It’s been 103 days since my last post. To quote all of Yen’s lines in Ocean’s 11…

It’s a fair question. Since my last post at the end of May, I started #vanlife and my laptop decided to stop charging – not ideal conditions for blogging. Luckily, I’m back on the grid now with laptop rejuvinated, and I intend to update the website with more frequent, (hopefully) shorter posts going forward. Thanks for staying with me. By the way, while I have you, sign up for my Mailchimp at the bottom of the page, so you can be notified by email whenever I post next.

Let’s get into it. I really wanted to make a post about what’s been happening lately — the Federal Reserve providing crazy support to all sorts of markets; unemployment spiking; COVID still not being understood in America — there’s plenty that has happened since my last update, but the feedback for my second post, Why save?, was so strong that I thought a lot of you would benefit from a simple prepper on personal finance. So once you know why you should save, the obvious question is how?

There are, as you might expect, plenty of answers to this kind of question, but I think generally when it comes to your finances, the simpler the better. With that, there are two questions you need to answer for yourself. First, how hands on do you want to be in investing your money? Second, in what accounts will you invest and how will you invest?

Question 2: What accounts do you invest in and where do you put your money?
I personally follow the flowchart on r/personalfinance, which provides a great framework for knowing where to put your money and why.

Step one is to make sure you’re in a position to invest. By virtue of reading a blog dedicated to demystifying confusing finance topics and current events, you’re probably well enough off, but the truth is for most people, negative net worth is real, and if you don’t have family support it’s important to get your immediate needs in order before starting to think further down the road. Typical advice is to establish 3-6 months of living expenses before you begin really investing. If you have access to money through credit cards or other means, you could be a little more aggressive and start investing before you have a full six months saved up, but realize what COVID has taught many people. Six months from March, when COVID really blew up, is right now. That’s not a lot of time, so make sure you are either in a stable job or you have access to money through family/other means.

If you have access to a 401k or similar program through work and your employer matches any part of your contributions, you should contribute as much as you can to make sure you’re getting the entire match (and at this point, no more money). This is common advice, but why do people say to do this? Think about the math behind what a match means. Say your employer promises to match 100% of the first 4% of your salary to your 401k and you make $75,000 a year. In year one, you would contribute $3,000 toward your 401k, your employer would match that entirely, and so you’d save $6,000.

With 401k match

Without any match, you would save $3,000, your employer would contribute $0, so you’d have just $3,000 at the end of the year. By getting the match, you have earned a 100% return! Try to find another way to get a guaranteed 100% return on your money year after year. It doesn’t exist and anyone promising it does might be selling you something that rhymes with Fonzi Spleen.

Without 401k match

Look at how different your 401k balance is in 2030: With the match, you have $94,702. Without the match, you have just $47,351. Get the match! In a 401k, you’re typically limited to what you can invest in to maybe 20 or so funds that have been chosen by your 401k provider/employer. So at this point, whether you’re using a hands on approach or not, there’s not a ton in the way of decision making here.

Step 3: Pay down high/moderate interest debt
If you have a lot of debt, you’ll want to figure out how to get it under control. That doesn’t mean you necessarily want to eliminate your debt as fast as possible though. Debt can be very useful – without mortgages, for example, no one could afford a house without being extremely wealthy from birth. If you pay down inexpensive debt too quickly, you might actually be hurting your net worth in the long run. See below for an example where you have $5,000 per year to either contribute to investing in the stock market or paying down your 4% mortgage.

Paying off your mortgage as planned and putting another $5,000 per year toward your 401k. Net worth in 2030: almost $137,000

Putting that $5,000 per year toward paying down debt instead of investing it in your 401k. Net worth in 2030: just under $98,000. You’re $40,000 poorer and you thought you were being prudent by paying off your debt!

Realize what I’m saying here. If you hold low interest debt, there may be a benefit to you paying it off over its life (i.e. a 30 year mortgage) instead of rushing to eliminate it all at once. If on the other hand, you hold any type of credit card debt or any debt where the interest rate is very high, you need to pay that off ASAP. That kind of debt will bury you over time and you just won’t make enough investing in the stock market to outperform your debt growing by 30% per year.

The problem is when debt becomes unaffordable. If you have a lot of debt or if you have debt that is very expensive — generally over 7% — it’s a good idea to pay that down. Otherwise, if you can comfortably pay your interest payments on your house, your student loans, whatever, it’s important to be putting money into the market as well. You can’t get rich by only paying off your debts.

Step 4: Savings for retirement in an IRA & higher education expenses
Ok, so I have an emergency fund, I’m getting the match in my 401k, and I’m paying down any big debts I have. Now what? Step 4 is making use of an IRA, which provides you tax advantages either in the current year (traditional IRA) or when you pull the money out in retirement (Roth IRA). I personally like having a Roth IRA (and Roth 401k) because I know the taxes have already been taken out from those accounts, so the money in those accounts is really mine; I don’t have to mentally adjust those balances for whatever I might end up owing the tax man in 40+ years.

This is where we finally get to bring in the distinction for how interested you are in paying attention to your finances. If you’re completely disinterested in finance, build a three fund portfolio. Determine your preferred balance of domestic stocks, international stocks, and domestic bonds, find your favorite ETFs to invest in those asset classes, and invest on repeat. The best part? This strategy is incredibly hard to beat over long periods of time even for professionals.

That last point is something unique about finance. What other field of study can you do better by trying less or achieve great results as a novice whereas a professional might struggle? Because of that weird reality, it can be very easy to think: hey this doesn’t look so hard! I’m going to manage all of my finances and make millions! Even worse you might think; stocks always go up. I’m buying call options with my student loan money #gainz. But the truth is earning a return that’s better than a three fund portfolio (or any well diversified, low expense portfolio) over long periods of time is pretty difficult. One of my favorite quotes from The Intelligent Investor — one of the best finance books out there — concerns this exact idea as it relates to doctors who look at the financial world and think psh this is easy…

Just because you might be smart and this might look simple, doesn’t mean this is all a cake walk. So what about having someone else manage your finances for you? In my mind, advisors are generally not worth the money. Most will charge a fee based on the amount of money you give them, and there may be fixed expenses on top of that. They may have a conflict of interest and push you into products from which they make massive commissions. They may charge you enormous fees just to put you into blue chip stocks. They may turnover your portfolio constantly in the hopes of looking like they’re doing something useful, but really they’re just resetting your tax basis (and thus lowering your returns). There’s plenty of reasons these people are not helpful – and there is a reason their industry is dying. All that to say, while you might sleep better at night knowing it’s someone’s job to protect and grow your money, you need to be careful before you sign anything. The single best thing you can do for your financial self is diversify your investments. Outside of that, contribute early and often, and you will likely beat 90% of savers out there.

If you’re more interested in taking a hands on approach to investing your money, there are plenty of resources out there, and I’d be happy to talk to you individually about how I manage my money. My biggest lesson learned this year? Don’t fight the Fed. More on this in another blog post.

Step 5: Save more for retirement
By step 5, you’re in a pretty good financial position, so steps 5 and 6 are pretty similar. If you have access to an HSA through your employer, you should contribute to that as it’s technically the most tax advantaged account that exists. From here, you can start contributing more to your 401k up to the total yearly limit. Beyond that you’re just investing in a standard brokerage account, which has no tax advantages.

Step 6: Save for other goals and advanced methods
Each quarter, JP Morgan puts out its Guide to the Markets – an in depth view of financial markets from the world’s largest bank. You can see in the chart below the total returns of each asset class by year from 2005-2019 and including year to date returns (as of June 30, 2020). Hindsight is 2020, but if you could pick one thing to invest in over the past 15 years emerging market equities and real estate (REITs) would have been it. What would have been the worst asset class? In most years, its cash! This is why you must invest. Keeping your money in a savings account earning 0.25% does nothing for you and will guarantee you do not achieve real wealth in your life. Instead, investing in a broad mix of asset classes — or choosing your own stocks to invest in if you’re a little more adventurous — is a very real way to improve your financial lot in life and ensure you won’t be trapped by debt and ever rising inflation. Good luck out there.

Look how often cash is the worst performing asset class. This is why you must invest!

To see any of the Google Docs that I included in this post, click here.