The financial index card is an idea that was created by Harold Pollack back in 2013.
In an effort to simplify his own personal finance habits, he wrote down 9 rules to follow
on a standard 3x5 index card.
Like many other people who want to take control of their finances, Pollack found the process
to be very intimidating.
By narrowing everything down to simple and easy-to-follow rules, he provided a clear
path to financial success that absolutely anyone can follow.
After taking a look at the rules on his financial index card, I found them to be a little outdated
and even a little more complicated than necessary.
So in this video, I want to share with you my new and improved version of the financial
index card.
To get us started, I’ll give you a little more background on Pollack’s financial index
card and the rules he laid out.
This way, we can highlight the parts that I personally believe are a little redundant
or unnecessary.
Then, I’ll walk you through my version of the financial index card in-depth.
We’ll dive into each of my 7 rules for personal finance and why they are so important.
By the end of this video, you’ll have a full understanding of the basic habits and
investments you need to live a financially secure life and retire comfortably.
If you like the idea of building your wealth, be sure to click subscribe, drop a like and
stick around.
We gotta start with Harold Pollack, because I think he illustrates why the financial index
card is such a powerful idea.
He isn’t a financial professional or millionaire investor, he’s a professor of public health
at the University of Chicago.
His motivation to find answers to his personal finance habits came when he and his wife encountered
some financial hardships of their own.
The problem for anyone in this situation is there is a lot of conflicting advice out there.
There are so many ideas for saving money, investing money, making money, etc., that
it’s hard to identify the essential habits among all the noise.
Especially when there are some parts of the financial industry that make money by telling
you things are too complicated for you to handle them yourself.
So with a lot of research and advice, Pollack was able to hone in on 9 of the most important
financial practices, which ultimately revitalized his financial health.
He didn’t start with millions of dollars or do anything inherently risky or lucky,
which I think shows that financial success can really be attainable for anybody.
But let’s see what he has on his financial index card.
#1 is max out your 401k or equivalent employee contribution.
#2 is buy inexpensive, well-diversified mutual funds, and he mentions vanguard target date
funds specifically.
#3 is never buy an individual security, because the person on the other side of that transaction
knows more than you do.
#4 is save 20% of your money.
#5 is pay your credit card in full every month.
#6 is maximize tax-advantaged savings vehicles like IRAs.
#7 is pay attention to fees and avoid actively managed funds.
#8 is make your financial advisor commit to a fiduciary standard.
And #9 is promote social insurance programs to provide help to others when things go wrong.
So a lot of these rules have to deal with how and where you invest.
But, there’s some overlap between them, so we’re going to simplify and combine some
of these on my financial index card.
I’m also going to put them in order of importance so that you can start with number one, and
then proceed as you improve your financial health.
So here is my financial index card:
Pay off your credit card in full every month.
Save up an emergency fund.
Save 20% of your income.
Don’t pay anyone to manage your investments.
Max-out your tax-advantaged investment accounts.
Invest in low-cost, well-diversified index funds.
Give back.
Now let’s take a closer look at why my list shook out this way, starting with number one:
Pay off your credit card in full every month
First, let’s be clear, if you don’t follow this rule, you will never be able to accomplish
anything else with your finances.
Credit card interest rates are absolutely absurd, with the average annual credit card
APR sitting at about 19%.
That means that the interest and debt on your credit card debt will grow faster than almost
any investment you can make.
To put this in perspective, the average annual return for the stock market is historically
about 10%.
So your debt will grow nearly twice as fast as an investment into the stock market would.
But like the stock market returns, your credit card debt will compound over time, so it can
end up being really dangerous if you let it get away from you.
And this is precisely why you cannot move on to these other rules before starting here.
Because credit card debt grows so quickly, it makes more sense to pay off that debt before
putting your money anywhere else.
In other words, paying off your credit card debt will guarantee you instant returns on
your money that are equal to your credit card interest rate.
So if you have this debt, paying it off is step number 1.
But if you don’t have a credit card yet, congratulations on being one step ahead.
Still, don’t let this warning scare you away, because credit cards can actually be
very powerful for your finances.
When used responsibly, they can help you build a strong credit score and even earn you some
extra money.
If you’re interested in getting started, you can check out the video I did a few weeks
ago where I shared how I made over $800 by using my credit card last year.
But the bottom line is, you can’t get to financial security with credit card debt weighing
you down.
A good rule of thumb is to only use credit cards to buy what you can afford today - and
then pay it off immediately.
If you can’t handle the temptation of charging something pricey to your credit card, there’s
no shame in avoiding them altogether.
Rule #2 is to save up an emergency fund.
An emergency fund is a sum of money that will protect you from any unforeseen financial
difficulties, but here’s why it falls so early on the list.
It’s estimated that as of last summer, 25% of Americans have no emergency savings.
Imagine you are in this position, and you’re suddenly hit with medical bills, home repairs,
car maintenance, or in an extreme scenario like the pandemic, you’ve lost your job.
In order to pay for these expenses, you’re forced to max out your credit card, take out
a loan or sell your investments.
Your credit card or a loan could send you right back to square one, setting you back
for months or years as you catch up on payments.
Selling your investments could also be problematic, especially if the markets are down and you're
forced to sell at a loss, or if it pushes back your retirement goals any number of years.
With an emergency fund, you’ll have cash set aside that can get you out of these situations
without causing any additional financial burdens.
It’ll also give you the cushion you need to begin investing your money, because you
don’t have to worry about needing to liquidate your investments if something comes up.
And like I said, a situation where you need to sell your investments could be costly.
Generally, it’s recommended to save between 3 and 6 months of living expenses for your
emergency fund.
If you want to dig deeper into how to calculate these estimates and where to hold your emergency
fund, I’ve done a whole video on that exact subject.
With high interest debt out of the way, and the cushion of an emergency fund, it’s time
to start saving money for your future.
And that brings us to rule #3, which is to save 20% of your income.
This 20% comes from the common 50/30/20 rule, which many experts agree is an effective way
to budget your money.
According to the rule and the experts who back it, 50% of your income goes to necessities,
30% to discretionary or miscellaneous spending, and 20% should be saved.
If you don’t have an emergency fund yet, this 20% should go towards that first.
But after building your emergency fund, you can put most or all of that 20% towards investing
for retirement.
We’ll talk more about investing in a minute, but for most people, 20% is a good number
to aim for to ensure you save enough money by the time you retire.
Obviously, this will depend slightly on income, because if you make a lot of money, you might
need to save less, and vice versa.
Similarly, if you want to retire earlier in life, you might want to shoot for a more aggressive
savings rate, like 25 or even 30%.
However, if you follow the rules we talk about next, 20% should be plenty to secure your
financial health regardless of your income level.
Rule #4 is don’t pay anyone to manage your investments.
This means you’ll generally want to avoid financial advisors and investing in actively
managed funds, which we’ll talk more about later.
But the reasons for this are pretty simple: these people may not have your best interests
at heart, they may not produce the best returns, and either way, they’re going to charge
you fees every step of the way.
There are many cases where financial advisors will push you towards certain investments
because it means they get a kickback when you invest into it.
In these cases, they might be more focused on getting that commission or management fee
than earning you the best possible returns.
Pollack’s advice is to make your advisor agree to a fiduciary standard, which is essentially
a promise that they put your interests before their own.
But I think if you follow the rest of these rules, you don’t even need to go that route.
Additionally, there’s overwhelming evidence that active money managers fail to beat the
returns of the market on a long-term basis.
An analysis in 2020 found that 90% of financial professionals failed to beat the market over
a 15-year period.
According to investment legend John Bogle, this number was even higher for the 15-year
period prior between 1983 and 1998.
So when you’re considering saving for retirement, which could be as long as a 40 year endeavor,
you could be missing out on significant returns by letting someone else pick and choose your
investments, rather than putting your money into the entire market via an index fund - which
we’ll talk more on later.
And finally, even if your financial advisor is not guiding you towards their own personal
interests, there will be fees involved.
Although these can vary quite a bit, a 1% annual fee is a common figure, and each dollar
you pay in fees takes away from the money that it could become in the future.
According to a study by nerd wallet, a 1% fee can cost over half a million dollars over
a 40 year period.
So clearly, minimizing these fees is in your best interest.
And we’re very lucky to live in a time where everyone has access to low-cost, hands-off
investing without needing to hire a professional.
Today, you can open an investment account with a robo-advisor, which can help you allocate
your investments at a fraction of the cost of a real advisor.
I personally have experience with the Betterment platform, which charges just .25% annually.
They’ll allocate your money based on your risk-tolerance, so you can rest assured you’ll
get desirable risk-adjusted returns at a low cost.
There are also many other options out there if you’re interested in going this route.
But after the next few rules, you’ll be able to handle your investments entirely by
yourself without paying any management fees whatsoever.
Rule #5 is max out your tax-advantaged investment accounts.
This is going to include things like IRAs, 401ks, and so on, and it’s where you’ll
be putting the 20% of your income that you’re saving.
The reason that you should max these out, is because if you do so, you’ll never have
to invest anywhere else in your lifetime.
The tax advantages of these accounts are seriously so powerful, that maxing out these accounts
alone can secure you more wealth in retirement than you’ll ever need.
So let’s take a look at how this works, both with IRAs and 401ks.
IRAs come in two forms, either a traditional IRA or a Roth IRA.
With investments in non-IRA accounts, you invest money after you’ve paid taxes on
earning it.
Then, when you sell those investments and withdraw cash, you’ll have to pay taxes
on any earnings you’ve accumulated.
Obviously, any dollar taken from your investments is one less dollar you have in retirement.
But, IRA accounts allow you to escape taxes either when you’re investing up-front, or
when you retire, all while letting your money grow tax-free.
A traditional IRA lets you invest pre-tax income, which means you don’t pay taxes
on the money you invest.
This will save you money up-front, giving you more disposable income during your working
years.
But, you’ll have to pay income taxes on the money you withdraw in retirement.
A Roth IRA is the opposite - you still pay taxes on the income you use to invest, but
you don’t have to pay any taxes on your earnings when you withdraw them in retirement.
Whether you choose the traditional IRA or the Roth IRA, both will let your money grow
tax free.
So, you won’t pay any taxes on any dividends or capital gains if you choose to trade any
of your holdings.
And this means your money will grow WAY faster.
Both traditional and Roth IRAs have contribution limits of $6,000 per year for 2021.
This means that maxing out the account is a pretty reasonable goal, and it should be
perfectly doable if you save 20% of your income.
And if you start doing this early enough, it could very well be the only investment
you ever need to make.
To show you how, let’s look at the results of an annual $6,000 investment into a Roth
IRA starting at 25.
A conservative 7% return would grow it into 1.28 million dollars of tax-free money at
the age of 65.
In a taxable account, with the same $6,000 contributions every year, you’d have just
855 thousand dollars because of taxes.
That’s 50% more money in your Roth IRA account because of its tax benefits.
Considering that your investments can grow to be worth so much by the time you retire,
having this money 100% tax-free can be a huge advantage, and that’s why I love the Roth
IRA so much.
If you want to learn about this account in more detail, be sure to check out my in-depth
video on the Roth IRA.
The 401k is a little different, because it’s an employer-sponsored account that you can
only invest in if your job offers it.
It may provide either the tax advantages of the IRA or Roth IRA, which is something you’ll
have to look into for your situation.
Compared to IRAs, these have much higher contribution limits, currently set at $19,500 for 2021.
So this can be good if you have extra money from your 20% savings that you’d like to
invest, but it may be difficult to fully max out.
Therefore, the number you should try to max out with a 401k is the employer match contribution.
Most employers offer this up to a few percentage points of your salary.
For example, my employer offers a 3% match, so for the first 3% of my salary I invest,
they’ll match it dollar-for-dollar.
That’s an instant 100% return, so this is a really powerful way to build your wealth
within this account.
But that brings us to rule #6, which is to invest in low-cost, well-diversified index
funds.
And this answers the question where do you invest your money after setting that 20% aside,
and putting it into your tax-advantaged investment accounts.
Index funds, put simply, are a basket of stocks wrapped into a single investment.
So by buying a share of an index fund, your money gets instantly diversified into all
of the stocks inside of that fund.
This is essentially a fool-proof strategy for investors, and it’s one that you can
follow without paying excessive fees, increasing your risk or missing out on returns.
I’ll explain how.
First, low cost index funds will protect you from the costs and poor returns of active
management, which we discussed earlier.
The firms that run mutual funds, which are teams that pick and choose investments from
the market, will charge you fees for managing your capital.
They also experience tax inefficiencies and the risks that come with actively trading
stocks.
This is why, like we saw before, over 90% of these actively managed funds produce lower
returns than an index fund.
Next, index funds minimize risk and guarantee returns by investing into every single stock
at once.
If you pick an individual stock, there’s always the risk that the company fails, or
at best, just fails to produce decent returns.
Picking the wrong stocks means your money might not grow at all.
With an index fund, it doesn’t matter if a single business or stock goes down, because
you’re holding hundreds or thousands of other stocks that will continue to deliver
returns for your portfolio.
You’ll also be less likely to trade emotionally, and although index funds may not be as glamorous
as stock picking, it is proven to produce better returns over long periods of time.
If you want to learn more about index funds, refer to my video summary of the little book
of common sense investing by John Bogle.
Alternatively, you can pick up a copy of the book for yourself, which is definitely worth
the read!
But if you’re looking for actionable index fund information, we’ll make it really simple.
The idea with the index fund is spreading your investment out to as many stocks as possible
to minimize risk and capture the returns of the total market.
In this sense, you’ll want to look into total market index funds.
Vanguard is still recognized as the leader in index funds, and they offer many of these
at minimal costs.
You may want to look into VTI, which invests into the entire US stock market, VXUS, which
invests into the entire international stock market, and BND, which invests into the entire
bond market.
At this point, you just need to worry about your allocation between stocks and bonds.
Stocks are generally a little riskier, with higher returns, while bonds are safer with
lower returns.
Younger investors have a longer timeline, so you can go heavier into stocks and transition
to hold more bonds as you get older.
A good rule of thumb is to use your age as an estimate for your bond allocation.
For example, I am 25 years old, which makes my bond allocation 25% of my portfolio, and
my stock allocation 75% of my portfolio.
Or, to make things as simple as possible, you can use a vanguard target date fund.
These automatically allocate your investments into total market stock and bond index funds
based on your estimated retirement age, and they’ll transition to be heavier into bonds
as you get closer to retirement.
So if I plan to retire at 65 around the year 2060, I’d invest in the Vanguard Target
Retirement 2060 fund.
Invest in this kind of fund in your tax-advantaged retirement accounts, and you’re set!
So that brings us to rule #7, which is to give back.
After you’re able to implement all of these rules and habits into your financial practices,
you should have a sound financial future.
And that puts you in a great position to help others get there, too.
Pollack suggests supporting social insurance programs like social security and medicaid,
since he personally benefited from these in his lifetime.
I think there are plenty of ways to give back, both financially and otherwise.
Personally, as I’m working towards improving my financial future, I’m proud to share
my experience and my learnings with audiences on YouTube.
I think both my successes and failures can help others better themselves financially,
and I’m looking forward to reaching a point where I can give back in more tangible ways,
too.
But with all that said, I want to give the reminder that this is by no means a perfect
blueprint to financial success.
The financial index card can give you a great starting point for taking control of your
future, but you may want to make some of these rules your own to better fit your goals.
For example, I’m personally saving 25% of my income because I want to stay a little
bit ahead of schedule for retirement.
And while I put most of my investments into index funds in my tax-advantaged accounts,
I also experiment with some stock picking in a standard taxable account.
But this is because I have extra money to invest after maxing out my investment accounts,
and I’m young enough to tolerate the added risk it brings to my overall financial strategy.
Now I’d like to hear from you guys - leave me a comment and let me know how you think
my financial index card compares to Pollack’s!
And if you found this video helpful, please consider subscribing to the channel so you
can look forward to more videos like it.
I post new videos every week, so take care and I’ll see you in the next one!