A perceived gap in financial knowledge can paralyze potential investors from starting their investment journeys. Tons of financial news gets published each day, much of it with intimidating language. But you do not need to spend hours a day reading financial news or learn what a Lipper rating is to start investing. (I had never heard of a Lipper rating before picking it out of this J.P. Morgan glossary of financial terms while writing this, and I am an above-average accumulator of wealth who has been investing for years.)
Despite the emphasis on financial literacy, financial discipline is much more important than financial knowledge. Investors with disciplined finances tend to be prepared for a financial emergency and their eventual retirement. Individuals focused instead on accumulating a particular level of financial literacy can either end up delaying investing, missing out on compound interest, or spending hours over-analyzing trends of a particular stock to make an extra $5 a year. This level of detailed analysis is certainly not necessary at the beginning of your financial journey, when simply accumulating more money should be your priority.
Certainly, an elementary baseline of financial literacy is necessary to get started. Here it is:
Spend less than you earn. This creates savings.
With those savings, build an emergency fund that is kept in an accessible place, like a high-yield savings account.
Once you accumulate a sufficient amount of money to fund an emergency fund, invest. Use the extra money you earn to invest at regular intervals.
If you absorb those three pillars of financial literacy from the time you start earning an income, you will almost certainly be in a good place financially for the remainder of your life.
But What About the Complexity?
Much of the assumed complexity in financial literacy exists only to give high-cost financial advisors jobs. Adding complexity to the financial industry facilitates a business model where financial service firms employ financial advisors who are continuously dependent on receiving a percentage of your investments, with the explanation that they “manage” those investments. Many families and individuals pay for these financial advisors because they want an expert consistently managing their finances since they either feel they have a knowledge gap when it comes to investing or they do not have the time to pay attention to market fluctuations.
In reality, an investor without a financial advisor will end up wealthier than the investor with a financial advisor that receives a portion of their wealth as payment. This does not assume that the investor without a financial advisor receives daily news briefings on the market or is well read in financial literacy. An investor does not need time or ongoing financial knowledge to create more wealth than an investor consistently paying a financial advisor.
Financial advisors taking a portion of an investor’s wealth use an assets under management (AUM) model of billing, meaning they take a percentage of each investor’s overall investments each year as a fee. Losing 1% of investments each year sounds small, but the lost interest year over year diminishes wealth significantly. Since even the best financial advisors using an AUM business structure do not consistently beat average market growth, using one of these financial advisors will only hurt your wealth building journey.
The jargon and excessive news production surrounding fluctuations of specific stocks keeps financial advisors using an AUM structure to make money in business. If investors perceive wealth building as complicated, they need to hire experts to fill their knowledge gaps.
In reality, investing is not complicated. The financial literacy required to become a successful investor is low and outlined above in three steps. It works because of one simple truth: Historically, the market has always gone up in the long run. If you are investing for the long-term, all you need to do is invest in the entire market, and you will make more money on your own than if you employed a financial advisor siphoning off 1% of your wealth each year.
So forget financial literacy. If you are this far into the article, you have enough financial literacy to build wealth. You just need financial discipline.
How to Make Your Finances Disciplined
The current age of automated financial transactions has pros and cons: It makes saving and investing easy, but it also makes buying easy. The trick to having disciplined finances is to lean into the ease of automated finances for saving and investing while making buying more difficult.
Spending less than you earn and starting an emergency fund, the first two steps in the required financial literacy you need to build wealth, can be set up with one simple step. Pay yourself first by sending a portion of your paycheck to a high-yield savings account, instead of your checking account, to accumulate enough money for an emergency fund. You have to set up this automatic transfer one time, and it will continue without you thinking about it again. Continue this transfer until you decide you have a sufficient amount of money in your emergency fund.
If you experience difficulty on the buying side of the “save more than you spend” equation, try making spending more difficult. Choose not to save your credit card information in places like Amazon, do not use Venmo or Apple Pay that make spending money easier, and avoid committing to too many subscriptions that keep you paying each month. Creating some additional friction in purchases helps you naturally spend less money.
For step three of the financial literacy list, follow the same logic as step one and two to make it easy by automating. If you have a retirement plan through your employer, like a 401(k), send part of your paycheck to it before it hits your checking account. If your employer does not offer a 401(k) or other retirement plan, send some of your paycheck straight to an IRA. If you want to contribute more, open a brokerage account, and send some money there. As long as you send the money straight from your paycheck, you will never miss it. You also only have to set up these recurring transfers one time and they will continue in perpetuity without you thinking about them until you need to use them years down the road when you want to retire.
Some employers will not allow you to set up automatic transfers directly from your paycheck. If that is the case, set up automatic transfers to be deducted from your checking account the day after each payday.
The only other step to take beyond setting up a recurring transfer is to verify that your money is being invested. Assuming you do not want to start reading daily newsletters to track individual stocks, investing in a total stock market index fund allows you to safely bet on the entire market without stressing about whether certain businesses will go out of business. A target date fund is the other option, particularly in 401(k)s that may lack some total stock market indices. You can always read where to invest when you do not know where to invest, but do not overcomplicate your decision! Just invest in the total stock market.
Comments