Give. Save. Spend.
Not in any particular order, but those are the three pillars of what I think make up a sound financial plan. Here in my late 30’s I feel like I have a good handle on my finances. Its beyond knowing how to balance a checkbook – its the understanding the entire picture. I need to have money for my day-to-day. I need to have money working for me leading into retirement. I need to have money for a rainy day emergency. And, I should be allocating money to support causes that go beyond me and my family.
This is the advice I plan to share with my son and future offspring. My hope is that they follow the playbook, and be even more ahead of the game when they are my age.
Simple axiom here – be charitable. I’ve read that some people look to allocate around 10% of their earnings to charity, and follow an 80% spend, 10% save, and 10% charity approach to their money buckets. Obviously, these percentages aren’t absolutes. People’s situations are vastly different, and the ability to give even a fraction of a percent may be challenging. The goal with my children is to try and ingrain this behavior very early in their earning experience, and train them to believe that they should always allocate a small portion of their income to causes outside of themselves. If the behavior is learned and conditioned early, my hope is that the children will implement and sustain it.
My plan is as elementary as every dollar of allowance has 10 cents go into a giving jar. Its that simple. I could even go a step further and offer to “match” whatever they put in the giving jar. That will teach another lesson I’ll talk about in a moment.
In the more macro picture, there are articles and anecdotal evidence to suggest that charitable people might be healthier and happier people. Do a Google search, you’ll find plenty. I also plan on explaining that we should be informed in our giving, and aim to fund causes where more of our money actually goes to the intended recipient. I’m not saying that high overhead charities aren’t worthy, I’m just saying that my personal preference is to see more of my $$$ go to the person in need.
This one is a beast. Or is it? It can be as complicated as you want it to be. I’d say the simplest fence post is stuffing dollar bills under your mattress for a rainy day, and the more complex fence post falls around an “all-seasons” type of portfolio championed by Ray Dalio. There is no shortage of information out there on how to save or invest your money. There are a ton of resources for the consumer to utilize. You can manage your portfolio yourself. You can consult a certified financial planner. You can turn your funds over to a money manager. And, there are so many financial tools out there to try and make your money work for you. When I eventually talk to Baby Breaking, I won’t do a deep dive and try to explain all of the complexities of the market. What I will do is paint in broad strokes about a sound and sustainable savings plan.
Some Money Working, Some Money Waiting
If I throw terms like growth, interest, and liquidity at a pre-teen, he’ll mentally check out. The simplest way I’ll be able to explain the idea of savings is to have a portion of it working/growing, and another portion ready for an emergency. There is no reason to have all of your money working/growing but not able to access it if you really need it, and, conversely, there is no reason to have all of your money waiting for an emergency and none of it growing/working for you. It comes down to an opportunity cost. The price you pay for having your money easier to access is overall less growth/return. The price you pay for high growth is that the money is less accessible. You need to strike a balance between the two.
Mrs. Breaking just told me a wonderful story from her childhood that rams home the point of saving and liquidity. There was a baby doll and car seat toy that she really wanted to buy. Her mom didn’t buy it for her (good for her), but gave her the opportunity to do chores around the house to earn the money for the doll. Once the $$$ was saved, she went back to the store to buy the doll. However, they were sold out. Though she was upset, she saw an opportunity through the tears. She opened up a Looney Toons Savings account and put all $20 into that account. She never wanted to be in a position where she didn’t have $$$ available if she wanted/needed something. When you think about it, that is a pretty remarkable lesson to learn at an early age. Kudos to her and her parents.
As it pertains to Baby Breaking’s savings jar, we’ll have two smaller jars. One jar will be for growth. He won’t be allowed to touch that jar. The other jar will be his emergency fund. That he can touch, but after he explains what is the emergency. At first, we’ll plan on 10% of his $$$ getting split between the two jars (probably half in each).
With regards to the emergency jar, the adult goal is to have about 6 months worth of expenses in that jar. For a child, we’ll figure out something that makes a little more sense. Maybe we set an arbitrary dollar amount that he must hit, and he’s not allowed to draw against it until he hits that minimum level. That is the same type of discipline an adult should have with regards to liquid savings.
To teach the idea of growth, I’ll offer to match whatever he puts in the growth jar (similar to the charity jar). If there is one financial lesson that I think is CRUCIAL to teach my son, its the power of compounding. If you learn about compounding early on, and harness its strength early in life, you can become financially independent relatively early into your adulthood.
Here are a couple examples that show the crazy awesome power of compounding…
Example 1: Invest $1000 at 5% annual return rate. Only reinvest the returns – do not add any more principle.
In this case consider a 20 year old that takes $1000 and puts it into a financial instrument that returns 5% annually until he turns 65. At age 65, that $1000 will have turned into $8985 (a 799% return on investment).
Now, consider a 30 year old person that does the same exact thing. Invests $1000, reinvests the proceeds, and then checks his balance at age 65. That $1000 will have turned into $5516 (a 452% return). That isn’t bad.
But, waiting 10 years to invest the $1000 cost this person about $3469!
Moral of the story – INVEST EARLY!
Example 2: At age 20, commit to investing $1000 each year into a financial instrument that yields a 5% return annually. You will reinvest the proceeds each year. At age 65, the person will have invested $46,000 out of pocket ($1000 each year). Guess what that seed grew into…$168,685! That is a 267% return!
Let’s look at our 30 year old. He commits to do the same thing as the 20 year old. He’ll make a $1000 deposit into a 5% annual yield instrument each year, and reinvest the proceeds. At age 65, he will have an account balance of $96,836. Over the years, he will have contributed $36,000 out of pocket, so his return is 166%. Again – not bad, but look at what 10 years cost him.
- Balance when investing at age 20: $168,685
- Balance when investing at age 30: $96,836
That 10 years equated to an account balance difference of over $70,000!
Moral of the story – invest early, and KEEP investing. If all of that math doesn’t ram the point home, I’m hoping that me throwing a dime on top of his dime in the growth jar will make the point for me.
When he’s a little older, I can talk about how to manage the growth bucket in terms of risk and return. Again, my advice will be broad and I’ll encourage him to do some research to learn more and formulate a refined strategy that resonates with him.
Some of those broad strokes include:
- If your employer offers a 401K and match, sign up and contribute as much as you are legally allowed (see the example on compounding to explain why). At minimum, contribute to max out the employer contribution (its free money!)
- When it comes to investment products, Index funds have a long history of providing reliable returns, and can be a bedrock of your long-term financial strategy. On that note – aim for funds that have LOW expense ratios. Every dollar out the door for expenses is one less dollar compounding for you.
- Consider an IRA once you are maxing out your employer matched 401K. Essentially, take advantage of all legal avenues that provide tax-free or tax-deferred investment growth.
- Don’t put all of your eggs in one basket – have some level of risk diversification in your portfolio. Don’t be 100% stocks. Have some exposure in bonds, commodities, and real estate.
- Don’t overreact to the market. It will go up, it will go down. Have faith in the course you’ve charted, and don’t do the foolish thing by selling low and then needing to buy high to get back in the game. Put yourself in a position to actually buy as the market bottoms out – great deals to be had there.
This is a simple idea – don’t live beyond your means. In other words, if you have $5 to spend, don’t spend $6. Easier said than done, right? There are so many ways for us to spend more money that we make. Some are good. Some not so good. Some financial people say that some debt is good. Some financial people say that no debt is good (including a mortgage). This is a wide spectrum, and people a lot smarter than me have devoted thousands of pages of prose to explain the “right” way.
Early in my life, I fell into the spend $6 when I have $5 camp. I racked up credit card debt, had student loans, and also had a car loan. I didn’t save and I didn’t give to charity. I was living paycheck to paycheck and was in the RED. That sucks. I spent a good chunk of my 20’s crawling out of debt, and was able to flip the script in my early 30’s with a robust savings plan. Now, in my mid to late 30’s, I am giving to charity, I am saving for the future, and I’m spending within my means. I feel like I came late to the party. My goal is to share my experience with Baby Breaking so he doesn’t dig a hole like I did. Here are some of the spending lessons I’d like to share…
- Set up a budget
- You MUST know how much money is coming in and how much money is going out. Every penny must be accounted for. You should set up a monthly budget and aim to stick to that budget. Aim for positive cash flow each month. Plan your known expenses into the budget, and scale back in other areas if necessary to keep in balance. Be sure to budget for savings and giving.
- Automate as much of your money movement as possible
- If your employer has direct deposit, use it to automatically disperse your funds. If your employer doesn’t offer that, see if your bank has a way to set up recurring transfers between accounts. Have a % go to savings automatically, and then the balance to your checking account. This way, you never see the savings $$$ and will be less likely to factor it into your lifestyle. Same idea applies to bills – automate payments as much as you can so you never miss a payment date. I’ve even used this automation strategy to buy bonds from the US Treasury each month. Without any effort on my part, I buy a certain number of bonds each month.
- Know your “latte factor”
- This is an interesting idea. I read it in the book, “The Automatic Millionaire.” The general idea is that everybody has a “latte” in their daily/weekly spending that can/could be eliminated in favor of a more cost effective sub. In the example of a latte – don’t buy at Starbucks, make a cup of coffee at home. The money you save each week/month could be used to fuel your savings or giving buckets (if they are neglected), or could be used to balance your monthly budget if its out of whack. The idea is to analyze your consumption habits, and look for the areas where you are leaking unnecessarily. If you plug those leaks, you can re-purpose those funds to a more productive end.
- If you have a credit card, be strategic about it
- Building credit is a big part of developing a strong adult financial profile. There are ways to build credit without a credit card, but it is by far one of the most common ways. Here is how you can be strategic with your credit card:
- Find one with a rewards program that makes sense to your life situation. Does cash back help you? Does accumulating travel/hotel points or miles help you? Find the card that reaps rewards for you, and use it responsibly.
- Pay off the balance each month. Don’t pay interest. If you use your credit card for every day expenses to rack up those points, make sure you are spending to your budget so you can pay the balance each month. Once you start floating your balance from month to month, and paying interest, you are losing the credit card game.
- Don’t try to keep up with the Jones’
- There is a ton of temptation out there to buy a new car, buy the new tech gadget, buy a big home, etc. Don’t succumb to the pressure and think you need to spend or live up to some false ideal. Your living and financial situation will change and evolve as you grow older. It is a fool’s errand to spend like a drunken sailor when you don’t have the money, just because you are buying cool stuff. Give yourself time – plan purchases and SAVE for things you want so you can pay cash. The way that millionaires become millionaires is by being frugal and measured in their spending. In the book, “The Millionaire Next Door,” I was amazed to learn about the percentage of millionaires that buy used cards (they don’t like the depreciation hit of a new car), and the amount of millionaires that shop at J.C. Penny’s. These folks have developed habits that are geared around the idea of living within their means, and aim to accumulate wealth rather than spending it. They never will be suckered into thinking they need to upgrade their golf clubs because John across the street has that new driver (he probably still sucks at golf by the way).
- Don’t use your emergency fund to supplement a chronic budget shortage
- If you always dip into your emergency fund because your monthly budget is short $50, you are defeating the purpose of both a budget and an emergency fund. Review your spending, find your latte factor, and balance your budget. If you can’t, you either need to increase your income (by selling stuff or grabbing a second job/side hustle), or by reducing your expenses (maybe you don’t need HBO right now). Yeah, you are making perceived “sacrifices” but if you keep living in the red, the piper will eventually want to be paid. That with either mean debt or worse.
See – pretty simple. Give a little of yourself to help humanity, save for the future security of you and your family, and spend within your limits. Three simple pillars that will hopefully set my children up to become financially independent.
Do you have any interesting or unique approaches to financial management? What are your thoughts on saving and giving? Feel free to share in the comments below. If you enjoyed this article, please “like” and share. Thanks.