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Personal Finance 101

How to Plan for your Future

April 21, 2022

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Table of Contents
Work in Progress 🚧

Hello! This page is still evolving. The information published is well-researched, but there is more to do, and always more references to find.

Some things I still need to do:

  • Discuss diversification and index funds
  • How to do accounting and taxes in the US
  • Compare countries where I lived (BE, CH, US)

TLDR;


Live below Your Means

As attractive as it is to live the most lavish life, research has shown us that it won’t make us happier. Cars, houses, and other material items rapidly decrease in emotional value (it’s called hedonic adaptation). The anticipation is generally more potent than the act itself. Inversely, good memories have great happiness value.

You should strive to live conservatively within your budget. If something is important to you (for us it’s good food and good times with friends, ideally outdoors), prioritize it. De-prioritize or save on other things.

Avoid credit at all cost. Accumulating debt is not living below your means. If you can’t afford it now, you probably shouldn’t buy it. There are often alternative solutions.

Calculating your Cashflow (Budgeting)

If you haven’t done so already, you should break down your current income and expenses.

In a table, have two columns. One is a description of the income or expense, and the other is the amount. The amount is positive if it comes into your account, and negative if it leaves your account.

I do it on a monthly basis. I’ll list either my net or gross monthly employment income (and add expected taxes if it’s gross) as a positive amount, then list all my expenses. Here’s a non-exhaustive list of potential expenses:

I haven’t listed savings in there, but these are also considered expenses (even though it just goes to another account of yours). So add them if you are already saving or investing a fixed amount each month.

Some elements will be estimates, and will be refined over time (for example the average cost of groceries month-over-month).

Other elements will be billed to you annually (or at least not monthly), and you should calculate the monthly expense equivalent. Indeed, most of the time annual payments might be cheaper, but you still need to take that into account in your monthly budgeting.

As a rule of thumb, you should not spend more than 25-30% of your income on housing expenses. If that’s the case, consider a less expensive place, or reduce your utility bills.

Once you’ve done that, sum all your income and expenses. If the sum is negative, you definitely have to cut back on some things. Maybe get rid of your Netflix subscriptions, or find another place to live in. Your goal is to have a net positive cashflow by the end of each month.

Once your cashflow is positive, make sure to start saving that extra-money. Start with your emergency fund. See the next section for more details.

For each expense item that you have listed, think about how you could decrease it. It might be a cheaper mobile/prepaid subscription, cutting down on services such as Netflix, buying fewer manufactured goods, selling your car, or moving to a cheaper place.

You choose what your priorities are. But live below what you can afford, and save the rest.


Planning for the Future

In this section, I will discuss short- and long-term savings. You should also save money (i.e., not invested but on a savings account) for unexpected emergencies (from losing your job to having a medical emergency or a car breakdown). This should probably be around 3 to 6 months of salary. Don’t use it for anything else, it is your safety net.

A Word about Inflation 💸

Inflation is the decline of purchasing power. That means that $1 today will buy less tomorrow. It means that prices increase.

When planning for future purchases or retirement, you need to factor in potential inflation.

In the rest of this article, I will consider a 3% yearly inflation (i.e., a rate of 0.03). This is arbitrary. You never know in advance how inflation (or deflation) will play out in a given year, but there are ways to safeguard your savings.

How much should I save? 💵

To know how much we should save, there exists a very useful equation:

[ PV × (1 + r)n ] + [ PMT × (1 + r) × ( (1+ r)n − 1) ÷ r ] = FV

We can use this equation in two very useful ways.

The first is to calculate how much will something costs in a number of years from now. In this case, PMT will be 0 (zero). PV is the cost of the item today, r is the expected yearly inflation rate, and n the number of years:

FV = PV × (1 + r)n

The second is to calculate how much you should save per period. In this case, PMT is the periodic amount to save (resp. monthly or yearly), FV is the future value of what you want to buy (computed with previous equation), r is the expected return rate of your investment (resp. per month or year), n is the number of periods (resp. months or years), and PV is your current savings:

PMT = [ FV - PV × (1 + r)n ] ÷ [ (1 + r) × ( (1 + r)n − 1) ÷ r ]

If you want to save every month but to plan on a yearly basis, n should be the number of years times 12, and r should be the return rate per month. If you only have it per year, divide it by 12.

With that, we are ready to tackle different kinds of savings.

Monthly Savings Calculator

Required Monthly Savings: $661.00

Retirement 💰

In planning for retirement, you need to factor in the following:

The first four should be straightforward, give or take a few years. The second two are more of a guess.

Let's look at these with an example

Let’s say you are 30:

  • today’s retirement age is around 68 years old, we can expect this to grow to at least 70 in the future given life expectancy projections,
  • fingers crossed, you think you can make it to one hundred years old,
  • living by yourself, you currently spend (cashflow out) $ 40,000 per year (net), and you don’t expect this to grow much,
  • you expect a 7%-return on your long-term investments (more on that later),
  • you can save up to $1,500 per month if you really need to, which your employer will match.

Given this information, you have 40 years (retirement age minus current age, equivalent to 480 months) to invest up to $3,000 per month in assets with an expected return of 7% per year, or (7% ÷ 12) per month. You will need $1.2M of current currency at age 70, if you want to live comfortably for the next 30 years. With a 3% inflation rate, this means you will need almost $4M by the time you retire.

If we plug these numbers in the two equations defined previously, assuming that you don’t have any savings, we get a PMT of $ 1,515.08. That means that if you save that amount every month for the next 40 years, you will have 4M by the time you retire.

We’ll discuss further down how to manage your investments at different stages of your life, including when you approach retirement age.

Retirement Plans

In most countries, there are retirement plans in place to help you reach your financial goals. They generally include three pillars:

  1. Social security (or government) mandatory savings, taken from your salary to fund the state pension schemes. When you retire, depending on how many years you legally worked in the country, and how much you earned, you’ll get a monthly “salary”.
  2. Employer-sponsored retirement plans are offered by private or public employers and provide tax advantages.
  3. Individual retirement plans provide tax advantages as well.

In employer-sponsored plans, your employer might match your contributions to a certain extent, or just save a standard amount. You should definitely invest as much and as early as possible if this is an option.

You might also read about “vesting” for some retirement plans. Basically, what it means is that the money in your employer retirement plan is not fully yours until it is fully (100%) “vested.” This incentivizes you to keep working at least until the money is yours. It might take five years to be vested, sometimes owning an additional 20% per year until you reach 100%.

returns
The solid blue line is how a one-time $10,000 looks like after 40 years at 7% yearly return rate. You get $150,000. If you now invest $10,000 per year under the same conditions, you get (dashed red line) $2,285,840.

Try it yourself with the small calculator below!

Future Value Calculator

Future Value: $2,278,578.00

Employer-sponsored and individual plans both provide tax advantages. This means you usually get tax deductions on the money you save for retirement, and your investment grows tax-deferred.

In the US, you also have the choice between Traditional and Roth plans. The former is pre-tax. The money is taken from your gross income and is not taxed until you withdraw the money. The latter is post-tax. This means the money is taken from your net salary (and is thus taxed), but won’t be taxed when you withdraw.

As a rule of thumb, it’s probably safe to go Traditional when your income is high (because your tax rate is proportional to your income), and go Roth when the tax rate is low. You can always have both plans to diversify.

Buying a Car 🚗

I’ve put together two small car cost calculators: one for gas vehicles, and another for electric vehicles. Change the predefined values to fit your needs and see how much your car is going to cost you over the years.

The calculator takes into account the original car price, the expected deprecation over the years, the number of years of ownership, the energy consumption and energy prices, and expects that you sell the car after you’re done with it (hence the deprecation rate).

The predefined values are for information only. Do your own research. The price of insurance is not included, nor maintenance (yet).

Car Cost Calculator

Cost of ICE Vehicle After Resale (USD): $23,513.00

First, ask yourself whether you actually need a car. In the US, this is practically a given if you don’t live in a large city. Even so, with rentals, or services such as Uber and Zipcar, you can probably manage without your own car if you can commute/shop by bike or foot.

Things to consider is also whether you have kids, the accessibility of healthcare services, and how frequently you need to use the car. When we lived in Switzerland, it was a no-brainer to forfeit the car and rent on weekends. The price of parking, fuel, maintenance, and insurance was much higher than renting when needed.

You’d be tempted to buy a car on credit (with a loan). This only makes sense if you can loan on a really low-interest rate, and invest the rest to offset the additional costs of borrowing money. Otherwise, it’s probably better to pay cash. It all depends on your financial situation.

Don’t forget that once you have your car, you’ll have to pay:

The recurring costs of your car also correlate with the type of car. Bigger cars are less efficient and cost more to maintain and to repair. Examine expected recurring costs for a given car and incorporate them in your budget. Don’t hesitate to consider a smaller, safer, and environmentally friendly option.

In Switzerland, getting your driving license requires: 10 hours of first aid lessons, a driving knowledge test, and a practical test. You then get a 3-year probationary license. During that period, you have to take additional classes to learn to handle your vehicle in dangerous driving conditions and eco-driving.

Let’s imagine we want to buy a car, cash. We can use the exact same equations used for retirement planning. If you want to buy a currently $25,000 car, that same car will cost approximately $29,000 in five (5) years with a yearly inflation rate of 3%.

If you don’t have any savings yet for the car, you’ll need to save $426 per month in the next five years to afford your car, given a yearly return of 5% (more on that number later).

You can try it yourself, with the Monthly Savings Calculator above.

Buying a House 🏠

Buying a house is a big deal. It’s a car, but bigger, much bigger. That means less flexibility, and more fixed and recurring costs. You need to be prepared.

To get the most out of your house purchase, consider the following:

If anything does not check out, consider a cheaper acquisition. You can always sell, and buy a more expensive house later. Your first house is a great “investment” if you see yourself living there for an extended period of time. You never know how the housing market will evolve. A high rate and long mortgage will end up costing you a lot more than the actual value of the house.

Before considering purchasing a home, you should budget your future costs. This includes:

We can use the equations above to calculate how much we need to save for the deposit. Once you have enough for a 20% deposit, shop around for the best loans and see what you can afford. It might be wise to also inquire about fixed costs. These are the costs that you will always have to pay when buying a house. If you move often and buy a new house every time, you will lose a lot of money. Fixed costs can include:

As a rule of thumb, you should probably avoid buying a house until you settle in one location, and only buy something within your budget.

You can use the Monthly Savings Calculator again to know how much to save for a deposit.

Children and College 👶

Kids cost a lot. But we don’t have any, yet. So the only thing I can give you for now is how much you need to save to send your kids to college in the US (if they want).

Tuition fees are around $ 20,000 in 2022 for one year of undergraduate degree. Completing an undergraduate degree should take about four (4) years. This means $ 80,000 for four years of college for one kid. In addition, you should consider a yearly stipend of approximately $ 24,000. That’s an additional $ 96,000 over four years.

Using the equations above, if you want to have two kids in college, you will have to save $ 1,540 per month for the next 20 years at a 5% return rate.

Until college, I expect increased housing, groceries, clothing, and other miscellaneous monthly expenses. That means fewer opportunities to save for retirement, a car, or a house. That’s why you should save/invest as early as possible.

Miscellaneous

It’s pretty obvious that you can use the equations above to plan for pretty much anything. It’s always good to be conservative in your expectations, and live below your means.


Investing

In the previous sections, we discussed 5 to 7% return rates on savings. But what does it mean? Let’s look at bonds, stocks, index funds, returns, and dividends in more details. I’ll also discuss other forms of investing.

Short, Medium, and Long-Term Savings 🤑

Generally, we distinguish three horizons for investing money.

Money that you can easily withdraw is generally considered a short-term investment. High-yield savings accounts are typically in that category. Your money will not lose as much value as if it’s lying around on your checking account. It might not perform well enough to beat inflation but you can withdraw it without fees and at any time.

A medium-term strategy allows you to invest your money, usually at a fixed rate, but once invested you can’t withdraw it until term. This typically includes government and company bonds. You won’t get the highest returns and it involves a little risk if the borrower (the entity you are loaning money to) cannot repay the loan. Generally, this is a good investment instrument when you know when you will need the money.

With that in mind, let’s imagine saving for a house deposit. We want to buy the house in 5 to 10 years, we can then choose a bond with a fixed-interest rate of for example 5% with a term in 5 to 10 years. If you save every month, make sure to buy bonds that have the correct a term date. Read more about bonds to understand how their pricing works.

A long-term investment strategy allows you to invest money for longer periods of time, with more uncertainty, but higher expected returns. Some of these investments cannot be easily withdrawn before term (e.g., retirement plans). They can lead to actual losses if for example the investment instrument is performing badly when you want to withdraw the money.

Specifically, long-term investing usually implies buying into the stock market. There are different ways to do so, but essentially you are using your money to buy shares of one or multiple companies. The company value will fluctuate over time. You will lose or earn money only when you sell your shares (or in the worst case the company goes bankrupt), not before.

Higher inflation is correlated with increased stock volatility, though. So how can we make the best of our long-term investments?

Diversification and Index Funds 📈

Coming soon!

Rebalancing

Coming soon!

Expense Ratios

Coming soon!


In Practice: Moving to the US

Here’s a small walk-through of financial tips for people moving to the US. It probably warrants a separate post but it will do for now.

Get an Address of Residence 📬

To do anything, you will need proof of residence. The most widely accepted documents in the US are utility bills (electricity, gas, internet). Sometimes, corporations might accept the insurance policy or rental agreement. For me, the fastest way to show proof of residency was getting my internet bill online.

It was strange coming from Belgium/Switzerland where you have to register with your local administration anytime you move. They thus provide the proof of address, and you are automatically registered for local taxes.

In addition, international companies might require a more formal proof of address than simply a utility bill. You can probably ask an official proof to your consulate (that’s what we did coming from Belgium), or ask the US Internal Revenue Service (IRS) for tax residency proof.

Open a Bank Account 🏦

Opening a bank account in the US is not particularly difficult. They will ask you for a proof of residence, though. For this you will need a utility bill (electricity, water, internet) with your name and address on it. A signed letter from your employer will also work. You’re a couple? Make sure both names are on the bill (hence the account is for both of you).

Choosing a bank account is a personal choice depending on what you value:

Generally, all banks will offer free accounts under certain conditions. You want to meet these conditions as fast as possible.

In my opinion, you want to reduce the number of financial institutions in your portfolio (i.e., you are a customer). This applies not only to banks but also brokers, credit card issuers, etc.

Why? I find it terribly difficult to keep track of all assets and debts when they are split across multiple institutions. Plus, the administrative overhead quickly becomes massive, in particular when you relocate internationally (taxes, residency, contact information, etc.).

Periodically, I’ll sit down and see if I can get rid of some complexity, for example by closing an account and moving funds over.

Get your SSN or ITIN 🪪

For legal and tax purposes, financial institutions will want to receive an individual tax identifier. In the US, if you are working, this will be your Social Security Number (SSN). If you are not but are considered a U.S. Person, it will be your Individual Taxpayer Identification Number (ITIN).

Some countries like Switzerland have different numbers for social security and taxes.

Once you have this number, you will have to communicate it to your financial institutions. They will use that number to correctly report your information to the authorities. It helps combat fraud and other illegal activities.

As a U.S. Person in particular, it is very important to communicate your SSN/ITIN to your financial partners. Since 9/11, companies all over the world have strict reporting requirements with the US government. They might stop your business relationship with them (and hence block your money) if they are not able to conply with these requirements.

Apply for a Credit Card 💳

Most of the time, you will need your SSN to apply for a credit card and start building a credit score. There are some credit cards without that requirement, for example if you are a student. You will need an ITIN or passport number, though.

As tempting as it is in a market dominated by credit and debt, you only need one credit card. If you want to change for a card with better benefits, just cancel the previous one.

Get a card with no fees, cash back, and services and protection. A credit card is useful for example to rent a car, and is unfortunately needed to have a good credit score /s. If a good card is available with your bank, I would favor taking it, that’s one less account to worry about.

As stated, don’t take on debt, just pay your credit card on time. If you can’t, cut down on your costs and pay your debt off as fast as possible.

Credit Scores 🙈

It might sound surprising (and it was for me coming from Belgium and Switzerland), but here in the US (and in other places) you have credit scores.

Your credit score gives authorities and companies an indication about your ability to manage your money properly. In a nutshell, this means avoiding debt, and paying your loans on time.

While in principles, this makes a lot of sense and minimizes risk for the lenders (individuals with high credit score demonstrating a good ability to manage their money), in practice the system encourages people to use their credit card(s) to “build their credit score”.

Credit card issuers’ marketing practices encourages you to have multiple cards to speed up the process. Don’t fall for that.

Enroll in your Employer Retirement Plans 🧓

Depending on your sector (public, private), you’ll have access to different retirement plans. Some are employer-sponsored, others are voluntary.

The sooner you start putting money in there, the better. Indeed, some plans having yearly limits, you want to maximize your contributions early, and factor these into your budget.

As a rule of thumb, put at least as much as your employer will match. Beware also of vesting requirements. Some plans are directly 100% vested, but others will require that you work for the organization long enough.

Keeping Track 📒

If you followed my advice and do not have tens of banks accounts and credit cards, it should be fairly easy to keep track of things. Most banks offer some form of expense summary/report that you can use to verify your budgeting.

Other banks such as Revolut offer built-in budgeting options. You specify how much per month you can spend in a given category, and the app will notify you when you reach your limits. They do this by automatically categorizing the expenses made from that account.

In the US, you can also sign up for a service such as Intuit Mint. You can connect most financial institutions to it and they will summarize everything in one interface. Pretty neat.

Accounting and Taxes 🧾

Coming soon!


References

Coming soon!