The Index Card: Why Personal Finance Doesn't Have to Be Complicated

by Helaine Olen

Save 10 to 20 percent of your money—or as much as you can, if you can’t put that much aside. Pay your credit card balance in full every month. Invest in low-cost index funds.

One quick note: You’ll notice we made a few alterations to the original index card. Most of these changes were either organizational or for wording, but a few are more significant. Most important: Harold originally suggested that people save 20 percent of their pretax income. It’s a terrific goal. It’s also all but impossible for many of us. Aiming for 10 to 20 percent is a more realistic long-term strategy. We also eliminated the recommendation to use target-date funds—read on to find out why. Finally, we felt it was important to include insurance and housing, both of which didn’t make it onto the original card.

So by following the nine simple rules as outlined on our index card, you will have the confidence to make your own financial decisions; discover basic financial truths such as that low-fee index funds outperform just about any more complicated investment you can buy and that simple fixed-rate mortgages remain the best way to borrow money to buy your house; be armed with a timeless set of guidelines that you can turn to no matter what financial issues you may face or how drastically the winds of financial change shift; and be sure you never make the same mistake Sam made and let your fears about the financial unknown prevent you from doing anything.

How much should we save? you ask. Well, the title of this chapter pretty much says it: Ten to 20 percent of your gross income, the amount listed on your paycheck before taxes and everything else are taken out.

You need to determine what day-to-day spending is necessary and unavoidable, what is a luxury but helps you get through the day, and, finally, what is excess. Only then can you avoid falling prey to spending traps.

Step 1: Monitor Your Spending For three months, keep track of everything you spend money on, no matter how small.

Step 2: Confront Your Spending At the end of the first month, look over your categories, and see how much you are spending in each. The first month will give you a sense of your recurring, nonnegotiable, nondiscretionary expenses: rent or mortgage, health insurance, car payments, gas, child care, and so on.

Step 4: Create a Plan A realistic spending and savings plan accounts for how much you earn and how much you wish to spend, and it leaves room for flexibility: Money for dining out, say, can be repurposed if you spend a bit more on computer equipment one month than you had otherwise accounted for.

Step 5: Make Sure to Leave Room for Fun See a movie, attend a concert, eat dinner out with a loved one a few times a month. Remember, starvation budgets work no better than starvation diets.

To build your emergency fund, start stashing away three months of living expenses in an accessible savings account.

The experts say we should not spend more than 50 to 60 percent of our take-home pay on such expenses.

Take all monthly bills and give them a good inspection. It’s unlikely you can eliminate your cell phone bill, but does it really need to be that high? You’ll likely notice fees and charges you don’t understand. Ask someone to explain them to you. It’s almost certain that either you are paying for things you don’t need or you can negotiate for a lower monthly charge. Do you really need to rent that cable modem? (No.) Can’t you live with a higher deductible on your home or auto insurance? (Almost certainly.) Scrutinize every line item on that monthly credit card bill. Harold found one exercise to be very useful. Imagine that someone stole your credit card and you had to cancel it. When your new card arrives, would you re-up for every magazine, iPhone app, or whatever else you’re automatically paying for right now? When Harold performed this exercise, he discovered many accumulated items. Some had festered for years, including the $10 monthly charge for a wireless hot-spot service he never used, its password long forgotten. An annoying ninety minutes on hold later, and he was free. Make the time to better plan meals. Something worth remembering: According to the market research firm Natural Resources Defense Council, the average American family of four throws out between $1,365 and $2,275 worth of food annually. (Helaine would like it noted she wrote this sentence on a day when she tossed six strips of uncooked bacon found in a sandwich bag and an open but barely eaten packag...

STARTS WITH AN A: SET UP AN AUTOMATIC SAVINGS PLAN

Capital One) told the New York Times that the most common nicknames for their sub-savings accounts were the following: 1. Savings 2. Vacation 3. Emergency fund/rainy day 4. House 5. Taxes

DON’T PRIORITIZE EMERGENCY SAVINGS OVER CREDIT CARD DEBT

Because the thousands of dollars she’s paid in interest payments could be resting comfortably in an emergency savings account.

GRANDMA’S BUDGETING SECRET: LACK OF EASY CREDIT

AFTER EMERGENCY SAVINGS AND CREDIT CARDS, FOCUS ON RETIREMENT

START YOUNG

Simply put, there is no better, more effective, or more lucrative way to begin building and growing your long-term savings than to make proper use of your defined contribution retirement account.

TAKE ADVANTAGE OF YOUR WORKPLACE RETIREMENT PLAN

Most experts say you need to consider saving between 10 and 15 percent of your gross pay to ensure you have a decent living standard in retirement. If you have a comfortable income now relative to your current needs, your 401(k) is a good place to save—right up to the legal limit. This is the main way Harold caught up on his retirement savings.

NEVER, EVER FORGO THE EMPLOYER MATCH

KNOW THE DIFFERENCE BETWEEN IRAS, ROTH IRAS, AND SEP-IRAS

NEVER TAKE MONEY FROM A RETIREMENT ACCOUNT UNLESS YOU ARE OUT OF OPTIONS

IF YOU CHANGE JOBS, DON’T CHANGE RETIREMENT ACCOUNTS

Workplace retirement plans almost always come with lower-fee investment options and stronger regulatory protections than you will get on your own. Your money is supposed to sit there, sensibly invested, and left alone. Rollover IRAs often come with high expenses and fees that can drag down your savings over time (we’ll get into this in the next few chapters).

TO REPEAT: DO. NOT. BUY. INDIVIDUAL. STOCKS.

Yes, mutual and exchange-traded funds are better. But even more important—one more time and this time with feeling—do not buy individual stocks. YOU’RE NOT WARREN BUFFETT

FINANCIAL ADVISORS DON’T PLAY THIS GAME MUCH BETTER THAN YOU DO (THOUGH THEY CHARGE YOU TO PLAY IT) AND MIGHT EVEN BE WORSE

NO ONE ON TV (OR THE INTERNET) KNOWS A STOCK’S FUTURE

INVEST YOUR SAVINGS

NOT ALL MUTUAL FUNDS ARE CREATED EQUAL

MUTUAL FUNDS VERSUS EXCHANGE-TRADED FUNDS

Mutual funds are not always index funds. Exchange-traded funds are almost always pegged to an index or other benchmark. Exchange-traded funds can be traded like stocks. Mutual funds can be bought and sold only at the end of the business day. Exchange-traded funds almost always have lower expense ratios but higher trading costs than mutual funds.

Different types of investments can be classified into different categories. A well-designed portfolio will contain representatives of several of them, with proportions determined by such factors as age, long-term investing goals, and risk tolerance. This is called diversification.

So how do you determine how much money you should put in stock market funds versus bond funds? Well, conventional advice goes something like this: 1. What’s your age? 2. Subtract that number from 100. 3. The answer is the percentage of your assets that should be invested in stocks.

Seventy percent: A good S&P 500 index fund. This fund will provide domestic and international (more on that later) exposure to large-cap companies based in the United States. The S&P 500 represents industries that include technology, banking, and health care so you are assured quick diversification. Fifteen percent: A small-cap index fund such as the Russell 2000 Index. While large-cap companies tend to drive headlines, you also want to make sure your portfolio contains exposure to small-cap funds. Why? Small-cap funds have generally outperformed large-cap funds. Before we get too excited about outperformance, remember that it comes with greater risk. Think of small-cap companies as small and agile. Some companies will be poised for growth and may even evolve into large-cap companies, while others may go bust. You will see this in the slightly more volatile returns of small-cap companies. Fifteen percent: A broad-based international fund like Vanguard’s Total International Stock Index Fund. You will want an international fund that has access to both developed—think Europe and parts of Asia—and emerging—think South America, Africa, and other parts of Asia—markets. Make sure that you choose an international fund and not a “global” fund. An international fund will have little to no holdings in U.S.-based companies, whereas a global fund will try to mimic the globe and, in turn, have exposure to the United States. At first glance, a 15 percent allocation to international marke...

Eighty-seven percent of us believe that if we speak with someone affiliated with our workplace retirement plan about our overall investment portfolio, he or she is obliged to give investment advice in our best interests. Seventy-six percent of us believe anyone going by the designation “financial advisor” is obliged to give investment advice in our best interests. Sixty percent of us believe insurance agents are obliged to make recommendations based on our best interests.

THE FIDUCIARY STANDARD VERSUS THE SUITABILITY STANDARD A fiduciary is a financial advisor who has a legal and regulatory duty to put your interests ahead of his or her own. A financial advisor working to the fiduciary standard 1. has a legal duty to act in your best interests; and 2. is not getting paid to steer you into buying overpriced investment products you don’t want or need.

THE ONLY CREDENTIAL THAT MATTERS: FIDUCIARY

THERE IS NO SUCH THING AS A FREE LUNCH—OR DINNER

YOUR FINANCIAL ADVISOR IS NOT YOUR FRIEND