Everyone has a different dream.
Maybe life sucks. You’re trapped by debt. You want to quit your suffocating job (or find a job). You feel stuck in your hometown and you want to explore the world.
Maybe you love your job. You’re debt-free. And you’re just trying to figure out how to maintain and protect your awesomeness for the long-term.
Regardless of your current situation, everyone shares the same basic recipe for financial awesomeness.
This is a simple, three-ingredient recipe — ideal for financial novices, who want to keep it simple. Master these three ingredients, and you won’t have to sweat about your bank balance anymore.
A Beginner’s Guide to Financial Awesomeness
At the most beginner, basic, bare-bones level (ah, I love alliteration), just follow three rules:
- Live debt-free.
- Keep massive cash reserves.
- Max-out your retirement accounts.
Do these three things, and you’ll be awesomesauce.
It’s simple. It’s basic. It’s as pared-down as possible.
How do you achieve this?
How to Live Debt-Free:
Spend less than you earn.
My favorite tactic is pulling your savings directly from the top, and forcing yourself to live on whatever money is leftover.
I call this the “anti-budget,” thanks to its simplicity. You don’t need to create an elaborate spreadsheet detailing how much money you spent on dog food in the past 7 days. Save first, and spend the rest.
How much should you save? Twenty percent is the bare minimum that applies to everyone. If you want to ditch the rat race and enjoy complete financial freedom, ramp this up to at least 50 percent. And if you have any high-interest debt (APR above 8 percent), you’re in an emergency situation. Halt all spending and pay that sucker down — ASAP.
“But how can I spend less?”
Restaurants are a luxury, not a human right. Same goes for cable TV, a new shirt, and prime cuts of meat from the store. You can achieve happiness without these. (And you can splurge on this later, when you’re debt-free.)
Then hustle on the evenings and weekends, to earn extra cash. (More on this below).
How to Keep Massive Cash Reserves:
Keep at least 3-6 months’ of expenses tucked away into a savings account or high-yield CD. I prefer Everbank accounts (aff link), which (at the moment) offers a 1.4 percent savings account rate, for the first six months, with a 1.01 percent APY. It pledges to always provide the top 5 percent of yields in the nation.
How can you start accumulating that cash? At the risk of sounding repetitive: Earn more, spend less. Let’s look at both options.
The two best ways to supercharge your income are:
- Angle for a promotion at work.
- Develop a lucrative “side hustle.”
Since I haven’t had a “day job” since 2008, I tend to focus on the second option: hustling during the evenings and weekends.
- Afford Anything reader Erika, who works full-time and attends grad school, earns an extra $20,000 per year by hustling during her very-limited downtime.
- By hustling during the evenings/weekends in my early twenties, I earned enough money to travel the globe for two years. (My higher-earning friends said they’d love to travel, but “can’t afford it.” #Excuses)
- These days, I run an online marketing company during the daytime, and invest in rental properties as my “side hustle.” This side-income produces an extra $35,000 per year, which is now totally passive.
I can hear the complaints already: “But I don’t want to work harder! I’d rather watch Dancing with the Stars!”
Yes, you’ll have to hustle. Most people aren’t willing to do that. Most people are broke.
If you want to attack the “spend less” side of the equation, focus on your housing costs. Housing is the single biggest expense that people endure. The average American spends between 28 to 33 percent of their take-home pay on housing. Chop this in half, and you’ve just increased your savings by around 15 percent.
How to Max-Out Your Retirement Accounts:
Here’s the simple formula:
- Contribute to your 401k up to your employer match.
- Pour every dime into paying off your debt.
- Afterwards, max-out the remainder of your retirement accounts (401k, IRA, HSA, etc.)
As a general rule, I recommend maxing-out your Roth accounts first (Roth IRA) before turning your attention to your Traditional accounts (401k). The only exception, of course, is capturing your employer match.
Where does this money come from? I hope that by now you’re spotting a pattern: The key to all of this is to “mind the gap“ between your earnings and spending.
If you devote your life to buying generic brands, bisecting dryer sheets, and waiting in line on Black Friday for discount TVs, you’ll save maybe a couple thousand bucks a year. That’s better than nothing — but it’s not going to move-the-needle.
If you boost your income by $330 per week, you’ll have an extra $17,160 annually — almost enough to max-out your 401k.
(That’s working 15 hrs/week at $22/hr.)
Shave an extra $500 per month from your housing costs — that’s $6,000 annually — and you’ve just maxed-out your IRA, as well.
Now that you’ve maxed-out your retirement contributions, how should you invest this money? Should you listen to your cousins’ best friends’ brothers’ hot-stock-tip recommendation? Hell no.
Here’s the world’s simplest, easiest investment plan:
Rule 1: Adopt a three-fund portfolio.
Choose index funds (or commission-free ETFs) from Vanguard, Schwab or Fidelity. These brokerages offer very-low-cost funds. If you’re going to embrace frugality in any aspect of your life, be frugal about your investment fees.
If you use Vanguard, stick with these three:
- VTSMX — Total (US) Stock Market Index
- VGTSX – Total International Stock Index
- VBMFX — Total Bond Market Index
If you use Schwab, stick with these three:
- SWTSX — Total (US) Stock Market Index
- SWISX — International Index Fund
- SWLBX — Total Bond Market Index
If you use Fidelity, stick with these three:
- FSTVX — Total (US) Stock Market Index
- FSIVX – Total International Stock Index
- FSITX — Total Bond Market Index
Rule 2: Subtract 110 minus Your Age. Put this percentage of your portfolio in stock funds; put the rest in bond funds.
A 20-year-old would put 90 percent in stock funds; 10 percent in bond funds.
A 30-year-old would put 80 percent in stock funds; 20 percent in bond funds.
A 40-year-old would put 70 percent in stock funds; 30 percent in bond funds.
A 50-year-old would put 60 percent in stock funds; 40 percent in bond funds.
A 60-year-old would put 50 percent in stock funds; 50 percent in bond funds.
If you’re an aggressive investor: modify this formula to 120 minus your age. If you’re a conservative investor: modify this formula to 100 minus your age.
How should you split the “stock fund” portion between US and international? The rule-of-thumb is between 20 to 40 percent of your stock funds should be invested in the International Index Fund, with the other 60 to 80 percent of your stock funds in the Total (US) Stock Market Index.
To keep it simple, let’s say you’re going to invest 30 percent of the stock portion of your portfolio in International Funds. Here’s how it would break down:
A 20-year-old would invest 63 percent in the Total (US) Stock Market Index; 27 percent in International; 10 percent in the Total Bond Market Index.
A 30-year-old would invest 56 percent in the Total (US) Stock Market Index; 24 percent in International; 20 percent in the Total Bond Market Index.
A 40-year-old would invest 49 percent in the Total (US) Stock Market Index; 21 percent in International; 30 percent in the Total Bond Market Index.
A 50-year-old would invest 42 percent in the Total (US) Stock Market Index; 18 percent in International; 40 percent in the Total Bond Market Index.
A 60-year-old would invest 35 percent in the Total (US) Stock Market Index; 15 percent in International; 50 percent in the Total Bond Market Index.
Your stock/bond diversification will change over time, as some funds rise and others fall. Once a year, “rebalance” so that you’re back at your ideal percentages (shifting slightly for your age).
And … that’s it. It doesn’t need to be any more complicated (or expensive) than that.
The Beginner Formula
The three steps above are beginner baby steps.
You’ll notice that I didn’t discuss investing in sector-specific funds, or allocating a small percentage to individual stocks, or buying rental properties. I specifically advocated a three-fund portfolio: I didn’t discuss diversifying based on size (large-cap/small-cap), style (growth/value), and geography (developed/emerging/frontier).
There’s a good reason for this.
The Three Beginner Steps are the equivalent of writing a chocolate-chip cookie recipe that says:
- Turn on the oven.
- Divide store-bought cookie dough into chunks.
- Place on baking tray.
Can you develop more elaborate recipes? Of course.
Will they taste better? Only if you get it right. If you get it wrong, the cookies will taste horrid. (Yuck.)
Don’t try to bake from scratch if you can’t yet turn on the oven.
The 80/20 rule says that we get 80 percent of our results from 20 percent of our efforts. Buying store-bought cookie dough represents that 80 percent. It propels us from “not eating cookies” to “eating cookies.” For most of us, that’s good enough.
If you want to further optimize, you can start testing recipes that involve baking soda, vanilla extract, and expeller-pressed oils. The financial-geek equivalent is investing in REITs, tax liens, and ultrashort bond durations.
If you’re devoted enough to dig “in the trenches,” you’ve earned the right to take those risks.
But don’t jump the gun. (I know — I’m mixing metaphors. Cookies and guns.) “Done” is better than “perfect.” This isn’t a guide for advanced or intermediate investors; it’s a guide for beginners. And if you’re getting started, the most important move that you can make is to START.
Start small. Start simple. Start slow.
Don’t Jump the Gun (and/or Burn the Cookies)
The single biggest mistake that beginners make is forgetting that they’re beginners. Too many people try to jump from “beginner” to “advanced” without taking the intermediate steps.
That’s the financial equivalent of burning an entire tray of cookies.
As a beginner, be neither swayed nor scared.
Don’t Be Swayed – Don’t be swayed by some get-rich-quick hot stock tip. (And please NEVER utter the phrase: “I’ll live in this house, and then maybe rent it out for awhile, and hope that it’ll rise in value.” That’s not a business strategy; that’s gambling.)
(“But I know someone who …!” Yeah, and I know someone who won at blackjack in Vegas. So?)
Raise your right hand, and make the following pledge: “I will ONLY buy a rental property AFTER I learn how to calculate net operating income, cap rates and the cash-on-cash returns.”
Don’t Be Scared – Don’t be scared away by the talking heads who want you to believe that you need to diversify into 50+ different mutual funds, based on criteria such as size, style, geography, duration, bond-rating, liquidity, sector-specific, precious metals, commodities, and management style.
Many people in the financial industry like to overcomplicate things. Probably because they know you’ll eventually throw your hands in the air and say, “Oh, just f*** it. This is too complex. You handle it. Make decisions for me. Here’s 1 percent of everything I’ve got — keep it as your fee.”
As I said: If you’re going to be frugal in just one aspect of your life, be frugal about your investing fees.
It doesn’t need to be complicated. Or expensive. Or dependent on a “hot tip” from your second-grade-teachers’ uncles’ dog-sitters’ third-cousin.
Just stick to the beginner recipe. Eat cookie-dough from the wrapper. Live debt-free, with cash reserves and a solid retirement. You’ll be fine.