Dollars and Sense

It’s time to get this blog thing going again! I have a queue of ideas pooled up that I’ve put a lot of thought into and seem to discuss over and over with people in person, so here is to the first one: some free financial advice for everyone. I am not an expert by any means, and while I’d love to not think about my money at all, the thinking and executing that I’ve done has given me a pretty decent plan that requires little ongoing involvement on my part and has been called things like ‘actually pretty ok’ by trained and certified financial planners. Follow these steps and you may eventually find yourself in better financial shape than you are currently. They are roughly ordered in order of priority.

Note: I am not trained or certified in giving any kind of advice, and certainly not financial advice. Everyone’s situation is different and while what I describe below works for me, you should talk with someone that is trained and certified before making any financial decisions that you’re not completely comfortable with, and probably before you make any financial decisions at all.

Spend less than you earn

Pay your credit cards in full each month, and don’t buy things that you don’t have cash in your account to cover. If you don’t do anything else on this list, you should be doing this one and it’ll all be ok. The less you spend, the more you can save, and the quicker you can ‘retire’ if you are into that kind of thing. Everyone has differing opinions on how much to save but given ‘the market’, any kind of long-term planning based on exact percentages is going to be no better than make believe. You can’t go wrong with this one. Apply this to all of the ‘saving’ things below by counting them as ‘spending’, and you’ll end up with extra cash for buying fun things and a slowly growing ‘nest egg’.

Live Debt Free

Spending less than you earn should cover this, but if you already have debt, do whatever it takes to pay that debt off. Pay off the debt with highest interest rates first, and do your own math if it makes sense to pay off low-interest-rate debt with money that you could be investing and getting better returns on. If you can conservatively get 6% in the stock market, you probably shouldn’t pay off your 2% student debt right away, but that 18% credit card bill needs to go. If you aren’t prioritizing this way, you are throwing money away. I’d even suggest paying off debt when you can afford it even if the market might do better, because the market is variable and your debt is not. Not ever having to even think about making a student loan payment again is far better than maybe having a few extra dollars in 20 years in my mind.

Look at the Big Picture

Mint is good for this. It can show your net-worth go up each month if you’re doing the first two things. This is good. It’s also nice for watching your spending categories change over time and identifying things that you’re spending a lot more on than you thought.

Build and keep an Emergency Fund

3-6 months of your after-tax income is probably plenty. 3 months of your ‘non-savings’ expenses each month is a good minimum. This gives you flexibility between jobs, the ability to pay for a car with cash, the ability to handle unexpected medical expenses, etc. Some people say not to use your Emergency fund for things like a car, but if you need a car and you can tap your fund to avoid getting a monthly car payment with interest, do it! I keep mine in an American Express Personal Savings account which pays only about 1% interest, which is low but better than nothing, and I won’t loose it if the market crashes. Which it will. Remember that as you pull from your Emergency Fund and as your income and expenses change, you’ll need to put money back in. This should be somewhere that is risk-free, where you can access it relatively easily, and definitely not in a retirement account.

Max out 401(k) matching, and possibly the federal limit if you can

If your employer matches up to 5% of your salary, put at least 5% of your salary into your 401(k). If you do not do this, you are throwing away free money. Your employer will have a bunch of plans available, but pick a target-date retirement fund and let it do it’s thing. Statistically, no mix of funds that you pick will do better than a target-date fund and they will all take more of your time to manage. If you can afford it (and probably after you’ve maxed out your ROTH IRA as described below), contribute up to the federal limit of $17,500 for 2013 (IRS details). This is tax-deferred which means that you’ll pay taxes on it when you withdraw for retirement, but you’ll be paying less taxes then so this is ok. The deduction now means that your taxable income for this year will be lower. Note, this money is for retiring so don’t put money in your 401(k) that you’ll need to spend before then or you’ll pay a lot of penalties if you need to use it.

Use a bank that isn't a pain to deal with

Simple has been my primary bank for over a year. I have a few invites, let me know if you’d like one! If you’re paying account management or ATM fees, or you don’t have a grasp on how much money is in your account or how much you can spend at any particular time, it’s time for a change. If you pay overdraft fees because a deposit hadn’t cleared yet and you didn’t know, you are throwing away money. Good customer service is always nice too, you’ll need it sometimes.

Use the best credit card that you don't have to think about

You could spend all the time in the world picking which credit card to use for every transaction you make, but I’ve limited myself to 2. For me, first is an American Express Blue Preferred card because it’s benefits give me the most bang for my buck with my spending habits (6% on groceries is really good) and American Express have the best extra features and customer service so my groceries and big purchases go there. Second is a Chase Freedom VISA that offers 5% back on some subset of things depending on the month. Thinking about which of the 2 cards to use when is a little overhead for me, but 5% back is a lot compared to the 1% on all purchases that most cards give. These may not be the best cards for you, but search the internet for comparison tools (Mint.com has a decent one here) and pick one or two. Shred the rest and forget about them, and feel free to cancel one of them every now and then. This may hurt your credit score a little bit, but you don’t need them and you usually don’t need your credit score. Remember that not every place takes American Express because they charge higher merchant fees, so have at least one VISA in the mix.

Pay the littlest amount you can when you borrow money

If you have to borrow money, don’t borrow from your retirement accounts. Borrow from the cheapest place possible. This probably means going to your family or taking out a home-equity loan instead of using a credit card. Refinance your mortgage if you can go a full percentage point lower in interest rates (that generally means the refinancing will be ‘worth it’), and consolidate any debt to the lowest interest rate possible. If you don’t do this, you are throwing money away. LendingClub is one place to borrow money to consolidate. I may even invest in your loan if you go there! If you don’t pick the cheapest way to borrow, you’re throwing away money.

Max out your ROTH IRA every year if you can and invest it

The most you can put into a ROTH IRA is $5500 a year in 2013 (details from the IRS). You pay taxes on this money before you invest, but it grows tax free so whenever you withdraw for retirement, you won’t pay any taxes. This is a good thing and is basically free money compared to just using a brokerage account where you pay taxes on all of the gains, or a tax-deferred account like a 401(k) where you pay taxes eventually. I use Wealthfront for my ROTH because they are low-fee and have several fancy features that put them ahead of most managed investing platforms. I make one yearly contribution to my ROTH from my Emergency Fund (you can also pay monthly or at any other frequency) and so far mine has generally followed the market without any work on my part. Betterment is a similar tool worth investigating. Note, this money is for retiring so don’t put money in your ROTH that you’ll need to spend before then or you’ll pay a lot of penalties and taxes if you need to use it.

Continually invest

You can try and time the market and buy-low, sell-high, but generally you’re never going to beat the market. As long as you continually invest and follow the advice above, and as long as you slowly change your asset mix over time to less risky things (All the services and funds mentioned above do this), you’ll do ok! I additionally invest in Betterment and LendingClub ever month. LendingClub is like a CD with higher interest rates and some risk. I’m averaging ~10% annual returns at both. This is ‘extra’ money that you could use in the future for anything you like, but that it’ll be ok for you to loose (or for the value to fluctuate with the market). Think about using this money to fund a big trip, pitch in to a down payment on a house, or loan to a friend or family member if they need it.

Automate

Lastly, your time is valuable. Automate everything you can including bill payments and investments. Find out the amount you need in your checking account to cover all of your recurring expenses (On Simple.com set up a goal for this amount that you never pull from) and make sure you always have that much available. If you pull it off and automate everything, this entire ‘plan’ shouldn’t take more than a few hours of your time each year.

If you’ve read other financial advice, you’ll notice that a few things are missing from this list, but they’re excluded for good reasons.

Budgets

I don’t believe in budgets as firm rules, and they cause far more stress (e.g. spending $5 too much one month on Coffee) than the benefits that they provide. If you’re doing everything I described above, you don’t need a budget. Spend whatever you like on shiny things or organic Cheetos as long as you’re doing everything above.

Stocks/Mutual Funds/ETFs/Investment Categories

Again, none of these matter. As long as your asset mix slowly moves from risky to less risky over time (Which target-date retirement funds, Wealthfront, Betterment, etc will all do for you), nothing you can pick will do better than the market and they will all take more time and effort. Sure, occasionally someone will ‘hit it big’ on a pick of some kind, but those are the exception and not something you should count on. Your core competency is something other than playing the stock market, so don’t bother trying.

Insurance

Insurance is an expense, not an investment. Only you can judge what kind of insurance you need. If you have $10 million in the bank you probably don’t need to pay for anything more than the legally requirement minimums for car insurance because you can just buy a new car and in a bad at-fault accident you’ll be writing a check regardless when they take you to court. If you have a mortgage, your lender will require homeowners insurance to cover their investment, and if you have more debts and guaranteed future expenses that won’t be covered by your assets (big mortgage, a child, etc) you’ll probably want some kind of life and long-term disability insurance. The cash value of a whole life insurance policy can be used as a non-risky asset in your diversification plan, but your retirement and investment accounts can match this on their own.

Cash

Plenty of people suggest that you use cash to manage your budgets and spending because it feels more ‘real’ than using a credit card. Get over it, credit cards give you free money for using them. You can loose cash, and it’s a hassle to keep up with.

Paying yourself first

I’m not even sure what this one means! It’s important to spend money on food, housing, and on things that bring you happiness, but ‘paying yourself’ something before you max out your 401(k) matching with your employer would be stupid (again, throwing away free money). Your future self will thank you. The Wikipedia page on Present Value has some things to say about this.

Salary

You obviously want to make enough money to meet your current and future needs, but it’s pretty independent from everything above. It’s probably a good topic for a separate post!

Questions? Ask away in the comments field below!