Matt's Magical Finance Plan for 20- and 30-somethings
Posted on April 12, 2018
“I’m so glad we studied parallelograms in school instead of wasting our time on stuff like how to do our taxes. It really comes in handy every year during parallelogram season.”
- funny people on Twitter
Imagine, really, though: what would it look like if you replaced Advanced Calc or Trigonometry or Economics with “Basic Budgeting and Taxes”? Maybe “Retirement and Investing 102”. “Why Payday Loans are the Devil 103.”
How much different would our lives be if we all understood how to manage our finances? In this post I’m going to try to give you my version of Basic Personal Finances 101.
Who am I?
Want to skip straight to the recommendations? Scroll down to “Matt’s Magical Finance Plan”.
Let's start here: I'm a computer programmer. I studied English in school. I am also a musician. I’m not an accountant, a tax professional, a mathematician, or even a Mr. Money Mustache or someone else famous. I haven't even cared much about investing or retirement until recently.
However, I am someone who likes finding smart people and distilling their wisdom down. That’s my hope here.
What am I trying to accomplish with this post?
I’ve seen so many people in my generation (I'm technically an old millennial) spend years completely unaware of the basic first steps for handling your current and future financial health. These friends may hear terms like “financial independence”, “index fund”, or “compound interest” thrown around, but that all seems to be for people who have the time—and interest—to spend all their free time learning about this stuff.
My hope is that I can give the guide I wish I had read when I was 25—just enough to get you on the right path, but not so much you’re going to be bored or overwhelmed. This won’t apply for everyone, but it will for most people. You may know enough that you disagree with one point or another; great! This post isn’t for you. My goal is to give you a good foundation and then for you to either coast on that foundation, or find wiser and better teachers than me.
My primary goal is for you to be happy and healthy and financially sound.
Who is this not for?
If you spend all your free time on Reddit subs about personal finances. If you've already read several books about personal finances and already have lots of opinions of your own. If your finances are already in order. If you don't live in the U.S.
Who is this for?
If your finances overwhelm you. If your debt overwhelms you. If you have so much crap to take care of in your life that the last thing you want is to spend a bunch of time learning about money. If you don’t have your finances perfectly handled and managed. If you know you’re supposed to save but you’re just trying to keep afloat. If you know you’re supposed to invest but it’s so overwhelming that you just let your savings account keep building up. If you can’t figure out whether to pay off debt or put money into retirement or put money into savings or whatever else. If you have never thought about your money before.
Ready? Let’s go.
A few helpful maxims
Before I give specific strategies, here are a few really key concepts I want you to remember. I know these are brief, but the books I’ve linked in the footnotes will explain all of them if you want to dig deeper. If any of these are confusing, just skip them for now and return when you have a better handle on the context surrounding them.
- Spend less than you earn.
There’s no way to save or pay off debt if you’re going further into debt each pay period. Don't use any more credit cards, and budget so you're spending less than you earn every pay period.
- Investing is exponential, so starting early makes an incredible difference.
Basically, when you put money in an account that generates interest, the money you put in generates more money. Then that money—both your original money and the interest it generated—generates more money. That means the longer your money sits, the faster it’s generating more money; so a graph of your money’s growth over time would look more like an exponential curve than a straight line. This means starting your saving just a few years earlier could have an incredible impact. Take a look at the graph on this StackOverflow question to see how you can make more money by starting your savings at age 25 than double that savings amount starting at age 40.
- If you want a different outcome than your peers, you’re going to have to make different choices than your peers.
Dave Ramsey (who's a jerk, and you shouldn't pay him money) says it a bit differently; “If you want to live like no one else in the future, you have to live like no one else now.” For the sake of having a different outcome, you may have to do things that feel weird or even make people question your decision-making right now.
- Handle your own investments; don’t trust money managers.
Read “The Simple Path to Wealth” to learn more, but the simple answer is: your best return on investment comes from throwing all your money into Vanguard mutual funds, which you can do very easily through a tool like Betterment or Wealthfront (more on that later.) There’s no one good enough at making money that they can beat the return you can get by investing it yourself, very simply. They may show you how their investments beat Vanguard in the short term but no one can beat a broad-market index fund (like Vanguard's basic offerings) over the long haul.
- Don’t use your bank’s savings account for investing.
Money saved in your bank’s savings account will lose money over time because of inflation; the interest rates banks give is abysmal. Keep emergency funds in your savings account, but everything else should go into one of the other investment options we’ll talk about below.
- When you can, spend your money on things that bring you value, not things that lose value.
If you throw $80,000 into a fancy car, it’ll lose a huge chunk of that value the day you drive it off the lot. It loses value over time. If you throw $80,000 into a house and then rent it out, you’re gaining value over time. For more of this thinking check out “Rich Dad, Poor Dad”; this is probably the most advanced tip here, so feel free to just ignore it for now.
OK. Let’s move on to the actual plan.
Matt’s Magical Finance Plan
Remember, this is just one path. It’s based on asking a few wise friends “What’s your magical finance plan?” and then reading a few books and living my life experience, but I’ve really just taken other people’s wisdom and packaged it in a way that makes sense to me. If something here doesn’t make sense, adjust. If you’ve read a lot on finances, you’ll probably have a million reasons why you disagree. But here’s the basic steps you should take if you’ve done nothing about your finances until this point.
I’m assuming here that you’ll have a bit of money available every pay check, once you start spending less than you earn (see point #1), that you can use to make wise financial decisions. So, in following this plan, you’ll basically use that money to accomplish the first item, and then the next, and then the next.
Read that again: You don’t start working on item 3 until you’ve accomplished item 2, and so on.
Note: All the “see more” books will be linked at the bottom of the page. They’re all affiliate links, but they’re also great books; if me using an affiliate link feels weird to you, just go look up the book name on Amazon and bypass my affiliate link.
1. Start spending less than you earn
Figure out how much you earn. Figure out how much you spend on average every month, and also as many of your non-monthly expenses as you can. Find some way—budget or whatever else—to spend less than you’re making. For this step, pay just the minimum payments on all your debt but stop accruing more debt. No more credit cards. Freeze ‘em. No payday loans. Just get your monthly expenses lower than your monthly income.
This is the most difficult step in this entire post. It’s harder the less money you make, but it’s hard for everyone. Essentially, you need to cut “discretionary spending” (eating out, new clothes for fashion’s sake, the latest greatest video games, expensive alcohol and drug habits, cable TV) until your expenses are below your income; if that doesn’t work, you may need to take some steps to lower your fixed expenses (get a cheaper apartment, share an apartment, learn to cook at home, eat rice and beans for a few meals a week, switch to a cheaper phone provider) in order to get there. For some people this step is not possible until they can get a better job, but it’s a lot less likely that this is the case for you than you think.
See more: You Need a Budget; The Millionaire Next Door
2. Create a “Dead Car” Emergency Fund
Save $1000 in an immediately-accessible savings account (one attached to your checking account, at the same bank).
3. Contribute to your 401k up to the employer match
If your employer offers a 401k with “match”, that means they’re essentially giving you free money to incentivize you to put your own money into a 401k, which is a “tax-advantaged” retirement account. DO IT. Talk to your benefits administrator and get your 401k contribution set up so you are giving up to the cap for the “match”. Don’t contribute any more than the “match” percentage at this point.
What’s a tax-advantaged account? It basically an account that puts your money in a place where the government can’t take as much of it.
See more: How 401(k) Matching Works | Investopedia
4. Debt snowball: high interest debt
Other than student loan and mortgage debt, pay off all of your high interest loans (with an interest rate of 10% or more; this includes most credit cards) one at a time. Pay the minimum on all your loans except one; pay that one off as aggressively as your budget can afford. Once you pay off that one, take the money you were using to pay it and roll it into the next loan.
To decide which to pay off first: either pay on the smallest loan first (easiest, most satisfying; called “snowball method”) or pay on the highest interest rate first (best financial sense, but maybe less satisfying; called “avalanche method”).
See more: Debt snowball vs debt avalanche
5. Create a “Job Lost” Emergency Fund
Upgrade your emergency fund to cover three to six months of your minimum living expenses. Imagine you lost your job and had to search for one for a while. What would it cost for you to get by? You can consider canceling Netflix and dropping down your phone’s data plan and whatever other changes you would actually make during this time, but make sure you can really get by with the amount you put aside.
6. Debt snowball: low interest debt
If you have any debt remaining (other than student loan or mortgage debt), hit this debt with the debt snowball as described in #4.
7. Max out your 401(k)
The annual maximum contribution you can make to a a 401(k) is $19,500, so max that out before anything else.
8. Contribute to an IRA
You (and your partner, if you’re married) can put up to
$5500$6000 into an IRA every year. This, like a 401k, is a tax-advantaged (meaning, you get to save your money and give as little to the government as possible) savings account. You can set one up plenty of places, but I use and love Betterment (referral link, but I'd recommend it whether or not you used my referral).
9. Options: Investing, max out retirement, save for kids, goal savings, early student loan payoff
At this point you’re doing great. You’re out of debt, you have a solid start to your retirement, and you have a three-to-six month emergency fund. The next step depends a lot on your life and goals.
Got kids? Consider setting up education savings accounts ("529 plans") for them. House or car purchase coming up? Set up a goal savings account with a good mix of stocks and bonds, or, if you’d rather be a bit safer, an Ally bank savings account. Focusing on getting really set in retirement, or just unsure of what to do? Invest the rest of the money in Vanguard's (directly, VTSAX, or using a tool like Betterment or Wealthfront).
See more: Simple Path to Wealth
- Tax-advantaged account: Tax advantaged accounts and savings are just ways to put your money in places where, based on how you're going to use that money, you don't have to pay as much taxes. 401(k) and IRA accounts are the most common examples. Since the two ways to optimize your money are A) make more and B) lose less, tax advantaged accounts help you lose less money to taxation.
- 401k / “match”: A 401(k) plan is an employer-provided retirement plan that is tax-advantaged. "401(k) match" means your employer is trying to motivate you to put money away into your 401(k) by offering to put some of their money in, too, up to a certain amount. So if you have a 3% match, for example, that means you can put 3% of your income into your 401(k) and your employer will put that same amount of cash into your account, just to motivate you to save for retirement. 401(k) match, then, is basically free money--but money you can't benefit from until retirement.
- IRA: An IRA is a tax-advantaged investment account for retirement ("Individual Retirement Account"). It's like a 401(k) or 403(b) except you set it up, rather than it going via your employer. All this means is that it's a special sort of bank account you can put a certain amount of money into each year without the government taking taxes out of it, in exchange for you agreeing to only use it for retirement.
- Vanguard: Vanguard is a company that manages funds you can invest in. The difference between Vanguard and its competitors is that while other companies have a board of directors and shareholders who will need to make money off of the business of letting you invest with them, Vanguard is owned by the investors--meaning you and me--so their rates are very, very low. When I refer to "Vanguard" in this post I mean Vanguard index funds, and usually I'm referring to their broad market funds like VTSAX.
- Betterment / WealthFront: Betterment and Wealthfront are web sites that simplify the most common investment practices: investing in Vanguard-backed funds, setting up IRAs, setting up education accounts for your kids, and more.
Frequent questions and objections
- Cryptocurrency: Don’t do it.
- Day trading, swing trading, single stock investing: Don’t do it. See The Simple Path to Wealth for why not.
- Student loans: They’re tricky, but usually low interest. General advice is to pay the minimums on them, but sometimes payments can be so huge they’re still disrupting your life. In this scenario, talk to someone wiser than me. The biggest question I’ve heard here is: “Why should I worry about 401k match, AKA free money for when I retire, when it feels like my debt is so crushing I’ll never retire?” My short answer is: If you want to skip the match (step 3) and go straight to debt repayment (step 4), go ahead! You do what you need to do for your situation. Student loan debt is low interest. That means it’s not a terrible idea to keep paying on it as slowly as you can. However, extreme debt can really shut down the rest of your life, and some times eliminating that force on your life is more important than deferred money 40 years from now.
- No, for real, I’m in crazy debt and this stuff all sounds like 201 and I just want 101: OK, this is super simplified, but get-out-of-debt-101: 1) Know your budget (income, expenses, debt) like the back of your hand. EVERY. ITEM. Strongly consider writing them all down in a spreadsheet or on paper somewhere. 2) Spend less money. Tell your friends and family what you’re doing and be willing to be “weird” and creative: rice and beans, movie nights in with your old VHS copies of Aladdin, vacations to the other side of town instead of Florida, meal prep, fix your clothes instead of replacing. 3) Make more money. Sell stuff you don’t need; ask for a raise; see if you can make any money from your hobbies; work extra hours; pick up a second job and put that money toward debt reduction. 4) Start somewhere. No matter what you do, just take one step. Any step. The first step, as they say, is the hardest.
- Edge cases:
¯\(°_o)/¯First thing I do is google
jlcollinsnh _subjecthere_. He’s the guy who wrote The Simple Path to Wealth and if he’s written about the issue, I trust him.
- Money managers: Vanguard’s VTSAX Mutual Fund (don't worry about the acronym; just think of it as "investing in Vanguard or something like Betterment or Wealthfront") beats everyone over the long haul, and it’s much cheaper than its competition. Vanguard is not owned by stockholders who need to make a profit off you the investor; Vanguard is owned by its investors, meaning it’s in its best interest to make you as much money as possible. Most people who tell you otherwise are doing so to make money off of you.
- But Betterment and WealthFront are money managers? Yes, they’re technically money managers. You’re technically better off to just set up the Vanguard accounts yourself. But if that sounds overwhelming, Betterment and WealthFront make it super easy to set up and manage several types of investment accounts, and their management costs are very, very low. Additionally, Betterment provides Tax Loss Harvesting which is amazing.
- Once my money goes into my retirement accounts, is it possible to get it out before I retire? You can, but it's not simple. You can withdraw the money you contributed to a Roth IRA without penalty. You can convert a Traditional IRA to Roth by paying taxes on it, wait five years, then withdraw it in the same way. And you can roll an old 401(k) into an IRA and do the same thing. If you plan to do this, please just refer to people smarter than me.
To learn more about these topics, here are a few places to turn:
- Budgeting and getting out of debt: The Total Money Makeover
- Investing: The Simple Path to Wealth
- Changing your perspective about wealth and how to get it it and what it looks like: The Millionaire Next Door, The Richest Man in Babylon
- jlcollinsnh (the author of the Simple Path to Wealth)
- Mr. Money Mustache — Early Retirement through Badassity
- /r/personalfinance common topics - covers a lot of these topics but in greater depth and level of intensity. Discovered after I wrote most of this post.
Recommendations from my friends that I have not read myself yet
I asked for recommendations to add to this post and got a ton of links. I can’t recommend these because I haven’t read them. But if you’re digging for more places to learn, these have all come recommended from friends.
- The Index Card: Why Personal Finance Doesn’t Have to be Complicated (I did read his original index card and love it)
- I Will Teach You To Be Rich
- The Minimalist Budget: A Practical Guide On How To Save Money, Spend Less And Live More With A Minimalist Lifestyle
- You Need a Budget: The Proven System for Breaking the Paycheck-to-Paycheck Cycle, Getting Out of Debt, and Living the Life You Want
- Bogleheads® personal finance planning start-up kit
- Destroy Student Debt: A Combat Guide to Freedom
- Live Richer Challenge: Learn how to budget, save, get out of debt, improve your credit and invest in 36 days
- Your Money Or Your Life
Thanks to Caleb Porzio, Sara Bine, JL Collins, Berry Long, and my dad for teaching me various things about finances that have gotten me to this place. Also thanks to all my Twitter friends who responded to my request for advice, and everyone at Tighten for sharing their advice and stories.
I’ve made a lot of assumptions in this post.
There are a million reasons this might not apply to you or might not work to you. I’m pretty confident there’s an annual income range at which some of the steps here might need to shift around some. I’m absolutely confident that step one (start spending less than you earn) is both the most globally true and also harder the less money you make. Your mileage may vary. Etc.
Did you just read this whole thing and you’re super overwhelmed? Here’s the simple starter kit version:
- Adjust your budget so you are spending less than you earn.
- Get a $1k emergency fund in a savings account somewhere.
- Take advantage of your employer 401(k) match; it's free money.
- Pay off your non-mortgage non-student-loan debt as fast as you can.
- Once you’ve paid off that debt, save your extra money in an Ally savings account (or any other high-yield low-cost savings account).
Everything else can come after that.
Comments? I'm @stauffermatt on Twitter