Finance 101

I previously had a series of posts on certain specific personal finance topics, mostly related to credit cards and various retirement accounts. As I looked back through them, though, I realized three problems: (1) they weren’t that much better versus what was already out there, (2) some of the content had gotten stale, and I wasn’t going to invest the time and effort to keep them up to date, and, most importantly, (3) they were fundamentally focused on the wrong things. Personal finance is a game of doing the basics, consistently; it’s easy to focus on the minutiae of which credit card is best for grocery spend, but these are optimizations that are only worthwhile after nailing the basics: understanding where your money is going, building up an emergency fund, paying off credit card debt, investing in low-cost index funds, etc. Therefore, I decided to delete a lot of the older posts focused on the less important minutiae, and instead highlight sources through which I learned about these basics, plus give some insight into the specific tools that I use. I’ve written other posts tied to my money psychology, which you can find from my main writing page.

Learning about personal finance

By and large, I’ve found Reddit’s r/personalfinance wiki to be a great first-stop for most topics. Reading through the Prime Directive page / flowchart is where I’d start if I were learning about things for the first time, double-clicking on various topics as needed to understand. A more-hardcore focus on early retirement called FIRE (Financially Independent, Retiring Early) has its own subreddit, wiki, and prime directive flowchart.

If you’re more of a book person, I’m a huge fan of three books: (1) I Will Teach You to be Rich by Ramit Sethi, (2) The Psychology of Money by Morgan Housel, and (3) The Art of Spending Money by Morgan Housel [1]. Both r/personalfinance and r/financialindependence have their own (much longer) reading lists as well.

Although I rely on YouTube for learning about many topics, personal finance isn’t one of them. I’m skeptical of the motivations of financial influencers (especially when it comes to credit cards); the basics of the game don’t change much and therefore it’s difficult to continuously put out content on the most important topics.

Tools/Banks I use

I’ve used Monarch for my ground source of truth for several years, and pay for it very happily. They’ve consistently delivered thoughtful software that does what I need it to do with minimal hassle, and I like their approach to monetization (no ads, no selling data).

I’ve banked with Schwab for literally over half of my life for everything from banking to investing to credit cards. Their customer service has consistently been phenomenal (24/7, US-based) and I’m often talking to a human in under 90 seconds. Most of their products are best-in-class, or at least quite good.

[1] I’m also a huge fan of Die With Zero by Bill Perkins, but I’m skeptical of how broadly applicable his advice is. My reading list has more notes on my thoughts + links to more discussion on the book. 

What does it mean to be rich?

Bloomberg recently published a fantastic article from interviews with high-earners across the country (you can open up the link in incognito and you should be able to read it for free). It covers two important points for nerds like me who care about personal finance:

  1. How your cost of living changes from city to city (within the US)

  2. People with high incomes that don’t necessarily feel “rich”

Cost of living

It’s hard to compare salaries between e.g., downtown New York City or San Francisco to suburban Atlanta or Houston. Does a salary of $150K sound high to you? In Houston, it’s pretty good:

I use $149,999 since the calculator uses buckets to establish percentiles. Anyone earning $150,000 - $199,999 sees the same result.

$150K in Houston entails earning more than double the median household income as an individual. Let’s look at Palo Alto. Bloomberg doesn’t account for tax differences between states, so we can use this calculator from SmartAsset to adjust for the state income taxes you’d pay:

Income tax breakdown for a household income of $149,999 in Palo Alto, CA. This includes 1 state personal exemption.

In Palo Alto, your $149,999 gross salary has ~$10K in state taxes that someone in Houston isn’t paying - so let’s see where $139,755 gets you in Palo Alto:

At a national level, things don’t change (the bracket that Bloomberg uses goes from $100,000 to $149,999). At a local level, you’re right in the middle of household incomes (again, as an individual) and the percentage of your paycheck going to housing has more than doubled.

people that don’t feel rich

There’s a (very dry) book called The Millionaire Next Door, where the authors (Stanley and Danko) write ad-nauseam about two archetypes of people: UAWs (Under Accumulators of Wealth) and PAWs (Prodigious Accumulators of Wealth). The branding could probably be improved; the overall story is clear - some people (PAWs) save their money and feel financially strong, other people (UAWs) spend most of what they take in, have fully succumbed to lifestyle creep, and don’t feel rich. I’d take it a step further - people who spend every dollar they take in aren’t rich, regardless of their annual income. They’re on a spending treadmill; losing their job could easily mean ruin. They’re keeping up with the Joneses - fast cars, nice homes, using “summer” as a verb, etc. - but they haven’t cracked achieving mental freedom from financial worry. In fact, money worries them, because they know how precarious their situation is.

The survey from Bloomberg based on 1,000 responses from folks making at least $175,000 a year. Even in the highest cost-of-living areas, that’s above the median income (though I note that incomes are for larger metropolitan areas, and $175,000 in the urban core can be very different from $175,000 in the suburbs). The fascinating results from this study aren’t the folks that feel comfortable or rich. It’s the people who feel poor despite their high incomes that matter; pay attention to the black bars.

The black bars tend to not have $500,000 saved up - and they worry about money.

They also tend to not have saved up for retirement:

Money is an especially emotive topic; not seen in the graphs are incredibly important factors like age, health status, family status (kids change the equation quite a bit, I’d imagine), and spending level. You don’t see how history and culture shape individuals’ feelings about money; people will overindex to what they’ve experienced.

While reading through the article, I was noticing how people defined “feeling rich”. The primary theme was that it entailed not worrying about money — worries which could arise from future expenses, debt, or concerns about job stability; worries which could be mitigated from more cash in the bank.

I’ll leave you with a few reading materials that I found throughout my personal finance journey:

Two Nonlinearities in Personal Finance

I wanted to share two rather incredible nonlinearities in the world of personal finance that have rather profound implications for how we treat money.

Nonlinearity 1: Avoiding Lifestyle Creep

  1. Suppose that Dave takes home $65,000 a year after taxes, and spends $60,000 a year maintaining hislifestyle - retirement savings, rent, food, transportation, travel, etc. Dave’s able to save $5,000 a year, which covers one month’s worth of expenses. My old roommate used to talk about earning runway, not dollars. Dave’s earning a month of runway per year. After 12 years (if Dave doesn’t invest at all, and ignoring inflation), Dave could go without income for a year.

  2. Now suppose that Dave gets a raise to $75,000 a year (post-tax). His overall salary went up by $10,000, or about 15%. What happens if Dave doesn’t change his lifestyle at all? He’ll now be savings $15,000 a year; 3x as much as before. Dave’s runway accumulation rate is now 3 months per year (or 0.25 years of expenses/year), it’ll only take Dave 4 years to earn a year’s worth of security.

  3. But what if Dave did in fact adjust his lifestyle, such that he now spends $70,000 a year? With a modest spending increase of 17%, he’s still saving $5,000 a year as in the beginning, but his runway accumulation rate is now only 0.07 years of expenses/year.

  4. If we go back to the beginning, and Dave is earning $65,000 a year post-tax, but he finds a way to cut $10,000 of spending per year, then Dave is able to save $15,000 per year, as in point 2 — but Dave is now earning runway at a year of 0.3 years of expenses/year.

Even modest percentage increases in income or expenses can have massive impacts on the percentage change in your runway accumulation rate.

Nonlinearity 2: Diminishing Marginal Returns

One of the most important concepts in economics is diminishing marginal utility, the idea that the first thing (a car, a meal, a backpack, whatever) might you make quite happy, but the tenth likely less so. It’s intuitive, then, that a study that tried to answer “does money buy happiness” found that emotional well-being tended to saturate at income levels of around $75,000, and a logarithmic relationship between income level and life satisfaction (the nuances of what emotional well-being is versus life satisfaction can be found here - also, it’s tough to conduct research on money and happiness, not just because studies are difficult to replicate, but also due to how easy it is for popular media to misinterpret results). Increases in spending may not actally much you that much happier; certainly a 15% increase in income is unlikely to make you 15% happier [1]. I’m curious as to whether the relationship is cleaner when you look at people’s household spending versus emotional well-being and life satisfaction (though that data is likely hard to come by).

[1] This probably doesn’t hold true for the lower ends of the income scale, where more money is legitimately the cure to most problems.

Almost a Tesla-naire

In case you’ve been living under a rock since March, here’s what’s happened to Tesla stock over the course of 2020.

The stock is up an insane amount. If you’re wondering how Tesla shares started the year at $100 a share, this is all after the 5-for-1 split that occurred around August. Tesla stock is now worth hundreds of billions of dollars – the market cap is now roughly worth Ford + Honda + BMW + GM + Daimler + Volkswagen + Toyota, combined (to be fair, it’s unlikely that the same statement could be said about enterprise value, which is a much more representative measure of a company’s worth). The P/E ratio is stratospheric. Elon himself said that he thought that the stock price was too high… back when the shares were worth a fifth of the present value.

This post isn’t about the current valuation of Tesla, though. Whether it’s too high or too low or just right isn’t an argument I could confidently have a strong opinion on. What’s interesting is seeing articles like these on Bloomberg: “Elon Musk Has Made Millionaires Out of His Most Loyal Fans”. It’s strange to hear these kinds of stories – people going full-send into a company that was up until earlier this year viewed as innovative as it was volatile; risky as it was exciting; dangerous as it was futuristic. I’ve heard stories of friends of friends that YOLO’ed their cash into single stocks that happened to pop: QuantumScape was the most memorable (due to my interests), though I also heard of people that owned Moderna among others. Bitcoin and cryptocurrency is somewhat similar: there are the stories of kids who HODL’ed Bitcoing or Ethereum or some random esoteric coin that happened to explode in value.

I’ve been privileged to a point where I’ve been investing since I was 12. Throughout that time my strategies have transformed from “I didn’t know what the fuck I was doing, I was 12” to “let me try picking stocks because I clearly know more as a high schooler and Reddit lurker than people that spend 60-plus hours a week doing research” to “okay I guess index investing is the way to go”.

I was “nearly” a Tesla-naire. I went full YOLO into Tesla Motors Inc., and at some point I had 85% of my entire net worth being in this small little California car company that I heard of through a web comic that used the phrase “Ferrari that got porked by a luck dragon”. Eventually I realized that I was being incredibly brash – the level of volatility I had voluntarily introduced into my portfolio was insane. Even before Elon talked to the Saudis to take the company private at $420 a share (a personal favorite episode of mine), I recognized that the distribution of outcomes had a very real possibility of backruptcy.

And so, I decided to sell out. Every last share I had ever owned got sold, with the final trade happening after the Cybertruck unveiling. I was fine with a botched demo, though I was less okay with the “unique” and “avant-garde” design. And here I am, just 13 months later, not driving a Model 3 Performance or with 7 figures inside of a Schwab account.

Maybe all of this is post-fact rationalization, but I’m okay with the choices I made. Not being a millionaire at the age of 23 is surprisingly acceptable, and I still assert that, 13 months ago looking at all possible worlds, the decision I made to end the gambling period and move to the relative safety and boredom of index funds was a good one. For every video on YouTube of a day trader making thousands in a day, there’s another one that didn’t get posted with a similar magnitude loss. For every kid that earned $100,000 by “investing” in Bitcoin or WSBHypeStock, Inc. there’s another one that lost their life savings. Survivability bias is real; why would you hear about the story of your friend’s friend that bet their life savings on Nikola Motors? Who wants to admit that they lost $10,000 on Dogecoin?

There’s this amazing book called Fooled by Randomness by Nassim Taleb, with the basic idea that people confuse their own luck for skill. Am I unlucky? Do I lack investing skill? Whatever the answer, I think I’ll stick with index funds.

P.S. I debated for a bit whether to put this in the finance section or the main blog section of my website, since I feel like the themes are relevant to either section.

Affective Forecasting and Dream Cars

I’ve had two friends of mine tell me that they want to buy a car after they graduate. Here’s a couple of scenarios - more real than you’d expect.

Marie is about to graduate with a degree in electrical engineering. She’s done well with recruiting and will start her tech as a software engineer soon at BookFace, Inc. in Menlo Park, CA. Her base salary is $110k per year, she’s been given an excellent benefits package, and she’ll even get a $70k signing bonus (this was not made up). She wants to pay her parents back for tuition over the college years, and could probably purchase the family’s Ford Fusion plug-in hybrid (at least a 2013) for about $10k. However, she’s a true Musk enthusiast, and has been eyeing a new Model Y. She likes black wheels, and although she doesn’t feel like she needs the performance model, she really likes the red brake calipers. Of course, the car must have the white interior (MSRP $60,990). She feels like she’ll get the car eventually, why not do it now?

Tom has been working as a security guard throughout school, and is also about to graduate. His options are open - perhaps he’ll continue working a fairly lucrative gig guarding a library; perhaps he’ll join the military. In any event, he’s managed to save up $25k in cash. He’s currently driving a 2012 Toyota Tacoma, but wishes it had 4WD. He’s heard great things about the 4Runner - it looks great, is highly capable, and is bulletproof reliable. He’s eyeing the TRD Pro model (MSRP $50,470).

Let me be clear: I’m a car guy. I like cars for a lot of reasons, especially the fact that we as humans are able to build en masse (about 100 million a year!) these major machines that weigh thousands of pounds and can safely transport multiple people and their stuff basically hundreds or thousands of miles across the country on a whim. I like fast, sleek sports cars and convertibles; I like rugged boxy SUVs; I like efficient and futuristic EVs. My desktop background is a slideshow of various cars that I find cool or interesting in some way shape or form. If I find a magic wand and can suddenly have any car I want in the world for free, you’ll see me cruising around in a Porsche Taycan Turbo S.

Nevertheless, I find it hard to justify the notion of buying a new car, and in this post, I’ll talk about the (many) reasons why that is.

my current car is more than fine

I currently drive a 2012 Ford Focus that my dad used to have. It’s got just over 127,000 miles, but Ford’s terrible tranmission aside, I really don’t see any reason why it couldn’t surpass the 200,000 mark (which seems to be the new standard for longevity). I’ve developed a weird kind of emotional bond with it that makes me want to see it go the distance, though my car is also nicer than your standard Focus. My dad had the foresight of giving me a car that could parallel park itself (something that never ceases to amaze others in the passenger seat), and I don’t really care much about Tesla’s 15” touchscreen as long as Bluetooth does its job. In a world without new cars, I’d honestly be content with my existing car; the desire to upgrade to something new is merely a function of other, newer products coming onto the market.

people suck at “affective forecasting”

I’m currently in a fantastic positive psychology class [1], and one of the most important takeaways I’ve gotten out of it so far is that people aren’t good at forecasting the emotional effects of future events (affective forecasting), in fact there’s a general bias toward overestimating the emotional impact that an event will have (the impact bias, I’d highly recommend skimming the Wikipedia article and reading this post by James Clear).

Back to cars and personal finance: a new car (let’s say a Tesla Model 3) probably wouldn’t make me as happy as I think it might. Sure, it’s fun to rocket from 0-60 in 3.2 seconds, or to use Autopilot for a long road trip, but as far as the way I actually use my car - weekly grocery trips to HEB and the various trips across town to grab food or spend time with friends - a Model 3 won’t do the job that much better or faster.

cars are really expensive

The average price of a new car sold in the United States was just under $39,000 in December of 2019. That’s absolutely insane when you consider the case of a median household income of something around $62,000 (after accounting for payroll and federal income taxes, you’re looking at 9.6 months of “disposable” income).

For me at least, it’s hard to justify spending $50,000 or so on a new Model 3 when I know what else I could do with that. My current, in-college annual cash burn is about $20k or so, plus another $12k for rent. So a $50,000 car represents over a year and a half of every single last expense for my life. If you gave me $50,000 in cash, I certainly wouldn’t buy a Tesla - I’d probably spend a month somewhere in Colorado and spend a few weeks hiking and biking with friends (and then pocket the rest of the $46k). I bet that that’d be far more memorable and happiness-inducing than having my car make farting noises everytime I tried to make a left turn.

nice cars have headaches of their own

My dad got a nice car back in 2015. Since then, he’s developed a habit of parking away from other people in parking lots, since he’s afraid of dinging the car doors. He spent a few hundreds of bucks on getting a clear bra in case anything chips the front. He’s obsessive with cleaning it, to the point that he pays $20 or so for an unlimited car wash pass. Tires are expensive, maintenance is expensive, insurance is… expensive.

I tried parallel parking my Focus one time and accidentally scraped a traffic pole. No biggie. I don’t car much about rock chips or car washing, I just vacuum the interior every now and then. I can park at the front of the HEB parking lot if I find a space - if someone hits my car when opening the door, it’s whatever. Cars are tools. Use them.

new cars have the steepest depreciation

I’m not sure why, but people that I’ve talked to have a really strong aversion to buying things used. I’ve bought my laptop and phone and watch used; they work fine. I got my car used (from my dad), and it hasn’t yet exploded in the garage or left me stranded on the side of the road. I’m not really sure why there’s such a strong pull toward a new car, to be honest.

Car depreciation (the loss in your car’s value with time and mileage) is super steep, especially at the beginning. NerdWallet’s article sums it up best:

“Your car’s value decreases around 20% to 30% by the end of the first year. From years two to six, depreciation ranges from 15% to 18% per year, according to recent data from Black Book, which tracks used-car pricing. As a rule of thumb, in five years, cars lose 60% or more of their initial value.”

What’s the value in buying a new car over a used car? Taking the example in the chart above and doubling it for my $50,000 Tesla, is it worth $24,478 to get a 3-year newer car with no miles on it? If I were to crash my car tomorrow, the jump from a Ford Focus to just about any Tesla will be larger than the jump from a MY2018 Model 3 to a MY2021 one [2].

What I’ll do when it’s time to buy a car

There’s a bunch of different ideas on how much one should spend on a used car. I’ve heard various rules of thumb tossed around like the 20/4/10 rule, but I’m not yet fully sold on that yet (at the very least, it’s probably much better than what your average car buyer is doing). It’s very likely I’ll end up buying a 3-year used Model 3 when I do eventually decide to give up the Focus - but it’ll hopefully be quite a while before that happens.

[1] There’s an absolutely marvelous talk by Dan Gilbert on some of our decisions biases that I’d highly encourage everyone to watch.

[2] This is pretty imperfect, since Teslas in particular hold their value somewhat better than other cars, and the fact that a MY2018 Model 3 would be super early as far as production goes, which makes reliability much more suspect.

Gross Salary vs. Take-Home Income

My friends are unfortunately being forced to recruit at what’s probably the worst time in a decade, and it’s honestly awful. Career fairs are being replaced with awful abominations of Zoom calls and Q&A sessions; the recruiting pipeline is drying up, and even the biggest firms on the market are hesitant to recruit.

Don’t feel too bad for them - most of them are still CS majors, and I’m sure that they’re doing better than 90% of the country right now. A few of my friends have started to get their offers in, and some of the numbers are pretty staggering. The lowest base salary that I’ve heard so far is over $100k, which, needless to say, is a lot of money for a 22 year old to make right out of a state school (Hook ‘em Horns!).

The catch is that while the gross salary number sounds really attractive, the reality is that their paychecks won’t be remotely as extravagant as their imaginations might desire. Here’s what happens to a “standard” $120,000 salary in San Francisco:

After taxes, you’re taking just under $3,000 home every two weeks.

That seems pretty crazy to me, honestly. Over 35% of the salary is lost to taxes, which brings each of the 26 paychecks to $2,964.19. On top of that, this person hasn’t actually saved any money yet. Let’s pretend that this person is really on board with saving money for an earlier retirement/more freedom later in life, and puts away the full $6,000 a year toward a Roth IRA, and the full $19,500 a year toward a Roth 401(k). Alternatively, perhaps our worker is trying to pay off their student loans quickly - in any case, $25,500 is gone each year, post-taxes.

After saving $25,500 a year in a Roth 401(k) and a Roth IRA, your paycheck drops under $2,000.

We’re now at $1,983.42 each paycheck, or a hair over $4,000 a month. Median rent in SF was well beyond $2,500 pre-COVID for a one-bedroom apartment, and we still haven’t covered the basics of transportation, groceries, etc. Donating to charity seems tough with these case prices and savings rates.

Going remote: life in austin

I decided to run similar numbers to show how things change in Austin (seeing as it’s a favorite destination for people leaving the Golden State, and the fact that it’s home to UT). In short - no state income tax, no local income tax, and no state insurance taxes puts almost $1,000 back in your pocket each month:

Just over $2,400 in each paycheck now.

Austin median rent for a one-bedroom apartment is about $1,280, which is a downright bargain by comparison. That creates a ton of headroom for tacos, entertainment, transportation, and the rest.

explore more

I used this calculator to run through all of the numbers - it’s certainly worth playing around with.

gross salary, take-home, and discretionary income

The major point of all of this is to show just how different three numbers can be: (1) your gross salary, which is (loosely) what your offer letter says you make, (2) your paycheck after taxes are deducted, which is what I refer to as take-home pay (and others call disposable income), and (3) discretionary income, the amount of money available for you to actually use after covering things like food and rent. Where you live has a huge effect on how much of your gross salary you get to actually enjoy.

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.