A few young people asked for financial advice recently so I thought it would be a good idea to write about it, in the spirit of not repeating myself. I remember asking people about money when I was their age and getting all kinds of advice, mostly bad. Even the good advice (in hindsight) was given in generalities which were hard to put into action and difficult to discern from the bad advice. This post is the advice I wish I was given when I asked the question: What do I do with my money?
I’m not a financial advisor so you should take the contents of this post with the gravitas of “I heard someone say” and do your own research.
Saving for retirement doesn’t mean the money is gone until you retire
This is the biggest one I wish someone had drilled into my head. You can save for retirement in ways which makes the money available to you should you need it. It’s not like every dollar you put into your retirement account is gone forever. I think I had this misconception because all I knew and heard about saving for retirement were traditional 401K and IRAs (see the terms section down below).
In reality, even retirement accounts like Roth IRA and 401K give you some flexibility. Since you contribute to these accounts after taxes, you can take out the money you put in without penalties. It is the gains which can’t be accessed without penalty until you retire.
Also remember every dollar you invest is in essence contributing towards your retirement. Paying off that credit card? That helps your retirement. Just opened a brokerage account? That helps your retirement. Thinking of buying a house? That will help your retirement. Basically any financially sound decision contributes to your retirement. So whether you’re planning on using the money 5 or 50 years from now, investing your money is in your best interest.
You can’t time the market
You have to come to terms with the fact that sometimes the right answer, the honest answer, is “I don’t know”. When it comes to investing in a single stock, company, product, asset, currency, etc., you may think you know what the market is going to do but the demonstrable fact is that you don’t. There are countless studies to back this up. So if you’re going to time the market by buying or selling individual stocks, or entering at a specific point because you think the market is going up, or exiting your investments because you think the market is going to go down (or worse, because it already went down), remember you’re just gambling with your money. If your goal is to grow your money then you want to diversify your investments on funds that track many assets and leave the money there through thick and thin.
- If your company offers 401K match then contribute to it up to the match
- This is like getting a raise
- If your company offers a stock buying program then participate in it
- This is like getting a raise
- Pay off debts above 5% APR
- Take the debt’s APR and that’s your return on investment
- Contribute to an IRA inverse of the 401K
- If the 401K is Roth you want the IRA traditional and vice versa
- You don’t know what will happen in the future so having both types is a form of hedging your bets
- Max 401K and IRA contributions
- Contribute to a brokerage account
Where to invest
- You can’t go wrong with Vanguard
- Don’t trade stocks or invest in mutual funds which actively trade stocks.
- Don’t try to time the market by entering/exiting on investments.
- Invest in index funds of different kinds.
- To start you can divide your money into different funds that track domestic, international, growth, dividends, real estate stocks. You can’t go too wrong as long as you’re investing in funds that track multiple assets (pretty much every fund Vanguard has to offer).
What to do when the market tanks
It’s all too easy to simply say “don’t sell, wait it out”, but that doesn’t help when the market is crashing and people are panicking. In those situations you have enough people saying it’s time to get out, that it’s normal to question “don’t time the market”. I want to give you a good reason for not selling, hopefully it’s compelling enough that you’ll resist the urge to sell when the market is tanking.
First thing is to know what should you do if you find yourself with a lump of money (a tax refund, a bonus, or just good old savings). If your goal is to grow the money then the answer is simple: Invest it. Now. The best time to start investing is yesterday, so do it today. You might be worried about the market going down right after you go in. That’s normal but think about it, there will always be that risk, there will be the same risk tomorrow, a month, or a year from now. You may think it’s better to ease into the market, that way if the market tanks you can cost average the investment. There are two problems with this. The first one is that you can’t time the market, if you’re really honest you have to admit you don’t really know what’s going to happen. The second problem is that the odds are against you. Two thirds of time you end up losing money by waiting before investing. Worse than that, if you wait more than 3 months you’ll lose money almost always. So the time to invest is now.
So imagine you have $5K sitting around and you want to make it grow, then you should invest it right away. Now imagine the market just tanked, should you go in now? The answer is of course! If yesterday was the best time to start investing, imagine how much better it is to get in at a huge discount. You should be ecstatic to enter the market after a crash. Again, you’re buying at a discount something you were willing to buy at full price to begin with.
Finally, imagine you invest $10K and the market crashes, hard, and your investments drop by half. Should you sell to prevent further bleed? Well, let’s analyze the scenario. If you sell, you would end up with $5K sitting around, and what should you do if you find yourself with $5K that you want to make it grow? That’s right, invest it, now. What should you do with that money after a crash? Be happy to enter the market to buy stocks at a discount. But wait, you’re already in the market so it doesn’t make sense to sell only to buy in again! Moral of the story is don’t sell, wait it out.
3 types of money
- Money you need in the coming months
- This is the money you use to pay bills, buy presents, etc.
- You can keep it in a checking account and use it as needed.
- Money you’ll need in a year or two
- This is the money to make renovations or taking a trip
- Contribute to this pool on a regular basis and you can enjoy guilt free spending when the time comes.
- For shorter time frames like 6-9 months from now (e.g. next christmas spending) use a high yield savings account. The money won’t make much but at least you won’t have to worry about market fluctuations in the short term.
- For longer time frames (1-2 years) use a low risk bond like investment with higher returns than a high yield savings. It won’t make as much as a regular investment, but the money will be relatively secure for when you need it.
- Money you’re not touching any time soon
- Invest in diversified index funds
To always be doing
- Get a side hustle and income stream
- Do stuff that will allow you to negotiate a higher salary/rate in the future.
Your salary is your business
I think everyone would agree having extra income is a good thing. Where people disagree is how to earn that extra income. If you’re like most people you trade your time for money in the form of a salary or contract. Now what if you could work on the side to build a business that brings you 10-20K per year, would you be interested in that? Well, one way to do so is by working on your career and maybe even switching to another job or company.
One thing to note is that there are many ways for you to spend your time which seems like they’ll grow your career and income but ultimately doesn’t. For example if you’re in a technical field and you continue learning things for your current position, you’re not growing your career, you’re just keeping up to date. You want to invest in things that will allow you to negotiate a higher salary a year from now. Do that and the salary increase is effectively the payoff of a side business.
- I don’t really practice minimalism but it’s a guiding principle for me and would recommend it to anyone, at least as something to aspire to.
- Some people swear by budgets and keeping track of expenses but I haven’t found them to be all that useful. Probably because I don’t spend that much.
- Given an amount of money and an amount of stuff to do or buy, instead of spreading the money evenly to get an average experience or average stuff, I would recommend lowering, as much as you can, your spending on the things you don’t care that much about, and then use the difference to max your spending on the things you do care about and will bring happiness and joy into your life.
- Always seek advice when making financial decisions. The easiest thing to do is to say “I’ve got this”, and the more costly.
Stock: A small piece of a company which can be bought and sold.
Fund: Group of stocks.
Traditional 401K: A retirement account you get this through your employer or if you’re self-employed. There’s a maximum you can contribute every year ($19.5K as of this writing). The money you put in isn’t taxed but you pay taxes when you take the money out. There are penalties for accessing this money before retirement. You pay taxes on the money you take out when you retire.
Traditional IRA: This is similar to a traditional 401K with the following differences. It isn’t tied to your employer so you can contribute to it as long as you’re making money or are married to someone who is. There’s a maximum you can contribute every year ($6K as of this writing).
Roth 401K: This is similar to a traditional 401K with the following differences. The money you put in is taxed. You can withdraw what you contribute to it at any point without penalties. Gains on the account can only be withdrawn without taxes or penalties upon retirement.
Roth IRA: This is similar to a Roth 401K with the following differences. It isn’t tied to your employer so you can contribute to it as long as you’re making money or are married to someone who is. There’s a maximum you can contribute every year ($6K as of this writing).