What Do Adults Do With Their Money?

What Do Adults Do With Their Money?

It all started with a question.

After spending a year working two part-time jobs, graduating from college, and spending another year working three part-time jobs, I was now in grad school over 400 miles away from home.

I had just spent a year in grad school on a slim stipend that put me around the federal poverty line, and I added up all my expenses. To my surprise, I found that I was actually making money in grad school! Not much, but hey, a surplus is a surplus! I did get an extra couple thousand dollars from summer employment, so I was actually doing okay. Not great, but okay.

But I had proven to myself that I could live—and pay all my own bills—on a $12,500 annual salary. Not that I had a very high standard of living, but at least I could do it!

After toting up the numbers, I came out 'in the black,' as they say. I never expected grad school to actually be profitable!

I wasn't only looking back at the past year; I was also looking ahead. In just a couple short years, I'd be earning an actual salary. For the first time in my life, I wouldn't be a student, or a grad student, or a young person balancing multiple part-time jobs while looking to further his education.

I'd have an actual, full-time job. With commensurate salary and benefits.

And I wanted to know what to do with my money before I got there.

Here I am in 2014, living on less than my $12,500 a year. In a couple years, my salary should roughly quadruple (and in retrospect, that's almost exactly what happened). Though I already knew my lifestyle might double once I was a real adult, it definitely wouldn't quadruple.

So...what do adults actually do with all that extra money?

What Do People Do?

I already understood that many people spend all their money, with facile justifications like “I work hard; I deserve to treat myself.”

And in some cases, people spend money they haven't actually earned yet. Thanks, easy credit!

Knowing myself, I wasn’t afraid of that pit. I was completely comfortable with the lifestyle of a grad student. As long as I had my own apartment, internet access, and books, I'd be just dandy.

Many people in my circumstance probably look at what their family does. In my case, the primary answer was savings accounts and CDs through a bank—all while complaining about the lousy interest rates.

I knew investing was a thing, but I didn't know any of the details. Certainly not enough details to put my hard-earned cash into something that some random person claims is an "investment."

After all, I definitely knew that scams are also a thing. And I knew considerably more about all the ways people will try to bilk you out of your money. So I was cautious. Perhaps overly cautious, since I had spent so many years working so hard yet earning so little.

Finding Out

Like any millennial, I Googled my question to see what answers were out there. I searched something like "what do responsible adults do with their money" and came across a few different answers. Most of what I found was not helpful. The writers usually gave me overly general advice about things I already knew, like 'save a little bit from every paycheck' or 'pay off your credit card every month' or 'get out of debt as soon as possible.'

But it didn't take long before I stumbled across investing advice, especially as it relates to the stock market.

And I became very, very interested in the nuts and bolts of what I found.

Much advice was centered on convincing the reader of the advantages of stocks, as well as determining optimum portfolio allocation. But I needed information that was more basic, more geared for beginners.

I wondered:

• How do you know which stocks will go up and which will go down?
• How do you know the stock market won't crash and wipe you out?
• What are these alternatives that people are discussing, like REITs and bond funds and mutual funds?

So I dug into it.

Okay, now that I'm satisfied about this stuff, let's assume I want to put some money into investments like stock index funds, bond index funds, and real estate investment trusts.

• How do I go about actually putting money into these options?
• Why should I invest through a 401(k)?
• What if I don't want to invest in my future employer's 401(k) because it has too many fees?
• Will I therefore be locked out of the market, and all these gains I've been reading about?

Beginner-level questions. But not beginner-level like 'what's the difference between a savings account and checking account?' More like, 'how do I invest? And what are some of the pitfalls I might encounter?'

Details, Details, Details

It seemed that the more I read, the more there was to discover.

Amidst all the stuff telling me to "make extra payments toward your debt if you can afford it" [doesn't apply to me] and "paint your rooms before selling your house so the interior looks nicer to buyers" [still doesn't apply to me] and "see if life insurance makes sense for you" [it doesn't], I came across information about put options and commodities and dollar-cost-averaging [whoa, slow down, there, hoss!].

I needed more details on the big-picture stuff.

And the most helpful information I found, believe it or not, came from personal finance blogs. There were enough of them that I could find an easy-to-digest answer for pretty much every question I had. These were some smart, well-informed, and helpful people—sharing their information for free!

I didn't rely on just one blog, or even a handful. I read articles on many, many different blogs. Alas, I didn't keep a collection of links. It would be an enormous list anyway. I also read several books on the topic, just to make sure the bloggers weren’t full of it.

They weren’t.

So I started a blog of my own, with the intention of helping others get the same information that I had digested over the course of several months, as well as the financial wisdom I had gathered over the years from family and friends.

Thus, the Froogal Stoodent blog was born in May 2014!

And now here we are, standing on the precipice of a possible recession. It amazes me how far I've come in my understanding in roughly a decade.

It also amazes me how far I've come in my actual finances. Suffice it to say that I'm well above the median not only for my own age group, but well above the median of the next-highest age group as well. I'm far from wealthy, but I've done quite a bit better than your typical American.

Much of that performance is thanks to the excellent defense I learned from my family (i.e. frugality, or not spending more than I have to), but some of it is thanks to beefing up my offense with the investing advice I've learned over the years.

I learned plenty of details. Some of them went over my head, but I wrestled many of them until I fully understood those details and their implications.

So What Do Adults Do?

In essence, here's what I've learned: my cheatsheet to handling your finances like a responsible adult.

1. Money isn't everything, but it's crucial nonetheless.

If you have money, life might be hard. But if you don't have money, life is certain to be hard.

That's the way it is. You don't have to like it. But those who understand money will always have a leg up on those who don't.

The very first step is to play defense, to borrow a term from Stanley and Danko’s classic book, The Millionaire Next Door. Look at money-saving alternatives on every bill. Look at alternative phone plans. Look at alternative housing arrangements. Shop around and negotiate for lower insurance rates. A new car is a black hole for money; a good used vehicle is much better when it comes to depreciation, insurance, and any needed parts. So take good care of your current vehicle, and keep it for as long as possible.

Not exciting. We all want to hear beautiful lies like “Buy a Ferrari! You can easily make that money back!”

But for most of us, that’s simply not true. Money is hard-won and slowly earned. So protect it the way a lion protects a fresh kill—don’t let the hyenas get too close! [But that’s really not fair to actual hyenas.]

2. Despise debt.

Debt is a vampire that feeds on your time, energy, and soul—not to mention your money. What a greedy son-of-a-gun!

Do whatever you can to eliminate it, fast. Make more than the minimum payments on your debts. Work a weekend/night job if you need to, cut back on your spending, or both...whatever it takes.

Don't like it? Tough. You’re adult enough to make the debt, you're adult enough to pay it off.

Sometimes, the debt is for something that isn't your fault, like emergency medical treatment. It's nobody's fault. You can argue plenty of things that are wrong with the way medical care is handled in this country.

But whether or not you did anything wrong, the debt is still going to hang over your head, cause you sleepless nights and anxiety, and generally make your life unpleasant until it's gone.

Attack that sucker. And then be vigilant about letting it sneak into your life again.

3. You need an emergency fund.

Everything that follows after #3 is predicated on you having already established and maintained an emergency fund.

It is foolish to invest in stocks—or even bonds—without having some money handy to take care of problems when they crop up.

When your car breaks down, a leak appears in your house, your employer downsizes your department and you no longer have a job—or maybe all three at once—you'll be glad you have more available than $35.16 in a checking account. And even a credit card may not bail you out; not everybody accepts them.

Things will go wrong. You can't help it, and you can seldom foresee it.

What you can do is prepare in advance, by having money available in a savings account or CD at your local bank or credit union.

There's some debate over whether you should pay off debt first, or build your emergency fund first. Perhaps it's best to try a little bit of both.

I'd be inclined to recommend getting a small emergency fund first (to prevent taking on more debt in the event of an emergency), and then paying off your debt aggressively, before further building your emergency fund.

Once you've got money in that fund, do not touch it!

I don't care how cute that outfit is, or how long you've been waiting for that new gaming system. It doesn't matter if that new cell phone is just perfect for your needs, or how many people at work are raving about their air fryer.

It doesn’t matter if that would help you put a big down payment on the house you’re looking at—that down payment needs to come from a separate fund.

Do. Not. Touch. That. Money. Until. You. Absolutely. Need. It.

If you have to deposit that money in a bank that's inconveniently located across town, so be it. If you have to trick yourself into forgetting about it, then do so. But you absolutely need to leave it for actual emergencies.

Exercise self-restraint. That is your shit-hits-the-fan fund. Don’t raid it until the shit actually hits the fan.

How much do you need in this fund? The general advice is 3 to 6 months' worth of expenses. Therefore, you have to know how much you spend in a typical month. This depends to a great extent on your circumstances.

Consider: your rent/mortgage. Your utilities. Your groceries. How often you eat at a restaurant or fast-food joint. Your gas and car insurance. Your cell phone bill. Your internet bill. Your cable bill (eh, screw it, cut the cord and put that money into your emergency fund instead). Your insurance—health, life, house, etc. Entertainment. Clothes/makeup/toiletries.

According to the most recent data from the BLS Consumer Expenditure Survey (for year 2018), the average American household spends about $5100 per month, for a total in excess of $61,000 per year!

This means the typical American emergency fund should total over $15,000, and as high as $30,000!

You would be wise to spend less than $5000 a month, even if you're a high-income earner. Reducing your costs gives you much greater flexibility—to retire early, take a different job that has lower pay and less stress, take an extended vacation in the middle of the year...whatever.

Isn't freedom more valuable than people's compliments about your house, car, or shoes?

4. Invest through your employer.

Your 401(k), 403(b), TSP, or Section 457 plan allows you to invest your money before taxes are taken out of your paycheck.

Named after the respective sections of the tax code, a 403(b) is for people who work in education, a TSP is for federal employees, and a 457 is for people who work in state or local government or nonprofits. The much better-known 401(k) is for people who work in the private sector. While there are some slight differences between the plans, all of these types of accounts function similarly.

The max contribution limit for all of these accounts is the same. You can contribute up to $19,500 in 2020. If you’re 50 or older, you can add an extra ‘catch-up contribution’ of $6500, for a max of $26,000. Also note that you only get the tax benefit until you make a certain amount; that limit is $285,000 in 2020.

There is a less-publicized limit for total contributions as well, between you and your employer. For 2022, that overall limit is $61,000 (or $67,500 for employees over age 50)—but if your salary is less than that figure, then your salary is the limit.

Your employer may offer a match, or a partial match. So for every dollar you put in, your employer will contribute an additional dollar. Or 50 cents. Or whatever the plan says. This is usually true up to a certain percentage of your paycheck. If you’re lucky, your employer may put some money in even if you don’t contribute a dime! This is rare, though, so don’t expect it.

For instance, my current employer contributes 50 cents on the dollar, up to 8 percent. So if I contribute 8% of my paycheck to my 401(k) plan (in my case, that’s around $62 weekly), my employer contributes another 4% (an additional $31). This arrangement maximizes the benefit from my employer.

The advantage here is that your pre-tax investment money grows, untaxed, for many years. Once you retire, you can take a portion of your money out of this account, at which point it is then subject to taxation.

But beware! If you take the money out before retirement, it's subject to both taxation and a penalty as well. There are exceptions to this penalty, but it’s still best not to touch your retirement money.

So once you put some money in, leave it alone.

Hey, you won’t need it. You’ve got your emergency fund, right?

5. Invest on your own.

Not everybody has access to a 401(k) or 403(b) or TSP or 457. Of those who do, some people may not like their employer's plan. It may have too many fees and expenses, or it may have a poor employer match—or no match at all.

That's okay. There are still avenues for you to invest on your own.

And even if you do contribute to a 401(k) or equivalent plan, you can still take advantage of these avenues.

IRA – Individual Retirement Account. This provides tax advantages for you; very similar to the 401(k)/403(b)/457 plans. You put the money in pre-tax now, and you don’t pay tax until you withdraw the money.

To avoid the penalty on withdrawals, you must be at least 59-and-a-half years old, or you’re using the money to pay for: qualified higher education expenses, certain medical expenses, qualified first-time home purchase, disability, death, or payment of health insurance premiums when unemployed.

However, your maximum contributions to an IRA in 2020 are $6000 for the year (or $7000 if you’re 50 or older). That’s a whole lot lower than the contribution limits for a 401(k) or equivalent plan!

Roth IRA – Roth version of an IRA. In this one, you pay the taxes now so that the money is not subject to federal taxes when you withdraw it (provided that the money has been in a Roth IRA for at least five years, AND one of the following applies: you’re using the money as a first-time home buyer, you’re at least 59-and-a-half years old, or you’ve died).

In case you’re wondering—no, you can’t contribute $6000 to a traditional IRA and another $6000 to a Roth. That $6000 limit is for both; you have to choose which type you prefer.

You could put part of it in a traditional and the rest in a Roth IRA. Say, $3000 in a traditional IRA and another $3000 in a Roth IRA. But you can’t contribute more than $6000 total, across both types of account.

From a tax perspective at least, the Roth IRA is better if you expect to be in a higher income-tax bracket after you retire—either because you’re planning to live it up after you retire, or because you intend to continue working (or owning a business, or somehow generating income) even after you retire. The traditional IRA is better if you expect to be in a lower income-tax bracket after you retire.

Brokerage account – this sounds fancy, but it really isn’t. In a brokerage account, you can buy and sell all sorts of investments, including shares of stock in a single company, or even more advanced stuff like commodities or put options or stocks on foreign exchanges.

But for many reasons, buy-and-hold for a low-cost index fund is still your best bet. For instance, if you make frequent trades, you’ll pay extra brokerage fees, and you may be liable to pay higher taxes as well, since gains on short-term trades are taxed at a higher rate than long-term gains. For tax purposes, long-term is defined as one year.

If you maintain a brokerage account, you’re subject to capital gains taxes once you sell the holdings. Here’s what I mean by that:

Let’s say your paycheck, after taxes and other deductions like health insurance, is $750. You save four paychecks, which totals $3000. You put that $3000 into a brokerage account (not an IRA or anything tax-advantaged), and invest that money in a total stock market index fund.

Over the very long run, history shows that you can expect returns of around 8% per year for this type of investment, even after accounting for your [very low] fees.

Your $3000 sits there for two years, turning into $3500 [if you want to be precise, $3499.20]. Now, after two years, you need that money for something. Since this isn’t a tax-advantaged account, you can pull that money out for anything you want, anything at all.

A wedding. A house. A really expensive gaming laptop. A trip to Vegas. A cash gift to your kids. Whatever.

Now remember, you’ve already paid taxes on the $3000, because that’s what was left on your paychecks. So you’re subject to taxes on the capital gain, which was $500. So how much tax do you owe?

Using 2025 numbers: if your taxable annual income is less than $48,350 [single, or married filing separately], you’re off the hook! You don’t have to pay anything! [No, seriously. The IRS itself says the long-term capital gains tax is 0% if your income is below that threshold.] If your annual income is between $48,350 and $533,400, you pay 15%.

Check the link - those numbers could be different, based on how you’re filing your federal taxes (e.g. single, married filing jointly, head of household, etc.).

If your annual income exceeds the top-end figure ($533,400 in the scenario above), you’re subject to a 20% capital gains tax, Moneybags.

The maximum is also different for selling collectibles, section 1250 gains on real estate, etc.

What Mistakes Should I Avoid?

1. Fees.

Fees of 1% are pretty low, right?

Wrong.

Check out the graph below. Over the course of decades, this amounts to tens of thousands of dollars transferred from your pocket into the pockets of financial professionals. If they work for us, how come they drive Porsches and BMWs while we drive Hyundais and Chevys? Well, this graph'll show you how:

Figure by Vanguard, via Next Gen Personal Finance

Mounds of evidence indicate that it's vanishingly difficult for an actively-managed fund to reliably, consistently beat a benchmark fund. A few can actually beat their benchmarks in a majority of years—but does that outperformance take their higher fees into account? If so, it's worthwhile! But if not...

People consistently underestimate just how much fees drag down your performance—even people who have learned about fees and are familiar with the above chart! It’s like running with a parachute, but the parachute gets bigger year after year.

2. Picking stocks.

As I mentioned above, there are reams of research evaluating people’s ability to beat the market. Those reams conclude that there’s very little evidence that anybody can consistently outperform their benchmarks.

That’s right. You’re better off getting the market average returns than you would be to pay for some fancy-pants stockbroker or investment professional.

Why is that? Go back and see Mistake #1.

Let’s be generous and assume your professional investor beats the market for 2 out of 10 years. Does he beat the market by a wide enough margin to make up the difference between his fees and the ultra-low fees of a stock market index fund?

How about the other 8 years? In those 2 high-performance years, does he beat the market by a wide enough margin to account for his higher fees not only in those 2 years, but also in the other 8?

The answer is almost certainly “no.”

The research suggests that you have better odds of picking the next big stock than of picking an advisor who will. Let me say that again: you’re more likely to pick a big winner yourself than you are to pick a professional who will.

So if you want to pay for somebody else’s Porsche, go for it. Maybe you’ll do better by listening to his advice.

But you’re probably paying for nothing more than a sales job.

I’ve seen one decent argument for paying an investment professional. And it is this: a good investment advisor will help you select and/or stick to a good investment strategy that works for your particular situation and risk tolerance.

In most cases, that’s a specious argument. You know what works for most people’s situations? Making as much money as possible. You know how to do that? Stocks. More specifically, low-cost index funds.

Don’t believe me; check it for yourself. Once you have the numbers in hand—including the expense ratio—you can test how a certain amount (say, $10,000) would have fared in various kinds of investments.

Over long periods of time, measured in decades rather than years, you’ll find that there's an edge in favor of value funds, even once you take fees into account. But you may also find that a total stock market index fund reduces your headaches.

You can check this out for yourself. I like to play around on Portfolio Visualizer. But you can gather the data yourself and run the formulas through a spreadsheet, or compare returns vs. expense ratios on different investment options, or however you prefer to analyze the numbers.

But after you do the analysis, you’ll probably wind up agreeing that you’ll want somewhere between 80% and 100% of your portfolio in stocks. You can accomplish this simply and with a minimum of fuss with index funds.

3. Listening to the news.

Whatever investment strategy you choose, let the money ride for as long as you can.

Ignore the noise coming from the evening news; it’s nothing more than entertainment.

People watch the news, get all hot and bothered about whatever’s going on at the moment, and then they take some sort of action based on what they hear.

This is a gigantic mistake.

The news plays on your emotions to keep you watching. But emotions, including both fear and greed, are your worst enemy when it comes to investment decisions.

When the news scares you into selling your positions, that’s almost invariably the worst possible time to sell.

When the news activates your greed by talking about how great the market has been doing, you’re almost invariably approaching the worst possible time to buy.

So just plan out your strategy—a strategy that you can live with, but one that should, frankly, include mostly stocks. And once you’ve figured out what you want to do, stick with it for years and years.

Once you get close to retirement, you should have a sizable pile of money in your investment accounts! My rule of thumb is once you’re within 5 years of retirement, it’s time to take a look at what the stock market is doing.

If it’s been on a long run of sustained success, like the 2010-2020 run, that tends to make most people greedy, and they want to hang on and make even more money. But it should make you nervous. A dip is coming. Maybe it won’t arrive for a couple years, but maybe it’ll arrive next week.

When the stock market has been on a multi-year bull run and everybody’s feeling good about their investment prowess, that’s probably when you should get nervous and roll more of your investments over into a bond index fund.

But if, when you’re 5 years away from retirement, everybody’s panicking about how the market has dropped lately—that’s a good indication that you should stay in stocks a while longer.

Despite the news shaping the general opinion that everything’s going to hell in a handbasket—that's when you can expect that a rebound is just around the corner! Stick it out, and you’ll be rewarded handsomely!

So don’t pay a bunch of money to that financial advisor to convince you not to panic. Toughen up, cupcake! Don’t indulge your tendency to panic.

Instead, research what happened to the stock market in the immediate aftermath of every big, panic-inducing market crash that’s occurred in the past century. 1929. 1962. 1973. 1987. 2000. 2008.

Before you even invest any money—research, learn, and consider. You’ll be much better off for it.

Financial Aphorisms to Remember

An aphorism is a short, punchy, memorable saying. In case your eyes glazed over while reading these 4400 words, you’ll do well to remember these pithy quotes:

1. Save more than you spend.

2. Your mindset matters far more than your income. [Froogal Stoodent]

3. Too many people spend money they haven’t earned, on things they don’t need, to impress people they don’t like. [Anon]

4. It’s not about timing the market; it’s about time in the market. [Anon]

5. Be fearful when others are greedy, and be greedy when others are fearful. [Warren Buffett]

6. A pin lies in wait for every bubble. [Warren Buffett]

7. Learning to separate ‘happiness’ from ‘spending money’ is the quickest and most reliable way to a better life. [Mr. Money Mustache]

8. Investing is the only business I know that when things go on sale, people run out of the store. [Mark Yusko]

9. The smarter side to take in a bidding war is the losing side. [Warren Buffett]

10. The best time to plant a tree was yesterday. The second-best time is today. [Chinese proverb]

11. Risk comes from not knowing what you are doing. [Warren Buffett]

12. In the production of rosy scenarios, Wall Street can hold its own against Washington. [Warren Buffett]

13. The media makes its money from advertising and not from its investment advice. Fear and greed sells. [Charles Boinske]

14. Nobody can help you except you. [Anon]

15. People tend to confuse wants with needs. [Froogal Stoodent]