A Pretend to Be Poor Investing Primer
So, you’re about to graduate, you got your first job, and you’re ready to invest for retirement. Congrats! Or maybe you’re finally starting to crawl out of student debt, but you don’t want to neglect retirement, either. Good for you! Perhaps you’ve got it all–all the expenses, that is. Kids, a mortgage, student loans, car payments….what does investing look like for you?
Getting started with investing can be overwhelming and confusing. I used to think of the stock market as a realm only rich people understood. I didn’t realize that investing is how regular people “get rich,” i.e. build wealth. Indeed, investing is what’s behind the “pretending” part of Pretend to Be Poor. Rather than allocating resources toward a lot of fancy gadgets, showy cars, or pricey vacations, we’d rather live simply and build wealth that will allow for more flexibility in the future.
Even once you get why to invest, it’s easy to feel intimidated by this seemingly abstract world. Where do I start? What should I invest in? Will I get ripped off? Will I have to start obsessively checking the stock market every day? I’m no expert, but I’m happy to share a few simple principles of investing, from one lay person to another.
Where should you start?
The place to start depends on your benefits. If you have an employer match in a 401k or 403b, start there. It’s like “free money,” or, more accurately, it’s part of your compensation. For example, the employer may contribute 3% of your salary if you contribute 6%. 401k contributions are made on pre-tax income. You can contribute up to $19,000 of pre-tax income per individual per year. But at the very least start maxing out that match!
If you don’t have an employer-matched option, start with an IRA. Individuals can contribute $6,000 to an IRA each year. There are two main types of IRAs: Traditional (pre-tax) and Roth (after tax). With the traditional, you’ll contribute on pre-tax income, and pay taxes later when you withdraw (like the 401k). With the Roth, you pay taxes on your income now, so you will not have to pay taxes later when you withdraw. There are pros and cons to each. Consider whether you are likely to be in a higher tax bracket while you are contributing, or later when you withdraw.
If you are on a typical American lifestyle-inflation plan where your expenses will increase with your income, you may want to pay those taxes now and go with the Roth. If you plan to keep expenses fairly stable as time goes on, and keep them well below your current income, then your “income” when you start withdrawing will be a lower later on.
How much should you invest?
Dave Ramsey recommends directing 15% of household income to investments as the 4th baby step after paying off all but mortgage debt. Others say the sooner you start investing the better, so don’t even wait to pay off debt to get started. It really depends on your comfort level with debt (and what interest rates you are paying).
Time is a key ingredient in growing investment so starting ASAP is wise. I highly recommend contributing enough to get your employer match from the day you get your first job, at the bare minimum. Work up to 15%, and then try to max out accounts as you’re able. If you reach that goal, look into index funds through a low-fee brokerage service such as Vanguard.
One strategy we’ve used to increase investments is to direct “extra” income to retirement. So when we get a bonus, we give at least 10% to our church/charitable causes, we may spend a little on an extra, but the bulk goes straight toward retirement. You might use the same approach to allocating side hustle money, gift money, or your household’s second income, if you’re able.
What should you invest in?
Index funds are a good, low maintenance, low cost approach. Index funds split your investment across lots of companies at once so your fund has diversity and stability. You can also be super lazy, as there’s no trading of individual stocks. Because they don’t require a lot of babysitting these funds have lower fees compared with other types of accounts. Many employer-based plans will have index funds to choose from.
Fees vary widely between different types of accounts and brokerage firms, so be sure to compare. And doesn’t it make sense to pay less fees and keep more of your money? It’s also wise to compare the performance of various index fund options before investing. For more on how to choose an index fund, read this.
What to watch out for
Annuities: these funds guarantee a certain annual income in retirement, but at a huge price. It’s really a type of insurance. While it seems nice to have a guaranteed income, there are lots of fees and charges, and they are less fluid and flexible. Your earning power is much great with an index fund. Do yourself a favor and avoid annuities like the plague.
Really, you’ll want to be wary of advice from anyone selling a financial product. Naturally they’ll have their own stake in the game. Many companies are cutting out the need for human brokers by using robo-advisors, and this is how they are able to provide lower fees. If you want to get professional financial advice choose a fee-only fiduciary. These pros are paid the hour rather than based on a commission for selling products. Radio personalities such a Dave Ramsey and Clark Howard offer lists of trusted financial services providers, searchable by location and type.
Individual stock-trading: while some people “get rich quick” day trading, it’s kind of like gambling in Vegas. Do you really think you’re the rare whiz who is going to beat the house? Your chances of beating the market consistently over decades are slim to none. Even stock market geniuses like Warren Buffet recommend index funds! Trading individual stocks simply isn’t a strategy for building a retirement fund.
High fees: even for solid types of funds, fees can vary widely between different brokerage firms. Be sure to compare fees before choosing a product or firm.
Wrapping it up
Of course, there are countless technical details about how to optimize your investments for tax advantages, balancing stocks with bonds depending on your age, sequencing returns, converting funds, and more. For more in-depth information on investing, check out The Simple Path to Wealth or The Legacy Journey. But when you’re getting started, the main principles are investing are quite simple:
- Get your employer match if you have one.
- Invest in low-fee index funds (401k or IRA).
- Keep investing and let the compounding interest do the work.
What other questions do you have about getting started with investing? Or what books or blogs did you find helpful for learning about it?
This post contains affiliate links.
What My Four-Year-Old Taught Me About Investing
Learning how to play catch & doling out investment advice.
The following blog post is part of The Road to Financial Wellness blog tour. The Road to Financial Wellness is a three-month, grassroots campaign promoting financial empowerment on a national level and encourages people to pursue their dream lifestyle. Find out more about local events near you.
My son staunchly refuses to write the alphabet, but he is fascinated by exponential growth. Not that he knows this is what it’s called. To pass time he loves to ask, “What’s two twos? What’s two fours? What’s two eights?” And so on. Luckily he loses interest before I max out my mental math capacity. The other day while playing this game he said, “You can’t count to a million by starting from one. You have to count with different numbers.”
Forgive my mom pride, but I couldn’t help interpreting this statement as the best investment advice ever uttered by a preschooler. Advice that I simply didn’t understand for a long time.
I’m a saver by nature, but I didn’t receive the most thorough financial education, nor did I come from a “Rich Dad” household. I never realized that just about anyone can “get to a million” using time, compounding interest, and basic earning and saving disciplines.
I saved money, dollar by dollar, through high school and college. In fact, my emergency savings was probably over-funded. Had I invested the extra, even though it wasn’t much, it would’ve been an early start at exponential growth.
After college graduation I blindly accepted the default retirement contributions set up by my employer. When I left that job after a year, I withdrew my funds, paying hefty taxes. Luckily it was 2007, the market was favorable, and it went toward a house down payment. But I’m still kicking myself for that one.
I just didn’t get it.
The Light Bulb Goes On
Not until I watched the first DVD of Dave Ramsey’s Financial Peace University. To be honest, that’s the only one I watched, but it was enough. He lays out the comparison of someone who invests $2000/year from ages 19-26, compared to someone who invests $2000/year from ages 27-65. Guess who has more at the end? The second guy never catches up. Though it makes assumes an overly optimistic 12%, the point is clear: start investing sooner rather than later. (Check it out here.)
By the time I watched this, we were contributing Ramsey’s recommended minimum of 15% to retirement accounts. But I was 25 and saving for retirement sounded amorphous, almost mythical. I wasn’t the least bit motivated about it, let alone informed. Since then I’ve become more educated about investing by reading a couple books & lots of personal finance blogs, as well as through conversations with my husband, who’s always learning more about this topic.
Maybe I should have finished watching the DVD course, but we actually had a lot of smaller pieces of personal finance in place. We were good at following a budget and limiting our spending. We had life insurance and a solid income. What I was lacking was the bigger picture of where these practical pieces could lead us. I didn’t need tips on how to save money; I needed a financial education.
Our goal isn’t to become millionaires, but to continue increasing our financial flexibility so that our life choices center more on our values and opportunities, and less on money. Paying off debt, simple living, and planning for retirement and kids’ college are all part of increasing our flexibility.
We won’t gain the flexibility we desire simply by scrimping and saving one dollar (or $100) at a time. For a long time I saved money without gaining the financial education about how to grow wealth. I’ve never wanted to be rich, but I do want the flexibility to prioritize family, volunteer, be generous, and retire someday.
That’s why we’re “counting by different numbers.”
How did you learn about investing? What’s the next step on your road to financial wellness?
The Power of Perpetuity
Photo by Neil Brooks
My son’s three favorite numbers are infinity, googleplex, and several. Lately, my favorite concept for considering numbers is perpetuity. The power of compound interest is a popular personal finance topic, but what may be even harder to get our finite minds around is the power of perpetuity. Its impact is significant both from the savings and income sides of a budget, yet we often write off opportunities for perpetuity when a sum sounds insubstantial in the present.
Let’s start by considering the savings side, because that’s a little easier to grapple with mentally. Take a relatively small expense like a cable bill. Let’s say you’re paying $60 per month. Sixty dollars is not a huge amount of money. It might not make a drastic difference in your finances. But when you think about the power of $60 per month in perpetuity, it looks a little different. That’s $720 per year. That’s $720 you can’t put toward debt, build into your emergency fund, invest for long-term goals, or share with people in need. That’s $720 more you need to bring in every year for the rest of your cable-watching life. That’s $720 per year that’s not earning interest. Sixty dollars per month is almost half a million dollars over 50 years at 8% growth ($479,932.83 to be exact).
I realize this example is a bit extreme in the time-frame. But at age 30, I’m facing an average of 50 more years on the planet. We need to start thinking more in perpetuity or we’ll miss out on its power. We think about what we want now and how it’ll affect today, this month, maybe this year if we’re relatively long-sighted. While we need to enjoy and appreciate living in the present, we also need to consider the real trade-offs we’re making with our money (and time). Would I rather watch cable TV, or leave my children or a charity half a million dollars? This is extreme and over-simplified for the sake of illustration, but I hope it brings home the point. (And just because I don’t happen to watch cable doesn’t mean there aren’t 100 other ways I could blow half a million dollars over the long haul.)
Now let’s think about the income side. Take, for example, investing in rental properties. The upfront cost of purchasing and fixing up a property may seem overwhelming. You might not start seeing a return on your investment for 5-10 years. But after that, you could bring in an extra $1k per month in perpetuity. Sure, you might have the property vacant for a few months here and there, and you’d have work and expenses to maintain the property, but an average of $1000 per month in perpetuity is nothing to dismiss, especially if you invest it in retirement or college funds.
Now let’s say you find a few ways to save money—on utilities, food, transportation, or whatever—and you’re saving $500 per month and (to be conservative) bringing in an extra $500 in perpetuity. That’s an extra $1000 per month to work with—in perpetuity. This is the power of frugality: if you live on less, you simultaneously can invest more and require less income in perpetuity. So while your investments grow, you freeze or even deflate your lifestyle, meaning you’ll need less of that stash when the time comes to start living off it.
Maybe you have no interest in cutting cable or owning a rental property. These are just examples. But if you can find something in your budget you’re willing to consider spending less on, and extrapolate the impact that could have over several decades, you may find yourself motivated to make a change you wouldn’t otherwise.
The same goes for the income side. Maybe you’re under-earning because you’re afraid to make a career change. You figure you’re making enough and feel safe where you are. I’m not at all in favor of revolving life around making as much money as possible. But you could be missing out on a more rewarding and lucrative career simply because it’s more convenient in the moment to stay put.
The power of perpetuity is why we’re willing to call our utility companies and negotiate lower rates. It’s why we shop at a discount grocery store and mostly cook at home. It’s why we buy second-hand (or even trash-pick) many items. It’s part of the reason Neil changed industries in his career, to increase his marketability and earning potential. In isolation, none of these moves might change the course of our financial lives; taken together in perpetuity, it’s the difference between financial slavery and flexibility.
Again, my point is not to work away your life and spend every spare moment scouring your budget for ways to save a dime. Rather, as you’re faced with day-to-day financial decisions, try to consider the power of perpetuity as well as the needs or whims of the present. It’s the latte effect on steroids. And it lets you dream bigger than you ever will just living for today.
How could you harness the power of perpetuity in your finances?
Ramsey vs. Alcorn Throw Down
Should I leave an inheritance or give away most of my money during my lifetime?
Should I pay off the mortgage early or invest that money in retirement accounts and college funds?
How much life insurance is enough?
How much retirement savings is enough?
How much money should I give away?
These are hot topics for those who are living below their means and have income to work with. We’re such money nerds we’ve even been known to discuss these topics during our monthly date nights. Once you get your spending under control, have a yearly budget, and have implemented some practical thrifty ideas, it’s time to start thinking about building and sharing wealth. As I mentioned in Resolve Your Reasons This Year, I recently read Money, Possessions, and Eternity by Randy Alcorn (2004) and chased it with Dave Ramsey’s latest, The Legacy Journey (2014). Both authors are Christians and wrote these books at least in part to share what they believe the Bible says about money. Their messages are strikingly similar in some areas while very different in others. Reading them back-to-back was challenging and thought-provoking, which is why I’m comparing and contrasting their views for you.
Before getting into the details, I want to fairly convey the purpose of each book. Alcorn’s book is not a how-to book. He is a full-time pastor with some thoughts on practical financial principles, but the book is mainly a treatment of the Scriptures on money-related topics. The subtitle of Ramsey’s book is “a radical view of Biblical wealth and generosity.” This is the famous financial adviser’s first book to delve into the Scripture’s teaching on money, but he only deals with a few passages he believes are often misunderstood. The main topics of his book are leaving an inheritance and giving generously. His book is A LOT shorter!
Ramsey’s book aims to counter the “toxic messages” that rich people are evil, their wealth always takes away from others’ fortune, and that they should be judged for enjoying their wealth while also giving generously. He provides practical examples of what to do with “extra income” beyond a set amount one agrees to live on. He suggests setting ratios on the overflow for giving, (taxes), investing, and “lifestyle” (= fun). Basically, his book is for people with money. Normal people who are approaching steps 6 (early mortgage pay off) and 7 (build wealth and give) will benefit from his book and it may help them make decisions about investments, budgeting extra income, giving, and leaving an inheritance.
Alcorn’s book basically assumes the reader will not become wealthy since he advocates giving away most extra income immediately, after investing something for retirement, children’s college, and leaving room for modest discretionary spending. With the exception of the tithe he avoids specific, numeric advice to leave room for personal decision-making. He says he struggles all the time with the tension of how much to save for retirement vs. how much to give away now. Clearly he prefers to err on the side of generosity. He critiques “financial independence” on some of the same grounds we do, which is why we’ve coined financial flexibility. We’re managers, not owners, of the wealth God’s given us, and we always want to depend on God financially and otherwise. And we want to use money to help others as well as meeting our needs.
Here’s the throw down of their positions on different financial topics, with my two cents, too:
| Ramsey | Alcorn | Pretend to Be Poor | |
| Debt | No consumer debt.Get rid of student debt ASAP.
15-year mortgages recommended; pay off early after steps 1-5. |
“We shouldn’t normally borrow and should always pay off debt as soon as possible”
“Not all debt is the same” e.g. mortgages can be reasonable. He paid his off early. |
No consumer debt, including cars.
Get rid of student debt ASAP by living like a student. 15-year mortgage; pay off early if possible. |
| Insurance | Get term, not whole life insurance. | Most Americans are over-insured.Life insurance should meet family’s needs for a period of time but not indefinitely.
Don’t replace depending on God & Christian community with insurance. |
Get term, not whole life insurance. |
| Investing for retirement | Once consumer debt is paid and 3-6 emergency savings funded, invest 15% of income in retirement accounts. | People think they need enough to live a high-expense lifestyle indefinitely to retire.
Don’t replace depending on God & Christian community with retirement account. Tension between meeting others’ present needs and our future needs; seek the Lord. |
Get your employer match.
Invest 15% after consumer debt paid & emergency fund in place. Conflicted about investing more vs. paying off house early. Investing makes more sense mathematically but we like the flexibility of no debt. |
| Giving | 10% minimum.
Not over 10% until out of consumer debt. Occasional extra giving after out of consumer debt.Set an amt to live on & set a giving ratio for “overflow.” “Go crazy” with giving once you get to step 6 or 7 (see above). Leave a golden goose (principle) that will continue to lay eggs. |
10% minimum.
Set an amt to live on that includes some recreational/discretionary spending, and investing for retirement/college funds, and give away the rest. Your lifetime is your opportunity to give; leaving isn’t giving; aim to leave as little as possible beyond small gift amounts. |
10% or more recommended.
Live on less without being miserly. Extra giving: prayerfully respond to needs as they arise. Time is also an important resource; therefore, we do not plan to build wealth at the expense of spending time to help others now. |
| Inheritance | A good man leaves an inheritance to his children’s children.
Only to be given to children who are following the Lord & agree on how to use the money for God’s kingdom. The golden goose should be kept to lay eggs to give away. |
Only leave small gift amounts.
You don’t know what your children will do with wealth; it is more likely to ruin than to help. Don’t set up a foundation; how can you tell God the principle is untouchable? |
??? Not there yet in our financial journey.
As of now we’d leave money for our children’s care since they are young. |
Overall, the normal income person could come away from the books with very similar applications. Give at least 10%, and more when you can (I don’t believe there’s anything magical about 10% but it’s a decent baseline). Get out of debt and stay out. Don’t over-insure. Plan for retirement and kids’ college. The big difference is their take on investments for building wealth and giving. I can see why, as a pastor, Alcorn has a different take on these issues than Ramsey, who has advised very wealthy people. I tend to agree with Alcorn’s interpretations of challenging money’s passages, but don’t like how he explains away Ramsey’s key verse about leaving an inheritance to your children’s children. I’ll post a more in-depth review of Alcorn’s book next since he deals with a lot of interesting principles that don’t fall into these categories.
Which author do you tend to agree with more? What financial questions do you wrestle with? Have you thought about leaving an inheritance?