Finances 101: Stuff We Wish We Learned in School
Personal finances have a way of creeping into nearly all of life’s major decisions. Here are just a few examples: buying a house, starting a business, or, you know, having a baby. We don’t always learn this stuff in school, so we at Mirza thought we should help! In today’s post, we’ll talk you through some basic personal finance terminology you may, or may not, be familiar with. Over the next few weeks, we’ll share some content to help you think through some big financial decisions. Today, the basics.
We can lump finances broadly into three categories; (1) savings, (2) investments, and (3) loans.
Savings
Many banks offer higher interest rates, closer to 2%, for high-interest savings accounts in exchange for limited account accessibility/functionality. For example, a high-interest savings account may provide limited withdrawals or transactions. These accounts can be useful when you don’t necessarily need to spend the money in the near-term and can afford to put the money aside and earn some extra cash. Before you open any bank account it is important to understand whether there are fees associated with the account because these can eat into your precious interest payments.
Investments
Under the investment bucket, things get a little more exciting. Here, we’ll include stocks and bonds to keep things manageable. Stocks come in a variety of flavours and risk levels. In general, diversifying your portfolio across multiple stocks helps reduce your exposure to the risk of one specific company. Funds, especially Exchange Traded Funds (ETFs), can be an easy and low cost way to invest in a broad basket of stocks. ETFs can also include bonds as well. Some ETFs even include stocks and bonds in what is usually termed a ‘balanced’ fund. Before investing in any stock or bond we recommend that you understand the risks and costs that are associated with the investment, and whether it is suitable for your specific needs. It may even be helpful to speak with a professional.
Loans
Next, there are traditional loans or lines of credit available through traditional financial institutions. With loans, the interest rate can vary depending on whether it is secured (backed by other assets) or unsecured. As a rule of thumb, experts generally recommend that total debt payments such as credit card, line of credit, mortgage, car payments, etc. should not exceed 40% (total debt service ratio) of your monthly before-tax income.
For example, if you make $70,0000 a year, that works out to approximately $5,833 per month before-tax. 40% of $5,833 works out to approximately $2,333. By this we mean that if your monthly debt payments are below $2,333 then you are in good shape according to conventional wisdom; of course we acknowledge that there are always exceptions depending on your personal circumstances. Keep in mind that the average monthly mortgage payment in the US is approximately $1,000. If car payments amount to $250 a month, and $500 is due on your credit card, that leaves you with capacity for an additional $500 potential other loans.
We are working on additional resources, because money matters for future parents (well, for everyone). We hope you found this post useful! Feel free to reach out to us with comments and/or questions.
Disclaimer: all content we provide is written by people who really care, but who are not personal financial planners. We do not claim to provide guidance on your specific situation such as risk capacity, financial returns, financial leverage, etc., etc.
