Summer is just beginning, which means that in my family as well as many others, people are graduating college and preparing to enter the workforce. I just heard that one of my cousins got a job. My first reaction was to be excited for her, and then the second was to be a little bit nervous: the habits she builds in her first few months of receiving a paycheck are very likely to affect her entire life an an enormous way.
While the amount of money you earn is important, what you do with that money is far more important. There is no shortage of people who make hundreds of thousands or millions who end up bankrupt or severely in debt. It happens all the time. But at the same time there are plenty of people who earn very little money but spend it wisely and never have a financial worry in their lives.
Money trouble is a leading cause of divorce. It's can be a huge source of stress. Not having enough money restricts your freedom, making it impossible to change jobs or to move to a different city.
Most Americans don't have enough money to handle an unexpected $1000 expense. This is MOST Americans, not just those who don't make a lot of money. And almost everyone will eventually have a $1000 expense they aren't expecting. A car breaks, they miss a flight, they get injured, their water heater floods, they get into a car accident, or they lose their job.
The most important benchmark, especially when you're starting out, is how many months of living expenses you have in the bank. If you can get this up to six or twelve, your whole life is probably going to be pretty easy. If it hovers at less than one month, you are always going to be stressed.
This benchmark is a function of two things: the amount of money you spend every month and the amount you have in the bank. If you have $12,000 in the bank, that could be six months of runway if you spend $2000 a month or three months if you spend $4000. So you want to work both angles: spend very little money and save as much you can.
Start off by understanding that by far the greatest luxury in the world is not worrying about money. No matter what your income is, you can work towards permanently achieving this luxury. So when I suggest things that sound like sacrifices, remember that you are sacrificing small luxuries now in order to earn this great luxury forever.
Housing will be your biggest expense. Spend as little as possible on a place that will not be stressful. In other words, get a small plain place, preferably with roommates. You were probably just living in a college dorm or with your parents, so don't jump too many rungs on the ladder just yet. Choose a location that is convenient for work and life and get the cheapest place you think you can find acceptable. Or maybe live with your parents for another year or two just to save money. It will cramp your lifestyle, but saving months or years of living expenses will improve your lifestyle by far more.
Never finance anything ever in your life except for a house, and even then think very hard about it. The only reason financing a house makes sense sometimes is because you would have been spending some amount of money on rent anyway. But even then the math doesn't always add up, because of property taxes, repairs, etc.
If you can't afford a $600 phone in cash, you certainly can't afford payments for it. At first these seem like a good idea because $20 a month for four years seems reasonable, whereas a $600 payment hurts.
But what happens is that you keep financing things, and soon you're spending a few hundred dollars a month on things you've bought in the past. And then if you lose that phone or you just want a new one, you have to start financing that phone, too. But you still owe the money on the old one, so you pay that, too.
Before you know it, a third of your salary is going towards things you've already bought. Now you only have two thirds to spend and save per month. And if you have the habit of financing things, that number is going to continue to go down.
Smart good people get into crippling debt all the time. Sometimes it happens suddenly because of a medical emergency, but usually it's from the slow accumulation of consumer debt. I've seen it happen to some of the smartest people I know, so it can definitely happen to you, too. If you don't want to end up in that sinkhole, make a hard rule for yourself to never ever get into debt no matter what.
Do not go into debt. Do not buy things you can't afford. If you have to finance it, you cannot afford it. You WANT to feel that sting of paying up front for something, because it reflects the actual cost of buying something. If it hurts too much, you should not buy it.
When you do buy things, buy things that are going to have lasting positive effects on you. For example, if you buy a bicycle because it's going to get you into better shape and save you money on taxis, that's great. If you buy healthy food (within reason), you are preventing disease, improving mental health, and giving yourself energy.
Do not buy things that aren't good values. Taxis are usually not a great value. Take the train or walk. Don't buy fancy food and drinks that you're not going to remember two months from now. Beware of anything that is a convenience, not a necessity. Keep your wardrobe simple and buy clothes that are versatile and will last. Don't spend $1500 a year on a gym when you could have spent $400. Each of these decisions will feel small, and a part of your brain will tell you that you can afford it, but it's the habit and pattern that matters.
Try to save half of your paycheck. This isn't even radical advice-- there's a huge community of people online who save eighty percent. If you do this, it will take you a year to save six months of living expenses. Do great work and aggressively ask for raises when you know that you have made yourself invaluable.
Don't worry too much about investing. Just keep the money sitting in a savings account. Simply by not paying finance charges and overdraft fees, you are benefiting from having that money sitting around. Once you have tens of thousands it's probably time to start investing, but that's a different blog post. Just watch your money pile up in your savings account and pat yourself on the back for buying yourself freedom.
Most people will read this and will rebel at the idea because their peers aren't doing it. But most peoples' peers are going to have financial trouble. This is not random chance or bad luck, it's because they are spending too much money and developing poor financial habits.
So what happens when you save up six months of living expenses? Well, first you've created a positive spiral and that number will probably keep increasing. Maybe some day that number gets to 18 months and you decide to take six months off to start a new project or travel the world. There's no other way to get that sort of freedom. Or maybe you want to move to a new city but want to take your time to find the right job. Now you have a buffer and it will result in you getting a job that will earn you more money or make you more fulfilled.
You can also capitalize on opportunities. Right now houses in Vegas are so cheap that if you have the cash you can permanently reduce your living expenses to a couple hundred bucks a month. My friends and I each spent a few months of living expenses to permanently own an island. We're going to do the same thing to buy a home in Budapest. If you don't have money saved, you just can't do these things. Rather than finance things that bring long-term debt, you can self-finance things that will bring permanent benefit.
You also have the opportunity to convert cash to assets. I bought a fancy watch and some museum-quality art. These are assets that will always be worth at least what I paid for them, so they actually cost me nothing. I bought a used watch for $1500 that's worth about $2000. So I can bang it up, wear it for a while, and then sell it if I want my money back. Contrast that to someone who finances the same watch, which would be $4000 for the new version. They'd end up paying thousands in interest and would lose money when they sold it later. Same with cars. I bought a twenty-year-old Mercedes for $2500 about a year ago (I also split it with a friend, so it really only cost me $1250). I could sell it for what I paid at any time. And even if it turns to dust tomorrow, at least I don't have any payments on it.
The point is that going into debt massively restricts options, while saving money creates options. Options are freedom.
To recap: congratulations on becoming a an adult! The way you handle your money over the next few months will be one of the biggest factors in your long term lifestyle and happiness. Sacrifice a little bit now, live below your means in a way which your peers won't, and live happily ever after because you've created momentum towards an amazing lifestyle that very few people actually achieve. And if you aren't just entering the workforce but aren't happy with your financial situation, use this as a wakeup call and follow the principles as closely as you can.
Photo is a cool bank of meters on the submarine at Pearl Harbor.
I'm on the island now, but I queued this post before going there. We have twelve people visiting this trip, which is by far the most we've ever had. In fact, I don't think we've ever had more than four before.
If I save 50% of my paycheck for a year, I can live off my savings for another year. Not 6 months as calculated in the article.
Tynan speaks the truth. --- It may go without saying but I'm saying it anyway. If you follow his advice now, someday, if you are lucky enough to live long enough, you will be old, and tired and possibly sick, and the freedom that this financial advice gives you will be that much more important because you will not have your whole life ahead of you then, and you will not have the energy to go out and make the money that you need. Tynan speaks the truth. This advice will do MORE for your ENTIRE life than almost anything else you can be told. ---- Take it from someone who didn't do this.
I think that the way most people spend money is absolutely nuts. I see people buying things they can't really afford, or things that will have no lasting impact on their lives whatsoever, and I cringe. Be frugal, I want to yell.
On the other hand, there are people who go way out of their way to save a dollar, even When spending that dollar would really make their life better, or create some lasting memory that would impact them long after the dollar was gone. Don't be cheap, be frugal, I want to yell.
Maybe a better phrase for frugal, at least the way I think of it, is financially-efficient. And just like most mistakes I see people make, this one stems from not actually thinking about decisions and just going with the flow.
Money should only be spent if you have it, first of all. Just because everyone else has a car doesn't mean that you are somehow entitled to one, too. If you don't have money for a car, don't buy one. Never finance anything, with the possible exception of a house. Even then, I think it's usually a bad idea.
Wait. Maybe not. Let's think this through.
I just got an email from a reader. It's a variety I get a lot. It goes like this:
"I'm doing X-practical-thing, but I'm passionate about Y. I don't like that X takes up so much of my time. But... it's practical. WTF?"
It could be "college," but it could also be a stable salaried job or whatever. Actually, this particular email wasn't about college, it was about a really well compensated salaried job that wasn't the person's passion.