Kind of a longer blog post today, but a good one! For people with ... shorter attention spans, I'm also breaking this out into a series of posts on each topic (which you can start here.)
There are a million ways to do anything, but my advice is always to start with small, manageable, and repeatable actions to build good habits. Having a good relationship with money has little to do with a high income and how much nice stuff you own and everything to do with living within your means and saving what you can.
Making big, sweeping changes all at once can set you up for disappointment when you inevitably hit a bump in the road. Instead, start small with actions you know you can manage and let those small victories build into something you can be proud of. Here are four easy to understand foundational habits that anyone can start using today, followed by deeper dives into each:
Spend a little bit less than you want to.
Save a little bit more than you have been.
Pay off debt a little bit faster than you need to.
Invest what you can when you can for the rest of your life.
I consider those four topics – cash flow, saving, debt management, and long-term investing – to be foundational to good financial health. I start each client relationship with a review of those fundamentals to establish a baseline (where are you right now?) and identify easy to understand practices that can help build the habits that will take you where you're going. There are certainly other important topics in personal finance, but getting those four right will set you up for a lifetime of positive financial health.
So let's dive into each topic and identify a few easy to understand ways to build good habits!
1. Spend a little bit less than you want to.
Morgan Housel calls wealth "the ability to do what you want, when you want, with who you want, for as long as you want to", and that's as good a definition as any I've heard. Another way to think of wealth is as potential: the opportunity to change your circumstances using money. So how do you get there? The first step is mastering your cash flow.
The basic formula for cash flow is this:
What You Earn - What You Spend = What You Can Save
Your savings represents all the potential you will ever have to change your circumstances in the future. In other words, your ability to save directly correlates to your ability to build wealth. I'm going to make the argument next week that saving could actually come before spending in terms of keeping it easy, but there is a compelling reason for starting with spending: earning and saving often depend on circumstances, but spending is completely up to you.
Yes, you can get a raise or take on more work or increase your fees to bump up the income side of the equation. But all of those options are at least partially out of your hands. Will your boss agree to a raise? Will your clients hire you more often or pay you more money? That can certainly happen over time, but the "when" of it is not up to you.
Spending, on the other hand, is in your control and you can change your spending today to improve your financial future. I'm never going to tell anyone to live like a monk for the next 30 years so they can finally live their dreams when they are old and rich. You've got to have some fun along the way! But I strongly believe that nearly everyone can spend a little bit less without impacting quality of life in any noticeable way. Let's start there!
Here are three ways that you can take action today to reduce your spending:
Choose 2-3 expenses that you can skip for a month, then evaluate the impact on your life. An easy place to start is subscriptions like streaming video, music, or news services. If the difference is minimal, consider eliminating those expenses indefinitely. If you decide to bring an expense back, look for another one to skip next month.
Set a "double check" policy – and a time delay – for any purchases above a pre-determined dollar amount. For example, you could say that any purchase above $50 requires a second evaluation after 30 minutes. This gives you an easy to remember rule to help prevent impulsive purchases. For even more accountability, ask a close friend to be the one to give the thumbs up or down. It's much easier for someone else to be objective when it comes to your spending.
Wait until the end of the week to buy the items in your Amazon (or online retailer of your choice) cart. With one-click purchasing available at all times through our smart phones, there is very little separating impulse from action when it comes to online shopping. Add a little resistance by waiting until a specified day & time to review your cart and make purchases. What seems super exciting in the moment might seem totally unimportant after 6 days.
2. Save a little bit more than you have been.
There is a push-pull relationship between saving and spending – the more you spend, the less you save and the more you save the less you can spend. In other words, a lot of savings tips also improve spending habits and vice versa. Here's that equation again:
What You Earn - What You Spend = What You Can Save
I'll say it again and again: your savings represents all the potential you will ever have to change your circumstances in the future. I want to enjoy my present as much as the next person, but tend to think that having more options in the future – including the option to work a little bit less – is a good thing. Luckily for us, saving is one of the simplest money habits to put on autopilot.
The common way many people think about saving is something like, "I buy what I need to buy and whatever is left over I can save." While that's true, I think it puts the cart in front of the horse. Consider two scenarios: 1) I hand you $100 and say, "use this money however you want, but save whatever is left" or 2) I hand you $80 and say, "I already set aside $20 in your savings account, so go ahead and spend all of this without worrying". Which version seems easier to you?
Rather than waiting to see what remains after bills are paid and groceries are bought (and a treat now and then because you should have some fun), it's easier & more effective to save before deciding how much to spend each month.
Here are three ways you can build positive money habits by saving:
Automate contributions to retirement accounts – This is easy to do if you have a workplace account like a 401(k) where the contribution is taken out before you receive your pay, but only takes a small amount of extra effort when contributing to an IRA or self-employed retirement account like a SEP IRA. Pick some target amount that you know you can live without each month and schedule recurring contributions on an easy to remember date (like the first of each month). Pro tip: it's better to start with an amount you know you can manage, rather than choosing a "perfect" amount that might cause stress down the road. You know what happens when new habits become stressful? People give up. Better to start small and adjust up once the habit is well-established. Could you save a dollar a day? How about $10 per week? Or $100 per month? Focus on finding an amount and frequency that feels effortless.
Out of sight, out of mind – I've found that I am very loose with my spending when my checking account is flush with cash, but quickly become frugal when I notice the balance dwindling. Does that sound familiar? You can use that tendency to your benefit by establishing a target maximum balance for your checking account and transferring everything above that amount into a savings account. Bonus points if that savings account is at another bank – that extra friction of waiting a day or two for transfers means you will be less likely to grab money from your savings for impulse buys. By limiting how much of your money sits in your checking account, you can manage both spending & saving with one easy to remember rule (especially helpful for self-employed people).
Use the 2x Rule – (Full disclosure: I am 100% ripping this off from Nick Maggiulli's book "Just Keep Buying".) Whenever you want to splurge on something nice for yourself, commit to saving an equivalent amount for the future. Let's say that I want to treat myself to a brand new fitted Durham Bulls baseball cap (the season starts in just over four weeks!) at the going rate of $38. Before buying it, I would also need to commit to saving $38. If that 2x price tag changes your opinion, perhaps you should wait on the purchase. On the other hand, if you decide to go ahead and splurge, you can feel better about your treating yourself because you also made an equivalent positive decision for your future. Huzzah!
3. Pay off debt a little bit faster than you need to.
Most of us are taught variations of this lesson at a very young age: debt is bad, living with debt is stressful, and you should eliminate it whenever possible. Being debt-free is certainly an advantage, but debt is a financial tool that – like all others – has its upsides & downsides.
Debt can be a means to acquire a home (which can build long-term wealth) or pay for higher education (which can increase income potential). Those are both great things. But unsecured debt, like credit cards, can quickly become an unmanageable burden and even "good" debt – the kind used to pay for something that will improve your overall financial health – can get out of control if people start skipping payments.
Paying down debt is important, but it is only one part of financial health. Before you go all-in on eliminating debt from your life, it's important to consider the state of your emergency fund, retirement savings, and overall impact on monthly cash flow.
Here are three ways you can keep it easy while repaying debt:
Always pay at least your minimum payment – every lender wants to get their money back, so they create a payment schedule by which you can repay your entire loan.* Sure, they're happy to charge you interest along the way, but you will eventually eliminate the debt if you pay the minimum amount on time without adding additional debt. Once you start skipping payments, though, you'll be hit with both accumulating interest fees and late penalties. You can avoid those unnecessary costs simply by paying the minimum fees each month. Also, on-time payments can improve your credit score, giving you more reliable access to loans in the future, while late payments will erode your credit score and make it harder to access loans.
Not all debt is created equal: prioritize high-interest debt repayment – Loans that are backed by assets are called "secured loans". The lender takes on less risk for secured loans (since they can take the asset away from you if you stop paying) and so they typically offer more favorable terms like lower fixed interest rates for the duration of the repayment term. Unsecured debt like credit cards, on the other hand, is not associated with any assets (the lender can't repossess the groceries you bought with your credit card) and so the lender compensates for the higher risk by charging higher rates that fluctuate based on inflation. That means that not only will you pay significantly more in interest fees for credit card debt, but that interest rate can increase without warning. Again, always pay at least the minimum payment each month for every debt, but if you are in a position to pay more than the minimum amount it's a good idea to prioritize those loans with the highest interest rates.
Overpaying by even a small amount will help you in the long run – A common question is whether to use extra money to invest (which we'll look at next week) or pay off debt. This does not need to be a binary "all debt" or "all investment" question, though; how about a little of each? You can shave months or years and save hundreds, thousands, or even tens of thousands of dollars over the course of a loan by overpaying be as little as 10%. Consider this example: if you bought a house today for $250,000 with a 30-year, 7.4% APR (about the current national average) mortgage and overpaid by just 10% more than the minimum payment ($1,476 instead of $1,342), you would save almost $49,000 and pay off your mortgage five and a half years sooner. Not bad for an extra $134 per month!
4. Invest what you can when you can for the rest of your life.
Let's finish up our look at four foundational habits for improving financial health with investing. While managing spending, saving, and debt are all about what is happening right now, investing is focused on what could happen in the future.
In a nutshell, investing means committing today's money to buy something that is likely to appreciate or generate income (or both) in the future. That could mean buying stocks or bonds; mutual funds or Exchange Traded Funds (ETFs) that hold stocks or bonds; real estate; precious metals; or even some collectibles and art.
The bad news is that the future is always uncertain so there is no guarantee that your investment will turn out the way you want. The good news is that you only need a few simple, easy to understand best practices to be a successful investor.
Here are four ways you can keep it easy while investing for your future:
Think long-term – how likely is it that the stock market will close higher today than yesterday? Or the day after that? The truth is that in the short-term – this week, next quarter, even next year – absolutely no one knows what will happen to the prices of the stock market, real estate, or those gold bars you've been using as bookends. (Anyone who tells you otherwise is full of baloney.) But if you can focus instead on the next 5, 15, or 50 years, things get a lot easier! The stock market averages a positive annual return about 73% of the time, or roughly three out of every four years. That's decent, but still fairly risky. If you look at any rolling 5-year period of the last century-ish, returns were positive about 86% of the time. That's a bit better! And if you zoom out to rolling 20-year periods, there is not one single instance of a negative return.* In other words, the historical data suggests that you can become a better investor simply by remaining invested for a long time.^
Only invest money that you will not need in the next 3 years – as mentioned above, the stock market is up on average about 3 out of every 4 years. That means it also tends to be down about 1 out of every 4 years. What if you've invested the money you planned to use for a house downpayment and this happens to be one of those bad years? Yipes! Investing is simply too risky for any money that you might need in less than 3 years.º Always make sure you are confident that you will not need that money in the next few years before committing it to investments.
Select investments you could imagine owning forever – guess how many of the top ten companies in the S&P 500 from March 2003 are still in the top ten today? I'll give you a hint: it's zero. Even the most successful companies will lose prominence (and investors' money) over time. But some investments don't come with any inherent expiration date. Index funds allow you to invest in hundreds or even thousands of different companies in a convenient package, and the holdings change over time to keep up with the relevant index without any effort on your part. Similarly, you can buy funds that track international stock markets, U.S. Treasuries, domestic & global bond markets, and real estate markets in the form of Real Estate Investment Trusts (REITs). Rather than worrying about today's trends, aim to buy investments that you could potentially own for decades or for the rest of your life.
The best time to invest money is when you have it – as the old adage goes, "the best time to plant a tree was 20 years ago; the second best time is now." Lots of people wait on the sidelines until it feels like a safe time to invest ... and end up missing out on years or even decades of lost opportunity. Rather than trying to pick the right time to get in or out of the markets, aim to invest what you can when you can through good times and bad. Adding a consistent amount each month or with each paycheck takes the guess work out of when or how much so that your money can start working for you as soon as possible.
That wraps up our tour through four foundational pillars of financial health, featuring tips on spending, saving, debt management, and investing. There are lots of other important topics, but getting those four right will put you on the path for a lifetime of better financial health – and hopefully with a lot less stress!
I'd love to hear if you've enjoyed this lengthly post or learned anything along the way. Send me an email to drop me a line! Thanks!
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
* That doesn't mean that it couldn't happen, just that it has never happened (and I believe that trend will continue).
^ Warren Buffett is considered one of the most successful investors alive. There are literally dozens (hundreds?) of books written about his approach to investing, presumably so that readers can attempt to replicate his success. What gets overlooked most of the time, though, is that 95% of Buffett's wealth was created after age 60s and 99% after he reached age 50. The staggering majority of his wealth is the result of simply staying invested for a really long time.
º Historical data suggests that investing in bonds is less risky than stocks in the short-term, but still not as safe as cash. Real estate also tends to be more stable than stocks, but real estate is illiquid – you might not be able to find a willing buyer at acceptable prices when you want to sell.
Iseler Financial helps creative professionals remove stress while taking control of their financial futures. As both advisor and accountability partner, we help identify current strengths and weaknesses, clarify and refine your long-term goals, and prioritize understandable, manageable, and repeatable actions to bring long-term financial well-being. Reach out today to take the first step.