The Psychology of Money: Part 2

If you’re reading this, you’ve hopefully read part 1: “How To Make The Most Of Your Money”. 

If you’ve done step 1 (you sat down and made yourself a budget), it’s now time to learn a little bit more about personal finance management so you can find the best ways to make progress on paying off your debts and saving money.

This time, I’m going to talk about personal finance terms you may not fully understand. If you don’t understand something, it can be easy to skip over it. That’s why it’s taken me 25 years to open up my 401k, ROTH IRA, and high yield savings account.

It’s never too late to start any of these things, but, the sooner the better.

To make things simple I’m going to split these finance concepts into 3 categories: Debt Terms, Saving Terms, and Investing Terms. That way I can try and explain how each of these finance concepts can be used in these areas.

Starting with the worst category of them all.

Debt is a scam.

Debt companies will screw you over if you don’t understand the concepts of compound interest, APR, minimum payments, and principal balance. When I opened my first credit card and saw that the APR was 26%, I brushed that off without even thinking much about it. Someone once told me that if you don’t carry a balance month to month you never have to worry, which is true, but if you do carry a balance… you’re screwed.

That part I did not understand.

Compound interest is the thing that will screw you over when it comes to debt. It’s the reason why you should be incredibly careful if you ever decide to use a credit card.

Not only do you have to pay back what you borrow, you’ll also be paying compound interest that will continue to grow on you. Compound interest is basically interest that grows on itself over time. Most credit cards have interest rates that are usually around 20-30%. That’s your APR (Annual Percentage Rate). That amount of compounding interest on a large balance can get out of hand quickly.

I’ll use myself as an example. Before my consolidation loan I was paying 26% interest on a large amount, and by making a minimum payment of over $300 I was just barely paying the interest off each month. At that rate, it would’ve taken me well over 10+ years to pay off my balance. Which is something I didn’t understand until my debt caught up to me. It took a while for me to realize that my minimum payment was essentially just a large interest payment with a slight principal payment.

So, in order to avoid the trap of compound interest, you should do everything in your power to pay off your credit card balance before you start accruing any interest on it at all. Ideally, when you open a credit card, you should only spend money you have, and are planning to spend anyways (gas, groceries, etc.,), so that you can pay off the balance immediately. That’s the best way to use a credit card and avoid the scam of compound interest, especially if the APR is a large percentage.

Minimum payments are also incredibly misleading. Don’t get me wrong, you should always at minimum make those payments, to avoid a bad hit to your credit, but you should also always make payments over the minimum if you’re in debt and have the money to do so. This will help you avoid paying as much in compound interest and in turn will help you pay off the debt faster.

That’s where your principal balance comes in. Principal balance is the original amount of money you borrowed. That original amount accrues interest, so your monthly payments are part principal and part interest. Meaning if you make a principal payment after your monthly payment, you’ll lower the interest because you’re lowering the total amount you owe before interest.

How I like to pay my personal loan; I make my monthly payment first, then any extra money I have goes toward making a principal payment. In the end, this saves me money on interest.

In short, if you don’t have credit card debt, avoid it. Make full payoff payments every month on your card, only spend what you have, and don’t let interest accrue. Credit cards can sometimes feel necessary, especially if you want to lease a home someday or need to run your credit to rent, but they can do more harm than good if you misuse them. 

If you’ve already used your credit card wrong, it’s a good idea to learn from your mistakes and pay them off as quickly as possible by paying more than just the minimum. Then reflect on how you got into the debt and never do that again.

My final point on debt is that if you can consolidate credit card debt into a loan, you should. You’ll likely get a much lower APR % and in turn you’ll pay off the debt quicker and pay less in interest. Just keep in mind that once your credit card hits zero, that is NOT an opportunity to use the card like you were when you got into debt. You can never do whatever you did to get into debt the first time. This is how you end the cycle of debt.

Saving Money is crucial.

If debt is a scam, saving money is the key to your financial wellness.

The best way to avoid debt is to have money saved aside for a rainy day. Sometimes we get ourselves into debt with bad choices, but a lot of us also get into debt because we aren’t prepared for an emergency. Anything can happen to us at any time, and almost everything costs money, so if you want to avoid debt, you need an emergency savings account.

Saving money is a habit that a lot of people know they should have, but choose not to. The first step to saving money is deciding to take it seriously and starting as soon as you can.

If you have a budget written out for yourself, decide how much you have left that can be put into savings. If you’re in debt, it might not be much, but any amount is a good amount to save. The last thing you want is to be paying off debt, run into an emergency, and have no money to take care of things, ending up in further debt.

Once you’ve decided how much money to set aside, you’ll want to open a high yield savings account to put your money into. Just like your debt earns compound interest, your savings can earn compound interest too. Most high yield savings accounts can offer 4% or more on your money. This APY (annual percentage yield) is the amount of interest your money will be compounding on itself just sitting in a savings account.

There’s no investing involved. Worst case, the APY can lower one day, but the money you’ve earned in these accounts can not be taken from you. By having one of these accounts your money makes money just sitting there, and you can easily access this money if you ever have a life emergency. It’s a no-brainer to open a high yield savings account. It’s basically free money.

Investing is easier than you think.

I used to tune people out when they mentioned investing to me. “That’s way too complicated. I have no idea what you’re talking about and I don’t care.” 

I’m sure a lot of people feel this way when they hear about investing, but it’s actually much easier than it sounds and it’s way more important than most of us understand. If you want to break the cycle of financial insecurity for your family, investing in your future is a must.

I’m not talking about investing in the stock market to see high returns tomorrow, that’s a whole other kind of investing, I’m talking about retirement funds. Opening a ROTH IRA and/or 401k is a big step into getting yourself ready for a comfortable life in your old age, and a comfortable life for any future kids you might have.

Your investments on these accounts can yield returns of around 8% or more (on average), this compound interest rate means that over time your retirement money will grow a lot. I’m not here to give investing advice, that’s out of my league, but do a little research, learn about index funds (and other IRA investment options) and open a ROTH IRA. It’s simple to start, and it will pay off someday.

So what’s the difference between a 401k and Roth IRA? Taxes and employer match. Typically, employers will offer a match (usually around 3% or so) on your 401k. That means if you put 3% of your income toward your 401k, they’ll match that 3%. Essentially, this is your job doubling your retirement fund for free, so always take the 401k match. However, unless it’s a Roth based account, 401k’s will be taxed when the money is withdrawn. So whatever the interest rate is when you retire is what you’ll be paying on your withdrawals.

On the other hand, a ROTH IRA is funded with post-taxed income. Meaning the money was taxed before it went into the account, so you won’t pay taxes on that money in the future when you pull out funds. Meaning, if the taxes are higher in the future, this is an easy way for you to save money. Since you’ll have already paid your taxes at the current, lower, rate. A ROTH IRA is also not employer linked, so you’ll have to open this account on your own typically.

I know retirement funds might sound boring and like a waste of money, but they aren’t. Especially if you plan to have a family of your own. You don’t want your kids to be forced to figure out what to do with you when you retire, so set yourself up for success. Even if you don’t have kids, you want to enjoy life in retirement right? Isn’t that the dream? To one day be able to relax and not think about making money.

Most importantly, START NOW! The most important part of investing in retirement is to start as soon as possible. Timing the market is not as important as time in the market. That basically means, instead of trying to be a fortune teller and waiting until the market is “in a good place” to buy into, just start investing in an account now. Compound interest grows over time, so the longer your money is invested the more you’ll make on it. I wish I knew this back in highschool, but better now than never. It’s not too late to start maxing out your ROTH IRA and taking your employer match on a 401k.

That’s another thing to mention about ROTH IRAs. You can’t deposit endless amounts of money into a ROTH IRA account. Each year there is a max amount you can deposit into your account. In 2024, the limit is $7,000. Ideally, you want to aim to max out your contributions annually. I’m not sure if I’ll be able to this year since my main goal is to get out of my consumer debt, but I hope to max it out for the first time in 2025.

It’s never as complicated as it seems.

Finances might seem really complicated. If you start watching finance content online you’ll notice that money can get really complicated, but it doesn’t need to be. Once you understand the basics of building a budget, getting/staying out of debt, how to save money, and how to invest in your future; you have all the tools you need to start living a more financially balanced life.

Just remember to stick to your budget the best you can, start an emergency savings fund, get out of whatever debt you’re in, and then look into investing in your future. 

A lot of times, we are our biggest obstacle to financial success. If you’re having a hard time sticking to your budget, it might be just as important to look inward and figure out why that is. Do you have a spending problem? Do you get tired after work and opt for fast food because cooking is too much work? Have you been over extending yourself in order to fit in with people around you? Or have you simply been ignoring your finances because you make all your monthly payments so, who cares?

Whatever it is for you, it’s time to face your obstacles head on. In order to get out of debt you need to learn about finances, apply what you know, and fix your mindset around money.

I’m going through these steps myself, so I know it isn’t easy. But I can tell you this, it is worth it to start the process right now. In a few years, we’ll both be in a way better place.

Stay Psyched,

Vicky Diaz