All the financial advice you'll ever need in one index card
I've recently come across some of the most comprehensive financial advice ever given, and it's all in a 4x6 inch index card.
Harold Pollack, a UC Chicago social scientist, wrote this in 3 minutes following an interview he had with a personal finance expert.
During the interview he commented, in passing, that the main problem with the industry was that the best advice on personal finance “can fit on a 3-by-5 index card, and is available for free in the library." He then added, "so, if you're paying someone for advice, almost by definition, you're probably getting the wrong advice because the correct advice is so straightforward."
After the interview, he kept getting asked from his listeners where they could find this index card. Well, it didn't exist. He was just using it as a metaphor. He decided, however, that it was worth exploring. He then took an index card from his daughter and wrote down 9 rules to live by.
Here’s what he wrote:
Max your 401k or equivalent employee contribution.
Buy inexpensive well-diversified mutual funds such as Vanguard Target 20XX funds.
Never buy or sell an individual security. The person on the other side of the table knows more than you about this stuff
Save 20% of your money.
Pay your credit card balance in full every month.
Maximize tax-advantaged savings vehicles like Roth, SEP and 529 accounts.
Pay attention to fees. Avoid actively managed funds.
Make financial advisors commit to a fiduciary standard.
Promote social insurance programs to help people when things go the wrong way.
With a few exceptions, I think these rules are worth living by. Even though these are straightforward concepts, they require some additional context. I wanted to give you my own take on these, but remember to take this as a grain of salt as I am not a financial adviser (neither is Mr. Pollock for that matter). Maybe that’s a good thing?
Let’s take it from the top!
1. Max your 401k or equivalent employee contribution
This one is a very important rule and I agree with it wholeheartedly. If you are not familiar with it, a 401k is a tax-deferral tool that helps you save money for retirement. That means you don’t pay taxes on that income now, but when you retire. This is really important if you think about compounding interest. Compounding interest is when you make money on the interest you accumulate so the longer time you have the more interest you make.
In addition, some employers offer to match your contributions up to a certain amount. Think of it this way. If your employer matches your 401k contributions by 50%, that means that if you contribute $300 from your pre-tax salary, they will give you an additional $150 to add to your 401k every month. That’s free money!
It is amazing that so many people don’t take advantage of retirement savings plans when they are offered by employers. Everyone is going to need money when they retire, but 56% of americans have less than $10,000 saved for retirement. This is especially concerning given that we are living longer and longer.
2. Buy inexpensive well-diversified mutual funds such as Vanguard Target 20XX funds.
This is also pretty sane advice. Inexpensive index funds have consistently out-performed actively managed funds in the last ten years. Other index funds, you could consider include: Vanguard High-Dividend Yield ETF and Vanguard 500 Index Fund
3. Never buy or sell an individual security. The person on the other side of the table knows more than you about this stuff
This rule is the only one I don’t agree with fully. While I do think you shouldn’t buy individual stocks before doing your research, with the right skills and discipline, everyone can learn. There are many tools online that help you become a better investor.
Beware, shameless plug ahead!
On the Pitly app you can learn about investing with bite-sized lessons that are kind of like digital index cards. You can also practice what you learn on the virtual portfolio. Even if you are going to put your money in an index fund, you should know how the stock market works.
4. Save 20% of your money.
Saving is also really important, not just for retirement, but for a rainy day. You never know if you need emergency funds to cover hospital stays or other unforeseen events. If 20% is too much for you, try saving 5 to 10% instead.
5. Pay your credit card balance in full every month.
It is really easy to get stuck in credit card debt. The average american has $8,377 in credit card debt. If you only pay the minimum balance, it can take you DECADES to pay that back plus the accumulated interest. One thing I would add is that you should pay your most expensive debt first. Keep in mind that Most Expensive Debt is the one with the highest interest rate, NOT NECESSARILY the highest monthly payment.
6. Maximize tax-advantaged savings vehicles like Roth, SEP IRA and 529 accounts.
These are not typical terms you would hear everyday, but it is important to look into them. Both IRA (Individual Retirement Account) and Roth IRA accounts are tax advantaged accounts. The main difference between a traditional IRA and a Roth IRA is that in a traditional IRA, you pay taxes when you take the money out (not when you put it in) and with a Roth IRA, you pay taxes when you put money in (but not when you take it out). In other words, if you think you will be in a higher tax bracket when you retire, you want a Roth IRA (since you are paying taxes now). On the other hand, if you think you will be in a lower tax bracket when you retire, you want a traditional IRA.
SEP (Simplified Employee Pension) is a type of IRA for people that are self-employed or own a small business. A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs
7. Pay attention to fees. Avoid actively managed funds.
This rule relates to #2 above. Actively managed funds in the US charge pretty hefty fees. About 98% of them only make enough money to cover these fees, meaning that you don’t make any money. Be alert to these fees. Actively managed funds charge 0.78% on average; Whereas, index funds charge 0.18% (and sometimes even less) according to Morningstar.
8. Make financial advisors commit to a fiduciary standard.
I didn’t want to get political, but this rule rings significantly strong now that the current administration has ended the requirement for financial advisers to abide by the fiduciary rule. The Fiduciary rule states that financial advisers not recommend something to their clients if it benefits them more than their clients.
When was the last time you went to your mechanic and asked if there was something wrong with your car and they said there was nothing wrong? Of course this is rhetorical, but it makes sense doesn’t it? Your financial adviser would probably get a nice referral fee from an actively managed fund than they would get if they recommended an inexpensive index fund.
9. Promote social insurance programs to help people when things go the wrong way.
I guess it is inevitable to get political when you are talking about finance stuff… this refers to the social safety net like social security and medicare. Regardless of where you stand on these issues, these programs are crucial to a lot of people. Anyone can lose their job or face an unexpected setback, even you.
Harold Pollack only wrote 9 rules on that index card; possibly because he ran out of room. He then added a 10th rule, which I’m pretty happy about (what? I like even numbers… and who’s ever heard of the 9 rules of anything?)
10. Buy insurance to protect from the big things
The big things meaning health, life and liability insurance. Health insurance is especially costly in the US. You should get as much insurance as you need and NOT MORE. Usually a high deductible plan is good enough for most people. Life insurance is important if you have people that depend on you. Liability insurance for your car is also important so you don’t get stuck with a bill for someone else’s car if you hit them. Most states require liability car insurance, but usually the minimums won’t protect you far enough.
Gotta give it to Mr. Pollack. Putting these rules together has helped a lot of people. Although I don’t agree with some of the rules, they give people a good starting point on how to take back control over their finances.
I don’t think there is anything wrong with investing yourself as long as you are disciplined and have the desire to learn. Give it a shot!