A lot of my friends have approached me lately about investing - I guess word got out that I'm obsessed with personal finance. They want to know what to buy, which firm to use, what accounts to open. You get the idea.
Before we get tactical, though, I always point out that this is a MAJOR ACCOMPLISHMENT! Deciding to invest extra money means two things: first, it means they have their acts together and are spending less than they earn. And second, it means they're thinking less about their next vacation and more about the long term. These are the building blocks of wealth; people who think this way tend to become wealthy. So props for having some extra cash.
So now they're smiling, they're feeling good. They want to jump right into which broker they should use or which stocks are the best value. <smh> At this point, I have to stop the whole conversation again, and ask two simple questions:
1) Are you sure you want to invest?
2) What are you investing for?
The answers to these two questions will have a much, much bigger impact on their investing success than any brokerage choice or stock tips I could share (which I would never share, because buying individual stocks is a sucker's game)... Anyway, let's dig into those two questions:
1) Are you sure you want to invest? This one's huge. So you've saved up ten grand and are ready to put it to work. But are you sure you should invest it? I mean, have you already reviewed your Personal Balance Sheet? If you've paid off your credit cards, stashed away some cash for an emergency, and don't anticipate any big expenses for a few years, ok - you might be ready to invest.
2) What are you investing for? Investing for retirement, a child's college tuition, or a down payment on a house each has a different time horizon. The last thing you want to do is pull money out of an investment account a year into a big market downturn. Once you know your time horizon, you can figure out which accounts to use, how much to allocate toward stocks or bonds, and even which broker to choose. Seems like a simple question, but it'll get you thinking.
So imagine we're friends. You might be a little peeved I didn't recommend buying AMZN, but you'll be glad I asked these questions. Take a day or two to think them over - review your Personal Balance Sheet and write down your long term goals. Then let's talk shop about when, how, and where to put your money.
Millennials want Financial Independence, not Retirement!
I get all worked up every time I read another one of the same articles on retirement. Save 1x your income by 30, 5x by 50, 12x by 67, yadda yadda ya. I really hate the way these people think. As if anyone in his or her twenties is going to stay with the same job earning the same income consistently for 30 or 40 years.
We're Millennials! We don't play by those rules. So what does that mean when it comes to our retirements? Should we bother saving anything if we're going to start the next Facebook? What if we're going to get an MBA in 5 years and then land a six figure job?
If you're anything like me, you've probably already tried one career and are on your second or third by now. Whether you went to business school and started fresh like I did or switched gears after a 5-10 year slog in banking, consulting, or big law, one thing is for certain: you are unique. So why do all the financial advisors recommend saving a certain percentage of your income every year, or working a certain number of years?
Instead, take a holistic view of your expected earnings over the next 30 or so years. Do you plan to work in Corporate America for a decade and then take a decade off to raise kids? Better save as much as possible while you can. Maybe you're going into business for yourself and can forecast income growth of 10% per year for the next 20 years - so it'll be more important to start small but ramp up savings consistently.
Consider, too, your lifetime expenses. Do you plan to have kids? Do you want to go back to school? Start a business in your 50's? Retire early?
Once you've considered the big picture you'll have a much better idea of what you need to do today.
You’d be surprised how many smart people don’t have a financial plan. Don’t be one of them!
The more you earn, the easier it is to save. Unless, of course, you spend it all. The key is to create a place for your money before you earn it, before you even think about ways to spend it.
Envision you earned $1M this week. Now that’d be nice, right? Really think about it. Your company goes public and everyone gets a huge bonus, you win 5 numbers in the Powerball, you discover that old stamp collection your great uncle left you is worth a fortune. It doesn’t matter where it comes from – the point is, you now have $1M. What would you do with it?
If you’re thinking about which loans you’d pay off tomorrow, what car or clothes you’d buy, or how much you’d give your parents for their dream vacation, keep thinking. We want to figure out where you’d keep the cash if you had to keep it.
Think of things like 401(k)s, IRAs, Roth IRAs, taxable investment accounts, high yield savings accounts, checking accounts. See where we’re going with this?
Now divvy up that $1M – you might want $350k in the 401(k), $150k in the IRA, $400k in the taxable account, $90k in savings and $10k in checking, for example. (It’s hypothetical, so let’s not get hung up on contribution limits.) Visualize those accounts.
Imagine checking them every month, watching them compound and grow. Imagine sleeping well every night knowing you have enough cash on hand to last several years. Imagine feeling proud of yourself for having the discipline to earn and preserve that kind of wealth.
Ok, back to reality. You’re probably at least a few years from that kinda cash. But keep the end goal in mind, because it’s only a matter of time before you get there. That visual is a rough cut of your financial goals. You know which accounts to open, which ones to fund. $400k in an investment account won’t happen overnight, but every bonus, commission, or raise could help get you there. Once the account is open and growing, you’ll feel compelled to add to it over the years.
Of course, the $1M target is arbitrary – you could start with an even more ambitious goal – maybe $5M – or something more reasonable, like $100k. The point is, visualizing that stretch goal will help things along.
When you have a place to put future earnings, you’ll want to put them there.
Investors have more options than ever these days. Thousands of stocks, mutual funds and ETFs are available in hundreds of assets classes – some are specific (small cap domestic energy sector stocks, or large cap technology growth stocks) while some are broad (all US stocks or all global bonds).
While choosing the right asset mix is most important, choosing the right assets is a close second. Many mutual funds charge high fees – some charge sales fees as high as 5% – and they all charge an ongoing “management fee” of up to 2% each year. Most people consider funds with fees of over 1% to be expensive.
Now you might think 1% or 2% doesn’t seem like a lot of money. If you were buying a cup of coffee and were charged a 2% convenience fee, you might not care. But when it comes to investments, even a 1% fee can take a big cut of your return.
Stocks have returned about 10% annually over the last 80 years. After inflation, the real return has been about 7%.
Now consider paying 1% in fund fees on your investments earning 7%. That’s over 14% of your expected return each year (1/7 is about 14%)! 1% doesn’t seem like a lot, but a 14% fee seems crazy. And that’s for a 1% fund in one year. A fund with a 5% sales fee could eat almost your entire return that year. And don’t even get me started about the impact of compounding that return.
Always remember to watch those fees!
You may have come across the term “asset allocation” as you read about investing. It’s one of the most important concepts to understand, and isn’t as complicated as it sounds.
Even though almost anything we own is an asset (furniture, cars, education, art), the assets we’re addressing here are stocks, bonds, and cash.
Each asset type carries a certain amount of risk and reward (called return). Cash is the lowest risk – a $100 bill won’t turn into $50 if you put it in your sock drawer for a month. But it’s also the lowest return – that $100 bill won’t magically turn into $200, either. Stocks are the other end of the spectrum: high risk, high return.
If you’re not thinking “how can I get the highest return while taking the lowest risk?” you may be asleep at your desk. Pay attention! The goal is to maximize return while minimizing risk. Since there are virtually unlimited combinations of assets in a portfolio, you can choose the risk/return scenario that you feel most comfortable with.
Generally, the younger you are, the more stocks you should own. In fact, there’s a simple formula for calculating the percentage of stocks to own: 130 (or 120) minus your age. For most millennials saving for retirement, stocks are the way to go, with perhaps a minor allocation to bonds and cash.
Until next time,
We all like lists, so I put this one together to highlight what I've found to be the Best 8 Rules of Investing.
Consider each of these when thinking about your investment goals. Did I miss any?
Setting and achieving goals is the whole point of personal finance! Why don't more people talk about goals?! Asset allocation sounds bland on it's own, but when it's in the context of an awesome, exciting goal, it's worth learning about. I'm not a materialistic person by any means, but it's my dreams that keep me motivated. Allow me to introduce The Lake House.
Now I don't actually know where the Lake House will be. Or how much it'll cost. Or when I'll buy it. But I have some ideas. I'd like to find one within a few hours' drive from my apartment. I'd like friends and family to be able to visit for spontaneous weekend trips or to fly in for a week or two. I'd like to have a few extra bedrooms for the Fourth of July or Memorial Day parties, 2-3 bathrooms, and plenty of parking. Wouldn't it be great to be able to go swimming, fishing, hiking, canoeing in the summer; ice skating and cross country skiing in the winter? 2020 sounds like a reasonable timeline that will give me a few years to get organized.
When I first thought about The Lake House, it seemed out of reach. But now it seems more feasible.
Let's just say I can find a place like this for $250k (and that it has enough parking!)
Now for the dollars: things like a down payment, taxes, insurance, broker fees, utilities, repairs, rent, and so on will all be important. I don't necessarily know what that'll look like, but I have an idea.
20% is typically recommended or required as a down payment, and it could be more. I'll need in the ballpark of $50k. (Maybe more due to closing costs and other fees. But we'll keep the numbers round.)
Taxes, utilities, repairs, etc. will all depend on location, square footage, age, etc. But let's assume this runs about $500/month. And a 30 year, $200k mortgage for someone with good credit will be a little less than $1,000/month (not including taxes, and assuming a 4% interest rate).
So now I've quantified my goal: I'll need about $50k up front and another $1,500 a month. The numbers aren't critical at this point, because I have a few years to tighten them up. The key is just to have the goal, even if it's not 100% accurate.
The beauty of the lake house is that I could probably rent it out to people on vacation. Let's assume the house will be desirable for short term vacation rentals for $1,000/week, and that there's sizable demand. If I can rent it for 2-4 weeks a month, 6-10 months each year, my carrying costs will be covered.
So the big task is to come up with that $50k by 2020. That works out to about $1,000/month if today is Day One. True, I could lease a pretty sweet BMW or go out for fancy dinners every weekend, but I'd rather put the money toward the house.
The best motivation to stick to a financial plan is your exciting, long term goal. It's about starting with a dream (fancy lake house), making it realistic (affordable lake house that could be rented out for part of the year), and mapping out a plan (setting aside $1,000/month for 4 years). And besides, if you change your mind, you'll be able to put the savings toward something else.
Because goals inspire us all, please share yours in the comments!
I went out to a baseball game last night and had a great conversation about all the things I'd recommend to become Financially Independent. Because I didn't want to ruin a fun night out for everyone, I kept my answer simple: Just follow the Three Rules.
1) Earn money
2) Spend less than you earn
3) Invest the rest
It really is this simple. But that doesn't make it easy. We'll get into the how as we go, but, at the highest level, this is what we'll come back to.
So, just to be sure, all you really need to remember about personal finance are these three rules:
1) Earn money
2) Spend less than you earn
3) Invest the rest
Until next time,
Today it begins. I decided to go public. Not with my company or anything, but with the blog. All the stuff I've been yammering about for years. Everything I've learned in the last ten years. All the details. I'm putting it all out there.
For ten years I've kept track of my finances - my income, expenses, assets, debt. I've defined my goals and put together plans to achieve them, and have done a lot of research each time I had to make a financial decision. I've earned millions of hotel and airline points, paid minimal fees on interest or investments, and benefitted tremendously from compound interest (even after just a decade!). I track everything in an excel spreadsheet <yawn> but I know where every penny went! This is good stuff. I keep a dashboard of some cool charts and visuals I like to check every few days.
So who cares?
Well, you might. If I can get you even 1% as excited about your finances as I am about mine, I'll have accomplished something great and you'll thank me someday.
So how did I get here? My journey really started when I realized we all have a choice: we can either work for money for the rest of our lives, or figure out how to get money to work for us. And besides, empire building is fun. I especially get a kick out of getting a good deal. I'm not into clipping coupons or passing up a hot coffee on a cold day to save money, but I do enjoy finding a good happy hour special or saving on a flight by being flexible with my travel dates. Every dollar counts.
Before I really get going with this blog, though, what do you want me to write about? Are you interested in knowing what I spent on Saturday? Or the big picture stuff like what goals I'm working toward? Do you want to know why I still haven't bought the Harley I've been eyeing up for over a year, or would you rather talk about asset allocation? Any feedback is welcome, and now you can publish comments below.
Anyway, I'm looking forward to sharing all kinds of stuff here - ways I've managed to save money, how compound interest works, what you should look for in a credit card, things to consider when buying real estate, why asset allocation is the key to successful investing, and so on. I'm psyched to start these conversations and look forward to your feedback!