These 7 Money Decisions (Should) Guarantee Long-Term Prosperity
This isn't financial advice. It's the advice I would give to a younger-version of myself.
Dear CMQ Investors,
You are about to read something that I wish I could have read in my twenties. I am in my early thirties, and as I wrote this, I imagined I was writing it to a younger version of myself.
I was inspired by Harold Pollack, a University of Chicago professor who went viral in 2013 after saying that all the personal finance advice you need can fit onto a 4x6 index card. I have included his viral flashcard at the end of this post. This post is my version of the flashcard.
The Financial Decisions
1. Avoid credit card debt like it’s the plague.
There is nothing worth having that comes with double-digit interest rates.
If you have credit card debt, don’t beat yourself up, but make paying it off your number one financial priority. You should not invest a penny until you pay-off your credit card debt in full.
Remember: Credit cards themselves are not bad. You can use them to boost your credit score. If you have a credit card that you use for some basic expenses, and you are 100% confident you can pay it off in-full each month, it will help your credit score.
2. Spend less than you earn each year.
This is time-tested common sense. If you spend less than you earn, and you make rational decisions with the excess money, you will do just fine.
This requires that you are frugal. It helps that you do not buy things just because you want to impress other people. It helps if you do not have expensive hobbies (or habits).
There’s no shame in being frugal. A lot of the wealthiest individuals in the world are almost comically cheap.
Warren Buffett still lives in the same home he purchased for $31,500 in 1958, and as you can watch in the video below, he buys a cheap McDonald’s breakfast every morning.
3. Know how much money you need for your yearly expenses.
This is an essential activity. When you know the number, then you can focus on reducing it. And since living below your means is essential for creating long-term prosperity, this is where you must start.
The good news is that doing this is fairly easy. There are apps that help. You can also do it the old-fashioned way by downloading a .csv file of your transactions from your bank and credit card providers. Upload it to Google Sheets or in Excel and take it from there.
4. Keep three-months worth of expenses in a high-yield savings account.
Having an emergency savings account is one of the best pieces of advice I applied in my twenties. It wasn’t easy. I was living in New York City (expensive) and making less than market rate because I was an early-stage employee at a venture-backed, technology startup. But I made it happen.
That same company, for reasons I can detail later, went out-of-business without warning. I decided I wanted to start my own business. Had I not had the financial flexibility that the emergency savings account provided me, I would not have been able to do that.
Bonus tip: The reason you want to use a high-yield savings account is because your money will make money with zero risk. Make sure the account is FDIC insured (most are). This means that you are automatically given ‘deposit insurance’ for up to $250,000 which is why I say “no risk”. (Hopefully your three months expenses are not more than $250,000).
5. Make consistent contributions into a retirement account.
If you work for a company that offers a 401K, make sure you are contributing to it regularly (and the maximum amount). You do not have to pay taxes on the income you contribute to your 401K. This is a huge advantage. You don’t pay taxes until you take your money out, which is hopefully in your retirement years.
If you do not have access to a 401K, you can open a retirement account on your own. Do this if you do not have a 401K. A Roth IRA is probably the smartest move. While you have to pay taxes on the money you contribute to your Roth IRA, the money you withdraw (which includes your gains) is tax-free.
6. Choose index funds instead of individual stocks.
The past doesn’t predict the future, but there is substantial evidence that making regular investments into a low-expense index fund (e.g. VTSAX) is the smartest way to grow your wealth.
The vast majority of investors, including the professional investors, do not beat the market over the long-run. Why should you assume you can beat the market?
Even if you have a good idea about an individual stock, and you put all your excess capital into it, how will you respond if/when the market tanks? Do you have the psychological fortitude to stick-it-out? Most do not.
Warren Buffet himself recommends this approach. Here is what Warren Buffett told LeBron James when LBJ asked for his advice on investing:
“…owning a piece of America diversified piece bought over time held for 30 or 40 years — it's bound to do well and the income will go up over the years and there's really nothing to worry about…nobody's ever followed that and gotten other than a decent result.” — Buffett
Like with any investment, make sure you understand what you are buying before you just follow my advice or anyone’s advice, for that matter.
7. Understand (and use) compound interest.
The reason you sensibly invest as much as you can each year, and beginning when you are young, is because this allows you to benefit from the mathematical phenomenon known as compound interest. There are no ‘secrets’ to becoming wealthy, but compound interest is the closest thing to a secret. CMQ stands for compounding money quietly. It’s not flashy, but it’s how you accumulate wealth over your lifetime.
Bonus Content: The Flashcard from 2013
Pay your credit card bill in full every month.
Keep a budget and spending diary. Pay cash up front whenever you can.
Don’t smoke. Mind your alcohol and dining spending, too.
Start saving early. Make it automatic, ideally through a 401(k).
If you have a job and no kids, aim to save 20% of pretax income.
Invest in low-fee total stock index funds, ideally in a 401(k).
Open a Roth IRA if you don’t have access to a 401(k).
Don’t buy individual stocks or try to time the markets.
Think federal first when borrowing for school. And don’t combine public and private loans if you consolidate.
A focused and rigorous major matters more than where you go to college.
Don’t push your friends to overspend. And beware the same peer pressures applied to you.