The 5 Pillars of Personal Finance

Personal finance can be intimidating, but it doesn’t have to be complicated. Making the most of your money starts with five building blocks, or the 5 Pillars of Personal Finance: (1) Earn, (2) Spend, (3) Borrow, (4) Save and Invest, and (5) Protect.

1. Earn

The ability to make more money is the single most important tool in your personal finance toolbox, especially when you are younger. When you’re young, the money you earn from your job is disproportionally large compared to the money you earn from other sources, like your investments.

Earning more money increases your cash flow, which gives you more money to save, invest, or pay down debt.

So, what can you do to make more money?

1.1. Job and Career

Having a job is a good start, but the important thing is to have a job with a growth prospect. A common trap that many people falls into is to become complacent with their job. You don’t want to be content just earning the next paycheck. That is not good enough! Always look for ways to work toward a promotion, or to gain new skills to help you find a better job.

If you can’t answer YES to any of the following questions, it is time to reevaluate your current job.

• Are you getting a promotion every 2-3 years?
• Are you learning new skills regularly?
• Are you getting above-average pay raises?

Regardless, it is a good idea to have an up-to-date resume, always be on a lookout for a better opportunity, and apply for that new job whenever you see one.

Here are some tips on how to aks for a pay raise and earn more from your current job.

1.2. Extra Income

Your job is not the only way to make money. We are living in a gig economy where people are doing side hustles like driving Uber, creating content for the web, making YouTube videos, etc. However, some of these are easier than others; and typically, the more rewarding ones take a much longer time to start up and you need to be persistent.

Ever since I started my first job, I always look for ways to make extra money on the side. To help you get started, here is our Extra Income Guide. The key to success is to wisely trade your time for money and keep moving toward more scalable and passive income sources.

1.3. Business Ideas

Thirdly, you might want to think about traditional business ideas that you can pursue to make more money. Granted, this is not for everyone because it takes knowledge, guts, and usually a big financial commitment. However, this is how many millionaires are made. Also, there are businesses that you can start as a side hustle and eventually turn them into a full-blown business.

Some of the more common businesses include:

• Food services, e.g., restaurant, bar, cafe, bakery, etc.
• Retail store, or online store
• Handyman services
• Yard maintenance services
• Cleaning services
• Bookkeeping

1.4. Investing

Last but not least, is investing. Investing is a big subject which we will discuss later. Here, I just want to note that investing for current income is a legitimate way of making money. However, it is listed last because your finances have to be well established for investing to generate any meaningful income.

The three most common ways to invest for current income are:

• Dividend investing using high dividend stocks and funds.
• Income investing with bonds.
• Real estate investing for cash flow with REITs or rental properties.

2. Spend

The second important part of your personal finances is managing your expenses. This is part of the key principle of “Spend less than you earn”. To better manage your expenses is to know where you’re spending money (e.g., budgeting), spend money wisely, cut out any unnecessary expenses, and minimize your taxes.

2.1. Budgeting

Budgeting is basically keeping track of your income and expenses, and using the information to keep your expenses below your income (i.e., “spend less than you earn”). Budgeting group expenses into different categories to make it easier to identify expenses that can be lowered or eliminated.

Here are sample budgeting categories and the ideal percentage of your total expense for each category to get you started. Be sure to customize it to fit your specific situation.

It is best to go through the full past 12 months of expenses so that you don’t miss any annual charges like membership fees, credit card annual fees, account annual fees, etc.

2.2. Smart Spending

Smart spending is all about building good habits to spend the least amount of money for the same products and services you normally use. These include:

• Comparison Shopping – this can be shopping among different stores for the same item, or choosing a cheaper version of the same item, e.g., buying store brand instead of name brand.
• Clipping Coupons and Using Coupon Code – whether you clip physical coupons, or using one of the many online coupons sites, they can save you several percentages off the normal price. For example, I have the Rakuten extension installed on my browser which automatically activates when I shop online.
• Cashback Reward – it is also worthwhile to use your credit card to get some cashback, especially if you can use a 5% cashback credit card.
• Waiting for a Discount – If you are thinking about buying something but you can wait, it is usually worthwhile to wait for one of the big sales events so you can get a discount.
• Buying in Bulk – Depending on your family size, you might be able to take advantage of bulk purchases to save you money.
• Set Up Autopay – Set up autopay for your bills to avoid late fees. If you’re in the position to pay with a credit card without having to pay a credit card surcharge fee, go ahead and pay with your cashback credit card.
• Price Protection – lastly, if you buy something pricey, it is worth checking back in a week or two to see if there is a price drop.  You can also try a free service from Paribus.co. I saved over $200 last year when Home Depot dropped the price on floorings I purchased and Paribus sent me an alert.

2.3. Expense Reduction

Once you have a budget set up, you’ll have a better idea about where your money is going. Now you can apply some basic expense reduction techniques to help you reach your target.

2.3.1. Big Expenses

First, look at your most expensive categories. These are usually housing, transportation, and groceries for most people.

• Housing
  • If you are renting and the lease is about to end, could you move to a less expensive house or apartment?
  • If you are a homeowner, can you refinance to lower your monthly payment?
• Transportation – Do you need that shiny new car? Maybe all you need is a reliable used car that can get you from point A to point B.
• Groceries – There are a few things you can do to reduce your groceries expenses: (1) shop around for less expensive alternatives, (2) limit food waste, e.g., don’t buy too much and don’t make too much, (3) use up items in your pantry and freezer, and (4) buy in bulk when it makes sense.

2.3.2. Recurring Expenses

Next, review your recurring expenses. Most people will be able to save money by finding a better deal, or eliminating, these expenses:

• Home and Auto Insurance – If your policies are more than 2 years old and you haven’t shop around, I bet you can save several hundred dollars off your home and auto insurance premiums. My most recent refresh of 11 policies saved a total of ~$1,800!
• Cable and Internet, especially if you have many different premium subscriptions.
• Cell Phone Plan
• Memberships and Subscriptions, e.g., gym, club, magazines, Audible, Amazon Prime, etc.
• Childcare

2.3.3. Discretionary Spending

If the above two techniques do not save you enough money, then you have to cut out your discretionary spending. These includes:

• Eating Out
• Snacks and Beverages
• Entertainment
• Hobbies
• Express Lane Tolls

2.3.4. Debt Payments

We will explore this topic in more detail below. In the meantime, what you need to know is some debts are bad because you are paying very high interest on the amount you owe every month. If you pay down these debts, the money you freed up from paying interest could be used for more productive things like saving and investing, or improving your quality of life.

Tip: Now that you have your expenses organized and declutter, it is also a good idea to physically declutter your house. You sell stuff that you don’t use or need for some extra money, and donate what you can’t sell.

2.4. Taxes

Taxes are mandatory expenses, but there are ways to keep them as low as possible.

First, let’s get the biggest misconception out of the way — getting a big refund check is NOT a good thing. When you get a big refund, it means you are paying too much taxes with each paycheck (aka, less money for you each paycheck). Think about this, you are giving the government a tax-free loan, and having to ask them to get your money back! If you normally get a refund check, work with your HR to reduce your tax withholding from each paycheck.

Second, if your budget allows you to do so, consider doing the followings:

• Contribute to your HSA account. Your contribution is tax-deductible, and you can money for eligible medical expenses tax-free or keep investing the money for future use.
• Contribute to your 401(k) account. Your contribution is tax-deductible.
• Contribute to your Dependent Care FSA account if you have eligible childcare expenses. Your contribution is tax-deductible, but any unused amount is lost at the end of the year.
• Contribute to your Healthcare FSA account if you don’t have access to an HSA account. Your contribution is tax-deductible, but any unused amount is lost at the end of the year.

Third, if you invest in a taxable account, you could look into tax-loss harvesting.

Fourth, if you are self-employed, you could set up an S Corp and put yourself on the payroll. This allows you to do two things:

1. You can pay yourself a salary at a reasonable amount, but lower than your total self-employment income. This allows you to pay Social Security and Medicare taxes on your salary only. Any excess income can be distributed from the corporation to you without subject to self-employment tax.
2. You can set up a small business retirement account like a Solo 401(k), SIMPLE IRA, or a SEP IRA. This allows you to contribute a large sum of money that is tax-deductible.

3. Borrow

Now that you have income and expenses in order, it is time to look at your debts — understand the difference between good debts and bad debts, and put together a strategy to pay down your bad debts and eventually pay off your good debts.

3.1. Borrowing

You can live without borrowing any money, but borrowing money is not necessarily a bad thing. The problem most people get into is they borrow too much and for the wrong reasons.

3.1.1. Credit Cards

The important things to know about credit cards are

1. you should strive to pay in full each month, and
2. you don’t need more than 2 or 3 cards.

A common misconception about improving your credit score is that you need to have many different credit cards and you need to carry a balance on these cards. Take it from someone with a very high score that this is completely false.

First, you should strive to pay in full each month. Carrying a balance doesn’t guarantee you anything except (1) costing you money in interest expenses, and (2) digging you deeper into debt. If you can’t pay in full each month, consider using cash or a debit card instead. At least, you won’t be accumulating debt.

Second, having a few cards make it easy for you to keep track of everything and minimize the chance of missing a payment which costs you money, and lowers your credit score. For me, I just have two cards for personal use (e.g., Amazon Visa and Costco Visa) and a business Amex card.

The only two exceptions are:

• You are doing credit card arbitrage where you take advantage of 0% introductory rate and balance transfer offers to earn interest on the money you’d otherwise use to pay down your credit card debt, or
• You’re trying to get all the signup bonuses.

Although, I personally don’t think these are worthwhile activities and they could also put your credit and finances at risk.

3.1.2. Home Loan

Taking out a home loan is a big decision. As a general rule of thumb, you shouldn’t buy a house if your monthly mortgage payment is going to break your budget — you don’t want to be house poor! When deciding between buying vs renting, there are many more factors to take into consideration.

If buying is the right option for you, it is worthwhile taking the time to understand the ins and outs of the home buying process and different home loan options. There are many home loan products out there to enable almost anyone to buy a house.

In general, good loans have the following characteristics:

• Lower interest rate
• Lower lender fees (which you pay at the time of your purchase)
• No Private Mortgage Insurance (PMI)

You might forego one of these characteristics if buying with the less ideal loan still save you money over renting.

3.1.3. Student Loan

America is in a student loan debt crisis. Yes, expensive private colleges are partially to blame; but, the students and their parents are equally responsible. I think there is an overall false belief that you have to go to a prestigious 4-year college to be successful, but that is not true at all. There are so many ways to have a successful career without getting in over your head in student loan debt.

Just like anything else, you need to do financial planning when you make decisions about your education. As a general rule of thumb, your total student loan debt should be less than your annual salary.

What are some of the things you could do to minimize your student loan debt:

• Consider vocational careers. Believe it or not, you don’t need a 4-year college degree to have a satisfying career and make good money doing it.
• Choose a marketable degree.
• Take more classes each semester. As a full-time student, you pay the same whether you take 4, 5, or 6 classes per semester. You just have to make sure you can handle the workload.
• Shop around for a less expensive school. If you want a degree from a prestigious school, you could go to a less expensive college and transfer in your junior year to the desired school.

These are just some ideas to minimize your student loan debt.

3.1.4. Car Loan

This is another area where most of us spend more than we should. Car companies are really good at enticing us to buy the latest and greatest cars, and for many people owning nice cars is a status symbol.

Next time you’re thinking about buying a new $30,000 car that you have to pay $540 a month for the next 60 months, ask yourself if a $10,000 used car can do exactly the same thing at one-third of the cost to you.

Here is an article to show you how to spend less money on cars.

3.2. Debt Reduction

If you follow the guide to increase your income and reduce your expenses, you will be in a good position to start paying down your debt.

Before you start paying down your debt aggressively, you want to have a small emergency fund on hand. You don’t need the full 3-6 months worth of living expenses, just about a $1,000 is enough. You can always fall back on your credit cards if needed.

Similar to your budget, you want to organize your debts into different groups. Here is the general strategy.

• Credit Cards – (1) Call each card provider and see if they will lower your interest rate, (2) balance transfer from the highest interest cards to a new card that offers 0% APR on balance transfer, (3) for the remaining cards, pay the minimum amount due for all the cards but pay as much as you can on the highest interest card.
• Car Loans – if your interest is higher than 5.25% (e.g., national average for a car loan), check with local banks and credit unions to see who can refinance your car loan. For example, my local credit union offers 2.14% to 2.99% for auto refinance.
• Student Loans – First look into student loan forgiveness options. Certain student loans can be forgiven under the right circumstances. Second, look into doing consolidation and refinancing options. Make sure you shop around to find the best option for you, whether that is the lowest possible monthly payment or lowest total life-time interest. If you have credit card debts and/or car loans, the lowest possible monthly payment is typically best so that you will have more money to pay off those expensive debts faster.
• Home Loans – Typically, this is the least expensive debt with the most tax benefits. The best thing to do is to refinance to the lowest possible rate without paying too much closing costs or adding too many years to the loan term, and then pay just the minimum each month until you pay down all other debts above.

It is important to understand that you don’t necessarily want the lowest interest possible, but the lowest monthly payment possible at a reasonable interest rate. This way, you can free up more cash to pay your most expensive debt as quickly as possible.

3.3. Your Credit

Whether you borrow money or not, your credit matters. In addition to being a critical factor when you’re applying for a loan, it impacts your ability to rent a property or get hired for certain jobs.

First, you can use free credit score websites to check your current scores (there are several different but very similar scoring systems). When you have your number, you can see if you have a good credit or not.

Next, check your credit reports for free at AnnualCreditReport.com. Get just one report initially and wait four months before you request another one from a different bureau.

Now you know where you stand, and you can take steps to improve your credit score.

4. Save and Invest

4.1. Emergency Fund

If you follow along so far and able to spend less than you earn, you are in the position to save and invest — congratulations!

The first thing to do is to save up 3-6 months of living expenses so that you have money to fall back on for emergencies, and during times of crisis. Keep this money in a safe and accessible place like a high-yield savings account. Do not invest the money in the stock market where short-term fluctuations could decrease the amount of money that you have, or in a CD where the money is inaccessible for the term of the CD.

4.2. Financial Planning

Once you have your emergency fund saved up, it is time to making a financial plan. This plan incorporates short-term and long-term goals. Some of these goals include:

• Saving for Retirement
• Saving for College
• Down payment for large purchases

To achieve these goals you need to figure out a few things:

• When do you need the money?
• How much money do you need?
• How much money do you need to save to accumulate the desired amount?
• What is the best investment to help you reach your goal?

For example, your goal might be to save $60,000 down payment for a house within 5 years. Since 5 years is a relatively short time, you probably want to use safer investments like a high-yield savings account or a CD ladder. The interest you earn will be relatively insignificant, so we can just figure out the amount you need to save each month by taking $60,000 divided by 60 months (5 years), thus you need to save $1,000 a month to reach your goal.

Another common goal is saving for retirement. Let’s say you want to have $1 million by the time you turn 65. Let’s say you’re 25 now. This means you have 40 years to get to $1 million. Since 40 years is a long time, you can afford to take more risks and invest in the stock market for the higher average return. Using a simple calculator at Edward Jones, one way you could accomplish this is to invest $500 a month every month for 40 years and earn on average 6.5% a year (which can definitely be done in the stock market).

4.3. Investing

To get started with investing, you need to learn the basics; so it is a good idea to pick up a few good books about investing.

4.3.1. Investment Accounts

In a nutshell, there are four accounts you can start investing in, and you should invest in the order listed below:

• HSA
• 401(k)
• IRA
• Brokerage Account

HSA

HSA is the best account you can invest in since contributions are tax-deductible and withdrawals are tax-free. On top of that, it can double as a retirement account.

To get started, ask your company if HSA is offered (if not, you’re out of luck). If it is offered, work with your manager and/or HR to set it up. You will set up a deduction from your paycheck to contribute to your HSA account. Your basic HSA account will look like a savings account, but you will have access to an investment account once you deposit enough money.

In your investment account, you can choose to invest 100% in a target retirement fund (if available), or invest in three funds consisting of 70% US Stocks, 20% International Stocks, and 10% Bonds (depending on what is offered). This is just to get you started. As you learn more, you can do a better job of choosing your funds and asset allocation.

401(k)

A 401(k) is normally offered by companies, so ask your manager if you have one. If you do, work with your manager and/or HR to set up a plan. An amount of money will be deducted from your paycheck each pay period, and you will have to direct the plan to invest your contribution in the investments you selected.

Similar to your HSA, you can choose to invest 100% in a target retirement fund (if available), or invest in three funds consisting of 70% US Stocks, 20% International Stocks, and 10% Bonds (depending on what is offered). This is just to get you started. As you learn more, you can do a better job of choosing your funds and asset allocation.

IRA

Before you open an IRA account, it is a good idea to review your finances with your tax advisor and see how much you can contribute to a Traditional IRA vs a Roth IRA. For most people, a Roth IRA will be a better fit.

Once you figure out how much you can contribute and what type of IRA, you can open an account with a stockbroker. If you’re new, I recommend that you talk to Schwab or TD Ameritrade where they will be able to help you better than the smaller brokers or banks.

Once your account is established, you will have to choose how your money is invested. Similar to 401(k), you can start off by investing 100% in a target retirement fund, or invest in three funds consisting of 70% US Stocks, 20% International Stocks, and 10% Bonds.  However, use ETFs in your IRA instead of mutual funds.

Again, this is just to get you started. As you learn more, you can do a better job of choosing your investments and asset allocation.

Brokerage Account

If you contribute the maximum amount allowed to all the accounts that is available to you above, and you still have more money to invest, then you need to open a Brokerage Account.

You can open a brokerage account with any stockbroker. For this, I recommend M1 Finance. Here, you can deposit any amount you want, whenever you want. You can also choose to invest in mutual funds, ETFs, or individual stocks.

If you’re a beginner, sticks with the investment plan above. As you learn more, you can adjust your asset allocation and asset location accordingly.

4.3.2. Key Investing Concepts

Asset Classes

It is probably easiest to imaging your investment portfolio (either in one account or aggregated across all of your accounts) as a pie.

The pie is then cut into 5 slices of different sizes, where a slice represents an asset class: Stocks, Bonds, Commodities, Real Estate, and Cash.

Each slice can also be further divided into smaller slices to represent a distinct subset within that group. For example:

• Stocks can be divided into US vs non-US and/or Large Cap vs Small Cap
• Bonds can be divided into US vs non-US and/or Government vs Corporate
• Commodities can be divided into precious metals, energy, and agricultural products
• Real Estate can be divided into residential, commercial, and other specilized real estate businesses
• Cash

Obviously, there are many different ways to “slice a pie”. As you learn more about asset classes and as your portfolio grows, you can diversify your portfolio in defferent ways.

The basic idea here is that you want to invest in different asset classes to diversify your risk.

Asset Allocation

Asset Allocation is how you are cutting up the pie, specifically what percentage of your portfolio is invested in different asset classes. Below are three sample portfolios. In a more conservative portfolio, you’d invest a bigger portion of your portfolio in bonds which is a less volatile asset class.

The key point here is investing can be as simple as choosing the right asset allocation and pick out an ETF to represent each slice of the pie.

For a more in-depth discussion of asset allocation, check out: Asset Allocation, Diversification, and Rebalancing.

Dollar-Cost Averaging

Asset Location

Withdrawal Strategy

4.4. Real Estate

• Primary residence
• Real estate investing

5. Protect

5.1. Insurance

Insurance are products designed to help you protect against loss and liability. There are so many insurance products out there that it is hard to list everything here. The important thing is

1. You need to have the four basic insurances for life, health, auto, and home, and
2. Don’t use an insurance product as a substitute for saving and investing (despite what the insurance agent tries to sell you).

5.1.1. Life Insurance

There are many flavors of life insurance products to fit every situation…or is it to confuse the heck out of your average joe consumers? Anyway, if you have someone that depends on your income, you should have life insurance. To keep it simple, there are two main types of life insurance: Term Life vs. Permanent Life.

You should buy a term life insurance with a term that is long enough to take care of your dependents. For example, I bought my first policy about 10 years ago when my son was born. I bought a 30 years term life insurance which will take care of my wife and son if I die prematurely. Due to changes in life circumstances, I bought a 20 years term life policy 5 years later to provide additional protection for my family.

On the other hand, permanent life insurance has very high premiums relative to term life insurance, and I prefer to buy term life and invest the difference.  For some people, a small permanent life insurance policy might be a good idea, for example, to cover final expenses.

5.1.2. Health Insurance

5.1.3. Auto Insurance

5.1.4. Home Insurance

Other Insurances, e.g., Long-term Care, Annuity, Disability

5.2. Identity Protection

• Use aggregator software like Personal Capital to track transactions so that you can do a daily or weekly review. If you see any suspicious transaction, you can follow up and take the necessary action like disputing the charge or reporting the theft to the financial institution.
• Set up alerts on your credit cards and bank accounts to notify you when a large purchase or a large withdrawal is made.
• Use free credit score monitoring sites like Credit Karma or Credit Sesame to review your credit score and get email alerts when there are changes.
• Use AnnualCreditReport.com to pull one credit report every 4 months. There are three credit bureaus and you can get one free report per year each. If you stagger the pull every 4 months, you can regularly monitor your reports.
• If you do not plan to get a loan, you can also call credit bureaus to freeze your credit.
• Sign up for online bill pay and paperless statements to minimize paper bills and statements.
• Properly store away or shred paper bills and statements. When they are no longer needed, shred them along with any junk mails that contain your name and address.
• Make your passwords harder to guess and store them in a safe location.

Pinyo Bhulipongsanon

Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.