Six Principles to Personal Financial Security
The bedrock principles that will influence how you live financially include:
1. Save as much as possible
When you're young, save 10 percent of your income. At middle age, aim for 15 or 20 percent. If you don't start until later than middle age, save every penny you can.
2. Learn and apply the magic of compound interest
The greatest invention of man was compound interest.
If you start early, tiny amounts grow to immense amounts, and pretty soon you're all set for retirement.
A thousand dollars socked away when you're 20 and growing at 10 percent per year will be almost $73,000 when you're 65. The same sum saved when you're 50 will grow to $4,200 at age 65.
3. Use Asset Allocation with passive index funds to reduce risks and increase returns
Start early, stocks are the answer. Over long periods, a diversified basket of common stocks outperforms bonds, cash, and real estate. There's also a lot of volatility in stocks. As you age, you'll want more of your money in bonds and money market accounts. These have lower returns than stocks, but they also have far lower volatility.
As a basic portfolio, put half of your savings in the broadest possible common stock passive index such as the Vanguard Total Stock Market Index (VTSMX) and half in the Vanguard Total Bond Market Index (VBMFX).
4. Know how much your investment returns
Now, this is largely unknown from year to year. But over long periods, stocks return close to 6.5 percent after inflation, and about 10 percent before inflation. You'll do best as a stock investor with index funds that cover the largest possible universe of stocks. These tend to be very low-cost in terms of fees and loads (sales charges), and beat almost all actively managed funds in terms of return over long periods.
5. keep your fees and costs low.
This principle is largely about using index funds and no-load mutual funds, which makes perfect sense.
6. keep an eye on taxes.
Finally, maxing out your tax-protected accounts like IRAs and 401(k)s; keeping high-dividend stocks in accounts that are tax-deferred; and, when retiring, carefully considering what bracket you'll be in and drawing out your funds to remain in the lowest possible one.