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April 18, 2016

Simple Financial Rules to Live By

Photo by Harold Pollack
Managing your finances is pretty simple. I don't know how Kiplinger's still exists. All they seem to do is repackage the same advice over and over. I will give you most of the financial rules you will need right here, and with them almost anyone can become Fiscally Free much faster than they thought.

Harold Pollack, a University of Chicago professor, famously said pretty much all the important financial advice could fit on an index card. At the time, no such index card existed, but after being bombarded by requests, he filled out the index card shown above.
I agree with most of the items on the card, but I think it could be even better. Below is my somewhat modified version of the index card:
  • Live below your means
  • Spend your money wisely; only buy meaningful experiences and quality products, but don't overpay
  • Minimize your monthly bills
  • Avoid debt and fees; pay your credit card balance on time and in full every month
  • Save as much of your income as possible
  • Ensure you get the maximum employer match in your 401(k)
  • Minimize taxes with products like 401(k)s, Roth IRAs, 529s, etc.
  • Buy inexpensive, well-diversified mutual funds or ETFs
  • Don't sell your investments until you need the money to live
  • Never buy or sell individual securities
  • Don't rely on social insurance programs now or in the future
  • Insure yourself and your belongings sufficiently
  • Have an emergency fund
Now that you have the bullet points, I will expand on each one slightly.

Live Below Your Means
This is the most basic principle of personal finance. It means spend less than you earn and save the rest. For example, if you earn $50,000 per year, don't spend $50,000. Try to spend $40,000 and save the remaining $10,000

Spend Your Money Wisely
This rule is pretty simple too. We all have to spend money sometimes, but it is important to consider what it is we are spending it on. As I said above, we should strive to only spend our money on meaningful experiences and quality products. Don't try to keep up with the Jones'. They are most likely deeply in debt and have a whole bunch of depreciating assets.
If you love baseball, it's perfectly fine to spend a few bucks on tickets and attend a couple games every year, but you probably don't need season tickets in a luxury box.
Physical products are similar. If you need something like a bicycle, spend a little more and buy one that will work well and last a long time. It is also important to properly care for the things you spend your money on. There's no point in buying a nice bicycle if you are going to leave it outside to rust or get stolen.
Finally, it is important to avoid overpaying for anything. There are amazing deals out there if you care to look. Buying used is one of the best ways to save.

Minimize Your Monthly Bills
It's easy to overlook seemingly small monthly bills, but it is important to minimize them because they can really add up over time. A few simple ways to do this are to reduce your electricity, water, and gas use. Cancel your cable TV package. Get together with your friends and family and use a group cell phone plan. Shop around for the best insurance rates. There are lots of places you can probably save a few bucks a month.

Avoid Debt and Fees
Paying interest and fees is the worst possible way to spend money. They provide absolutely no value. Credit cards are very convenient and can offer some nice perks, but you should only use them to buy things you can afford to pay cash for, and you should pay off the balance on time and in full every month.
The only thing worth paying interest on is a house and maybe your first car, but you must shop around to get the lowest fixed rate possible.

Save as Much of Your Income as Possible
This is pretty obvious, but it has to be said. If you ever want to stop working, you need to build a sizable nest egg, and the only way to do that is to save religiously. I don't like to give a specific savings percentage because it will vary depending on your situation, but at least 20% is a reasonable goal.

Ensure you get the Maximum Employer Match in Your 401(k)
This is of course assuming you have a 401(k) plan at work and your employer offers any sort of matching contributions. If you do, take advantage of it. There aren't many ways in life to get free money, and this is one of them. All you have to do is save a little, which is a good idea anyway, and you will be given even more money. It's a no-brainer.
For example, my current employer will match 4% if I contribute 6%, so I will definitely contribute at least 6%.
Depending on your specific 401(k) plan you may or may not want to contribute more then is necessary to get the maximum employer match. If you have a good plan with a variety of quality, low-cost investment options, you should probably contribute much more. If your plan isn't so great, you may want to stick to whatever gets you the maximum employer contribution and no more.

Minimize Taxes
If interest and fees are the worst thing to waste money on, taxes are a close second. That's why it's important to minimize the taxes you pay. The easiest way to do this is by using tax advantaged accounts like a 401(k), IRA, Roth IRA, 529, or a combination of them.
You don't need to be an accountant to reduce your tax burden, although there are certainly some more complicated strategies that could be used.

Buy Inexpensive, Well-Diversified Mutual Funds or ETFs
The best way to earn the highest returns with minimum risk is to invest in low cost mutual funds or ETFs. Funds that track the S&P 500 have historically done very well and require minimal management, so the expenses are typically low. Find a couple more funds that cover broad sectors (small cap, international, etc.) and enjoy your returns.
Although I don't own any, Vanguard funds are often very good.
In a future post, I will share what I have in my portfolio for your entertainment.

Don’t Sell Your Investments
This bullet point could also be titled “Don’t Panic.” The stock market is going to fluctuate over time, but it will trend upward. When the market goes down, don’t sell. That is the best way to miss the inevitable recovery. I know it feels scary when the market takes a nose dive and you see lots of red in your portfolio, but you must resist the urge and potential peer pressure to sell. This is actually the best time to buy.
Obviously you may need to occasionally sell some investments to rebalance or relocate your portfolio, but in general, you should buy and hold.

Never Buy or Sell Individual Securities
Unless you work on Wall Street, picking stocks isn’t your game. Don’t try it. Even professionals rarely beat the return of the S&P 500, so you probably won’t either. Buying individual securities is very risky and very stressful. It's not worth it.

Don’t Rely on Social Insurance Programs
I’m primarily talking about Social Security here. Given the current financial status of the Social Security system, it seems doubtful people in my generation will be able to collect anything when they are older. We might get a small payment, but it probably won’t be enough to live on. The safest bet is to plan for no Social Security and treat it as a bonus if any payments come.
The same thing goes for health insurance subsidies from the Affordable Care Act. Health insurance may seem cheap now, but who knows what will happen if the ACA gets repealed.

Insure Yourself
I may be biased because my dad was an insurance agent, but it is incredibly important to carry sufficient insurance coverage. I don’t like paying for insurance, but it is a necessary evil. Crazy things can happen, and insurance is often your only protection.
What would happen if you crashed your car into and totaled a Ferrari? A “friend” fell off your deck and sued? What if you died? Would you or your loved ones lose your house? Make sure that doesn’t happen by insuring yourself sufficiently.

Have an Emergency Fund
Most people recommend having six months’ worth of expenses in an emergency fund, and that seems reasonable to me. I’m still trying to figure out how to get a decent interest rate on those emergency funds. The current favorite seems to be “high yield” checking accounts, but the rates are still pretty low and you often need to jump through hoops to get the highest rate.
I’m also trying to figure out how to “recession proof” my retirement savings, but I don’t have a solid plan for that yet. I will let you know when I figure it out.

Those are my simple financial rules to live by. There’s nothing revolutionary, but they will let you become Fiscally Free in no time.

Let me know if you would suggest any modifications to my list in the comments.

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