Starting From Square One (Or $20 in my bank account)

Picture this: You’ve just graduated college and received your first '“big-kid” job. You have about $20 in your name. Although it is a new concept, with a new job comes new responsibility, and you decide you should probably be more mindful about your spending (and saving) habits. But how do you start?

I had the unique privilege of beginning my career at Human Investing shortly after I graduated. As you can imagine, working at a financial advisory firm meant that before I started contributing to the company’s 401(k) plan, I was given a beginner’s course in investing.

AN ENDLESS MAZE OF DECISIONS

Like many people who join corporate America, I opted into its retirement plan because it was a free benefit I received. I knew saving for retirement was important, and the investment options available to me would benefit my long-term financial plan.

When I received my first paycheck, I learned the importance of contributing to my 401(k), but in a way that was compatible with my cash flow.

A common rule of thumb is to contribute 10-15% of your gross salary to your retirement account if you can (this includes the employer contribution/match). After learning this, I was eager to invest 15% into my 401(k). However, I did not consider other key factors that made up a healthy and holistic financial plan, like funding an emergency savings account or considering other short-term goals (ex: continuing education or buying a home). Although I was so eager to contribute as much as I could to my retirement plan, I ended up contributing much less than expected after assessing my current financial situation.

Unpacking where to start

I share this story because, like most people new to the financial scene, I wanted to manage my money well, and I figured investing all of my excess income would equate to successful money management. What I didn’t do was take a step back and assess my entire financial landscape. Thankfully, Human Investing was there to provide some guidance. That’s why we made this visual. We call it “The Pyramid to Financial Wellness.” Use the visual as a map; start at the foundation and then work your way up. Before continuing, please know that we all have unique financial situations, and not every block may apply to your situation.

LEVEL 1: Build a Foundation

Build a Budget to understand your monthly cash flow: If you’re looking to invest dollars from your paycheck, you need to know how much bandwidth you have at the end of each month. If you don’t currently have any excess dollars, try to get creative. Look at your current spending habits and see if you need to minimize spending in a certain area. Don’t be afraid to rely on savings apps for help. We generally recommend Mint or Digit.

Pay off High-Interest Debt: Focus on higher interest, non-deductible loans first, such as credit card loans. Consider refinancing your loans or reconsolidating your debt to make payments more manageable.

Contribute to your Company-Sponsored Retirement Account: If applicable, contribute enough to receive the employer match. For example, if your employer matches up to 6% of your contribution, try to meet the 6% savings rate.

Build an emergency fund: If something unpredictable happens, make sure you’re prepared. Click here to learn how to build an emergency savings fund.

Level 2: Plant Long-term Seeds

Open a Retirement Account for future savings: Based on your age and tax bracket, start contributing to either an IRA or a Roth IRA. Click here to see if a Roth IRA account is the right account for you.

Continue paying down student loans: If student loan payments are on your horizon, don’t delay! Try to pay off what you can now. Consider refinancing your loans in order to make regular payments more manageable.

Save for a Home: If this is a goal of yours, start saving. Depending on your timeline, try to save in either a High Yield Savings Account (Short-term goal) or a Roth IRA (Longer-term goal).

Level 3: Hone your Monthly Budget

Open up a 529 account for a child or grandchild: If you are hoping or planning to fund your child’s college education, utilizing a 529 account can protect your purchasing power. The same rules that apply when flying apply here too. Put your mask on before taking care of others.

Pay down your mortgage: Target additional mortgage payments if you are able. Consider refinancing your mortgage to possibly find greater savings with lower interest rates.

Save for Short-term and Mid-term goals: Short-term goals include immediate expenses, paying down debt, having an emergency savings fund, etc. Mid-term goals are big purchases that you plan to make before you retire. This includes saving for a house or a car. Avoid borrowing and start planning to save. If you’ve exhausted other savings vehicles (like your 401K and Roth IRA), consider opening a brokerage account.

If you have any questions about how investing can fit into your financial plan, contact us! We are here for you and are excited to cheer you on as you learn to manage your money well.

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“You need to make more money…”

My budget coach and I sat there silent in the face of what seemed like an impossible reality.

For me, and perhaps for some of you, the option to make more money was laughable.  At that life stage, I was in the midst of a financial tornado: our nation’s economy was hung-over from the market crash of 2008, my employer at the time lost a grant that substantially reduced my paycheck, and an unexpected illness and injury lead to weighty bills and rendered additional work next to impossible.

Each month I felt like I was scraping up pennies just to make ends meet – Maybe some of you feel the same today.

Unavoidable realities like a job loss, illness, injury, and accidents are financial burdens that most of us will face at some point in our life.  The support of a funded emergency savings account is a solid way to ease some of the financial blows that come our way.

I am happy to report that, though it took some time and sacrifice, I was able to meet my “impossible” goal to have a funded emergency-savings account, and I would like to share with you some of the helpful tips I learned along the way.

organize where your dollars are going

There is a link between paying attention and success, so consider paying close attention to where your dollars are going.  List all purchases, spending, and expenses for the month and ask: What, When, How Much and Why are dollars leaving my account?  What are the “surprise” expenses?  Take a moment to consider needs vs. wants.

Next, (you may have guessed it—and even groaned) consider making a budget. If you hate dealing with money or do not even know where to start, there is HOPE!  There are many creative ways to budget that do not take a lot of time or effort but help you to pay attention and stay on track.

• If you don’t have a budget consider: YNAB; Mint; Cash Envelope System (or digital); The  50/30/20 method, value-based budget, or unconventional alternatives such as a visa cash card loaded weekly/monthly with your budgeted amount.  I found success with the 50/30/20 method combined with the envelope system.

• If you do have a budget, look closely at the How Much and Why.  Consider setting a goal to check on your spending and expenses once a week and ask:  How am I doing?  What can I change to improve?

Open a Savings Account and Set Goals

This is not just wishful thinking – it is preparing to succeed.  Many financial institutions will allow you to open a savings account simply and easily online.

Here are a few recommended examples for high yield online savings:

• Capital One

• Ally Bank

For most households, an appropriate emergency-savings buffer is three-months of your living expenses.  Write it down.  Take a moment to imagine that amount and how you will feel when you meet your goal.

Set a goal: Ask your employer about directing a portion of your paycheck directly to your savings account.  An alternative is to set monthly, automatic transfers from your checking to your savings account.  It is generally best to have this occur the day after payday to give your funds a day to settle.

Setup auto-deposits: This also may help with large, annual bills.  Take your annual bill and divide it by twelve – this is how much you need to save every month to pay for this bill outright – Plus, you may actually save money when you pay in full!

Boost your savings when that “Free Money” comes your way

You just got your tax return.  You just got a stimulus check.  Your grandma just sent you a birthday card.  Your company gave you an unexpected bonus.

Your heart, your peers, and your social network cheer:  Treat yourself!

It is easy to think of unexpected cash as “free money.” Yet if your goal is to build up an emergency savings fund, “free money” is a great way to get a big boost.  To satisfy that itch to have a treat, consider making a deal with yourself:  I will set aside 20% (or $20, or whatever you feel you can stick to) into my savings account, and the rest I can use for a treat.

If you plan for your treats and stick to your plan, you gain a double reward.

hustle and Ask for deals

While it may not be a benefit to bundle in services you will not use, it is a wise idea to call your service providers to ask about unadvertised promotions.  Our household was able to keep our high-speed internet bill at $30/mo for nearly 5 years by calling once a year to ask about current promotions, specials, and loyalty rewards.  This annual phone call saved a total of $240 per year.

Tighten Your budget’s Belt

Unsubscribe: Do you know how much you really spend on your subscriptions? Look at your credit or debit card statements for a few months and see what you find.  Often, we sign up for a free month trial and forget to cancel, we don’t notice the $50 because it’s billed annually, or we don’t actually use what the subscription offers.  

Take what is free: Did you know that most libraries have free audio, video, and eBook apps?  Did you know that Harvard offers a whole range of classes for free?!  As you make good choices about reducing your subscriptions, consider taking advantage of the huge range of free courses, events, activities, and entertainment.

Dine-in: Eating out is to your budget what driving a semi-truck is to fuel efficiency: a drain.  Your budget will stretch further on fewer dollars when you eat at home.  Consider leveraging the percent principle noted above – Make a goal for eating at home so that eating out becomes a treat. Don’t know how to cook?  Learning can be easy! Or fancy!  Hate cooking and think you don’t have time?  Cooking can be simple!

Every little bit counts: One of the key-ways dollars sneak away from our wallet is thinking, “It’s only $10 a month” or “Three-dollars won’t go very far” – Perhaps it’s just the cost of your morning coffee. If the only thing you do is make your coffee at home, you stand to save approximately $800 a year or more.  And look closely:  that’s only one cup of coffee a day!

Make it fun: There are dozens of ways to save money and even have fun while you’re at it! Here are a few to get started:  Staycation!  Be a Winner! Grocery Wins!  Become a Hunter! Up-Cycle!  “Use it up, wear it out, make it do or do without…” – Calvin Coolidge

CELEBRATE THE LITTLE VICTORIES

I hope this has given you some practical steps and encouragement to begin an emergency savings account for when life, inevitably, happens.  In closing, I want to offer the most powerful tool you have: Hope.

“Success is failure turned inside out—the silver tint of the clouds of doubt.” - John Greenleaf Whittier

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The financial world can be a confusing place filled with jargon, technicalities, and little to no guarantees. Research suggests that those who are financially literate tend to have better financial outcomes. Financially literacy is typically measured by asking some core financial concept questions. Let’s walk through some financial literacy questions from the National Financial Capability Study, and explain the why behind the answer. Feel free to guess and score yourself at the end:

Question 1 - interest:

Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

A. Less than $102
B. Exactly $102
C. More than $102

Answer: C, more than $102.

Explanation: The key part here is “After 5 years”. We are told the interest rate is 2% per year. That means every year, 2% gets added to our principal balance. To break it down year by year:

The interest earned increases each year. This is due to compound interest: the original principal ($100) grows, and the interest you earned previously (in year 2, $2) both earn interest. At the end of 5 years, we have $110.41 which is C More than $102.

Why this matters: Interest affects you when you save money to grow it, or borrow money to pay it back later. Knowing how interest can work for or against you is critical for financial success.

Question 2 - inflation:

Imagine the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?

A. Less than today
B. Exactly the same
C. More than today

Answer: A, Less Than today.

Explanation: They key here is the inflation rate is higher than the savings rate. Inflation is growing at 2%, meaning the price of goods (rent, utilities, food, cars, etc.) is going up by 2% each year. The cost of $100 of goods today will be $102 in 1 year. Your interest on savings is growing at 1% a year. That means in 1 year you will have $101 to spend on goods. In 1 year, you will have $101 to buy $102 worth of goods. Your ability to buy is A less than today.

Why this matters: Even if you keep your money “safe” in the bank or under the mattress, inflation is going to make that money less and less valuable. Thus why investing is so important. Investing can be scary due to downturns in the market, but ultimately the odds are in your favor to grow your money over time. Unless you can save significant portions of your income, growing your savings faster than inflation is critical for being able to retire.

Question 3 - Risk Diversification:

Buying a single company’s stock usually provides a safer return than a stock mutual fund.

A. True
B. False

Answer: B, False.

Explanation: To answer this question correctly, it is important to understand both risk and that a mutual fund owns a variety of companies. They keyword here is safer. Financial markets have two types of risk: market risk and company-specific risk (aka systematic risk and nonsystematic risk respectively).

Market risk refers to risk all companies face. Examples of market risk include a change to the US tax code, a global pandemic, or shifts in consumer tastes like a shift from fast food to organic freshly prepared food. You will always face market risk because every company is exposed to these risks. Company-specific risk refers to risks unique to one company. Examples of company-specific risk include sudden changes in management, a press release about product defects, mass recalls, or a superior/cheaper product released by a rival company. Because you own a variety of companies in a stock mutual fund, you diversify away (i.e. reduce your risk) if any single, specific company has a terrible event.

Why this matters: Don’t invest all your money in one company. Especially if you work for that company, and your compensation is based on the company doing well. By spreading out your investments, you reduce your risk of catastrophic returns, and smooth out the ride so you can sleep at night.

Question 4 - interest of the life of a loan:

A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the interest paid over the life of the loan will be less

A. True
B. False

Answer: A, True.

Explanation: Because of the shorter life of the mortgage loan, you pay less interest. Remember in question 1, interest compounds every year. When you borrow money, that compounding works against you. Therefore, the faster you are paying off debt, the less time for interest to compound and grow the total amount you have to payoff. The monthly payments are typically larger, but the overall interest paid is less.

To illustrate with numbers, let’s look at the difference between a 15 year & 30 year mortgage, assuming a 5% interest rate for both:

Why this matters: You can see from the example how much money is saved by opting for a 15 year mortgage. Can you afford that extra monthly payment? That’s worth investigating, but you’ll never explore your choices if you don’t know what they are. You can also usually get a lower interest rate for shorter term debts, which saves you even more money. Anytime you borrow any amount of money, the faster you can pay it off, the less you will pay total. Even if you don’t get a lower rate on the debt, if you pay off the principal sooner, that means there’s less interest compounding against you. When looking to borrow money, evaluate what term (length of time) works best for you and your budget. You want to minimize your cost of borrowing, but you also want to give yourself enough flexibility that you’re confident you will make all those payments on time, regardless of what life brings.

Question 5 - Bond prices and interest:

If interest rates rise, what will typically happen to bond prices?

A. They will fall
B. They will stay the same
C. They will rise

Answer: A, they will fall.

Explanation: This is the question most people get wrong. A bond is government or corporate debt. The government or company pays you coupons (interest payments) based on the issued interest rate. At the end of the bond’s life, it matures, and you get the principal back.

Imagine Disney issues bonds paying 5% interest, the current market rate. You purchase a bond for $1,000, and you get a $50 coupon payment from Mickey Mouse every year until the bond matures. If interest rates rise next year (say to 8%), and Disney issues new bonds, they will issue them at the new interest rate. Your neighbor Laura decides to buy $1,000, and she gets an $80 coupon from Mickey Mouse every year. Because interest rates rose, the value of your bond paying $50/month goes down in value, less than $1,000, because the $1,000 could buy Laura’s bond paying $80/month. The reverse if also true. If rates had fallen to 3%, Laura’s bond would only pay her $30, and your $50/month bond would be worth more than $1,000.

Why this matters: Interest rates change over time. This causes bond prices to change. Bonds will still be less volatile than equities, but they do also fluctuate in value. Don’t panic when you see interest rates rise, and your bond prices going down in value. This is both normal and expected. Rising interest rates are also usually a healthy sign for the economy, and so your equities will generally be rising in value to help offset the loss in value of your bonds. The reverse is also true here. Falling interest rates tend to indicate a less healthy economy (think about when rates have dropped significantly & quickly; the 07-08 financial crisis and COVID-19) which means falling stock prices. Because they don’t tend to move together (uncorrelated), bonds and stocks are an excellent pair for smoothing out your investment returns.

How did you do?

If you got some questions wrong, I hope you understand the why behind the answers and how to utilize this knowledge to better your financial life. If you have questions about financial vocabulary or systems you’d like me to blog about, please email me at andrewg@humaninvesting.com. If want to talk to an advisor, please email us at hi@humaninvesting.com.

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