What Schools Don't Teach You About Money
In this video, I cover 5 things about money I wish we learned in school!
5 things school does not teach you about money
A lot of things I’m covering in this video are pretty specific to living in the US, and maybe you went to a better school than I did and they taught you some of this, but that wasn’t my experience. Apparently, it was super important for me to memorize the quadratic formula but not learn about how to manage finances. So let’s get started.
How much to spend on housing
Rent
According to the US Department of Housing and Urban Development, there were 43.6 million rent-based households in the US, making up 36% or all households.
So, if you’re wondering how much you should be spending on rent, the most common way to get a ballpark figure is by using the 30% rule, which states that your monthly rent payment shouldn’t be more than 30% of your gross monthly income. This does not account for utilities or renters insurance.
So if you’re making $40,000 a year pre-tax, you wouldn’t want to spend more than $1,000 on your monthly rent payment. Now the origins of this rule come from the National Housing Act of 1937. This act created the public housing program for low-income families and established guidelines for maximum rents for them. From 1981 to present, that amount has been 30%.
Now here are some flaws with this rule: It doesn’t account for inflation, income stagnation, or rising rent prices/area affordability. It also doesn’t take into account any debt, your tax situation, or your financial goals.
If you live in areas where there’s a greater disparity in rent prices versus salaries, it can be really difficult to not go over 30%. The average rent in LA is about $2500, up 5% from 2020. To hit the 30% rule, you’d have to make about $100,000 per year. But the median household income in the area is $68,000, highlighting the disparity in average rent versus average income. Ideally, you’d have a roommate or significant other to help pay rent.
But, despite the flaws, this rule gives you a good starting point, and you can get a more accurate number by budgeting, which I’ll cover in a little bit.
Source: TheBalance.com
Mortgage
According to Rocket Mortgage, your total homeownership expenses shouldn’t take up more than 33% of your total monthly budget. And that makes sense – it really shouldn’t differ too much from our rent rule. Just make sure to consider the mortgage terms – maybe you didn’t put 20% down and you have to pay PMI – or private mortgage insurance as an added monthly fee, as well as costs like homeowners insurance and property taxes.
Again, in Los Angeles, the median selling price for single family homes was a whopping $915,000.
If you are fortunate enough to afford a $183,000 down payment, your monthly mortgage costs would be around $4300. To follow the 33% rule, your household will need to earn about $13,000 per month. So uh, yeah, that’s a lot – but it’s important you don’t overextend yourself by buying more than you can truly afford, no matter what amount you get prequalified for.
Debt to Income Ratio, DTI
If you have a debt to income ratio greater than 50%, you will possibly have trouble finding a loan, so find ways to lower your debt or consider renting.
Source: RocketMortgage.com https://www.rocketmortgage.com/learn/how-much-should-i-spend-on-a-house
How to Build Credit
I truly don’t remember hearing anything in school about your credit score or building credit or anything along those lines, but, especially here in the US, having a good credit score can make your life a whole lot easier. And while I think the whole credit score system is horribly flawed, it is the standard here and until they make improvements to it, we’re kind of just stuck with it.
Your credit reports are a reflection of how you've managed debt in the past. The three-digit score—which typically ranges from 300 to 850—assesses the risk you pose as a borrower. The factors that influence a credit score, according to Experian, are
Payment history
Credit utilization
The types of credit accounts you have open
How long you've been using credit
Your debt balances
Bankruptcies
The number and recency of credit accounts you've applied for
Your payment history is one of the most important credit scoring factors and can have the biggest impact on your scores. Having a long history of on-time payments is best for your credit scores, while missing a payment will hurt them. Missing payments like your mortgage or property tax payments – could also wind up with a public record, such as a foreclosure or tax lien. That can also end up on your credit report and can hurt your scores. A payment 90 days past due will hurt more than a payment 30 days past due. And these missed payments will stay on your report for up to 7 years.
I always treat credit cards like debit cards – I’m only spending the money if I actually have it in my checking account, and I’d recommend doing something similar. You’re building your credit by having a credit card in your name and making on-time payments.
If you are young and your parents have a good handle on their finances, they can add you as an authorized user on their credit card account. When you’re added as an authorized user, the account gets added to your credit report along with the account history and details. So as long as your parents have a strong payment history and a low credit utilization rate, this will help your score and allow you to get better credit offers like mortgages, car leases, etc.
That’s what my parents did back in my younger days, so when I check my credit report, we can see I have a credit card account with a 22-year history of on-time payments, which certainly helped when I wanted to get approved for my own credit card.
Credit usage is also an important factor, and it’s one of the few that you may be able to quickly change to improve your credit health. Your utilization rate is the ratio between the total balance you owe and your total credit limit on all your revolving accounts (credit cards and lines of credit). So sometimes, you may check your credit in the middle of the month before you’ve paid off your credit card for the month and you’ll see your credit utilization be on the high side. You also don’t want your utilization rate at 0% either – remember your credit score is all about your ability to borrow money and pay it back on time, so they want to see you responsibly borrow a reasonable amount for your credit limit, and then pay it back. It’s honestly a terrible system, but understanding how it works can make your life a bit easier.
How much to save for retirement
According to study from Fidelity, they concluded that most people will need somewhere between 55% and 80% of their pre-retirement income to maintain their lifestyle in retirement.
They recommend saving at least 15% of your pre-tax income each year, which includes any employer match. That's also assuming you save for retirement from the age of 25 to the age 67. So if you make $40,000 per year, they recommend you save $500 per month to put into retirement. Now saving for retirement isn’t exactly fun – we’re a society programmed to desire immediate gratification and socking away hundreds of dollars every month so that in 30 or 40 years you’ll be all set isn’t an exciting proposition for most people. It’d be more fun to buy some video games, take that vacation, buy that Peloton – but the later in life you start saving for retirement, the higher percentage of your income you’ll need to save to catch up.
If you’re relying on social security or a pension to pay for your retirement, consider this:
From Social Security, the max you can get in 2021 is $3,148 a month while the average is $1,543 a month. It was designed to supplement retirement income, not to be the only source of retirement income. And who knows if social security will even be around when it’s time for people my age to retire.
With pensions, just 31% of Americans have a defined pension plan and the annual benefit is just over $9200 for a private pension. This number bumps up to over $22,000 for federal government pension, but really, it’s not that much.
Now for retirement plans, there are several options.
A 401(k) plan is a tax-advantaged retirement savings plan offered by many employers. The employee who signs up for a 401(k) agrees to have a percentage of each paycheck paid directly into an investment account. The employer may match part or all of that contribution. You don’t pay taxes on the money you contribute or the profits it earns until you withdraw it, usually after retiring.
My last employer offered this program with a match, so in 2017, I maxed out my contributions on every paycheck, which was usually around $171 and then increased to $208 as my pay increased. I only put in $2,308.64 of my own money, but with the employer match and the returns earned from the Vanguard fund it sits in, my $2300 is now over $6600 – so it’s a small sacrifice when you get your paycheck, but it’s well worth it long-term. After I left that job, I rolled the 401(k) over to a Simple IRA plan. Now, let’s quickly cover my favorite retirement plan, the Roth IRA.
With a Roth IRA, you pay tax on your money as usual, but the money grows tax-free. So in retirement when you make withdrawals, you don’t have to pay taxes on it. This plan is best if you think your taxes will be higher in retirement than they are right now. Now, there is a cap on how much you can contribute every year – for instance in 2021, the limit is $6,000 for people under the age of 50. But if you start saving in your 20s and are able to max out your contributions every year, compound interest will go to work and having a Roth IRA account with over one million dollars will be very achievable. There are some other conditions with Roth IRA accounts and this is just a quick overview, so if you want to learn more, I recommend checking out Investopedia – just lookup Roth IRA or 401(k) or whatever – and they’ll break down everything in more detail.
And since I mentioned compound interest, take a look at this graph showing the difference saving an additional 1% of your income can make over time. 1% of a $50,000 salary equates to a $41,000 difference over 30 years… so keep that in mind as you start saving for retirement.
Source: https://www.merrilledge.com/article/how-much-do-you-really-need-to-save-for-retirement
How to Budget
The next thing our school system has failed us with is budgeting. There are several ways you can do it, and it all accomplishes the same goal of helping you identify and control where your money is going: how much you’re spending and how much you’re saving.
The basic idea is to add up your monthly income and your monthly expenses. Ideally, your income is greater than your expenses. If it’s not, you need to find an expense you can lower or eliminate altogether – maybe it’s cutting out eating at restaurants or canceling that gym membership. With any leftover income, create a spot in your budget for savings to allocate the remaining income. If your goal is to buy a house in a couple of years, you can create a downpayment savings line in your budget so that you know how much you’re saving for your future house and you won’t spend that money on splurges or impulses that aren’t as important to you.
One popular budgeting method is the 50/30/20 rule. You start with your monthly, after tax, after retirement contributions, net pay. 50% of that goes to your needs. Housing, food, transportation, utilities, insurance, minimum debt payments, etc.
30% of your income goes to your wants. Maybe that’s Netflix and Spotify subscriptions, travel, entertainment, going out to eat – whatever.
Then, 20% gets allocated to savings and debt. For savings, this might literally be just a savings account at your bank – as an emergency fund – or if that’s already in a good place, you might put a portion into an investment account –like I’ve mentioned before, I have an account with M1 Finance and have automatic deposits of like $300 per month that automatically gets invested in companies and funds that I chose. You also want to pay off debt with this 20% – especially any high-interest debt you may have accrued.
So here’s an example from NerdWallet:
If you earn $2,800 per month after taxes, you’d divvy your paycheck up like so:
$1,400 for needs like rent, utilities, groceries, insurance and minimum debt payments.
$840 for wants like shopping, happy hour and concerts.
$560 for savings and additional debt payments.
There is a lot of budgeting software out there like You Need a Budget and EveryDollar and Mint. I even made a simple budgeting spreadsheet that you can download for free that shows you how much you can save if you budget correctly and invest what you have left into a simple investment account. You can check it out here.
How to Invest (opening a brokerage account, investing in ETFs/index funds/etc.)
Another thing I wish I would’ve learned in school is how to invest my money. There are lots of options when it comes to investing and it really comes down to the individual. You’ll have to decide for yourself your strategy, how involved you want to be, what instruments you want to invest in, etc. The simplest way is to open an individual brokerage account on something like M1 Finance, Webull, TD Ameritrade, or whatever platform you prefer. Then, deposit some money and buy shares of companies you like or funds that have a proven track record of above average returns. I prefer Vanguard ETFs personally. But here’s a quick look at my M1 portfolio– I have VUG which is a growth ETF, VONV which is a value stock ETF, ARK K which focuses on disruptive technology, Apple, Amazon, and ARK G, an ETF that focuses on innovative healthcare companies.
If stocks confuse you, I would recommend keeping things as simple as possible – that’s why I like M1, and no they aren’t a sponsor, but you can look at their “expert pies” based off your goals and simply add it to your portfolio, so it’s a pretty frictionless way to get started. For a little bit more on this, check out this video.
Final Thoughts
Those are 5 crucial aspects to personal finance that I think the US school system has really done us all a disservice by not including in their core curriculum. And of course, this was just a brief overview of all these topics – there is a lot more details and nuance for each one that I didn’t cover, so please continue to learn more about each topic because there’s only so much I could squeeze into this video.