Personal Finance 101

In our school of finance aficionados, it is surprising how some things that are very important are not necessarily taught in classrooms. Whether you're looking forward to a full-time salary or a minimum wage summertime paycheck, here are some tips to help you stretch out your money the farthest.

Banking

Banks take your deposited money and loan it out to home-buyers, businesses and others. Because lending is profitable, they are willing to pay you money to hold your deposits. They will pay you a percentage of your deposit every year. This is what's known as the interest rate.

However, interest rates are currently really low. The current best interest rate for a savings account is 1.14%, which means that if you have $1000 in a savings account for a year, you're only going to make $11.40 in interest. So it's not really that important right now to pick a bank because of its high interest rate.

A smarter move is to pick a bank that minimizes fees. There are two main sources of fees - ATM withdrawal fees and overdraft fees (when you try to withdraw more money than you actually have in the account). Fortunately, there are some banks that are not evil. I recommend Ally Bank, a new online bank. You can withdraw your money from any ATM and Ally will refund the fee. Also, you can sign up for overdraft protection, which will transfer in money from your savings account (with no fee) if you overdraft in your checking. They also have 24 hour customer service and funny commercials. The one downside is they do not have physical branches, so if you like depositing your money with a teller, you might not want an Ally account.

Credit Cards

Credit cards are very convenient - they allow you to buy things now and figure out how to pay for them later. They also offer great rewards programs, for example free flights (after enough purchases) or 1% cash back on every purchase that you make.

The downside is that if you don't pay off your balance in full every month, they charge a very high rate - often 15% or more - on your outstanding payments, and your credit score will take a significant hit. So the rule with credit cards is pretty simple - don't buy stuff that you can't afford. Do not sign up for a credit card if you think you would go into debt. The only way they make sense is if you pay off your balance in full every month.

On the flipside, if you are currently in credit card debt, paying it off should be your #1 priority. If I have $1000 in debt and I pay 15% per year in interest, I can save $150 in interest payments by paying off the credit card now, instead of one year from now - a guaranteed 15% return. This will outperform most bank and market investments, as well as help boost your credit score.

Your credit score is a number which tells lenders how likely you are to pay them back (Above 800 is a very good score and below 650 is a very bad score). Having good credit is very important for getting good rates on loans for a new home, car, or line of credit. Not paying your credit card balance in full will always damage your credit score. You should regularly ask your card issuer for credit limit increases, even if you do not use anywhere near your full credit limit, because it helps your credit score to have lots of available credit that you aren't actually using. Federal law states that you can view your credit score for free once every 12 months at annualcreditreport.com. Do not go to freecreditreport.com, the site with the catchy commercials, because they will scam you, and it is not free.

In terms of choosing a credit card, the general advice is to put all of your rewards on one card (instead of using store-specific cards, which don't give you as good a deal), and to avoid a yearly fee, as there are enough good cards now that don't have one. I used bankrate.com to compare credit cards. Also, many credit cards have little known perks like automatic 1-year warranties on all purchases and discounts at many national retailers - see this post on Ramit Sethi's blog for more information.

Investing

The US government's Social Security and Medicare programs are growing at an unsustainable rate. This means that you should not count on having much, if any retirement help from the government, and you should save enough to cover the entire cost of retirement. Thanks to the miracle of compound interest, money you invest now will likely increase to 10 or 20 times its value by the time you retire. You should try to set aside 10-15% of any money you earn for retirement, or a rainy day.

The best evidence we have says that, Warren Buffett aside, it's  extremely rare for anyone to beat the return of the stock market over a long period of time. Of course, people can beat it in the short run, just like if you had 1,024 people flip a coin ten times in a row, you would expect two of them to have all heads or all tails. However, there's an easy way to perform at least as well as the overall stock market - invest in index funds, which allow you to own shares in thousands of companies for the price of one share (this is how all of my money is invested). Index funds also have low or no fees, compared with a mutual fund, which might charge you 1% or more every year to manage your money.

However, index funds aren't perfect for everyone, and I'd recommend you take advice from a more serious source than relying on my personal opinion before deciding how to invest your money.

Also, the best evidence we have says that people who buy and hold investments tend to do better than people that frequently buy and sell stocks. When you buy and hold, you don't have to pay fees or taxes from selling or purchasing shares. Furthermore, you don't have to worry about whether you could be earning a better return or whether the market is going to do well or poorly. I would recommend using Sharebuilder.com for an investment account - it costs $4 a trade.

Roth IRA

A Roth IRA is a specific type of retirement account. Normally if you use your job income to buy a stock, you get taxed twice - income tax on your paycheck, and capital gains tax if your investments make money. However, if you put your money in a Roth IRA account, you pay no tax when your investments gain money, which gives your return a huge boost. The catch is that you can only get the tax benefit if you are older than 65 when you withdraw the money - otherwise you have to pay tax at the normal rate.

Now I know this sounds really complicated, but you can set up a Roth IRA account on Sharebuilder in under 15 minutes. You can put the lower of your total earned income for the year, or $5000, into the account. I would recommend trying to max out this account every year.

More Information

Feel free to ask questions, leave suggestions in the comments or email me with thoughts. I'd also recommend checking out Ramit Sethi's blog, I Will Teach You To Be Rich.