I recently responded to someone who had received a distribution of money, and was deciding what to do with it. My response has cascaded into others reaching out for additional thoughts or advice, and have compelled me to write this blog post.
Spoiler alert: You do you. People love to talk about their successes, but rarely in complete terms, as in net results. I'll get to that later. What matters is that you learn enough to know your fundamental choices are the best possible that you can both understand and live with.
Let's start with budgeting. Your income should be split into three or four categories, depending on the conditions you are living in. The first is pure, basic necessities: Food, clothes, shelter. Not HOW you'd like to live, but how much is needed for a safe, acceptable lifestyle. We all know that there are parts of the world where people can't even afford THAT, but let's set that aside for now.
This money must be accessible to you immediately, but that doesn't necessarily mean right away. I use a credit card for purchases. I get benefits for using this credit card. Any debt on that bill, as in credit card interest, doesn't occur until the bill is past due. So as long as my savings ensures the money will be there to pay it on time, I'm golden. And since that credit card pays me 2% on all purchases, I am making 2% for being financially responsible. So, if it's through a credit card, NEVER spend more than you have budgeted and can pay off without interest when the bill comes due. All those credit card perks I get, like cash back, cheaper rental cars, etc. are being paid for by those who pay interest on that kind of debt.
Generic savings accounts in the USA are typically paying 0.5% interest.
A second category is short term savings, which is great for debts that only show up once in a while. Annual payments fall into this. This savings can be put into investments that it takes a while to cash out, but return a high interest. Money market accounts, CDs, even stocks can fall into this category, but don't take a lot of risks here. You KNOW you'll need this money in the near future, and don't have anywhere else to turn if it goes bad.
These kinds of accounts in the USA are typically paying up to 5% interest. That's TEN TIMES the average bank account!
There is a catch. The more money you put in, the more interest you can earn. The riskier the account invests in, the more you can earn (or lose), so NEVER put your short term investment money in something that can't afford to lose the interest on, but make sure what you contributed will always be yours. You're counting on this for your bills or debts.
Some people like to break out another category called discretionary spending. That includes things like buying nicer versions of things. Going to a show once in a while. The extras. I reward myself sometimes for living within my budget by doing something special.
Some people also like to include expenses that hardly ever happen, but likely will, in this pot of money. A major appliance fund, for instance. If you have to have a vehicle, and they normally last around ten years, wouldn't it be great to know that next time the money is already in the bank, and you're not going to pay interest on a load for one? Plus, you may be able to pay less because you have the money in hand, meaning the seller is not charging you for the risk you can't pay it off.
The third category is outright savings for wherever your future takes you.
When you build financial reserves, you have better control over your future. You can make life choices that align more with YOUR values and needs. When the Enron Scandal occurred, government lawyers asked a number of employees why they did things they knew were illegal. The most common answer was, "I couldn't afford to go without a paycheck".
It is currently estimated that over 70% of Americans are living paycheck to paycheck. That leads to bad choices and bad decisions. THAT should be a primary goal of building wealth: Give yourself the POWER to make life choices on your terms.
Of course, it can also contribute to a nicer, safer, and/or more desirable life. I love that! But that power of choice will free up all levels of expenditure and decision-making for you.
Before I go, I want to touch on three more topics: rates of return on your money, a general rule of investment, and the rule of 72. Oh, and crypto.
You want the financial returns you earn to be greater than the general inflation rate. Otherwise, you're falling behind on living expenses.
A general rule: Better investment returns come with higher risk. Make sure you understand the risks you're taking, and ALL of the expenses you may be charged for. This is not always the case, and as you learn more, you will better understand risk, and make better decisions. I highly recommended investment broker sold me two investments, saying they guaranteed a minimum 7% return. When the American government changed disclosure laws in 2019, I learned that, after fees, I was making 1%! Shame on me for just taking his word and that of my recommending friends on it.
The Rule of 72 makes some of your decisions easier to understand. Divide 72 by the interest rate to know the interest impact. If I invest at 12% return and leave that money alone, it will double in 72/12 = 6 years. If I take a long term debt, like a 30 year home mortgage, at 12% and make just the scheduled payments, then after 30 years I will have paid FIVE TIMES the amount of the loan! If you have a credit card that is charging 24% interest, and only making minimum payments, well...
Crypto: I like it, so long as you realize it is a COMMODITY, and NOT MONEY until you convert it into real money. The guy last year who told me he'd lost $125,000 in crypto? Never happened. Commodities are things NOT BACKED by real money, and can change value at any time. Raw petroleum. Wheat. Minerals. Artwork. Anything who's price is driven by demand.
The percentages of your income that should go into your three or four categories can vary a lot. Start by figuring out what you truly need to get by. Take the remainder, and consider 75% in short term places that may take a little while to get the money out, but you should earn more. The rest is long term for you to gain control over your life and decisions.
Focus on two NET RESULTS
What did you make after all related expenses? IF you made $500 but paid a fee of $100, you only made $400. The second is how are you doing against the cost of living.
Now come the legal part, becasue Americans love to sue each other, regardless how inane the information is.
I am not a financial analyst. Your decisions are your's alone.
I recommend learning. There are some good, easy to understand resource out there that are not trying to sell you anything. Try Khan Academy and Million Bazillion for some straight-forward information.
Best wishes to all of you on achieving a life under your terms.
