Inspiration from Willian Bernstein's "If You Can".
See Bogleheads thread "Books for someone who is not that interested", started Tue, May 13, 2014 by "Weston".
I've done a fair amount of reading on personal finance, but I have a natural inclination and interest in the topic. Unfortunately, it seems the average person does not share my enthusiasm about personal finance. Like so many things in life, people want an easy turnkey solution that doesn't require learning a lot of new terminology or, god forbid, math.
There's no shortage of "personal finance 101" articles out there on the Internet, but I haven't seen any that are truly simple. Trying to put myself in the mind of someone who wants a turnkey solution for their finances, the following is my attempt at a truly simplified solution for sucessful personal finance. First are the rules, in their simplest, most terse format. Then I repeat the rules with a little more detail.
The fundamental rule here---and it's so important, we might as well call it the Golden Rule (of Finance)---is "spend significantly less than you earn". Following the above steps forces you into compliance with the Golden Rule. Some people like to say "live below your means", but to me, it doesn't drive home the point as well.
At this point, many articles might dive into the whole "needs versus wants" discussion, but I'll spare you that for now, and instead add some detail to the rules above:
A 401(k) is but one of many "defined contribution" plans that an employer can offer. Not all employers offer them, and even if they do, not all employers offer a match.
This rule is specifically about any kind of defined contribution matching your employer offers. If your employer doesn't offer a match, it might be time to re-evaluate your job. If it's simply not possible to work somewhere that offers both a definied contribution plan AND a match, you can skip this step. But, do work hard to be in a position where this step is relevant.
If you don't take full advantage of your employer's matching, you are voluntarily taking a pay cut. It's that simple. Why would anyone work for less money? Chances are, your contribution plus employer match alone are insufficient to fund your retirement. We'll get to that later. This first step simply ensures you are fully realizing your wage.
In personal finance circles, there is talk of "good debt" and "bad debt"... but for the person who wants a turnkey solution, we will simplify and say all debt is bad debt. Debt is a tool; in finance, it's the same as a hammer or saw in carpentry. It's a very powerful tool, and has its place in the hands of those willing to understand its nuances. If you are reading this, you don't want to know the "whys" or "hows" and simply want a recipe. So, we keep it simple: eliminate debt.
What this means: you buy nothing outside of the following:
If this sounds hard, well, it is. Think of debt as a cancer, that slowly eats away your financial health, until it is gone.
Some day, you may want to buy a house, and it seems that "everyone" buys their house with a mortgage. I will go so far as to say, you are not allowed to entertain the thought of buying a home on loan until you are willing to truly obtain a deeper understanding of personal finance in general, and debt in particular. (Generally speaking, from a historical perspective, home ownership is not to be thought of as an investment.)
The emergency fund. Many "personal finance 101" articles will make the establishment of the emergency fund the first priority. I deliberately put debt elimination before emergency fund because debt is an emergency. Let's take a look at typical emergencies that someone might face:
So what is a "six+ month emergency fund"? This is an amount of money sufficient to sustain you for at least six months in the event of a job loss.
For the person who doesn't want to track their expenses, and/or hates math, or thinking in general: this is half a year's net salary. Given that we've already established that you will spend much less than you make, half a year's gross salary will be well over six months of living expenses. But more is better, and hey, you avoided having to think about it.
I'd recommend taking this a step further: put the money in a dedicated account at a separate financial institution (than you normally use). Best case is you generally forget about this money, except when you really need it. This money cannot be used to buy new toys, such as an iPad.
Here's the short and easy version: once all the above have been addressed:
Some people may take issue with the Vanguard target retirement funds. I think they are the ideal product for someone who wants to save and invest in their future financial security without having to learn all the ins and outs of investing. Furthermore, they completely avoid all kinds of nasty landmines that lie in wait for the financially uneducated. There are indeed arguably more optimal ways to invest for retirement, but they require a non-trivial time investment to learn and understand a fair amount of subtlety. And in my opinion, the additional optimization is quite small relative to the time commitment required to understand these concepts sufficiently.
Put another way: anyone who tells you that this advice isn't ideal is selling you something. I make no income from this website (it's literally an expense to me); I am not selling anything. I endorse Vanguard because the company was founded to be a better liason to Wall Street than competing investment firms. Stepping outside the suggestions here might give you slightly better long-term results, but only if you commit to getting a respectable personal finance education.
The long(er) version: once all the above is addressed, then you can start saving for retirement in earnest. You should target a percentage of your income to donate to retirement savings, and never deviate from that (except of course to increase your savings rate). There are online calculators that offer rules of thumb for how much you should be saving for retirement. A very conservative, yet no-thought-required rule of thumb is as follows: save 50% of your net income for retirement. Though that sounds hard, consider the following:
As for the actual method or vehicle for retirement savings: we've already discussed employer-sponsored plans (typically 401(k)) above. But there are additional self-directed options; the most common ones are the Traditional IRA and Roth IRA. Too keep this article brief, a simple rule of thumb is that Roth IRA is the generall right choice for most people. The limitation of the Roth IRA is that it is not available to those with an income above a certain threshold. (Even then, there are tricks that allow high earners to take advantage of the Roth IRA, but that is beyond the scope of this article.) Anyone can invest in a Traditional IRA. In fact, if you are elligible for the Roth IRA, you can do both the Traditional and Roth IRAs. The only other caveat with these accounts is that there are annual contributions limits. It should come as no surprise, if you're still reading this artcile, I recommend maximizing IRA contributions.
Perhaps the easiest way to start a Roth and/or Traditional IRA is to open an account with an online broker (I recommend Vanguard). Modern online brokerages make this process very simple, and generally have help available if you get stuck. As for what to invest in: that is a discussion beyond the scope of this document, but in general, go for low-cost, index mutual funds or exchange-traded funds (ETFs). In particular, there are three Vanguard funds that could easily form the basis of a retirement portfolio:
How should one invest in each of the fund categories? The answer to that question falls under the concept of "asset allocation". For the purposes of this simple article, we say there are simply two asset classes: stocks and bonds. Per above, VTI and VXUS are stock funds, and BND is a bond fund. Generally speaking, young folks with a long investment horizon (say 20+ years) will want to have mostly stocks and a little bit of bonds. As you near retirement age, that allocation should shift more towards bonds. A good starting point might be 10-20% in bonds, and 80-90% in stocks. If I was a recent college grad who was just starting to save, I would probably do something like this:
The beauty of the Vanguard target retirement funds is that they basically take all the "thinking" out of the equation. You don't have to worry about stocks versus bonds, front- or back-loads, over-high expense ratios, or any of the other million pitfalls that await investors.