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Understanding the Yield to Maturity (YTM) Formula

When investors evaluate which bonds to buy, they often take a look at yield to maturity (YTM), the total rate of return a bond will earn over its life, assuming it has made all interest payments and repaid the principal.

Calculating YTM can be complicated. Doing so takes into account a bond’s face value, current price, number of years to maturity and coupon, or interest payments. It also assumes that all interest payments are reinvested at a constant rate of return. Not surprisingly, many investors rely on online calculators to help them determine yield to maturity, but with these figures in hand, they will be better equipped to understand the bond market and which bonds will offer the greatest yield if held to maturity.

What Is a Bond’s Yield to Maturity?

The yield to maturity is the estimated rate investors earn when holding a bond until it reaches maturity or full value. The YTM is stated as an annual rate and can differ from the stated coupon rate.

The calculations in the yield to maturity formula include the following factors:

•  Coupon rate: Also known as a bond’s interest rate, the coupon rate is the regular payment issuers pay bondholders for the right to borrow their money. The higher the coupon rate, the higher the yield.

•  Face value: A bond’s face value, or par value, is the amount paid to a bondholder at its maturity date.

•  Market price: A bond’s market price refers to how much an investor would have to pay for a bond on the open market currently. The price buyers pay on the secondary market may be higher or lower than a bond’s face value. The higher the price of the bond, the lower the yield.

•  Maturity date: The date when the issuer repays the principal is known as the maturity date.

The YTM formula assumes all coupon payments are made as scheduled, and most calculations assume interest will be reinvested.

How to Calculate the Yield to Maturity Formula

To calculate yield to maturity, investors can use the following YTM formula:

Where:

C = Interest or coupon payment
FV = Face value of the investment
PV = Present value or current price of the investment
t = Years it takes the investment to reach the full value or maturity

Here’s an example: Suppose there’s a bond with a market price of $800, a face value of $1,000, and a coupon value of $150. The bond will reach maturity in 10 years, with a coupon rate of about 14%.

By using this formula, the estimated yield to maturity would calculate as follows:

The Importance of Yield to Maturity

Knowing a bond’s YTM can help investors compare bonds with various maturity and coupon rates. For example, consider two bonds of varying maturity: a five-year bond with a 3% YTM and a 10-year bond with a 2.5% YTM. Investor’s can easily see that the five-year bond is more valuable.

YTM is particularly useful when attempting to compare older bonds sold in a secondary market, which can be priced at a premium or discounted — meaning they cost more or less than the bond’s face value. Understanding the YTM formula also helps investors understand how market conditions can impact their portfolio based on the investment they select. Since yields rise when prices drop (and vice versa), investors can forecast how their investment will perform.

Additionally, YTM can help investors understand how likely they are to be affected by interest rate risk — the danger that the value of a bond may be adversely affected due to the changes in interest rate. Current YTM is inversely proportional to interest rate risk. That means, the higher the YTM, the less bond prices will be affected should interest rates change.

Yield to Maturity vs. Yield to Call

With a callable, or redeemable bond, issuers can choose to repay the principal amount before the maturity date, halting interest payments early. This throws a bit of a wrench into the YTM calculation. Instead, investors may want to use a yield to call (YTC) calculation. To do so, they can use the YTM calculation, substituting the maturity date for the soonest possible call date.

Typically a bond issuer will call a bond only if it will result in a financial gain. For example, if the interest rate drops below a coupon rate, the issuer may decide to recall the bond to borrow funds at a lower rate. This situation is similar to when interest rates drop and homeowners refinance their home loans.

For investors that use callable bonds for income, yield to call is significant. Suppose the issuer decides to call the bond when the interest rates are lower than when the investor purchases it. If an investor decides to reinvest their payout, they may have a tough time finding a comparable bond that offers the yield they need to support their lifestyle. They may feel it necessary to take on more risk, looking to high-yield bonds.

Limitations of Yield to Maturity

It’s important to note that YTM calculations exclude taxes. While some bonds, like municipal bonds and U.S Treasury bonds, may be tax exempt on a federal and state level, most other bonds are taxable. In some cases, a tax-exempt bond may have a lower interest rate but ultimately offer a higher yield once taxes are factored in.

As an investor, it can be especially helpful to consider the after-tax yield rate of return. For example, suppose an investor in the 35% federal tax bracket who doesn’t pay state income taxes is considering investing in either Bond X or Bond Y. Bond X is a tax-exempt bond and pays a 4% interest rate, while Bond Y is taxable and pays 6% interest.

While the 4% yield for Bond X remains the same, the after-tax yield for Bond Y is 3.8%. While it seemed like the less lucrative of the two options up front, Bond X should ultimately yield a higher return after taxes.

Frequently Asked Questions

Q: What is a bond’s yield to maturity (YTM)?
A: A bond’s yield to maturity is the total return an investor can anticipate receiving if the bond is held to its maturity date. YTM calculations assume that all interest payments will be made by the issuer and reinvested by the bondholder at a constant rate of interest.

Q: What is the difference between a bond’s coupon rate and its YTM?
A: A bond’s coupon, or interest, rate is fixed from the moment an investor buys it. However, the same bond’s YTM can fluctuate over time depending on the price paid for it and other interest prices available on the market. If YTM is lower than the coupon rate, it may indicate that the bond is being sold at a premium to its face value. If it’s lower, it may be that the bond is priced at a discount to face value.

Q: Is a higher YTM better?
A: A higher YTM may be better under certain circumstances. For example, since a higher YTM may indicate a bond is being sold for less than its face value, it may represent a valuable opportunity to invest. However, if the bond is discounted because the company that offered it is in trouble or interest rates offered by other investments are more appealing, then a high YTM might not be such a good thing. Investors must research investments carefully and understand the full story before they buy.

The Takeaway

Using the yield to maturity formula can help investors compare bond options with different coupon and maturity rates, market and par values, and determine which one offers the potential for a higher yield. But calculating the YTM is not an exact science, especially when you’re gauging the return on a callable bond, say, or adding the impact of taxes to the mix. YTM is just one tool investors can use to determine which bond may best serve their financial needs and goals.

One alternative to choosing individual bonds is to invest in bond mutual funds or bond exchange-traded funds (ETFs).

SoFi Invest® offers affordable access to a wide range of investment selections, including bond funds. The Active Investing platform lets investors choose from an array of stocks, ETFs, or fractional shares. For a limited time, opening an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is sign up, play the claw game, and find out how much you won.

Find out how SoFi Invest can help you reach your financial goals.


Claw Promotion: For the full terms and conditions of SoFi’s Claw Promotion, click here. Probability of a customer receiving $1,000 is 0.028%.
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The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
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Should I Buy a New or Used Car in 2021?

Should I Buy a New or Used Car in 2021?

A witches brew of COVID-related lockdowns, renewed demand after those initial lockdowns were lifted, ensuing shortages of semiconductors, and other auto supply issues have thinned out inventory for vehicles. All of the above combined to force car prices higher in 2021.

How high? Data from Cox Automotive pegs the average price of a new vehicle at $41,000, which represents a 5.5% upward spike in price compared to 2020. Used vehicle prices are on the rise this year, as well, with the average cost of a used vehicle with 67,000 miles on it standing at $24,414, compared to $19,646 in 2020.

Higher car prices make auto-buying decisions more difficult to make in 2021, and that’s especially the case with the time-honored dilemma of buying a new or used car this year. This year, it’s not an easy choice, but with the right information, you can make the choice that works for you.

Benefits of Buying a New Car

Besides the luster and pride in a brand new set of wheels, a new vehicle purchase has additional benefits.

You don’t have to kick as many tires. New vehicles arrive on dealer showroom floors (and at online auto sales platforms) in pristine condition with very few miles on the odometer, so you don’t have to spend time checking for vehicle inefficiencies and maintenance or repair issues.

Multiple auto financing choices. With a new car, it’s easier to get a good financing deal compared to financing a used car. That’s because the vehicle hasn’t been driven, has no structural problems, maintenance, or repair issues, and should hold its value if the new owner takes good care of the vehicle. That’s important to auto loan financers, who place a premium on avoiding risk.

The newer, the better. The auto industry is doing wonders with new vehicle construction, with features like electric-plug-in models, better gas mileage and technology advancements that improve vehicle performance in a wide range of upgrades. Those upgrades come most notably in car safety, cleaner emissions, and digital dashboards that improve driving enjoyment.

Warranty and service benefits. New car owners are typically offered a manufacturer’s warranty when they buy a new car, which typically grades out better than third-party warranty coverage on a used car. Additionally, auto dealers are more likely to offer services like free roadside assistance or free satellite radio to lock down a new car sale. Those services and features are harder to get with used vehicles.

Recommended: How to Save Up for a Car 

Drawbacks of Buying a New Car

Some disadvantages of a new car purchase might sway a buyer’s decision.

Immediate depreciation. The moment you drive a new car off the dealer lot, it loses several thousand dollars and an estimated 15% to 20% in the first year of ownership.

You may owe a lot of money on the vehicle. As car costs escalate, buyers who borrow 80% or more to purchase a new car, truck, or SUV may owe tens of thousands of dollars in auto loans before they’re free and clear. According to data from Lending Tree®, the average monthly payment for a new car loan stands at $563 in 2021.

Higher insurance costs. Auto insurers typically deem new cars as being more valuable than used cars and assign auto insurance premiums accordingly. According to Bankrate.com™, the average cost of minimum auto insurance in 2021 is $565 per year. Since new cars cost more, auto insurers prefer to see new auto drivers get full coverage and not minimum coverage. The price for full coverage, Bankrate reports, stands at $1,674 annually.

Benefits of Buying a Used Car

Used cars offer buyers value and savings, which are attractive benefits to drivers who may not have a big budget, but still want to drive a quality vehicle.

You’ll probably save money. No doubt about it, most used cars sell for significantly less than a new car with the same make and model. Case in point. The National Automobile Dealers Association (NADA) notes the average American owns 13 vehicles over the course of their life, with each vehicle valued at $30,000, on average. If a buyer waited three years to buy the exact same vehicles, NADA stated, that buyer would save $130,000 by not paying for the cars when they were brand new.

Slower depreciation rate. New cars tend to lose value quickly, especially if they’re not properly cared for. But used cars tend to depreciate more slowly, especially if they’ve had regular maintenance, and their sustained value makes them a good resale candidate if the owner wants another vehicle, but still wants to make a good deal when selling the vehicle.

A large down payment goes further with a used car. Buyers who can manage a robust down payment on a used vehicle can bypass a good chunk of the debt incurred in purchasing the vehicle. It comes down to simple math—if a buyer purchases a $20,000 used vehicle with a down payment of $10,000, there’s only $10,000 left to pay on the vehicle. If a buyer purchases a new vehicle for $40,000, and puts $10,000 down, that buyer still owes $30,000 on the auto loan.

Recommended: 9 Tips For Buying A Used Car

Drawbacks of Buying a Used Car

When deciding whether to buy a new or used car, these issues may be worth considering.

Reliability is a big deal. With a used car, an owner may be getting a quality vehicle—but maybe not. A used car may have spent years on the roads and highways, incurring a fair share of dings, dents, and general wear and tear that may have aged it prematurely, particularly if it hasn’t been maintained well.

You may not get the exact make and model you want. The options can dwindle when it comes to buying a used car. Whereas auto dealers can offer a wide range of make, model, and color for a new vehicle, those choices can be significantly limited with a used car, truck, or SUV. That could mean that a used vehicle buyer may have to compromise on different factors, in contrast to a new car buyer who can usually get their vehicle of choice.

You may pay more for vehicle maintenance. Consumer Reports found that auto repair costs double every five years, so the longer you own a used car, the more money you’re likely to pay in maintenance and repairs.

Other Car Purchasing Options

Auto consumers don’t have to be limited to a “buy new or used car” purchase decision. There are other valid options that go beyond the question of “should I buy a new or used car”: buying a pre-owned car or leasing a vehicle.

Certified Pre-Owned Cars

Car buyers who want to know that a vehicle is ship-shape, but who don’t want to spend a great deal of cash on a new set of wheels can compromise with a certified pre-owned vehicle.

A certified pre-owned vehicle means just what it says—it provides buyers with a vehicle that has low mileage, has no significant damage, has passed a battery of auto shop maintenance and performance tests, offers a new warranty, and likely costs thousands of dollars less than a new car. While you won’t be getting a brand-new car, you are likely getting a vetted and trustworthy vehicle at a decent price, which fits the bill for legions of would-be car owners.

Recommended: Smarter Ways to Get a Car Loan

Leased Cars

By leasing a car, you’re not buying it, you’re just renting it for a fixed period of time, usually with the option to buy the vehicle after the lease period is over.

Most auto leases average three or four years, and upfront costs are typically less than purchasing a new car (lease owners pay an upfront fee plus regular monthly payments for the duration of the lease period.) Once the lease period is over, the driver has the option to return the vehicle to the dealer, who may either lease it again or sell it outright as a used vehicle.

Car leases do come with restrictions on key performance elements like mileage, and also require that the vehicle is returned in sterling condition when the lease period ends. Ignoring those issues can lead to hefty fees charged by the lease provider and owed by the leasing customer.

Typically, about 26% of auto consumers decide to lease their vehicles, with an average monthly price of $460 per vehicle.

The Takeaway

Like any major purchase decision, auto buyers are advised to shop around, check the book value of favored vehicles, and look at the car’s maintenance and repair history to ensure it’s in good condition, and (if it’s a used car) make sure it’s inspected by a trusted mechanic.

By doing these things, the choice between a new and used car can get easier and enhance your chances of driving away in the vehicle that best fits your auto needs.

Saving for your next used car purchase or down payment on a new car can be challenging, but with a cash management account like SoFi Money®, the savings can add up, helping to reach a financial goal as quickly as possible. SoFi Money account holders pay no account fees, have free Allpoint® Network ATM availability, and the ability to earn interest on the money in their account. They can also save for other goals in addition to that future new or used car purchase by setting up Vaults in their SoFi Money account—no need to have separate accounts for separate savings goals.

Learn more about saving for your financial goals with SoFi Money.

Photo credit: iStock/Ivanko_Brnjakovic


SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC .
Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank. SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
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External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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Do I Need a Long Term Savings Account?

Do I Need a Long Term Savings Account?

A long-term savings account, as the name implies, is one opened to deposit and hold money for a longer period of time. They can be contrasted to checking accounts used to pay monthly bills or regular savings accounts that might earn interest, but maybe not much. A long-term savings plan might be set up for a child’s college education, for large purchases such as a home, or for retirement, for example. In general, they’re used to save up for a goal that is years away.

Different types of savings accounts qualify as long term, and here’s an overview of options, along with information about setting long-term financial goals and more.

Long Term Savings Options

Here are five options, along with some pros and cons of each of them.

High Interest Savings Accounts

This type of savings account can provide some of the flexibility of a standard checking account while offering higher interest rates than the average savings account. It’s generally just as easy to access a high-interest savings account as it is a standard checking account, although there may be limits on the number of withdrawals you can make per month with this type of savings account. They often offer ATM access, sometimes with fee reimbursement, mobile check deposit, and online account management via an app. Financial institutions that offer these accounts include regional banks, local credit unions, and online banks.

To open and maintain this type of account, there are often certain requirements that need to be met. This could include setting up a direct deposit, maintaining a minimum balance, or limiting the number of withdrawals per month. Some high-interest savings accounts also offer tiered interest rates for different balance ranges. For instance, a bank might offer a base tier of .25% on balances up to $25,000, and an upper tier of .40% on balances greater than $25,000.

One item to check for in the fine print: the balance cap on interest earned. If that’s included, this means that there’s a limit to the balance on which interest can be earned. For example, if the interest rate is 3%, but the balance cap is at $2,500, then the interest rate is only earned on money up to the cap. Any amount above the balance cap will not earn a high interest rate.

Recommended: Is a High Interest Savings Account Right for You?

Money Market Accounts

A money market account is similar to a high-interest savings account, but will likely have more requirements for keeping it open. For example, some accounts require initial deposit minimums, and a certain minimum balance may be required to prevent monthly fees from being charged.

With both high-interest savings accounts and money market accounts, funds can typically be deposited and withdrawn fairly easily.

Certificates of Deposit

A certificate of deposit (CD) is a deposit account that typically offers higher interest rates than a regular savings account and pays compounding interest. In other words, interest is paid on the interest.

One challenge with a CD, though, is that the account holder must agree to keep the funds in the account for a predetermined amount of time. So this may not provide the liquidity—the ability to quickly turn the account into cash—that some people want and need. If funds are withdrawn before the maturity date, a penalty is typically assessed.

Interest rates on CDs are typically structured in tiers, based upon how long a person agrees to keep the money in the account. A two-year CD, then, will likely pay a bit more in interest than a one-year CD.

Recommended: What Is a Certificate of Deposit?

Retirement Accounts

Retirement accounts have one thing in common: they are investment vehicles designed to help people save for their post-working years. They typically have tax advantages. Here are three of the types.

1. Traditional Individual Retirement Accounts (IRAs)

The account holder opens this account and makes contributions on their own instead of through an employer. There may be an income tax deduction allowed on contributions made, and the funds are tax-deferred, meaning the contributions aren’t taxed but the withdrawals are. As of 2021, the maximum allowable contribution amount is $6,000 annually or $7,000 if age 50 or older. If funds are withdrawn before the account holder is 59 and a half, there is a 10% penalty levied on the amount withdrawn in addition to the usual tax on the withdrawal. Contributions aren’t tax deductible if the account holder also has a retirement plan through work and has an adjusted gross income (AGI) above a certain dollar amount.

2. Roth IRA

This is also another type of individual retirement account that a person opens and funds without the involvement of an employer, this time using after-tax money to contribute. This means that account holders cannot deduct contributions on their income tax. However, the balance grows tax-free, and when funds are withdrawn during retirement, they are also tax free. Annual contribution caps are the same as a traditional IRA.

To contribute to a Roth, the account holder must be earning an income. Once that person’s AGI reaches a certain level—for the 2021 tax year, this is $198,000—then the ability to continue to contribute will begin to phase out. If the account holder is filing joint federal income taxes, then the amount is $208,000 for the 2021 tax year.

This type of account is typically best for someone who appreciates the ability to withdraw funds in retirement without paying taxes, and a Roth IRA can work especially well for people currently earning a lower income than they expect to earn in the future.

Recommended: What is a Roth IRA and How Do They Work?

3. 401(K) Retirement Account

This is a retirement plan offered by an employer to qualifying employees. Contributions are made with pre-tax money, which means they will reduce the person’s taxable income. The money grows tax-free, with taxes paid when funds are withdrawn in retirement.

For the 2021 tax year, the maximum annual contribution amount is $19,500; an additional catch-up contribution of up to $6,500 can be made by account holders over the age of 50. These contributions are taken from the employee’s paycheck, and some companies provide matching funds up to a certain amount. Sometimes these accounts have fees that must be paid.

Although these are not the only kinds of retirement accounts available, they are among those most commonly used.

So, returning to this post’s original question, do you need a long-term savings account? The specifics depend upon personal financial goals.

Recommended: Back to Basics: What Is a 401k?

Long Term Financial Goals

By setting long term financial goals, people can create a plan for a more comfortable future and make a commitment to stay on track with savings goals. The reality is that 40% of Americans would find an unexpected expense of $400 challenging for them to pay, a figure that shows how many people are currently living month by month, focusing on the immediate expenses.

Creating a long-term financial plan and focusing on that plan can help people reach financial goals. Steps include setting goals with these five components:

• Clarity

• Challenge

• Commitment

• Complexity

• Feedback

These components are included in “A Theory of Goal Setting and Task Performance,” published by Edwin Locke and Gary Latham.

First, be clear about what, specifically, you want to accomplish—and don’t be afraid to dream big. What challenges might you face? Break your goals into smaller parts to simplify the journey. Prioritize them and make a commitment to follow shorter-term goals, one step at a time, which also helps to gain momentum on the longer-term ones. The excitement that may be felt about this process can help to solidify a sense of commitment.

For some people, it can help to partner with another person and share goals, keeping one another accountable. Or perhaps a mentor can be helpful. Other people may find it more effective to reward themselves when certain goals are met. Whichever method is chosen, it typically works best when progress is regularly reviewed and adjusted, as needed.

Emergency Savings Account

Although saving for long-term goals is wise, it can make sense to prioritize creating and funding an emergency savings account if one doesn’t already exist. It’s usually wise to choose an account type that offers liquidity because this is one where you’ll want quick access if an emergency occurs. A typical recommendation is to keep three to six months’ worth of living expenses in this account. That way, if someone in the household loses a job, an emergency home repair seems to come out of nowhere, or medical bills need to be paid, money in these funds can help to keep all on track or at least mitigate the impact of the expenses.

The Pivot

If using separate savings accounts for different financial goals isn’t something you want or need to do, consider using one main account that lets you save for your financial goals, spend money, and earn money, all in one place instead of keeping track of your money in multiple accounts.

SoFi Money® is a cash management account that offers those things, in addition to other benefits including:

• No account fees.

• No fees with in-network ATMs.

• Mobile check deposit.

• A mobile app for ease of accessing and managing your money.

Save for your financial goals with SoFi Money®.

Photo credit: iStock/AndreyPopov


SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC .
Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank. SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Update: The deadline for making IRA contributions for tax year 2020 has been extended to May 17, 2021.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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10 Signs You're Living Beyond Your Means

10 Signs You’re Living Beyond Your Means

Living beyond your means is an easy trap to fall into. And if you’re not keeping close track of everything that’s coming in and going out of your financial account, you may not even realize you’re doing it.

But if you often run out of money before the month is over — and you don’t know exactly where all the money is going — it could be a sign that you’re living above your means.

Over time, living a lifestyle beyond what you can actually afford can lead to mounting debt and also keep you from reaching your financial goals.

What Does “Living Beyond Your Means” Mean?

Simply put, ”living above your means” means that you are spending more money than you are earning. People are able to do this by relying on credit cards, loans, and pior savings to cover their expenses. However, the process is not sustainable, and eventually overspending is likely to catch up to you.

Living beyond your means can also mean that you’re spending everything you bring in, and, as a result, don’t have anything left over for saving or investing, such as building an emergency fund, saving for a short-term goal like buying a car or a home, or putting money away for retirement.

Here are ten red flags that you’re living a lifestyle you simply can’t afford — and tips for how to get back on track.

1. You Live Paycheck to Paycheck

If most or all of your paycheck is spent immediately on bills, and you don’t have anything left over at the end of the month to put into savings, you are likely living over your means and may need to make some adjustments.

If your current lifestyle has become a habit, you may feel there is no place to cut back. However, if you get out your monthly statements for the past three months and take a close look at where all your money is going each month, you will likely find places where you can cut back on spending. This might be ditching cable, cooking (instead of ordering take-out) a few more times per week, or quitting the gym and working out at home.

2. Your Credit Score Has Dropped

If you’ve been putting a lot of your expenses on your credit card and/or don’t always pay your bills on time, you may see your credit score take a hit.

This number is important because it can be accessed by anyone considering giving you new credit and may be used to determine the interest rate you’ll pay on a home or car loan, and also new credit cards.

If you aren’t sure what your credit score is, you can get a free copy of your reports from all three credit bureaus at www.annualcreditreport.com .

Looking it over can help you understand why your credit score has dropped, and help you take the necessary steps to repair it.

For example, you might set up automatic payments for the minimum amount due on credit card bills and loans, so you never miss a payment.

You may also want to pay down your balances on your credit cards and lines of credit. This can lower your “credit utilization rate” (how much of your credit limit you are using), which is factored into your score.

Recommended: What Is Considered a Bad Credit Score?

3. You’ve Stopped Your Retirement Contributions

If money is feeling a little tight, you may feel that now is not the time to worry about retirement. But you likely won’t be able to work forever, so it can be wise to make saving for retirement a priority and to get started early.

Thanks to compounding interest (which is when the interest you earn also starts earning interest), the earlier you start investing in a retirement fund, the easier it will be to save enough money to retire well.

You don’t have to contribute a lot–even just putting aside a small amount of each paycheck into a 401(k) or IRA each month can help you build wealth over time.

4. A Big Portion of Your Income Goes to Housing

Keeping your rent or mortgage below 30 percent of your monthly pre-tax income is sometimes recommended because it can leave you with enough income left over to save, invest, and build wealth in general.

Staying below 30 percent can be difficult, however, if you live in a region of the country where the cost of housing is high.

Nevertheless, spending a lot more than a third of your income on housing can leave you “house poor,” and put your other financial obligations at risk.

If you find that your housing costs are taking too large a chunk of your monthly paycheck, you might consider downsizing, taking on a roommate, or finding a way to increase your income with a side hustle.

5. Your Savings Account Isn’t Growing

Another sign you may be living beyond your means is that your savings have stagnated.

Making regular deposits into your savings account–in addition to your 401(k) or IRA–allows you to work towards your short- and medium-term financial goals, such as putting a downpayment on a home or a car or going on vacation.

6. You’ve Been Charged an Overdraft Fee More than Once This Year

An overdraft fee — or “non-sufficient funds fee” — is charged when there’s not enough money in your account to cover a check or debit card payment.

Mistakes happen, and a one-off overdraft isn’t necessarily an indicator of overspending. But repeat offenses can be a sign that you are living too close to the edge and don’t have a clear picture of how much money is going into your account and how much is going out.

You may want to start tracking your spending and keeping a closer eye on your spending account to make sure you always have enough to cover your electronic payments.

Recommended: Using a Personal Cash Flow Statement

7. You’ve Never Set a Budget

Many people think making and following a budget will be too complicated. But having a budget can actually simplify your spending decisions by letting you know exactly what you can and can’t afford.

Having a budget also helps to ensure you have enough money to cover essentials, fun, and also sock some away in savings.

If you’ve never set financial parameters for yourself, you may want to consider taking an honest inventory of how much you are bringing in each month and how much is going out each month.

Once you get a sense of your own patterns and habits, you can work toward building a realistic budget that allows you to spend and save more wisely.

8. You’re Leasing a Car You Can’t Afford to Buy

Leasing a vehicle you would not be able to purchase outright or finance can be a major financial red flag. Leasing lets you rent a high-end lifestyle, but many people end up with leases they really can’t afford.

You might be covering your monthly payments, but if you can’t do that while meeting your other expenses and also putting money into savings, then your car is likely too expensive.

You may want to consider downgrading your vehicle or saving up enough money to buy a car — either outright or by making a solid downpayment so your monthly payments are low.

9. You’re Only Making Minimum Payments on Credit Cards

It’s fine to use your credit card to pay for everyday expenses and the occasional big purchase. But if you can’t pay off most of the balance each month, you’re likely living beyond your means.

Rather than give over part of your paycheck just to interest each month, you may want to cut back on nonessential spending and divert that money towards paying off your balances.

10. You Don’t Have an Emergency Fund

Not having a stash of cash you can turn to in a pinch can be a sign that you’re overspending. You may be gambling on the fact that nothing will go wrong. But life is unpredictable, and getting hit with an unexpected expense you can’t pay for can lead to a financial crisis.

Instead, you may want to build an emergency fund that can cover three to six months worth of living expenses. That way, you’ll be covered should something happen, such as an illness or injury, job loss, housing issue, or any other expensive personal matter should come up.

The Takeaway

Unfortunately, living beyond your means is all too easy to do. And while a few weeks or months of spending more than you earn may not be a major problem, overspending on a regular basis will likely catch up to you in the form of high debt and neglected savings.

Creating (and sticking to) a spending budget can help ensure that you can afford your bills and basic expenses, and still have money left over to save for the things you want in the future.

Ready to get better control of your spending? With a SoFi Money® cash management account, you can easily keep track of your weekly expenses right in the dashboard of the SoFi app.

Learn how SoFi Money can help you manage your spending and saving today.

Photo credit: iStock/urbazon


SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC .
Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank. SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
​​Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s
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Marginal Propensity to Save: Definition & Formula

A Look at Marginal Propensity to Save (MPS)

The marginal propensity to save (MPS) refers to the amount of disposable income a consumer is able to save. It’s used to reflect the proportion someone is willing to save for each additional dollar of their income.

To understand why MPS is important when quantifying fluctuations in savings and income, we’ll go over how to calculate MPS and how to apply it to your budgeting strategy.

What is the Marginal Propensity to Save?

The marginal propensity to save is defined as the portion of an increase in income that goes towards household savings. In other words, it’s the percentage of additional income a household saves instead of spending on goods and services, and it offers insight into the consumption habits of consumers.

MPS is also referred to as leakage, where the savings is an amount (expressed as a percentage that doesn’t go back into the economy via consumption. Typically, the more a household saves, the more likely it indicates that there is a higher income and better equipped to cover their household expenses.

So, theoretically, if a household saves 10%, it means that for every additional dollar they earn, they’ll save 10 cents.

When consumers are more likely to save as their income grows, the chances are higher they’ll become wealthier. Plus, households will also be able to access services and goods that require more money, such as larger homes in higher cost of living areas, elaborate vacations, or luxury vehicles.

How Income Level Affects Marginal Propensity to Save

Given data on household income and household saving, economists can calculate households’ MPS by income level. This calculation is important because MPS is not constant—it varies by income level. Typically, the higher the income, the higher the MPS because as wealth increases so does the ability to satisfy needs and wants, and so each additional dollar is less likely to go toward additional spending. However, the possibility remains that a consumer might alter savings and consumption habits with an increase in pay.

The Multiplier Effect

The MPS plays an important part in regulating the multiplier effect. The multiplier effect looks at the proportional increase or decrease in income that comes from consumption or savings.

For instance, if there is spending at the government level, it’ll have a multiplier effect (much like how a snowball rolls down a hill) on different parts of the economy. This change is due to the fact there is now additional disposable income consumers can spend on consumption and savings.

By understanding what the MPS is, economists can see how increased government spending can influence savings. It’ll also help to determine how consumers’ saving habits will influence the overall economy. The lower the MPS, the more of an impact on changes in government spending there will be.

Calculating the Marginal Propensity to Save

Calculating the MPS involves dividing the change in savings by a change in disposable income.

The following formula is used to calculate the MPS:

MPS = change in savings / change in disposable income

The savings represented by the value of the MPS will change if income changes by a dollar. Presented on a graph, the MPS is the equivalent of the savings line that’s created by plotting changes in income on the horizontal line (x-axis) and changes in savings on the vertical line (y-axis).

Another important point to note is that MPS will range between zero and one. If the MPS is zero, then it means changes in income doesn’t have an effect on savings (consumers spend all additional income). If MPS is one, then all additional income is saved.

Example

Jasmine successfully negotiated a promotion and annual bonus and received an additional $3,000 with her next paycheck. Jasmine decides she wants to spend this amount on a nice dinner out with friends totaling $150, and a vacation in Mexico for $2,000. The total she spends out of her bonus is $2,150, saving $850.

Using the above MPS formula, the calculation is as follows:

$850 / $3,000 = 0.283 = 28.3%

Therefore, Jasmine saved 28% of her additional income or 28 cents for each additional dollar she earns.

Remember, MPS isn’t constant since various factors in addition to changes in income will influence consumer spending habits. For instance, the time of the year can influence seasonal trends, which can correlate with higher spending.

Applying MPS to Your Budget Strategy

Though it seems like MPS is more for economists, you can apply this tactic to your personal budget.

When it comes to increasing your income, it might be tempting to spend a large portion of it. After all, you might want to celebrate a pay raise or promotion. Or, you might decide to increase your grocery budget, swapping out some of your regular produce for organic varieties.

However, there are benefits to saving some of the extra money. Perhaps you have a financial goal you can use it towards, like saving for a down payment on a house. Or you want to start investing and with this boost in income, you now have the means to do so.

If you haven’t yet decided what you’re saving for, just getting into the habit of saving will get you on the right track. Plus, you’ll learn how to budget effectively, no matter which type of budgeting technique you use.

Let’s say you want to be able to set aside 20% of each paycheck towards investments and a larger emergency fund. You received a $1,000 bonus from work this month and want to make sure you’re not tempted to spend it all.

Using the above formula, you want to have an MPS of 30%, or 0.3. That means with that bonus, you want to be able to save $300, allowing you to put $800 of it towards other areas in your budget. Once you have this number, you can take proactive steps to save that money. Automatically transferring $300 to a separate savings account is a good start.

Considering your income may fluctuate, you’ll probably want to revisit this formula on occasion to make sure you’re on track. Plus, it’s likely your spending habits will also change—such as spending more during the holidays—so if you need to spend more, then you can adjust your savings rate temporarily. At the end of the day, it’s all about being aware of where your money is going.

Recommended: 39 Ways to Earn Passive Income Streams

The Takeaway

Marginal propensity to save may seem like a term that doesn’t relate to your budget since it’s normally used to help economists. However, thinking about it in simple terms such as a savings rate is more helpful. That way, you can use it to apply it towards your savings goals and budgeting tactics as your income changes.

Saving money is half the battle: making sure your money is working for you is the other half. Opening a cash management account like SoFi Money® can earn you more than the national interest average, squeezing even more value from your hard-earned dollars.

Check rates offered by SoFi Money.

Photo credit: iStock/Toxitz


SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC .
Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank. SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
As of 6/9/2020, accounts with recurring monthly deposits of $500 or more each month, will earn interest at 0.25%. All other accounts will earn interest at 0.01%. Interest rates are variable and subject to change at our discretion at any time. Accounts opened prior to June 8, 2020, will continue to earn interest at 0.25% irrespective of deposit activity. SoFi’s Securities reserves the right to change this policy at our discretion at any time. Accounts which are eligible to earn interest at 0.25% (including accounts opened prior to June 8, 2020) will also be eligible to participate in the SoFi Money Cashback Rewards Program.
The SoFi Money® Annual Percentage Yield as of 03/15/2020 is 0.20% (0.20% interest rate). Interest rates are variable subject to change at our discretion, at any time. No minimum balance required. SoFi doesn’t charge any ATM fees and will reimburse ATM fees charged by other institutions when a SoFi Money™ Mastercard® Debit Card is used at any ATM displaying the Mastercard®, Plus®, or NYCE® logo. SoFi reserves the right to limit or revoke ATM reimbursements at any time without notice.
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