Why You Should Use Index Funds in Your Retirement Accounts

When I first started learning about investing and retirement accounts, I struggled to determine where I should invest my money.  Thankfully, several great personal finance web sites (including Motley Fool and Bogleheads) agreed that investing in index funds led to the most benefit for most people.  Index funds are mutual funds that track what is called a market index, like the Standard and Poor’s 500, and maintain small slices of companies in proportion to the companies’ share of the index.  For example, if Apple currently makes up 2% of the S&P 500, an S&P 500 index fund would place 2% of its holdings in Apple.

Why is indexing preferred over investing in actively managed funds, where fund managers buy and sell stocks on a frequent basis?  The frequent buying and selling of stocks generates commissions for the fund managers and their companies (this is your money going to pay the fund managers).  Additionally, there are often fees associated with the initial purchase of actively managed funds.  At the end of the day, actively managed funds must increase in value not only to match the gains of index funds, but also to cover actively managed funds’ much higher expenses.

Study after study indicates that index funds outperform actively managed funds:

http://www.cnbc.com/2015/06/26/index-funds-trounce-actively-managed-funds-study.html

http://www.usatoday.com/story/money/personalfinance/2016/03/14/66-fund-managers-cant-match-sp-results/81644182/

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005

I recommend Vanguard Funds (www.vanguard.com) for index funds, as Vanguard’s funds have the lowest expense ratios.  One fund that is highly recommended by many proponents of indexing is Vanguard’s Total Stock Market Index Fund (VTSAX), which has an extremely low expense ratio of 0.05%.  In comparison, many actively managed funds have expense ratios of over 1.00%.  While this extra percentage point may not seem like a lot, when compounded over time, this extra 1.00% may result in you paying fund managers tens of thousands, if not hundreds of thousands, of dollars that could have been used to grow your retirement nest egg.

 

Great Personal Finance Podcasts

One of my favorite things to do on long drives is listen to personal finance podcasts.  There are a handful that I have found (so far) to be better than the rest:

My favorite podcast is Afford Anything with host Paula Pant, as she combines an entertaining delivery with great guest speakers.  Paula encourages listeners to both increase their incomes while decreasing their expenses (increasing the “gap”).  Her focus on increasing income differentiates her from many, many other personal finance bloggers who put a great focus on limiting expenses and frugality.  I certainly think both are important, but Paula’s focus on making the gap bigger blows past the flawed binary view on many blogs that we should focus on either increasing income or reducing expenses, but not both.  Paula provides a ton of insight, too, into real estate investing.  I definitely, definitely recommend the Afford Anything podcast.

The Mad Fientist podcast focuses on reaching financial independence.  The Mad Fientist provides some original (to me) ideas:  How to use a health savings account (HSA) as a “super IRA” account; how to minimize taxes when investing in retirement accounts.

The Dave Ramsey Show podcast is targeted more toward people trying to get their financial house in order, but it is still very motivational.  Dave Ramsey releases three hours of the show every weekday, so there’s plenty to listen to.  My favorite segments are Dave’s millionaire theme hours, where millionaires are interviewed and insights are provided into their spending, saving, and investing habits.

Financial Peace With the Prince of Peace

My favorite mantra delivered by Dave Ramsey is the one that he uses to end his radio show:

The only way to true financial peace is to walk daily with the Prince of Peace.

Our lives should be focused on primarily serving our Lord, our comfort and our King.  Today’s morning prayer from the Liturgy of the Hours speaks of the peace the Lord provides:

Alone with none but thee, my God,
I journey on my way.
What need I fear, when thou art near,
O King of night and day?
More safe am I within thy hand,
Than if a host did round me stand.

My destined time is fixed by thee,
And death doth know his hour.
Did warriors strong around me throng,
They could not stay his power;
No walls of stone can man defend
When thou thy messenger dost send.

My life I yield to thy decree,
And bow to thy control
In peaceful calm, for from thine arm
No power can wrest my soul.
Could earthly omens e’er appal
A man that heeds the heavenly call!

The child of God can fear no ill,
His chosen dread no foe;
We leave our fate with thee, and wait
Thy bidding when to go.
‘Tis not from chance our comfort springs,
Thou art our trust, O King of kings.

As we seek to improve our financial lives, let us always remember to first find peace in the Prince of Peace!

Measuring Progress – Tracking Net Worth

As we budget, save, grow our income, and practice self-control in spending, it’s important to have a method for tracking progress.  After all, if we are indeed working to improve our financial lives, shouldn’t we have a way to measure our improvement (or regression)?

I have a coworker who has turned into a terrific friend and we’ll often talk personal finance in our downtime.  He shared with me his primary method for tracking progress in his financial life:  Tracking net worth.  This was definitely a “light bulb” moment and something I started doing (in November 2012) after we had the discussion.

In summary, you list your assets, list your liabilities, and take the difference, which gives you your net worth.  I calculate (actually Microsoft Excel calculates) my net worth every month and this lets me see how I’m doing financially.  Increasing the value of my assets or decreasing debts will send my net worth in the right direction.  Alternatively, keeping monthly tabs on my net worth lets me see where I might be slipping and hurting my net worth, giving me the chance to correct bad habits.

The following is the Excel spreadsheet I use to track my net worth:

Net Worth Spreadsheet

Net Worth Spreadsheet

If you would like to download this spreadsheet, click here.  The spreadsheet includes some simple formulas, including what percentage each asset comprises of each asset category.  Columns F, G, and H detail my net worth history and columns J through P detail what comprises the net worth value.

Categorizing your assets and liabilities can turn into an exercise, as you’ll need to consider whether certain items are assets, liabilities, or both.  For example, you could list your home’s equity as an asset, but you’ll also want to list your mortgage as a liability due to it being a debt owed to the bank.

As you keep track of your net worth, I think you’ll find a sense of accomplishment if you’re growing your net worth.  This will provide added motivation to steer your financial ship properly.  If you’re going in the wrong direction, use this as a tool to help identify what’s driving your loss and what you can do to fix it.  Good luck!

The Debt Snowball

One of my favorite concepts from Dave Ramsey’s Financial Peace University (FPU) is the debt snowball.  The debt snowball is the second of Dave’s baby steps to financial peace and is a technique for paying off debt that pays off the smallest debt first, the next smallest debt next, and so forth.

The debt snowball starts with you listing all of your debts.  You then pay the minimum on all your debts except for the smallest debt.  With the smallest debt, you pour all of your excess cash to paying it off.  An example:  If you have a $40,000 student loan, a $2,500 credit card bill, and a $15,000 outstanding balance on a new car, the debt snowball technique has you pay the $2,500 bill first, the $15,000 bill second, and the $40,000 last.  While you’re paying the $2,500 credit card bill, you continue making minimum payments on the two other debts.  The end result is that you pay off the smallest debt quickly.

You may have noticed that I made no mention of considering interest rates when determining which debt to pay first.  From a mathematical perspective, it certainly makes more sense to pay off debt with the highest interest first.  Dave Ramsey teaches, though, that if personal finance was strictly a mathematical issue, hardly anyone would be in debt.  On the other hand, Dave recognizes that personal finance has a large behavioral and psychological component to it.  By paying off the smallest debt first, you receive a psychological victory that rewards your discipline.  Having achieved this small victory, you’re then more likely to stick to your debt reduction plan.  You then focus on the second debt and gaining another psychological victory.

 

Happy Independence Day!

I wish you, your family, and your friends a happy Independence Day!  Let freedom ring!

Happy Easter!

Happy Easter!  I pray that you enjoy this joyous day with family and friends.  Christ the Lord is risen today!

Tithing in the Catholic Church

This year’s Corpus Christi Sunday’s readings got me to wondering about the Church’s stance on tithing.  From the first reading, Genesis 14:18-20:

In those days, Melchizedek, king of Salem, brought out bread and wine,
and being a priest of God Most High,
he blessed Abram with these words:
“Blessed be Abram by God Most High,
the creator of heaven and earth;
and blessed be God Most High,
who delivered your foes into your hand.”
Then Abram gave him a tenth of everything.

So, since Genesis makes a reference to “a tenth of everything” and common knowledge regarding Christians and financial giving says to give ten percent of our income, Catholics must interpret “tithing” as giving ten percent to the Church, right?  Maybe not.  Let’s dig a little more.

The Catechism of the Catholic Church

As Catholics, we don’t believe in Sola Scriptura.  That is, we don’t believe in the notion that the Bible can stand on its own as the sole source of knowledge for the Christian life.  We must supplement scripture with the teachings of the Magisterium, including the Catechism.

Paragraph 2447 of the Catechism makes it clear that we are called to commit works of mercy, including giving alms to the poor:

The works of mercy are charitable actions by which we come to the aid of our neighbor in his spiritual and bodily necessities. Instructing, advising, consoling, comforting are spiritual works of mercy, as are forgiving and bearing wrongs patiently. The corporal works of mercy consist especially in feeding the hungry, sheltering the homeless, clothing the naked, visiting the sick and imprisoned, and burying the dead. Among all these, giving alms to the poor is one of the chief witnesses to fraternal charity: it is also a work of justice pleasing to God:  He who has two coats, let him share with him who has none and he who has food must do likewise. But give for alms those things which are within; and behold, everything is clean for you. If a brother or sister is ill-clad and in lack of daily food, and one of you says to them, “Go in peace, be warmed and filled,” without giving them the things needed for the body, what does it profit?

Though this passage does not give a specific percentage regarding how much we are to give financially, we see that giving alms is “one of the chief witnesses to fraternal charity.”

Scriptural References

1 Corinthians 16:1-2 provides further clarity:

Now in regard to the collection for the holy ones, you also should do as I ordered the churches of Galatia.  On the first day of the week each of you should set aside and save whatever one can afford, so that collections will not be going on when I come.

What’s interesting here is that no hard and fast number is given regarding the amount an individual should tithe.  Rather, the phrase “whatever one can afford” is used in order to provide room for personal discretion.  From 2 Corinthians 9:5-8:

So I thought it necessary to encourage the brothers to go on ahead to you and arrange in advance for your promised gift, so that in this way it might be ready as a bountiful gift and not as an exaction.  Consider this:  whoever sows sparingly will also reap sparingly, and whoever sows bountifully will also reap bountifully.  Each must do as already determined, without sadness or compulsion, for God loves a cheerful giver.  Moreover, God is able to make every grace abundant for you, so that in all things, always having all you need, you may have an abundance for every good work.

This passage encourages cheerful and free giving, not forced withholding.  Just as God loves us freely, we have free will to decide the degree of love we give him and his people.  God promises that the more we love (i.e., sow), the more we will reap in the long run.

Book Review: The Millionaire Next Door

The Millionaire Next Door by Thomas Stanley and William Danko provides profiles of several millionaires’, their lifestyles, and the financial decisions these individuals make.  The authors divide the book into chapters based on factors that allowed these millionaires to achieve financial independence.

My favorite advice from the book is:  “You will never achieve financial independence without acquiring assets that appreciate without realized income.”  Simply put, this can be interpreted as “let your money work for you.”  I find this philosophy especially interesting as I didn’t learn this concept until recently, while the wealthy teach their children this concept from an early age.  Now that I’ve learned this concept, one of my focuses financially is that of acquiring assets that generate passive income.  So far, my passive income is generated by equity investments, bond investments, and cash in savings accounts.  I would eventually like to enter the rental real estate market and use it as a source for passive income.

The Millionaire Next Door makes another point that resonates with me:  The wealthy spend more time managing their finances than do the less wealthy.  This time usually includes a very methodical approach to spending and saving.  A coworker once told me, “Why do we work so hard for 40 hours (or more) a week, but spend so little time managing the money we earn in those 40 hours?”  The wealthy understand that achieving the goal of financial independence requires meticulous planning and discipline in spending and saving.

Of the personal finance books I’ve read, this is by far my favorite.  I definitely recommend the book and also recommend it as good financial reading for students.

Cash Flow Planning – Step by Step

I previously posted an article regarding cash flow planning and noticed that a lot of the visitors coming to this site are viewing this article.  I decided to create a more thorough walk through of creating your own cash flow planning Microsoft Excel spreadsheet.  Having learned to cash flow plan through Dave Ramsey’s Financial Peace University (FPU), I use my cash flow plan on a weekly basis, but I remember that I had plenty of questions when I first learned the concept.

Of course, if you’d prefer to just download my already-prepared spreadsheet rather than create your own, you can download it here:  Cash Flow Plan

Creating a Cash Flow Plan Spreadsheet

  1. Open Microsoft Excel.  I’m using Microsoft Excel 2010, but any version of Excel will suffice, as we’re not using any of the advanced features.
  2. In cell G1, enter your monthly net income.  In my spreadsheet, I’ve entered $2,878.59, which equates roughly to an annual salary of $42,979.61, the average wage of a U.S. worker in 2011 according to the Social Security Adminstration.Add Net Monthly Income
  3. In cell A2, type Category. This column will be filled with categories where you will allocate money (for example, savings, housing, etc.).
  4. In cell B2, type Description. This column will be filled with the descriptions of items where you plan to spend your money (for example, rent, renter’s insurance, mortgage, etc.).
  5. In cell C2, type Sub Total.  This column will list the amount spend per each item listed in the description column.
  6. In cell D2, type Total.  This column will include the total amount allocated for a category.
  7. In cell E2, type % Net.  This column will contain calculations indicating how much of your net pay will be allocated per category.
  8. In cell F2, type Actually Spent.  This column will indicate how much you actually spent per item and will allow you to see where you underspend and overspend.  Your spreadsheet should now look like this:2
  9. The next step is to consider major categories that your spending falls into.  Examples might be charity, saving, housing, etc.  Enter your first category in cell A3.  Enter your next category in cell A6.  Then enter all other categories, giving yourself a couple of cells of cushion for each.  The spacing isn’t critical here, as you can simply cut and paste later in order to give yourself more room.  Here is what my spreadsheet now looks like:Categories
  10. You’ll now want to fill in each spending item in column B.  For example, under the Charity category, you may list Church, Catholic Radio, Franciscan Friars of the Renewal, or any of your favorite charities.  Go through each category with the intention that all of your spending is classified (i.e., every penny you spend should fall under a category and sub-category).  Here is what my spreadsheet now looks like:Spending Items
  11. Your next task is to determine how much to allocate for each item.  Certain items are easy to place a number on, like rent, mortgage, and your cable bill.  These bills are the same each month.  Other items will be more difficult to come up with, as they fluctuate on a monthly basis.  After tracking your spending for a few months, you’ll develop a better idea of how much you spend on these items.  You can then update your spreadsheet accordingly.  Here is my updated spreadsheet:Items with Amounts
  12. In cell D57, type the following:  =SUM(C4:C54)  This will provide a sum of all of the values in column C and will tell you how much you’ve allocated.  This should match cell G1.
  13. (Optional)  I consider this step optional, but I like to do this so that I can see what proportion of my money I spend on each category.  In cell E8, type =(SUM(C4:C7)/G1)  This will tell you what percentage of your net monthly pay you have allocated toward the Charity category.  If you aim at a 10% figure for tithing, this tells you that you need to allocate more for charity.  Do this for each category of spending.  My updated spreadsheet:Percentages
  14. Next, we’ll want to enter formulas for calculating how much you *actually* spent.  In cell F8, type =SUM(F4:F7)  At the end of the month, after you go line by line in your cash flow plan and enter how much you have to your diocese, your parish, and so on, cell F8 will tell you how much you actually gave to charity.  Do this for each category in your spreadsheet.
  15. Finally, add up how much you actually spent for the entire month.  In cell F56, type =SUM(F8,F14,F18,F24,F28,F36,F40,F43,F49,F53)  Note that the cells in this formula are the summations of each category.  If you added an item or took an item away, you’ll need to adjust your formula accordingly.  My finished cash flow plan looks like this:8

Your cash flow plan will be a work in progress, especially for the first few months that you practice using it.  You’ll find categories to add, items to add, and things to rename.  Good luck!