When I was growing up, my family didn’t discuss money. I didn’t learn about bank accounts, never heard about saving money or investing it, or planning for the future.
When Theresa and I began living together (1988?) I watched her balance her checking account. She offered to balance my accounts, and asked me to provide her my ATM slips. I had no ATM slips. I didn’t know I was supposed to save them or track my spending. I started to realize that I was financially illiterate.
I am more literate now than I was then. I’m not great at some of this….but as a result of being conscious of it, Theresa and I are in a much better place now than we were in 1988.
For the younger people on this distribution, and those who also grew up in households without financial role models, I am going to share with you some of what I have learned. I hope this is not in bad taste. I recognize that we don’t discuss money in our culture.
One of the benefits of financial literacy is financial freedom. I re-read a book recently (The Psychology of Money by Morgan Housel) that describes financial freedom as the ability to do what you want, when you want, with the people that you want to do it with.
As a result of doing what I have written below, we have financial freedom. I am grateful for that and I would like to share it with you.
Our Five Steps to Financial Freedom:
- Spend Less Than We Make: this is the foundation for everything that follows. Financial freedom isn’t possible if I spend more than I make.
- True story: when Theresa and I moved in together, she suggested (insisted?) that we only purchase what we could pay cash for (or only charge it if we could pay off the credit card bill 100% at the end of the month). As a result….we did not have bedroom furniture. No bed, no boxspring, no mattress. We slept in a sleeping bag for months, until we saved enough money to purchase a mattress, and then later a boxspring, and then a bed frame. So when I say “spend less….” I mean that I slept in a sleeping bag for several months in order to be financially free.
- Some other things that we agreed to in order to spend less than we made:
- We “brown bagged” our lunch for decades. We packed our lunches the night before work/school.
- No credit card debt. Ever. Theresa explained to me that credit card interest rates were often as high as 18%. And that making only the minimum credit card payment means that I will never pay off my credit card bill. That doesn’t sound like freedom. So we never had credit card debt. Ever. If we couldn’t pay 100% of the bill for something at the end of the month, we didn’t purchase it. Don’t believe me? See “sleeping in a sleeping bag” above.
- Max our 401ks/IRAs/529 savings: I will get to this later (in “Save the Difference” and “Invest”- saving in tax advantaged programs like 401ks and IRAs is a way for us to prioritize our financial future.
- Live frugally: This is baked into “brown bag our lunches”, “no credit card debt”.
- Save the difference: the point of #1 (spend less than we make) is to save the difference between what we make and what we spend. Saving money means that I started to think ahead in my life. Saving money also means (and I mean this seriously) that I am not stuffing money in a mattress, or hiding it in a closet. Some of my older relatives did that as a result of Great Depression bank crashes. I don’t have to do that. I save all of my money in one place, in an insured and protected institution, so that I can track it and be conscious about it.
- Invest some of my savings: this is a topic that requires another essay for a full discussion. Let me start with a disclaimer or two…..I am not a Certified Financial Planner (CFP), and I am not giving you advice. I am sharing experience that worked for me.
- I was married to a young lady (Theresa) who worked at Vanguard Investments, founded by Jack Bogle, who created and popularized index funds. That meant that she brought books home from work (seriously) about low cost index funds, shared them with me, and I learned that I could do investing on a “DIY” (Do It Yourself) basis. This happened at the same time that 401ks and IRAs began to gain popularity in the United States. So Theresa suggested that I save the maximum allowed amount every year in my 401k, and invest it is an S&P 500 index fund.
- For those of you unfamiliar with 401ks and IRAs (and 529 plans), these are saving/investing programs available to most full time employees in the United States. If you aren’t sure if your company offers them, ask. If your company doesn’t offer them, you may still be able to do some tax-advantaged saving on your own.
- 401ks allow you to save up a certain amount of money on a pre-tax basis (meaning that money isn’t taxed until you take it out for retirement). This helps lower your tax bill the year you make the contribution and also invest a larger amount than if you invest after-tax funds.
- Disclaimer: How you invest, where you invest, and what you invest in is a personal choice. Seek professional advice. My comfort zone is investing in the largest profitable companies in the world. The S&P 500 is composed of the 500 largest companies in the world. They are publicly traded, they answer to shareholders, and their records are public. Thirty years from now, there will still be an S&P 500 (there will still be 500 global profitable companies to invest in), and I will own shares of those companies.
- Compounding: this is miraculous stuff. I was confused by it when I first learned about it.
- Example 1: The principle of compounding is that if an investment grows by 7% this year, and then grows by 7% next year, the total growth is slightly more than 14% (7% + 7%). That is because the 7% growth next year is growth on top of the 7% growth this year.
- Example 2: if I invest $10,000 and it grows by 7% this year, that means that it grows to $10,700. If that grows by another 7% next year, that means that the $10,700 grows to $11,449 (a growth of $749, not $700). So my money starts to make money. The $700 I earn this year makes an additional $49 next year (assuming 7% increases).
- So what? The “so what” is that over the course of 5, 10 or 20 years, that growth may be life altering. When I started investing in the S&P 500, it was at 257. It is now at 6737.
- What does that increase mean? See below- $10,000 invested in the S&P 500 in 1988 is worth $262,900 today.
- Now I need to insert a couple of disclaimers here.
- One is the classic financial company disclaimer that states “past results do not guarantee future results”, or something like that.
- The other disclaimer, and this is important, is that every investment has risk. There are no guarantees. You may invest $10,000 next week in your 401k, and the week after, the market may have a downturn.
- Your $10,000 investment may be worth $8,000 overnight.
- Your $100,000 investment may be worth $80,000 overnight.
- Your $1,000,000 investment may turn into $800,000 overnight.
- Your $10,000,000 investment may be worth $8,000,000 overnight.
- Can you accept that risk?
- Look at the chart above, (the chart with the green line that goes up). Look for the places where the green line goes down. Those are market downturns.
- Wait Wait Wait: this is really important, simple in practice but difficult to do.
- I have never touched our retirement savings. Not once. Not ever. Not one penny. Never. Neither has Theresa, and neither have our daughters (yes, they started saving for their retirement in their 20’s).
- The only way for compounding to do its magic is to leave the money where it is. And wait.
- In this case, “WAIT” is an important part of the recipe for financial freedom. I have shares in the S&P 500 that are several years older than Heather. And Heather is 30 years old.
