Americans are wealthier
than any people in the history of the world. Yet many are stressed
out about their finances. Are people living beyond their
means even though their incomes are relatively high? Are they maxing out credit cards
and living paycheck to paycheck? Are they saving for
unexpected expenses? Can you be financially
secure even if you don’t make a lot of money? Can ordinary folks invest
in the stock market with manageable risk? The answers to these questions
are the beginning of a checklist for what we call
financial literacy. When you talk about the
checklist of things that people need to understand to be
considered financially literate, I think it delves into
a number of categories. It numbers into your basic
everyday financial living, the basics of debt, and
understanding just sort of what credit card debt means, what
mortgage debt means, what a car payment means,
budgeting, understanding money in, money out. It's stuff that really
sometimes can seem very basic, but clearly is not. If you're not financially
literate, then you have to worry about your spending. You have to worry if when you
retire, you can meet your goals. It all starts with income. Income means the
money you have coming in. How do you make your money? The Law of Comparative
Advantage comes in handy when making career choices. Figure out what you do well and
enjoy that others value highly. I’ve worked very hard and built
a successful business, and I don’t have to worry anymore in
my life about, you know, your month to month bills
and things like that. But that is true only
because I did use to. I didn’t have parents
to give me money. I didn’t have anything
to fall back on. There wasn’t a safety net. But what I did was rigorously
plan and sort of set goals and then try to go
about achieving them. You don't have to own a
business to think this way. Start thinking how you can
make yourself more valuable to potential employers,
coworkers, and customers. How can you do your current job
better, even if it is a minimum wage job, internship,
or volunteer position? Are you working harder than
others - first one there, last one to leave, not
texting while on the job? These types of choices help
differentiate you from others, and they create value
for you in the job market. Remember, in the real world, you
don't get paid for effort, but rather when you
create value for others. And managing that money is
just as important as earning it. Expenses are money going out. How do you spend the
money you've earned? Do you even know where
all your money goes? Many people don't. If I could only teach to young
people today, just one financial literacy skill, a necessity
that people understand, is to construct their own
financial budget and how they execute upon that. All I mean by this is
to understand that there are fixed expenses. They have $3,000 that
comes in, and they have $2,500 of expenses. They need that fixed expenses,
the stuff they have to: your rent, your car payment,
your whatever the case may be. They need that number to be
lower than what's coming in. I think the easiest way is the
50, 30, 20 rule, which is 50% of your monthly income goes
towards bills and housing. 30% goes towards finances, which
is paying off debt or saving, and the final 20 goes towards
entertainment or going out, for things that you like to do. So obviously, the fixed have to
come first, and you chip those away, and those get done. And then applying
percentages to the rest. I think there's very
little of that that goes on. Some of the things can go wrong
when one doesn't do it, and this is, of course, very common, you
end up living your life in a way that you're always playing
catch up, and it becomes very debilitating when
someone gets behind. They may have the
benefit of the consumption. Then a new paycheck comes, a new
bonus comes, and they don't get to enjoy the fruit of it
because they're paying off the last toy that
they purchased. And so you live
behind instead of forward. I think that has a profound
impact on one's stress level, but also, just their incapacity
for the enjoyment of life. If people just started with
that, the layering of financial priorities in their month to
month cash-flow planning, I think that would be the
immense first step towards financial literacy. Assets are stuff you own. Everything from your savings
account, to a house, to a car. The road to building
assets starts with saving. The best reason I can offer for
why even a high school student with a part-time job should
start saving to some degree, just the habit,
it's habit-forming. I believe that there is
something to be said that for the merit of just getting in the
practice of putting aside $5 a week, $10 a week,
whatever the number may be. Save regularly for
"unexpected" expenditures. You know that your car will need
a repair, your cell phone may get stolen, and
you may fall ill. I like to set up a savings
account so I don't see that money because if I see
it, then I will spend it. So each paycheck, I take out a
certain amount of money towards my bill for my car insurance at
the end of the year, and it's automatically moved to
the savings account. So that your paycheck hits your
account and then automatically you have your bank account
set to send from your checking account to your savings
account or just electronically off the top. You make your
savings a fixed expense. It has to come straight out
of your checking account. You're paying yourself first. When that's in place, that opens
up a lot of freedom to then go do other investment accounts. This approach will help you
live a life with minimal financial stress and anxiety. It'll help you avoid
financial troubles and pitfalls. As you build some
savings, make sure to diversify your investments. Remember, never put all your
eggs in one basket - just don't. Because if that one basket
should fall...well, you get the picture. When you purchase a stock on the
exchange, you're buying into a small piece of that company. So you are getting an interest
in that company, and you're becoming an owner
of that company. And it entitles you to the
stream of profits of that company hopefully
will make in the future. It has risk because the
company may not make it. So the stock market is a way of
funding business in America that carries with it an appropriate
level of risk and reward. The best way for somebody to
invest in stock market with a small amount is by purchasing
an index fund, or an ETF, or a mutual fund because they are
getting broad exposure to many different companies instead
of just buying one position. What’s all this talk of
index funds and mutual funds? A mutual fund is a
professionally managed investment portfolio that
pools money from all sorts of investors, like you,
who are looking to diversify their investments. It’s the easiest way to ensure
you aren’t putting all those eggs in one basket. Index funds or Exchange
Traded Funds, ETFs, are similar, except they are
managed to match the performance of a particular group of
companies – say, a group of tech companies or a group of
consumer goods companies. Instead of picking individual
stocks, I want to own Apple, and I want to own Nike; they might
just buy an index that includes a whole basket of
these companies together. There's all kinds of different
indexes and, therefore, index funds out there. The most common might be the
S&P 500 representing sort of 500 major publicly traded
U.S. Companies. With diversification, you can
take comfort in knowing that when the value of one asset is
down, others will likely be up. But they want to make sure that
the purpose of the money they're putting in is longer term money. The return of the stock market's
been very good over time, but there's periods of time
where it can be quite volatile. And so that's where one's
financial literacy will hopefully lead to them
understanding what instruments are good for short term goals,
what instruments are good for intermediate goals,
and then longer term. One powerful tool in your
plan is compound interest. Albert Einstein once stated,
"The most powerful force in the universe is compound interest." The best way to take advantage
of it is to start saving when you're young and investing
strategically after you have your real-world
savings account ready. Over the course of 20-30 years
of compounding, it’s adding hundreds of
thousands of dollars. I'm saying for regular
middle-class families, the difference between starting to
save at age 50 and starting to save at age 25 can be hundreds
of thousands of dollars, and that's just simply from the
benefit of time and allowing that money to work for them
for a greater period of time. Even with all of the recessions
and expansions of recent and distant past, diversified stock
holdings have earned about a 7% real annual rate of return. Rate of return is
extremely important. An asset earning 3% annually
will double in value in twenty-three years, but an asset
earning 7% will double in value every ten years. Investing in the
stock market offers opportunities for everyone! It makes such a difference when
you can really exploit the time value of money when you
put time on your side. The leverage they get onto
that contribution to themselves because of the time value
of money is monumental. And there's calculators that
people can play with to go see, and they never
believe the results. Simple interest would just work
like this: you have $100, you earn 5%, you now have $105,
and then you're going to make another 5% on that $100. Now you have $110 and the next
year $115, the next year $120, so that 5% is simply being
applied to your original $100. Compounding means that your $100
goes into $105 the first year, but then 5% gets applied to
$105, and let's add numbers $111, and then it
gets applied to that. So the numbers start to
break apart from the original denominator of the money. And so that's why compounding
carries with it just a real special force, mathematically. I think that there is really no
financial literacy when people don't understand
time value of money. Liabilities are debts you owe. The time value of money
can also work against you. A lot of people get into
financial trouble by constantly spending more than they earn. Credit is readily
available today. That's both good and bad. It's good because credit
can enhance your ability to undertake attractive
investments such as a college education or a home. I fundamentally believe that
there's a key difference between buying something with
credit that is an asset versus consuming something with credit. Okay, when you go to the pizza
place with your friends and use money you don't have,
you don't still have the pizza, it is really gone. Whereas when you buy a home, you
are borrowing money, but you are purchasing an asset that retains
some degree of value and then assuming that the servicing of
that debt, paying that person back with interest is
affordable, it enables you to buy a very expensive
asset before you have to save for the whole amount. By being able to make a really
sacrificial endeavor to save the down payment and take on an
amount of debt that the service of which might even be less than
they're paying in rent anyways, or maybe equal to it, then
they're building equity. The other example has always
been, we talked about student debt, where you're taking on
debt, you're going to have to pay it off, but at least you're
building an investment into a career into future to education. But borrowing can be bad: when
you borrow to buy things that will soon be of little value,
use student loans to go on spring break or max out
credit cards only to pay the minimum amount due. When you recklessly spend more
than you earn, your financial anxiety will build as your
wealth declines, and you make large interest payments on
items you've already consumed. As a general rule, paying
for your vacations and your surfboards, and your clothes
shopping, and your nights out with your friends with
credit, well, clearly, the asset is gone. You have zero of asset,
but you still have the debt. So all you're doing is making
yourself poorer by doing that. The avoidance of credit card
debt early on is probably one of the great blessings a young
person can ever give themselves. It's very debilitating to have
to unwind significant credit card debt when you're really
trying to get ahead and move forward in your adult life. It's going to make you a lot
less financially secure because you're going to have stress
and have to worry about your interest rates going up from
not being able to pay off those cards every month. Someone could get to a point
where they're literally spending over $1,000 a month, and
they're not chipping away at the debt at all. And I think that that is what
really ends up happening is, you get used to the idea, I have a
fixed expense of just making a credit card payment. I just paid 700, 800 bucks a
month for a credit card payment. And that could be a very high
percentage of one's income. It ultimately leads to that kind
of exasperation of feeling like you're never getting ahead. You get a raise, but you don't
get to save or invest any the money cause you're still
getting behind, getting out from being behind. The worst ramifications
of excessive debt have always been emotional. They drain on people's joy. They add to their anxiety,
but they take away hope. They take away from that feeling
that you can move forward. So, income is the
money you earn. Maximize those
earning opportunities. Save to build up
assets – things you own. Put together a financial plan,
and limit your expenses and liabilities to things that
increase assets or your ability to earn an income. Most people don't need an
education to know how to buy more pizza or go out with
their friends more, but it takes education, and it takes
sacrifice, character traits, if one's going to really learn
the practice of saving, goal setting, budgeting,
things of that nature. I think the biggest thing with
people not knowing about the financial market or not knowing
about a plan, or saving, a budget, any of the things that
we discussed today is because they are afraid that they'll
sound stupid or they don't know anything about it. So just don't talk
about it at all. But I think that's the
worst thing you could do. The more you talk about things,
the better you understand them, the more you know,
the more you can share. Successful personal finance is
about following sound principles and cultivating them as a way
of life, a manner of living. You can enjoy financial
security, even if your earnings are modest. But it will involve both
planning and commitment. Develop your plan today
and resolve to maintain it throughout your life. Your future self will thank you.
