Lately I’ve received a few questions from readers asking about the difference between an ETF and an index or mutual fund, and which one is better. Well, as with almost all things, there are pros and cons to each. There is no right answer that applies to everyone, but I’ll provide a little background information and examples of why one might be better than the other for certain reasons and situations.

ETF Basics

An ETF, or Exchange Traded Fund, is nothing more than an investment portfolio consisting of many investments that trade like stocks. An ETF holds a collection of securities that are designed to track the performance of an index. This means that if you purchase a share of an ETF that tracks the S&P 500, you should see daily changes in your share price that come very close to, or exactly mirror the actual performance of the S&P 500.

ETFs were introduced in 1992, and back then, there were only a couple offerings. Even as late as 1999, there were only 32 ETFs in existence here in the U.S. markets. The ETF market has grown considerably as there are now nearly 1,000 available. This is good news for investors who are looking for ways to invest in many specialized niches, but it is also bad news because it can make choosing the right ETF more difficult than it has to be.

Mutual and Index Fund Basics

To give you some perspective, mutual funds have been around for a very long time compared to ETFs. The first mutual fund was established in 1924, and they have served as the primary investment vehicle for the average investor for decades. Like their ETF counterpart, a mutual or index fund is simply a collection of investments that are designed to reflect the performance of the underlying holdings. Mutual funds may have widely varying portfolios may not track a specific index, whereas an index fund is designed to track the performance of an index.

One of the biggest differences between funds and ETFs are the way they are bought and sold. ETFs trade like stocks, so that means the price per share of an ETF changes continually throughout the day while the markets are open. This allows you to buy and sell an ETF multiple times a day if you wanted. On the other hand, mutual and index funds only trade once a day. Because of this, you might place an order at 10 am, but you will get the shares for whatever the closing price is at the end of the day.

The other difference is in the fee structure. Mutual funds can have a number of ways to charge the investor–from front-end loads, back-end loads, early redemption fees, and everything from management to advertising expenses. ETFs have a very straightforward and transparent expense ratio (although, some mutual and index funds do as well).

Advantages of ETFs

While there are many similarities between these products, there are some potential advantages to ETFs:

• Low Ownership Costs - Because of their efficient structure that tracks an index rather than pay investment managers to create a portfolio, the recurring expenses for most ETFs are very low.
• Tax Advantages - While this isn’t really a concern if you’re investing in a tax-deferred account, ETFs are generally very tax friendly. In many cases, you are in control of when you pay capital gains tax because you pay it when you sell your shares. You aren’t at the mercy of wondering whether your mutual fund is going to declare a capital gains distribution or not. Many ETFs have never issued a capital gain distribution, and even the ones that do generally minimize the impact significantly.
• Liquidity - As I mentioned above, ETFs trade throughout the day just like a stock. This means you can buy and sell multiple times a day if you want, or buy and sell with virtually immediate results. You can also place market, limit, and even stop-loss orders through your broker for ETFs.
• No Minimum Investment – With an ETF, you are only limited by the amount of money you have and the price per share. Many mutual funds require thousands of dollars as a minimum before you can even invest in a fund, so ETFs have a much lower barrier to entry.
• Options - Since ETFs trade like stocks, many popular ETFs also have corresponding options. For more sophisticated investors, this means you can buy puts and calls, create spreads, or other creative techniques to hedge your investment. You can also trade ETFs anywhere you can trade stocks, so a discount broker like TradeKing is an affordable option.

Drawbacks of ETFs

Even with so many advantages, there are also some drawbacks:

• Trading Costs - Since ETFs are traded like stocks, that means they generally have transaction costs like you would trading stock. Trading commissions can vary widely, from $0 to $20 or more per trade. These costs can eat into your returns.
• Brokerage Requirement - While most brokerages offer ETF trading availability, if you don’t currently have a brokerage account, that means you have to establish one. Brokerage accounts may also have account minimums or recurring fees, so you need to shop carefully.
• Slippage - This doesn’t really apply to someone buying an ETF with the idea of holding it for many years, but because ETFs trade like stocks on the open market, they have a bid and ask price. This means at any given time, what you can buy and sell a share for will be different.
• Dividend Drag - Unlike mutual funds, dividends paid out by the ETF are not reinvested which is common with mutual funds. This means the investor is paid the dividend in cash.

Advantages of Index/Mutual Funds

We’ve taken a look at the pros and cons of ETFs, so let’s now look at how index and mutual funds shine:

• No Trading Commissions - In most cases, you can invest in a no-load mutual fund without incurring a trading fee. While there may be a minimum initial investment, you can make purchases without being charged a trading commission as you would with buying/selling a stock or ETF.
• Dividend Reinvestment - Unlike ETFs, dividends paid out by the fund can be set to be automatically reinvested into the fund. This can be a significant benefit for funds that pay out regular and sizable dividends.
• Breakpoints and Share Classes - While I advocate no-load funds, the fact is that many investors do invest in funds that have loads, whether through a broker or otherwise. With different share classes from front-load, back-load, institutional shares, there is flexibility in how funds are purchased. There are also breakpoints on fees for having a certain amount invested with one particular fund company.
• No-Fuss Pricing – Since funds are price once at the end of each trading day, there are little surprises. With an ETF, the underlying share price may change minute to minute, and fluctuate a few percentage points throughout the day. While not a huge concern for the long-term investor, it can be a little unsettling to lose 1-2% on your trade mid-day trade due to market conditions out of your control.

Drawbacks of Index/Mutual Funds

ETFs and mutual funds have many things in common, but there are some drawbacks as well:

• Actively Managed Expenses - Not so much a concern for the index fund variety, but some actively managed funds may come with high expenses. These high expenses can really drag down your performance over time.
• High Minimums - Many funds require a high minimum investment just to get started. In some cases, this can be anywhere from $1,000 to $5,000 or more. This prohibits new investors without a lot of capital from getting started in the fund they may want.
• Additional Fees – Some funds have substantial front and back-end sales charges, and may even have 12b-1 fees to cover expenses such as advertising. While not all funds have these, some investors may inadvertently invest in funds with these fees without realizing it or by being tricked by a salesman.
• Style Drift – Funds that aren’t tied to a specific index are subject to the whims of the portfolio managers. This means they can alter and change the investment holdings in an attempt to bolster returns. This can be good, but more often than not, it means your investment is not doing what you wanted it to do when you purchased it.

What’s Right for You?

Hopefully the information above has shed some light on the pros and cons of both types of investment vehicles so that you can determine what would work best for you. There is no right or wrong answer, and there is no single product that fits all scenarios. In fact, there are many instances where it is desirable to have both ETFs and mutual funds in your overall portfolio. The tax advantaged ETFs will make more sense in a taxable account, and funds that regular issue capital gains distributions will be better suited for tax-deferred retirement accounts. And if you’re interested in short-term trading, ETFs are the way to go, but if you will be investing small amounts regularly, a mutual fund is going to help eliminate the trading costs associated with ETFs.

So, take a look at your situation and what you want to accomplish with your investments. There are a lot of choices out there, and it can be overwhelming, but it doesn’t have to be difficult. Take the time to understand how these investments work, and what the true costs associated with them are, and you’ll be on your way to maximizing your returns in no time.

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This isn’t anything new. The stock market is always in flux and there are periods of bull and bear markets. Unfortunately, the last decade has displayed some exaggerated bull and bear markets adding more volatility than generations past had to deal with. Ultimately, this extreme volatility and human nature are what cause so many people to lose money and faith in stocks. It’s not that stocks are a bad investment, rather it’s usually the fact that people do the exact opposite of what they have  been taught that causes the pain of losing money.

It’s All in the Recent Headlines

If you want to see dumb investors in action, just check out some of the articles in the media coming on the heals of the best two year stock market rally in history. Investors flood back into stocks (March, 2011), investors ease back into stocks (November, 2010), experts say to get back into stocks (January, 2011), richest investors come back to large-cap stocks (February, 2011), main street investors change their strategies (February, 2011). These are just a few, but every week it seems like new data is coming out showing more people flooding to stocks.

If these stories weren’t so sad, it would be comical. When these articles talk to real investors it can be almost shocking to see the destruction of wealth based on nothing more than poor timing due to human emotion. A common theme can be found in this quote from the most recent story from above:

“It didn’t feel right to be back in until now,” says Richard Dukas, who heads a public relations firm in New York City. “I still don’t want to put all my money in the market, but I believe we’ve come through the worst of it.”

After the 2008 financial meltdown, Dukas and his wife converted their 401(k) retirement accounts into cash. They had been burned during the bubble in technology stocks a decade ago, and Dukas says he has been “extremely skittish” ever since.

Now Dukas, 48, says 85 percent of his portfolio is back in mutual funds, although he maintains a small cushion of cash.

If anything, this is probably the most typical scenario I’ve come across in both my time working with investors and in helping friends and family navigate their investment strategy. Just look at the quote above and you’ll see how poor of a decision that was. First, they waited until after the 2008 financial meltdown before cashing out their stocks. That’s mistake number one. By the time they sold, all the damage had been done and they locked in a 40-50% loss. Second, in the article he says it now feels like it’s finally time to get back in and now has 85% of his portfolio back in stocks. Problem number two is that they let the two best years in stock market history pass them by which would have helped them recover the bulk of their losses, and instead are now buying back in at what appears to be the peak of a bull market. They sold low and are buying high. You can’t make money that way.

The common thread is that in the past six months or so the trend is for more money to be going into stocks than cash or bonds, which has been the trend over the last couple of years. How ironic is that? In 2009 and 2010 the majority of money being invested was by far going into cash or bond assets, yet the market was tacking on gains at a record clip. Today, after the market has bounced back nearly 100% from its lows, it’s only now that investors are feeling comfortable to invest in stocks again.

To better illustrate this perilous investing behavior, here’s a quick chart:

Just like Richard in the article mentioned above, he had seen enough in late 2008 and decided it was time to bail out of the market. Well, as you can clearly see, by the time the end of 2008 rolled around the bulk of the damage had already been done. The S&P was already down between 30-40% at this point. Granted, it still had more downside yet to come and you can argue that selling then missed that, but look at how quickly the market recovered from that ultimate low. Had you not been paying attention to the news a month or two would have gone by and you wouldn’t even have known. And from that point forward the market has been going up sharply.

So, as you look at the chart you’ll notice that 2009 was the year to invest if you had the foresight to invest early in the year. The market rallied close to 65% in just nine short months. That’s unheard of, but guess what? John Q. Public investor missed out. They got shaken by the sharp drop in October of 2008 and bailed out completely, and being afraid of the volatility in the market probably let 2009 and most of 2010 go by before realizing the market rally is real and they should probably get back in. It doesn’t take rocket science to see the problem with these two circles. The “sell” circle is lower than the “buy” circle, and you don’t make money selling low and buying high.

The Missed Buying Opportunity

It isn’t just the wholesale selling of stocks and buying back in later that can cause damage to your portfolio. We all know that if you sold after the crash and waited two years after a rally to buy back in that’s a losing proposition, but there’s another layer of missed opportunity here. When most people sold their stocks back in 2008-2009, they also stopped putting new money into stocks (if they were investing at all). That’s what many of those articles referenced above point out, that for those two years the bulk of new money being invested was going to cash or bonds. Well, what a wasted opportunity.

Had you continued to make regular investments in your 401(k) or IRA or whatever you use into your stock holdings during that down period of a year or two you would have racked up a nice amount of money that had an average purchase price well below the peak from just a few months prior. In most cases, that money would have been buying stocks at a 25-40% discount only to then rally in the coming year and earn you a hefty profit. Instead, most people turned to cash or bonds for all of their new money and while stocks were setting record gains, they were content earning 1-5% on their money.

The gains are real. As I wrote about in the lost decade of investing, those who took the tried and true approach of regularly investing over time in a diversified portfolio and rebalanced regularly, came out ahead. While the decade of stocks is “lost” on paper showing a negative total return, a real investor who didn’t make rash emotional decisions and stuck to their guns actually made money in a period where people claim it would have been better to put your money under a mattress.

Lessons to be Learned

“Those that fail to learn from history are doomed to repeat it.” That quote pretty much sums it up because it’s true. Sure, it’s easy to look back over the past few years and see where everybody went wrong. When you’re living in the moment and staring into the teeth of a bear market it can shake even the most astute investor. But as history has also shown, the world didn’t come crashing down and a rash decision often proved costly.

With every market dip there are people who proclaim that this time is different. This is the time where the country goes bankrupt, your cash is worthless, and the best investment is that of guns and ammo. Well, maybe that day will eventually come, but I’m willing to bet that’s far less likely than some would lead you to believe. We’ve had countless market downturns over the past 100 years, each caused by a different driving force, yet somehow we’ve managed.

So, the key here is to learn from history so you don’t continue to make the same mistakes. Don’t wait until the market goes down, sell all of your stocks for a loss, and then wait well into a subsequent rally to buy back in. When you react to what has already happened, you’ve already lost. The only way to make money timing the market is to be ahead of the curve. You need to sell before stocks go down and buy before they go up. For the average investor you’re probably better off going to Vegas and playing blackjack.

The rules haven’t really changed even though the economy has.

1. You need to create a diversified portfolio.
2. You need to regularly invest, in good times and bad.
3. You need to rebalance your portfolio regularly.

It’s that simple, yet adhering to it can be difficult. Ultimately, at the very least you need to diversify. Most people, especially those later in life, are overexposed to stocks. Sure, everybody wants to play catch-up since they got a late start in saving, but taking on more risk isn’t the answer. So creating a portfolio with a solid asset allocation might not be flashy or make you rich overnight, it will do the dirty work of mitigating risk so you aren’t left to your own devices and trying to time the market. Second, you need to continuously invest. When you invest on a fixed schedule it doesn’t matter what the market is doing. Sometimes you’ll be buying low and sometimes high, but in the end you’re going to end up with even more money than if you had been on the sidelines. And finally, rebalancing is important because it forces you to take profits off the table. As the investments in your portfolio do good or bad their proportion gets thrown off your target. By rebalancing you’re then taking profits from the investments that did good and shuffling them into the investments that aren’t doing so good, which is effectively selling high and buying low.

One final thought, and that has to do with Warren Buffett. He’s known for saying, “Be fearful when others are greedy, and greedy when others are fearful.” Since the public is usually the last one to the party, I’m a bit on the fearful side these days. While mainstream media says it’s time to get back in, I’m doing the opposite and pulling some of the profits from the past few years off the table. I don’t move my entire portfolio in and out of stocks like a fool, but in times like these I am extra careful about buying into the excitement.

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Are you wondering if you’re going to get a tax refund or maybe owe Uncle Sam this year? Well, instead of waiting until you completely go through your tax return you can plug in some numbers and get a rough estimate today. This can be especially helpful if you end up with a surprise showing you may owe money. While it’s generally too late to make any changes to your tax situation now, the earlier you spot this, the more time you’ll have to get the money to pay the tax bill.

TurboTax has launched something new called TaxCaster, and it is a quick calculator that can help you determine what your tax bill or refund will look like. While they just provide an estimate, as long as your tax situation isn’t overly complicated, the results will generally be pretty close. Keep in mind that they are just estimates though, and it will only be once you complete your tax return that you’ll know exactly what you’ll see as a refund or owe the IRS. But this is a nice planning tool if you’re looking to get an idea of what to expect while it’s still early in the year before you’ve sat down to actually do your taxes.

So, if you’d like to see what your tax refund might be, I’ve included the TaxCaster widget below. And don’t forget, doing your taxes with the help of TurboTax can help you get all of the refund you deserve.

Powered by Taxcaster Tax Refund Calculator

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Are you planning to, or have you recently left or lost your job where you had a 401(k)? The good news is that since these accounts are tied to your employer, once you cut your ties with that employer, you’re generally entitled to do what you wish with those funds. Unfortunately, a lot of people take unnecessary losses and penalties by withdrawing the funds. This can set your retirement back years, and tens of thousands of dollars. So, the best option is to opt for a 401(k) rollover.

The 401(k) rollover is ideal because it allows you to transfer your existing retirement account into another retirement account without being subject to unnecessary taxes or withdrawal penalties. Remember, retirement accounts like a 401(k) are funded with pre-tax dollars, and grow tax-deferred. That means if you take a premature distribution, the IRS is going to stick you with taxes on all of that money, and also apply an additional 10% penalty if you withdraw the money prior to age 59 1/2. This is a pretty raw deal if you don’t need that money for a dire emergency, yet so many people will take the penalty simply because they don’t know how to do a rollover.

Your Rollover Options

The first decision you need to make when it comes to rolling over your 401(k) is where you want to roll the money to. There are three primary options that I’ll discuss here and provide some of the benefits and drawbacks of each.

Rollover Into New Employer’s 401(k)

If you find new employment and they also offer a retirement plan such as a 401(k) or 403(b), in most cases they will allow rollovers into your new account. But is this a good idea?

Pros: The benefit of rolling into your new employer’s 401(k) is that it doesn’t matter how much money you have since there are generally no investment minimums on the fund options. If your rollover isn’t that much, you may find that you don’t have enough money to properly diversify your money with a particular mutual fund company. In some cases, you need a minimum investment of $3,000 just to invest in a single mutual or index fund at a fund company. If your 401(k) balance is low, say $5,000, it will be harder to diversify that money than if you were to move it into the new 401(k) where you could spread the money out regardless of how much you have to invest.

Cons: Aside from that primary benefit, there are also plenty of drawbacks. First, is that you’re losing a lot of flexibility. Remember, these are employer-sponsored accounts, so as long as you’re an active employee, you’re bound to that plan and its rules. This means you’ll be stuck with whatever investment choices they offer, and will not have access to your funds again unless you want to take a loan (if it’s allowed) or you terminate employment.  In addition, a lot of 401(k) plans have relatively high fees. This is especially true for smaller employers. You could find that you’re paying on average 1% or more for each investment when you could easily find a comparable investment outside of the plan for half that.

Rollover Into a Brokerage IRA

Another common option is to roll over your 401(k) into a brokerage IRA account. This can be done at almost any financial institution, but most often people flock to the discount brokers where trades have low or even no commission.

Pros: Brokerage accounts provide the ultimate flexibility. In a 401(k) you’re typically bound to just mutual or index funds. This is great for most people, but there are a lot of other investment options out there. The biggest benefit in a brokerage account is being able to take advantage of Exchange Traded Funds, or ETFs. With thousands to choose from, low expenses, and no investment minimums since they trade like stocks, these can be an attractive investment vehicle for a retirement account. Not only that, but with a brokerage account you can buy individual stocks, mutual funds, individual bonds, and in many cases, even things like options and CDs. So, if ultimate flexibility is what you’re looking for, a brokerage IRA is going to provide it.

Cons: Even though there are many great benefits with this option, there are obviously going to be some drawbacks as well — the biggest being cost. Unlike investing in most mutual funds that just have a built in expense ratio, with a brokerage account you’re going to be charged a fee each time you place a trade with most brokers. And if you trade an ETF, you’re also dealing with recurring expenses built into the fund on top of the trade commission. Also, some brokers will charge a transaction fee to place a mutual fund trade that you otherwise wouldn’t have inside a 401(k) or if you had an account directly with the fund company. The good news is that you can eliminate most of these fees by opening a brokerage IRA with a free or discount broker such as TradeKing.

Rollover Into a Mutual Fund Company IRA

The third main option for rolling over your 401(k) is to roll it directly into an IRA held at a mutual fund company. Popular fund companies include Vanguard, Fidelity, T. Rowe Price, and so on.

Pros: Rolling directly to a fund company will typically be the cheapest way to invest in their funds. There are no commissions, and in most cases, no account fees if you meet some basic requirements. It can also be helpful to stick with one provider so it’s easier to keep track of your investments.

Cons: If flexibility is what you’re after, this may not be your best option. For one, you’re basically tied to this fund company’s offerings. While most fund companies will have plenty of options to satisfy most investors, if you want to dabble in individual stocks, ETFs and so on, you’ll more than likely need to then open a separate account with a brokerage to do this. In addition, you have investment minimums to contend with. All fund companies are different, but most require that you have anywhere between $500 and $3,000 to invest in a single fund before you can buy any shares. For smaller accounts, this might mean being unable to invest anything, or only buy one fund until you save up more money to invest in another.

Your Rollover Step-by-Step

So, you’ve decided that you’re going to do your retirement savings a favor and roll over your 401(k), but where do you get started? Don’t let the process intimidate you. Sure, there may be some complicated looking forms to fill out and it might mean that you’re dealing with your life savings, but it isn’t hard if you know the steps involved.

1. Check Rollover Eligibility With Your Old 401(k) Provider

Before you do anything, check with your old provider. You want to make sure there won’t be any unexpected snags or fees and make sure that you’re showing up as a terminated employee. They can’t release the funds unless you’re terminated, and I’ve often seen cases where your employer doesn’t notify the plan provider, and you’re still flagged as an active employee in the system. Then when you try to do the rollover, it doesn’t go through, you’re not often told why, and it is up to you to make the contacts to get that resolved. So, save yourself some time and make sure you are cleared to move the money and that there are no unexpected penalties, fees, or restrictions.

2. Obtain Rollover Forms From Old Provider

If you’re already on the phone with the old provider checking to make sure you are free to move the money, you can also use this time to ask for the required paperwork. In most cases, you will need to submit paper forms in order to initiate a rollover, so you’ll want to tell them that you intend to roll the money over, and that you want the forms needed. They will either send them to you in the mail, or you may be able to request them via email or by fax. There are some providers that will only require a rollover request form from your new plan, and if that is the case, simply move on to step 3.

3. See What is Needed for the New Provider

Next, you’ll want to check with your new account provider to see what they require in order to accept the rollover. Whether it’s a new 401(k), brokerage account, or mutual fund company, each will have their own unique, but similar process.  In some cases, you may be required to open up an account first, and then submit a rollover form. In other cases, the account creation and subsequent rollover may all be part of the same form or process. Either way, determine how they require it to be done, and make sure you have all of the appropriate information from the previous provider to complete everything.

4. Complete the Forms Properly

This is an important step, especially if you’re doing it on your own. All of these forms may have a lot of information, and to make sure things go as smoothly as possible, you’ll want to make sure you fill it out correctly. For instance, if your rollover form from your previous carrier asks what type of distribution this is, you want to be sure to choose a Direct Rollover. This ensures that the funds are made payable to, and go directly to the new account. This often requires information as to how to make out the check or where to wire the money. This is information that you’d need to obtain from the new provider.

If you have questions at this stage, call the company and ask for help. Whether it’s questions with your outgoing provider or incoming, don’t assume and just fill it out the best you can. Sometimes just an unchecked check box, or an overlooked signature can kick the forms back and delay the process for weeks. In the worst situations, you aren’t even informed there is a problem and it can drag this process out forever. So, save yourself some trouble and make a quick call if you have questions.

5. Submitting the Forms and Follow-up

Once completed, it’s time to submit the forms. Whether it’s forms for both providers or just the new one, you’ll need to mail or fax them to the appropriate location. But your job doesn’t stop there. You need to stay on top of this process. There is a nasty habit of outgoing providers to make it difficult for people to pull their money out. If something is wrong with one of the forms, or they never receive anything, you aren’t always going to get a call or letter right away alerting you. They don’t want to see those funds leave, so they aren’t going to be quick to tell you something that will speed that up. So it’s up to you to follow up on your own in most cases. If you haven’t received your check, or the funds haven’t been deposited after about two weeks, I’d make a few calls and make sure all parties received the appropriate paperwork and that they are in good order. If not, you may need to have them send the forms back so you can correct the error, or simply provide some information over the phone. Either way, don’t assume that everything is going smoothly behind the scenes if you don’t hear anything.

In many cases, you will receive a check for the full amount of the rollover in the mail. It is then up to you to make the deposit into the new account. Make sure the check is made out properly, and submit it for deposit with any required deposit forms. If you previously called and they said a check has already been issued and mailed, keep an eye out for it. Again, you want to be on top of things if it doesn’t show up so that you can have a stop issued on the check and a new one sent. And don’t hang on to the check once you receive it. Get it deposited as soon as possible and out of your hands so that you don’t forget about it, it gets lost, etc.

Making the Right Choice

As you can see, there are many different options available to you when it’s time to do a rollover. There isn’t a right or wrong answer, as each method has its own pros and cons. So, don’t become paralyzed by the choices or process, because the worst thing you can do is withdraw the money unnecessarily. Obviously, there may be some financial emergencies that may dictate a rollover isn’t the best course of action, but for most people, this will go a long way in helping you achieve your retirement goals.

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Do you need to improve your credit history? If you’re like the majority of Americans, the answer is yes. According to FICO, 60% of all people have a credit score less than 750. This means there is plenty of room for improvement for many people. There are many methods to check your FICO Score and Report.While you can’t simply fix your credit history overnight, there are many things you can do to begin building a more positive credit history. Here are 15 steps you can take:

1. Pay Your Bills on Time

This one is probably quite obvious, but it has to be mentioned right out of the gate. The single greatest factor that determines your credit score is your payment history. If you pay on time and continue to do so for years, this will lay a solid credit foundation. One thing you do have to keep in mind is that this goes beyond just paying your credit card, mortgage, or car loans on time. Even things such as utility bills, cell phone, rent, and so on will likely be reported if late. While these types of accounts don’t generally show up on your credit report if you’re in good standing, they usually will still show up as a blemish if you’re late (usually after 30 days late).

2. Don’t Bounce Checks

What does bouncing a check have to do with your credit history? On the surface, it seems like an innocent bounced check wouldn’t be of much concern other than the overdraft fee, but it can adversely affect your credit history. While your overdraft may not show up on your credit report, most banks have their own system to track customers with bad finance habits. It is called ChexSystems, and if you don’t think it will show up the next time you’re looking for an auto loan or mortgage through a bank or credit union, think again.

3. Start Small

If you have a limited or poor credit history, the likelihood of being approved for a large amount is slim. Without a proven credit record, most lenders won’t be willing to extend significant amounts, so it is in your favor to start with smaller requests. A lender would like to see that you are financially responsible with a relatively small amount before taking on more risk with a larger sum. Sometimes you have to crawl before you can walk, but even a good payment history with small amounts can go a long way towards proving you are responsible over the long run.

4. Visit Local Lenders

A local lender may be more willing to extend credit to you than a large national chain. In many cases with the large chains, your Social Security number simply gets run through a computer that checks your credit information and automatically approves or denies your application. When you work with a small and local institution, the decision may be based on more than a simple computer calculation. They may know you personally, know your employer or family, and this can potentially lead to an approval.

5. Apply for a Secured Credit Card

If you are having a hard time getting approved for any standard credit card, you may want to consider opening a secured card. To establish a secured credit card, you typically have to keep a deposit with the bank that can cover the charges you make on the card. This works as collateral just as a home or vehicle would be on a mortgage or loan. While it won’t quickly improve your credit history, it will begin to show that you are financially responsible and lead to possibly getting approved for other loans or credit cards to further build your credit.

6. Apply for a Small Loan or Credit Card with a Co-Signer

If you’re unable to get approved for a loan or card by yourself, you may consider applying with a co-signer. This is different than just adding an authorized user as it an actual joint account. Use this as a last resort and keep the limit small, but if you maintain a positive repayment history on this account, it will help you begin to establish and improve your credit history.

7. Review Your Credit Report Once a year

When you know you have bad credit, one of the last things in the world you feel like doing is pulling your credit report just to be reminded of it, but it is still important to check it annually. The information is usually accurate, but mistakes do happen on occasion, and even worse, you may notice fraudulent activity. It is in your best interest to correct these issues sooner rather than later. If too much time passes before you try to resolve an issue, it may be too late, and that inaccurate mark won’t disappear for seven years.

8. Review Your Credit Report a Few Months Before Requesting a Major Loan

When you’re thinking about applying for an auto loan or a home mortgage, make sure you give your credit report a once over a few months before going into the application process. This will give you a head’s up on any potential inaccuracies so that you can have them resolved before going into the loan, or at least help you be prepared to explain to the lender why an item is on your report and whether or not it is being resolved. The lender is certainly going to pull your report, so the last thing you want to do is go in uninformed and possibly face a surprise.

9. Avoid Letting Accounts be Turned Over to a Collection Agency

If you thought a few late payments to your lenders was bad, you don’t want to entertain the idea of letting your accounts go to collections. The last thing a lender wants is to turn over an account to a collection agency because they will only recover a fraction of the outstanding debt even if you pay the collection agency in full. Since the lender doesn’t want to turn you over to collections, it is in your best interest to work with the lender directly when problems arise. If you’re already late and foresee a problem of getting your account current, give them a call and see if they will work with you. In most cases they will work to develop a more reasonable payment plan so that this can be avoided.

10. Avoid Having Judgments Filed Against You

Being dragged into court faced with a judgment against your debt is clearly not a position you want to be in. Unfortunately, if you fail to repay a debt, this is a very real possibility. Just like with collection agencies, even if you pay what the court says you owe, the judgment will stay on your credit report for seven years. This will not help your chances of getting approved for a credit card or loans. Again, it is in your best interest to work with your lender at the first sign of a problem to avoid this from happening.

11. When Denied Credit, Review Your Credit Report

When you’re denied a loan or credit, the lender is required to offer you a copy of your credit report at no cost. While they may give a brief explanation as to why you were denied, this is a good time to pull your report and find out exactly what they saw. It could be a legitimate problem with your history, but you also want to keep an eye out for something out of the ordinary if this denial came as a surprise.

12. Try to Avoid Constantly Switching Employers

Understandably, this isn’t always possible, but if you have the option and ability to remain at an employer you should do so if you’re seeking credit. Lenders like to see stability in employment as stable income means you’ll have a better chance of making good on your payments. Once you’ve been with an employer for about five years, this really begins to improve your chances with lenders. Of course, this doesn’t mean you should stay at a dead-end job just for the sake of your credit score, but you do need to be conscious of the fact that this does play a role in your chances in being approved.

13. Try to Avoid Frequent Changes in Residence

Just like constantly moving from job to job, lenders like to see stability in residence. If you’re renting a new place every year, the lender will wonder why you need to keep moving. Lenders also look favorably upon homeowners, so if you currently do own a home, this can also help.

14. Work to Increase Your Income

Easier said than done, but your debt-to-income ratio is quite important when it comes to getting approved or not. In addition to the actual ratio, lenders like to see regular increases in your income. Whether this is through annual raises or occasional bonuses, this can help your chances of getting approved. Also, if you are expecting a bonus sometime shortly after applying for a loan, bring this up to your lender. Knowing that you’ll be receiving additional income can be a deciding factor if you are on the line of being approved or not.

15. Work to Decrease Your Debt

The debt-to-income ratio can be improved by decreasing outstanding debt. The more income you have relative to your debt, the better. So that means if you can’t easily increase your income, you can achieve the same results by decreasing your debt. If you continue to use credit cards while paying them off, your amount of debt relative to your income won’t improve. On the other hand, if you can show that you have consistently been reducing your overall debt for a period of time, this can look as good as showing regularly increasing income.

Remember, It Takes Time

It can be frustrating, but working to establish or improve your credit history takes time. There isn’t an overnight solution, so you have to approach this as a long-term goal. If you’re just beginning to establish credit for the first time, take things slow and begin by opening a few small accounts. With these initial accounts, make sure you use the credit wisely and develop sound habits. It won’t be long and you’ll be on your way to building a great credit history.

If you already have a credit history but it has been damaged by something mentioned above, don’t despair. While you won’t be able to increase your score 200 points in the span of a a couple months, following the suggestions above will put you on the right track to begin increasing your score. But whatever the situation, it is important to monitor Your FICO® score & credit report.

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