Four Stages of Financial Development

by Stephanie Stern

My friend Mark is the type of person who regularly reads the business section of the newspaper, and I often go to him for financial advice. He has a well-paying job and owns a house. So I was surprised to learn recently that he didn’t start out being very knowledgeable or responsible with his money. In fact, Mark started out with credit card debt and car payments, just like many of us. Since then, Mark’s way of thinking about money has shifted as he has learned more and entered new stages of life, or “stages of financial development” if you will.

Mark was lucky coming out of undergrad — he was a computer science major and got a job in software. His starting salary was more money than his father had ever made, but he naively thought this meant that he didn’t have to worry about money, so he bought a new car and quickly racked up a large credit bill even before he’d received his first paycheck. When the bill came due, he knew he was in trouble and immediately started a budget spreadsheet; this was the beginning of his financial education. Then, at his first post-college job, his company brought in a financial expert to talk to employees about retirement accounts, and Mark figured he should start saving.

Most of us don’t have financial gurus to turn to, or companies that bring in financial experts, and we’re left figuring it out on our own. Looking at Mark’s life to-date (he’s in his mid-30s), I can see how his attitude about money has changed as his income has increased and his priorities shifted. Coupled with some philosophies from a few personal finance gurus, perhaps there are a few stages of financial development to go through to figure out this money stuff.

Stage 1. Can You Save (Even a Little)?

Reading about personal finance, you often run into people telling you either not to buy coffee because it’s a small cost that adds up, or railing against this restriction. This idea, the Latte Factor (coined by David Bach),refers to the fact that if you spend a small amount of money on something regularly (like a latte, but it could be something else, like eating a meal out rather than cooking, or taking a taxi rather than the bus), the expense actually costs you a lot in the long run.

Not only does the actual dollar amount add up, but, if you had invested that money instead, you would also earn interest. For example, if you saved $4 a day by forgoing lattes, that adds up to over $1,460 a year, which (assuming a 6% interest rate), could be over $120,000 in thirty years. (There’s a good summary of the idea and math here.) Mark started off small, as did I when I started off working. I still spend money on coffee, but really, the Latte Factor is a lesson that everyone can save, and even a little bit can add up. Also, it’s best to start early so that you can reap the benefits of compounding interest overtime.

But it’s not always about lattes, either. Don’t sweat the small stuff until you’ve taken care of bigger issues: If you’re not earning enough money, coffee-cutting won’t help you — negotiating a higher salary will; getting adequate health care will do you more financial good than focusing on lattes — the number one cause of bankruptcy in America is due to medical bills, not overspending.

Stage 2. Should You Learn the Basics? (Yes!)

Once you’ve started being able to save a bit, where do you put it? And, if your employer offers a retirement account, should you do that? These are the type of questions that Mark faced in his first job, as did I. Mark turned to a coworker of his and asked for advice, and subsequently started a Roth IRA. Having contributed to it every year over the past decade that he’s been working, he now has over $100,000 saved for retirement.

The Billfold recently read Suze Orman’s The Money Book for the Young, Fabulous and Broke for a book club reading. Though Nicole fairly critiques this book, it does cover some good basics, such as building an emergency fund, paying off debt, retirements accounts, and buying a home. Orman’s advice is basic. The New York Timessummarizes it well: “Track your spending. Stay out of debt. Take care of your car. Look into a Roth IRA. Though she is larger than life and wealthy, her primary message is not about larger-than-life ambition or a sky-high entrepreneurial spirit. Orman’s advice rarely sounds like ‘Go West, young man.’ It sounds more like, ‘Everyone should have a liquid eight-month emergency fund.’”

There are other basic books out there, but the lesson in this life stage is, if you are supporting yourself, you should learn the difference between a Roth and a Traditional IRA. You should know if you are taking advantage of your employer’s retirement benefits. If you have debt from credit cards or student loans, you should figure out what the right order to pay them back is (it depends on your interest rates). If you do nothing and avoid dealing with your money, you are missing out. Because of inflation, your money loses value if you do not invest it. This information isn’t for “other people”- it’s for you, for all of us.

Stage 3. What Do You Want to Spend Money On?

Mark has a habit of spending too much money on nice dinners. At first he felt bad about it, but eventually he realized he has enough money to spend on this, and this is exactly the type of life pleasure that it worth the money to him. This is the next stage of development: once you have covered your basics, what do you think is important to spend money on?

Ramit Sethi’s philosophy (of I Will Teach You to Be Rich) is that you should be able spend money freely on things that are important to you. For example, he wants to be able to treat his friends to a round of drinks without worrying about it. To achieve this, he recommends cutting down or eliminating costs that are not giving you value, especially focusing on “big wins” like negotiating your rent and cell phone bill (because they are monthly expenses, a lower price will keep saving you money). After that, Ramit suggests earning more money on the side. It is hard to figure out how much money is enough, but the point of this developmental stage is to realize what is important to you to spend money on, and, instead of feeling bad about it, figure out how to make it happen.

Stage 4. The Big Question: What Do You Want to Do with Your Life?

A few years ago, Mark started reading Mr Money Mustache’s blog. His philosophy is one of “financial freedom.” Mr. Money Mustache has made some extreme life choices: he and his wife saved very aggressively (over half of their income) in the first 10 years of their career in order to essentially retire, live a frugal lifestyle, and spend more time with their family. Most of us aren’t able to literally follow in these footsteps and retire by the age of 30, but the concept of financial freedom is an interesting one.

It’s also advanced; this is not a life stage that I think most people get to, and certainly not by their mid-30s. But, I think there are some good questions here about what is important to you in your life, and good lessons about the value of money. Like Sethi’s philosophy, it’s prioritizing things that matter, while being frugal about everything else.

For Mark, financial freedom means saving a bit more aggressively now, while he’s making a good income, in order to buy himself the freedom to change careers and do something that pays significantly less in the future, or even take a risk and start his own company.

Right now, I’m between stages 2 and 3, still learning more basic and figuring out what is worth spending on the money on and how much to save for the future. Yet, thinking about stage 4, financial free, is an important lesson to value the freedom that saving money can eventually buy. This freedom allows me to dream a bit bigger for the future. Of course, everyone’s choices will vary based on circumstances, not to mention personality and priorities.
What stage do you think you’re in?

“The Grindstone” is a series about how we work today by Billfold writers Leda Marritz and Stephanie Stern. Looking for advice? Want to see a specific issue covered in the future? You can email them here.

Steph Stern works in energy and environmental policy in the San Francisco Bay Area. She writes about careers and life choices at Small Answers (or follow on Twitter: @smallanswers).

Photo: Son of Groucho

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