Personal Finance Strategies

Personal Finance Strategies: The Money Guide I Wish Someone Had Given Me at 23

 I've sat across the table from a lot of different people about money. 

Twenty-two year olds with their first paycheck and no idea what a 401k match is. 

Forty year olds with two kids and a mortgage who feel like it's too late to start. 

The advice that actually works is rarely exciting. It's a series of small decisions, made early and consistently, that compound into something impressive later.

 

Let's get to the actual advice, then.

 

Know Where Your Money Goes (It's Probably Not Where You Think)

 

Most people aren't bad at budgeting. They're bad at tracking. You can't fix what you can't see, and most of us are flying blind when it comes to our finances - we have a general idea of how much we make, and a general idea of how much we spend, but no real sense of where the latter is actually going.

 

I want you to take your last three months of bank and credit card statements, and sort them into categories. Housing, food, transportation, subscriptions, whatever floats your boat - just know that there will be a category called "miscellaneous" and it will almost certainly be larger than you expect.

 

When I did this with one of my clients, a marketing professional who felt like she was always broke despite making a decent salary, she discovered she was spending $412 a month on food delivery. Not $400. 

$412.37, to be exact, because I'm a petty person and I thought the extra 37 cents was almost an insult to the math. This isn't a moral failing, it's just a fact. Once you see it, you can fix it.

 

Your categories should be pretty straightforward. For reference, I'm a big fan of the 50/30/20 rule as a baseline, though you might need to adjust it depending on where you live:

 

• 50% needs

 

• 30% wants

 

• 20% savings/goals/debt

 

If you live in a city with a notoriously high cost of living, you might be looking at 65% needs, 25% wants, 10% savings. 

Your savings rate is what matters most, so adjust the other two numbers as necessary.

 

Pay Yourself First (It's Not As Simple As It Sounds)

 

I know, I know. It's much more exciting to invest in the stock market, but an emergency fund is a boring place to park your cash. 

The thing is, the stock market doesn't pay for car repairs or medical bills, and a cash reserve in a savings account is basically a 24% interest loan against yourself.

 

Three to six months of expenses, in a high-yield savings account, separate from your checking, is the standard recommendation. 

If you're in school or just starting out, you can scale this to a more manageable $1,000. The point is to have a financial cushion that you can access without jumping through hoops. 

$1,000 covers most minor expenses and inconveniences, and it's a good goal to shoot for if you're just starting out.

 

The most important thing about an emergency fund is that it's not actually an emergency fund. It's a savings account, and you should be contributing to it like one - ideally, on a recurring basis, so you're not thinking about it at all. 

Set up a standing transfer for the day after you get paid, not the day before rent is due. The less visibility you have over this money, the better.

 

Not All Debt Is Created Equal (And Some Of It Is Actually Good)

 

There's a big difference between a 6% student loan and a 24% credit card balance, but most people treat them the same when it comes to paying them off.

 

There are two popular strategies for paying down debt:

•   Avalanche method: Pay minimum payments on all accounts, and throw extra money at the bill with the highest interest rate. 
• Snowball method: Pay off the smallest balance first, in entirety, then move on to the next-smallest.

 

The avalanche method is objectively the most effective way to reduce the amount of money you owe, because you're minimizing the amount of interest you pay over time. 

The snowball method is psychologically rewarding, because you can check off balances as you pay them in full.

 

I'm a big fan of the avalanche method myself, for mathematical reasons, but if you're someone who struggles to stay motivated, the snowball method might be a better fit. 

You can't really do both, so pick one and stick with it. The most important thing is to have a plan, and to follow it consistently.

 

If you have credit card debt, and money in a brokerage account for "fun", you need to stop doing that immediately. 

You are almost certainly earning less of a return on the money in your taxable account than you're paying in interest on the credit card. 

That needs to stop, immediately, and you need to prioritize paying off the credit card first.

 

Take Advantage of The 401(k) Match At Your Company (It's Basically Free Money)

 

If your employer offers a 401(k) match on any contributions you make, you need to contribute at least enough to get the full match. 

It's free money, basically, and you should always take advantage of it, even if you have other financial priorities.

 

Let's say your company offers a 50% match, up to 6% of your salary. You make $60,000. You put in 6% ($3,600), and your employer would contribute another $1,800. 

That's a 50% return on your investment, with no risk, before the market even has a chance to do its thing. Turning that down is like giving up a raise.

 

If you're a young professional, and you're just starting to think about retirement, this is especially important. 

A small contribution now will have a much bigger impact than a larger contribution later, simply because of the math involved. 

You can expect to retire with $200 a month starting at 24, growing at an average 7% annually, turns into something north of $500,000 by age 65, but if you started contributing that same $200 a month at age 34 instead of 25, you're only looking at about half that amount. 

It's easy to think of compound interest as some nebulous concept, but it really does punish people who wait, and reward those who contribute consistently early on.

 

Investing Doesn't Have To Be Hard (In Fact, It Shouldn't Be)

 

If you're not a day trader, and you don't have a consistent edge in the market, you should be investing in a diversified index fund, and not think about it too hard. 

Something that tracks the whole market is going to do better than most individual stocks, over time, and you can expect to outperform actively managed mutual funds about 60% of the time.

 

Vanguard, Fidelity, and Schwab all offer low-cost index funds that track the total U.S. market, or a blend of U.S. and international stocks. 

These are much better investments than most people realize, especially when compared to actively managed mutual funds, which typically charge between 0.5% and 1% per year in fees, and underperform the market by a significant margin.

 

If you're looking for a specific example of an investing plan, you can't go wrong with something simple like the three-fund portfolio. 

It's perfect for most individual investors, because it's easy to implement and understand, and it's going to help you meet your long-term financial goals.

 

•  A total U.S. stock market fund

 

•  A total international stock market fund

 

•  A bond fund, with a heavier allocation as you get older

 

You might be 90% stocks and 10% bonds at age 25, but that allocation would shift as you get closer to retirement. 

Rebalancing once a year is usually enough, and that's it. That's the whole point of a three-fund portfolio, and I'm not going to apologize for how simple it is.

 

Roth IRA vs traditional IRA, briefly - Roth IRAs are taxed when you withdraw the money, while traditional IRAs are taxed when you contribute to them. 

Roth IRAs are typically a better deal for people who are in a lower tax bracket now than they expect to be in retirement, and traditional IRAs are better for people who are in a higher tax bracket now. 

There's no one-size-fits-all answer, but you should strongly consider a Roth IRA if you're early in your career.

 

For The Mid-Career Reader Who Feels Like They're Starting Too Late

 

If you're reading this and you're in your late 30s or 40s, and you feel like you're starting too late, I want you to know that it's not true. 

The later you start, the harder it is to meet your retirement goals, but the math still works in your favor if you take action now. 

You should absolutely take advantage of catch-up contributions if you're 50 or older, but before that, you need to increase your savings rate as much as possible.

 

Raising your savings rate by 12% is going to have a bigger impact on your retirement date than almost any other change you can make, and it's not as hard as you think. 

It's much easier to adjust your spending habits than it is to time the market, and it's definitely easier than trying to convince yourself that you'll stop spending money on experiences now so you can have more experiences later.

 

If you have kids, and you're considering funding a 529 plan before you fully fund a retirement account, I want you to stop and think about this for a second. 

Kids can take out student loans, but nobody will give you a loan at age 68. 

You need to make sure you can take care of yourself before you try to take care of your kids, because nobody else is going to do it for you.

 

Lifestyle Creep Is A Thing

 

You get a raise, and instead of increasing your savings, you decide to upgrade your car, or your apartment, or your spending habits in general. 

Nothing crazy, really, just a small increase in each category. Five years later, you're earning 40% more than you used to, and you're saving the same amount of money you did before the raise.

 

This is the single biggest threat to wealth creation for most people, and it's rarely something they even realize is happening.

 

The best way to combat it is to increase your savings rate as soon as you get a raise or bonus, before you do anything else. 

Raise your 401(k) contribution, increase your savings account transfers - do something to make sure the extra money actually goes toward savings, instead of your discretionary spending. 

It's much easier to adjust your spending habits when you're not used to the new salary yet, and it only takes about six weeks for most people to get used to a raise.

 

Some Things I Used To Think Were True, But Aren't Anymore

 

When I was younger, I was a big fan of paying off all my debt before paying myself. 

I'm much less dogmatic about it now, and I think it's much more important to take advantage of any employer match, and pay off my student loans before my credit cards, simply because of the interest rates. 

Paying off a 5% student loan is much less urgent than paying off a 22% credit card balance.

 

I've also become much less prescriptive about budgeting in general. 

I used to tell people to track everything in a spreadsheet, but most people don't have the time or energy for that. If you want to use a spreadsheet, by all means do, but use whatever system works for you, and actually stick to. 

A pretty spreadsheet you open up once a year isn't going to do much for you, if you're not actually using it.

 

The Important Stuff

 

None of this requires a lot of financial expertise. It's mostly about making a few simple decisions early on, and then letting things take care of themselves. 

The people who actually do this stuff tend to be boring, in the best possible way. They make the obvious choices, and they stick to them, even when things get scary. 

They ride out the downturns, and they don't panic when the market takes a nosedive because they've been investing for decades. 

They know the math, and they understand that a Roth IRA is much more valuable to them than a traditional one, simply because of their tax situation.

 

Whatever it is, just start. It's much easier to fix the wrongs of the past than it is to prevent them in the future. 

If you're just starting out, pick one thing to focus on. Pay yourself first, or build an emergency fund, or contribute to your 401(k). 

Do whatever you think is most important, and then do it again next week.