People are generally confused about what to do with excess money. The words we use to talk about this are not helpful. Most people think of saving money by putting it in a bank. However, the key to financial success is investing money by putting it in a 401(k), an individual retirement arrangement (IRA), and a taxable brokerage account to buy stocks (real estate is another option if you have the requisite expertise).

However, saving money is important. You want to have savings to cover your expenses and unexpected financial needs. But, as your financial capital grows, an increasing proportion of it should be in stocks. This is why sound financial advice advises establishing an “emergency fund,” which is savings to cover several months of living expenses, before you start investing. Another prerequisite to investing is eliminating high-interest debt, such as credit cards.

Typically, people talk about a savings account being “safe” and investing being “risky.” In one sense, this is true. With a savings account, you can’t wind up with fewer dollars than you deposited, while an investment in stocks can result in losing money. However, in the long run, avoiding investing is the truly risky maneuver. Unfortunately, half of Americans avoid investing entirely, which is financially ruinous in the long term.

The best way to invest is to buy the whole stock market via a mutual fund commonly known as an “index” fund. Instead of picking stocks or market sectors, you can invest in the whole U.S. publicly traded stock market by purchasing shares in an index fund that invests in the approximately 3,500 publicly traded U.S. companies, proportionate to their value (that is, their market capitalization). Apple is the most valuable company, so as of this writing, about 2.9% of your money will be invested in Apple, 2.7% in Microsoft, 2.5% in Microsoft, 2.4% in Google, … 0.8% in Home Depot, 0.7% in Boeing, and so on.

Index funds of the whole U.S. stock market have very low fees and a high probability of greatly increasing in value over the long term (15 years or more). Although in any particular year, there is about a 25% chance of losing money and a 75% chance of making money, over longer spans the chance of losing money approaches 0%.

Additionally, it is sensible to hold an index fund of the “international” stock market; that is, all publicly traded companies not based in the United States (for example, the Vanguard Total International index). The largest of the approximately 6,100 stocks in this fund are presently Tencent (1.15%), Nestle (0.95%), Alibaba (0.8%), Samsung (0.8%), and HSBC bank (0.75%). Of the proportion of your money invested in stocks, many people suggest putting about 80% in the U.S. market and 20% in the international market. Others recommend 100% in the U.S. market (most notably Warren Buffett) and others recommend a 50%/50% split. Considering the whole earth, the U.S. market’s valuation is about 50% of the earth and all other countries are about 50%.

Many people think of investing as “gambling.” This is not correct. The saying, “the house always wins” is accurate; when you gamble, be it in a lottery, casino, or buying scratch-off tickets, you are more likely to lose money than gain. As you gamble more and more, your probability of making money approaches 0%. Investing is fundamentally different, because the odds are in your favor—your probability of making money approaches 100% the longer you stay invested in the whole stock market.

Not investing is risky because over time, you are going to wind up with far less money as compared with someone who invests in index funds of the whole U.S. stock market and optionally/additionally the international stock market. When we talk of equities (stocks) being “risky,” if referring to the whole stock market, this risk is time-limited. Over decades, the riskier path is actually sticking to “safer” choices like savings accounts, money market accounts, certificates of deposit, and bonds.

With investing, starting earlier is better, and investing for retirement is critical. Your 401(k) and IRA can be in a money market account earning next to nothing, or in index funds of the whole U.S. and international stock markets earning large, tax-deferred or tax-free gains. The choice is yours. (Although some 401[k]s do not offer an index fund of the whole U.S. stock market, in these cases it is reasonable to invest your 401[k] contributions in a Standard and Poor’s 500 [S&P500] index fund.)

Fidelity, Vanguard, Charles Schwab, and TIAA are the largest brokerage firms where you would select to buy an index fund with low fees (i.e., 0.25% per year or lower) for your taxable brokerage account and retirement accounts. In addition to investment returns, retirement investing is important because you are offered tax reductions and credits for doing so, but you can only invest up to a certain amount each year, so if you start later, you can’t go back and contribute for previous years.

Another benefit is that the so-called “unearned” income received via investing (namely, capital gains) is advantaged over earned wages in other ways, even in a typical taxable brokerage account—for example, you don’t have to pay Social Security or Medicare taxes on your capital gains, and you can choose when to receive the capital gains by cashing out in a tax year that is advantageous to you (known as “tax gain harvesting”).

One of the biggest financial risks for young and middle-aged adults is not investing. Although two-thirds or more of Americans do not understand investing and other basic financial concepts, the information can be learned on your own, from websites and books. However, weeding out widespread bad advice is difficult. Many financial professionals are trying to sell you on managing your money with them, for their own personal gain rather than your gain. Many financial pundits talk about investing in particular stocks to the public’s detriment, because it is simply boring to only talk about investing in the entire stock market, despite being preferable.

You can learn about finance and wisely invest in index funds of the whole stock market without anyone’s help, but you must put forth time and effort. Hiring a “wealth manager” or financial advisor can be dangerous to your financial health; you must be sure they are acting in your best interests, rather than for their own profit. Demanding they conform to the “fiduciary standard,” not the “suitability standard,” is a good start. Regardless of whether you hire a financial advisor, educating yourself is critical, and will pay off massively over the course of your life.

Payday should be just like any other day. If there is a spending decision to be made, the outcome should not be any different based on whether you recently received a paycheck or benefits payment that is not contingent on lack of assets.

A key factor in the path to financial independence is earning much more money than your expenses. The idea of orienting your discretionary purchases and bill payments around when you get paid is antithetical to this principle. The timing of when your paycheck comes should be a mere triviality.

There is a mindset toward spending money as quickly as it comes in. I am not sure where it comes from, but it seems to be clustered in families, social circles, people of certain age brackets or socioeconomic status, et cetera. Platitudes about needing to enjoy life and the certainty of one’s continued destitution are common. There is an idea that one should consume resources quickly, before they are seized, stolen or become worthless. This is evolutionarily and historically appropriate, but inappropriate for modern financial life in developed states like the United States, European Union, and People’s Republic of China.

There is a justified, populist backlash against “experts” chastising the public for their financial situations. For instance, when MarketWatch recently declared that Americans should have twice their annual salary saved by Age 35, the derision on social media was widespread.

Many people are in financially untenable situations through no fault of their own. They are not feckless or even necessarily financially illiterate, and are often work full time or even more than full time. This has been explored in great depth, such as on the Bad With Money podcast. For example, the cost of housing in the United States has become quite high relative to incomes, contributing to penury and inequality.

Many people inherit financially unfortunate circumstances. Although people are lucky to be born in the United States, the inequities of being born into education, wealth, et cetera are profound. It is not fair that some young adults have to work and pay rent at a young age while others get to live rent-free with family. It is not fair that children of financially independent parents enjoy financial security, better nutrition, more time with their parents, and greater opportunity, without justification based in human rights or merit.

Separating what you can change from what you cannot change is important. I think it can be done in a “judgement-free” way, but this is difficult even one evaluating oneself, and nigh impossible for an outsider. One can look at examples of those who have succeeded despite bad situations, although others have not been so fortunate and/or diligent.

Regardless, the mathematics remain the same. To become financially independent, one must somehow increase earnings, save a high proportion of income, and invest it in reliably profitable avenues—most commonly, equities or real estate. Along the way, getting paid has to completely lose its day-to-day, practical significance. For example, if your expenses are $2,500 per month and your net income is $2,700 per month, getting paid matters (assuming you have a low amount of liquid net worth). However, if your net income increases to $5,000 per month, getting paid might continue to matter if your expenses rise to $4,800 per month, but will quickly not matter if you keep your expenses at their prior level, due to accumulation of savings. Toward this end, a useful psychological “trick” is to automatically contribute a large portion of pay to your 401(k) and savings/investing accounts.

There are definitely exceptions to the principle that payday should be just like any other day. For example, if you are a recipient of Supplemental Security Income (SSI), you have to maintain assets of less than $2,000 to continue receiving benefits. Similar means tests apply to other benefits such as subsidized housing. Such recipients are in an ironic situation, as they move away from financial independence by accumulating assets, and consequently should keep their expenses close to their income. For everyone else, having low overhead is key. Hence, payday should be just like any other day.

As a financial researcher and aspiring financial educator, I’ve been thinking at length about the principles behind good financial teaching. These five ideas are by no means new or original. However, they are research-supported and not yet mainstream.

1. Behavior Under Management

Know when the student is not ready.

This is straight from Andy Hart’s podcast and conference, with support from a wealth of research in behavioral psychology, economics, and personal finance. Emotion, perception, knowledge, and experience all play an important role in why people make bad financial decisions.

It is widely accepted that younger people should be fully invested in stocks, because their time horizon is long. As they get older, volatility and profits should both be suppressed by divesting stocks into safer, less profitable assets such as bonds. However, young people commonly freak out when there is a bear market, selling their investments and even losing part of their principal. This is traumatic and may result in them never investing in stocks again, which is a worse outcome than if they had invested later in life with greater knowledge, experience, and resilience.

It is not fair to a student to advise an objectively superior course of action when it will lead to financial ruin because the student is not ready.

2. Educate in Arithmetic and Statistics

When the odds are in your favor, it’s only “gambling” if the consequences are disastrous.

Recent evidence suggests that mathematical education may be more important than financial education. The ability to perform mental computations is important, as well as skill with picturing compound interest and percentages. Understanding risk and reward over time is critical. Anyone with a complete understanding of gambling mathematics should know that as you gamble more, you get closer and closer to a guaranteed loss of money.

Investing in the whole global stock market, on the other hand, is neither speculation nor gambling because the odds are in your favor and the consequences of loss are temporary. Although the market declines in about 25% of given calendar years, over longer spans it almost surely increases from the starting point.

Insurance companies make money because they pay out less money than they take in. On average, the odds are in their favor. For any one individual or family, however, the consequences of losing the bet are disastrous. This is why it is wise to purchase health insurance, term life insurance, auto insurance, et cetera. You are insuring against uncommon yet disastrous events. Nonetheless, these disastrous events are much more likely to occur than winning a large lottery jackpot. On the other hand, purchasing insurance against minor losses, like a SquareTrade warranty or collision insurance on a car, is only necessary if these items are critical to you and you do not have the funds to replace them.

3. Make Choices Simpler

Don’t do business with businesses that put bad choices on the table. (Unless you are beating them at their own game.)

People often ask why one should pick Vanguard over Fidelity, Charles Schwab, or another firm for directing their investments. Although Fidelity and Schwab do offer low-cost index funds and arguably offer superior customer service, they are also determined to sell you on products and services that are very bad for your financial health, such as actively managed investments with high management fees.

It is an unpleasant and cognitively taxing experience to be required to repeatedly decline detrimental options. The extended warranties that are sold at the checkout counter at Best Buy are an awful deal. Likewise for trip “insurance” from your airline and GoDaddy’s upsells of inferior hosting services and over-priced options when all you want to purchase is a simple Internet domain name. It is bad enough when a business puts bad choices on the table; aggressive sales tactics are the coup de grâce.

This is why a hard rule of using cash instead of plastic is effective and beneficial for most consumers. The exception is if you are a “travel hacker” beating the credit card issuers at their own game. If you have to ask, you’re not a travel hacker. Simplifying the equation by avoiding the potential for making bad choices is worth losing a few benefits that are, by comparison, small. In some industries, all the major players violate this rule. However, when there an alternate option is available, it should usually be preferred (e.g., Vanguard, cash or debit cards instead of credit cards, etc.).

4. Inculcate a Habit of Inquiry

The squeaky wheel gets the grease.

There is plenty of information available easily via web search. For example, you can easily learn about investing, retirement accounts, or strategies for convincing your bank to waive an overdraft fee by searching Google. However, many people are not in the habit of seeking information nor asking for special consideration from a lender, bank, et cetera. There are differences between how subject-matter experts and novices seek information; novices may not know where to begin, and are typically unfamiliar with the jargon of personal finance, insurance, taxes, credit cards, mortgages, student loans, credit-reporting bureaus, and more. Therefore, it is unfair to blame them for failing to seek out information. Instead, we should educate them in the basics and encourage them to build a habit of inquiry, so they less likely to be shortchanged in their financial dealings.

In addition to educating others, we should lobby for laws and regulations that compel employers and financial institutions to conduct business in ways that do not unfairly disadvantage the non-wealthy (e.g., comprehension rules), and advocate for prosocial behaviors among employers, financial institutions, corporations, and governments that benefit the poor. For instance, it is unfair that many government benefits are not received by the most needy, due to being difficult to claim.

5. Focus on Long-Term Lifestyle Strategy

But, give tactical advice when appropriate.

Reducing bills, increasing income, and changing one’s habits is important. There are many forums and other websites about living frugally. In some ways this overlaps with Item 4; for example, one can save quite a bit on a car, phone or cable bill, rent, or terms of debt service by inquiring with sellers, service providers, landlords, and lenders. Responsible financial educators should encourage learners to (a) reduce expenses as a way of life (e.g., smaller living space, more roommates, no dining out, etc.), (b) focus on significantly increasing income by leveraging education, skills, et cetera, and (c) eliminate debts, save, and invest.

Financial education appears to be more effective when it either focuses on norms and general principles or is given tactically (i.e., “just-in-time“). The best time to tell someone how to write a check is immediately before they need to write a check. Financial advisers can serve as financial educators by offering key information and advice soon before significant financial events such as shopping for a house and mortgage. On the other hand, if this advice is offered many months or years in advance, it is neither remembered nor followed.

The above article is also posted on Thripp.com.

This is a June 2018 video by Richard Thripp (39 minutes) explaining the choices, answers, and rationale to a financial literacy quiz written by Richard Thripp in May 2018.

When watching it, I recommend adjusting the YouTube quality setting to the highest resolution (720p).

The video covers computing compound interest, numeracy skills, stock investing, tax issues, healthcare, retirement, credit scores, and many other issues.

Building on my prior post, to achieve financial independence, meaning being able to live off your accumulated assets without any other income, you need roughly 9,000 times your daily expenses.

The 4% “safe withdrawal rate” rule means that you can generally withdraw 4% of your investment portfolio per year, in perpetuity, without running out of money. This should not be taken as 100% assured, but is more likely to result in a much greater portfolio balance decades in the future rather than running out of money.

Based on the 4% guideline we can say that you need 25× your annual expenses, or 300× your monthly expenses, or 9,125× your daily expenses (rounded to 9,000× here for simplicity). The bulk of this money should be invested in equities, such as the Vanguard Total World Stock Market index fund. This could alternately be split between their U.S. fund and International fund for the same result with slightly lower fees, or restricted to U.S. stocks only if you want to bet on continued prosperity in the United States.

The 9,000× rule means that if your expenses are $100 per day, you need $900,000 invested to be financially independent. If you buy a $5 coffee everyday, you need $45,000 invested to sustain this habit in perpetuity. If you average $25 per day on food expenses (eating out, groceries, etc.), you need $225,000 just to account for this.

The 9,000× rule is more useful when looking at day-to-day recurring habitual expenses. If you smoke two packs of cigarettes per day at $6 per pack, you need $108,000 to cover this. (You may need extra money to account for increased health insurance premiums, reduced life expectancy, and worse health.)

If you are considering monthly bills, the 300× rule is simpler. If your rent is $1,200 per month, multiply by 300 to see that you need $360,000 invested to be financially independent with respect only to this expense.

The 9,000× rule can be quite useful for putting into perspective how much those “little” daily expenses are actually costing you. When Alex Trebek peddles whole life insurance as costing “less than 35¢ per day,” actually, the cost is closer to $3,150 with respect to financial independence, which is bleak indeed for an insurance policy that may have a maximum payout of $5,000 or less. A habit like dining out for lunch instead of packing a lunch could easily mean you need an extra $50,000 invested just to achieve financial independence. This is why there is such an emphasis on frugality in the financial independence / retire early (FIRE) community.