job environment and our national attachment to easy credit (and its damaging effects on long-term financial security)…

Naturally the question turns to what measures an individual can do to prepare for the future. Answer: save and invest more than you are currently, and assume you can do better. Refer to this Geezeo article and calculator if you’re wondering exactly how much you should be saving for your retirement.

An important part of retirement planning is to figure out your “Break-Even Rate of Return”. To get ahead you must earn more than the amount lost through inflation and taxes.

Here’s a net return on $100. The conditions are:

5% interest earnings
4% inflation, and
a 35% tax bracket (that’s 28% federal + 7% state).

The following example comes from the book “Left-Brain Finance for Right-Brain People” (268):

If $100 earns 5% interest, at the end of the year it is worth $105. That $5 is fully taxed. In the 35% tax bracket you will pay $1.75, which leaves a net earning of $3.25, or a total of $103.25. The 4% inflation rate then reduces the purchasing power of $103.25 to $99.12. In other words, the $100 that grew by $5.00 in one year is worth $99 at year’s end after inflation and taxes take their bite.

Your dollars shrink every year that they don’t break even.

Here’s the formula to figure out your break-even rate of return:

Inflation Rate
————————
(100) - (Tax Bracket) = Break-Even Rate of Return

A standard rule of thumb: you need to receive a net 2% return after inflation and taxes. That means 2% ABOVE your break-even rate of return.

If you think the above break-dance move looks painful or impossible… think about the fiscal moves you’ll be forced to make when you’re old and gray if you don’t start saving and investing NOW.

Yesterday in our “back to basics” series we focused on how to gain an overview of your financial health. We also explored why knowing your top three financial goals is critical to your success. Today we climb the so-called “Risk Pyramid” and highlight five investment purposes.

Like the U.S.D.A.’s Food Pyramid, a personal finance “Risk Pyramid” is open to debate and interpretation. Still, it’s handy to know what the experts recommend. I take this overview from Paula Ann Monroe’s excellent book, “Left-Brain Finance for Right-Brain People”, (Chapter 6).

Here’s the structure of Monroe’s version of a Personal Finance Risk Pyramid:

Foundation - Shore Up The Basics:
Property, Casualty, Liability Insurance (to protect your assets)
Healthy and Disability Insurance (to protect your health and also your income-earning potential)
Life Insurance
Emergency Fund (I like to call this the “Emergency Prevention Fund”)
Personal Residence
Specific Savings Goal or College Fund
Retirement Plans

Income
Bonds and Government Securities
Income Mutual Funds and Blue Chip Stocks

Growth and Income
Rental Real Estate
Mutual Funds and Limited Partnerships

Growth
Common stocks and Growth Mutual Funds
Growth Limited Partnerships (e.g., movie rights, commercial real estate), Hard Assets, (e.g., works of art, precious metals) and Land (you know what land is…)

So, from bottom (basics) to top (growth) these are the financial components that make up your personal finance “risk pyramid”. As you move toward the top the investments have more associated risk.

Yes, owning empty land is one form of “risky”. This is one example where folks disagree on risk pyramid structure. Sure, they aren’t making more empty land. Unlike other investments, land value is associated with uncontrolled nearby conditions. In contrast, an asset on that land (like a home) could always be sold off or insured for financial protection against an unforeseen event.

How do you evaluate all these different investments? It breaks down like this: look at each asset in the pyramid on these criteria. Compare what you find to your goals, your tolerance for risk, and your specific situation. Here are the things to consider:

Safety
Liquidity
Income
Tax Advantages
Growth Potential

If you’re a beginner, focus on strengthening the base of your financial risk pyramid. Educate yourself and get professional opinions before attempting more sophisticated investment strategies. Use Geezeo’s tools and social resources to make more informed choices.

Finally, and the most important: finding purpose in your investments is a head and heart activity. Use your head to evaluate and implement your investment strategy. Use your heart to determine why you want to improve your financial situation. Incorporate giving to others as part of your strategy and you’ll find true purpose to stay financially fit.

Climb that pyramid!

How do you check your financial health? Today we’ll continue our series on “the basics” and discuss what you need to do to get an overview of your “financial fitness”.

Why Should I Take a Financial Inventory?

Let’s face it: motivation is key. If you are vague about your starting point (e.g., “I know I’m in debt, but God knows how much!”), it is highly unlikely you’ll swiftly reach any financial goal — even a small one.

Think about your top three financial goals. Can you name them right now? If not, chances are good you’re not maximizing your resources. As a result you might never reach your financial goals.

Here’s a personal example. My top three financial goals were: paying off my college loans, saving for retirement, and purchasing my first home. Once I was able to passionately get behind all three “end game” goals I could find the discipline to save and invest accordingly. I’m happy to report that I’ve purchased my first home and am now re-adjusting my “top three” goals. That’s the power of taking and monitoring a financial inventory.

How Do I Figure Out My Financial Inventory?

First, you must answer these three questions.
1 - How much do I earn?
2 - How much do I spend?
3 - What do I own, versus what do I owe?

Next, you’ll use two tools - they are power tools that don’t require protective gear.
1 - A cash flow statement
2 - A net worth statement
Don’t be scared!

Figuring out your Cash Flow. This compares the money you earn to the money you spend. The simplest way to do this is to make a list of every regular monthly expense you have. Yes, I know some expenses vary. Focus on the firm expenses first and then use a budget to determine your flexibility in areas that fluctuate.

Use Geezeo’s Budget tools to get an accurate look at your cash flow. Geezeo’s Spending Targets will change from green to yellow to red to let you know when you’re approaching trouble. On paper spend down your entire inflow of cash so you can direct your cash toward your top three goals.

Figuring out your Net Worth. You can do this the old-fashioned way by making a list with two columns. On one side list all of your assets. On the other list all your debts owed. Tally both columns and determine if your net worth is positive or negative. Or you can do this the hands-off way: you can see and track your net worth over time in your Geezeo Dashboard.

The point is: track your net worth because it keeps your “eye on the prize”. It’s motivation. Tomorrow we’ll discuss how to know what you want to achieve with your money. Good luck!

Related
* Stock Cash Flow 101
* Why the Statement of Cash Flow Matters
* Investing: Getting Started with Discounted Cash Flows

Okay, here in the “back to the basics” series we arrive at a junction where people either really agree, or really disagree.

It concerns PMA. (No, not the stock Powershares Mega) Call it your “Prosperity Mental Attitude”, or “Positive Mental Attitude”. Some view this attribute as too New-Agey or soft, but, it’s been my experience that attitude about your finances changes everything. So ask yourself: am I thinking thoughts that will benefit my financial life, or harm it?

Your PMA is part of the bigger picture. Everyone is born with different talents. We’re born into families who either provide, or do not provide, financially-favorable conditions. What’s the one thing you can control? Your PMA. You can choose to see possibility and opportunity — and act on it.

Here are some attitudes that will quickly destroy even the best budget or most diligent investing:

Blame

At some point we’re all a bit guilty here. Blame places the responsibility of your financial failure on forces “out there”. Blame seldom solves a financial problem. And, if you’re the type who constantly complains and blames…you’ll find that economic opportunities dry up as fast as the willingness of others willing to listen.

Quick phrase to stop an incessant blamer: “I just don’t understand how you can possibly go on with [insert object of blame here]. How do you go on?” It’s my experience people who complain and blame are looking for attention more than actual problem solving. This phrase forces their hand. Frequently, they’ll back up and say, “it’s not that bad…”

Scarcity

This is the viewpoint that originates in fear and says “there isn’t enough for everyone”. This is the view that financial life is a constant battle. The problem is self-serving. Battles need victims and to participate in this view you need to be the victim. This can trigger the stupid battles you witness over coupons at the grocery store, for example.

Why change: if you stop fighting and start giving thanks, life becomes a lot more enjoyable. We all have something to be thankful for — if only that living in the U.S. gives us rights, freedoms, and opportunities.

More is Better

More money can solve some problems. But money alone can’t solve all problems. Worse: many of us work to achieve a symbol of financial success rather than focus on what makes our lives truly meaningful (however you define that).

Security cannot be purchased. It doesn’t come from possessions or status items. Chasing after the bigger house, newer car, latest clothes, etc., doesn’t bring happiness. Focusing only on achieving these symbols with your money can leave you feeling empty. Do more with your money than simply making more of it.

Procrastination

In money management it’s often repeated that the best time to save or invest was yesterday. To really achieve the financial success you desire, you must commit to action. You need to remember that small steps add up. Dropping a habit of procrastination will do wonders for your wallet.

Educate yourself now. Take action now. Continue on your financial journey with an internal commitment to keep a Prosperity Mental Attitude. It will prevent vanishing money and you’ll be happier, too. Good luck!

Why should you spend a few minutes reading about personal taxes? Aren’t there other equally confusing and boring topics? And won’t my tax accountant do it all for me anyway?

Consider that taxes are a lot like someone (Uncle Sam) peeing in your (financial) pool. The difference being that when someone pees in your pool you get upset. When Uncle Sam does it, his efforts go toward maintaining our highways, schools, and other public ventures. So, complain as we might, no one who ever peed in your pool does so much for you. It’s a trade-off.

As stated, this series will focus on the basics. Here are the basics to remember about personal taxes:

1. It is illegal not to pay taxes. Proceed cautiously if you smell advice that is intended to avoid taxes altogether. You cannot plead ignorance or stupidity. You can, however, be fined considerably and/or yanked out of line and into jail. Just say’n…

2. That said: the name of the game is to pay what is legally required but nothing more. Pay your share willingly. Americans pay considerably less in taxes than folks in other countries. (If we paid more, maybe we’d have the luxury of free health care, too!). How do you prepare? Organize, organize, organize. Save receipts throughout the year so you can back up any deductions.

3. File your tax return even if you can’t pay your taxes. When you file but don’t pay, the IRS assesses a penalty of 1/2% percent per month on the balance due. That’s a lot better than the 5% penalty compiling daily on top of this 1/2%, plus market rate interest if you don’t even file. It can seriously add up.

4. Never ignore any mail from the IRS. The government can freeze your bank accounts, garnish your wages, and put liens on your property. You will endure a lot of embarrassment, fines, and aggravation if you choose to ignore the IRS. Save yourself the headache.

When in doubt, speak to someone who knows the law and likes to crunch numbers. Remember: it’s your tax return.

Related:
* 3 tips: how do I hire an accountant or tax professional?
* Year-End Financial Housekeeping
* Don’t Let the “Gotcha’s Get You