Have you ever just opened up your bank account and felt absolutely helpless? I have. Maybe you’re sitting there thinking, “Help me, I’m poor!” Regardless of your situation, you can always become one step closer to achieving financial autonomy, or if you’re already there, you can keep taking steps to get further and further away from becoming financially dependent.
Either way, I am here to help!
The #1 reason that I started writing blogs for einvestingforbeginners.com was because I realized just how hard it was to learn about simple personal finance topics. I mean, things like how to save, how to invest, what brokerage firm to use, and many other things that might seem complex to someone new but they seem very basic now.
Today we’re going to get back to the basics and really breakdown what is keeping you from finally getting ahead.
So how do you start?
It all starts with your personal P&L, or profit and loss. Your personal P&L is nothing more than an income statement – it’s the money you make subtracted by the things that you spend money on. This is otherwise known as a BUDGET!
I know that to many people a budget has a negative connotation. You might think, “Oh, I don’t have time for that,” or “I already know how much I spend on things.” Or, maybe you’re thinking, “A budget has never worked for me,” or “Budgets take too much time.”
Regardless of your reason, they’re all a bunch of baloney/bologna!
If you’re poor then you’re breaking the first of seven cures to a lean purse, per George Clason in ‘The Richest Man in Babylon – Start Thy Purse to Fattening!
What does that even mean? It means that you need to be saving a minimum of 10% of your income.
“But Andy, how do I do that?”
Well, if you get paid $1000, then the very first thing that you need to do is set 10% of that aside, or $100 in this case. Then, you will be forced to live off the remaining $900 until your next payday. If you can’t save at least 10%, then you’re likely going to be living paycheck to paycheck for your entire life.
As with anything in life, the hardest thing is to simply just to start. Whether it’s a new weight loss program, doing chores around the house, waking up earlier, and of course saving money – starting is the hardest thing.
But why is it so hard?
Working out Day 1 isn’t actually harder than it is Day 10,000. I mean, maybe it is if you’re really out of shape, but you should also really be pushing yourself super hard in day 10,000 because hopefully you’re more physically fit and can do more!
It’s the same task – the only thing is that you have a different mindset. Your mindset at the time of starting is that you’re used to doing anything other than what you’re about to do and chance are, what you’re about to do is less fun than what you’re currently doing.
Personal Finance is no different.
Many people have said a quote similar to this, but it’s Jerry freaking Rice so I’m going to use his version…
“Today I will do what others won’t, so tomorrow I will do what others can’t.”
Man, that thing really gets to me. Do you know what that quote says to me?
“Andy – Bust your butt today so you don’t have to worry about retiring when you’re 65…you’ve already been retired for 15 years!”
It motivates me to really stick to my goals and get going on my financial path, and as I mentioned, it all starts with a budget.
For me, personally – I think that Doctor Budget is the best budget tool that exists. It is the perfect combination of being simplistic yet also forcing you to track your spending, which I think is the #1 key to a successful budget.
Having a budget is the lifeblood of personal finance. It all boils down to this – do you make more than you spend or do you spend more than you make?
If you spend more than you make then everything else, all of the investing strategies, proper ways to create assets, tax-advantaged accounts, everything, is just nothing more than a waste of your brain space.
It would be like learning accounting rules and principles before you know your numbers. Yeah, great knowledge, but absolutely useless if you’re not starting off on the right path from the get-go!
So, that’s why I prefer using Doctor Budget, because I think it’s the tool that you are most likely to use and when you use it, will then set you up the best for your financial journey.
If you already have a budget that works – don’t change!! Personal finance is just that – it’s personal. It’s all about finding what works for you and it’s definitely not a one size fits all.
“Andy, I’m definitely making more than I am spending, so what do I do with this extra cash that I have?”
Great question! Now’s the fun part!
Essentially your goal is to try to create assets. This could be by investing, purchasing real estate, starting your own business – anything! I know that seems pretty open ended, and it is, but that’s the mindset you need to create first and foremost.
If you’re struggling having this mindset, I recommend reading ‘Rich Dad, Poor Dad’. That book was a gamechanger for my opinion of personal finance, and if you don’t want to read the book, at least checkout this book summary.
So, you now have extra money at the end of the month and your mindset is right – how do you finally get ahead in life?
This was something that was always super hard for me and I touched on it in depth on The Investing for Beginners Podcast.
Essentially, I just really made things simple and focused on what makes sense, so let me give you my priority list to Financial Freedom!
1 – Max out employer 401k/403b match
Believe it or not, but this is actually somewhat controversial. I often hear people tell me that they will always pay off debt before investing anything at all, including their 401k. I’m completely fine if you prefer to pay off debt prior to investing but maxing out a company match of a 401k or 403b isn’t investing. That’s free money – plain and simple.
I went back and wrote an article showing the real cost if you choose not to max out your match, and its way worse than just the market returns. For instance, not matching out a 1:1 401k match isn’t just a 100% ROI loss…it’s more like 1600%.
2 – Pay off all credit card debt
This is an easy step 2 in my eyes and is most likely wayyy higher than any other debt that you have. Most “high interest” loans are in the range of 8-10% but for a credit card, 20-25% is extremely common.
I don’t want to say it’s theft because you’re the one that signed up for the card and the one that racked up the debt, so I won’t say it – I’ll call it more of a donation.
I highly advise that after you have taken care of your 401K match, all extra income needs to go to paying down your credit cards. Just as a 1:1 match on a 401k is essentially a 100% ROI right off the bat, paying off a credit card is an instant 25% ROI and not to mention, you’re improving your credit score as well!
3 – Create your emergency fund
It’s a bit controversial to have this listed below paying off credit cards but to me, it’s really this simple:
- If you create an emergency fund first:
- Emergency Occurs – you use your emergency fund
- No Emergency Occurs – your money sits here, earning 1-2% interest even if it’s in a high yield savings account like Ally while you keep paying interest on your credit cards
- If you pay off credit cards first:
- Emergency Occurs – you put money back on the credit card
- No Emergency Occurs – you keep paying off your 25% interest rate debt but don’t earn any interest
In my eyes, by building up an emergency fund first, you’re basically building up money to protect you from a worst-case situation of putting money back on your credit card but guess what – YOU ALREADY HAVE MONEY ON YOUR CARD!
For that reason – it’s a simple decision for me, but don’t downplay the value of an emergency fund. It’s easy to create one and easy to decide how much you need if you understand the basics. The key is to protect you from an emergency, and I think it’s invaluable to have this sort of security in your life!
4 – Pay off all debt that is above your “Trigger Point”
As I stated above, the stock market has average 11% annually since 1950. Do I think that will continue? Most likely not. I think that the market is very overvalued right now and that things have a lot of room to move down. That’s why I like to use 8% as a more conservative estimate when I am doing my own financial planning.
So, what is a Trigger Point? A Trigger Point is the point where you would flip from investing to paying off debt. For instance, since I use 8% as a conservative estimate for the stock market, then any interest rate on my debt above 8% I should pay down instead of investing because I am saving more interest than I would gain by investing.
On the flip side, if the debt interest rate was 4%, then I should invest all of my money because I am assuming, I would get an 8% return instead of saving 4% on interest.
Since paying off debt is a 100% guaranteed return, I bring my trigger point down even further – all the way to 6%. So, any debt over 6% gets paid off before I invest (outside of my 401k match) and any debt under 6% only gets the minimum payment.
If you’re more conservative, bump your Trigger Point down to 4% or 5%. More aggressive? Maybe go up to 8%. It’s all about your own appetite for risk of having that guaranteed return of paying off debt while you’re missing out on the potential of a 30% year like 2019, but also missing out on a potentially negative year.
The stock market is very volatile – that’s why it’s so important to know yourself before you get involved in it!
5 – Invest in tax-advantaged accounts
Ooooo this is one of my favorites! Of course, I already hit on the 401k which is likely the one that you’re the most familiar with, but there’s some other major tax-advantaged accounts that you need to be aware of. Below are my top 3:
1 – The IRA
Just like a 401k, an IRA has a Roth (post-tax) or a pretax option. The contribution limit is $6000 in 2020 for any individual meaning $500/year or $231 if you get paid biweekly. The IRA is very similar to a 401k in that it is a retirement account where you can take out money penalty free at age 59.5 but a great benefit is that you can remove any contributions, at any point, penalty free.
So, if you put in $10,000 and it grows to $30,000, you can remove that $10,000 without any penalty at any time. If you want to take out anything more than that, you do have to pay a penalty. I really advise you to not ever take money out of an IRA as it is meant for retirement, but it is another layer of safety that you have if you ever need it.
I love IRA’s because they’re very simple to open and simple to use. I have a Roth because I know that once that money is in there, I won’t pay a single penny in taxes ever again on it, including any capital gains that I might owe in a normal brokerage account!
2 – The 529
A 529 is a great tool meant for you to help provide for your children’s future. It’s intended use is to pay for future schooling, whether it’s private grade school, college, or even potentially a trade school. A 529 has a lot of uses more than just college!
In a 529, you put in post-tax dollars and the money will grow tax-free until you take it out. The beauty is that all of those gains will not have any taxes on it whatsoever, and those gains can be pretty major!
If your child ever ends up not using the money, for whatever reason, you can always cash out but you will pay a 10% fee on whatever you made. This is obviously less than ideal but still a great option for you to help out your kids with this opportunity!
3 – The HSA
This is my FAVORITE tax-advantaged account. HSA stands for Health Savings Account but the acronym really should be ‘HAWT’ because it’s a Huge Awesome Wealth Trick!
I can’t believe I just typed that. Oh well.
The thing with the HSA is that you get a triple tax-advantage – Its pre-tax money going it, it grows tax free and then it’s not taxed when you spend it!
So, essentially, it’s the dream retirement account except it’s not, it’s only for health spending. But what if it actually wasn’t? What if I said that you can withdrawal it, penalty free, for any reason at all at say…oh, I’m not sure, age 65?
That’s exactly how it works and that’s why I love it. Essentially, you have a high deductible insurance plan but then you have this account where you can put money in to use it on any qualified health expense, which is like doctor appointments, surgeries, medicine and many other things.
If you don’t use it, like I mentioned, it goes in tax free, grows tax free and then you can pull it out tax free. So, you get an extra tax advantage, either on the front end going in or the back end coming out, vs. an IRA, and the only thing that you sacrifice is that you have to wait 5.5 more years than an IRA to pull it out penalty free. And that’s debatably a good thing!
Not to mention, some employers will contribute to your HSA each year to help fund your account and since your deductible is higher, your premiums are lower than a conventional plan. The max that you can contribute is $7000 in 2020, so yet another benefit vs. the IRA! It’s seriously the most amazing thing in the world. I urge you to find out if your employer offers a plan like this and if they do, take advantage of it!
6 – Keep on, keeping on!
If you’re moving on past these first five steps then you are on an AMAZING path! Keep on doing your thing! Open a brokerage account to invest even more albeit it won’t be tax advantaged. Consider buying some real estate so you can have some more, diversified, income-producing assets!
There are many things that you can do but the #1 thing that I recommend is to just keep on sticking to the plan that you’re currently executing. Don’t lose focus – you’re doing great!
No matter where you are in your Financial Journey, I urge you to really take a look at these steps and see if there are any areas that you might have some room to improve. None of us are perfect and there are likely always some sort of steps that you can take to improve. Maybe it’s to put more in the 401k or 403b or max out that HSA where you’re only putting in $5k currently.
There are always ways that you can continue to improve and adapt your financial independence plan and the minute that you get complacent, you’ll fall behind! If you’re struggling to find out how you’re doing on your journey, don’t sweat – I’m here to help!