The 6 Steps That Took Me From Debt To Heft In One Year
During my senior year of college I got it in my head that I wasn’t going to work until I was 60. I had somehow run across the FIRE movement (Financial Independence/Retire Early) and I was hooked. I was drawn in by the freedom this lifestyle espoused — freedom from a paycheck, freedom to pursue my interests without the necessity to extract money from them.
The three most harmful addictions are heroin, carbohydrates, and a monthly salary.
— Nassim Taleb
When I graduated I moved across the country to start my first job. Being a recent graduate I was not fully aware of how useless I was. I had an inkling, sure, but I didn’t truly understand the depth of my uselessness until I started living alone.
There are tons of examples.
I’d never done my own taxes. Both in high school and college I just plopped my W-2 form on my dad’s desk and he took care of it.
When I bought my first car during college, my parents just added me to their insurance.
I had friends who were helping support their families in college. My girlfriend paid her way through college by herself. To this day I have no idea what my university’s “Pay Tuition” page looks like.
The list goes on and on, but the point is that I had it good. There were few intrusions from the “real world” into my life.
The first clue that things wouldn’t always be like this was the email letting me know I owed $30,000 in student loans. The second was when I went to look at an apartment at 8 in the morning, deciding to take it, and finding out it was already taken when I called at 3.
Yet over the past year I’ve gone from owing $30,000 to having $78,000. A big part of this is due to my salary. I’m lucky to work in a field — computer science — with above average salaries (if you’re still deciding what to study don’t forget that what and where you study is an important financial decision!).
But there are things I learned that can be helpful for anyone looking to build wealth, especially those clueless ones like me, out there in the world pretending to be adults.
Here are the 6 things I’ve done over the past year that have made the biggest difference:
1. How much am I spending?
The factor that best represents your financial health is your savings rate. In fact, your savings rate directly determines how long it will take you to retire. If you manage to save half your paycheck, you can retire in 17 years, less than half of the typical 45+ year slog.
Savings Rate = (Income — Expenses) / Income
I didn’t make an explicit budget for myself since I’ve never been one to spend much. My main expenses were rent and groceries. At the end of each month, though, I tracked all my expenses in a spreadsheet and calculated my savings rate. I found my savings rate was about 80% and that was good enough for me.
2. Begone Navient, I know who you serve
The first step in getting my finances in order was to get out of debt. Navient was really sweet. They told me I could get on one of their 25-year repayment plans and just make low monthly payments until we were all squared away. But I know the devil. His name is Debt and Navient is just one of his faithful followers. So I said “No, thank you” and spent those first few months paying off the loan.
3. Get your hand out of my pocket, Uncle Sam
While I let the Devil sneak up on me, I was able to anticipate the attack of another well-known money grabber. He puts on a friendly face, but he’ll snatch every dollar he can get his hands on. His name is Uncle Sam and he “wants YOU” to give him all your money.
By the second week at my new job, I was enrolled in my company’s 401k plan and had set up automatic contributions.
401k’s are a benefit companies offer to their employees to help keep Uncle Sam at bay by lowering your taxable income. So if your salary is $50,000 and contribute $5,000 to your 401k, then you pay taxes on $45,000 rather than the full $50,000. Another benefit of 401k’s is that companies usually make some sort of matching contribution. For example, your company might match the first $2,000 you put in the 401k — contribute $2,000 and get an extra $2,000 from your company for free.
The downsides to the 401k are that you can’t access this money until you’re 59 (it’s meant to promote saving for retirement) and that you can only contribute up to $18,500 a year (matching contributions from your company don’t count towards this limit — if you put in $18,500 and your company adds in $2,000, then your 401k will have $20,500 in it, but your taxable income will only be reduced by $18,500).
I set my monthly automatic contribution at $1,542 to reach the annual limit of $18,500 and moved on.
4. Index funds coming in hot
At this point I had paid off my student debt and was doing what I could to keep Uncle Sam’s paws out of my pocket.
What else could I do to push up my retirement date? Invest.
The word “invest” makes me think of The Wolf of Wall Street and, subsequently, cocaine, instant riches, and Lamborghinis. Turns out I’m not the only one.
Around this time most of my friends were using an app called Robinhood to invest their hard-earned dollars.
“It’s amazing! You can buy and sell stocks for free!”
Can rarely means should, however, and Robinhood is no exception. I recently talked to a friend who has used Robinhood to turn his $5,000 investment into $4,000 — a 20% loss during a great economic period where the market has increased about 17%.
Fortunately, by this time I had already been introduced to the magic of index funds and I was able to resist Robinhood’s sweet siren song. I opened an account at Vanguard and started making monthly investments into VTSAX.
I’ve talked about index funds plenty of times before, so I won’t do it again here, but here’s what I wrote on index funds.
5. Oh, right, I need health insurance
It turns out that, surprise, you need health insurance.
Healthcare in the US is weird. There are specific yearly periods when you’re able to enroll in a health insurance plan. Miss the deadline and you’re out of luck.
When I started my job I had over a month to enroll in a health plan, which of course I procrastinated on and ended up missing the deadline.
When enrollment opened again I looked through my options and ended up choosing an HSA (Health Savings Account). HSA’s are paired with a high-deductible health plan (HDHP) and, like 401k’s, let you reduce your taxable income.
High-deductible health plan are plans with, well, a high deductible. In my case it means that my first $1,500 of medical expenses every year come out of my pocket — my insurance covers nothing until I’ve paid my deductible of $1,500 [though they cover some “preventative” care — they covered the blood work I did to check my cholesterol, for example].
HDHPs work well for people who are healthy (knock on wood) and don’t generally spend much in medical expenses every year. They’re much cheaper than full-fledged health plans and come with the benefit of an HSA.
The annual limit for an HSA is $3,450 so every month I contribute $295 to my HSA to reach the annual limit, along with the $27 fee for my HDHP.
What’s also useful is that you’re allowed to use your HSA as another investment account — it’ll come as no surprise that I use my HSA to invest in a low-cost index fund (SPTM). However, this HSA money cannot be touched until I’m 65 (it can be used to pay for medical expenses, though).
J.L. Collins gives a great breakdown on HSA’s explaining why they’re so useful.
6. Get your hand out of my pocket, Uncle Sam, part 2
I was now in a comfortable spot — debt-free, saving, and investing. But looking through my options I found one more way to stymie Uncle Sam — opening a Roth IRA.
The Roth IRA (Individual Retirement Account) allows you to contribute up to $5,500 every year (depending on your income). Unlike the 401k and the HSA, the Roth IRA doesn’t lower your taxable income. However, once you turn 59 you can start making withdrawals from your Roth IRA tax-free. You can also withdraw your contributions to your Roth IRA at any time (withdrawing money from your 401k or HSA before you turn 59 comes with a hefty 10% penalty.)
In a normal investing account you don’t get to reduce your taxable income (like the Roth IRA) and you get taxed on your withdrawal (if you pull out $5,000 from your normal investing account, you’ve increased your taxable income by $5,000)
Last month I opened up a Roth IRA with Vanguard and invested my contribution in VTSMX (you guessed it — another low-cost index fund).
- One step at time: This past year has been an iterative process when it comes to money. I didn’t get everything set up at once — I missed deadlines and procrastinated. Yet by doing ONE easy thing per month (pay off debt, enroll in 401k, start investing, etc.) I made sure to make constant progress. Avoid the deer in the headlights panic. The worst thing to do is to get overwhelmed with all there is to do and not make progress because of all there is to do. One bite at a time.
- Put your hands where I can see them, Uncle Sam: You need to reduce your taxes as much as possible. Enroll in the 401k at your job if it’s offered (look into whether your company offers matching contributions. And set up automatic contributions!). Use an HSA as your insurance plan if your job offers it. Look into opening an IRA (which unlike the Roth IRA does reduce your taxable income) or a Roth IRA.
- Keep it simple: I don’t have to do much every month. Part of my paycheck is automatically deducted and goes straight into my 401k and my HSA. And in the first week of the month, I put some money into VTSAX. The rest goes into my checking account to pay for my monthly expenses. That’s it. Use low-cost index funds (don’t try to pick stocks!) and slowly grow your money, stress-free.
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