This post contains unsolicited financial advice that I would have liked to receive when I was your age. And, if it is possible that the information could be useful to you, then it is important that I attempt to share it.  Personal finance books can exceed hundreds pages of information. Hopefully you are willing indulge me for just five or six.

The goal: To get started, I’m going to state an unqualified opinion: It seems to me that young adults consider saving and investing something that is done for retirement.   And, since retirement is for old people (that is, people much older than you!) – there is plenty of time to start….later. If this is how you think about saving and investing, then I would suggest a different perspective. Regardless of one’s age:

The goal of saving and investing is to achieve financial independence.

Retirement, in contrast, can often be a matter of non-financial considerations (i.e., age, health, family circumstances). So, to be more specific; the goal of investing is to achieve financial independence before circumstances encourage or require retirement. As a young junior officer in the Navy, my Executive Officer told me that it was OK if I was unable to arrive at meetings with him on time…I was allowed to be early. In the same way, there is no requirement to be financially independent at the time you retire; it is OK to be early.

The means: A simple definition of financial independence is the ability to generate income sufficient to cover your living expenses from sources other than your business or job. In other words, income received without having to physically “show up” to work. The term for this type of income is residual income.

Financial Independence is exclusively a matter of residual income.

Financial Independence for the rest of us: The information I have to offer is about seeking financial independence as a regular ol’ wage earner. The focus will be exclusively on generating residual income through accumulated savings and investments. There is nothing here about starting and operating a business. I am completely unqualified to offer advice in that arena. However, if you are drawn to business ownership, it would seem prudent for you to find a successful business owner to act as a mentor. If you have the opportunity to create other forms of residual income ( e.g., rental income, a pension), then fold their value(s) into the math described below.  This letter sticks to simple and conventional financial market investing.  With the advent of online brokerages, it is an investment vehicle that is readily available to absolutely everyone.

Begin with the end in mind: What I am asking you to consider may seem a bit ironic. Just as you are starting your working career, I am encouraging you to actively pursue the means to end it. To be clear, what I am suggesting is that you give yourself options. Having options is typically a good thing. And, those options also include following your passion (which may be your career) for as long as possible.

Many Sources of information: You are certainly encouraged to invest some of your time in the study of investments and personal finances. No one should care about your finances more than you. Those that ignore this topic do so at their own peril. The list of books and blogs on the topic is endless. Listening to the TV talking heads or reading online news everyday is likely the poorest source of information. It is fine to keep up with the financial events of the day…that said, you must absolutely refuse to believe that acting on a barrage of daily stock tips qualifies as a useful investment strategy.

The Control Panel: There are three “levers” that you get to operate in order to achieve financial freedom:

1. Time in the market (how many years you invest and hold investments)
2. Asset allocation (how much you invest in stocks versus bonds versus real estate etc.)
3. How much you invest each month/year (the hard part)

Lever # 1 – Time:

Time is the most powerful investment lever at your disposal. Every birthday that you celebrate reduces its power. The difficulty here is that as you start your working career, there are a bunch of competing priorities for your money. It is absolutely essential that you make saving and investing one of those priorities. This lever gets the shortest explanation – though its importance above the others cannot be over-emphasized. If you ignore the rest of this letter and start investing today in a randomly selected stock mutual fund – you will likely achieve significant results. I’ve heard it said that there are two best times to plant a tree…twenty years ago and today. The same can be said of investing. Get started now! Start small and never stop watering your money tree.

Lever # 2 – Asset Allocation:

What asset classes (stock, bonds, real estate, etc) should you invest in? Answer: All of them! And, how do you decide the right proportions?

Hire a team of experts: Let a mutual fund company set and maintain your asset allocation. The simplest way to get started is with a target-date mutual fund (like this one ). The asset allocation is designed to achieve broadly diversified growth.  As the target date approaches, the fund’s asset allocation is modified to become increasingly conservative. Pick the target year to coincide with your 65^th birthday. These funds typically have expense ratios less than 1%.  (If you find yourself considering a mutual fund with an expense ratio greater than 1%…find a different fund).  A target date fund strategy is as simple as it gets and can be used for your entire investing career. These types of funds are available from every investment company (Fidelity, Schwab, Vanguard, etc). Because of its simplicity and effectiveness, a target date fund strategy is my recommended approach for beginning investors. Remember Lever #1 – you can get started with this approach completely online – right now.

Lever #3 – How much

This is where the rubber meets the road. The answer to “how much?” depends on your residual income goals. First, let’s put assets versus residual income into perspective.

The 4% rule: Here is a financial independence rule of thumb to consider: The current industry standard for sustainable income recommends that individuals may withdraw 4% of their investment capital (per year) in order to avoid out-living their savings.

Applying the 4% rule: So, let’s apply the thumbrule to the following scenario: Congratulations! You’ve just won the state lottery, paid taxes on your winnings, and have a million dollars sitting in your bank account. You’ve quit your job and are now basking in the bright sun of good fortune. You meet with a financial advisor to set up an annual allowance to pay for your new “crib”, your upcoming trip to the south of France, and other essential living expenses of the rich and momentarily-famous. The answer from the advisor is that you can safely withdraw 4% per year. In other words, your allowance is $40,000 per year. Hmmm, maybe a trip to the south of Fresno would be a better choice.

The numbers in these examples can be very intimidating…but have faith! They are far more achievable starting at 24 than 64 (this is why Lever #1 is sooo important!) Your goals will take time, but they are achievable with time and persistence. So, here are some more numbers to consider relative to your goals:

What does it take to generate a minimum wage lifestyle?

Assume someone works 50 weeks/yr X 40 hours per week. That is, they work 2000 hours per year. So, someone earning minimum wage in California ($8/hr)will earn $16,000 per year. In terms of the 4% residual income thumbrule, it takes $400K in assets to generate $16K per year (4% of $400K). A related number: At the time of this post, the average networth of a 65 year old American is about $360K (you can do the rest of the math).

How about generating the median US family income?

At the time of this post, a recently published value for median US family income was $62,572 per year. $62.6K is 4% of $1.6M.

At this point you might agree that millionaire status may not be the final goal, but a very important milestone along the journey. In absolute dollars, inflation has substantially raised the bar of financial independence over the past couple centuries. Still, popular literature and media generally sticks to a million bucks as the ultimate achievement and the definition of “wealth”. Maybe the financial services industry believes that we can’t handle the truth…but ignoring the basic math seems dangerously misleading. Again, it’s better to understand the math now rather than 30 years from now. In 30 years, you’ll only have two levers to work with!

Setting the target: You can find any number of calculators online (like this one ) to determine how much a consistent yearly investment and return will yield over time. And, the time frame involved is measured in decades. In the beginning, your portfolio will have far more stocks than bonds. The stock market has historically returned 9.5% on an annual basis. Your results WILL vary. You will experience happy up-markets and scary down-markets. Stay the course! Use 9.5% (or less) as a starting place to calculate expectations for the future value of your portfolio. Use the 4% thumbrule to evaluate the results.

You decide how hard to pull the lever: Your residual income goal is dependent on your forecast of ‘living expenses’. This means that, regardless of how much you make, the more frugal and debt free one’s lifestyle, the earlier financial independence is achieved. High living expenses and moderate savings translates to a much longer road than moderate living expenses and high savings.

If you establish a habit of setting aside adequate money for saving and investing, then you can spend every remaining dime on whatever you want…and the process works. By developing a saving and investing habit, you can hope to enjoy financial peace of mind – a rare commodity these days. About a hundred-fifty years ago, while pondering the lifestyle and finances of his day, Thoreau famously wrote, “the mass of men lead lives of quiet desperation.” It appears that little has changed since then.

So, here are a few figures, facts, and opinions that you can use to set goals and evaluate your progress.

1. You can easily calculate how much investment capital it takes to generate a particular level of sustainable cash-flow. Simply multiply the desired monthly income or living expense by 300. Or, multiply the annual number by 25. This calculation incorporates the 4% thumb-rule referred to earlier.
2. Your home equity is not part of your assets for financial independence purposes. That is, leave your home equity out of your residual income calculation. In my view, you can include home equity in your assets calculation only if you are willing to sell your home and live in your car.
3. Despite #2 above, your monthly mortgage payment or rent is likely to be the biggest single cost when determining your monthly cash flow needs. So, keep it as low as possible. Debt management is critical to achieving financial independence.
4. If you choose to own a home, beware of purchasing too much “house”.  Though a large house may impress your friends, servicing the associated large mortgage can prevent you from saving and investing. This is a situation to manage carefully…especially in high-priced markets like California. Real Estate agents will take exception to this notion. They are likely to say that your home is the most important investment you’ll ever make – go all in! (refer back to #2). Always consider whose interests they really have in mind!
5. Be absolutely committed to paying off your credit card bill(s) every month. The day you carry forward a balance is the same day you need to take a hard look at how you are spending your money. Heavy use of consumer credit will almost certainly undermine your plans to achieve financial independence. And, here’s an indicator that you are headed for trouble: you find that you can pay your credit card bill only after receiving next month’s paycheck. It feels like you are paying off your credit card debt, but you are not. In reality, you are borrowing against next month’s income to pay for last month’s purchases. This one I know from experience.
6. Set up automatic investments with your bank or employer. Studies have shown that if a human being has to handle the money between paycheck and portfolio, some or all of it will be spent on ice cream. (OK…I made up the part about the ice cream) This process can be put on auto-pilot. And, works best when it is.
7. Start with a monthly investment amount that you believe is sustainable.  Consistency is important.  Over the years, increase/decrease the amount as circumstances allow.  If you find you need to frequently pull out money that has been invested, you may be committing too much income to the process.  Or, it is an indicator that you might be living beyond your means.  ‘Means’ is a word that seems to resist a clear definition.  Perhaps the ability to regularly save and invest is one of the best ways to know if you are living within your means.
8. To evaluate your progress, take the sum of your investment assets and multiply by 4%.  The resulting number represents a sustainable annual residual income.  Initially, the result of the calculation will probably make you laugh.  Eventually, the result will start to look like something you could live on – and this will also make you laugh!  Your boss will not understand why you’ve become so calm and happy at work (He/she prefers to manage employees that are quietly desperate).

 

The final push: Today, we are experiencing the rapid extinction of company sponsored pension plans and persistent claims that Social Security is at risk.  As a result, the urgency for young adults to take immediate and personal responsibility for achieving financial independence is especially great.  The good news is that current technology has made the necessary tools more simple and accessible than ever before in history.  Just get started as soon as possible, make it automatic, and remain invested in the process (pun intended).  If this process seems boring and simple…it is.  And, that’s really good news.  Even so, many people will wait too long to begin, start and then stop, or never start at all.

You’ve made it to the end of the letter!  I hope it has been worth your time to read it.  I know that it has been well worth mine to write it.  Happy investing!

P.S.

If you find this topic as interesting as I do, then you will want to read and investigate more.  Below, I offer up some books that I have found either useful or interesting.

1. The Millionaire Next Door by Thomas J. Stanley Ph.D. – this book debunks common mis-conceptions about millionaires and their lifestyle(s).  The book makes it clear that becoming a millionaire is well within the reach of nearly anyone.  The most important thing is to start saving and investing as early as possible – and stay consistent.  (sound familiar?)
2. A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkeiel – An investment classic.  This book will (or should) cure most everyone of believing they can pick individual stocks, or that is even worth the time to try.
3. How to be Richer, Smarter, and Better Looking Than Your Parents by Zac Bissonnette.  I’ve only skimmed through this book.  The title has me thinking that the book has got to be good.  Mr. Bissonnette has a style of delivery that you might enjoy. (Note: you guys are already smarter and better looking…for which you can thank your mother).