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The Basic Financial Plan

Basic Plan

A frequent question that people ask their one financial friend all the time is, “What should I expect when…” and the next bit is usually the part about getting a new job, or paying for a house, or what a good interest rate looks like for a car. Sometimes these questions are about saving for retirement, what a realistic return is for their 401(k), and how they should prepare to retire. Occasionally the question is “why is it important that…” or “Do I really need…” of course the answer is usually yes.

“Yes if you save younger it’ll make it so you can retire easier”, “Yes, Life Insurance is beneficial for most people who have dependents or debt like a mortgage”. The fact that you’re asking, is a sign you have a general idea of what you should be doing.

I figured I’d try to compile a bunch of basic principles that will get any individual to retirement in a relatively save and aware way. The purpose here is to help you set your expectations of what you need to do and understand in order to have enough money to one day be able to say, “You know what? I don’t need a job anymore, and I can live the rest of my life off of my own money.”

 

There are three basic parts of our financial life: Saving, Investing, and Diversifying.

First: Saving

Everyone hears a ton about saving, so I’m not going to hash why you should save any more. Just a few stats. The average person that should retire, (I.e. is 65+ years of age), only has about $80,000 according to Dr. Craig Israeleson of UVU. The Motley Fool recently found numbers could be potentially as high as $148,000 for those between 65 and 75.

Why does that matter to you as a 20-30 year-old? Here’s why, those people that can’t retire, they are holding your jobs. Once they retire, everyone down the line can start moving up.

The amount you save will directly relate to how much money you have for retirement. Many experts recommend saving 10% of your income, Dr. Craig Israelson, who performs research and analysis on portfolio theory, and investment returns suggested in a lecture at UVU that many millennials should adopt a rate of 15% of savings for retirement. Once you graduate and get that first job, immediately start saving 15% of every dollar you earn for retirement, and according to the experts, you’ll be very much secure for retirement.

Second: Investing

Being a Millionaire has nothing to do with income, but everything to do with Net Worth. Think about how time affects the value of money. Its been exhaustively said, so you can just google it, but the difference between the same $5,000 invested at the age of 25 and invested at 50 when you’re 65 is dramatic and exponential.

Consider a Crockpot. Have you ever gone to church on a beautiful Sunday morning, come back in the afternoon, and decided, “I want a nice roast and potatoes for dinner” then set the crock pot at 5pm for dinner at 6?

If you have, you should seriously reconsider your dining experiences. Waiting until “Later” to save if you’re not in school, is the same as setting the crock pot a-cookin’ after church, instead of the morning of, so it can simmer and soak in goodness all day.

Investing: I’m sold, but WHERE?

This is where everyone says, “Jacob, you’ve sold me on this. Where do I put my money?”

Betterment is an amazing place to invest your money. Acorns isn’t half bad either. Wealthfront is a newer online investment site that utilizes algorithms, often called a robo-advisor(LINK TO 7 TYPES OF INVESTMENT ADVISORS), and your risk to make your money grow too, and its free for portfolios smaller than $15,000. It’s also not hard to go directly through a major company like Schwab, Fidelity, or VanGuard.

Part of your portfolio (your money for retirement), will be in your 401(k) at work. You’d better be matching that sucker to 100% of the matching contribution, because if not, that’s free money you’re missing out on. Make sure the limit of up to $5,500 a year beyond your 401(k) is going into an IRA with whatever advisor you’re using, because that can create some tax savings. Then, any above that can go into either a personal brokerage account through your investing institution or other more complex retirement accounts you can work with a professional on. (The secret is to get started).

Third: Diversify

Here is where I’m going to teach you some amazing truths about investing. If you’re invested in 10 different things and they are all going up by exactly 6% a year. There is some serious issues. That means all of your investments are perfectly correlated, which means if they drop one year by 40% (cough 2008) then they are all dropping. A good portfolio has uncorrelated assets. Meaning that at least part of the time, when one is going up, another will be going down. Some parts of the global economy will be having rough weeks or days or years, while others have awesome times, then 5 years down the road it’ll switch. Because the market is unpredictable, meaning that it’s impossible to know exactly what will happen, a diversified portfolio that has a little bit of money in all types of markets is proven to generally outperform any one specific investment type.

Three Analogies: Baseball, Salsa, and Cereal

Imagine that stocks are like baseball players. If one stock bats at .365 and another bats at .127 but only hits home runs, you want a little bit on both players! According to portfolio theory, the more batters you have, the higher your average becomes, while reducing variance. Stocks bat at about .700 and bonds bat at about .960. Enough to be in the hall of fame for any baseball player in the history of ever.

So, what does this mean? It means you should put money in stocks, put some in bonds, put some in Mutual Funds that use active aggressive algorithms and research to try to find opportune moments to buy and sell stocks to make you money, use some passive ETFS that just automatically balance 50 or 100 stocks in a particular category like large healthcare companies, or medium growth companies that pay dividends.

Imagine this investing like making Salsa. If you invest in the S&P 500, sure, you have some diversity, but you just purchased 500 different types of tomatoes. Of course, you can’t invest in the S&P500 but you can invest in ETFs and mutual funds that invest in it. So, if you invest in some large cap stocks for your tomatoes, then you buy some bonds for your onions, purchase some commodities for your cilantro, and so on and so forth, you’re going to be making a good salsa.

In fact, experts have shown that the recipe (allocation) of your salsa (investments) accounts for 94% of the deliciousness (returns) in them. Meanwhile, the ingredients (actual funds and investments) only account for less than 6% of the taste (return). Using a great recipe for salsa makes better salsa then just getting good ingredients, but having an awful recipe. If you have perfect ingredients, but the wrong recipe? You’re not even making salsa any more.

Many people have told me, “I’m invested in a mutual fund, I’m diversified”, or “I’m invested in an ETF” or “Target-date Fund”. Well, yes, this is diversity, but it’s the 200 types of tomatoes diversity. Think about Cereal boxes. Do you remember those funny boxes that had 8 miniature boxes inside of them? This is how you should think about a mutual fund. Each box of cereal is a specific investment, the Mutual Fund, or ETF, or Target Date Fund, is the whole package. It choose those 8 investments and said, “here’s a good deal”. If you choose a Mutual Fund for 12 different asset classes: Large Stock, Small Stock, Mid stock, non-us stock, emerging markets, real estate, resources, commodities, US bonds, TIPS, non-US bonds, and Cash, you’d have a pretty awesome set of cereals.

You will have created a beautiful portfolio, a fund of funds of funds. That is a recipe for success, that now only needs your savings added.

 

Remember your basic financial plan.

  • Save (now)
  • Invest (all of it above emergency funds and short term purchase plans)
  • Diversify (so 2008 doesn’t get you)
  • Retire (at 45, okay maybe not, but still retire)

You’ll thank yourself later (about the retiring side of it, and the stressful side of it, and the peaceful side of it)

 

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“Safe” Investments: What You Need To Know

The 8th Wonder of The World.

ae-quotes
Albert knows his stuff

Money is pretty cool right? And knowing that compound interest is the 8th wonder of the world, (Thanks Einstein for that gem) we usually turn to dropping our money in the bank.

Problem is, that money makes next to zero doll-air-oes. Back in the 90’s when interest rates with in the 12-14% it was safe to put money in a CD at 10% interest. Today, interest on a 3-year CD is puny, 1.4%. Interest rates are down 90%, which is good for inflation and other things, but makes me think, “What do I do to grow my money?

Numbers

First: let’s talk numbers. I conducted a survey and found that most people struggle with knowing where their money can grow, and what’s riskier or not.

Problem: “What tends to have the highest growth over periods of time as long as 18 years”

A. Checking Account
B. U.S. government savings bonds
C. Stocks
D. Savings Account

What is your answer?

I’m glad to say that not a single person put Checking Account. I’ll still explain that for a moment, a Checking account is what I classify as “Cash & Cash equivalents”. It’s liquid, it’s being used day-to-day, and mine currently has a return of .02%. This isn’t where money goes to grow, it’s where a money goes to be spent.

B. U.S. government savings bonds. These investments are usually given a pretty small interest rate, and are guaranteed by the government. I was actually quite shocked by just how many people thought that this was the best place to grow money! These are given a guaranteed return, but usually is equal or less than what inflation is.

D. Savings account. A few people thought this was a good place to grow money. Savings accounts are similar to Checking Accounts, in the fact that they have very poor growth rates, usually higher than Checking, but still very low. In my mind, they are basically a way to keep your money in 2 seperate locations so you don’t spend it all. I think there are better ways to organize money, but that’s just my thoughts.

C. The Stock Market. This is where money goes to grow. Naturally there are risks, but there are many ways to mitigate the risk. Diversification, Allocation, and having a good time horizon for investments helps. With an 18 year time frame, and being diversified across many stock types, this is where money will grow.

Lets look at the data

I looked into typical rates for Savings Accounts, Checking Accounts, Government Bonds, Corporate Bonds, and the Average Stock Market Yield. Here is what $1000 dollars looks like over a 20 year investment.

growthof1k
Chart by TheFinancialGinger – 2016
www.nerdwallet.com/rates/checking-account – Zion’s Bank Checking Account
www.nerdwallet.com/rates/savings-account -Zions Bank Savings Account
www.treasury.gov/resource-center/ – Government Bonds
finance.yahoo.com/bonds/composite_bond_rates – 20 year AA corporate bonds
http://www.moneychimp.com/features/market_cagr.htm – Stocks average from 1995-2015

Looking at this, some people are probably shocked. Know that Stocks have the risk of going down, they will go down and up. Greater Risk often yields greater upside potential.

Fine, I’ll put it in stocks. How do I do that?

If you have $5000 or $10,000 to invest, put it into the stock market. There are some great places to open an account online.

TDAmeritrade has a pleasant platform that is excellent for beginners and isn’t too expensive to use at $10 per trade.

OptionsHouse is an online broker that has $5 trades and has no minimum balance.

TradeKing is another online broker that has $5 trades and no minimum balance.

My absolute personal favorite is Vanguard. The reason for that is they are all about the idea of buy-n-hold with stocks, and stock-packages called Mutual Funds or ETF’s. The idea behind that is simply buying a preset group, then waiting and letting it grow over time.

If not, you can probably talk with your Bank, Credit Union, or find a good local individual company such as EdwardJones to get you started. Make sure that if you use a broker/dealer company that you know the cost associated with it.

In Summary

Checking accounts are where money goes to be spent. Savings accounts are for emergency funds and money to be used within 6-12 months. Bonds are where money grows safe but small, and the stock market is where money belongs for long-term growth.

So, open an investment account and invest! Don’t let $5000 extra dollars be left sitting for no reason in the bank.