Since I became active in WSO several weeks ago, I've noticed a few threads on "I have this much money, what should I do with it?" And the amounts have ranged from $2,000 to $20mm, and to put it bluntly I'm tired of people giving stock tips to strangers when they have no business doing so. Now, astute investors like @heister will definitely give you some great ideas and share experiences on how he's invested his money, but if you ask for stock tips before you've gotten basic personal finance right, you've got it backwards. In this thread, I'll attempt to answer that question on a 30,000 foot level and entertain questions in the comments.
So you know my background, in late 20s, partner in a practice (one of the big 3 wirehouses: MS/ML/UBS) in the southeast with around 500mm AUM, responsibilities are marketing, AM, and general financial planning. I am client facing. I say this because there are several people I know who are help desk people at Vanguard in places like Charlotte who say they're financial advisors just because they have their Series 7 and answer questions about what a 12b-1 fee is. Not to knock that job, but I think it's important you know what I do, for whatever that's worth.
No matter how much money you have, you need to learn basic personal finance habits. Whether we're talking $5k you got as a graduation present, $100k you got as your Associate bonus, or $20mm you got because your friend's startup of which you were a shareholder went public and became the next Angie's List, you need to do some basic things first (in this order):
1. Rainy Day Fund:
This is a pile of cash (not literally, use a bank/brokerage account) that exists solely for emergencies and unexpected expenses over and above what you can take care of from your paycheck. Things like hospital bills, insurance deductibles, major car repairs, speeding tickets, etc. Ideally this should be at least 6 months' salary (not just living expenses, salary), but you'll occasionally hear 3-6 months of expenses. The reason I say salary is because most quality jobs take a while to find (especially if you have to move), so if you can essentially be "paid" for 6 months if you found yourself in Morgan Stanley's commodity business that got sold, you don't have to settle for a lesser job just because your savings account has run dry. Also, if you got laid off and have to go through interviews, you're going to want a new suit, make sure you have the cash to clean up your wardrobe
2. credit/debt:
I could write an entire thread on how to get good credit, what to look for in mortgages, credit cards, etc., but honestly a lot of the incremental benefits you get from one provider to the other are moot. If you don't mind debt, pay down/off your higher interest rate stuff if you have the extra money. Otherwise, keep the minimum payments going. I personally recommend not carrying a balance on credit cards, which may not always be the optimal money decision, but it's a great habit to get into (use it like a charge card, not a loan). If you hate debt, pay it down/off as much as will help you sleep at night.
3. Retirement Savings:
Max it out, period. If you have the salary, max this out even if your company doesn't match. Again, while you may be able to get better returns if you trade pork butt futures, the fact that 401k plans are automatic, passive savings plans (you don't have to make the decision to save each paycheck) make them effective vehicles for the average person. I'm a fan of Roth personally, but it depends on the person. I won't get into the weeds of that here, though. This also includes any on the side savings that's specifically for your retirement, be it revocable trusts, IRAs, etc. Won't get into the weeds of finding out how much you need to save, because this number varies from person to person, but if you truly save the most you possibly can and invest along the way, you'll be fine.
4. Other goal savings:
this includes vacation, weddings, college, etc. The reason I say take care of retirement first is I'm a big believer in taking care of #1 first. You can elope in a courthouse, you can skip vacation, you can borrow for college, you cannot borrow for retirement. After your retirement savings are taken care of, it's time for other things, and the priorities will vary from one person to the other. When you're in your 20s, it may be wedding, then vacation. When in your 60s, it may be vacation, then college/wedding for grandkids. Whatever the case may be, determine where these goals rank in priority, how far away they are, what the dollar amounts will be, and how much you’re willing to dedicate to this goal.
5. Non-financial stuff:
This includes things like POA (power of attorney), HCPOA (health care POA), Living Will, will, trust, life insurance, disability insurance, IRA beneficiaries, etc. It’s a good exercise to review all of this stuff every 1-2 years or every time there’s a death/divorce/marriage in your immediate family. The last thing you want is to die with all of your money going to an ex and have your kids/new spouse be screwed. When you get HCPOA/living will, carry a little card with you in your wallet or in your car that indicates who those people are (wherever you keep your health insurance card) so if something does happen, the hospital can take instructions from somebody. Some firms will even give you an electronic version of this so the hospital can view it right there. Point being, get all of this stuff set up however it works best for your personal situation, and review it on a regular basis (again, every 2 years is fine less a major event in your family).
Notice I didn’t talk about investing here? That was on purpose, too many people lose the forest through the trees here. The thing is, although I’m decidedly a value guy and firmly believe that over long periods of time value stocks outperform, picking all of the best stocks will not help you pay for groceries if you get laid off (especially deep value!). Once you have the above right, you’re ready to get into the weeds and either interview people to help you out or embark on your own and become educated about what to do with your investments. I imagine I’ll get specific investing questions in the comments, so I’d rather not write a dissertation on that here.
Also, I always think rules of thumb are helpful, and even though these are not going to work for everyone and nor will everyone agree with them, here are a few I enjoy (some are overly conservative, FYI)
5 Rules of Thumb
1. Save 10-20% of what you make, put half of that savings towards cash (assuming #1 above is taken care of) and half towards investments. Once your cash hoard exceeds your “other goals” and emergency fund needs, invest that money
2. Never buy a house that’s more than 2x your annual household gross income (your income + spouse, gross of taxes, multiplied by 2. So if you’re both analysts making 100k, don’t buy anything more expensive than a 400k house)
3. Never have non-mortgage debt be over 20% of your budget (cars, student loans, furniture loans, etc.)
4. Take your annual spending, divide by 4%, that’s the amount of money you need to retire with your current lifestyle, in today’s dollars. Obviously that will change if your lifestyle changes and it doesn’t take inflation into account, but still a good exercise
5. And my personal least favorite: your allocation to stocks should be 100-minus your age. I personally do not like this as this greatly depends upon risk tolerance and overall level of wealth, but it will help prevent you from blowing yourself up in the stock market even though it will lower your long term return. I hesitated adding this but I felt it was worth mention.
If you have any questions, feel free to ask here or PM me.
Mod Note (Andy): #TBT Throwback Thursday - this was originally posted on 5/16/14. To see all of our top content from the past, click here.
This is all great advice, assuming you are okay never exceeding the upper middle class. I don't define class status exclusively by net worth, income brackets, or any real "hard" number basis. I would say guy A would be in the upper middle class if he made a million dollars a year and spent 950K of it every year while not achieving any progress towards a truly economic freedom path. I would say guy B would be in the upper class if he made 300k a year at a job and 300k a year off of income derived from investments. Why? He can quit his job tomorrow and replace 100% of his working income. This will free up his time and allow him to do what ever he wants.
Time is what makes you truly wealthy. It takes money to buy time. Therefore money is a component of wealth, but nothing more than a component.
I guess I might as well wade into this "discussion" about real estate. For the most part real estate is a long play for equity gain through marginal to okay asset appreciation. However if you are looking at your investment through the scope of how much will my asset increase in value this year you should pack your bags and just keep moving. That is a loosing game and you will never win in the long run. Could you have made great money doing this in the early 2000s in SoCal or Miami? Sure you could have, however you would have been wiped out if you didn't get out before the middle of 2007. Guess what, when one is in that kind of bull market greed trumps all reason. I don't care what kind of system you pitch me, I will never believe any of you if you say you have the discipline to heed warning sings when you are getting 5% returns every month for just holding the asset.
The point I am making is that the house you live in is the worst investment you will ever make in your entire life. It doesn't matter if you get out in 10 years with a 120% return on your investment. The opportunity costs alone could be valued more than the appreciation. However, home ownership isn't a bad thing, it is actually a great thing. You just can't look at it as an equity investment. It's just has several monetary advantages over renting however since you are directly paying for all of the equity gain derived from debt pay down you are not getting the true value out of the real estate investment.
The real estate game is one of arguably more risk than the stock equity markets. The risk manifests over a much longer period of time but it is still there. There is no such thing as a risk less return. Don't let your valuations teachers fool you, even T-bills have risk.
If someone else isn't paying for your equity, you aren't investing you are just living.
+SB, great post. This information is spot on and summarized in this really handy infographic I came across a while back:
Young monkeys, print this off and try to abide by it. I would argue that prior to contributing to an emergency fund you should be matching your employer's 401(k) contribution as that's free money, but then you should be focused on building your rainy day fund before contributing any more to retirement accounts.
I guess whether or not to match the 401(k) first depends a lot on the level of your company match. If you're in O&G with some crazy 15%+ match then yes, it may be a little aggressive to match. However, I'm assuming most folks here are in finance, which doesn't seem to match more than a few percent (highest I've seen is 4.5%). At these levels, I think the guaranteed 100% ROI on your employer match completely outweighs the marginal drop in the amount you can put towards your emergency fund. Consider these examples:
Emergency Fund 1st Year Analyst Salary = $70,000 Tax Rate = 35% (25% bracket + city and local) Annual Take Home = $45,500 Emergency Fund Target = $22,750 401(k) Balance at Year End = $0
This is a basic example but you can see that after expenses in a major city, it could easily take a year or more to build up that 6 month salary war chest.
Match 5% 401(k) Employer Contribution 1st Year Analyst Salary = $70,000 Company Match = 5% Taxable Salary = $66,500 Tax Rate = 35% (25% bracket + city and local) Annual Take Home = $43,225 Difference in post-tax take home = $2,275 less with 401(k) match 401(k) Balance at Year End = $7,000
Compound that $7,000 over 40-45 years and the ending amount would be astonishing, all for the sake of $2,275 not going towards an emergency fund which is going to take a year or more at least to build up to the full amount anyway.
I completely understand that OP is going for the ultra-conservative, financial independence route, but I think the benefit of throwing a few percent of your pre-tax salary at the 401(k) from Day 1 far outweighs the cost.