How to diversify and allocate your finances

The diversification of your finances is one of the most important tasks you can work (or get started) on today. We often hear that the best time to start is now.

The good news is that Millennials and the Z Generation still have a long life ahead of them. Saving and investing for the future works best when you have longevity on your side! This is because of the compounding nature of interest.

Compounding occurs when a bank or an account pays interest on both the principal (the original amount of money) and the interest an account has already earned.

To calculate compounding interest you can visit Investor.gov.

 

Types of Accounts that Pay Compounding Interest:

 

  • Most savings accounts
  • money market accounts
  • certificates of deposit (CDs)
  • Retirement accounts (IRA’s and 401k’s)

Interest Rates: A Current and Historical View

 

Over the past several years, the federal funds rate (the interest rate at which the federal reserve lends money to other banking institutions) has been ridiculously low! The Federal Reserve has been trying to stimulate the economy by lowering the interest rate.

This means that the public is penalized for keeping their money in the bank and incentivized to invest in the stock market or take out loans to purchase larger items.

Currently, at the time of this writing, you are lucky to get even close to a 1% return on your investment for putting cash in the bank.

The world of finance is part of a natural business cycle. What goes up,  must come down. This means that although we have experienced nearly 8 years of fairly low interest rates, the federal reserve will someday have to increase it in order to prevent a runaway (overheated) economy.

Over the last 200 years we can see that interest rates have increased and decreased over time:

Finance.-Average-interest-rate-over-200-years

Photo credit average interest rate over the last 200 years

Why Cash is King

You might be saying, why would I put my money in the bank and only earn 1%? Especially since inflation is nearly 2% to 3% per year! Wouldn’t I be losing money? The short answer is yes.

This is why I recommend a diversified portfolio. In financial terms, diversification means spreading out your risk. In more simple terms, it means not putting all of your eggs in one basket. You should allocate a percentage of your income each month towards saving, investing, and retirement.

You may be wondering why I am advocating that a portion of your investment portfolio should be held in cash. This is because cash is king! Currently, we have been experiencing an 8-year bull market. While it might be tempting to invest all of your money into the skyrocketing stock market, at some point the market will take a turn.

When it does, the cash that you have been saving will give you the opportunity to purchase heavily discounted assets (foreclosed homes, stocks that took a beating, etc).

There are two kinds of buyers. Momentum buyers and contrarians.

Momentum buyers purchase when the stock market is rallying (headed in an upwards direction) and believe that the stock will continue to rise. This is also called purchasing with the crowd or crowd consensus.

On the other hand, contrarians love discount shopping! Contrarians know that the business cycle has natural ups and downs. They are the ones waiting for the inevitable “coming of winter” (Game of Thrones reference there). Contrarian investors were the ones purchasing all of the foreclosed homes in the middle of the Great Recession (in 2010) with CASH!

Roth IRA’s

In a prior blog ” Roth IRA: How to Become a Millionaire by the Time You Retire! “, I explain how over any 40 year period the average return rate of the stock market is about 7% a year. This includes all of the ups and downs (booms and busts). An awesome blog called, “Dollar after Dollar” created a Pinterest post showing how compounded interest works (he used an 8% yearly return on investment).

Most of the Millennial and Z Generation realize that Social Security will probably be a thing of the past (when we come of age to collect).

This means that more than ever we need to save for our retirement, have a rainy day fund, plan for our children’s college savings(through a tax-advantaged 529 plan), and have enough money to enjoy our lives today.

The financial world can be difficult to navigate, which is why it is so important to prioritize and automate many of the functions. Automation is the best thing that can happen to your financial life! The specific steps are included in this blog.

The Current Financial Situation for the Millennial and Z Generation 

Millennial’s, people who are born from 1981 to 1996 and are now between the ages of 22 to 37. We are entering a stage where many of us are getting married, having children, and really getting into our careers.  The difficulty is that our finances are being pulled from many opposing directions.

For the Z Generation (1995 to 2010 or ages 8-22) the oldest of you are just starting college, landing your first job, learning how to build credit, possibly navigating taking on student debt, and living on your own.

You are at the perfect point where building the right habits can really make a difference in the trajectory of your life! You haven’t had time to make bad and severely impactful financial decisions yet.  What you do NOW will affect the rest of your life.

One of the biggest takeaway points that I learned from a finance professor in college was to start a Roth IRA and max it out ($5,500) every year for 40 years. If you do this, financial calculators online will show you that you can save over $1 million for your retirement.

Growing up with FOMO (fear of missing out) has led to a situation where many Millenials have not started to save for retirement or plan for the future. Generation Z, don’t let this be your story too. Prioritizing and planning through a set of predetermined percentages will help you set aside the right amount of money each month.

Steps to Get your Finances on Track:

1) Track your income and expenses

2) Go through your monthly expenses and see where you can cut back on spending

3) Set a dollar amount or percentage of income that you want to save per month

4) Look at your expenses and see what else needs to be eliminated so that you can meet that goal (step 3)

5) Set up overdraft protection on your bank accounts (and credit cards)

6) Set up an auto deduction of the dollar amount you chose to save (step 3) to be diverted to a “rainy day” fund account (your bank will be able to help you do this. Most banks allow you to set this up online as well).

7) Set up an auto deduction of $458 ($5,500/year) each month to be diverted to a Roth IRA. Read about how to dollar cost average and purchase ETFs.

8) Set your credit cards, rent/mortgage, and utilities on auto pay.

9)Perform a monthly audit of your credit card statements. I have personally caught at least one fraudulent financial transaction every 6-8 months on one of my credit cards.

10) Check your credit history and score often!

** A rainy day fund: should cover 3-6 months of expenses without any income coming in.

Taking these steps will ensure that you are automatically saving each month. It means that you have made saving a priority!

Do not save what is left over after spending, spend what is left over after saving!

Warren Buffet

If you are maxing out your credit cards, read “How to Increase your Credit Score Now”.

 

Ways to Cut Expenses (Costs):

  • Go on a hike instead of going to the movies- This doubles as exercise and a great way to chat with family or catch up with a friend!
  • Cook at home and meal prep instead of going out to eat- Read the article How to Aggregate Time to Become More Efficient
  • swap yoga and calisthenics on Youtube for a gym membership
  • Opt for Netflix and your cancel cable subscription
  • Live in a smaller apartment
  • Most outdoor activities only require that you buy the equipment once (there is no membership cost)

 

Just remember, every dollar and activity comes with an opportunity cost. There is always a cheaper alternative! On that note, let’s talk about the opportunity cost (the loss of an alternative option) of the earth’s natural resources vs exponential economic growth!

Balancing Economic Growth with Environmental Sustainability:

 

The difficulty is that we live in an economy of ever-increasing exponential economic growth. The government and financial institutions would like to see a 2% to 3% growth in GDP every year for the indefinite future. In order for this to happen, we constantly need to go through boom and bust debt cycles. According to Investopia’s article called “Is Infinite Economic Growth on a Finite Planet Possible?

Economic growth has been defended for its contributions to human well-being and increasing standards of living. Yet, it is becoming more evident that the degree to which economic growth has depended upon increasing use of the Earth’s natural resources is unsustainable. It is clear that we cannot continue to consume more water, burn more fuel and spew out more and more carbon dioxide at ever increasing rates. While theoretically possible, we are at a point in history where separating economic growth from physical growth has to become a reality or economic growth will begin to reduce human well-being.

Natural resource depletion and degradation have left us with phrases such as peak oil, global warming, and climate change.

I am sure we remember our parents telling us that relationships work best when we “give and take”. The relationship between humans and mother nature has been unequal for a long time. I urge you to read the children’s book “The Giving Tree”.

Not only is budgeting and saving money good for your bottom line, but it is also good for the planet. We need to learn to live in harmony because it is our future that is at stake. This blog is all about education and promoting intellectual conversations. What kinds of activates do you do that are low cost and have a low environmental impact? Comment below!

Increase Your Financial IQ:

Coming soon: Learn How to Understand and Master the World of Finance!

Spam is gross. Unsubscribe at any time! Powered by ConvertKit
The following two tabs change content below.

Lynzee Lai

The goal of this site is to increase conscious consumerism (when consumers “vote” for earth-friendly products and practices by purchasing from companies who put its people and the planet first). The idea is that if there is a high demand for products that protect the environment, companies will be incentivized to expand their earth friendly product lines. On the other hand, environmentally damaging companies will be economically motivated to change their practices or face going out of business. Click on the Eco Economics tab to read about the company's mission and goals.