Financial Architects

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“Adulting” Milestones

I had a conversation recently with a young adult who was focused on buying a home. It got me thinking about priorities, and while it was on my mind I wrote some general advice for young people:

While individual situations will vary, as a young adult there are some basic financial milestones that I think you should strive to achieve. These are listed in roughly the order I think they should ideally occur:

  1. Complete your education.
  1. Have the ability to pay your own living expenses from your earned income. For most people this means having a spending plan (aka a budget). This doesn’t mean you actually have to be paying your own expenses, but if you aren’t, then you should be saving the amount that you are being subsidized. In other words, if you are on someone else’s insurance/Netflix account/cell phone plan/etc., that’s fine, but you should be saving that amount then, not spending it.
  1. Have appropriate amounts of the crucial types of insurance: health insurance, disability insurance, and liability insurance. (If you have people who are financially dependent on you then add life insurance to this list.)
  1. Save in your employer’s retirement plan, such as a 401(k), each year to the extent of any match.
  1. Have no consumer debt (i.e., credit cards, car loans, etc.).
  1. Accumulate three to six months of expenses in an emergency fund.
  1. Get estate planning done. This may move up (or down) the list depending on your individual situation, but at some point, you should get a:
    • Will (this is important if you have a minor child or assets that would pass through probate)
    • Durable power of attorney (specifies who handles your finances if you can’t)
    • Living will (specifies what life-prolonging actions you want taken, if any)
    • Durable power of attorney for healthcare (specifies who makes medical decisions if you can’t).

(In some states, such as Georgia, those last two are combined into one document called an Advance Medical Directive.)

  1. Save to the maximum limit of retirement plans such as a 401(k) or IRA/Roth. This will be a financial stretch (or perhaps impossible) if your income isn’t high. For a younger person in 2024 the 401(k) limit is $23,000 and the IRA/Roth limit is $7,000 so this is $30,000 combined before you move to the next level.
  1. Accumulate a 20% down payment for a home. There are two reasons for the 20% number. First, and most obviously, that is the level that saves you the private mortgage insurance (PMI) premium. Second, and more importantly, if you can save that then you probably have the financial habits and ability to handle the ongoing responsibility (and irregular expenses) of homeownership.
  1. Buy a home. This is optional, but this is the spot on the list where it would go.

As a young person, that list undoubtedly seems daunting, but that’s why I put it in priority order, you just have to work your way down. The further you get down the list the brighter your financial future will be. (See also Four Rules for Guaranteed Financial Success.)

Happy adulting!

I want to expand a little on buying a home. Many young people have no idea how much home they can afford, and lenders will encourage borrowing more than I think is prudent. There are two rules of thumb for this:

  1. Regular homeownership expenses should not exceed 28% of gross income. Those expenses are PITI (Principle, Interest, Taxes, and Insurance) plus any HOA/COA/POA fees. This ratio is frequently used by banks and other lenders.
  1. The value of the home should not exceed 2-3 times gross income. This is my rule of thumb and is usually more conservative than the banks’ rule.

People tend to get excited about buying after real estate prices have risen quickly (they do the same with other assets too). Prices may continue to rise or they may not, but the long-term expected appreciation on real estate is roughly the rate of inflation. Total return on real estate is higher because of rental income, or imputed rent (the rent you don’t pay on your own residence), but of course there are expenses as well.

Furthermore, for a young person, flexibility is important. In the early years of employment, moving (even across town) to take a better job frequently changes the trajectory of lifetime earnings, and renters are much more willing and able to do that than homeowners are.

Finally, people often “stretch” to buy their first home and then are in a precarious situation if they lose a job or the HVAC system needs to be replaced. Waiting to buy until more financial resources are firmly in place is more prudent in many cases.

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Investment Rules

A while back the topic of “Investment Rules” came up in an email exchange, and I wrote a quick list of mine. These are just my simple, and perhaps arbitrary, rules. I’m mostly trying, as Charlie Munger said, to not be stupid: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be intelligent.”

  1. No sector investing – I generally don’t have enough sector expertise to have a better opinion than the market.
  2. No zero-sum asset classes (derivatives) – I don’t want to be reliant on someone else losing for me to win. They undoubtedly think they are smarter than me, and there is no obvious reason for me to disagree.
  3. No investments where a negative opinion (shorts) can’t be expressed (IPOs, PE) – When only bullish opinions can be reflected it would be hard for prices to be attractive, or even reasonable.
  4. Don’t buy things with high expense ratios – expensive is, of course, relative, but why have headwinds?
  5. Don’t buy things that are illiquid – I am unconvinced that an illiquidity premium reliably exists. (And Cliff concurs.)
  6. Don’t buy things where the counter-party can change the rules against you in the middle of the game (many insurance products).
  7. Don’t buy things that are expensive (even if it might seem justified) – mean reversion is a real thing (even if folks are confused about what it means).
  8. Don’t buy things that have no possibility of cash flows (i.e. zero-dividend stocks are fine, but no NFTs, art, gold, cryptocurrencies, etc.) – there is no way to value such a thing that doesn’t end up being a mere psychological exercise – “People seem to like it/have always liked it so it must be worth something.”

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Being Helpful

A while back I was thinking about advice for younger professionals so I read a few networking books. (I thought I had read them a long time ago, but apparently I picked up the essence without ever actually reading the books. I corrected that.) Anyway, I highly recommend, Give and Take. A related book is The Heart and Art of NetWeaving which is similar to Give and Take, but not as good. However, it does have a few very good questions that can be used in business networking situations to get past superficiality and see how you can really help someone (my paraphrases/versions of the questions):

  1. Some version of, “How do you make money?” We all tend to ask people what they do, but if you can get to how they actually get paid it’s much more insightful.
  2. “What’s your biggest problem/obstacle/need/opportunity?” As I envision a networking situation, I might ask, “What’s the hardest thing about what you do?”
  3. “What’s your strategic/comparative/differential advantage (aka USP)?” Again, as I envision this, I would probably ask, “What makes you different from your competitors?”

He also throws in a personal one which is perfect for a financial planning discussion with clients or prospects: “If you weren’t doing what you are today, and money were no object, what would you be doing (and why)?” This is a more concrete version of, “What’s your passion?”

Both of those books reflect our approach to business: Be helpful to folks and you will be successful. I didn’t say be helpful to be successful. This isn’t mercenary or strictly reciprocal. But I think if you just try to maximize total societal outcomes it works. Let me see if I can explain that better. Some people see the pie size as fixed (and sometimes it is): if your portion is bigger, then mine is necessarily smaller. But often you can increase the size of the pie and everyone can win. I go a small step further and will have my piece a little smaller if it makes the whole pie much larger. Let me give a few examples:

  • Fixed-pie situation: I can help someone, but they can help themselves/do it themselves as easily as I can (and we are equally busy, etc.). I’m not doing that. There is no net win. I lose, they win by exactly the same amount.
  • Grow-the-pie situation: I can help someone easily and they can help me easily. We help each other and both win. This might be undefined. I might help a co-worker right now and then they sort of informally owe me a favor to be used later. This is usually really loose, but assuming conscientious folks, it works out fine. Outside the workplace this is just being neighborly.

No one is “keeping score” (at least I’m not) on any of that, but it probably all comes out at least even, but I think in aggregate everyone probably wins.

  • Grow-the-pie with karma situation: I can easily help someone a lot but they almost certainly can’t do anything at all for me. I probably help anyway. Examples:
    • Pro-bono advice for people with low incomes and trivial net worth, no connections to any prospective clients, etc.
    • Coffee with young people needing career advice or connections, etc.

We’re pretty happy to help with all of that even though there is a small cost (primarily time) to us. The help to them is (hopefully) very large so the total pie is still bigger (our slice is a little smaller, but theirs is so much bigger it’s larger at the aggregate level).

Regarding, the fixed-pie vs. variable-pie views above, Paul Graham also wrote an excellent piece on this topic years ago. I highly recommend that motivated young people read this and internalize the key factors of leverage and measurement.