As of this writing, 2015 has not been a great year for the United States financial markets. As of today, the S&P 500 index (possibly the truest representation of the US stock market, seeing as it's the broadest index) is down 6.69% for the year. To contrast this with previous performance of this index since 2009:
- 2009: Up 23.75%
- 2010: Up 13.14%
- 2011: Down, but only 0.87%
- 2012: Up 13.91%
- 2013: Up 30.5%
- 2014: Up 12.93%
Over the last decade, I've had more than a passing interest in the field of personal finance, since I believe it informs us a great deal about the human condition. Conservative or liberal, Democrat or Republican, we're all capitalists and we all work to make money, hate it or love it, ostensibly to improve our lives. Money is inherently neither good nor evil; it just is, because of rules we've agreed upon as a society. It's truly fascinating, especially when you consider how even the world's greatest economists can make only marginal progress toward understanding how money "works".
Anyway, I wanted to devote some space here to discuss not only my approach toward personal finance, but also some of the best teachings I've ever had regarding the topic. I'll try in this article to keep things interesting and not go too deeply into the weeds. I will also try to show you with concrete examples how I calculate stuff (this may be in polar opposition to the previous statement), because I've developed a system over the past several years that I feel works very well - at least for me, though I admit I am the type of guy who is happiest inside a spreadsheet. Let's get started...
Belief #1: Invest, and Ye Shall Be Saved
When I graduated from Rutgers in 2006 and got my first job, my father insisted I start contributing to my employer's 401(k) plan as soon as possible. As I've mentioned before, I lasted at that job for about eleven months before leaving for graduate school. I invested about $3,000 over those eleven months, rolled it into a self-directed IRA after I quit, and lost almost half of it in the Great Recession. (I made a stupid investment - I failed to diversify, a mistake I routinely try not to make again and invest dozens of hours each year in order to avoid in the future.) Since then, though, I've turned that three grand into over four grand, just through compound interest (without saving a single additional dime into that account).
In fact, in thirty years (when I'll be 61 years old), that measly three grand will have grown to over $146,000, not counting inflation and assuming the S&P 500 index continues to grow over the next thirty years the same way it's grown over the last hundred-plus years*. (*NOTE: This may not happen, but it likely will.)
One of my favorite tools on the entire internet is MoneyChimp's Compound Interest Calculator. It's simple, but elegant. You input the amount you've already saved; how much you plan to save each year in the future; input an interest rate and a number of years, and that's it. The calculator spits out how much money (in present-day dollars) you'll have at a certain point in the future.
You can play around with the above calculator as much as you'd like, but over many instances of using it, I've learned the following:
- Interest rate matters a ton. If you assume 7% compound interest over a thirty-year period (a safe, conservative assumption), you'll get about 20% the output as if you assume a 12% interest rate. Which interest rate is more accurate? No one knows for sure, but my favorite personal finance article ever claims that historically, over a thirty-year period, the S&P 500 index has never returned less than 12% annualized. More often than not, I assume 7% because I'm a pessimist, but 10% or even 12% is probably more accurate.
- Time matters just as much. Realistically, most people I know will have to save at least one million dollars before they can retire. Assuming you draw down 4% of the total in retirement each year, having a cool million saved means you can live on $40,000 each year (tight, but maybe doable if you make some adjustments). That 7% (or 12%, or whatever) interest rate really works its magic over medium-to-long periods of time. That's the power of compound interest; it, y'know, compounds.
- Continuously investing matters, but not as much as having already invested. It's pretty clear, if you didn't know this already, that continuously investing a set percentage of your paycheck matters a lot toward building wealth. You get to "dollar-cost average", which essentially means you invest the same amount whether the market's up or down at a given time. Your dollars are more powerful when the market is down, but since you've set it and forgotten it, it only matters in the long run. As an exercise, though, hop on the Compound Interest Calculator and assume you've already invested $200,000. Set your interest rate to 7%. If you set your annual addition to twenty grand, you'll have $3.7 million dollars after 30 years. If you invest thirty grand instead, you'll have $4.7 million; more, but not a ton more than $3.7 million, in my opinion. What matters most is having the two hundred grand already invested - if you only had, say, twenty grand in the stock market right now, you'd have to invest $45,000 each year in order to hit that same $4.7 million dollar mark in thirty years. Since no one I know can afford to save $45,000 per year, it makes sense to save a little bit each year, starting from an early age.
Belief #2: Track EVERYTHING.
I keep tons of spreadsheets, but the two most germane to this article are (a) my monthly budget spreadsheet and (b) my net worth tracking spreadsheet. I'll discuss both of these in some detail, below.
I update my monthly budget spreadsheet every time a significant life event happens (e.g, a change in income, a change in employment status, a change in family status). What it contains changes each time I update it, but the core worksheet is always the same. Down the left-hand side, our household's monthly expenses are listed, row by row. My wife and I have separate columns, beginning with our gross (pre-tax) monthly income and ending with our net (post-tax) monthly income. After that, we deduct each expense from that amount (depending on whose responsibility it is to pay that bill). At the bottom of the spreadsheet is the amount of money we have left over each month after saving and paying our bills (a very fortunate thing for us).
Below is an example of what I'm talking about, with the details completely blacked out:
The devil is in the details: your spreadsheet is only as honest as you are, and if you routinely blow your stated budget on "Credit Cards" or "Dining Out," you might as well wipe your behind with it. There are several items on this list I've had to revise (sadly, mostly upward) over the years to reflect reality. But in the long run, it's turned into a highly useful tool which has allowed me to quantify our ability to output more money as a household than we've input, each and every month.
My net worth spreadsheet is password-protected, and if my wife outlives me, it's going to be a pain in the ass for her to open it. I update it twice per year; once in May (which happens to be the month we closed on our house in 2011; this was the single most impactful financial decision of our lives to date, so it makes sense to track our wealth each May) and once in December (as my income is bonus-dependent and I get said bonus in December each year).
I update this spreadsheet relatively infrequently, because a person can drive themselves nuts (and make bad decisions as a result) worrying about month-to-month fluctuations in net worth which end up signifying absolutely nothing. While there are personal finance sites (such as Consumerism Commentary) out there which focus on regular people updating their net worth monthly, this feels less like reasonable personal finance and more like lifestyle porn to me. If I have my specific details taken care of with my monthly budget spreadsheet, the net worth spreadsheet is for the big picture stuff and as a result, it does not need to be updated any more than twice per year.
The rows of this spreadsheet represent our core assets (e.g., investment accounts, home equity) and our debts (e.g., mortgages, car loans, student loans). Each May and each December, I update the spreadsheet with the present values of each asset and each debt. The formulas I've created calculate our net worth as the simple subtraction of our debts from our assets. Below is an example of this, again with the details completely blacked out:
The most important column in the spreadsheet is the "YOY (delta)" column. This calculates the year-over-year appreciation (or depreciation) of each row in the spreadsheet. I mentioned before this is a big picture spreadsheet, and with the information this column provides, I make big-picture decisions about whether our household's finances are heading in the right direction. I put a ton of faith in the "YOY" column.
The most important row in the spreadsheet is the "Net Worth" row (of course). It's nice to see our net worth grow each year (though it frankly may not in 2015), and quantifying the extent of the growth builds confidence that what we've built so far can continue to grow with time.
Belief #3a: Buy and Hold
Belief #3b: Don't Trust Most "Experts"
I put these side by side because they together inform my beliefs regarding long term investing. The first statement is my strategy for selecting investments, and the second is my strategy regarding taking advice about these investments. (I realize if you're reading this column you may be taking my advice - do so with a grain of salt, as I am not a financial professional, just a regular guy making it through this mortal coil as effortlessly as I can.)
The second statement might be the more controversial of the two, so I'll address it first. There are undoubtedly financial advisers out there who believe the truest way to grow their business is by serving in the best (e.g., fiduciary) interests of their clients, there are many more who believe the truest way to grow their business is through higher commissions charged to their clients. In general, I don't trust many people in the financial field because through my work, I've seen many of them don't operate in the best interest of their clients. I can afford to make this claim because of Belief #3a, which allows me to state virtually no one knows how to play the stock market in the long term, so the best you can hope for is to ride the stock market.
This, too, is a somewhat controversial claim. Each year, there are mutual fund managers whose funds beat the market. There are even some who may beat it reliably for a few years. My argument is the percentage of mutual fund managers who routinely beat the market is the same as the percentage of online poker players who routinely make money. (It's a low percentage, in both instances, though you wouldn't believe it if you heard other people's boasts.) As a result, I invest my money passively - meaning I don't count on human beings to make informed stock picks, instead choosing to invest in entire markets and indices (such as S&P 500 index funds).
This doesn't mean I don't pick stocks occasionally. I do, but it treat it the same way I treat my online poker habit - as gambling money. I put a very small percentage of my portfolio towards it. If I make money, great. If I don't, no big deal. It's just for leisure and entertainment.
But when it comes to saving for retirement - something I hope to do at some point in my fifties - the stakes are as serious as they can get. My belief is that despite whatever amount of intelligence I may have, I am not smart enough to pick stocks and I am not smart enough to pick stock managers. I can only control the fees I am charged, so I seek to keep these as low as possible. I do it by investing in index funds, but there are other methods that work too. You can read one of the books I reference below, if you're interested more in this.
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There are other topics I could write about here as well (such as diversification, which may alone be more important than anything else described above), but I'd be stepping way out of my depth in doing so. I'm telling my personal story here, and of course, your mileage may vary.
If you're interested in learning more about this (to me) highly interesting topic, here are some books which have helped me over the last ten years:
- The Wall Street Self-Defense Manual, by Henry Blodget: The first serious personal finance book I ever read, written in newbie-friendly terms (and only 98 cents!).
- A Random Walk Down Wall Street, by Burton Malkiel: The go-to guide for the rationale behind passive investing. A bit more technical, but still a good read. I re-read it, usually on the beach, every couple of years.
- The Four Pillars of Investing: Lessons for Building a Winning Portfolio, by William J. Bernstein: The most technical book I've ever read on the topic (written by a neurologist and investor), but worth the effort. When I mentioned diversification above, this is the book I refer to when rebalancing my portfolio each year.
