Now, Who's Richer?
Personal finance tips may be designed to help you be less poor instead of becoming rich. But how do we define wealth in the first place?
🤝 Happy Labor Day!
❤️ You can support my writing by forwarding this to a friend or family
👊 If this was forwarded to you, subscribe for future notes
🗑️ I've received emails that the newsletter lands in spam/promotions for some of you. Kindly mark it as "Not Spam" or move it to your inbox if this happens to you. Let's dive in.
All Personal Finance Experts Are Liars is a title I couldn't ignore. The blog post in question claims that most personal finance tips are bullshit. That things like creating a budget, minimizing expenses, and investing don't work for the average person. Indeed, many personal finance experts didn't get rich by doing things they preach. Most finance insights don't teach you how to be rich but instead help you become less poor. It doesn't mean that the so-called experts are lying. People usually create content to capture a large enough audience. Many people would rather not deal with money problems. The tips that are thrown out are meant to work for as many people as possible. It doesn't mean that it applies to every individual's unique situation. In the author's own words: "the average person wants the easy way out. They want the miracle pill that will make them thin or buff. They want something that requires little effort." This is one of the reasons why my blog is highly targeted towards young investors. I find it challenging to write for a generic audience, but long-term readers would know that I avoid some things on the list below. Let me add some color.
The personal finance experts all say that in order to get rich you need to:
- Create a budget
- Open a retirement account (401(k), IRA, etc.)
- Have 6 months in emergency savings
- Invest in index funds
- Buy a house (since it’s your best investment)
- Save 10% of your income
- Eliminate all debt
- Minimize your expenses
- Spend less than you earn and invest the difference.
I’ve pretty much summarized every personal finance book ever written. I’ve saved you hours of reading and paying for the books.
You (may not) need a budget
I've never been able to maintain a budget longer than a month. They aren't for those trying to get rich; they are for people that want help controlling their spending. If you're a high-income earner that somehow spends every cent on eating and drinking out, you may not need a budget. It's weird how we're quick to assume what people want in life. Budgets are for changing spending habits. If you're not interested in changing that habit, then you're wasting your time with budgets. If you are, then I recommend reading books on habits rather than jumping into a budget. Learning how to form new habits and break old ones will improve your spending more than any budget. The Power Of Habit and Atomic Habits are good options (you don't need to read both). But budgets can't work if you don't have money to spend in the first place.
If you are reasonable with your money but barely make enough to cover your bills, a budget won't change that. It cannot increase your income. People often default to it because it is easier than the alternative. Increasing your income means taking more risks with your time or money. Again, people look for the easy way out, and side hustle culture has capitalized on this. I had a conversation with a guy bringing in an extra $3,000 a month from his side hustle. Amazing! But after accounting for taxes and other costs, he was doing a whole lot to bring in less than minimum wage an hour. That's not it. Just as you shouldn't create a budget for the sake of having a budget, don't create side hustles simply because of the additional income without accounting for costs. Actual side hustles or passive income streams require a significant amount of upfront time or money investment. Or luck. Sometimes you have to be there to catch an emerging wave.
But I agree with the author that time is not scalable. Decoupling your time from your sources of income requires you to take risks. Some people hear this and quit their jobs in pursuit of launching a business. There's nothing wrong with that. I've met others that continue to get showered with cash from their employer. Instead of starting something new with their time, they use their money to bootstrap something new for others. In either case, you're risking something. Whether you're jumping from one job to the next or jumping into something different, you're taking a risk. Make sure the expected upside is reasonable.
Six months in emergency savings is very arbitrary. When the coronavirus epidemic hit in 2020, I had little to nothing in emergency savings. Instead, I had short positions. The market downturn created the cash I needed to buy the dip or fund emergencies. Now that was lucky. I was short retail in 2020 not because of some god-like foresight but because I had shorted retail every year since 2017. I don't expect people to learn how to short companies, but investors need to understand their "worst-case scenarios." If your only skill is in investment banking, an empty cash reserve like I had could be very dangerous. On the other hand, if you're a tenured professor holding 100% of your net worth in cash, not only are you losing the game, but you're not taking advantage of a stable industry. In my post on personal human capital, I wrote about how future income expectations and job security should affect investment portfolios. It's a difficult but necessary exercise. Whatever the case is for you, you should never be in a position where you're forced to sell out of stocks.
The probabilities of the market tanking or mooning do not matter. What's important are the consequences of those events. Cash reserves usually come in handy when the market is bleeding. That's also the time most companies downsize to conserve cash. Would you regret not having an emergency fund if you get laid off while the market is down fifty or eighty percent? Play it out. Pull out your portfolios and cut those numbers by half, and set your monthly income from your job to $0. What would your life look like? Will you still have a roof over your head? How long would it take you to start generating income again?
The idea that everyone needs to have six or twelve months of expenses saved up is quite dumb. Some people do; some may even need more. But it is on a case-by-case basis. The worst-case scenario for some people may not be that bad. It comes down to whatever helps you sleep at night. For me, a good night's sleep is wealth. My risk tolerance doesn't need a huge pile of cash for me to sleep soundly. A fully long portfolio without bets to hedge against the unknown scares me more than not having an emergency fund. But it really helps to know yourself. If you're trigger happy with the sell button, it helps to never be in that position. That's why emergency funds are a necessary tool in your arsenal. They're not there to help you get rich. They're designed to keep you from selling assets at a steep discount. If you need them, use them.
I spent many of my earlier investing years worrying about the best way to optimize tax-advantaged and individual taxable accounts. Questions about whether taxes will be higher or lower at retirement are difficult to answer since so much can and will change between now and retirement. If you spend a lot of time contemplating which accounts to hold dividend-paying positions for preferential tax treatment, I hope you enjoy it because it isn't all that important in the long run. Unless you receive Buffet-level dividends, chances are the qualified dividends tax rate won't drain your wealth. But trading fees and short-term capital gains taxes will. Beyond an employer's 401k match (an automatic 100% pretax return), I think retirement contributions should be given more thought. Maxing them out isn't always the right thing to do. It's never that simple. Illiquidity could end up costing more in the long run. No one ever gets a perfectly optimized portfolio. Those that strive for portfolios that outperform in every market condition end up losing to fees or underperformance.
I love diversified portfolios, but there are limits to the benefits of diversification. At some point, you end up holding more of the same stuff. Your ability to stick with your asset mix is more important. If you find it easier to hold individual companies in bad times because you understand them, index funds may make less sense. If your thought process requires you to be familiar with all of your holdings, sticking with index funds might be difficult. Again, there's no magic to index investing. Don't force yourself to buy them if you know you'll sell them as soon as there's trouble.
What everyone is doing or what everyone tells you to do may not be right for you. Hard rules like "you need a budget" or "eliminate all debt" are some of the reasons I started this blog. I got those answers from my experts when I started my journey without much explanation other than "it's what people do." My first post talked about leveraging time. The fourth one talked about using leverage or options if you can stomach the worst-case scenario. They are options many would never consider till it's too late. I write about them because I believe it's important to be educated about your options as an investor. If they turn out to be too complicated for you, you can walk away. Not knowing is worse because you end up choosing only from the options presented to you. If all you know are target-date funds, a stock-only portfolio may seem outrageous even if you are twenty-one years old with over forty years till retirement.
I wanted to wrap this up with something that took me a few years to grasp. Till recently, I never understood why someone would pay more than their monthly mortgage payments. I had a conversation with a friend whose rental was cash-flow rich. He was making extra monthly payments and forgoing the income despite paying taxes on it. He told me he wanted to own the home outright. I didn't get it till I got a chance to refinance my rental last year. I had the option of increasing my monthly cash flow by a few hundred dollars or taking a decade off my loan. I chose the latter option. I bet I could have done some exciting things with the extra income. But ten years was invaluable, so nothing else mattered. Not even the most rational options. When I see statements like "You’ll NEVER get rich by working for someone else," I have to ask: how do you define wealth? I have a friend who loves her corporate job and all its benefits. She feels challenged by her work, could care less about a startup's upside potential, and has excellent relationships. Is someone like that poor? She's someone who wants nothing more than what she already has. Now, who's richer?