Investing For Young People… BNL Style

This morning I read a post at Brip Blap about investing for young people.  I always enjoy Steve’s articles (including this one) and I found this post a good muse for my own recommendation on how to start off your investing life after college.  

Buying a Home

Unlike BripBlap, I do not consider home ownership an investment.  In most cases, it is a a preferred option to renting, but it’s not an investment in that you will gain money over the long run.  Historically, house prices have tracked well with inflation meaning the real gain is zero.  An investment, on the other hand, is intended to loan money in order to finance activities that should bring in more money.  The primary reason I want to bring up this clarification is because so many people get mis-led (usually by their baby boomer parents) that they should buy the biggest house they can afford because it will go up in value over time.  I’m one of the people that fell for this myth, but have since corrected my mistake.  The other thing to consider is that a big house requires more furniture to fill it, more electricity to heat/cool it, and more time to clean it.  I’ve also found it to isolate a family.

Wedding Expenses

A wedding is (hopefully) a one time ordeal, and can be very expensive.  My preference is to keep it as small and simple as possible, but I understand that this could be a sticking point between a couple and I would not let it ruin a marraige before it commences.  On the other hand, if you are unable to agree on the size and cost of a marriage, it’s a good time to have some tough discussions about money before you tie the knot.  Taking out debt to fund a marriage is always a bad idea and should be strictly forbidden.  If you must have a celebration that would require debt, I suggest a civil union with a celebration at your 1st or 2nd anniversary when more money is available.  The same advice goes for honeymoons.

Buying a Car

When you buy your first car, buy a reliable used car.  You can always upgrade later.  Too many people buy their first car at a price that is close to an entire year’s salary only to regret it later when they realize how much living expenses really are.  Realizing it was a mistake, they look to offload it but can’t bear the realization that it is worth half what they originally paid for it so they keep paying the monthly fees for years until they own it outright.  Also, consider no car at all.  I don’t own a car, but I do own a motorcycle that I purchased for only $3500 and it gets 50 mpg.

Medical Expenses

If you’re working full time, you will likely have coverage from your employer.  If so, there’s not much you can do to save on expenses.  I recommend you set up an FSA and save on taxes.  If your employer does not cover your health insurance, consider an HSA with a high deductible loan.  

Saving

I recommend to everyone to save at least 50% of their income the day you start your first job. In almost all cases this is possible with little sacrifice, but people don’t realize it. Chances are you were living off very little in college, and that doesn’t have to change.  After living poor in college, people tend to get excited when they see their first paycheck.   They quickly start spending it on new clothes, dinners out, $100 bar tabs, and lavish travel.  After all, they “deserve it.”  The truth is, they can afford it but they are building themselves golden handcuffs.  Instead, by saving 50% you are building an emergency fund, then a retirement fund..  And at the same time you are freeing yourself from the Consumerists golden handcuffs.  Each year that you receive a raise, split the increase evenly between your spending and savings.  For example, if you get an 8% raise, increase your spending budget by 8% and your savings by 8%.  Regardless of your savings rate, this distribution will keep it static each year. This keeps your budget growing with inflation plus a little fun money on top, while maintaining an aggressive savings rate that will get you closer and closer to financial independence.

As you build up your savings, invest with a diversified portfolio that includes stocks, bonds, treasuries, and perhaps even gold.  Don’t fall victim to the common thought that you should be 100% in stocks because you are young. The truth is that a diversified portfolio, when rebalanced regularly, has historically had a higher net annualized return than 100% stocks.  For more information on portfolio management, I strongly recommend The Intelligent Asset Allocator.

Find Fun and Cheap Hobbies

It’s still important to have fun.  Before kids, my hobbies included running, reading, and entrepreneurship.  Entrepreneurship was especially nice because it actually made money while still being fun.  With kids, our hobbies include going to the park, making fun foods from scratch, reading, hiking, and riding bikes.  All essentially free, but still fun.  Hobbies to avoid are things like golf, bar hopping, shopping, traveling, and boating.   

Work Hard

Your first few years are your best years to work hard and increase your pay.  You will likely come in at a low salary, so getting to higher pay can be quick if you work hard.  It’s also the time where you stand to learn the most because you are new, so find good mentors and soak up their knowledge like a sponge.  Good senior employees in most companies are usually happy to have a new person help them out.  They get to unload some of the more crappy work on you, and you get to learn from them.  It’s an informal apprenticeship.  This time of your life is also easier to work long hours because you have few commitments.  A spouse takes time, as do kids.  When I was unmarried I worked 80 hours per week, now I’m 33 with a wife and 2 kids working <40 hours per week.  Soon, I hope to take that to zero.

Your first few years are such a great time to have fun while getting a head start on savings that will pay dividends for the rest of your life.  Don’t fall victim to the consumerist lifestyle that binds you to a lifetime of soul-crushing work, worries about bills, and concerns over job security.  




20 Responses to Investing For Young People… BNL Style

  1. Iowa says:

    One comment I’d like to make about home ownership….Make it an investment! Especially for those in college yet, or better yet just getting out of high school. I first started out with a (dare I say) nice trailer I bought when I was 19. I rented out both the spare bedrooms of the 3 bedroom Rolls Royce without wheels, sold it a year and a half later (to one of the then roommates- he caught on too!) to buy a house. Rented out the other 3 bedrooms of the house. You can see where I’m going with this, mortgage was paid along with my beer money and all the roommates got cheaper rent than they would have otherwise. Just be sure you know the people you live with, don’t sign any leases- you then have authority to move people out as needed. Still live in the house today with another roommate- my wife.

    • Good point, Iowa. I should have mentioned that. If I could do it again, I would have purchased a duplex or 4-plex instead of a house, and living in one of the rooms. By now I would own all 4 and have reliable income coming in.

      Renting rooms is also a good option when you are young, and come to think of it, I did that. I rented out a room to a coworker for $400/month, which was 1/3 my mortgage on my first house. He lived there 2 years, so that was good income. At the time, I just looked at it as a nice acquaintance and some beer money, but it’s also a good way to make your home an investment.

  2. This is awesome advice.

    I’ve maintained for years that ownership, of a primary residence, is not an investment. In an area like Washington, D.C., where I live, the difference between the cost to rent and the cost to buy is pretty large. As a renter, I’m able to save/invest way more money than I would if I were buying a house.

    Although I’m fairly happy with the money I’ve saved so far, I wish I’d read your recommendation to save 50% of my income when I was 23 years old. Many financial experts suggest saving 10% of your income. That’s not nearly enough.

    • Every other month I watch Jean Chatzky come on to the Today Show and talk about retirement savings. And every time she recommends saving 10-15%. As if that’s not bad enough, she then backs down and says to at least save the amount that your employer matches in your 401K, usually 3-5%.

      Maybe she should do the math.

  3. Great Tips! I like the strategy of splitting your raises as your salary climbs, that’s a very effective way of rewarding yourself without going overboard. My first year of work I saved about 40% of my overall salary (mostly just paid my mortgage off faster). I intend to get a decent safety net on my mortgage (95K house, gotta love rural living) before I start a Smith Manoeuvre to make my mortgage tax deductible in Canada. Basically this consists of taking out a HELOC and then investing it in blue-chip Canadian dividend players. You use the dividends to pay off your mortgage faster and then get the tax break. That’s my primary focus right now.

    • I’m not too familiar with Canadian finances, so pardon my ignorance.

      But isn’t that essentially investing levered money (your mortgage)? That seems risky, is that why you want to first build the safety net?

      • It is using a little leverage, but not a whole lot. The real leverage is when take out the initial mortgage. I guess there would some leverage danger if there was a chance I would need to sell of the investments within the next few years, but as long as I am invested for a thirty+ year time horizon there is relatively no risk. If I were to borrow more than I had in home equity and be subject to a margin call, this would be way too much leverage for my blood.

  4. I don’t think buying a big house is an investment either. I rented out the spare bedroom a few times when we lived in a house and it worked pretty well, but once you get married it’s harder.
    Great tips on saving 50% right out of college. I don’t think many people can actually do that. The first job doesn’t pay much and the you have a lot more expense than in college. At least max out 401k and Roth IRA to start with would be good.

    • My first job after graduation was $50K. My expenses were $15K, 90% went to rent, food, and my school loan.

      Although most people don’t make $50K at 22 years old, I do think most make more than $30K (if not, they shouldn’t have wasted money on college and instead learned a trade). Also, if you don’t make more than $30K, you should be able to get down to $12K on expenses without any real sacrifices.

      • “Although most people don’t make $50K at 22 years old, I do think most make more than $30K (if not, they shouldn’t have wasted money on college and instead learned a trade).”

        Ain’t that the truth. Spending 6 years (apparently that’s how long it takes the average person to obtain a 4-year bachelors these days) of your life to get a degree that costs tens of thousands of dollars should generate substantial, long-term income. For many, it does not. We need to abandon the idea that everyone should go to college. Get a trade and get to work.

      • I tell students this every day, and I get criticized by parents and other teachers for it. Many of them still believe you need the piece of paper from university to be considered smart. I always respond with, “How about I save you the time and money and just give your child a reading list, then he can be smart and actually earn money.”

      • I think the reason college has become an assumed path is supply and demand. There are more people than there are jobs. So hiring companies can make dumb demands like a bachelors degree where one is not required, rather than finding the true best candidate.

        I don’t think that problem is going away anytime soon, unfortunately.

  5. Steve says:

    Thanks so much for the ‘linked’ article. I’ll be honest: my thinking on the quality of a home as an investment has evolved over time. I still think of it as an investment, but now I think of it as an emotional investment, not a financial investment. I think of a home as a place to sink your money for the sake of an emotional return – pride of ownership, yada yada. I know it’s probably not a great financial decision. You’re right, too, that buying a HUGE home is almost always a bad decision, regardless. My home’s too large in an ecological footprint sense, but from a financial point of view we moved from NYC to Florida and got a lot less house than we could have. So that’s a wash. Renting might have been better but I love having the option to tear up my yard for a garden and roll the dice on the value of the home increasing. I’ll know in 20 years if that was a good bet…

    Weddings are a waste. I credit my wife with attacking our wedding planning to ensure the lowest possible cost short of eloping – reception at our brother-in-law’s restaurant, wedding outdoors with only a tiny handful of family and close friends, etc. Even that cost more than a car, and that’s my current thinking on the subject: weddings are simply bad financial ideas. Period. Eloping (my parents did that) saved them thousands, and who knows how much those savings worked out to in today’s dollars.

    Savings. This is your strongest point (Shawanda touched on this): lifestyle inflation is the absolute killer of early retirement. Almost every year of my life has seen lifestyle ‘creep’. It takes constant effort and vigilance to fight it back – and if I had been more vigilant and more aggressive when I was 25, I’d be better off. I didn’t get aggressive about it until a few years ago (better late than never). But anybody who is just graduating college should be browbeaten into saving ALL of their income that’s over and above their college-living-style-expenses for at least a year or two. I wish I had (even though I was still probably better than 99% of my peers).

    Great post. I liked yours better than mine :)

    • “Lifestyle inflation” and “lifestyle creep” are great terms. I’m going to start using them if you don’t mind. 😉

      Lifestyle creep is exactly what happened to me. I grew up pretty poor, and continued to be poor in college. After graduation, I kind of identified with poorness and called it frugality. For me, I quickly grew from 50K/year to more than 100K/year (almost 200K per year when my wife worked) and slowly we quit paying attention. While I never bought a fancy car or expensive clothes, we started traveling more (too much), bought a big house with a pool, and ate out a lot.

      By the time I realized it, I felt stuck and depressed. It wasn’t until I took the huge leap to change jobs, move cities, sell my car, and downsize my house that I was able to hit the reset button.

      Now I know to watch out for the lifestyle creep.

  6. I like the saving 50% of your income. It was easy for me to do that. Worked out well.

  7. Best thing we did early on, live on 50% or less of your total household take home pay. Use the other 50% to build up an emergency fund, pay down debt, and save for future goals. That is the only way we have come so far so fast.

  8. Funancials says:

    All good tips. Only thing I would change: FSA should be in bold, italics, and underlines. Most young adults don’t know how advantageous these are.

  9. I just wish FSA’s rolled over year to year. We always put money in there very conservatively so we don’t lose it at the end of the year.

  10. BrunoB says:

    “For example, if you get an 8% raise, increase your spending budget by 4% and your savings by 4%”

    Being the math geek that I am, I couldn’t help but notice this. You are right in term of splitting absolute dollars 50-50 but it is still an 8% increase in savings/spendings.

    Let’s say you earn 50 000$ and you get an 8% raise. That’s 4000$. Further, let’s assume you split your income 50% spendings, 50% savings.

    Before the raise you were saving/spending 25 000$. After the raise that amount would be 27 000$ (25 000$ + 2000$ half of that awesome 4000$). That is still an 8% increase in savings/spendings. 4% increase in savings/spendings would be 26 000$.

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