Now that the global economy seems to have settled down a bit, most people are rubbing the financial slumber from their eyes and trying to figure out what happened and how to better prepare for the future.  As I’ve thought about the economy and personal finance in the past few months I’ve continually come back to the idea of becoming more financially resilient – basically, becoming better able to withstand and even thrive during future economic downturns.

It’s nearly impossible to become completely independent of the world markets, but the following are a few ways to help ensure that if things go south in a hurry (they will again, someday, sometime), you will survive and won’t be swept up in the wave of financial destruction:

1. Learn to track your spending – unless you can get a grasp on where you money is going each month, you have no basis for managing your finances.  With the availability of free online budgeting software like Mint and Wesabe, there is no excuse for not being able to track your spending.  Once you can categorize and measure the various financial transactions you make on a regular basis you can then develop a realistic spending and savings plan.

2. Be merciless with debt - during the past two years of financial wreckage, the first people to go under have often been those buried in debt.  An unexpected job loss, pay cut, or rise in interest rates can overwhelm anyone with a high debt-to-income ratio.  Whether you start with the smallest balance first, or the one with the highest interest rate, the important thing is to rid yourself of debt as quickly as possible and avoid accumulating more.

3. Cut costs/D-I-Y/Sustainability – to become better off financially there are only two options: spend less or make more money. Cutting costs is often a much easier short-term solution to increasing our wealth. Start by looking at your monthly expenses (see Step 1), identifying your biggest costs and whether or not they can be reduced. Do you have interest rates or fees that can be negotiated down? Subscriptions that you don’t really use? A simple phone call may save you hundreds, it costs nothing to ask.

Second, identify things that you could produce yourself. For example, my wife and I discovered that our monthly grocery bill was larger than we liked, but felt that much of it was due to our desire to eat healthy, fresh foods, specifically produce. Rather than cutting this out of our diet, we made the decision to plant a vegetable garden this coming spring. It won’t completely replace the grocery store, but growing our own tomatoes, lettuce, cucumbers, etc. will save us a significant amount of money over time, provide us with healthy, organic food, and insulate us from rising food prices.

4. Develop multiple streams of income – the second part of the wealth equation deals with making more money in the first place. Even if you have a full-time job, you can increase your financial resilience by developing multiple streams of income. For example, while it doesn’t earn much, blogging provides me with an additional source of income.

Focus on developing passive income, or income that comes from activities that don’t require your full-time engagement. Examples of this would be rental income, advertising revenue from websites/blogs or royalties from publishing a book or other intellectual property. Think “set it and forget it.” By increasing your streams of income you help ensure that if one stream dries up you are still able to survive.

5. Build an emergency fund – If you live paycheck to paycheck you are not alone, but you’re playing a dangerous game.  No matter how well you budget there are always going to be unforeseen costs and emergencies.  Car trouble, medical issues, last-minute travel, etc.  The way to make sure these events don’t crush you is to build an emergency fund.  Trent at the Simple Dollar explains,

“An emergency fund is cash that you’ve saved up for the sole purpose of helping you maintain your normal life through the emergencies that life hands you. “

Check out his awesome step-by-step guide to building an emergency fund here.  Various numbers on how much you should have in savings get thrown around by the experts, but 6 months of income is a good place to start.

6. Maximize contributions to Roth IRA – there is no better retirement vehicle available to young people today.  The Roth IRA allows the money in your account to grow tax-free and keeps you from having to pay taxes when you begin to withdraw payments come retirement time.

Do everything in your power to contribute the maximum ($5,000 for 2009) each year.  It may not seem like much at first, but if you start in your 20’s the magic of compounding interest can work for you and provide you with a good chunk of retirement income.

7. Diversify investments – “I believe that 98 or 99% – maybe more than 99% – of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs.” Warren Buffett.

The principle laid out by the Oracle of Omaha is sound advice for investors.  Since you don’t have enough knowledge (worry not, even the “experts” on CNBC don’t) to consistently and accurately predict which markets will provide the best returns and which will tank in years to come, invest in all of them.

How does the average 20-something do this?  By investing in low-cost index funds like the Vanguard S&P 500 Index Fund, which purchases shares of every company in the S&P 500.  By taking out the guess-work (excuse me, ehem, “technical analysis”) of fund managers the funds are able to charge the investor significantly less.  For more info check out Ramit Sethi’s in-depth post on mutual funds.

Of course, diversification extends beyond stocks.  Many have found real estate to be a profitable place to invest, as well as bonds, commodities, currencies etc.  However, for the average investor, index funds provide a great place to start.

8. Learn entrepreneurship – entrepreneur and author John Robb explains, “One of the best ways you can prepare for the future is to train yourself to become an entrepreneur — essentially a person that makes their own economic opportunities.”

Not everyone dreams of running their own business, but as more and more jobs are outsourced to countries who can do them for less money, the types of skills that may help you survive are those found in successful entrepreneurs.

Start small, test fast, fail fast and keep going.  Entrepreneurial opportunities are often much closer to home than you may think (sounds eerily like a piece of fortune cookie wisdom).

9. Nurture relationships – Very few people get through life without depending on the generosity, wisdom, or partnership of their friends and families in reaching their financial goals.  Besides the obvious benefits of having people to bail you out if you find yourself in trouble, relationships provide you with a network of people who can give you advice, mentorship and in some cases capital for a start-up or investment opportunity.

By nurturing close personal relationships you tap into a greater resource than any bank or investment firm could ever offer you – people who share in your vision and authentically want to help you succeed.  And in the end, no amount of money will fulfill if you don’t have people to share and enjoy it with.

10. Hold on loosely – Some of you might be asking, “Wait a minute Cameron, you just got done telling me how to make more money and keep it, now you’re saying to loosen my grip?”  Absolutely!  Money is a great tool, but it has an amazing ability to corrupt people who make it the chief end in itself.  When taking positive steps to better your personal finances it’s easy to become greedy as you witness just how much is possible with a few solid decisions and some daily fiscal discipline.

How do you fend off greed?  Simple, by giving money away.  Being rich isn’t about the bling, it’s about freedom.  For me this means the freedom to support my family and bless others at the same time.  Many of my friends are involved in some incredible non-profit organizations and missions – being able to support them is one of my favorite things in life.  Holding on tightly to your money may help you feel in control, but in the end it keeps you from receiving a much greater reward, the joy of helping others.

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No doubt about it, last year was atrocious when it came to the world of finance.  If you’re like me you watched your investments magically get cut in half like a Ginsu knife commercial.  It was a year that brought high costs, pay cuts, slow business and even layoffs.  So what can the average guy do to turn things around in 2009?  What new strategy can be implemented to see rapid gains and a replenishing of one’s finances?

Unfortunately, nothing too sexy, just the same dusty principles that many great men of finance have taught for ages — principles that all revolve around one grand idea: make less money go out and/or more money come in.

The reality is there’s no secret or magical formula when it comes to personal finance…it’s boring! No one knows the next hot stock, no matter how many degrees they hold or how many times they’ve appeared on CNBC.  No one knows where the bottom of the market is or when the economy will turn around.  And although many young brokers on Wall Street have tried (credit-default swaps), no one has figured out how to make money appear out of thin air.

Sure people catch a lucky break every now and then, people also win the lottery and get struck by lightening, it doesn’t mean anything.  What people have lost sight of, and what helped lead to our current mess, is that making money on a consistent basis takes self-control and discipline. It means making lots of small, but good decisions over a long period of time.

But, that message doesn’t sell books or DVD sets.  So, most people brush it off as old-fashioned and set off on their next get-rich-quick scheme only to find the pot of gold at the end of the rainbow is actually full of red ink.

The following points are probably ones you’ve heard a thousand times, but maybe it’s time you took them seriously.

1)  Live Within Your Means – Just because you can buy something, doesn’t mean you should.  All of us have something inside us that leaps with excitement when we buy something shiny and new, but within a few days, weeks or months, that feeling is gone and all we’re left with is less closet space.  I’m not saying you should stop buying new things altogether, I’m simply asking that we recognize our weakness and tendencies to justify buying things we don’t really need.

One must decide on a daily basis how much short-term comfort and pleasure they would like to sacrifice for long-term prosperity. There are a million factors that go into these decisions, but in the end life is about choices.  Each person must decide for themselves how much they are willing to sacrifice and plan their finances accordingly.  If you buy the brand new Land Rover now that’s fine, just don’t be surprised if your neighbor who bought the used Honda is doing a little better financially in five years.

2)  Create and Stick to a Budget - Two words: Wesabe and Mint.  These two completely-free online budgeting services are incredibly useful in helping one set up a detailed budget.  Not only do they automatically upload the information from your various bank and credit card accounts, they also allow you to tag purchases (groceries, entertainment, bills, etc.) and set spending limits for each.

If a person wanting to better their finances is not using one of these free and easy services they are missing out on a great opportunity.  The trick after setting up the account is checking it at regular intervals to monitor one’s progress.  This is the only way to consistently adjust your living habits to your budget (the purpose of making a budget in the first place).  If I know that I only have $100 left for the month to spend on groceries it will make the decision between filet mignon and chicken breast a much easier one.  Just like a business cannot begin to make progress without great accounting, an individual has no hope navigating the world of personal finance without a budget and an understanding of where they stand in comparison.

3)  Be Aggressive With Debt – The problem with debt is that you become a slave to another person or institution.  The whole point of money is to give one freedom, not bondage. There are times where taking on debt is necessary, maybe even advisable (student loans, exceptionally low interest rates, etc.), but for the most part it should be avoided like the plague.  Unfortunately, credit cards make taking on debt seem acceptable, even exciting.  When one finds himself in debt, the best tactic is to be incredibly aggressive in paying it down.  Everyone has seen the charts showing how expensive a purchase can become if one makes only the minimum payments, if you haven’t see here.

Pay down the debts with the highest interest rates first.  Also, don’t be afraid to call your credit card company and ask for a lower interest rate, in many cases they will help you out if you are adamant enough.  See here.  Debt is a dangerous thing for one’s finances because it always costs more than you want to pay. Most people understand this and struggle with more complex debt-related questions like whether to pay-off debt completely before investing, buying a house or renting, to consolidate or not.  Theses questions are highly dependent on the specific circumstances the person asking them, so I would be silly to offer any sweeping conclusions.  Do your homework, ask lots of questions and make a good decision.

4)  Max Out Your Roth IRA – Whenever one of my friends asks me what they should do with their extra income I always have the same question two questions for them: 1)  Have you started a Roth IRA  2)  If so, have you maxed out your contributions for the year?  If they answer no to either of these the answer is simple, get it done.  There are millions of different investment options available, but if you’re young and don’t make a significantly large income (more than $105,000 single filer) it is almost always the best option for you.

Exception*** If you’re employer offers to match your 401k, then max that out first and use whatever you have left to contribute to your Roth.

As I explained in a previous post,

A Roth IRA is different because while you get no tax break up front, your money grows tax-free in your account and when you take it out come retirement time, YOU PAY NO TAXES, not even on the earnings. Another way of saying it, traditional IRAs are “tax-deferred” and Roth IRAs are “tax-exempt” savings. American Funds has a great comparison chart comparing the two types.

For a good summary of the Roth IRA rules for 2009 see here.

5)  Educate Yourself – How much time do you invest in your financial education?  Chances are it is very little…probably less than the time you spend watching “The Office” each week.  It’s funny that for such an important aspect of our lives so many of us spend startlingly little time trying to educate ourselves.  It’s not surprising since much of the industry seems to thrive on making itself seem overly complicated – not to be understood by mere mortals.  Liars!  It’s not rocket science, even basic science for that matter.  It just takes some time and effort.

There are a lot of great books, blogs and classes out there to help you understand finance, but I’ll keep it simple and recommend two for 2009:

1)  A Random Walk Down Wall Street by Burton G Malkiel

2) I Will Teach You to Be Rich – Ramit Sethi’s Blog

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Due to my love for finance and my ability to throw out the random buzzwords like “asset allocation” and “diversification” to sound really smart, many of my friends have begun to come to me for investment advice. “Cameron,” they ask, “this investing stuff is just too complicated, I am (insert an age) and still haven’t invested in anything, I don’t even know where to start.” The first question I always ask is whether or not they have a Roth IRA? Judging by some of the responses I have received I think it’s time to explain what a Roth IRA really is and why if you are young (college, twenty-something) and you don’t have one, you are throwing piles of cash down the toilet.

IRA stands for Individual Retirement Account, basically a simple way of saving money for retirement — remember though, it is just an account, not an investment itself. With an IRA you can choose where you want to invest your money. Think of an IRA as a basket in which you can throw various kinds of investments. Most people choose to throw a mutual fund in their IRA which is why you will hear the terms getting thrown around and mixed-up most of the time. As long as you remember that an IRA is simply an account to place investments in, you’ll avoid a lot of confusion.

Traditional Vs. Roth – These are the two main types of IRAs. I will save you the trouble right now and tell you that if you are under the age of 50 and you don’t make six figures then Roth is the way for you to go. The main difference between traditional and Roth IRAs are how you are taxed. With a traditional IRA you get a tax break when you deposit the money in your account each year. This means if you make $50,000 of taxable income in a year and place $3,000 in your IRA you will only pay taxes on $47,000 that year. Your money will then grow and when you take the money out after age 59-1/2 you will then pay taxes on the money in your IRA. A Roth IRA is different because while you get no tax break up front, your money grows tax-free in your account and when you take it out come retirement time, YOU PAY NO TAXES, not even on the earnings. Another way of saying it, traditional IRAs are “tax-deferred” and Roth IRAs are “tax-exempt” savings. American Funds has a great comparison chart comparing the two types.

Some Rules to Know – First, being that it is a retirement account you will be heavily penalized if you take the money out early, meaning before age 59-1/2 (there are a few exceptions like a first-time home purchase). This means put money in your IRA that you won’t need in the near term.

Second, for you overachievers, the maximum contribution has just changed from $4,000 per year in 2007 to $5,000 per year in 2008.

Finally, to be eligible for a Roth IRA you must make less than $101,000 as a single filer or $159,000 as a joint filer in 2008. So, if you’re raking in some good money already and you exceed these limits you will only be able to invest in a traditional IRA, still not a bad thing.

How to Set Up a Roth IRA – First, remember that banks and investment companies want your money, so they’re going to make it as easy as possible for you to give it to them and if they don’t, shop somewhere else. All you need to set up your account is your W-2 form showing you have earned income. There are a few different places you can go to set up your Roth IRA: bank/credit union, mutual fund companies, or discount broker. The bank route would be for the ultra-conservative investor that wants to use CD’s or money market accounts as their investments (if you’re under the age of 50 this is probably too conservative).

Next would be opening it through a mutual fund company. My favorites include: Vanguard, American Funds, USAA (All of these links will take you to the page dealing with opening an account with the company). By going through a mutual fund company you can then purchase shares in one or multiple funds from the company and put them in your Roth IRA. This method also helps ensure greater diversity being that with a mutual fund you are automatically investing in hundreds of companies rather than just one or two, spreading out your risk substantially. Plus, many times the minimum investment is lower when opening a retirement account than it would be with a normal brokerage account. The final avenue would be using a discount brokerage service, similar concept as above.

Once you have opened your account the next step is setting up an automatic investment plan (takes out money from your paycheck and automatically puts in your investments) so you can harness the power of dollar cost averaging (DCA), an investment principle I wrote on earlier (here).
Once you have this set up your goal then becomes to “max out” your IRA each year, or getting as close as possible.

With our country’s social security system looking more and more shaky all the time and many businesses moving away from traditional pensions, taking control of your own retirement is becoming more necessary than ever before. Probably the biggest reason people put off retirement planning and investing is simply lack of knowledge. The financial education given in the primary and secondary school systems is abysmal and unless you actively seek out investment classes in college, one can go through many years of school without learning even the most basic investment principles. So, if that is you, start now. Don’t be afraid to ask questions. Remember that your future is no one’s responsibility, but your own. As a young person time is on your side and by starting now you can quite easily amass a large amount of money so you can do the things you want to do when you want to do them.

Other good articles on Roth IRAs:
- The World’s Easiest Guide to Understanding Retirement Accounts – Ramit Sethi (the man)
- Why You Need a Roth IRA – Kiplinger.com
- Roth IRAs: A better IRA for almost everyone – AmericanFunds.com

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It amazes me the amount of financial advice available today. Books, seminars, blogs, dvds, etc. with the sole purpose of showing you how to make money. I’m all for it to be honest, the more information available the better….although there are a lot of crooks and idiots out there as well. So, you have to be careful who’s advice you take.

I found a blog yesterday entitled I Will Teach You To Be Rich by Ramit Sethi, a young Silicon Valley entrepreneur. While I admit I haven’t had the time yet to read through all of his articles, I was in agreement with his general views on creating wealth. The principles below are from his blog with some extra info added in by yours truly. I post these because they are, in large part, the same principles that I have come up with as I’ve attempted to hack my way through the jungle of financial plans, solutions and gimmicks in my own life. Nothing cosmic…THERE ARE NO SECRETS…but sound advice to any college/twentysomething wanting to create a stable financial base:

– Create and Maintain a detailed budget. Wesabe is an excellent site I use that helps you do this…best part, completely free! Upload your accounts, label transactions, set spending limits and you’re on your way.

– Get your credit report. A recent amendment to the federal Fair Credit Reporting Act requires each of the nationwide consumer reporting companies – Equifax, Experian, and TransUnion – to provide you with a free copy of your credit report, at your request, once every 12 months. To get these reports go to www.annualcreditreport.com

– Make sure you’re not paying fees on your bank accounts or credit cards.

– Open a high-interest bank account. www.bankrate.com will give you a comparison of all the different banks and their interest rates.

– Establish a savings goal of 20 to 30 percent of your income, if possible.

– Open an investment account at a discount brokerage. Most of my friends that I talk to about this look at me with horror saying they just don’t know what to do…believe me, brokerage houses don’t get rich by making it hard for you to open an account with them. Call, ask questions, don’t make any quick decisions. If you already use USAA they do a good job, I’m also a fan of American Funds…if you go the mutual fund route.

– Fully fund 401(k)s and Roth IRAs. If you are over the age of 22 and do not have a Roth IRA set up, even if you don’t contribute much yet, you are flushing money down the toilet. It takes literally a few minutes to set up an account that will allow you to grow money throughout your life TAX-FREE.

Popularity: 3% [?]