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From Harold Pollack

Everything You Need to Know About Investing for You and Your Family

Primary Points:

  • The Index Card of Knowledge: Everything you need to know about investing can fit on an index card
  • Keep It Simple, Keep Costs Low, and Keep investing automatically in broad index funds. 
  • Set all of your investments to automatically be taken out each month–this helps reinforce your spending plan and achieve your financial goals! Don’t underestimate the power of this simple lifehack! 

One of the common barriers to start investing for retirement or one’s future is that the whole process seems too daunting–where does one even start? Isn’t that just for really wealthy people? I can hear the comments continue, “I don’t have excessive money lying around, how could I even hope to do that?” or, “I’m just not that kind of person–I’m not rich!” And behind the objections belie the assumption–That’s just not something I can do or That’s just not me. The “just” in those sentences assumes “this is how the world works, this is my reality.” But it’s a lie, you can do it and it’s actually far easier than you could have imagined. Everything you need to know about investing can fit on a 3 x 5 index card. And University of Chicago professor, Dr. Harold Pollock, did just that. So once you implement these strategies, you can MUST set the autopilot of automatic monthly investing and start to watch the magic of compounding interest work towards your freedom! Even if you’re the “paying down student loan debt / consumer debt” stage, if you can put $20 a month automatically into your investments it will be significantly easier to increase it later on than if you didn’t have it set automatically already. If you don’t first decide what you will invest and automatically have it withdrawn before you can get your hands on the money, you won’t actually invest–lifestyles adjust to paychecks! Something will always come up, so there will always be an excuse to spend your paycheck, which is why setting it up automatically is so important. I like to call this “a good self-sabotage” because I’m sabotaging the behavior I don’t want.  Remember, set all of your investments to automatically be taken out of your paycheck and/or bank account each month–this helps (re)enforce your spending plan and investing plan! For more on this, see 6 Simple Rules for Saving Money .

From Harold Pollack

Match your 401k / 403b employee contributions.

Let’s take it line-by-line:

Match your 401k / 403b employee contributions.  If you’re lucky enough to have a job that (1) provides you with a 401k or 403b and (2) will provide you with a matching contribution, then it’s important to contribute up to the mach. Many companies will mach 3-6% of what you put into your 401k or 403b. It’ll be important to invest in the least expensive passively managed index fund  (e.g. something that tries to match the S&P 500 index, or the total stock market). I personally use Vanguard funds because I trust the structure of the company.

    1. Call your Human Resource representative and ask for a list of funds available in your 401k/403b plan, pay attention to their Expense Ratios (ER) and any load fees (a load fee is a fee they charge just to invest in the fund). Stay away from all funds with load fees or 12b-1 fees, it’s just less money you get to keep and grow in your investments. 
    2. Look for funds with Expense Ratios (ER) below 0.20%. For example, currently Vanguard Total Stock Market Fund Admiral shares (VTSAX) expense ratio is 0.04%. 
    3. Most 401k/403b’s have an additional administration fee (~$70 or higher per year) in addition to the ER–just ask your Human Resource representative, and if they can’t find it for you, call the company that your 401k/403b account is through (e.g. Vanguard, Fidelity, etc.). Or you can look at your statements and figure out exactly which bit is the administration fee if you know the ER of the fund you hold.  
    4. If your 401k/403b plan offers a cheap index fund option (e.g. VTSAX), you might consider attempting to contribute the maximum amount of money into this account. In 2018 the maximum amount you can contribute is $18,500 per year (or $1,541.66 per month).

Buy inexpensive well-diversified mutual funds such as Vanguard 20xx funds

Buy inexpensive well-diversified mutual funds such as Vanguard 20xx fundsThese kinds of funds are called “Target Date” funds because they are all-in-one funds that have a pre-set percentage of stocks and bonds (both domestic and international) that annually and slowly move from more aggressive assets to more conservative assets like bonds as you get closer to your retirement target date. These options cost a little more. For example, Vanguard Target Date 2055 fund has an ER of 0.15% and holds 90% stocks and 10% bonds because it’s a ways off until we reach 2055 and it has plenty of time to grow and recover if the market goes through another 2008. 

    1. This is a great option if (1) you hate the idea of spreadsheets and you want everything to be as simple as humanly possible, and (2) you don’t want to rebalance or think about “asset allocation”.
    2. This option might not be fore you if (1) you are more hands-on and don’t mind spreadsheets; (2) the thought of spending even 0.11% more each year in expense ratio costs will bother you; (3) your own desired asset allocation is different than what a target date fund will offer; and finally (4) You don’t mind rebalancing your asset allocation and the idea of  keeping your own particular asset allocation to your liking is a more comfortable thought than handing that responsibility over to the target date fund. 

Never buy or sell an individual security. The person on the other side of the table knows more than you do about this stuff.

Never buy or sell an individual security. The person on the other side of the table knows more than you do about this stuff. Just don’t do it, it’s not the long-term investors game. Is it exciting, are there opportunities to make greater gains? Sure, but for every 1 security/stock that does well you’ll have many more that will disappoint you for many, many years. You might be able to put together a 15-30 stock portfolio with a low standard deviation (low risk rate) but due to Terminal Wealth Dispersion you’ll actually be losing out. Unless you spend your life learning about investing and are willing to underperform the stock market, do NOT buy or sell individual securities. 

    1. People who sell securities are out to make a profit and often they do not hold to a fiduciary responsibility, thus they aren’t thinking of your best financial interest. 
    2. Fees can easily eat up 25% of your returns so pay attention to them. 
    3. Do not buy annuities or other complicated high-fee structured retirement tools. Watch this video on the devastation of fees and what high expensive annuities can do to wreck your financial future

Save 20% of your money.

Save 20% of your money. For some saving 20% seems outrageous, for others saving only 20% is unacceptable. Regardless, 20% should be a good first goal, but if you hope to achieve FI earlier rather than later you’ll need a higher investment rate–shoot for 50-75%. Please note, saving is different than investing–mere “saving” gets eaten up by inflation while investing in low-cost index funds outruns inflation and actually builds you wealth. All that to say, your percentage rate of investing will all be dependent on what your goals are and the timeframe that is expected. It’s important to know where you’re at currently, and what the possibilities are. It’s a good idea to play with these numbers to find out what it could be. 

( See “How to Make a Spending Plan”)

Pay your credit card balance in full every month.

Pay your credit card balance in full every month. Another way of saying this is if you do use a credit card, treat it like a debit card–if you charge it, it will actually  come out of your checking account at the end of the month. It’s not worth becoming a debtor to an 18%+ credit card company. Being in debt is its own kind of enslavement–don’t do it, it’s not worth your life energy that it takes to make that money. Regardless, you already have a spending plan (See Keys to the FI Kingdom Part 2) and have given every dollar a home so if you spent it, it was already accounted for and you’re ready to pay it off because the money is already there! Freedom is… oh so sweet! 

    1. Though I’m not a big fan of Dave Ramsey, his strategy for the layperson on how to get out of debt and start training yourself for financial peace is a tried-and-tested true approach that can help many people. You don’t have to be religious or hold to Dave Ramsey’s belief system to glean some really powerful tools from him.
    2. Without having your spending plan, you cannot know what your target FI number is, and you’re wandering in the dark financially speaking. Without a spending plan that you observe religiously, you will stumble and find yourself in a financial bind. It’s part of your responsibility of being an adult human being to develop your own spending plan that fits your own unique needs. 
    3. Always spend forward, never spend backwards. In other words, when you get paid at the end of the month–e.g. August 31–that month is for the next month’s expenses. This months bills are paid by last months paycheck. For example, if you get paid on August 31st, that paycheck is pre-spent on September’s bills. In this way you’re less likely to overspend since (1) you gave every dollar a home before it was spent, and (2) you’re not spending and then crossing your fingers hoping that your paycheck at the end of the month will be enough to pay the bills, and (3) it’s psychologically more powerful to pre-spend and keep to the budget than to spend and then hope to have enough. 

Maximize Tax-Advantaged savings vehicles like ROTH, SEP, and 529 accounts.

Maximize Tax-Advantaged savings vehicles like ROTH, SEP, and 529 accounts. I would like to add two vehicles to this list: (1) Health Savings Account; (2) the Traditional IRA not just the ROTH IRA; and finally (3) 457b account if that is an option for you (and as long as your 457b account does NOT have a clause that states something like “I understand that all amounts credited to my account under the Plan are subject to creditors of the Employer in the event of its bankruptcy or insolvency”–your investments should not be subject to the solvency of your employer). The idea behind all of this is, if you’re going to invest your money, you might as well invest it in accounts that will shelter you from taxes in one form or fashion. Said another way, if you invest here instead of your regular Brokerage Account, you save money in the form of taxes you’re not paying to the government. 

    1. If you’re going to invest money you want to first put your money in these kinds of tax-sheltered accounts. On order of priority, here’s where I place it:
      1. 401k/403b company match or SEP (and if you have good cheap options, go ahead and max it out if you can afford to)
      2. Health Savings Account (I’m assuming a HSA company that provides low fees and good options for investing in low-cost index funds. The money goes in tax free, and if spent on healthcare needs, the money goes out tax free, and at age 65 it can act as an IRA if you don’t spend the money on healthcare cost by then. Check out the Mad FIentist on this one.).
        1. But also, you need to recognize the negative behavior that normally comes with choosing a High Deductible Healthcare Plan (HDHP), and the limitations of maximum allowed contributions vs. the high annual deductible. For this and other reasons, I recommend to account for at least a “mortgage payment sized” amount for healthcare costs. So your projections for FI should include a healthy sized amount per month, e.g. $1,000, for your unknown medical needs. You can estimate your monthly premium costs as well as deductibles by using the free plans option–just plug in your numbers and see what options you will have. It’s also a good idea to evaluate different ages (e.g. what might your estimates look like in today’s dollars if you estimated your age at 40, 50, etc.?). This should give you a very clear picture of what to expect regarding your healthcare costs in the immediate future. Currently the tax credit you receive for keeping your costs low are really good and all the more reason to live a frugal lifestyle.  Root of Good has a great post on Subsidy Cliffs and sweet spots for the FIRE community. 
      3. Traditional IRA (I’m assuming a person wants to hit FI early, thus Traditional IRA is the way to go. On why Traditional IRA over against the ROTH, check out the Mad FIentist)
      4. 457b (if the fund options are low and the fees are reasonable)
      5. Brokerage account (only funds with 90% or above qualified dividends. If you’re investing with Vanguard, this information is readily available). If you fall within the 12% tax bracket, and you’re married, and you’ve held your investments for at least 1 year and a day then you’ll be able to withdraw up to $77,200 (in 2018)  and pay $0.00 in taxes–This is because the long-term capital gains tax is not taxed at the same rate as your normal income. It really does pay to keep your expenses down and be a long term investor! If you want to learn more about this cool loophole, check out Jeremy Jacobson’s article on the matter

Pay attention to fees

Pay attention to fees. This cannot be stressed enough. High Fees, front load fees, backend fees such as 12b-1 fees, administration fees, or any other fee that a for-profit investment company can invent. So what constitutes a “high fee?” Its any annual fee that’s 0.20% or higher which acts as a parasite on the total value of investments via percentage of that value. That means, as your money grows, so does the actual dollar amount you spend on fees–they’re lock-stepped. This is absolutely insane that a company can charge more money because the value of your investments has grown rather than the much more rational flat rate fee approach or a graduated flat fee metric. They’re not doing any more work for your account as the numbers in those accounts grow. Even Vanguard–in my opinion the best option out there–still charges a fee based on a percentage (the Expense Ratio) of your portfolio. The more money you have the more money they get to leech off of your account–it truly is a virus model. High fees, like the ones you can find in nearly every investment company, can eat up as much as ~ ⅓ of your earnings

Avoid actively managed funds

Avoid actively managed funds. I spent 10 years in actively managed high cost front-load funds and when I saw the light, I got out as soon as possible. An actively managed fund is a basket of stocks that manager selects and then charges high fees (in today’s market, anything above 0.20% ER) for you to purchase. Often times they have high front-load fees in the range of 5-6%. So if you’re putting back $1,000 each month, before the money even gets there it’s taking a haircut and you’re actually only investing $950 of that $1,000. At first this doesn’t sound so bad… until you start looking at what that’s actually costing you over a 10 year period. A mere 5% on that $1,000 is an opportunity cost of $8,650 before we even add in the 1-2% ER fee! Expand that out over the lifetime of investing and you’re just giving away huge portions of your life-savings to a an evil soulless dehumanizing money hungry corporation that will tell you anything to take your last dollar. 

    1. Actively Managed funds are notorious for high fees as well as Churning . What is churning you ask? It’s an evil practice of buying and selling to generate extra money for the company, and ultimately making a profit for everyone except for you. 
    2. Actively Managed funds try to beat the market–they are inherently looking at short-term gains instead of long-term gains. This defies CENTSability. It is anti-Warren Buffett, Anti-Jack Boggle, and just a horrible practice for someone attempting to build long-term wealth. 
    3. Actively Managed funds often will sell on the down turn of a market locking in a “real loss” rather than waiting out the “paper-loss” and allowing your funds to recover their lost paper value.  Index Funds inherently are immune to this since they hold the market or sector depending on what index you’re holding, and they don’t churn or sell when the market is down in paper-losses.  Actively managed funds make a bad situation worse. 

Make your financial advisor commit to a fiduciary standard.

Make financial advisor commit to a fiduciary standard. If you don’t want to spend a few weekends reading up on this stuff and you really are unsure about your financial context, then finding a flat-rate financial advisor who will commit to a fiduciary responsibility in writing might be a good option for you and your family. One option to consider is Michael Kitces’s organizations.* Another option is Advice Only Financial (Harry Sit from The Financial Buff).*

*I have no affiliations with either of these companies. 

Promote social insurance programs to help people when things go wrong.

Promote social insurance programs to help people when things go wrong. One bit that I would augment here is that most people with poor credit and without means to obtain cash quickly in case of an emergency do in fact need an emergency fund–3 to 6 months worth of cash stored in a high-yielding savings account (e.g. Ally bank, etc.) in case of unemployment or illness. Once that’s done, and you’ve established the principles above, it’s time to promote the welfare of your community. Just like when you’re flying and the airline attendant tells you to put on your own air mask before helping others, you need to secure your own financial stability before giving away your financial resources. If you want to give at the beginning of your FI journey, give by donating your time and energy. I personally find value in giving a set portion of our income to charity. There’s value in giving; it represents the reality of a shared humanity. For example, no one should be afraid of going bankrupt if they have a child who needs to go to the emergency room.  

    1. Consider giving your time to local charity organizations that need your help. Do so responsibly by evaluating how your charity utilizes their resources. Here are some resources:

So there you have it, the basics. If you want more information, I recommend some of the resources found on the Resources page.

What other foundational principles do you use? What’s your own “order of operations”? Let me know what you think in the comments below!

The Financial Bishop
Personal Finance for the Real World

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