Photo by micheile henderson on Unsplash
After reading a dozen books on personal finance over the last year, here are two actions you can take now to start on the path to financial independence.
Most people spend unconsciously. We work hard for our money so we believe that we have a right to spend our entire paycheck as soon as we receive it.
This mindset will keep you on the hamster wheel of financial dependence until you decide to start saving.
There are many ways to track your money. You can do it yourself by keeping a notebook or starting a note in your phone. Every time you spend money, write down the date, how much you spent and what you spent it on. At the end of every week, add these purchases to a spreadsheet where you separate your purchases into different categories.
These can be anything from “Rent,” “Groceries,” “Car Maintenance” to “Fun.” Whatever you are spending money on, put it into a category.
At the end of the month, when you have plugged in every purchase you have made, add up the total for each category. With these numbers, reflect on what is more important to you: the 3 dollar bottle of water you buy everyday on your way to work, or the 60 dollars you could save by taking a water bottle with you.
Repeat this process for your recurring purchases, identifying the ones you “want” vs the ones you “need.”
This process will help you find money to start saving. Currently, 57% of Americans cannot afford a $1000 emergency. Life is unpredictable, having money stored in a FDIC-insured high-yield savings account will be a huge benefit to your mental well-being (less stress or anxiety) and it is the first building block to financial independence.
Once you have at least 6 months’ worth of money saved for your basic needs, i.e., rent, car payment, student loan payment, then you are ready to move on to the next step.
The best way to make sure your money is working for you and staying ahead of inflation is via the stock market. Most people have a lot of apprehension about investing. Other people have a casino perspective of the stock market, expecting to make millions off one trade. Neither mindset is beneficial to you when you are 65 years old and hoping to retire comfortably.
The historically best method of investing in the stock market is to:
A) Open a tax advantaged account
This can be a traditional IRA, Roth IRA, or a 401(k) provided by your employer.
In a Traditional IRA, you put money in now and pay taxes on what you take out when you retire
In a Roth IRA, you pay taxes on the money you put in now and then get to withdraw the money tax-free when you retire.
Many employers will match your contributions to a 401(k) up to a certain percentage. If your employer does this take advantage! That is free money!
There are separate yearly limitations on how much a person can contribute to their IRA and 401(k). If you can max out your IRA and the employer match on your 401(k) you are doing great!
B) Invest in a low-cost Market Index Fund
Everybody thinks that they can “beat the market” with tricky investing choices. However, unless you are a full-time investment guru that knows exactly what to look for in companies that are about to explode in value (and have the cash reserves to be wrong) then its best to let your money grow with the market.
In A Random Walk Down Wallstreet, Burton G Malkiel explains, in every way possible, why the majority of people are best served by an index fund that tracks the S&P 500 index. Before you start investing, I highly suggest picking this book up from your local library or bookstore. You will start off way ahead of everybody else who cannot be bothered to read about the stock market before investing.
This will save you a lot of lost time, money, and your pride.
C) Let time work for you
Once you start saving and investing, let the magic of compound interest carry you into financial independence. The sooner you can start the wheel, the better. So start today.
Albert Einstein is attributed this quote:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”
If you invest $1,000 and it earns a 5% return in a year, at the end of that year you will have $1,050. If you leave it and do not add anything new, by the end of the second year you will have $1,102.50. Let us say you leave that money for 20 years without adding or withdrawing any money, you will have $2,653.30!
You will have earned $1,653.30 just by leaving $1,000 in an account that yields a 5% interest rate for 20 years. That is your money working for you. All you had to do was not spend it, and now it has made more money for you.
Now imagine if you max out your IRA ($6,500) every year for the next 20 years at 8% (this is the most commonly used rate of return used to explain the S&P 500 index). If you start at $0 today, and add in $541.67 every month for the next 20 years, you will have $297,086.67. How is that for magic!
