Your Personal Finance Guide

We’re going to talk about becoming “good with money” today. Which is tricky, because Americans hate talking about money.

Survey after survey shows that we’re more comfortable discussing our marriage problems, mental illness, addiction, race, sex, politics and even religion than we are talking about our finances, causing us to lie to our friends, our children, and even our significant others about our saving and spending habits.

Why are we so nervous about saving? 

Because we don’t do it

This anxiety only really starts to make sense once you look at the shocking statistics around saving and personal finance in this country.

A staggering 69 percent of us have less than $1,000 in savings in our bank accounts, and 45 percent have nothing saved. Another survey found that up to 78 percent of Americans could be living paycheque to paycheque.

And that’s all data that came out before the COVID shutdown, during which up to 47 million of us have already lost our jobs.

If you’re like most Americans, chances are you don’t have very much saved and that you might not be making very much either.

So what can you do?

As uncertainty around the economy grows, most of us are probably less focused on striking it rich than we are on:

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💸 Getting our financial act together

🏦 Cutting expenses and building a saving habit

🧾 Sorting out our bookkeeping, accounting and taxes

🔻 Paying down our debts

💰 Building an emergency fund

💹 Setting aside money to invest, after expenses

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As daunting as all of those goals might sound, being good with money and building wealth isn’t necessarily complicated. There’s no real ‘secret’ to it.

It all comes down to spending less money than you earn, and then saving it responsibly. 

That sounds obvious. So why do so many of us have trouble doing it?

Mental Accounting & Why We Spend More Than We Earn

If there’s any secret to being good with money, it’s realizing that there are a bunch of forces working against us being good with money.

First, there are all the forces you have no control over: 

• Recessions- When COVID hit, everything shut down unexpectedly. Economy down X%.
• Layoffs- Entire industries can vanish overnight- banking, hospitality, travel. 
• Unexpected dips in income- You may take a pay cut, change jobs, or start a business. 
• Bad luck- A hurricane ruins your home, or car breaks down on you. 
  

The world is an unpredictable place and it can be hard to find the financial footing you need to start putting money away. 

But these forces aren’t just external, either.

They’re also literally baked into the way our brains think about every dollar we earn and spend.

Economist Richard Thaler talks about these forces in his theory of ‘mental accounting,’ which could be one of the biggest roadblocks between you and better saving habits.

How Mental Accounting Works

Thaler ran a famous experiment back in the 80s where he walked subjects through two scenarios:

Scenario #1

First, he asked them to imagine they had lost a $10 ticket on the way to the movie theatre. Do they buy another ticket when they get to the box office? 

More than half of the people in the experiment said they wouldn’t.

Scenario #2

Then, he asked participants to imagine that they never purchased a ticket. Instead, they dropped a $10 bill on the way to the theatre. Would they buy a movie ticket now? 

88% of Thaler’s subjects said they would.

Thaler pointed out that this was irrational, and that it proved that our brains spend our money for us, subconsciously, before we ever get a chance to spend it ourselves. 

Thaler’s conclusion? Our brains are literally hard-wired to be bad with money.

$10 for a future movie ticket

$500 for a future designer handbag

$20 for a future taxi ride

Subconscious spending makes it harder to SAVE.

So what’s the solution? 

Do your earmarking now, while you’re thinking about getting better at money and saving, before letting your irrational brain earmark it for you later.

That means coming up with some kind of system for tracking and planning your expenses. It means you need to start budgeting.

How to Become “Good with Money”

One big misconception about people who are good with money is that they’re penny pinchers or that they know exactly where every dollar they make and spend is. In my experience, that’s rarely true.

What’s more often the case is that these people have put systems in place that do the work for them. Maybe they automatically set aside 10% of every paycheck. Maybe a robot withdraws X dollars from their chequing account into a long-term savings fund.

Setting one of these systems up isn’t rocket science, but it does take some time and organization. That said, ANYONE can do it.

1. Figure Out Your Monthly Cash Flow & Do Your Bookkeeping

Getting your books together and seeing your financial situation on paper could be all the motivation you need to start getting your financial act together.

Northstar Money's Chris Pimpo talking about monthly expenses and budgeting.‍

The foundation of your financial health is your cash flow—how much money you have coming in every month and how much going out to fixed costs. This looks like:

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Take a few hours to sit down with your bank and credit card statements, receipts, invoices, and any other financial records you have and figure out what your monthly revenues and expenses are.

If you want help with this, there are tools that can help you automate this process. You give them access to your accounts, and they’ll do the work for you. 

Accountants call this bookkeeping, and it’s the starting point for every good financial plan.

If your income is variable and you don’t have a set salary, you’ll want to go back at least a few months through your records, or calculate a yearly cash flow and average it out over twelve months.

The goal here is to create as detailed a picture as you can of all the money coming in and coming out. This will be your starting point for everything else you do.‍

2. Cut Expenses

It’s usually pretty straightforward to pick out the obvious luxuries on your credit card statement—Uber and Lyft rides, entertainment, food and drinks with friends, etc. But what about:

• Online courses
• Your gym membership or virtual classes
• The trip you have planned to see your family
  

If there are big, necessary expenses that you simply can’t cut out of your life, that’s fine. You might just have to start budgeting (i.e. planning) for them. (Check out the “saving goals” section below for more on that.)

3. Use the pandemic to your advantage

The COVID lockdown has forced us to approach the saving problem backwards. We've already stopped eating out, traveling, shopping, etc. 

Instead of thinking about which expenses to phase out, we’re thinking about which expenses to phase back in.

• You’ve saved money cooking at home, so maybe you don’t need to eat out as much.
• Maybe you need a car more now to get out of the city (if you live in one). 
• You really want your gym membership back, or you’ve realized you’ve found other methods. 
  

As things slowly get back to normal, maintain some of that unintentional saving you’ve been doing. Ease your way back into spending and ask yourself whether there are any expenses you could permanently do without.

4. Treat Saving Like Any Other Habit

You know that person in your life who has their financial act together and is really diligent about saving? Ever wonder how they do it?

Short of being raised that way—like Blair in our Mo Money, More Problems episode—your only other option is to slowly develop a saving habit over time through practice.

Like building any other kind of habit, if you’re particularly bad with money, the worst thing you can do is set your goals too high to start. 

5. Set Reasonable Goals

How much should you start putting away?

Setting aside $100 or even $20 at a time can do wonders for someone who’s used to saving $0.

If you’re feeling more ambitious and have specific saving goals, tell yourself that you’ll start putting away an arbitrary X% of your monthly income every month, and stick to it. 

The goal here is to not overthink saving and make it an automatic activity.

6. Get a Robot to Do It For You

You could manually set aside that money by moving it to a savings account every month. But automating that process and putting it out of your mind altogether by using services like Albert Finance, Northstar Money, Marcus for Savings and Wealthfront could be a whole lot easier.

Here’s a quick breakdown of my favourite FinTech services to help you decide which one is the best for you:

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These are just suggestions. Your bank most likely offers automated savings and investment accounts. We’ll discuss investment accounts later in this guide. 

So, How Does One Invest In the Long Term

Getting to the point where you’re saving is a big achievement. But we're not out of the clear yet.

To make sure those savings are working for you in the long term, we need to use them to:

1. Pay down your debts
2. Set them aside for future expenses and emergencies
3. Invest them for the long term
   

1. Pay down your debts first

Northstar Money's Will Peng discusses paying off debt and different strategies.

We all know that the hardest part of paying down our debts is just doing it. But not all debt reduction strategies are built the same, and it helps to learn a little bit about debt before you choose one.

Learn how debt works

For every debt you have, you should know:

• the principal (initial amount you borrowed)
• the term (your time limit to repay)
• and the rate (interest you’re paying on the loan)
  

You should also know what the annual percentage rate (APR) is on your credit card debt—that’s the total effective fee, interest plus fees, that you pay every year to service that debt.

What credit cards teach us about debt

Understanding how credit cards work in particular can be a big help when wrapping your head around debt.

The interest that credit card companies charge is usually among the highest of any debt, sometimes upwards of 20%. The reason why is because that debt is unsecured, meaning that the only thing the credit card company can do if you don’t repay the money is lower your credit. 

(That’s opposed to a secured loan, which involves putting up some kind of collateral that the lender could later seize, like real estate.)

Wage a battle against interest

“One secret that I love related to paying off debt is that if you make payments to your loans more often than monthly, you actually save money on interest,” pointed out entrepreneur Will Peng in a recent episode of our show.

Most of us pay our debt bills once a month. But because interest is charged daily on some debts, that daily interest compounds—in other words, you start paying interest on interest. You might be better off making multiple payments a month to stop some of that compounding.

Pick a Debt Reduction Strategy

Knowing how debt works can be particularly useful in a situation where you have multiple sources of debt and are trying to decide which one to tackle first. 

It’s almost always better to pay down your high-interest debt first, i.e.:

• Credit cards
• Student loans from private banks- private banks are more expensive that government loans, are less likely to be forgiving.
• Lines of credit or other loans from online lenders
• Payday loans
  

You might hear finance people call this the “avalanche” debt reduction strategy. All this means is that you make minimum payments on all of your other debts, and use the excess to tackle your high-interest debt first.

Another approach to debt reduction is the “snowball” method, which involves paying down your smallest (i.e. lowest principal) debts first. 

The snowball method is a great way to build momentum. As the number of different debt sources you have decreases, your ability to pay off your remaining debts increases.

(Audio, Will Peng talking about Avalanche vs Snowball) 

2. Create Savings Goals and an Emergency Fund

I mentioned earlier the phenomenon of mental accounting and how, if you don’t do it first, your brain will subconsciously earmark your dollars for certain purposes.

Set meaningful savings goals

One way to nip mental accounting in the bud is to earmark your money ahead of time. It becomes a whole lot easier to leave your dollars alone and save if you’re saving them for a specific reason.

Take some time to also think about why it is that you want to save, and what exactly it is that you’re saving for.

Is it for a vacation, to buy a home, or send your kids to school? 

It might very well be that the reason you’re having trouble saving is because you don’t know what you’re saving for.

Find a good savings account

Then it’s time to move on to the how. 

• Get a savings account that offers a competitive interest rate
• Look for a competitive annual percentage yield (APY)—that’s just the effective amount of interest an account will earn you over one year
• Get an account with limited restrictions, which is fancy finance talk for “easy to take your money out in case something bad happens.” 
• Make sure to get clear on any fees associated with the account

Set up an emergency fund

Chis Pimpo walks you through why you need an emergency fund, and how it's different from your investment account.

• Set aside some money for an emergency fund—a pile of money you leave in the bank for when shit hits the fan
• Personal finance coaches will recommend you set aside three to six months of expenses for emergencies—and up to nine months if you’re self-employed

3. Invest for the long term

It’s possible to keep too much money in your savings account. Why? With the potential increase in inflation (cost of goods going up) and interest rates at historic lows, you’re not actually earning anything on your money. One could argue, you’re losing money. 

Once you’ve set aside three to six months of expenses, or whatever goal you’re saving towards, you’re almost certainly better off putting the excess in a retirement or investment account. Longterm, you want your money to compound over time. 

You’ll want to get an accountant or financial advisor to help you if you get to this stage, but this isn’t rocket science either. You can use the suggestions of some of the platforms above to help you. The differences between a retirement account and an investment account is:

• You can’t touch the former until you’ve hit the age of retirement.
• With your retirement account, you have tax benefits if you wait till that certain age. 
• There are also penalties for taking your money out early with a retirement account. 
• Your job might matching plans for your 401K.  
  

Both involve putting your money into a fund that your financial institution will then invest in a mix of equity (stocks), debt (bonds) and or index funds (diversified pools of stocks that you invest in collectively).

Investment accounts

How exactly you invest your money will come down to how tolerant you are of risk. I like to think of risk as what are the chances you’re going to lose your money or investment. 

But whether you’re risk averse or risk loving, the important thing to remember here is to focus on the long term. It can be tempting to make decisions based on short-term fluctuations in the market, but the best investors are always the ones with a longer term view.

When someone opens an investment account, they’re usually using it to invest in one of three things:

1. Debt: Low Risk/Low Reward

If you’re a conservative investor and don’t have the temperament for the high risk, high reward world of equity investing, debt might be more suited for you. But unless you’re about to retire, this is not how you will build wealth over time. 

• US Treasuries 
• Municipal Bonds
  

2. Equity Medium/High Risk-> Medium/High Return

As a general rule, stocks are a riskier bet because they’re more volatile (i.e. fast-moving and unpredictable), but they also provide potentially higher returns. 

If you’re confident in yourself as an investor and are ready to put skin in the game, buying stock in companies you believe have long-term growth prospects can be a great way to build wealth.

Stocks are also categorized into value (lower risk/lower reward) and growth (higher risk/higher reward). Although, that’s not to say that one couldn’t make a large return over “lower” risk company overtime. Apple is a great example of that. 

• Value: Walmart & Apple
• Growth: Shopify & Tesla
  

Picking and choosing stocks takes work and assessment. If you’re prepared to do that, understand the risk you’re taking and slowly dive in. Find names that you understand. 

3. Exchange Traded Funds (ETFs) & Index Funds Medium Risk/Medium Return

These come in somewhere between debt and equity on the risk meter, for one simple reason: diversification. An Index fund or ETF is a diversified portfolio of multiple companies, or a portfolio of both debt & equity. They are relatively low cost to own. 

The more diversification you have, the more you spread your risk, but your return might be lower. In this case ETFs and Index Funds are for you to perform/slightly outperform the overall market. 

Index funds & ETFs differ simply in the way you can buy and sell them. You can buy & sell an ETF like a stock, and an Index fund is traded only at the end of the day. 

The diversification protects you from industry-specific or short-term fluctuations. Within index funds & ETFs, you have multiple options:

• Vanguard S&P 500 ETF (VOO)- this ETF that tracks the 500 largest companies in the US.
• Vanguard FTSE All-World ex-US Index (VFWAX)- this ETF exposes you to companies in Canada & Europe
• There are ETFs for US tech stocks, for US value stocks, for Emerging markets and so on. 
• You don’t have to overthink this. This is what the platforms we mentioned above do for you. They’ll automatically do all the work, but I want you to understand it. 

Retirement accounts

Chris Pimpo explains how it's important to start investing, even with a small amount of money. The importance is get started.

Retirement accounts aren’t just a great way to build wealth in the long term. They’re also tax-sheltered, which could save you loads of money in the long term.

Employer 401k

The first place you should think about putting your money is your employer’s 401k. Employers will often match any contributions you make to a 401k, and you don’t pay taxes on the earnings it generates until you start withdrawing money from it after ret

Your spouse’s 401k

If your employer doesn’t offer a 401k but you have a spouse whose employer does, consider maximizing contributions to their 401k.

Roth IRA

If you’re in that situation and you’re single, consider putting money into a Roth IRA, which lets you invest in a tax deferred retirement fund. 

“Tax deferred” means that any money or gains you withdraw from that fund upon retirement is 100% tax-free. If you put in $20,000 today and it grows to become $100,000, you don’t pay taxes on the $80,000 in earnings like you would on a regular investment.

Traditional (vanilla) IRA

Your other option is to make contributions to a traditional IRA, which you can write off on your taxes and which will also grow tax deferred. You pay taxes on any gains you make only when you start withdrawing those funds upon retirement.

Ok, there you have it. You have all the basic tools to get your foundation down. You know what you need to do, and I hope you understand it better. The good thing is there are so many automated platforms you can use to do all the hard work for you. Feel free to write questions in the Circle group. As a Talk Money member, we can continue this discussion offline. We’ll be offering more guides that dive into other subjects. Wishing you all the best! 

Glossary

401k

A tax-sheltered retirement fund, contributions to which your employer will usually match.

Annual percentage rate (APR) 

The total effective annual fee—interest plus fees—that you pay every year to use a credit card.

Annual percentage yield (APY)

The effective amount of interest that account will earn you over one year, taking compounding into account.

Bookkeeping

The process of recording and organising all of an individual’s financial records.

Cash flow

How much money you have coming in every month and how much going out to fixed costs.

Compound interest

The interest you pay on interest.

Emergency fund

Three to six months of emergency spending, put away in a savings account.

Equity

Another word for the stocks or ownership shares you buy in a company.

FinTech

A new generation of financial services companies offering robo-advising, automatic withdrawals and investing, and other financial services based on automation.

High-interest debt

The debt you pay the most interest on. Your worst debt.

Inflation

The purchasing power of your money goes down, while the cost of goods goes up. It’s why bread used to cost $.25 and now it costs $5. 

Index fund

An investment account that contains a diversified portfolio of investments, usually stocks.

Individual retirement account (IRA)

A tax-sheltered retirement account that self-employed individuals can use to save money for retirement.

Investment account

Money set aside specifically for buying debt or equity.

Mental accounting

An phenomenon identified by economist Richard Thaler whereby the brain will subconsciously earmark money for certain purposes.

Principal

The initial amount you borrowed.

Rate 

The interest you’re paying on the debt you have. 

Retirement account

A (usually tax-sheltered) fund used for retirement saving.

Revenue

You total monthly take home pay.

Risk averse

A conservative investor who doesn’t like risk.

Risk loving

Someone with a high tolerance for risk.

Secured loan

Debt that requires you to put down some collateral (usually lower interest than unsecured debt).

Term 

Your time limit to repay a debt.

Unsecured loan

Debt that doesn’t require you to put down any collateral. Not repaying this usually just means your credit score goes down.