Unicorns, Soviets, and Compound Interest: Demystifying Personal Finance Part 1
Two years ago, I gave a presentation to my office on how to manage your money as a young professional. Sound boring? The title was “Compound Interest is a Magic Unicorn of Awesomeness.”
Why was I giving a presentation about personal finance to my office of software engineers (of which I am one)? Well, I’m known as the finance geek. And compound interest is, in fact, just as awesome as a unicorn.
After Mrs. Frugalwoods and I bought a single-family house in Cambridge, MA (one of the most expensive real estate markets in the country) at the ripe old age of 28, my coworkers began querying me on real estate, debt repayment, 401Ks, frugality, and general “how to be an adult with money” questions.
(The best part? My colleagues don’t know about Frugalwoods and have actually suggested to Mrs. FW and I that we should “start a blog about frugality.” We smile, bite our tongues, and take it as a compliment. I’m glad people can smell our frugal nature from a mile away!)
My coworkers are mostly Millennials. With a few exceptions, my office is entirely under the age of 35! At 31, I’m often referred to as “the old man.” It’s a heck of a time be be in software engineering… but I digress.
While Mrs. FW and I managed to avoid many of the money pitfalls of the Millennial generation (through as much luck and good fortune as intelligent decision making), I have a front-row seat at work to the average Millennial profit and loss statement. And the numbers aren’t good.
The media is fond of describing Millennials as irresponsible brats who don’t understand hard work and have horrible personal finances. While I’m sure that holds true for some folks, most of my coworkers are honest, hardworking young professionals who never learned the basic underpinnings of how to live a successful financial life.
Something about growing up in the glory days of the ’90s gave us a mindset of plenty. The Soviets were vanquished, the economy was roaring, and gas was under $1/gallon. While we were playing Oregon Trail (or learning to program using Logo!), computers were revolutionizing the way work was performed in America.
Then the recession hit, wiping out what meager savings most Millennials had along with tanking their job prospects and permanently hindering their lifetime earning potential. Scraping by became the default, not the exception.
Being broke became not only socially acceptable, but almost cool (hello, hipsters). And somehow, that mindset persists despite the good jobs that many Millennials now finally have. My perennially broke, yet well-paid, coworkers being exhibit A.
At least that’s the story I like to spin about how our generation seems to have missed the boat on how to manage money responsibly.
But hark, fair internet friend. Do not despair. My experience with my friends and coworkers has shown me than plenty of Millennials will absolutely make the right decisions when presented with a plan.
The proof? I’m proud to say that after my presentation, my company’s employee 401k participation increased from 65% to 90%!
The Demystifying Personal Finance Series
Today begins a multi-part Demystifying Personal Finance series here on Frugalwoods. This series is all about how to assemble a sound financial life as a young professional, though many of the topics covered will be useful to folks of all ages. Much of this is cribbed from the powerpoints I created for my presentation, but with less swearing and more Frugal Hound photos. Frugal Hound gets embarrassed when her parents swear in public!
This series will also serve as a reflection of the steps Mrs. Frugalwoods and I have taken to stay debt-free (other than our mortgage), save 71% of our incomes, max out our 401Ks every year, avoid the lifestyle inflation trap, and map a plan for reaching financial independence in 2.5 years at age 33.
How many parts will this series have, you ask? Well, dear frugal reader, as of now there are 3 parts written and I’m not finished yet. So let’s say more than 3 and less than 50 :-).
What will this series cover? What won’t it cover!
- How to take stock of your current financial situation without it being a giant bummer
- Tips on building an emergency fund
- Getting out of debt (mostly links to people who know this stuff waaaay better than Mrs. FW and I and who have personal experience with the process, which we don’t)
- Investing for retirement the simple and logical way
- How taxes work, and how to minimize them
- Discussions on whether to buy a house as a young professional
- Wills and insurance
- Pets and relationships
- Frugal Hound photos
My goal for the series is to create a resource to reference when Mrs. Frugalwoods and I are trying to explain the arc of financial responsibility to someone who is new to personal finance and wants to take charge of their money.
(While it isn’t directly aimed at teach any of you old financial dogs new money tricks… I hope it helps to frame your own conversations with friends, coworkers, family member, and friendly greyhounds.)
Things that I am not:
- Certified Financial Advisor
- Certified Public Accountant
But seriously… I am just some guy on the internet and my profession by training is software engineering.
This guide is meant to engender curiosity and give you the vocabulary and the framework to confidently approach financial decisions and use your own judgement.
This guide is not meant to tell you particular stocks to buy or places to put your money. I’m not that kind of guy, and this isn’t that kind of guide.
Time to Talk About Privilege
I am a white male born in the United States of America. My parents both have college degrees and are not divorced. My folks also made good choices about money and never experienced any long-term financial disasters. Mrs. Frugalwoods’ parents also both have college degrees, are still married, and never endured any epic financial calamities. We both grew up in stable, safe, loving, and highly educated middle class homes.
AKA the game was rigged in my favor from birth, and I want to recognize that.
I think it’s easy to be judgmental–both of ourselves and of others–when we talk about the “right” financial choices to make. Even using words like “right” and “good” can cause us to slip into labeling not only choices, but people, as “bad.”
Frugalwoods, and this guide, is a judgement-free zone. If you’re in debt up to your eyeballs, that doesn’t make you bad or dumb. It just is what it is and you’re making wise choices for your future already just by reading this blog (it’s also OK if you’re only here for the Frugal Hound pics).
I’m not into labeling people. And I’m not a fan of dwelling on the past or passing judgement on another person’s actions. Let’s go forward knowing that people have complicated and deeply personal histories with money and that we can all do better in the future.
And so, with that in mind, let’s get started!
Demystifying Personal Finance Part 1
Step 1: Know what you have to work with
There’s no sense making a plan for the future if you don’t know what your current financial landscape looks like. This can be harder than it sounds, but it’s an essential first step. Plenty of folks have employed the ostrich method of financial management up to this point: head in the sand.
I get it. It can seem overwhelming, intimidating, and even embarrassing! But it’s time to figure out exactly what you owe and what you own. There’s really no point in doing anything else before you first assess what you’ve got.
Make a list of your assets and your debts:
- Checking, savings, and brokerage account balances
- Retirement savings
- Value of your car and house
- Anything else of substantial value. (Be honest, don’t be counting your set of Fiestaware dishes. For your reference, Mrs. FW and I don’t include any of our possessions in our list of assets, mostly because we tend towards very conservative estimations of our net worth. However, if you own something of true value, include it.)
- Student loans
- Mortgages and HELOCs (home equity line of credit)
- Credit cards
- Lines of credit
- Car loans
- Personal/family loans
On your list, note the details of each line item. For brokerage-held assets like stocks and bonds, be specific in terms of actual assets held and fees assessed.
For debts, make sure to note the term of the debt (how long you have to repay it) as well as the interest rate.
Now make another list of your monthly expenses:
- Cable, phone, internet
- Restaurants and bars
- Household supplies
- Gas for the car
For more possible ways to assess your monthly expenses, check out Mrs. Frugalwoods’ Uber Frugal Month Challenge, which includes tips on how to figure out where you spend your money.
Putting this list together can be arduous to do by hand, especially if you have multiple credit cards or bank accounts. So, I highly recommend using a software service to aggregate your spending across your accounts. It’s what Mrs. Frugalwoods and I do and we think it’s the only way to sustainably keep an eye on spending over time.
We use two different pieces of software to track our money:
- Mint (good for an overview, but they haven’t innovated in years and it sometimes breaks)
- Personal Capital (great for tracking investments as well as spending, innovating rapidly, but not as flexible on categorization)
Both are free and secure, so I’d suggest you set-up both and see which one clicks with your financial paradigm.
(A full post on how we track our money, including details on both of these systems to come. For the time being, you can check out How We Manage Our Household Finances).
No Regrets, No Dwelling
The key in all of this is to internalize the reality that the past is over and done with. You can’t go back in time and un-spend money (much as we all might wish…). So don’t dwell on your bad decisions–and trust me, everyone has bad decisions in their financial past.
Instead, commit to yourself that you’re going to start afresh financially today (see Mrs. FW’s post about our 2014 savings rate, in which she discusses how we launched our journey towards financial independence and haven’t looked in the rearview mirror since). Just start and do it now!
Embrace the freedom that comes with allowing the past to teach you lessons without letting your past beat you over the head with a cast iron frying pan.
Step 2: Build an Emergency Fund
This is going to be short because I think it’s intuitive.
Life is full of little emergencies. A financial cushion is the difference between an inconvenient emergency and a ‘death spiral of debt’ emergency. When something unexpected happens (say a family member dies and you need to fly across the country last minute), you don’t want that to cause you to pay your rent late (fees!) or not pay your electric bill (lights=good).
More broadly, you want to be in the sort of financial position that allows you to be annoyed and not panicked if you get laid off from work tomorrow.
The common wisdom that an emergency fund equates to 3-6 months of living expenses seems pretty reasonable to me. I’d go for even more if you work in an industry that endures boom/bust cycles like homebuilding or oil.
Keep your emergency fund in a savings/checking account where it’s available but not too available. This is not an “emergency pay-a-bar-tab fund.” And if you do need to tap into the fund for a true emergency, prioritize replenishing it with your next paycheck.
While these first two steps might seem rudimentary or overly simplistic, don’t discount their importance. Without a clear, honest snapshot of your financial status and an emergency fund to cushion you from future debt, moving onto investing and retirement planning would be like running before walking.
For Mrs. Frugalwoods and me, judiciously managing our finances is what’ll enable us to retire to a homestead in the woods at the age of 33. We didn’t win the lottery or make millions in the stock market (or even in the greyhound glamour shots business), we’ve just been seriously frugal, mindful, and aggressive with how we’ve tracked, saved, and invested the money that we do have.
There’s no ‘one weird old trick’ to building financial stability, it’s just careful, straightforward accounting and math-based investing approaches. Next time on the series, I’ll be tackling debt and the repayment thereof.
What first steps would you advise a financial newbie to take?
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