Financial Life After Yale – Money-Discipline
Your money path. In my recent posts, you’ve read about financial literacy in general and about budgeting in particular. When you create your budget, you take a huge step forward – something in which you can take pride! Your next steps will require patience and discipline.
In this post, let’s go over:
- How to bring your budget to life; and
Bringing your budget to life. Clicking here will take you to a budget created by a recent Yale College graduate just after she left campus. Names and places have been removed to protect the innocent! Let’s call this your Big City Budget (“BCB”). My previous post covers the five “moving parts” of your BCB:
- What you bring in (e.g. gross salary)
- Your tax payments
- Your savings goal
- What you need to spend
- What you want to spend
Let’s pretend the BCB is yours: you’ve budgeted your salary at $48,000, your combined taxes at a bit less than $10,000 (Federal, state, Social Security, Medicare), your targeted savings at a bit less than $4,800 (a bit less than10% of your salary), your spending needs at $27,300 (e.g., rent, basic clothing, groceries, and commuting to work), and your spending wants at $6,300 (e.g., vacations, socializing, gifts). Your BCB also breaks up your spending (needs and wants) into categories.
Don’t let creating your BCB turn into an abstract exercise, though. Budgeting isn’t supposed to be punishment. Your budget won’t hover over you like a dark cloud. Creating your budget can help you in many ways.
Every few months, see how you’re actually spending money. Then compare that to your BCB. Do you see a few big variances? That doesn’t necessarily mean your budget was wrong, nor does it mean that you spent unwisely. Many things that we spend money on fluctuate seasonally, for example; looking at a few months won’t reveal the big picture. Also, over longer time periods, life events and lifestyle and – well – chance happenings will change your budget and spending picture. That’s perfectly normal.
The key is remembering that good budgeting informs good spending, and vice versa. At my age – well, let’s not go there! – I’m still regularly refining my monthly and annual budget. Those refinements reflect career changes, new hobbies, offspring going out on their own, ups and downs in the financial markets – and getting older!
Remember, too, to revisit your early-career savings goals. As you progress along the arc of your career, a growing salary may give you the chance to bump up your budgeted (and actual) savings. It’s a worthy goal!
Money discipline. As you confront your own Financial Life After Yale, having a flexible budget is a great place to start. But how you behave, money-wise, will be even more important. For example:
- Guestimate fearlessly. Where will interest rates be next year? Tax rates in 2020? Inflation in 2025? Assumptions on these and many other variables matter…and can be daunting. But the truth is, with a bit of browsing you’ll see how other people (and various financial planning packages) deal with assumptions like these. And other assumptions won’t be quite as tough. For example: how many years can you expect to work full-time, earn money, and save? You may not feel much certainty, but reasonable guesses would seem likely to fall in a range of between 40 years and 50 years. Be brave! Guestimate!
- Spend ONLY what you don’t save; NOT the opposite. When you create your budget, it’s perfectly natural to take what you earn and subtract taxes, and then subtract what you need to spend, and finally to subtract what you want to spend. Is anything left? That’s what you’ll (try to) save. This sort of budget logic may seem natural, but it’s also insidious: the savings amount that you set aside in your budget is merely what’s left over. Instead, flip things around. Set yourself an annual savings goal. Then: allocate what’s left in your budget among your non-discretionary and discretionary spending categories.
- Early savings matter! The longer you can put your savings to work, the better. Here’s a simplified example. Assume that (i) you plan to work 45 years before retiring; and (ii) during the first five of those years, you manage to save a cumulative $20,000; and (iii) you decide to invest these savings in an index fund designed to mimic a major US stock market index; and (iv) over time, major stock indices continue to beat inflation by 7% (as they often have over long periods of time in the past). If all these assumptions were to hold (and of course they won’t), so that (subject to a few nausea-inducing bumps) your savings remain hard at work for you for 40 years, growing in real purchasing power at an annual rate of 7%, your savings would grow in value from $20,000 to $20,000 x (1.07 ^ 40) ….. roughly $300,000 in today’s purchasing power! If you were aiming to accumulate (say) $1,000,000 by the time you retired, just these early savings would – in this scenario — have gotten you 30% of the way to your goal!
- Unless you accept some risk, your savings will erode. The flip side of #3 is that, unless you accept at least some risk when you put your savings to work – instead of stashing all of your cash under your pillow or in a savings account – inflation will cause your hard-earned savings to wither away. The Great Recession may have frightened you, but don’t let it take you out of the game.
- Stay the course – you’re in this for the long haul. Ask yourself a question: If you’re planning regularly to take portions of your savings and deploy them in investments that mimic major stock market indices, and if those indices have nausea-inducing highs and lows, when will you struggle the most to stay disciplined and to keep making your regular investments? Most people will say that it’s hardest when market indices are down or falling…and I agree with them I can still remember how hard it was for met to keep putting money into the equity markets in 207, 2008, and 2009). But it’s also tough to do so when the markets are flirting with new highs. The point, here, is: don’t try to time the market. Few people can do this. Stay the course, keep to a schedule, and accept that –in some years – you’ll buy less with your dollars than in other years. When it comes to putting aside money for things like retirement, you’re in this for the long haul.
- Keep things simple. Brokers and investment advisers will often imply that you need to invest in quite a few different things in order to diversify your portfolio. But – in reality – there are investment vehicles called mutual funds and exchange traded funds (ETFs) that accomplish diversification before you even buy shares in them. For example, you can find mutual funds and ETFs that mimic stock market indices, or industry sectors, or regions of the globe, or companies of certain sizes, etc. With investments in as few as 3-6 of these, carefully-chosen so as not to be redundant, many of us can be quite-well diversified.
Your financial dashboard. But even if you bring your budget to life, and even if you’re money-disciplined as discussed above, over the long haul things may not turn out as you had hoped. If you fall behind on your path to retirement, what can you do? Guess what? Each of us actually has a financial dashboard! On it, we can find levers and dials (figuratively-speaking) that change our financial outlook in ways that can help us catch up.
In my next blog, stay tuned for a tour of your financial dashboard. And then get ready to navigate your long path path to retirement!