How to Set Up Your Financial Life | Investing for Beginners
Episode 276
Episode Guide
Episode Summary:
Episode Timestamps
ChooseFI Episode Show Notes
Episode Summary:
Understanding the foundations of setting up your financial life is crucial for achieving financial independence. Key insights include the importance of starting with a solid banking framework, understanding various types of fees, and establishing a budget that minimizes stress and promotes savings. The hosts share personal experiences about the power of compound interest, emphasize the significance of automating finances to avoid overdraft fees, and explore essential steps for navigating banking and investment options effectively.
Key Takeaways:
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Banking Basics: Set up a checking account as the clearinghouse for all financial transactions.
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Avoiding Fees: Choose accounts with no monthly fees and avoid overdraft options to maintain financial health.
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Investing Strategy: Contribute enough to your 401(k) to receive the full employer match for maximizing your benefits.
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Budgeting: Prioritize living off last month’s paycheck to ensure financial stability.
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Importance of Index Funds: Index funds offer the best chance for long-term financial success due to low related costs.
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Episode Timestamps:
- Introduction to Banking Basics
- Understanding Fees and Investment Options
- Setting Up Your Financial Framework
- The Importance of a Budget
- Strategies for Investing
- Final Thoughts on Financial Setup
Key Quotes:
- "Unlock the power of compound interest—start saving today!"
- "Helping people feel confident in managing their finances is our mission."
- "Say goodbye to financial stress by living off last month's paycheck!"
- "Index funds offer the best chance for long-term financial success."
Actionable Takeaways:
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Set up a checking account to coordinate all transactions.
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Automate your bills and spending to simplify financial management.
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Maximize your retirement contributions to benefit from employer matches.
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Related Resources:
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Simple Path to Wealth: Visit here
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Travel Rewards Course: Visit here
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FAQ:
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What is a good starting point for financial independence?
Begin by establishing a solid banking framework and budget to track your income and expenses.
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How can I minimize fees associated with banking?
Choose accounts with no monthly fees, avoid overdraft options, and always review for hidden fees.
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What's the ideal way to start investing?
Start with your employer's 401(k) plan, especially if they offer a match, to take advantage of free money.
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Discussion Questions:
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What banking features do you value most and why?
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How can you automate your financial life to reduce stress?
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What tips do you have for choosing investments in a retirement account?
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Podcast Description:
Join us as we explore the essentials of setting up your financial life for success. Learn how to navigate banking systems, avoid hidden fees, and prioritize investments that will help you attain financial independence.
Podcast Intro: You're listening to ChooseFI. The blueprint for financial independence lives here... Podcast Extro: You've been listening to ChooseFI Podcast, where we help middle-class America build wealth one life hack at a time.
Setting Up Your Financial Life for Independence
Achieving financial independence starts with understanding the foundation of your financial life. This guide will walk you through essential steps, including the importance of banking basics, budgeting, and investment strategies, to empower you on your journey to wealth and security.
Understanding Banking Basics
Choose the Right Bank Account
The first step in managing your finances is selecting a suitable banking account. Ensure you:
- Establish a checking account as the primary clearinghouse for your income and expenses. This account will facilitate automatic payments for bills and provide a clear view of your monthly cash flow.
- Be aware of any minimum balance requirements to avoid monthly fees. Many banks now offer accounts without these fees.
- Set up direct deposit to enhance your benefits, as some banks lower or waive fees when you have direct deposits.
Automate Your Finances
To mitigate stress associated with financial management:
- Automate your bills and payments, linking them directly to your checking account.
- Set up alerts for upcoming bills to avoid overdraft fees, ensuring you don’t spend beyond your means.
Fee Avoidance as a Strategy
Minimizing fees is crucial for maintaining financial health. Follow these best practices to avoid unnecessary fees:
- Investigate account options thoroughly to ensure you choose one with favorable terms and minimal charges.
- Request your bank to disable overdraft protection to prevent incurring fees when you have insufficient funds.
- Be mindful of ATM fees and strive to use in-network ATMs to access your cash without incurring convenience charges.
Establishing a Budget
Importance of a Budget
Creating a comprehensive budget is foundational in achieving financial independence. A well-structured budget should:
- Include both income sources and expenses to provide a complete picture of your finances.
- Use last month’s paycheck to cover this month’s expenses, which will help alleviate financial stress and create a cushion for emergencies.
- Allow room for savings, which will eventually form part of your investment strategy.
Strategic Investing: The Key to Building Wealth
Start with Your 401(k)
Once you have your budgeting and banking systems established, it’s time to focus on investing. The first avenue to explore is your 401(k):
- Contribute enough to your 401(k) to receive the full employer match, as this is essentially free money.
- Understand the specifics of your company's 401(k) plan, including contributions and matching percentage.
Selecting Investment Options
Investing can seem daunting, but starting with index funds simplifies the process:
- Index funds typically have lower expense ratios compared to actively managed funds, helping you maximize your returns over time.
- Verify your fund options within your 401(k) to find low-cost index funds that replicate market performance without high management fees.
Creating an Emergency Fund
Before investing without hesitation, ensure you have a sufficient emergency fund:
- Aim for three to six months’ worth of living expenses in an easily accessible account to cover unexpected costs.
- Understand that while savings accounts are important, prolonged cash savings in these accounts can lead to lost opportunity in terms of growth.
Building Wealth Through Consistent Savings and Investment
The Power of Compound Interest
Start investing early to reap the benefits of compound interest:
- Even small amounts can grow significantly over time. Reinforcing this habit can lead to substantial wealth accumulation.
- Consider setting aside a portion of every paycheck for investments to keep contributing toward your financial goals.
Explore Various Investment Accounts
Once you are comfortable with your 401(k):
- Consider opening a Roth IRA to allow for tax-free growth, providing flexibility as you save for retirement.
- Diversify your investments by exploring other vehicles like taxable brokerage accounts, depending on your long-term goals.
Conclusion: Embrace the Journey to Financial Independence
Building a secure financial future takes patience and diligence. Focus on:
- Setting up an efficient banking system.
- Maintaining a strict budget that emphasizes savings and expense tracking.
- Exploring investment options to grow your wealth through well-documented strategies.
By following these recommendations, you can confidently navigate your financial journey toward independence. Remember, every small step contributes to your overall success, laying down the groundwork for a financially free future.
What You'll Get Out Of Today's Show
Continuing the conversation discussing financial basics, today's episode covers how to get started investing, banking, and setting up your financial life.
As a recent college graduate, Brad had the motivation to get his financial life together but didn't really know how to go about doing it. During his first job, he wanted to open up a Roth IRA after learning about the power of compound interest.
Unfortunately, the investment advisor who helped get him set up invested in a fund with a 5% upfront load. That means 5% of his investment automatically went to pay the advisor's commission. Brad's investment was treated like a quick payday for the advisor.
Not all financial advisors are bad, but you can learn how to get set up with a low-fee or no-fee investment without feeling confused or overwhelmed by the process.
It's important to understand all of the possible fees that can impact the return on your investment. In addition to load fees, there are other fees to watch for, such as assets under management fees where you pay a percentage for the advisor to manage your account, or expense ratios which pay the team who actively manage the activity of buying and selling within the fund account, and with a surrender charge, you may pay fees to get your money out of the investment.
If Jonathan was giving a family member financial advice on how to get started, it would begin with banking. Do they have a banking system set up and understand the differences between checking and savings accounts? What other variables should be considered?
Getting a checking account set up is first and becomes the repository for income coming in and money going out, such as paying bills. Brad uses autopay to have many bills automatically draft from his checking account.
Brad likes simplicity. Because he knows which days money will be coming in, he sets up his bill autopay dates around that. He also ensures he has a couple extra thousand dollars in his checking account to cover anything unexpected with him having to track the balance every day.
Jonathan does something similar in that he uses the pay from last month to pay this month's bills, which means there is always around a month's worth of pay in his account giving him plenty of margin.
Try to minimize fees in every aspect of your life. Select a bank account option that requires the lowest minimum account balance to avoid a monthly fee. Avoid overdraft fees by asking the bank to remove that option or connect to a credit card. Don't pay ATM fees by trying not to use cash or plan ahead and withdraw cash from your own bank fee-free. Some online banks will reimburse ATM fees.
Brad doesn't keep all of his financial assets in a checking account. He used to use a saving account at the same bank that was connected to his checking account. However, it earned very little in interest. Online savings accounts, like those at CIT Bank, frequently offer a much higher interest rate on their savings accounts and still allow access to the money within 2-3 business days.
Your investing goals are determined by two items: your cashflow and what sort of safety net you need. Money that might be needed in the short-term and accessible within days, such as for emergencies, should be kept in cash in a savings account. Money that isn't needed for 10 years or more, should be invested because money can lose value over time due to inflation. Instead, that money can be making money and beating inflation. To maintain value, your money needs to make 1-3% per year just to keep pace with inflation.
Knowing how much to keep in savings and when to move to investing depends on your risk tolerance.
Make sure your bank is FDIC insured, which means it's backed by the United States Government and covers depositors in the event of bank failure.
Once you have a checking account set up and you are putting away something each month into savings, getting started investing would be the next step.
Brad says the best place to get started is with your company's 401K. Find out what the 401K match is and invest at least up to the match. The match is free money from your employer and technically part of your overall benefits package.
It may be something like a 100% match on the first 3% of your salary you invest. If you make $100,000, 3% equals $3,000, it means you invest $3,000 of your salary and your company also puts in $3,000. It's a guaranteed return.
If there's an option to check a box and automatically increase your contribution by 1% each year, do it.
Instead of a 401K, teachers may have a 403b or 457 which are essentially the same type of investment vehicle.
The maximum amount an employee may contribute in 2020 is $19,500. The total limit for employee and employer contributions combined in 2020 is $57,000.
Each person needs to figure out what works best for them in terms of funding an emergency fund, paying off debt, investing in their 401K, or Roth IRA. Since contributions may be withdrawn from a Roth IRA tax and penalty-free, it could be used like an emergency fund.
A 401K is funded with pre-tax dollars, meaning it was invested before that portion of your income was taxed. When it is withdrawn at the age of 59 1/2 or later, it gets taxed at your marginal tax bracket.
When picking a fund within a 401K, Jonathan's strategy has been to look for index funds or anything with the index beside it.
Brad notes that the list of funds may also show the funds' expense ratios. Look for the ones with the lowest expense ratios which will be the most similar to total stock market or S&P index funds. Go to Google and type in the ticker symbol to find out more about the specific fund.
Actively managed funds are run by teams of well-compensated people whose goal is to beat the market. Their fees are incorporated into the expense ratios. Index funds do not try to beat the market, they try to track their market index. Their expense ratios are dramatically smaller since they are managed by a computer algorithm not a team of managers.
ChooseFI is anti-debt, but not anti-credit card. Credit cards a financial tool when used responsibly and paid off on-time and in-full each and every month.
Brad tries to use his credit card as much as possible for the safety and security credit card purchases provide, as well as for the travel rewards points that allow his family to travel the world for free or almost free.