This post is part three of a series that is meant to serve as a quickstart guide to finances I am calling Spending Less. My goal is to post it as quickly as possible to hopefully begin helping people, so I may revise it after initial publication.

You can find part one here.

Step Eight – Determine your ultimate need

How much will it cost you to live in retirement? How long will it last? How many doll hairs do you need to safely support that? How long will this take you?

These can be scary questions. Maybe you’ve never considered the answers, maybe you’ve been purposefully avoiding them. It’s important to quantify.

Until you consider these questions and quantify the answers, you’re taking a stab in the dark. You’re saving money, but for what? Are you on track? Ahead? Behind?

To be fair, maybe you don’t plan on ever retiring. That’s fine too, but let’s make the decision a conscious one. Even if you’re not planning on retiring it’s important to consider how you’re going to support yourself and what your goal is if not that.

One easy rule of thumb is to use the 4% rule. While it’s beyond the scope of this piece, let’s assume that a 4% withdrawal rate is a safe way to go about retirement or financial independence. Living off 4% of your portfolio per year, assuming this is enough for you to live off of, is virtually guaranteed to allow you to live without depleting your portfolio, regardless of what age you start.

Figuring out how big of a stash you need to safely live by the 4% rule is pleasingly simple: divide your desired yearly income by .04 (4%) or multiply by 25. For example, if you can live comfortably and happily for $40,000 a year (some people will gasp at how low this is, others how high – it’s perfectly doable and simply an example), you can retire once your net worth (assets minus debt, of which you quite sensibly have none) hits $1,000,000 in today’s dollars*.

From there it’s easy to figure out how many years it will take at your current savings rate (how much more you need to save in total divided by how much you save per year), how much you would need to save each month or year to hit your goal in x years (how much more you need divided by x units of time), etc. Simple math.

Step Nine – Begin investing

“Woah there, Wallet” you’re thinking, “I thought you were telling me NOT to spend my money! Now you’re telling me to buy things?”

Well, maybe. Let’s back up a bit.

In order to build wealth and retire (early or not), you need to start investing. Putting your money to work, if you will (the only situations in which you can probably skip this are if you won the lottery, are a trust fund baby, or are already independently wealthy. In any of these cases, please contact me. I will gladly accept gifts to support the important work I am doing here for humanity. Also, why are you still reading?).

The simple truth of the matter is, your money needs to be working for you. They don’t say “you need money to make money” as a joke.

A wise man once said, “Poor people pay interest. Wealthy people get paid interest.” Or something like that. Okay, I’m not sure who said that or when, but it’s worth taking note of! That new car that costs your annual salary – totally makes sense right? Interest rates are low, financing is easy, let’s do it! In fact, instead of just paying a years salary, let’s pay more than that! Not my idea of a good time. Let’s put our money to work for us instead of working to catch up to the money we’ve spent.

Compounding (where your interest goes on to earn more interest for you, which then goes on to earn more interest for your, and so on) isn’t called the eighth wonder of the world for nothing! Even small amounts invested consistently over a long enough period (or higher amounts over a shorter period) can quickly grow to vast sums that will allow you to choose how you would like to spend your time, instead of having it chosen for you and being tied to golden chains.

How does one go about investing, though? I am going to provide one example here that I think will be good enough for most people, especially if you’re just starting off. I am by no means suggesting that this is the only way or that you should just take my word for it, but if you are reading this and don’t want to spend a lot of time researching this topic on your own, this is the best advice I know to give you. Many books and articles have been written on this topic (some of which I’ve even read) and I will cover various aspects of this topic in more depth as time allows, but a thorough review of all the information is beyond the scope of this post. If you want to cover this topic in more depth, I’ll refer you to Jim Collins’ excellent Stock Series.

The first step is determining where you are at in your journey to financial Independence. Are you still working on accumulating wealth, or are you already there and looking to preserve it? Is your tolerance for risk high or low? What type of time horizon are we looking at? Do you plan to reach FI within the next year or two? Five? Ten? Twenty?

Based on your answers to these questions, you can decide on a distribution between the two major asset classes we’ll be considering: stocks and bonds. The more risk you’re willing to take the earlier you are in the accumulation phase, and the longer you have to invest, the more you should allocate to stocks. Stocks are the most effective wealth building tools we’ve seen in history, but it’s a bumpy ride.

In the wealth preservation stage? Less willing to take on risk? Shorter time horizon? Add bonds. Bonds won’t get you there quite as quickly as stocks, but they can serve to smooth out the ride if you’re not sure you have the wherewithal not to sell in a downturn or crash. I am personally almost 100% invested in stocks because I have a high tolerance for risk, a long time horizon, and don’t mind a bumpy ride.

The most effective way to invest in stocks is via mutual funds. Mutual funds allow you to purchase entire portfolios of stocks and in some cases even every possible stock in the market. This is a huge benefit because owning individual stocks exposes you to additional risk associated with each of those individuals companies.

Diversifying your risk in this way means that the poor performance of one company won’t really affect the overall performance of the market. There are many reasons we won’t go into here why the stock market will always go up over time, even if it’s a bumpy ride. Because we know it’s a bumpy ride, we will mostly ignore short-term volatility, knowing it will eventually continue it’s relentless march upwards.

Mutual funds also have the benefit of often not charging commissions (as purchases of stock often do) and having low management fees. In particular, we are looking for passively managed funds, as it is exceedingly rare for actively managed funds to consistently match the returns of passively managed ones, particularly over long periods of time.

While many companies offer these products, Vanguard stands far and away above the others. Vanguard has a unique organizational structure where it is owned by the mutual funds it manages. This aligns the interest of shareholders and managers in a way that is unique in the financial world. Vanguard also generally has the lowest fees for its funds, which makes a huge difference over the long run. For what it’s worth, Vanguard doesn’t pay me any money or know that I’m promoting their services.

Specifically, I would recommend purchasing the Total Stock Market Mutual Fund for stocks and the Total Bond Market Mutual Fund for bonds. An easy rule, if you’re completely lost and don’t want to go 100% stocks, is to subtract your age from 100 to get your allocation to stock (with the rest going to bonds) or your age from 120 for a more aggressive allocation. There are also Target Date Funds which will automatically choose allocations for you and shift to more conservative allocations over time as you near retirement, although this will entail slightly higher fees.

While we now have an idea of what we might want to buy and from who, we still have to figure out where to hold these investments. The basic idea is that there are certain types of accounts that are tax-deferred, so that you only pay tax on part of the money and its growth or pay it later, allowing it to grow unhampered first.

The most common tax-deferred accounts are the HSA, 401k, and IRA. My recommendations in order of ability to find would be to contribute to your 401k up to the employer match if you have access to it, max out the HSA (and not spend it), max out the IRA, go back and max out the 401k, and then if you still have funds to invest fund a regular taxable/brokerage accounts. This should maximize your tax savings in most cases.

For the 401k and IRA, you also have to choose between traditional (tax benefit now, may pay taxes later) and Roth accounts (pay taxes now, don’t pay taxes on growth later). There are reasons either could be beneficial depending on your specific situation, but if you’re just looking for a quick answer I would recommend the traditional version of each account unless you plan on working forever and making a lot more in your later years (when you would be withdrawing the money) than you are now. Even then, the benefit can be dubious. If you’re interested in diving deeper into this topic, refer back to the stock series or check out these excellent posts by The Mad Fientist and Go Curry Cracker.

This section, in particular, glossed over a lot of details due to the depth and breadth of this topic. Once again, this is only intended as a quick primer and not as the definitive, cookie cutter answer for you, although I do believe it is one of the simplest and most effective solutions that would work well for most people and reflects the views my own investment philosophy and decisions are based on. I will be writing in much more depth on these topics in the future.

Step Ten – Next Steps

At this point, you should be well ahead of the crowd with a solid grasp of the basics. This should be enough for most people to get a grip on their finances, tackle and eliminate any debt, build up a rainy day fund, and begin planning and saving for retirement.

Conceivably, if you want to focus as little on money as possible, this could have most of the information you need to get you to financial independence and beyond. If that’s the case, most of this will begin running mostly on autopilot once you get past the initial learning and setup phases. All you need is some basic maintenance: checking in with where you’re at every month or so, rebalancing about once a year if you’re doing that manually and not 100% in stocks, and watching your stash grow.

Otherwise, your main decision is whether to dig deeper. Maybe you want to learn more about investment strategies, whether real estate could accelerate your path to FI, tax optimization strategies, more advanced or radical strategies and tactics for tackling debt or saving money, or a host of other topics. You can spend as little or as much time as you’d like on this, as it’s a pretty deep rabbit hole.

As always, I wish you the best on your journey. It is my sincere hope that this quickstart guide helps you to live a happier, healthier, more fulfilling life, both financially and otherwise.

If you have any thoughts or ideas about how I could make this guide better, please let me know as I consider it a living document. For more content like this, deeper dives into these individual topics, and much more, subscribe or visit me here!

Love,
(Your) Wallet