When I first started learning about personal finance, it felt as if I had a huge pile of information to wade through before I could even wrap my head around it.
For e.g. when I wanted to learn how to set up a budget, I looked into several budgeting videos on YouTube before I settled down on something that worked for me. The same applied to decide whether I need to pay off debt or invest? Should I use a credit card or cut them up? The list goes on.
Over the course of this exercise, I realized one thing. Every single topic I encountered, had so many conflicting recommendations that it was up to me to decide which path I needed to take. If you are new to any of this, it will make your head spin. I quickly realized that personal finance is more personal than finance. I am glad I realized it early before I went down a rabbit hole.
There’s More Than One Way To Skin The Cat
Having this unique insight led to me the next thought.
If there are so many ways to achieve your end goal, which is to build wealth or achieve financial independence, you must know who to listen to and where to get your advice from.
Personal finance is littered with a lot of opinions and people often peddle stuff that worked for their unique situation to be the Gospel of Truth. I would caution you to not fall for it. A lot of Money Gurus will prescribe their kool-aid and if you refuse to drink it, you will be subject of ridicule from their army of followers. It’s just too much noise out there for you to think clearly.
You’ll often see different camps in the personal finance community and will be torn between what’s recommended vs what’s right for you. It is, for this reason, I felt everyone should have their own map to help them navigate their journey that fits their life.
The idea of writing this blog post is to help you come up with one such map for your journey. It will serve as your North Star and help you reach your desired destination. So I highly recommend you spend time on this. I personally have built mine by answering these 5 areas of my personal finance.
So what are these 5 questions? Why is it important you answer them correctly to know if you are on the right track?
1. What Is Your Stance On Consumer Debt?
I have written earlier about the million dollar question – Payoff Debt Or Invest? It was early 2018 and we had to decide which path we wanted to take. The reason why this mattered because choosing one over the other meant we would fundamentally wire our brains to look at debt in a different way. If we decide to go ahead and carry consumer debt forward, it would signal to our brains that it’s fine to be in debt. It’s just a normal way to build wealth. I personally didn’t feel the need to subscribe to this school of thought, even though I was the one who got us into debt in the first place.
Our debt was mostly our car loans, small mortgage balance on an investment property and some credit card balances. Since I got us here, I wanted to take ownership of my mistakes and set them right.
My wife and I looked hard at the debt and questioned ourselves what mattered more to us and our peace of mind. Being able to pay off the debt slowly but make progressing on our savings goals or get rid off this debt immediately and then attack other savings goals?
When I Look back at it now, I feel we made the right choice. We chose to become debt free. It helped us in 2 ways:
- We became extremely diligent on how we spent our money. Since we had a concrete number to knock off in terms of debt, it was very motivating to achieve that goal. For some reason, paying off debt seemed more rewarding and fulfilling than seeing our bank balance grow with some savings. Whenever I looked at my net worth in personal capital, I saw the big “negative” number which used to pull my net worth down. I simply hated to see it. I couldn’t wait to make it zero. It’s just a very personal thing and I am aware this may not be true for others. But all else being equal, I would not trade my decision to become debt with anything else in this world.
- We became extremely good at budgeting. We did hit some bumps along the road in the first 90 days. Our budget often went off track and we felt guilty of over spending. But we didn’t give up. We simply stomached our failures and kept chugging along. This was one of the best decisions we took. Now that we are well past those days and are working towards saving for a down payment for a home purchase, there are times when we cut ourselves loose and we can easily miss the savings goals. There’s no target on our backs and there is no real Gazelle intensity that Dave often talks about. Truly speaking we’ve let the foot off the gas peddle a little bit. But it drives home the point#1.
Being debt free feels awesome and I don’t wake up every single day stressed about the payments or look at my net worth in personal capital and agonize about the “negative” number that’s bring it down. It worked out very well for us and will serve as a reminder that we never want to go back into debt again.
2. What Is Your Investment Philosophy?
I am still a very new investor. I don’t have a lot of experience in this yet to call myself an expert DIY investor. My pursuit to educate myself in personal finance led me to the world of investing. Before learning about investments, I often thought that I needed 1000s of dollars to be even be considered as an investor. I was so wrong. I have reviewed a few books on investing, on my blog, that I found to be immensely helpful. I would encourage you to check them out too.
The funny thing about the whole journey is that, while I was completely oblivious to the world of investing, I was still contributing the maximum allowed to my 401K. In my mind, this didn’t count towards investments at all. Why? I didn’t think I wasn’t investing is still a mystery!
So whenever people in my friends circle discussed investments, I used to feel secretly guilty about not doing my bit. I used to think I’ll get there someday too. For me investments meant, opening a brokerage account and trading stocks or buying some mutual funds. My mind has bucketed the investments to exclusively refer to taxable investments. I am glad I invested steadily in my 401K and HSA accounts.
The other thing about investments that kept me from learning about them was this notion that I needed to be an expert and pick stocks. I guess I was heavily influenced by the market timers who get prime time coverage on new outlets to tell their viewers which is that hot stock they need to be investing next. Seeing this commentary for a long time made believe that investing == stock picking!
The truth is far from it and in fact, a good investment has nothing to do with stock picking or market timing. It was one of the biggest revelations for me! In fact it is anything but this!
The next thing I realized about investing is the fee that’s involved in trading the mutual funds or ETFs using the brokerage account. It was after this that I went back to my 401K account and looked at the expense ratio of all the funds and their performance for the past 10-15 years.
Some of the funds I was invested in was 1.25% in expense ratio. I realized I was paying too much. I was also enrolled into Fidelity Managed Services, their active management portfolio management service. I have since then moved out of Fidelity managed 401K services to a flat fee structure offered by a Robo Advisor called ‘Bloom’. I have been very happy with the results I am seeing and the overall expense ratio of my portfolio went from 0.78 to 0.3 after this switch.
To summarize I came up with the following rules to be my guiding principles of investing my money:
- Max out the tax-advantaged accounts first – 401K, Roth IRA, HSA
- Costs do matter in investing. So pay close attention to them. Use a low-cost brokerage firm like Vanguard for IRAs and for 401K, use a Robo Advisor like Blooom to reduce the costs of investing.
- I didn’t start off as a DIY investor since I didn’t know anything about investing. So when it came to taxable accounts, I started with Wealthfront, Betterment and finally moved out of them once I learned enough about investing. At this point, I am comfortable with investing myself and I believe in the 3 fund portfolio that many Boggle-heads recommend. I think I have found my groove. I personally manage my own Roth IRA investments.
- I don’t believe in investing in individual stocks, so I am not going to invest in any. I don’t believe in timing the market and I will refrain from doing it. This should serve me very well in the long run. So no stock picking and jumping in and out of the market. I love index investing. So I’ll just Index and Chill
I am so fortunate to escape the horror stories one often gets to hear in the world of investing. My ignorance didn’t cost me too much, unlike others who have burnt their hands. But once I educated myself enough, I felt I found my thing. Now I have pretty much a good handle on my investment philosophy and it works for me.
3. What Is Your Risk Tolerance?
Every single financial adviser that I have worked with (including the brokerage firms) ask you this very basic question, even before they propose their plan. I feel it’s a double-edged sword. If you are not educated enough to gauge the questionnaire and extrapolate your answers to match a certain risk number, you might be in for a rude shock. So be very careful about what you are getting into.
Fortunately, a good financial adviser will walk you through each question and if they find your answers to be different from what they gather from talking to you, they will ensure they clarify them for you. As humans, we often overestimate our strengths and underestimate our shortcomings. If you haven’t been an investor before and haven’t seen what a bad market looks like, you might just be overestimating your risk appetite.
We often look at risk as a measure of our ability to stay put in the of an adversity like a bear market. This is often factored in to the financial plan and you would be recommended a portfolio to reflects your risk profile. It’s a financial adviser’s responsibility to educate you about the specific investments to suit your risk appetite.
If you are someone who is very risk-averse, you’d be heavily invested in asset classes that don’t provide huge returns but also don’t display a lot of volatility with changes in the stock market. The opposite is true if you are someone who has a stomach for risk.
However, you need to know that managing risks and investment returns to meet a client’s financial goals is a balancing act. Who doesn’t want maximum returns and zero volatility? But investing is inherently a risky affair. So you need to calibrate your risk and invest accordingly.
My experience with managing my risk has been to keep myself off of making any knee jerk reactions to the stock market on any given day. I do this by keeping my hands off of it.
- My 401K is managed by a Robo Advisor and I can’t execute any trades without going through them. This artificial barrier helps me avoid doing anything stupid.
- When it comes to my Roth IRA, I was heavily invested in 100% stock portfolio in Vanguard. I was 100% into VTSAX the whole of last year. The 3rd of December really tested me as an investor when I nearly see a lot of my gains evaporate and the investments went under water. Fortunately I held my ground and today it’s finally shown some gains. I did however make one small change. I went from 100% stocks to 90% stocks and 10% bonds. I realized I need to take some edge off of my investments to feel a little safe.
So my advice here would be to know yourself. You are bound to make mistakes if you take the DIY route. So make sure you work with a financial adviser or a financial coach who can help you stay the course and stop you from committing costly mistakes with your investments. Once you have enough knowledge you can manage your own investments.
4. What Are Your True Financial Goals?
This is one of the fundamental questions you need to answer in your wealth building journey. Beyond the necessities of life like paying bills, taking care of food, shelter, and clothing, etc., you need to find out what your true financial goals are.
There are different kinds of financial goals one can set. They can also vary dependent on the time horizon one wishes to accomplish them. The reason why this is so important is it will help you to prioritize your cash flow to meet those goals.
One of the first questions my financial adviser asked me before presenting a plan was to find out what my financial goals were. It was a true eye opener for me since the list seemed very long and I had limited cash flow to meet it. But fortunately there weren’t too many big ticket items in there. You’ll often find competing goals trying to eat into your cash flow. So it’s entirely up to you to prioritize them and make sure you don’t get derailed. Any misstep can often take you down a path which can be hard to recover from and cost you not just money but valuable time.
The whole process becomes extremely exciting and challenging when you have goals like FIRE by age ____. You now have to not only cater to your other financial goals like maybe buying a house or fund a kids’ 529 plan or start a business but also make sure your FIRE goal is met.
Often when people find themselves swamped with too many competing goals, something’s got to give. Hence it would be a great idea to plan the way you are going to build that nest egg and still fund other goals. How much money gets diverted to each one of those goals is eventually going to decide if you’ll succeed or miss the goal post by a wide margin.
I would advise you to use this opportunity to plan your life around the financial goals you are going to list and prioritize them accordingly. Once you set the priority and the number to meet, set a timeline and work backward from that date. You’ll then spend time adjusting your cash flow to reflect the plan.
It is often during this journey you’ll realize which goals don’t seem important anymore or what are the other ways you can earn more money to fund a goal that’s lagging behind. This will surely make you think not just your finances but your other priorities in life like Marriage, Kids, House, etc.
5. Do You Have The Right Safety Nets Built Into Your Financial Plan?
I look at my wealth building journey as an act similar to a performance by an acrobat. You journey is not one straight well defined path since life is never that simple. You’ll often hit roadblocks and challenges that you’d not accounted for. While it’s true that you can’t control every unforeseen event, you can certainly spread some safety nets to protect your plans.
Safety nets come in a lot of variety and often server different needs. Let me share some of the safety nets I have discovered that I believe will help me feel secure in this journey.
- A skill to bring you a steady paycheck
I am talking of your day job and your ability to deliver the expected results every single day. I want to make sure I invest into my skill sets and stay current with the market since it’s going to be help you stay employed and earn a living. Most people don’t look at their skills as a safety net but I do. It helps you find employment and bring in a steady income every single month. Don’t discount this one.
- An emergency fund
This is your insurance against a bad job market or an emergency that can’t be cash flowed. I would highly recommend you have the fund filled up as per your personal situation. If you area of work is volatile or a job loss can be hard to overcome with another job, I would suggest you to have this filled up 6-8 months. Otherwise a standard 3 month emergency fund is always a good place to start. This will give you the confidence to sleep well at night and know that an emergency can be taken care of without going back to debt.
- Carrying the right insurance
In an economy that runs on contracts, I can’t stress enough on the need to carry the right insurance to meet different needs. It can involve carrying an auto insurance with the right level of coverage for liability, collision, etc. Also having a good emergency fund helps you carry a higher deductible and can save you thousands of dollars in the long run.
If you are a home owner, I would also recommend you to carry a home owner’s policy and an umbrella insurance. The umbrella insurance can work out very cheap if you club it with auto, home owners and this policy. It is a great first level of defense against creditors or anyone who would come after you and sue you for any damages. Typically your auto insurance doesn’t cover beyond the normal 100k-300K range. So an umbrella insurance is set up to kick in to cover a liability more than this amount.
Once you have this covered, I would look at owning a Disability I
Having these safety nets in place ensures your plans are secure and don’t fall apart at the occurrence of one unexpected event. It’s totally worth your effort to not just shop the right insurance but also shop for the best in class.
I hope answering these questions will help you finding your true Financial North.