The Personal Finance Index Card: Everything Money in 4×6

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Meet Harold Pollack. He’s a professor of Social Service Administration at the University of Chicago, and he’s proving that you don’t have to be a genius to tackle personal finance. Which makes him a genius.

Pollack managed to fit all the personal finance advice you need on a single index card. It’s just 9 rules. According to him, if you follow the 9 rules on this personal finance index card, you’re set!

Then he coauthored a book, The Index Card: Why Personal Finance Doesn’t Have to be Complicated to expand on some of his ideas. And yes, he’s aware of the irony of writing a book to explain that personal finance can fit on an index card 😉

The 9 Rules of Pollack’s Personal Finance Index Card

Let’s look at each of Pollack’s 9 index card personal finance rules and make sure we know how to implement them.

Oh, and FYI: we’ve not had the pleasure of meeting Pollack, so we’re not speaking for him here. The rules are copied verbatim from his index card, but the commentary is ours.

1. Max your 401(k) or equivalent employee contribution.

Amen! Maxing your 401(k) (or other retirement account) is one of the best things you can do for your finances. It just means you’re saving the legal maximum in your retirement account.

Why is there a legal maximum? Because of tax breaks! The government doesn’t charge you income tax on any money you earn that you save in a qualified retirement account like a 401(k) or IRA. And the government can’t lose out on too much tax revenue, so they have retirement account caps. For 2018, everyone under 50 can save up to $18,500 in a 401(k), and up to $5,000 in IRAs (people over 50 can save more to “catch up” before they retire).

Btw, if you’re new to retirement account lingo, check out 3 Easy Steps to the Retirement of Your Dreams. It lists some of the different account types and how they work.

Oh, and if you think you’re going to build a life you don’t want to retire from so you can just work forever, think again. What if you’re sick or injured? You may not have the option to work forever, so be prepared.

But getting back to the general rule…this rule raises 2 important questions:

1. How the eff am I supposed to save $18,500 per year for retirement? That’s $1,542/mo!
2. Can’t this wait a few years? I’m decades away from retirement.

 

How to find money to save for retirement

If you’re in your 20s, $1,542/month is probably a fortune! I’m approaching mid 30’s (gasp!), and it’s still a ton of money to me. Here are a couple ways to deal with this:

• You don’t have to immediately start saving $18,500/year. You can work up to that number. Start with just 2% of your income and sign up for automatic increases so every year another percent or 2 will be added to your contribution.
• Throw raises and bonuses into your retirement account. You’re used to living without that money, so you’ll never miss it.
• When you get a new job with a higher salary, continue to live on your old salary, and stash the rest in your retirement account.
• When you pay off debt, put the money you were using for monthly debt payments toward retirement instead.
• Start a side hustle to increase your income so you’ll have enough money to save more

It may take a few years, but you’ll be up to $18,500 before you know it.

Can this wait a few years?

No. No, this cannot wait. If you have an income, you need to be saving for retirement. Why not? Because compound interest.

Compound interest is magic, but it needs time to work. The sooner you start saving for retirement, the more time your money has to grow.

Besides, it’s just a good life habit to establish young.

The habit of saving is itself an education; it fosters every virtue, teaches self-denial, cultivates the sense of order, trains to forethought, and so broadens the mind.

~Thornton T. Munger

2. Buy inexpensive, well-diversified mutual funds, such as Vanguard Target 20xx funds.

The most inexpensive, well-diversified mutual funds you can buy are a special type called Index Funds. An index fund is like a sampler box of a bunch of different stocks or bonds. So when you buy a share of a stock-based index fund, for example, you’re actually buying little pieces of a bunch of different companies’ stocks.

Here’s why they’re brilliant:

• Because they are sampler baskets, they are automatically diversified; if one stock plummets for some crazy reason, you still have all the rest to help absorb that loss.
• They are passively managed, so the fees are super low. And the fees are paid out of the balance of your account, so you don’t get a bill you have to pay out-of-pocket.

As with any investment, there is some level of risk, but as long as you’re in it for the long-term, Index Funds are firmly on the safer side of the risk scale. Index funds just follow the market, so when the market’s up, they’re up, and when the market’s down, they’re down. In the short-term, this could be a little risky because the market always fluctuates, and you might need your money on a day when the market happens to be down. But if you can let the money sit while the market corrects itself, you’ll be just fine!

3. Never buy or sell an individual security. The person on the other side of the table knows more than you do about this stuff.

So we just said one of the reasons index funds are so awesome is because they are automatically diversified. Some of the risk is automatically mitigated for you.

That’s not the case with individual securities, like plain old company stock. If that company performs poorly, you could lose some (or very-unlikely-but-still-technically-possible, all) of your investment.

Chipotle is the perfect example. They were on the rise, and no one could have predicted the 2015 E Coli outbreak that destroyed their stock price. Chipotle stock prices are still on a downward trend. If you bought a share of their stock for $725 in October 2015, it’s only worth about $314 as of the date of this post.

Do not buy a share of stock for an individual company. It’s too unpredictable.

4. Save 20% of your money.

Ok, 20% sounds like a lot, but it’s not completely crazy if you consider that a good chunk of this is going toward retirement. Start now with whatever you can swing and build up over time. Just like we talked about with retirement savings: starting saving now and building up to maxed out retirement accounts.

5. Pay your credit card balance in full every month.

Carrying debt is expensive. Check your credit card statement to see how much of every payment goes toward interest alone. The average American household pays nearly $1,000/year just in credit card interest. Think of the better things you could be doing with that money!

I like to use my credit card for most purchases to earn rewards points, and I avoid interest charges by paying the credit card balance in full every month. You know yourself. If you can’t be trusted with credit cards, cut them up and avoid the risk altogether.

Need help tackling your debt? Our Champagne Waterfall Strategy could save you thousands of dollars in interest charges!

6. Maximize tax-advantaged savings vehicles like Roth, SEP, and 529 accounts.

401(k) and IRA retirement accounts aren’t the only accounts with tax breaks. Pollack’s personal finance index card suggests using tax-advantaged plans to store some of your savings to keep your income tax bill as low as possible. He specifically mentions Roths, SEPs, and 529s, so let’s explain each of those.

Roth

A Roth is a special type of IRA retirement account. They are very similar, but with one big difference: taxes. Unlike pre-tax IRA’s, Roth IRA’s are post-tax accounts, so you don’t get to deduct the amount of your contributions from your income taxes as you save. Your tax break on a Roth comes at retirement. Unlike 401(k)’s and IRA’s, you won’t be charged any income tax on this money when you start using it at retirement.

SEP

A SEP is yet another type of retirement account, this one specifically for employers or self-employed individuals. Like 401(k)s and IRAs, your contributions are tax-deductible.

529

529 accounts are savings accounts specifically for education. They were originally designed in the 90’s for parents who wanted to save money for their kids’ college. But the new code is expanding the plan to include private elementary and high schools.

You don’t get an upfront federal income tax break on your contributions (although some states allow you to deduct some of your contributions from state income tax), but as your money grows through compound interest, you won’t be charged income tax on any of that growth when you withdraw the money for education later.

Word of caution when using tax-advantaged savings vehicles

You should know that these tax-advantaged accounts can be restricting. In retirement accounts, your money is specifically designated for retirement, and you could be penalized for using any of the money in those accounts before retirement. And your 529 savings must be used for education, or you may be penalized.

7. Pay attention to fees. Avoid actively managed funds.

This directly relates to our earlier conversation about rule #2: buying inexpensive mutual funds. Remember, the passive Index Funds often outperform actively managed funds, and they have much lower management fees. So again, when in doubt, stick with Index Funds.

8. Make financial advisor commit to a fiduciary standard.

You probably don’t have a financial advisor yet. And that’s fine. It’s perfectly ok to DIY your financial management, especially when you’re just starting out and have little to manage.

But when you reach the point where you decide to involve a financial advisor, Pollack recommends making your financial advisor commit to a fiduciary standard.

Meaning?

Meaning your financial advisor should commit to putting your financial needs ahead of the needs of himself/herself and his/her employer.

See, all financial advisors in the US are required to abide by one of two standards: either “fiduciary” or “suitability”. We just nutshell-defined fiduciary as putting your needs over theirs. The suitability standard, on the other hand, just says that the advisor won’t advise you do to or buy anything that isn’t suitable for you.

Let’s look at an example to distinguish between the two. Your advisor could have two suitable products for you to invest in: one that is likely to perform better, but has lower fees, and one that is not likely to perform as well, but has higher fees that will make his or her boss happy.  Under the suitability standard, the advisor can recommend either product. Under the fiduciary standard, the advisor must recommend the product likely to perform better even if it means lower fees for the firm.

Most financial advisors are stand-up people and are very careful to look out for your best interest. But it can’t hurt to ask for the commitment to the fiduciary standard.

9. Promote social insurance programs to help people when things go wrong.

I mentioned that Pollack’s field is social service administration, right? So it makes sense that he’s interested in promoting social insurance programs (Social Security, Medicare, etc) to financially help those people whom he feels can’t help themselves.

You may or may not agree with this section of the personal finance index card. Take it or leave it 🙂

How the Book Differs from the Original Personal Finance Index Card

Interestingly, the 9 rules offered in The Index Card: Why Personal Finance Doesn’t Have to be Complicated are a little different.

This is likely because Pollack was shooting from the cuff when he wrote his index card. He was responding to a listener’s question after he did an interview, so he didn’t craft this as a book idea from the get-go. Once he gave it more thought, he made some revisions to his personal finance index card.

The rules are rearranged in the book to put the most important items first:

1. Save 10-20% of your income (he concedes that 20% isn’t possible for everyone)
2. Pay off your credit card balance in full every month (and other debt)
3. Max out your 401(k) and other tax-advantaged savings accounts

Notice rule #3 there? It combines his original rules #1 and #6. That freed up a bullet point for him to add an additional rule to the book: “Buy a Home When You are Financially Ready”.

The book also eliminates rule #7 about paying attention to fees because it’s a little redundant with original rule #2: buy inexpensive mutual funds. So that freed up another bullet point, which was replaced by a new rule: “Insurance – Make Sure You’re Protected”.

Let’s quickly look at those two new rules.

Buy a Home When You are Financially Ready

Real Estate is one of my favorite investments as explained in 3 Reasons You Should Buy Real Estate (Even if You Don’t Want to Own Your Home). Many of the young women we speak with have no interest in home ownership because they don’t want to be anchored to one spot, and they saw the adults around them struggle with the housing market crash in 2009.

First, I can assure you that buying a home doesn’t mean you’re stuck there. Hubby and I move a lot. Something like 14 times in the last 15 years. We bought our first house in LA in 2012, lived there a couple years, then moved to San Diego, then Hamburg Germany, then Chicago, and currently Frankfurt Germany.

The key is to buy smart. Buy in an area where you can rent the house for far more than your monthly payment (including property taxes and insurance costs). That way you can seize opportunities as they come, wherever they may be, and just find good renters to pay down your debt and cover your expenses on the property while you’re away.

And what about the housing crash? What if that happens again?

Well, additional regulations have been imposed on the mortgage industry in the hopes that we can avoid such a dramatic downturn in the future. Having said that, real estate is cyclical. Prices rise and prices fall, so you should be prepared to hold the property long-term and wait out any market fluctuations.

Over the long-term, real estate is often one of the best investments people can make. It grows in value, you can rent it out for cash flow, and you’ll have a place to retire so you won’t need to worry about paying ever-increasing rent prices when you’re a fixed-income retiree.

Insurance – Make Sure You’re Protected

Pollack’s last new rule is to protect yourself by investing in adequate insurance. This will become more important the older we get because we’ll have more assets to protect.

For now, health and disability are the priority. Good health insurance covers illnesses and even preventative measures like check-ups. And having disability policy will help you survive financially if you’re injured and unable to work.

If you have a family and want to make sure they’re financially provided for if you die and they lose your income (harsh way to look at losing a loved one, right?), you should consider getting a life insurance policy.

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What do you think of Pollack’s personal finance index card? What do you agree or disagree with?