The Little Book of Main Street Money

1. Your Financial Life is Bigger Than Your Brokerage Account

Our finances are far, far larger.

Holistic View. Your financial picture extends far beyond just your investment accounts. It includes your human capital (earning potential), Social Security, pensions, debts, and future goals. For example, a young professional with a secure job has a valuable asset in their future earning potential, which should influence their investment strategy.

Human Capital as an Asset. Think of your ability to earn income as a bond that pays you regularly. This "human capital" is a significant asset, especially for younger individuals. A 22-year-old with a long career ahead of them should invest more aggressively in stocks to diversify their "bond-like" income stream, while a retiree with a fixed pension might favor a more conservative approach.

Leverage and Debt. Debts, like mortgages and credit card balances, act as "negative bonds," costing you interest. Understanding how debts leverage your entire financial picture is crucial. For example, paying off high-interest credit card debt can be a better investment than earning a modest return on a low-yield bond.

2. Trade-offs Are Inevitable: You Can't Have It All

Everything’s a tradeoff.

Limited Resources. Every financial decision involves a trade-off. Spending on one thing means less available for something else, whether it's a vacation, a new car, or retirement savings. For example, choosing an expensive car lease means less money for a summer vacation or for savings.

Prioritize Goals. Since you can't do everything, you must prioritize your financial goals. For many, this means focusing on retirement savings first, even if it means scaling back on other goals like a bigger house or fully funding children's college. For example, starting retirement savings early, even with small amounts, can have a much greater impact than delaying and trying to catch up later.

Concurrent vs. Consecutive. Instead of tackling goals one after another, address them concurrently. This means saving for retirement while also considering other goals, rather than waiting until later in life. For example, starting retirement savings in your 30s, even while paying for a home and children's education, is more effective than waiting until your 50s.

3. Money Can Buy Happiness, If Spent Carefully

Money can buy happiness—if we spend it carefully.

Experiences over Things. Spending money on experiences, like travel or concerts, tends to bring more lasting happiness than buying material possessions. Material items often lose their appeal quickly, while experiences create lasting memories. For example, a family trip to a national park will likely provide more lasting joy than a new gadget.

Counteract Adaptation. We quickly adapt to new things, so the initial thrill fades. To counteract this, celebrate achievements, display photos of good times, and take time to appreciate what you have. For example, framing vacation photos can help you relive the experience and extend the happiness it brought.

Purpose and Connection. True happiness comes from a sense of purpose and strong relationships. Focus on activities that give you a sense of accomplishment and spend time with loved ones. For example, volunteering, coaching a sports team, or spending time with family can provide a deeper sense of satisfaction than material possessions.

4. Great Savers Outperform Great Investors

Give me a choice between some savvy investors and some diligent savers, and I’d bet on the savers every time.

Savings as the Foundation. Consistent saving is more crucial to long-term financial success than trying to pick winning investments. Even if you're not a market expert, diligent saving will build wealth over time. For example, saving 20% of your income consistently will likely have a greater impact than trying to beat the market by a few percentage points.

The Power of Early Savings. Starting to save early in life makes it easier to reach your financial goals. The earlier you start, the less you need to save each month, and the more time your money has to grow. For example, saving $400 a month starting at age 30 will result in a much larger nest egg than saving $760 a month starting at age 40.

Tax Advantages for Savers. The tax code is stacked in favor of savers, with various tax-advantaged accounts like 401(k)s and IRAs. These accounts allow your money to grow tax-deferred or tax-free, making saving even more beneficial. For example, a 401(k) offers an initial tax deduction, tax-deferred growth, and often a matching employer contribution.

5. Time is Your Most Valuable Financial Asset

The best day to start is today.

Compounding's Magic. The earlier you start saving and investing, the more time your money has to grow through the power of compounding. Compounding allows you to earn returns not only on your initial investment but also on the gains you've already made. For example, investing $100 a month at 5% will grow to $267,977 after 50 years, demonstrating the power of time and compounding.

Critical Mass. In the early years, your savings will be the primary driver of your portfolio's growth. But as your nest egg grows, investment gains will start to outpace your savings. For example, after 15 years, your investment gains may start to exceed the amount you save each year, accelerating your portfolio's growth.

Time as an Option. Starting early gives you more options later in life, such as the ability to switch careers or retire early. If you start saving early, you may have the option to work part-time or pursue other interests, while those who delay may be stuck in jobs they dislike.

6. No Investment is Truly Risk-Free

No investment is free of all risk.

Diversification is Key. All investments carry some level of risk, whether it's stocks, bonds, cash, or hard assets. Diversifying your portfolio across different asset classes can help reduce overall risk. For example, owning a mix of stocks, bonds, and real estate can help cushion your portfolio during market downturns.

Inflation Risk. Even seemingly safe investments like bonds and cash can be risky due to inflation. Inflation erodes the purchasing power of your money over time, so you need investments that can outpace inflation. For example, if your bonds yield 5% but inflation is 3%, your real return is only 2%.

Risk vs. Reward. Higher-risk investments, like stocks, offer the potential for higher returns, but also come with greater volatility. Lower-risk investments, like bonds, offer more stability but may not provide the returns you need to reach your goals. For example, stocks have historically outperformed bonds over the long term, but they also experience greater short-term price swings.

7. Asset Allocation Drives Portfolio Performance

Portfolio Performance: It’s All in the Mix.

Stock-Bond Mix. The most important decision you'll make is how to allocate your money between stocks and more conservative investments like bonds. This decision will heavily influence both your portfolio's short-term volatility and its long-term returns. For example, a portfolio with 70% stocks and 30% bonds will likely have higher returns but also greater volatility than a portfolio with 50% stocks and 50% bonds.

Time Horizon. Your time horizon should influence your asset allocation. Those with a longer time horizon, like younger investors, can afford to take more risk by investing more heavily in stocks. Those closer to retirement should shift to a more conservative mix with more bonds. For example, a 30-year-old might have 80% in stocks, while a 60-year-old might have 50% in stocks.

Rebalancing. To maintain your desired asset allocation, you need to rebalance your portfolio periodically. This involves selling some of your best-performing assets and buying more of your underperforming assets. For example, if your stock allocation has grown to 75%, you would sell some stocks and buy more bonds to bring your allocation back to 70% stocks and 30% bonds.

8. Stocks Represent a Share of Economic Growth

Stocks are worth something.

Ownership in Companies. Stocks represent partial ownership in publicly traded corporations. As these companies grow and become more profitable, their stock prices should rise, benefiting shareholders. For example, if a company's earnings grow by 7% a year, its stock price should also increase over time.

Earnings and Dividends. The long-term return of stocks is driven by corporate earnings growth and dividends. While short-term price fluctuations can be significant, over the long term, earnings and dividends are the key drivers of stock performance. For example, a company that consistently increases its earnings and pays a dividend is likely to provide a good return to its shareholders.

Long-Term Perspective. Focus on the long-term fundamentals of the stock market, rather than getting caught up in short-term price swings. During market downturns, remember that stocks are now cheaper relative to their earnings and dividends, which suggests better performance thereafter. For example, when the market falls, it's an opportunity to buy stocks at lower prices, increasing your potential for future gains.

9. Overcome Subtractions: Costs, Taxes, and Inflation

To add wealth, we need to overcome the subtractions.

The Triple Threat. Investment costs, taxes, and inflation can significantly erode your investment returns. Even if your investments earn a good return, you'll pocket far less if you're careless about these subtractions. For example, an 8% return can be reduced to 1.5% after accounting for costs, taxes, and inflation.

Minimize Costs. Choose low-cost investments, such as index funds, to reduce the impact of investment costs. High fees can significantly reduce your long-term returns. For example, a fund with a 0.2% expense ratio will likely outperform a similar fund with a 1.5% expense ratio over the long term.

Tax-Efficient Investing. Use tax-advantaged retirement accounts, such as 401(k)s and IRAs, to minimize your tax bill. These accounts allow your money to grow tax-deferred or tax-free. For example, investing in a 401(k) allows you to defer taxes on your contributions and investment gains until retirement.

10. Aiming for Average is a Winning Strategy

Aiming for average is the only sure way to win.

The Difficulty of Beating the Market. Trying to beat the market is extremely difficult, and most investors fail to do so over the long term. The market is efficient, and it's hard to gain an edge. For example, most actively managed mutual funds fail to outperform their benchmark indexes over the long term.

Index Funds as a Solution. Index funds aim to match the performance of a specific market index, such as the S&P 500. By investing in an index fund, you can capture the market's average return, minus a small expense ratio. For example, an S&P 500 index fund will provide a return that closely matches the performance of the S&P 500 index.

Relative Certainty. Index funds provide relative certainty, meaning you can be confident that you will capture the market's return, minus your investment costs. Active investors, who are trying to beat the market, can have no such confidence. For example, while an index fund may not provide the highest possible return, it will provide a return that is close to the market average, with a high degree of certainty.

11. Wild Investments Can Tame Your Portfolio

Wild investments can tame our portfolios.

Diversification Benefits. Adding volatile investments, like commodities or emerging market stocks, can actually reduce your portfolio's overall risk. These investments often move in different directions than traditional stocks and bonds, providing a cushion during market downturns. For example, commodities may perform well when stocks are struggling, helping to reduce your portfolio's overall volatility.

Long-Term Perspective. While these investments can be volatile in the short term, they can provide valuable diversification benefits over the long term. Don't focus on short-term performance, but rather on how these investments can help you achieve your long-term goals. For example, while commodities may experience sharp price swings, they can provide a hedge against inflation over the long term.

Rebalancing Opportunities. By rebalancing your portfolio regularly, you can take advantage of the differing performance of various market sectors. This involves selling some of your best-performing assets and buying more of your underperforming assets. For example, if foreign stocks have performed well and U.S. stocks have struggled, you would sell some foreign stocks and buy more U.S. stocks to bring your portfolio back to its target allocation.

12. Short-Term Results Matter to Long-Term Investors

Short-term results matter to long-term investors.

Compounding and Losses. Truly terrible short-term losses can have a devastating impact on your portfolio's long-term growth. The math of investing is brutal, and it takes a much larger gain to recover from a loss. For example, a 50% loss requires a 100% gain to get back to even.

Sequence of Returns. The timing of your investment returns can have a significant impact on your retirement. If you experience poor returns early in retirement, your nest egg may never recover. For example, if you retire just before a major market downturn, your portfolio may be severely depleted, making it difficult to maintain your desired lifestyle.

Cash Cushion. To mitigate sequence-of-return risk, retirees should hold a cash cushion equal to several years of living expenses. This allows you to avoid selling stocks during market downturns. For example, if you need $15,000 a year from your portfolio, you might keep $75,000 in cash or other conservative investments to cover your expenses for the next five years.

Last updated: January 28, 2025