- When I think about managing my money,
I tend to set it around an idea
that you've probably seen in video games before,
the idea of the war chest.
Think about a game like Civilization.
In that game, you need resources
both to expand your empire,
but also to be able to essentially take a punch,
to deal with enemies attacking you,
to train up soldiers to go to war for you,
and the resources you build and gain in that game,
like gold and food and production of the things,
they represent your war chest.
If they run out,
then there's not a whole lot you're gonna do
and you're probably going to lose the game.
Now, in the real world,
your money is your war chest
and it serves pretty much the exact same purpose.
It lets you, number one,
take advantage of opportunities
like getting a better place to live
or investing in your education.
But it's also there to help you take punches,
like your car getting a flat tire.
And when it comes to building my own war chest,
when it comes to managing my own money responsibly,
I have always had some rules that I've followed
ever since I became an adult and left my parents' house.
So, what I want to do in this video
is actually share some of those rules with you,
including some rules on saving money,
on using credit cards responsibly,
and on investing for the future.
And to give you a bit of a sneak peek on
what's actually coming on this channel in the future,
I want to build a more detailed library
of personal finance videos here in 2022,
because I want this channel to evolve past
just covering productivity or academic success,
and to start to encompass more of what it means
to live a fuller, more capable life.
And I kind of centered on that term, capability.
So, think of this video as a bit of a foundation
to the more detailed topics
that we're gonna be covering in the future.
And with that,
let's jump into our first rule.
Build up an emergency fund and a cash buffer.
So, as I mentioned earlier,
your war chest is what allows you
to take advantage of opportunities,
but also to take punches and stand easily back up.
Now, unfortunately,
a lot of people live paycheck to paycheck,
which means they spend almost everything they make
in the months that they make it.
They don't have a war chest.
So, to become financially independent,
financially secure,
your first priority should be to build one.
And in the game Civilization,
there's something called the Tech Tree.
It's this list of technologies
that your people can research
and it's laid out in a certain order.
So, for example,
you have to research pottery
before you can research writing.
And Civ is my favorite video game analog
for personal finance,
because we can actually think of the financial journey
as a tech tree as well.
And in fact, I have actually built that tech tree
and I've shared a link to it in the description down below.
And I've also included detailed comments
for each checkpoint on the tech tree,
so, if something I say here isn't clear,
you can check those comments
and there's probably more detail for it.
Now, there are four main branches on the tree,
savings, income, debt, and budgeting.
And along the savings path,
you will notice the very first checkpoint
is a $500 emergency fund.
This is a savings account
separate from your checking account
that you do not tap
unless you absolutely have to,
unless something unforeseen comes up
for what you absolutely need that account,
like bursting a tire on your car
which you need to get to work.
And the reason that having this account is so important
is that if you don't have one
and something unexpected comes up,
you might be forced to borrow money to handle it,
or even put the expense on your credit card,
which could put you into a debt spiral.
So, if you don't have an emergency fund yet,
build one at all costs.
And the next thing you want to do after that
is to build what's called a one-month cash buffer.
And you can do this by first figuring out
how much you need each month
to pay your necessary expenses
like rent and groceries,
and debt minimums,
and then making sure you at least have that much
in your checking account,
even after all of this month's expenses are paid.
This concept can also be called
it living on last month's income.
And doing so gives you a ton of peace of mind,
because at this point,
you're no longer living paycheck to paycheck.
And this brings us to rule number two,
which is to invest as much as you can
into what are called tax-advantaged retirement accounts.
These include accounts like 401ks and IRAs.
And if you use them strategically,
you're gonna end up with a lot more money
during retirement than you otherwise would.
Now, you've probably heard
of these types of accounts before,
401k, IRA,
but what exactly do they do
besides adding more acronyms to your life?
Well, a 401k is an account usually managed
by your employer,
whereas an IRA is something that you typically open
and manage yourself.
But both of these accounts
let you do essentially the same thing,
they let you invest money into stocks or bonds,
or other kinds of investments
that you can't touch or withdraw
until you're at least 59 and a half years old,
which sounds like kind of a bad deal
until you realize that in exchange,
you get to defer the taxes
that you pay on some of your income
by investing into them.
So, for example,
if you normally make $80,000 a year,
but you contribute $5,000 of your salary to your 401k,
then you're actually only taxed on $75,000 that year
instead of 80K,
which reduces your taxable income
and hence, reduces your taxes.
This is called a pre-tax contribution.
Now, there are a ton of details
around this whole tax deferral thing.
And there are Roth IRAs which work quite differently.
So, I'm gonna cover all that in a future video.
But the other huge benefit to using IRAs and 401ks
is that money invested in these types of accounts
tends to grow a lot faster than it otherwise would
if you had just invested it normally,
in normal taxable accounts.
An example in the book,
A Random Walk Down Wall Street,
shows how $5,500 invested each year for 45 years
grows to $1.6 million inside of an IRA.
Well, the same money only grows to $938,000
invested in a taxable account,
even though it was put into the exact same investments,
the exact same mix of stocks or bonds or mutual funds.
That's a difference of over $600,000.
And the reason for it is something called tax drag.
This is when taxes act like molasses,
slowing down the growth of your investments.
See, anytime you make income off of your investments,
you have to pay what are called capital gains taxes
on that income.
And to give you a very simple example of this,
one form of income that most people get off
of their investments,
at least that they hold stocks,
are called dividends.
And these are just regular payments
that shareholders get,
literally, just for holding the stock.
Now, not all stocks pay dividends.
Some stocks are called growth stocks,
and there are companies that basically want to take
all of their income to grow the companies.
They don't pay out a dividend,
instead, reinvesting the money to grow the company.
But a lot of older, more mature, bigger companies
do choose to pay out a dividend
either because they can't find anything else
that would be a better investment
for that extra money
or because they have investors who want dividends.
The greedy bastards.
And Nintendo is one of those companies.
They do pay out a dividend.
So, for every share that somebody holds currently,
Nintendo is paying out about $2.30 per year.
So, for example, right now,
I have about 140 shares in Nintendo
in my Fidelity account.
So, they are currently paying me about $322 each year
in dividends.
Now, older investors might take these dividends
and actually live on them.
But most younger investors,
myself included who are trying to grow their investments
as much as possible,
choose to automatically reinvest their dividends instead.
And it's the smart play
because every single dollar invested
is going to grow over time.
So, in my case, it means buying
another $322 of Nintendo stock automatically,
or at least it would, if not for taxes.
See, since those dividends are income,
the government comes in
and takes 20% of my dividends in taxes,
capital gains taxes.
So, I actually only get to reinvest about $257,
not 322.
And that's $65 that I don't get to invest
and grow over the next 20 or 30 years.
And that's tax drag.
Now, the great thing about IRAs and 401ks,
tax-advantaged retirement accounts,
is that they are not subject to capital gains tax
when things like this happened.
So, if mine Nintendo stock were in an IRA,
I would actually get to invest the entire $332
instead of the 257.
And with compound interest working the way it does
and with a long period of time ahead of me,
that tax drag or lack thereof
makes a huge difference on my overall returns.
So, for this reason,
I do my best to contribute as much as I possibly can
to my retirement accounts each and every single year.
Now, one caveat that I will throw out there
before we move on
is that it's generally impossible
to take money out of one of these accounts early
without paying a huge penalty,
and then also paying taxes on them.
So, if you're saving it for something big,
like a down payment on a house,
you may want to consider that
when deciding how much to split out into an IRA or a 401k,
and then to maybe a savings vehicle
or a taxable investment account.
Now, there are ways to take some money out of an IRA
for a first-time home purchase,
and you may want to look up that,
but in general,
it's good to know about the withdrawal penalties as well.
Now, our next rule sounds kind of bad at first glance.
Be a deadbeat.
But this is actually a really good thing to aspire to be.
This term has to do with how you use credit cards.
See, in the credit card industry,
a deadbeat is somebody who always pays their entire balance
on time every single month.
And if you know anything about credit cards work,
you probably know that they come
with some pretty insanely high interest rates,
often over 20%.
But if you pay off the entire balance every single month,
you actually don't pay any of that interest at all.
And since the credit card company
isn't making any money off of charging you interest,
you, my friend, are considered a deadbeat.
Now, I got my first credit card when I was 18 years old
and I have been a deadbeat ever since.
Not once have I ever let the credit card company
charge me interest,
which means that I've gotten all the benefits
of credit cards essentially for free.
And there are quite a lot of benefits.
Notice how this rule isn't,
don't use a credit card,
it's, be a deadbeat,
because I truly do believe
that you should have and use credit cards.
And there are several reasons for this
that we could list off.
For one, credit cards generally have better fraud protection
for online shopping than debit cards do.
And a lot of them also give you cash-back rewards,
travel points, miles,
all kinds of nice little bonuses,
which are cool to get.
But the main reason that you should have a credit card
is to build your credit score.
Now, I've got a whole video on credit scores in the works
with lots of more detail coming down the pipeline,
and you can also learn more about credit scores
in the tech tree as well.
But what I'll mention here
is that your credit score controls
a lot of what you can do in life.
Honestly, it probably controls a bit too much,
but, hey, we got to play the hand that we're dealt.
And your credit score right now determines
whether you're gonna get approved for a home loan,
for one,
what interest rates you're gonna pay for home loans,
for literally any other kind of loan,
the higher your score,
the lower the interest rates.
So, it literally saves you money
to build your credit score.
And it can even decide whether or not
you're gonna get approved as a renter
for rental units or townhomes, apartments,
things like that.
I recently saw a townhome for rent here in Denver
that actually requires a minimum 700 credit score
just to get approved.
But the problem when you're young
is that you probably don't have a whole lot of experience
using credit cards or using loans,
which means that you don't have much credit history
and you might not even have a credit score at all.
You need at least one loan
or credit card on your report
to have a credit score.
And while you can build up that credit history
with things like car loans or student loans,
the nice thing about a credit card
is that it actually allows you
to build up your credit score essentially for free,
as long as you're a deadbeat.
Now, essentially is the key word there
because ever since 2009,
actually the year I graduated high school,
it's harder for people who are 18 to 21,
and it's harder for people who don't have credit history,
to get a credit card.
Back when I was in high school and college,
they were shooting credit cards
out of T-shirt cans at people.
It was really easy to get one back then,
not the case today.
So, today, typically the easiest way to get a card
with no credit history
is to get what's called a secured card
where you make a deposit upfront,
then becomes your credit limit.
So, for example, you give the bank $200,
you receive a secured credit card with a $200 limit.
Now, eventually you can get that deposit back
and the card goes from being secured to being unsecured
like a regular credit card.
And once you've got it,
you can start building up your score over time
by following Tom's three golden rules of dead beatitude.
Number one, always pay your balance on time.
On time payments, unsurprisingly,
are the biggest single factor
in determining your credit score.
Number two, always pay your balance in full,
again, so you don't get charged any interest
on that credit card.
And finally, number three,
never use more than about 30% of your credit limit.
Now, this last drill has to do
with something called credit utilization,
which is your current balance divided by your credit limit.
And the lower that ratio is,
the better your score is gonna be.
So, by keeping it under 30%,
you are gonna be building a good score over time.
30% isn't a hard rule,
but it's a good rule of thumb.
Additionally, it is a great idea
to set up automatic payments for your card as well,
so you're guaranteed to never miss a payment.
And I actually made a whole video about that,
so you can check that out after this one.
Now, one final rule that I'm gonna mention
is to consistently be investing,
not in stocks, not in bonds,
not in mutual funds,
but in yourself.
So, my second rule was to maximize your retirement accounts,
and that is a great idea,
but I truly believe the best investment
I am ever going to make is in improving myself,
which means continually improving my current skillset,
learning new skills,
and most importantly,
looking at the world with a beginner's mindset,
rather than assuming that I know everything already.
I want to be open to learning new things.
It also means taking advantage of opportunities
by connecting with new people,
maybe even traveling to conferences
and professional events,
to deepen relationships you've made online.
And it can also mean improving your meta skills,
like your ability to solve problems creatively.
Since easy problems are very easily automated
in pretty much every single industry out there,
the people who can innovatively solve complex problems
are the ones who are most in demand.
And if you wanna improve your skill in this area,
one great resource that you can practice it at
is Brilliant who have kindly sponsored this video,
and who have been an amazing supporter of my channel.
Brilliant, if you haven't heard about it,
is an online learning library
that teaches you math, science, and computer science,
while also helping you become
an all-around, better problem-solver.
And they do this by creating courses
that are entirely based
on the principle of active learning.
The vast majority of the time you're going
through any of their courses,
you are not reading walls of text,
you're not watching videos,
you're actually solving interactive puzzles and challenges.
And Brilliant's library has more than 60 of these courses
that cover topics like calculus, statistics,
logic, computer algorithms, and lots more.
So, if you want to start building your STEM expertise,
if you want to get better at problem-solving,
and if you want to support this channel,
you can head over Brilliant.org/ThomasFrank
to start learning today.
Or you can click that link onscreen right there.
If you enjoyed this video,
if you learned something,
you might also want to check out that video
I mentioned earlier
on automating your finances,
or this video here,
which YouTube has kindly picked for you.
If you enjoyed this video,
definitely hit that Like button for the algorithm.
Hopefully, you learned something useful here.
Let me know if you have questions
in the comments down below,
and I'll see you in the next one.