A step-by-step guide of how to completely automate your finances
 
 Summary:

• Keep 2 months run-rate savings in your checking account and 4 months in your savings account
• Automatically contribute to your 401(k) with each paycheck and at minimum contribute how much your employer matches (if any)
• Setup automatic wire-transfer to Wealthfront (or another automated investor) for at least 25%+ of your bi-weekly paycheck
• Put all recurring bills on auto-bill pay and on your credit card if possible
• Always max out ($5,500 for 2016 ) your Roth IRA or IRA contributions at the beginning of every year

​Managing your finances doesn’t have to be hard. And research has actually proven that by automating your finances, you are more likely to save more and stick to it. 

Given this research and a desire to simplify as much as possible, I’ve designed (with much tweaking) a very simple and easy to maintain personal finance automation system. The system (as I’ve outlined below) is really focused on making it as simple as possible to maintain while still following what academic research tells us is the best way to save and invest.

So let’s take a look at the design and we’ll review each component after. 

Note: To keep it simple, I’m not including taxes in the design but they don’t have much effect in terms of the actual logistics.
 
Below I've provided some additional nuances for each section:

1. Salary: Link your checking account to your company. To ease the maintenance of your account, I recommend only linking a single checking account to reduce the number of different accounts that you have to check.


2. 401(k): Most employers offer 401(k) plans and some employers offer 401(k) matching. If your company offers matching on a 401(k) plan, you should always contribute the maximum of your employers matching. For example if your employer offers matching on a 1 : 1 basis up to 3% of your salary, always contribute at least 3% so you aren’t missing out on that additional compensation!


3. Checking Account: I recommend having your checking account with a credit union vs a bank, mainly because credit unions are not-for-profit and typically have better customer service and rates and fees. I personal recommend Alliant but in most areas there are great local credit unions as well.   

As noted in the diagram, I recommend always keeping 2 months reserve in your checking account. Having this reserve will help ensure that you never have an overdraft and will bring you a significant amount of peace of mind when random expenses pop up.


4. Automated Investing:  If you’re unfamiliar with what automated investing is you should make sure to read my other post ‘How do I actually invest’. In short, automated investing is where a software takes your personal risk tolerance (based off questions you answer) and builds you a diversified investment portfolio based of that risk tolerance and maintains it for you as well. I personally prefer Wealthfront (you can get your first $15,000 managed free by using this code), but there are a number of other great provides such as Betterment and Vanguard Personal Advisors.  

Once you’ve selected your automated investor, you can setup an automatic transfer between your checking and the firm. At a minimum you should be transferring at least 25% of your paycheck each month into the automated investing account. If you can invest more, do it! The benefit of automated investing is that you can basically set it and forget it and it will keep growing for years and decades to come.
 

5. Credit Card: All too often you hear about people having 10+ cards and getting all sorts of deals and discounts because of those cards. However, having a lot of cards is very difficult to manage and often results in missed payments and rarely provides much additional benefit. I recommend only having 2 credit cards. With 2 cards you can have one primary card for most of your purchases and use the other in unique instances where the rewards are higher than your primary one. I'd recommend the Chase Freedom Unlimited and the Discover It Cashback Match as a good primary card. The biggest thing to remember though about credit cards is to always ALWAYS pay your bills in full every pay period, no amount of rewards points will make up for the high interest rate they charge you! 

Once you have your primary credit card you should link auto-bill pay to it from all of your recurring charges, such as gyms, power and gas, and cable and internet packages bills. This way you never have to worry about missing a payment and you earn cashback and rewards by using your credit card.
 

6. Savings Account: As I mentioned in the checking account section, I really recommend doing your banking through a credit union, preferably through the same credit union as your checking account so you can transfer very quickly in between them when needed. You should always try to keep at least 4 months spending (not much more though!) in your savings account so you are able to pay for any unforeseen expenses but still earn a small return on your savings.  

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7. Roth IRA: Depending on your income you may not be able to contribute to a Roth IRA, but if you’re able to, you certainly should. Roth IRA’s are not taxed when you put money into them and are only taxed when you take money out. No matter if you have a Roth IRA or just a general IRA, I always recommend maxing out your contributions to lower your tax bill. For 2016, you could contribute $5,550 if you’re under 50 and $6,500 if you’re 50 or older. I recommend maxing out your IRA with one deposit at the beginning of every year so you don’t have to think about it again until the next year!

A look at the logistics of portfolio management
 
(This is the third part in a three part article series designed to bring anyone up-to-speed on how to invest)
 
Summary:

• Good investing is not sexy, it’s boring
• If you’re managing your own money, only trade to harvest taxes or rebalance your portfolio
• Don’t every pay more than a 0.30% fee for an investment advisor
• Only look for investment advisors that passively invest and “match the market return”
• If you’re the type of person who doesn’t need to interact with a person, invest in a software based advisor like Wealthfront or Betterment
• If you need human interaction, sign-up for Personal Capital, Vanguard Advisor, or LearnVest

​For every personal investor, there are two ways to go about investing – you can either manager your own portfolio or you can let someone else manage it for you. I’m not here to advocate (too much at least!) for either position. That decision is entirely up to you and will vary by person. I’m here to help you make the smartest decision for whatever choice you make and ensure you are investing wisely. So let’s take a look at both options and go over the best choices for either one. 

There are a wide variety of investment advisors out there. If you’ve ever looked around trying to find one, you’ll likely have noticed that most of them claim to better safeguard and grow your investments more than the other guys. They’ll tell you about their historical returns, their, personal touch and their investment experience. However, as you hopefully remember from my article, academic research has concluded that investors are very very rarely able to beat the market on a repeatable basis and are better off just tracking the market.
 
With that in mind, there are really only three areas you should evaluate investment advisors:

• Passive investing strategy
• Costs
• Relationship

 
Passive Investing Strategy
This is a simple one. You just need to ensure that the investment advisor is not actively trying to beat the market and passively investing by tracking the market. If the investment advisor is an ‘active’ investor, he will likely try to convince you that the only way to earn a good return is by trying to beat the market and may be even be able to provide some statistics. The key though is to continuously go back to the fact that the smartest investors in the world (Warren Buffett, John Bogle, and Nobel Laurates) have proved and believe that passive investing is the absolute best investing strategy.
 
Costs
The cost of an investment advisor cost should be very easy to determine (if it’s not, don’t even think about investing with them). Almost all are a percentage fee of the assets under management. Take for example, if you have $100,000 invested with an investment advisor with a 1.00% management fee, they would take $1,000 of your money regardless of whether your investment went up or down.
​

To give you another example, let’s suppose you can invest $100,000 for 40 years with three different advisors each with the same 6% return and the only difference is their management fees, see Figure 1. If you chose to invest in the 0.15% expense ratio fund, you would end up with ~$197k more than if you invested in the 0.75% expense ratio fund and ~$270k more than if you invested in the 1.00% fund. That means purely by picking an advisor with a low management fee you will end up with 25% to 40% more money. ​

Sadly, our brains aren’t naturally hardwired to think that these small percentage point differences will actually make that large of a difference. To counteract this natural tendency, you need to train your brain to think about these percentage point differences as huge ‘canyon wide’ gaps that could save you thousands of dollars in the long run.
 
Investment advisors are inherently costly and I would personally not recommend the vast majority of advisors just because of the cost. However, there is a relatively new entrant into the investment advisory space – software that automatically invests using a passive investing strategy for very low management fees (typically in the range of 0.15% to 0.25%). Besides, the cost there are a number of other benefits of software based investing, such as daily automatic tax loss harvesting, automatic portfolio rebalancing, and risk tolerance adjustments. Some great software based investment advisors today are Wealthfront (get your first $15,000 managed free by using this link) and Betterment.
 
Relationship
One of the biggest benefits that investments advisors offer is a personal relationship with an educated (hopefully) investment professional. The benefit of this relationship will vary significantly across different people and really depends on your own personal traits. For instances, when the market declines a significant amount (which is an inevitable risk of investing), you may be a person that would benefit from having a live person to talk to and reduce your worry. If you know that you are the type of person that has difficulty stomaching these risks of investing, you may want to look into a more personal relationship investment advisor such as Vanguard Personal Advisor.
 
I’ve compiled a list of my recommended brokerage firms and investment advisors below:
 
Software Based

• Wealthfront (get your first $15,000 managed free by using this link)
• Betterment

Personal Relationship

• Vanguard Personal Advisor
• Personal Capital
• LearnVest

​For the vast majority of personal investors, I would recommend investing through a software based investment advisor such as Wealthfront or Betterment. With their low cost and automatic investing strategy, there are few other options available that can beat the after-tax return of these platforms. Now if you are very interested in investing yourself, all the more power to you - just remember that good investing should not be sexy, it is very boring and only requires constant attention related to tax loss harvesting and portfolio rebalancing. 

When thinking about how to best invest your money, there’s three main concepts to understand and consider:

• Diversification

• Passive investing
• Risk tolerance

 
Each of these concepts builds upon each other and by the last one you’ll have the best portfolio mix possible for your current life situation.
 
Diversification
​
One of the biggest underlying principle with investing (and basically all of finance) is the concept of diversification. In its simplest form, diversification is investing in a wide variety of assets to reduce your risk. Most people don’t understand the incredible amount of risk they are taking on when they invest in a single or only a few stocks – a single event could cause them to lose all of their savings!
 
So the idea of diversification is that by holding a large number of investments, you reduce your exposure (and thus risk) to a single investment which can be easily adversely affected by unpredictable events such as natural disasters, executive departures, and regulations. There is a huge body of academic research that has been done to determine the optimal level of stock diversification and most settle in the area of 30 stocks.

The next question you’re hopefully asking yourself is – how does diversification affect my return? And lucky, research has also shown that a diversified portfolio will actually have a higher expected return than a non-diversified portfolio when taking on the same amount of risk. In the rare case that you’re still skeptical of diversifications benefits – Harry Markowitz published Portfolio Selection (which championed the benefits of diversification) in 1952 and later won him the Nobel Memorial Prize in 1990.
 
Passive Investing
 
There are two types of investors: active and passive. Active investors are trying to actively beat the market, which you can think of as the S&P 500, and passive investors are purely tracking the market and matching its performance. And academics for the past half-century have been studying the return performance of actively managed funds (hedge funds, mutual funds, etc.) and has determined time and time again that almost no one is able to actively beat the market on a repeatable basis. Additionally, when you take into account the fees these active investors charge, typically upwards of 1-2%, an even smaller number is able to outperform the market after fees.

​With all these facts in mind, the best way for an individual to invest is to do so passively and the best way to invest passively is to do so with Exchanged Traded Funds (ETF). An ETF’s sole designed purpose is to track, and track very closely, indexes like the S&P 500 and almost any other index you want. The biggest benefit of ETFs over other investment vehicles, like mutual funds, is that they typically have very low expense ratios in the realm of 0.04% - 0.30%. As you can see below, the returns of a $10,000 investment with a 6% return and two different expense ratios, a high expense ratio will significantly lower your returns over the long run.  

Risk Tolerance
 
The last major concept to understand is risk and, lucky, the basic concept for risk is fairly easy to understand as a trade-off between risk and return. 

When people talk about risk they are referring to the variability of your return both upwards and downwards. So when people say they are taking on more risk, they mean there is more uncertainty with whether their investment will go up or down. In the personal finance world, this means more risk generally means more stocks and less risk means more bonds. Therefore when you are determining your risk tolerance, you’re essentially determining what percent of stocks and bonds you want in your investment portfolio.

So the next step is determining your personal risk tolerance, in other words, your willingness to have variability in return, both up and down. For instances, if you are in your mid-20s you will likely have a larger risk tolerance because you don’t need to access that money anytime soon – so a 30% down swing will be a little easier to digest. However, if you are in your 60’s and you need to access that money soon (retirement, medical expense, etc.), you can’t tolerate those large swings. Risk tolerance isn’t standard by age though either, it will depend greatly your own individual circumstance. To get an idea of your own risk tolerance answer these 3 questions.

Based off your answers above, determine what risk tolerance bucket you fall into below (obviously you may not fall exactly into one bucket, but pick whichever one feels closest):
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A critical look at the benefits and risks of investing
 
(This is the first part in a three part article series designed to bring anyone up-to-speed on how to start investing)
 
Summary:

• Let your money help you generate more money by investing it
• Compounding interest is the most powerful tool to grow your money
• Investing is risky but there are ways to make it less risky

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The Power of Investing
​
There are only two ways to make money in life:

1. Work for money
2. Have your money generate more money

Let’s take the first one and walk through an illustrative example of a 30 year old person, who we’ll call Jennifer.

• Jennifer has $50,000 in her checking account
• She saves $25,000 a year and expects to save a similar amount going forward
• She wants to retire by the time she’s 60 and expects to spend around $50,000 a year (in line with what she spends today)
• The estimated life expectancy for a female in the US is 79 years old

By the time Jennifer is 60 years old, she will have saved $775,000 – quite an accomplishment and one that would take a significant amount of dedication. However, when you look at her retirement you can see that she quickly depletes that savings as she has no new source of income – and by age 75 she is completely out of savings. Of course this is a drastically simplified example, but it illustrates the main problem of not investing – that you have to work for each and every single dollar that you spend and save. 

So let’s move onto the second way to make money, letting your money generate more money (in other words, investing). And let’s use the same illustrative example of Jennifer as above but have her invest in a portfolio with an average annual return of 5% (a fairly conservative return estimate).

As you can see above, there is a stark difference if Jennifer chooses to invest her money. Not only does she not run out of money but she now has the ability to spend much more during her retirement and still have her savings grow. To understand more about why this difference is so stark, learn about compounding interest.

Returns and Risks

The next logical question you are likely asking yourself (and rightfully should be) is, ‘What evidence is there that my investments will go up overtime and at what rate?’. Unfortunately for us, the only evidence we have available to us is historical data. Fortunately though, we a have significant amount of this historical data dating all the way back to before the 1900’s and there has been significant amounts of academic research using this data. 

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​Above, you can see the annual return of the S&P 500 from 1966 to 2015 was approximately 10%. Just to put that number in perspective, that means if you invested $100 in 1966, let it grow for ~50 years and took it out in 2015 you would have $9,834. So if future returns look anything like these historical returns, you would be wise to start investing now.

However, I certainly don’t want to understate the risks of investing. In the above images, in 2008 the S&P 500 return was -37% which would be a scary experience for any investor. Most of all, there is absolutely no assurance that future performance will look anything like historical performance.

If you’re someone who is looking to mitigate these investment risks as much as possible, there are a number investment strategies that you can still do. The benefit of investing is that you can control (to a certain extent at least) the risks that you take by investing in less risky assets, such as treasury and corporate bonds – which we will explore in further detail in the next article in the series.
 
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Lastly, I want to leave you on a more personal note. If you read all of this and feel overwhelmed with all of the investment terminology or fear losing your hard earned money by investing it, I want you to know that there are many different types of investment products and portfolios out there for you. My sole purpose of writing this is to help you make the smartest personal finance decisions and steer you away from the over-hyped and extremely costly financial products that are likely marketed towards you.

If you read nothing else, read this post.
 
Summary:

• Track all of your expenses
• Live (significantly) below your income level
• Save a minimum of 20% of your after-tax income
• Minimize your fixed expenses
• Pay your credit card balance in full every period
• Never buy or sell an individual stock
• Invest in Exchange Traded Funds (ETFs), primarily through low-cost providers like Vanguard

​If you follow this one rule, you won’t need to follow any others (although I don’t advise that!) to start growing your wealth. When most people think about what they can save, they subtract first subtract out their typical spending amount and come up with a number.

By reversing the equation, you’ll set an upper boundary for your spending which forces you to think more critically about what you are willing to spend money on. Additionally, as seen in Figure 2 when (or if in these days) your income starts to increase do not allow your spending to increase in direct proportion to your raises. In fact, try to achieve a ratio of at least 4 to 1 – meaning for every $4 more you earn in income, you only get to spend $1 more (I call this concept Savings Scaling).   
 
Lastly, and probably most importantly, is the idea of taking pride in being frugal. When most people make more money they feel that not only that they are entitled to a fancier car or luxury item but that these items will bring them more happiness. As a significant amount of research has already proven, this idea has been proven false after reaching a certain minimal level of spending and diminishing returns thereafter. In fact, the only way for a majority of people to become “millionaires” is to adopt a less materialistic lifestyle.

​3.     Minimize the percentage of your spending that falls under fixed expenses, (preferably under 50% of your after-tax income).  ​

​​Now that you have a set upper boundary for your spending, let’s work on getting your expenses to fit inside that amount. And the first place to start is minimizing your fixed expenses to a max of 50% of your income - if it makes up a larger percentage you will find it incredibly hard to hit your savings goal.  

For almost all people, their mortgage or rent is far and away their biggest fixed expense and it is the hardest one to lower. The typical rule that I use with housing expenses is to keep it under 30% of your after-tax income (and don’t forget to include the property taxes on your house). If you’re significantly above 30% I recommend you seriously reconsider your motives in having such an expensive place relative to your income (learn more about the true cost of houses).

For all other fixed expenses, you need to answer the following two questions:

1. Do I really need this on a recurring basis?
2. Am I positive I’m getting the best deal?

 
If you hesitated on either of these questions, make sure to read my post on lowering your fixed expenses.


4.     Always pay your credit card in full every cycle, never (EVER!) let interest accrue

If you are ever in doubt about whether you will be able to pay for something, do not purchase it. There’s nothing more detrimental to wealth creation then high interest rates and bad credit. If you currently have credit card debt, there are a number of steps you can take to get on a path to financial security.
 
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Investing Money

There are two common misconceptions people have when it comes to investing (and sadly both are kept alive by the financial services industry).

People either:

1. Think they’re smart enough to beat “the market”


2. Think they have to pay someone (a lot) to manage their money

Let’s start with the first one and the first rule of investing.

1.     Never trade individual stocks – the person on the other side is more knowledgeable than you.
​​
When most average people go about investing in the stock market they do so with this general mindset – “All I have to do is find the next trend and invest in that company and I’ll make a lot of money”. Although this mindset isn’t necessarily wrong, it’s just nearly impossible to do so on a repeatable basis. Literally tens of hundreds of academic research papers have been published that analyze the historical performance of all types of investors – from elite hedge fund and mutual fund managers to individual investors – and the reports consistently conclude that only a tiny (and I mean tiny) percentage are able to outperform the market on a risk adjusted basis.

To understand why this is the case, it’s helpful to go through an example. Let’s say you’ve recently been reading articles on how 3D printers are going to take over manufacturing and a few friends say they just bought stock in called 3D Systems (DDD). So you decide to invest as well.

Now let’s consider the opposite side of the equation, the person (or more than likely professional investment firm) you’re likely buying the stocks from, let’s call them Ultra-Capital. As with most professional investors, Ultra-Capital has a large staff of analysts whose sole job is to dig through DDD’s public filings, analyze its financial statements, compute its liquidity metrics, monitor its debt solvency, and memorize every little thing about the company. Additionally, Ultra-Capital’s analysts have made hundreds of calls and site visits to DDD’s suppliers, customers, and, employees, asking how their products compare to other companies in the industry. And to top it all off, Ultra-Capital has consulted with two Nobel Laureates in the field of mechanical engineering to explain where they think the 3D printing industry is heading.  

​​Are you sure you want to be on the other side of the trade as Ultra-Capital?
​

2.     Invest in low-cost Exchange traded funds, ones with expense ratios below 0.15%

​There are two types of investors: active and passive. Active investors are trying to actively beat the market, which you can think of as the S&P 500 or Dow Jones indexes, and passive investors are purely tracking the market and matching its performance. As I mentioned above, there’s been hundreds of research papers that show that almost no one is able to actively beat the market on a repeatable basis. Additionally, when you take into account the fees these active investors charge, typically upwards of 1-2%, an even smaller number is able to outperform the market.
​
Given that fact, you should always invest passively and the best way to do so is with an Exchange Traded Fund (ETF). An ETF’s sole designed purpose is to track, and track very closely, indexes like the S&P 500 and almost any other index you want. The biggest benefit of ETFs over other investment vehicles, like mutual funds, is that they typically have very low expense ratios in the realm of 0.04% - 0.30%. As you can see in Figure X showing the returns of a $10,000 investment with a 6% return and two different expense ratios, a high expense ratio will significantly lower your returns over the long run.

​​If you don’t already have an investment account, I recommend signing up for a Vanguard account as it has some of the lowest expense ratio ETFs and you are allowed unlimited trades of Vanguard ETFs. Lastly, if you are looking for the best ETF to start with, I always recommend the Vanguard Total Stock market ETF (VTI) and the Vanguard FTSE All-World ex-US ETF (VEU), which are two broad based ETFs with very low expense ratios. 

Never invest in an equity fund with an expense ratio above 0.15%
 
Summary:

• Always pay attention to expense ratios when selecting a fund
• All else equal, the lower the expense ratio the better the fund
• Small difference in expense ratios will make a massive difference in your savings
• Compare expense ratios across funds at the same asset class level

 
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When selecting a mutual fund or exchange traded fund (ETF) one of the first things you should look at is the expense ratio. In simplest terms, the expense ratio is the percentage of money the fund takes from you every year. Take for example, if you have $100,000 invested in a mutual fund with a 1.00% expense ratio, they would take $1,000 of your money regardless of whether your investment went up or down. 

​​Sadly, our brains aren’t naturally hardwired to think that these small percentage point differences will actually make that large of a difference. The same effect takes place when people are deciding on mortgage interest rates - they don’t realize that by lower their rate by just 0.50% on a $500,000 home loan, they could save $50,000 over 30 years. To counteract this natural tendency, you need to train your brain to think about these percentage point differences as huge ‘canyon wide’ gaps that could save you thousands of dollars in the long run. Now that you understand how important the expense ratio is, let’s get into some specific details.
 
When determining what a good or bad expense ratio is, always compare funds on a relative basis. The basic rule is the more complex and niche the index the higher the expense ratio. For instance, if you’re looking at a broad based US fund, you shouldn’t ever pay more than 0.06%, but if you’re looking at a commodities fund you should be willing to pay a little above 0.50%. The reason there is such a large gap between these two asset classes’ expense ratios stems from the complexity of the asset (US equity is generally less complex to track than commodities) and from the amount of money invested in the fund (the more money in the fund the smaller percent they need to operate and cover their expenses).
 
I’ve compiled a list of the most popular asset classes and the best funds by expense ratio in them.