Why nobody taught me personal finance?
Why nobody taught me personal finance?
and why you should learn the basics
This is not financial advice!
Growing up in a modest family in a small town, I never had the impression that finance was something I should care about, my family didn’t have money to spare so it wasn’t part of the conversation. In fact until very recently my definition of “being rich” was to buy groceries without looking at the price.
The first time I became aware of how finance affected my life was, like many millennials, during the financial crisis of 2009-2011, when the concepts of sovereign debts and derivatives trading were the main topic on the news.
Before that, my family's encounters with anything resembling financial services (other than mortgages) were postal savings that were (still are) very popular in Italy as a safe way to store your money. Anyone with any proper knowledge of personal finance would never buy such a product and they do not.
Then I joined a big company and made friends with people that had different interests than me, started learning about this topic, panicked, and ended up spending a lot of time learning the hard way.
I was recently telling this story to some younger colleagues and it became extremely clear that most of them had never thought about this problem at all, and I was not an exception by any means.
Financial illiteracy is necessary for the system to work
My favorite financial writer Matt Levine recently talked about the trouble of small banks in the United States and he masterfully explained how the entire banking system is sustainable only if all of us agree to not think about it:
I put my money in the bank because it is convenient and safe, with the understanding that safe means that if I put 100 bucks in my account today I can take 100 bucks out whenever I want, with no exceptions
My bank lends that money to companies that want to expand, and to people that want to buy houses, within certain constraints
In turn, my bank makes money by charging fees for their services plus the interest payments that they get from lending, investing, credit cards, etc etc
The safety of my money is all in the hand of the financial regulators, like the deposit insurance scheme or the minimum capital requirements
It follows that the system works only if you are happy with the fact that:
your money isn’t really in the bank but is lent to other people for their more or less risky endeavors that will probably pay back with interest (or might lose it all!)
your money is also lent to your government by buying short/long-term bonds that pay interest (that is far superior to the near-zero interest paid to you)
with the rise of digital banking, there is no real difference between any bank unless they fail and your money is lost
Once you look at it this way, why would you keep more money in your account than it is strictly necessary to pay bills and groceries? And so, why the system doesn’t fail?
The system failed for banks like Silicon Valley Bank, First Republic, or Credit Suisse, I will leave it here because there are a lot of nuances to this statement so I will just point you to the mandatory subscription to Matt Levine’s Money Stuff.
And I think that we should all become a little bit more sophisticated with our hard-earned money because nobody out there is looking after us, especially when we grow older.
Financial institutions take advantage of financial illiteracy
The problem isn’t just that your checking account is close to useless, the problem is that financial institutions market products that are legal but senseless:
Let’s say that you have a child and you want to start saving money for them so they can study abroad or buy a car when they are 18 years old.
You go to your bank and you are offered an extraordinary zero-fee saving account for your child, that is great, right? Right?
If your bank is ABN Amro you can see what interest rate they pay on that “special saving account”: 1.25%.
With that money, ABN Amro can immediately buy Dutch Government Bonds and earn money in a super safe way or do something riskier and earn even more money.
So you are subsiding ABN Amro’s top management bonuses for the great honor of using this “free” savings account (you are losing money when accounting for inflation).
This is not something specific to this bank or country, this is common to all banks.
So where do you start?
Now that I convinced you that this problem is essential, you would like to know more about it!
This could be scary at first because there are a lot of big words thrown around and it gets overwhelming very quickly.
I have ranted before about the failings of formal education in the Western world and this topic is no exception, unless you have made specific choices in your life there is no way someone taught any of this.
Luckily the world wide web is full of people smarter than me that filled it with a lot of content we can use.
The most complete resource I can point you to is the wiki page of the r/personalfinance subreddit1
For the sake of making this post readable, I will also badly explain2 a couple of concepts that I think are important to know:
Interest rates, is a broad term that refers to the amount of money you need to additionally pay when you get a loan from a bank. When you hear in the news that “the Federal Reserve raised interest rates” that means that the central bank of the United States wants more money if a bank needs cash from them. Interest rates and inflation (the increase of prices over time) are tightly linked and that is why these days they are both on the news.
Stocks or shares, the two terms are used interchangeably by most people: if you own shares of a certain company you own a piece of it.
Public vs private company, a public company is a company for which you can buy and sell shares in a public stock market (like the London Stock Exchange or NASDAQ) to anybody that wants them at the right price.3 You can still sell shares in a private company but it will be much more difficult to find someone since there is no public market to use, and there will be conditions attached to it.
Bonds, a way for companies or governments to get a loan from the general public instead of banks, with the promise of paying the money back at a certain date and with a certain interest rate. The higher the interest rate, the higher the risk that you will never see your money again. The U.S. Treasury bonds are considered the safest bonds in the world and also the ones that pay the least amount of interest.
Equity compensation, is a way for a company to reward and motivate their employees by sharing a “piece” of the company. Nowadays it is common in public companies, especially for technology workers, and in cash-strapped startups that can use it to lure more senior employees by offsetting lower salaries. The two commonly used types of equity compensation are Restricted Stock Units (RSUs) and Stock Options. If a company is publicly traded, your equity compensation is equivalent to cash, if it's not, you'll have to cross your fingers and hope for a liquidity event that pays back those stocks.
Diversification, is a way to lower the risk of losing your money by investing in many different, hopefully unrelated, companies or products (diversified portfolio).
Passive investing, is a form of long-term investment in which you create a diversified portfolio based on several rules and then touch the portfolio as little as possible for many years. The most famous passive investing products these days are index funds and ETFs.
My strategy is to be boring
Here’s how I interpreted the advice I have read online and discussed with friends, your mileage might vary so please take it with a grain of salt.
Budgeting
You will find plenty of documentation on how to build a personal budget, especially on a more specialized subreddit dedicated to FIRE (Financial Independence Retire Early), and how aggressive you can be on your budget.
I do not subscribe to the movement because I am not planning to retire early, but financial independence is important to me. So I am a more light touch on the way I manage my money:
Spend 1/3 of my income on fixed expenses (mortgage/rent, various bills, groceries, etc)
1/3 goes into savings
1/3 is free to be used for free time and maintenance of the house
Additionally, I have a floating line in my bank account, the day before I get my salary I will move all the money above the line into savings.
You should see this budgeting on an annual basis, otherwise, it would be impossible to plan big expenses like a vacation.
At the casino the house always wins
The failure of any player at a casino is to think that they can beat the house, this is exactly why I don’t spend any money picking stocks in the stock market.
Picking stocks is a fool’s errand even for professional investors: Warren Buffet (one the richest man alive) made a 1M$ bet that a general index fund would outperform a very famous hedge fund (an investment type reserved for the wealthier people that promises “smarter” management of the money when compared to the “dumb” index fund) and he won.
So I followed Warren Buffet’s advice and simply buy shares in an index fund that tracks the MSCi World Index and that is it.
I put money in it once a month as a way to reduce volatility (see DCA), and the reason why it works is because no matter what you do the biggest law of finance is the power of compounding.
Diversification
Age is important!
The strategy above is 100% stocks and, make sure to read prospectuses, it has an investment horizon of 10-15 years with an average risk of losing money. This is a good strategy when your retirement age is still far away, as you get older you want to start investing a bit more in Bonds ETFs for example. If you are much younger than me, maybe you want to be even more aggressive instead, and go for something riskier. There are plenty of guides out there to help you out.
Invest in owning a house that appreciates over time
I also own a house and have a mortgage on it. If you have the means to buy a house in a location that makes sense to you (something that has become a luxury in many big cities) do so and take a mortgage on it, as long as you can sustain the payments in your budget. Although there are mixed opinions about this advice in the econ community.
Pension funds are tax exempt
I have mixed feelings about pension funds, while it is a way to save money for the future in a tax-efficient way, I don’t trust that our current pension systems will be sustainable by the time I am retiring. Maybe it’s just because I share with my fellow millennials a pessimistic view of the future.
What about crypto?
As I said already, the house always wins so if you want to speculate on something be my guest.
You should have more questions than answers in your head right now
After writing this up, I realized that this post got a bit complicated with a lot of external links to click. Take it as an introduction to the topic and spend time doing your research using the links provided and the ones you will find and don’t trust my word on any of this.
Note: this is not financial advice! Talk to someone competent if you want advice.
I hope this link will keep working and Reddit’s CEO will stop destroying this cozy dumpster fire
I know these are not perfect explanations by any means, what I am trying to do here is to give a general idea for anyone to grasp quickly
Took me long enough to understand how the stock market works, I will skip the explanation here