Several years ago, I wrote a really popular article entitled Everything You Ever Really Needed to Know About Finance on the Back of Five Business Cards. It was shared on countless social media feeds and resulted in a bunch of media interviews and even some discussion about writing a book with that framework (I couldn’t make a full book-length manuscript work, so instead I just gave away the “book” that I was working on (it’s not exactly book length, but it is fairly long).
A few years later, a similar idea began to be spread around: a 4″ by 6″ index card that contained “all of the financial advice you’ll ever need.” The card was written as a collaboration between Harold Pollack and Helaine Olen and it, too, was passed around many different sites and became quite popular. They also went on to write a book around that idea, The Index Card.
I picked up that book recently from my wonderful local library and gave it a read. The book was filled with a lot of good personal finance advice, as I expected, but the one interesting part I noticed was that there was a perforated index card at the back bound into the book – you could tear it out if you wanted, but this library copy still had it intact.
The index card was a revision of their original index card. This new card contained 10 rules that supposedly contained all you need to know about personal finance – the rules happened to match up with the chapters in the book.
Reading through their rules, I realized that I happened to completely agree with parts of them, somewhat agree with other parts, and, well… other parts left me shrugging my shoulders. I thought it might be interesting to walk through their 10 rules and, at the same time, list what 10 rules I would put on such an index card.
Let’s get to it!
Their Rule #1: Strive to Save 10% to 20% of Your Income
Given that we live in a country where 76% of Americans live paycheck to paycheck, this is a great little rule to include on this card. After all, any significant increase in savings is going to be a good thing for almost anyone in terms of their long-term financial future.
The thing is, though, if someone reads this book at age 50 and hasn’t started saving a dime yet, saving only 10% of their income per year is simply not going to get them to adequate retirement savings. They’ll be able to get by, but that savings will end up just being a small addition to their Social Security benefits. It will simply be a very tight existence.
My Rule #1: Save At Least 20% of Your Income By Cutting Your Worst Expenses
My advice to almost everyone is to save as much as you possibly can, no matter your age. People always want a number as a benchmark, though, so my suggestion is that if you’re not saving at least 20% of your income each year, you’re probably not saving enough for the things the future has in store for you.
The reality is this: You are more equipped with natural gifts right now in terms of being able to shoulder the load and save more than you will be at almost any other point in your life. Yes, even busy parents with lots of children. Why? For starters, you’re almost assuredly in better shape right now than you will be at most later points in your life. You have more time ahead of you right now than you will have at any other point in your life. Your health and your energy and your time are your most valuable resources and you have them in an abundance right now, an abundance that won’t last.
Use that abundance. Don’t let it slip by. Don’t waste it.
The problem that many people have with this advice is that they’ve backed themselves into a corner with the debts they’ve taken on and the spending habits that they have. They’re barely making ends meet and they simply can’t believe someone would seriously suggest that they put away 20% of their income. If they pull 20% out of their income given their current routines, they’d be in a disastrous situation very quickly.
The thing is, most people waste a lot of their income. I’d go so far as to say everyone, but there are people with a very low income who manage to stretch very little into a stable household who likely don’t waste very much money.
Here’s a simple exercise: Go through your bank statements and credit card statements for the last few months and mark each transaction with a + sign and a – sign. Write a + by every single transaction that actually covered a genuine need in your life. Write a – sign by all of the others. Then, add up all of the + transactions and all of the – transactions. I’m willing to bet that the – transactions add up to more than 20% of your spending.
Now, how much of those “-” expenses were actually worthwhile and brought value into your life? This is a situation where the 80/20 rule pops up – 80% of the actual enjoyment you got out of those purchases came from just 20% of those purchases. The other 80%? It’s largely wasted on forgettable things.
Figure out how to cut out those 80% of expenses that are forgettable and you’ll easily have your 20% of your income for savings.
Whew. Let’s move on.
Their Rule #2: Pay Your Credit Card Balance in Full Every Month
Let’s see… what do I think of this one?
My Rule #2: Pay Your Credit Card Balance in Full Every Month
Of the 10 rules, this is the one I totally agree with. If you have credit cards and use them for regular purchases – which I do – pay off the balance in full every month.
The reason is simple: Credit card interest rates are painful. If you pay off the full balance each month, you’re still within the grace period on those purchases so they haven’t started accumulating interest. If you only pay the minimum, the rest of the balance is going to start building interest, and credit card interest is nothing more than money being picked out of your pocket.
Pay off your full credit card balance each month if you don’t want that money just picked out of your pocket. If you find that difficult to do, then sit down the credit cards for a while and learn how to live solely out of your checking account. Once you’ve mastered that, you’ll find that a credit card is just a very effective purchasing tool.
Their Rule #3: Max Out Your 401(k) and Other Tax-Advantaged Savings Accounts
Who on earth is this advice written for?
In a given year, you can contribute $18,000 to a 401(k) and $5,500 to an IRA; contributions to a 529 college savings plan are basically limitless (though there is a $14,000 gift tax exclusion). The average American family, with two kids, would then be contributing $36,000 to 401(k) plans, $11,000 to IRAs, and $28,000 to 529 plans – and that’s just those three accounts.
The average American family only earns about $60,000 a year pre-tax. If you actually “maxed out your 401(k) and other tax-advantaged savings accounts,” you’d be contributing every dime of your salary and still falling short.
This advice isn’t being written for the average American family. It’s being written for someone who’s in at least the top 10% of income earners and probably closer to the top 1% of income earners. It’s not useful advice for most Americans.
My Rule #3: Save 2% of Your Income for Retirement for Every Five Years You Didn’t Save
Here’s a much better approach: Save a percentage of your income for retirement and don’t sweat a 529 plan unless you’re actually hitting your caps on retirement plan contributions.
My basic rule for how much to contribute to retirement plans is described above. Just save 2% of your income for every 5 years of your life that you didn’t save – and round up, not down.
So, let’s say you’re 23 and you’re just now starting to save for retirement. If you take 23 and divide it by 5, you get 4.6. Multiply that by 2% and you get 9.2% – and if you follow my advice, you round that up to 10%. If you’re making $40,000 a year, then that means you’re shooting to save $4,000 a year overall.
What if you’re older than that? If you’re older than that, you need to contribute more to earn a stable retirement. Let’s say you’re 37 and you’ve never saved a dime before this. Take 37 and divide it by 5, giving you 7.4. Multiply that by 2% and you get 14.8%, and round that up to 15%. If you’re making $40,000 a year, that means you should be shooting to save $6,000 a year overall.
I’ve found that time and time again this little formula points you right toward a healthy amount to save for retirement. You can go over it if you’d like and you can save for your children’s college education, too, but make this your priority. Your children can always make it through college, but you only have one shot for retirement savings.
Their Rule #4: Never Buy or Sell Individual Stocks
I agree with this rule, but I think it’s kind of subsumed by the next rule on their list and my own fifth rule, which we’ll get to in a minute.
Individual stocks, in my view, are akin to gambling unless you invest a lot of time doing research (full-time-job-level research) or are investing at a level that gives you direct input into how the company is run through seats on the company board. If neither of those are true, then you shouldn’t be investing in individual stocks.
My Rule #4: Save in a 401(k) up to Employer Match, Then Max Out Roth IRA
My fourth rule continues the retirement advice from the third rule above. You’re saving some lump sum of money for retirement, but what exactly do you do with it?
First thing: Does your employer offer a 401(k) plan (or a similar plan like a 403(b))? If they do, do they offer matching contributions in any way?
If they offer such a plan and offer contributions, all of your retirement contributions should go there first to gobble up as much of the matching money as you can get. Some employers match all of your contribution and if that’s the case all of your contribution should be going into your 401(k). Some employers match up to a certain percentage, and if that’s the case, you should be contributing that full percentage.
What do you do if you don’t have a 401(k) or similar plan at work, or if your employer doesn’t offer one? In that case, you should open up a Roth IRA on your own. It’s easy to open one – not much different than opening a savings account, really. You can do it online by finding an investment house that you like and opening a Roth IRA with them (I really like Vanguard, for reasons I’ll explain later).
The vast majority of Americans are eligible for a Roth IRA, so that should be the type of retirement account you choose. When you take money out of that account in retirement, it’s tax free, so if most of your retirement savings is in a Roth IRA, you’re going to be paying very little income tax in retirement between your Roth IRA money and your Social Security money.
Their Rule #5: Buy Inexpensive and Well-Diversified Indexed Mutual Funds and ETFs
This is a rule I largely agree with, except that I usually don’t think there’s a reason to buy ETFs unless you’ve got an arrangement to buy them without any fees. Typically, ETFs are bought and sold through traditional stock brokers, which means that you’re paying a “buy” cost each time you buy and a “sell” cost each time you sell them. On the other hand, buying and selling index funds rarely has such fees associated with it. Since there isn’t much you can do with an ETF that you can’t do with an index fund, there’s really no reason to buy them if you’re having to pay an extra fee to do so.
I completely agree with the “well-diversified indexed mutual funds” part, though. An indexed mutual fund is probably the best opportunity out there for an individual investor who doesn’t have the time to study investments all day and doesn’t have enough money to buy voting interest in a company. Essentially, an indexed mutual fund – usually called simply an index fund – is one that operates by a very simple set of rules, like “own a small portion of every publicly traded stock in America.” That means that running the fund itself can easily be fully automated, which means you don’t need many people actually running the fund, which means that the cost is a lot lower.
My Rule #5: When You Invest, Buy Diverse Index Funds and Hold Them for the Long Haul
So, I’m fully in favor of buying index funds. What do I mean by “diverse,” though? I simply mean that you should never have all of your eggs in one basket. Never own just growth stocks or just value stocks or just stocks from small companies or just stocks from big companies or just stocks from one particular industry.
Diversify. The easiest way to do that is to buy into a “total stock market” index fund. Beyond that, it’s also a good idea to invest in other things as well – bonds and real estate for starters. You can buy index funds of those, too.
If you’re just saving for retirement, the easiest way to do all of this at once is to simply buy a “Target Retirement Fund.” At Vanguard – my preferred investing house – their target retirement funds are made up of a mix of other index funds – stocks, bonds, real estate, and other things – that’s geared toward how far away from retirement you are. If you’re far away, the fund has higher risk and higher reward. As you get closer, the risk goes down so that you’re not losing a lot of balance close to retirement – in other words, money starts moving out of stocks and into bonds and even into cash.
Their Rule #6: Make Your Financial Advisor Commit to the Fiduciary Standard
There are two different standards that different financial professionals have to hold themselves to. One is the “suitability standard,” which means that they simply have to find investments that match the needs of the client. The other is the “fiduciary standard,” which means that they have to put the needs of the client before their own.
Under the “suitability standard,” financial professionals can choose investments that give them a lot of commissions as long as it matches client needs in some way. On the other hand, under the “fiduciary standard,” your advisor has to pick the option that is really the best for you, and there’s a lot of specific guidance and rules in determining that.
You’re going to want an advisor that uses the “fiduciary standard,” but how do you find one? For starters, you should ask whether they commit to that standard. You should also check out their certifications – are they a registered investment advisor? Who are they registered with? Does that group require commitment to that standard? This should be one of the first things you check before signing up with a financial advisor.
On the other hand…
My Rule #6: Teach Yourself About Finance and You (Usually) Won’t Need an Advisor
For most people, a financial advisor does not do anything that you could not do yourself with just a little bit of self-education. After reading a few books on investments like The Bogleheads’ Guide to Investing, you’ll actually have the knowledge you need to handle most financial situations that arise in life. You won’t need an advisor, and you certainly don’t need their fees in your life. Just do it yourself – that’s what I do.
Now, there are situations that can arise where you might need some help. A challenging inheritance, for example, or an enormous windfall might be situations where you want an advisor. However, those are situations where you’re not hiring someone to run things for you, but simply to help you figure out how to hold the reins yourself.
Even if you’re not willing to do this, you still owe yourself some basic knowledge about personal finance so that you can understand what your advisor is doing. I’ve found that if you put in the effort to learn the basics, it doesn’t take long for you to realize that you can just do this yourself almost as easily and a lot less expensively.
Their Rule #7: Buy a Home When You’re Ready
What does “ready” mean? It’s a word that means a lot of different things to different people. Does it mean when you’re financially ready? Does it mean when your life is ready for a home?
Here’s my answer to that issue…
My Rule #7: Buy a Home When It’s More Cost-Effective Than Renting
For me, it all comes down to whether your finances are ready. Just run the numbers for your current financial situation through a good rent-versus-buy calculator like this one and see what comes up.
You’re going to need to know some information about your situation, particularly the state of your local real estate market (which you can find approximations of on Zillow) and your own taxes. Some of the numbers can definitely be adjusted one way or another quite a bit.
In the end, though, you’ll come up with some results that can tell you pretty clearly whether you should rent or buy, and that comes down to which one is really the most cost-effective in your life.
You’ll notice a few general patterns along the way, though. For example, if you’re not going to live in a place very long, the advantage slides toward renting; if you’re going to be there for a long while, the advantage slides toward buying. It’s that connection between the “personal” and the “finance” that really comes up here.
Their Rule #8: Insurance – Make Sure You’re Protected
This is another “rule” that’s really vague. That’s because the insurance needs of a family tend to change a lot depending on their income level. The higher your income level, the more sense it makes to get things like long term care insurance and long term disability insurance and umbrella insurance. If you don’t have much to begin with, those types of insurance are less important and make much less sense.
So my approach is a little different…
My Rule #8: If You’re Married & Considering Kids, Get a 30-Year Term Life Policy for 10 Times Your Upcoming Salary
The one piece of insurance that I usually recommend for people (beyond the legally mandated ones, like health insurance and auto insurance and homeowners insurance) is a term life insurance policy for themselves if they have a family. I generally tell people that it’s a good idea to get a 30-year term policy as soon as you start considering kids, and if you already have them, you should get a policy with a term length that covers the years until your children are out of the nest (for me, that would be a 20-year policy at this point).
How much should it be for? I’d shoot to replace 10 times your current salary, unless you’re in a position where you are very realistically and seriously expecting a significant salary bump in the next few years, in which case I’d base it on that future salary.
Shop around for this policy. If you’re young and healthy, this policy really won’t be all that expensive, since it ends short of when you should reasonably expect to die. The reason for getting it is to help your family in the event of your unexpected death before your children have a chance to grow up.
- Related: Term Life Insurance: The Basics
This felt like a political intrusion into a set of good ideas, so I largely ignored it. It’s a good concept, but it doesn’t help people’s finances in the here and now.
My Rule #9: Spend Your Spare Time on Skills and Side Gigs
A much better rule for improving your personal finances in the here and now is to spend your spare time trying to increase your income, whether through personal improvement or through building side businesses to directly earn income.
Spending your spare time on skills is a great choice if you have a lot of room for advancement in your main career or you are considering a career switch. In those cases, working to improve the attributes that would make you valuable to different companies is going to be a great investment of your time and energy and pave the way to a brighter financial future for you.
On the other hand, if you’re happy with your career state, a side gig can be a great way to earn more money. Whether that takes the form of a part-time job or a microbusiness that you want to run (like starting a YouTube channel), you can turn some of your extra spare time into additional streams of income that can bolster your situation now and provide support if something goes wrong in your primary career.
Their Rule #10: Remember This Card
This final rule isn’t really helpful, either. A good summary rule to finish things off is probably more sensible…
My Rule #10: Spend Less Than You Earn. Always.
This is the fundamental rule of personal finance, in my opinion. No matter how much you earn, you should strive to spend less than that, every month, every year, every decade. If you do that consistently, you’re going to naturally build up savings that will support you in whatever hand life deals to you.
Naturally, there are two main ways of doing that. You can work to “spend less” – being frugal, being smart about what you spend, and so on – and you can “earn more” by building your career or starting a business or getting another job. Ideally, both can be incorporated into your life.
Together, those two factors – spending less and earning more – create a gap between how much you earn and how much you spend. It’s that gap that provides the real foundation for all of these other rules.
Don’t get me wrong, the index card advice is largely pretty solid. My only real criticisms of it come down to two things: one, it’s largely written for a much wealthier audience than the average American, and two, even on a 4″ by 6″ card, there’s some fluff.
My approach is more from the perspective of the average American income and even those significantly below that income level, and for all of us, the index card needed a few tweaks. Hopefully you’ll find this advice useful in your own life.
If you do nothing else on the card, do these two things. First, spend less than you earn. Doing that is the key – what you do with the leftover money in terms of saving for the future is just icing on the cake. Second, never stop learning about personal finance, and you can start by reading some of my favorites.