Anyone has the ability to take control of their financial situation, and never again let it control them. I promise you it is achievable. And attaining this level of financial freedom all boils down to one simple formula:
Spend much less than you earn and invest the surplus wisely.
And you can do this in five steps.
But let’s first begin our journey by asking a critical question:
Where Does Your Hard Earned Money Go?
Almost everyone underestimates the amount of money they spend each month. I sure did.
When I started my first full-time job after college, I listened to traditional financial planning advice. I made sure that I was saving for my retirement and that I wasn’t spending more than I was earning. And if I had anything left over, I would keep it in my checking account or maybe buy a few “can’t miss” stocks.
I lived downtown, leased a brand new car that I drove at most 3-4 times a month, ate out for lunch during the week, spent money at bars on weekends, paid for cable TV, worked out at a nice gym, and paid the minimum payments on my student loans, all because I knew I could afford it.
Seems like a pretty standard life for a guy in his twenties, and it was.
That all changed the summer of 2016 after I was unexpectedly laid off from my job and endured a life-altering breakup. It not only forced me to reevaluate my life, but I also had no choice but to substantially reduce or eliminate my spending habits just to match my tiny unemployment checks.
After a few months, a crazy thing happened. I realized that spending less did not negatively impact my life at all. In fact, I actually enjoyed reducing my spending and the creativity that was needed to save money.
The simple truth is, if you spend the money you earn, you cannot save it. And if you don’t save, you will be dependent on work income for the rest of your life and will be highly susceptible to events outside of your control such as layoffs, a financial emergency or an economic recession. That’s a tough way to go through life.
The wealth you generate is directly proportional to how much you save, and the most powerful way to increase your savings rate is by decreasing your expenses.
Step 1: Follow Your Dollars
The first and most important step to decreasing expenses is understanding exactly where your money is going each month. The best way to get this clarity is by tracking where each dollar goes for one month to truly understand where your money flows.
This can easily be done online by following your credit or debit card transactions. Once you see the picture a little clearer, you will likely find a shocking amount of unnecessary expenditures in your life that you can very easily live without.
This simple but powerful action will set the foundation for financial success.
Step 2: Decrease Expenses
Here comes the fun part – gaming the system. What an awesome time to be an American citizen. Healthy food is cheap and abundant, ride sharing apps make getting around easy and inexpensive, and music, movies, and television can all be instantly accessed online for next to nothing (especially if you think about how much money it cost to have a media collection less than 10 years ago).
All you need to do is be a bit more thoughtful on what you spend your money on. Just a few little tweaks can positively alter the trajectory of your financial future without negatively impacting your daily life at all.
Where should you start? Consider these.
- Stop buying coffee and lunch during the week – Those routine $4 coffees and $10 lunches really add up. Bringing a lunch is a much healthier alternative and you can learn to love the free coffee at the office. Buy lunch or coffee as a treat every once in awhile rather than a daily, mindless occurrence. You will appreciate it so much more that way.
- Break up with cable – This one is a truly awesome life hack. I was paying around $160 a month for cable until I made the switch to Sling TV. I will never go back. Sling costs $25 a month and streams live TV channels online through the Sling app. I get every channel I need and am saving roughly $1,500 a year with this simple switch. It makes cord-cutting painless.
- Rethink your commute – If you live close enough, don’t drive to work. And instead of public transit, consider walking or biking. Monthly train passes can cost over $100 a month and walking or biking is not only free, but it’s also great exercise and stress relieving. I can either take a 25-minute commute packed in a crowded train or a pleasant 45-minute walk. Walking wins every time. And if you live close to work, do you really need the car? Does it make more sense to use Uber Pool or Getaround when needed instead of paying for a car, insurance, parking and maintenance? If you must drive, there are other ways to save which we will get to later on in the playbook.
- Take advantage of the library – Two summers ago, I decided to set foot in a public library for the first time since I was a kid. To my surprise, the Chicago public library system had nearly every book on my list and is absolutely free. I can renew checked-out books up to 15 times. Additionally, there are apps like Hoopla that allow you to “borrow” ebooks and audiobooks straight to your phone for no cost. If learning is your thing, this is magical.
- Analyze all of your recurring bills – What can you decrease? What can you cut out entirely? Do you still pay for magazines you barely read? Do you need to pay for that Netflix account or can you share a login? Are you stuck with your high cell phone bill or can you shop around or hop on a family plan? Do you need to spend $100 a month on your gym membership or can you find a perfectly good one for $30 or less? Just analyze. If you decide that any of your monthly subscriptions are worth it at the price, keep them. But if there are expenses you can decrease or cut out entirely, it will go a long way.
So now that you have some excess cash in your pocket, what exactly should you do with it?
Step 3: Establish An Emergency Fund
Let’s be honest. Life loves to throw us curve balls. Emergencies happen. People lose their jobs, have unexpected car repairs, injuries, pet emergencies and plenty of other expensive surprises. When an emergency comes up, you want to be able to easily pay for it in cash, definitely not on credit.
This first step is all about having enough money in the bank that allows you to sleep well at night. Start with $1,000 or $2,000 in a savings account earning at least 1% on your money. CapitalOne 360 is what I use.
Eventually you’ll want to work your way up to having 3-6 months of your fixed expenses saved up, but start with a solid baseline first before moving to the next steps. You will sleep much better at night knowing you have money in the bank to access easily for situations that may come your way unexpectedly and you’ll have the confidence to begin your financial journey.
Step 4: Pay Down High Interest Rate Debt
Before you even think about investing, your high-interest debt must be eliminated. If you have credit card payments of any kind, that ultra high interest rate should be considered an emergency and anything you save needs to extinguish that debt now. If you have other debt such as student loans (especially with an interest rate north of 5%) I recommend paying that off before beginning to invest.
Now before we get to step 5, we need to understand a few key aspects of investing.
How to Invest
Once you have an emergency fund in place and your debt is under control, it’s time to put your extra savings to work. All of investing is predicated on your time horizon and risk tolerance, so that must be figured out before a plan is put in place. When will you need the money and how much risk are you willing to take with your investments?
Stocks are traditionally riskier than bonds but provide much higher returns over time. Investing in the stock market is widely considered to be the best way to build wealth long-term because of the magic of compound interest (the interest on your investments earns interest on itself and creates an exponential growth effect over time).
Yes, the stock market goes up and down all the time, but as long as you can afford to take a long-term approach, short-term fluctuations won’t matter at all. In fact, if the market declines, that means you will be buying new shares at a discount, which would be the best way to build your portfolio.
Warren Buffett is widely considered to be the most successful investor of all time and firmly believes that passive investing, not stock picking, is the best way to build wealth for 99% of investors (basically everyone not named Warren Buffett).
What Is Passive Investing?
Passive investing is simply putting your money into a low-cost mutual fund that consists of hundreds, and sometimes thousands of stocks in a particular index. For example, an S&P 500 index fund invests in all 500 American public companies that make up the S&P 500 index, a common benchmark for the US stock market.
Instead of paying a manager to pick individual stocks for you, index funds are hands-off and automatically mirror whatever benchmark they are tied to. This allows for these funds to cost substantially less in fees than actively managed funds and they are almost certain to give you better returns over the long-term. Why?
Decades of research has shown that it is virtually impossible to predict how individual stocks will perform, but the market always goes up over the long run. Think of it this way:
During the mid-1990’s the hottest stocks were companies like Kodak, Polaroid, Enron, and Sears, which are now either out of business or on life support.
Since that time, our country has been through a lot. We endured the 2000 dot-com bubble burst, the deadliest attack on American soil since Pearl Harbor, two lengthy wars in Iraq and Afghanistan, and the most crippling stock market crash and recession since the Great Depression.
Despite all the extreme challenges our country faced, the S&P 500 averaged a 9.6% annual return from 1994 to 2017. With a return like that, you would double your money roughly every 7.5 years.
The point is, picking individual stocks, or paying someone to do so, has proven to be a losing strategy.
Step 5: Set It And Forget It
So how should you invest? Keep it simple.
All you need to do is diversify your investment portfolio with a few low-cost index funds (domestic, international, bonds) from Vanguard, Charles Schwab or Fidelity and you are all set.
Start by contributing to your retirement accounts like an IRA or 401(k) and contribute at least up to the company match. Consider target date funds for your retirement accounts which automatically become more conservative as you approach your retirement date.
Once you fund your retirement accounts, you can then contribute to a traditional (non-retirement) investment account for your intermediate savings goals.
For your non-retirement portfolio, consider utilizing robo-advisors such as Wealthfront or Betterment which does all of the index fund investing and diversification for you automatically at a very low cost.
Then, simply automate your savings to go to your investment accounts each month, set it and forget it. Your investment portfolio will go up and down hundreds of times and that is perfectly okay because history shows us it will increase significantly over the long-term if you continue to invest and let it run its course. Stick to your plan and you will without a doubt come out way ahead.
And always remember to keep investing costs low. It is the key to long-term success. You should never, ever invest in a fund that has an expense ratio above 0.50%. Aim for funds well below 0.35%.
Ready?
And there you have it. Simply spend much less than you earn and invest the surplus wisely. Follow this playbook and you will be well on your way to a beautiful financial future for you and your family. Of course, there is plenty more to discuss and that is what I am here for, to help you on your journey.
Let’s get to work!
The Personal Finance Playbook 