What classes did you take your senior year of high school? I’d be willing to bet Information Age Personal Finance was not one of them. As teenagers our main point of reference in personal finance is the actions of our parents and family members. For most of us, if our financial advice only comes from our family members, we’re screwed…
Unless you take an interest in personal finance in your 20s, there will be a massive knowledge gap between what you know from traditional schooling versus what you actually need to know to build wealth.
I’ll have future posts about the best books on real estate and personal finance. For now, if you understand the following concepts and take disciplined action, you’ll be on the right path to the new retirement.
Two words: Compound Interest
This is the concept of “interest on interest.” Money invested is called principal. Money earned on this invested principal is the interest. If you invest $100 in year one and your return is 5%, the value is now $105. So a return of 5% on $100 is $5. Assuming this 5% return continues in subsequent years, your new starting point is $105. That same 5% return on $105 would now be $5.25, increasing that total to $110.25.
This is a very basic example for simplicity. If you combine time with compound interest, you will be happy you started early.
Start a Roth IRA
A Roth IRA is an individual retirement account (IRA) where any earnings can grow tax-free. The ‘roth’ aspect means you will have already paid taxes on the contributions. The contributions would come from a paycheck where taxes have already been removed. This is different from a 401(k), where contributions are pre-tax. More on these differences later.
For 2023, the individual contribution limit is $6,500. These accounts are very simple to start and are NOT tied to an employer. Simply open an online brokerage account, like Schwab, Fidelity, or TD Ameritrade. Choose the type of securities you want to invest in; stocks, bonds, ETFs, index funds, or mutual funds. Last and most important, set an automatic contribution each month into this account.
Pensions are long gone
The beauty of a pension is that an employee can work a specific number of years at a company and know their exact monthly benefit in retirement. My grandfather was fortunate enough to have this benefit from working at General Motors for 37 years.
A pension is referred to as a defined-benefit plan. A 401(k) is a defined-contribution plan. Companies offering a pension have an ongoing future liability to meet the obligations of retirees. Estimating these figures can be complex as it comes from future earnings.
Enter the shift from defined-benefit to defined-contribution. Offering a 401(k) is an alternative to a pension while still providing a retirement vehicle for employees. Instead of being funded by the company, it is now funded by employee contributions. Employees choose their contribution amount and where the money is invested. The employer’s potential contribution is a match or profit sharing, rather than a guaranteed future income stream.
What does this mean for you? Do not solely rely on any company to fund your retirement. Yes, contribute to the 401(k) especially if you are getting an employer match. I would argue this is one of the purposes of me starting this website and brand. If you are responsible for retirement, you need to know about different types of accounts and financial skills needed to create your nest egg. Likely before you were even born, employers shifted this liability from them to you.
If you want to buy a coffee in the morning, buy a coffee
The daily Starbucks seems to be a debate in the personal finance world. Some people would advise, well if you just didn’t buy that $5 coffee every day, you’ll save $2,000 annually.
Here’s the thing. Coffee, for a lot of people, is one of the little things in life that brings people joy. Yes, it IS a habit. If we totally cut it out would you save money? Yes. But something as simple as coffee is what some look forward to in the morning. It gets their day started. For some, they love the experience.
The reality is, if you are going to cut back to try to save money by the month, the easiest way to do this is through expenses like your mortgage and insurance. With a simple phone call you can review your homeowner’s policy with your agent and find a way to save $10-$20 per month. Boom. Go get that coffee! Enjoy the small things that bring you joy!
How to budget: The 50/30/20 rule
This is a basic budget rule to ensure you’re saving enough each month.
Here’s the 50/30/20 budget breakdown:
50% Needs
Housing
Utilities
Insurance
Groceries
Transportation
30% Wants
Shopping
Dining Out
Amusement
20% Savings
Retirement
Investing
Emergencies
Credit Utilization Rate of 30%
Buying a house, investment property, car: you need credit for all of them. Credit can grant you financial leverage. This means if you have proof you can pay your bills; car, credit card, mortgage, utility bills, then banks will allow you to use that credit to make larger purchases.
By larger purchases, I mean you can put 3% down on a property and a bank will loan you 97% of that property. Credit utilization means if you have a credit card with a $10,000 limit, try to maintain a balance of $3,000 or less. If you always have a higher balance, this is viewed as more risky and can negatively impact your credit score.
Asset vs Liability
In the simplest form, assets put money in your pocket and liabilities put money in someone else’s pocket. Just like companies keep track of their own balance sheet and financial statement, you need to maintain a personal balance sheet. Below are some examples of assets and liabilities.
Asset examples
-Cash
-Investments
-Real estate
-Inventory
-Service business
-Online business
Liability examples
-Mortgage debt
-Credit card debt
-Vehicle debt
My take on the future of retirement
The first mental shift you need to make is rely less on others and more on yourself for retirement. Companies do not exist to take full responsibility for your financial future. They’ll offer a 401(k) plan at the most, as opposed to pensions that guarantee a retirement income stream.
The second point is that life is truly a game and you need to learn the rules of money. Employers in the 1980s and 1990s decided to fend for themselves and shift the retirement burden to the individual. Although this happened, the average person doesn’t realize the need to now add more income streams to their portfolio.
This means you can’t just save forever in hopes of retiring. The company you need to focus on is YOU. Build your personal balance sheet. Understand your own financial statement of income and expenses. It’s fair to conclude that if someone goes through life never understanding how a balance sheet or income statement works, they’ll never truly understand their own finances.
Here’s an action plan to follow:
- Put your personal balance sheet and income statement on excel.
- Decide what new assets you can add to the balance sheet, like real estate, investment accounts, digital assets, etc.
- Work on building these assets and reducing your liabilities.