September 18, 2023
"Whoever has the gold makes the rules."
- Aladdin (I think)
Much Ado About Money
So you started earning money for the first time and perhaps realize you don't know what you're doing. Everything here assumes you're a young, single person.
Let's walk through the basics. Although, you'll realize, it's all pretty basic.
Disclaimer: This is for hypothetical learning purposes and not financial advice.
Credit
Starting Out
Let's assume you have no credit. Never taken out a loan. You may have a checking and/or savings account but no debt except maybe student loans. You'll need to start building your credit.
If you have no credit, you can get a basic, unsecured credit card. Secured means you put some money down (like $500) and that's your credit limit and is generally for people with bad credit. Once you prove you can pay they give you your $500 back and it becomes unsecured. If you have no credit you can just get an unsecured card right away.
I personally like the Discover it card. Make sure you choose one with no annual fee. I like the 5% cash-back card with rotating categories because it stays relevant as you get more cards.
Credit Scores
There are a few main factors that determine your credit score:
To maximize your credit score: Pay your bills on time. Acquire credit as fast as you can so new cards don't hurt your average age as much. Have a variety of fixed and revolving credit. Put a subscription on a card with auto-pay and forget about it if you don't actively use it.
One thing people don't seem to realize is that you only pay interest when you don't pay off the full balance. Set up auto-pay for the full statement balance each month and you'll never pay a dime of interest.
This is a bit dumb but I put sticky notes on my physical cards to tell me what to use it for with the highest cash-back, like on my Savor card I have "Restaurants".
Credit Card Suggestions
I personally recommend the following cards:
Savings (Respectively)
Safety Net
Assuming you have a Checking Account, the first step will be opening a savings account.
This account will be your safety net where you keep 3-6 months of expenses in liquid cash for emergencies.
Any time you take money out, replace it as soon as possible. If you're not good at saving money, maybe direct deposit a portion of your paycheck directly to this account.
401k
If your employer offers a 401k match, that's the first place you'll want to invest money.
You might see something like "50% match up to 6%" which means they'll match 50 cents for every dollar you put in, up to 6% of your income. This is basically a 3% of income match but forces you to save more (6%).
For now, only worry about putting in the match. This is a risk-free 100% return on your money.
Do this even if it hurts.
High-Interest Debt
If you do happen to have debt, you'll want to pay off your debt based on the interest rate. Always pay off high interest rate loans first. Always.
You'll want to weigh what you pay off or contribute to based on interest rates and expected return (ER). It would flow like the following example:
You would pay these off in order to maximize your return. First, contribute to your 401k Match, then pay off high-interest debt, then contribute the annual maximum to your IRA, then contribute to remaining debt based on APR. When deciding between the smaller APR loans and contributing to like your trading account, do whichever one you think will have the greatest expected value.
This is a good place to say that, if you have a loan lower than inflation - That is free money. - Do not pay it off early no matter what. If you have a house below 4% interest. Never. Sell. Unless of course you can get a better rate somehow.
Health Savings Account (HSA)
If you're young, single and have little medical expenses (and expect it to stay that way), you may have opted to have a high-deductible health plan. If so, that qualifies you for an HSA.
I put this before IRAs because this is the only truly tax-free money you can ever have. If you contribute to an HSA through a payroll deduction, you won't even have to pay FICA or Social Security taxes (unlike an IRA).
Contributions are tax-deductible and distributions over the age of 65 are tax-free if used for medical expenses. Non-medical distributions are taxed as ordinary income over the age of 65. Non-medical distributions under the age of 65 are subject to an additional 20% penalty.
There's a 2023 contribution limit of $3,850 and a 2024 contribution limit of $4,150.
If you want to be really extreme about it, you can pay all your medical expenses in cash over the course of your life, save the bills, and take tax-free distributions in retirement to pay yourself back. Pretty crazy.
Roth / Traditional IRAs
Next, you'll need an "Individual Retirement Account", of which there are two types.
Regardless of which type you choose (or both), every year there is a contribution limit. This year it is $6,500.
Roth + Traditional can only add up to the limit, although you generally only contribute to one. For example, you could contribute $3,500 to a Roth IRA and $3,000 to a Traditional IRA but not more than $6,500 total.
Roth IRAs - Roth IRAs are "post-tax". This means that you'll take that sweet, sweet cash from your job (that you've already paid income tax on) and deposit it into a Roth IRA.
The beautiful thing about this is that you don't pay tax when you take it out- and you'll take out much more than you contribute thanks to the beauty of compounding.
You can only contribute the full $6,500 to a Roth IRA if you make less than $138,000. You can contribute a reduced amount when making between $138,000 and $153,000. Any more than $153,000 and you can no longer contribute.
You can always convert a Traditional IRA to a Roth IRA- AKA "Backdoor Roth Contribution"- there's no income limit on conversions.
Traditional IRAs - Traditional IRAs are "pre-tax". This means you'll still contribute the same $6,500 of post-tax money but you'll get to reduce your taxable income by that amount*** when tax time rolls around.
There is no income limit when contributing to a Traditional IRA ***but is only fully tax-deductible if you make $68,000 or less, partially deductible making between $68,001 and $78,000 and not at all deductible past that.
Traditional IRAs are also subject to Required Minimum Distributions (RMDs) starting at the age of 72.
Deciding Between The Two - Essentially, Roth and Traditional IRAs are equivalent if you think you'll be in the same tax bracket and tax brackets themselves will stay the same between now and retirement.
If you think your tax rate in retirement will be higher than your tax rate now, you should contribute to a Roth IRA (and pay the lower tax rate now).
If you think your tax rate in retirement will be lower than your tax rate now, you should contribute to a Traditional IRA (only applies when Traditional IRA contributions are fully deductible- up to $68,000- past that you'll have to calculate).
I think it's safe to assume that I'll pay a higher tax rate in retirement so I will contribute to a Roth IRA until I hit the income limit. After that I'll do Backdoor Roth Contributions until I reach the highest tax bracket.
The Remainder
If you have more money than the above, first of all, congratulations.
This leaves you with some options:
"Be Prepared."
- Boy Scouts Motto