As I was reminded repeatedly by TurboTax’s 2023 ad campaign called “Don’t Do Your Taxes,” most people would rather scale an icy mountain than file their taxes.

While I absolutely used to feel that way, too, I’ve come to love tax season as a time for reflecting on my financial progress, collecting forms like rare Pokémon, and poking around my tax software of choice, TaxAct (not a sponsor, but you should be!), for deductions I didn’t realize I qualified for. (The part where the software tells me I owe tens of thousands of dollars is my least favorite part, but it’s decidedly fun up until that point!)

So, we’re discussing three ways to lower your tax bill that I’ll highlight below, but I also wanted to cover a few bizarre forms you may encounter when you begin dabbling in the world of deductible contributions to qualified retirement plans. (This won’t be exhaustive, but they’re items Henah or I have personally come across after implementing our own strategies.) It can be scary the first time you hit a speed bump in the tax software that’s like, “Yo, you may have screwed this up!” 

Now, depending on how you earn and your access to retirement accounts and certain healthcare plans, it’s possible that all three of the options we cover today will be viable for you, but they all have one thing in common: 

They’re all legal ways to hold on to more of your income, instead of forking it over.

Crucially, these vehicles allow contributions made this year—in 2025—to be characterized as though they were made last year, in 2024. And at the risk of stating the painfully obvious: To take advantage of this, you have to have the cash available to invest. 

Which tax year should you select when making contributions in 2025 for 2024?

When you’re contributing to these investment accounts, they’re going to ask you which contribution year you’re electing. If you’re trying to ease your 2024 tax burden, be sure to select 2024! If you choose 2025, it’ll apply the contribution to next year’s tax bill.

The Traditional IRA and a few related fun formz

If you (and your spouse, if you have one) are not covered by employer-sponsored retirement plans at work (read: a 401(k) or 403(b), most likely), you can each contribute up to $7,000 to your own Traditional IRAs for the 2024 tax season. 

That’s up to $14,000 you can wipe right off the top of your taxable income, if both partners contribute the full amount to their respective IRAs.

A minor point of clarification for couples with combined finances: These are intended to be individual retirement accounts, so there’s no such thing as a “joint” IRA.

How do I calculate the tax savings I’ll score from contributing to the Traditional IRA?

For example, if you and your spouse are in the 24% marginal tax bracket after other deductions and you both contribute the maximum allowed, that’s a joint tax savings of approximately $3,360 (a calculation we arrive at by multiplying our contribution, $14,000, by our marginal tax rate, 24%). 

This means if you owed the IRS, say, $1,500, this one move would wipe out that tax liability, and probably generate a refund, too.

But here’s how your income may thwart your plan to deduct your contributions

Straight from the mouths of our boiz of the IRC, here are a few income limits and phaseout scenarios to be aware of for the 2024 tax season:

If you ARE covered by a workplace retirement plan…

• A single taxpayer (or head of household) begins to phase out of being able to take a deduction for their contribution when their MAGI (Modified Adjusted Gross Income) exceeds $77,000, and is totally ineligible for a deduction once they earn more than $87,000

• A married couple filing jointly begins to phase out of being able to deduct their contribution when their MAGI (We Three Kings, baby!) exceeds $123,000, and is totally ineligible for that sweet, sweet deduction once they earn more than $143,000 

If you are NOT covered by a workplace retirement plan, but your spouse is…

• A married couple filing jointly, where you are not covered by a workplace plan (but your spouse is!) begins to phase out at a MAGI of $230,000 and is totally ineligible once MAGI exceeds $240,000

And if you’re married filing separately, good luck—you can’t earn more than $10,000. (I know, I don’t get it, either.)

When this won’t work

To put a finer point on this one, this can only be leveraged to the hilt if you both aren’t covered by retirement plans at work. 

Also note that you’re only allowed to contribute a maximum of $7,000 across your Traditional and Roth IRAs, so this won’t work if you’ve already contributed the maximum for 2024 (even if you were contributing to a Roth IRA, not a Traditional—but if you contributed, say, $3,000 to a Roth IRA, you’d have $4,000 left that’s fair game to contribute to either). 

Fortunately, if you are covered by a plan at work and not eligible to consider a deductible Traditional IRA contribution, you can still contribute up to $7,000 to a Roth IRA (with some income limitations; here’s a video about how to get around those), though that won’t lower your taxes this year. 

You can open a Traditional or Roth IRA at pretty much all major brokerage firms; I prefer roboadvisors for ease of use (think Betterment, M1 Finance, etc.), but if you choose to take the DIY route, remember to invest the cash you contribute. I know way too many smart people who opened an IRA, funded it, and never invested the cash, so it just sat there…for years…uninvested. We have an episode about indices to consider when you’re building a diversified portfolio.

If you make excess deductible contributions, you’ll get prompted with a message (in TaxAct, at least!) that looks like this.

This screen grab is from the 2022 tax season.

Notice how TaxAct tells you what your maximum allowable deductible contribution is—in this case, the couple’s income, $213,789, was above the upper limit for a couple where both spouses are covered by plans at work in 2022. 

Form 8606 (I promise it’s not too scary)

All you need to do is file Form 8606, declaring that—oopsie daisy—you were totally just kidding, Uncle Sam, and your contributions were actually non-deductible all along! 

That looks like this: 

In this example, one individual in the couple accidentally contributed $2,400 to a Traditional IRA without realizing they couldn’t deduct the contributions. By classifying the entire amount as nondeductible, they’ve dodged the penalty bullet.

A quick jargon interlude: “Deduct” or “deductible” effectively translates to “wipe the amount off your taxable income as though it never happened.” Deductible contributions to pre-tax accounts are what allow us to save income tax in the present year. In this case, the couple became ineligible during the course of the year to deduct their Traditional IRA contributions, so the contributions become “non-deductible.” I.e., they’re no longer allowed to take the tax deduction.

So while you can easily fix excess deductible contributions by classifying them as “non-deductible,” you still won’t be able to deduct them (but they’re still tax-sheltered investments for the future, so all is not lost!).

And while we’re on the topic of Traditional IRAs, let’s talk about the 1099-R…

If you rolled over a 401(k) into an IRA in 2024, you received a form called the 1099-R. It’s a form your investment firm sends you whenever you take a distribution from a retirement account (yes, even a legal, unpenalized, run-of-the-mill rollover distribution!).

When I first received one a few years ago, I was convinced I was on a Pentagon watch list and had royally f***ed something up, but not to fear—this is a relatively straightforward declaration as well. 

For example, in the TaxAct software, in the “Income” section, you’ll see an option for “Taxable IRA Distributions.” When you click on it, you’ll have the option to add a 1099-R. If you fill out the form exactly, it should include a few things:

• The amount you rolled over

• The “code” for the rollover 

• The taxable amount (if it was just a direct rollover that didn’t change tax status, it should say $0.00)

…and that’s about it. Regardless of your rollover amounts, filing your 1099-Rs shouldn’t impact your tax bill, but you’ll still want to make sure you report ’em. The IRS is ~super serious~ about transparency, you know?

Next up: The SEP IRA

If you have any self-employment income (read: 1099 income), this last-minute Hail Mary might be a godsend. Side hustle girlies, #rejoice.

A few things to note:

• If you have a business with full-time employees, the rules are a little different; you have to contribute to their SEP IRAs, too, so if that’s your situation, you probably have a business CPA who can guide this choice—but if you’re just a solopreneur or side hustler, this is probably a fairly uncomplicated option for you. 

• You can contribute to a SEP IRA even if you’re also covered by, say, a 401(k) at a W-2 employer, since they’re accounts funded by two different sources of income.

The TL;DR on the SEP IRA for solopreneurs is that you can contribute up to 20% of your net business income, up to a whopping $69,000 for 2024. 

If you want to calculate a super precise contribution for the biggest deduction possible, you can always pay a CPA to do it for you—but a tax pro I befriended (yep, I love me some tax nerds) taught me a cool trick to make this a little easier. 

Since you deduct your self-employment taxes of 15.3% in order to get your “true” net business income on which the contribution is based, you can simply multiply your “self-employment income after write-offs” by 20%, rather than 25% (which is what you’ll see elsewhere online as the upper limit). This will give you a rough estimate of how much you can contribute to your SEP IRA.

So if your business earned $15,000 and you’re writing off $3,000 for expenses, leaving you with $12,000 of net business income before other deductions, you’d multiply $12,000 by 20%: You can contribute around $2,400 to your SEP IRA. 

For those with a lot of side hustle or self-employment income, this deduction can be quite significant.

When this won’t work

This won’t work if (a) none of your income came from self-employment or side hustle-type sources or (b) you’ve already contributed the maximum to a Solo/Individual 401(k). For the uninitiated, a Solo 401(k) is just a 401(k) you can open for yourself and use as a self-employed person. 

SEP IRA vs. Solo 401(k)

For example, if I had a Solo 401(k) in 2024 and I already contributed 20% of my net business income to it as “employer contributions,” I can’t then double-dip and contribute 20% more to a SEP IRA, too. 

If you had a Solo 401(k) but didn’t fund it, you could finish funding the Solo 401(k) (with “employer” contributions) in 2024 for the 2024 tax year. That’s totally fair game, too—no SEP IRA required.

The reason the SEP IRA is a more viable option for retroactive tax minimization? You can’t open a Solo 401(k) in 2025 and fund it for 2024. The Solo 401(k) has to be opened by Dec. 31, 2024 to be eligible for 2024 contributions. That’s why the SEP IRA is such a baller tool—you could have started a business in 2024, made absolutely no moves to invest in pre-tax self-employment vehicles, and decide on April 13, 2025 that you want to open and fund one for 2024.

You can generally open SEP IRAs at all major brokerage firms without much fuss; roboadvisors typically offer them as well.

Beware of a SEP IRA if you do the Backdoor Roth IRA (and one way around it)

One watchout: If you’re currently someone who dabbles in the Backdoor Roth IRA strategy because you’re over the Roth IRA income limit, you’ll want to weigh your priorities before opening a SEP IRA, as a SEP IRA “counts” as a Traditional, pre-tax IRA and will make executing a Backdoor Roth IRA more complicated. 

Sometimes, people opt for Solo 401(k)s instead for this reason. But if you’re down for a complicated workaround, you can open both a SEP IRA and a Solo 401(k) in 2025, fund the SEP IRA for 2024, and then—after you’ve filed and tax season is over—roll that shit over into your Solo 401(k) such that you have $0 balance in the SEP IRA again. Problem solved. Backdoor Roth IRA commence! Just note your business needs to be incorporated with an EIN number to open a Solo 401(k).

How to ~declare~ these glorious deductible contributions

Under “Deductions,” you’ll see a line item for “Self-employed SEP, SIMPLE, qualified plans.” That’s where you’ll tell the software how much you contributed, and “ooh” and “aah” as your tax bill lowers accordingly. As you can see, in 2021, my SEP IRA/Solo 401(k) contributions saved me an absolute boatload (yacht-load? We are talking about a billionaire’s game, after all).

And finally, the HSA—the consolation prize for our late capitalist healthcare hellscape!

If you have a high-deductible health plan (as defined by the IRS), you may be eligible for an HSA plan. The contributions and growth will be tax-free forever if you use the money for qualified medical expenses, so it’s a great place to rack up hella capital gains.

For 2024, the minimum annual deductible to be considered a high-deductible plan for self-coverage only is $1,600, and for family coverage is $3,200. The contribution limits vary on HSA plans for the 2024 tax year: If your health insurance plan just covers you, the limit is $4,150, and if your plan covers your family, it’s $8,350 for 2024.

You may already have an HSA set up through your work, or you may need to open one yourself, but once you surpass a certain amount of cash in the account (typically somewhere in the $1,000 to $2,000 range, but it varies by plan), you’re usually able to invest the funds—something you’ll do within your HSA account portal. 

You’ll have to go to your HSA provider and make a direct contribution (as opposed to a payroll contribution) to contribute one big, fat lump sum, which is technically suboptimal because direct contributions aren’t exempt from FICA tax the same way payroll contributions are. The good news is, an HSA contribution made in 2025 can be retroactively tax-deductible for 2024.

Moving forward, consider making your 2025 contributions through payroll deductions, because then your contributions won’t be subjected to FICA tax, either! Woohoo! Another 7.65% saved.

Any after-market HSA contributions (read: not payroll deductions, but new manual contributions) you make in 2025 for 2024 will be captured in the “Deductions” section:

When this won’t work

If you’ve already contributed the maximum to your HSA in 2024, unfortunately, this retroactive move isn’t an option (those contributions will be noted on the W-2 that your employer sends you). This also won’t work if you have a low-deductible plan.

The HSA is one of the best tax vehicles out there, because it’s effectively a second Traditional IRA that’ll never be subjected to required minimum distributions. 

If you hang onto your HSA until you’re 65, it’ll basically “convert” to follow the same rules as a Traditional IRA, and you’ll be able to make withdrawals for whatever you want (not just health expenses) without paying a penalty. You’ll pay taxes on your withdrawals like you would with a Traditional IRA if you don’t spend them on health-related expenses, but that’s about it. 

Someone who’s not covered by a retirement plan at work, has side hustle income, and has a high-deductible health plan could theoretically use all three methods.

Talk about a triple tax whammy! (I hate myself.)

It’s worth restating: I’m not a licensed tax professional. Please consult your CPA and do your own research before making big money moves. Hopefully this serves as a starting point for your pre-tax investing game this tax season if you haven’t made any decisions yet!

How to do the Mega Backdoor Roth IRA

Ironically, the “Mega Backdoor Roth IRA” is not a Roth IRA at all: It’s technically an “after-tax” contribution to your employer-sponsored 401(k) or 403(b) plan, not to be confused with a Roth contribution, which is much more boring and akin to going through the “front door.” 

Unfortunately, not all 401(k) plans allow for after-tax contributions beyond the standard, employee elective deferral of the $23,500 contribution limit (of the four companies I’ve worked for, only two have allowed it). 

But in 2025, this strategy allows you to get another $46,500 of Roth dollars in the bank on top of your regular $23,500 contribution to a 401(k) or 403(b).

Bonus, albeit a potentially confusing one: You’re still in the clear to contribute $7,000 per year to a Roth IRA or Backdoor Roth IRA if you want to, as well. Your IRA activity is wholly separate from today’s discussion of juicing your employer plan for all it’s worth.

Why? Because the actual contribution limit for 401(k)s in 2025 is a whopping $70,000. 

Here’s how it works:

1. In your company’s retirement portal, you elect to contribute after-tax dollars above and beyond the $23,500 limit.

2. Your plan administrator then (a) converts them to Roth in-plan or (b) permits in-service distributions, allowing you to roll over the funds to a Roth IRA.

…and that’s about it. I pulled an old screenshot from a former employer’s contribution page so you can get a sense for what this might look like on the back end:

Since my base pay at the time was $128,000 and I wanted to contribute a pre-tax $22,500 as well as an after-tax $6,500 (I basically wanted to mirror a regular Roth IRA limit in 2023), my “percentages” were 17% and 5%, respectively. You’ll probably see some language around a “Roth In-Plan Conversion” that’ll ask if you want to “convert after-tax contributions” to Roth, and your answer is a resounding yes. 

Candidly, it might be more trouble than it’s worth if you have to manually roll over and convert the after-tax contributions every month, but if your plan converts them to Roth in-plan for you and you can afford it, it’s probably a no-brainer to get a few more tax-advantaged dollars working in your favor.

If you are faced with the manual-only option, some people like to wait until the end of the year to roll over a full year’s worth of their after-tax dollars to their Roth IRAs—but it’s worth noting you’ll pay additional tax at that point on the growth of those after-tax dollars at the point of conversion (assuming they grew, of course).

It’s also worth noting that your employer match counts toward the overall $70,000 limit. If you contribute $23,500 and your employer contributes $10,000 (#goals), your 401(k) bucket technically has $36,500 of “room” left ($70,000 – $23,500 – $10,000 = $36,500).

Importantly, there’s no income limit for this (yet!), so people who earn too much to contribute directly to a Roth IRA (or don’t want to bother with a regular Backdoor Roth IRA) may find this a more seamless way to get both pre-tax and after-tax/Roth exposure in one fell swoop. Now, to find a job with a tech company that offers this Mack Daddy benefit…

In that article, I made a rogue prediction for the bottom: the S&P 500 at 3,200 points. The math of how I arrived at this figure is unimportant, but it was the result of my attempt to “undo” quantitative easing’s effects on markets, since all the smartest Twits on FinTwit were confident that until we flushed the excess cash out, things were going to be overvalued. At the time the piece was published, the S&P 500 was at 3,966—which would’ve meant it had a pretty far way to fall for my premonition to come true.

It’s important to note at this point that my wheels-off efforts at cosplaying a human fortune cookie were solely for shiggles: I was dollar-cost averaging into the inferno the entire time, and trying to make the thrashing a little more entertaining.

Fortunately, I was wrong (and a bit too pessimistic). The real bottom happened on October 12, at 3,491. So while I didn’t accurately predict the bottom, it turns out our guest that week on The Money with Katie Show did.

A guest on The Money with Katie Show may have accurately called the bottom

On October 19, we released an episode with Liz Young, the head of investment strategy at SoFi. I was reading her interview this morning because I seemed to recall her delightfully common-sense (and oddly prescient!) explanation for the situation we’re in now, in 2023: The S&P 500 is up 16% YTD, as of today, July 3. Unemployment is still at an all-time low. Interest rates are in line with historical averages. Inflation peaked a year ago and continues to come down. As Jack Raines asked a couple weeks ago, did the Fed pull off the soft landing?

Nothing about the 2023 forecasts suggested we’d be riding high right now, and yet…here we are.

So what gives? Let’s ask Liz, from her October 2022 interview:

“The market is a forecasting mechanism. It’s forward-looking; it tries to predict what the economy will be 6–12 months from now. The market bottoms first, earnings bottom second, and the economy last.”

This reality—that the stock market and the economy are operating on different “timelines,” so to speak—triggers a flaw in human judgment that creates issues for regular-shmegular investors. I can’t tell you how many messages I received throughout the second half of 2022 that said something to the effect of, “Things are looking like they’re going to get worse. Is now a good time to hold off on investing more?” 

Of course, that’s the exact opposite of what those types of tumultuous times call for, but the collective amnesia that sweeps through brokerage accounts is enough to make even the most seasoned investor second-guess their plan. 

But Liz had some words of wisdom in that episode that now stick out to me as perhaps the best advice we’ve ever shared on the show:

“I have a feeling that we’re going to look back on this period and wish we had bought more.”

Had our listeners heeded her advice that day, they’d be up roughly 21% right now. 

I was afraid to air the comment

I distinctly remember the post-production process for this episode, because we had a conversation about whether or not to cut that line—could it be construed as financial advice? “I don’t know, man,” I remember thinking, “Shit is so bad right now. Is it irresponsible for us to release this in the event things just keep crashing? What if this time it’s different?”

After all, remember that the months leading up to the interview looked like this:

In the end, we decided to keep it, because we knew Liz was a professional and her sentiment was expressly about “feelings” as opposed to a hard-and-fast recommendation or directive.

But it gives you a sense for the vibes of the period.

The last 12 months have been a crash course in trusting the data instead of the vibes. As that annoying saying goes, “Facts don’t care about your feelings.”

That’s why this week’s episode of The Money with Katie Show is all about the classic investor folly that’s statistically most likely to cut your returns in half (and that’s no hyperbole). Give it a listen—because who knows? It just might prevent you from selling off at the most inopportune time.

2024 Roth IRA income limits

Someone making six figures who also reads this blog is likely contributing the maximum to their Traditional 401(k), which means they’re probably claiming a deduction of $23,500 in 2025—which means they’d probably need to make closer to $188,500 single and $293,000 married in order to be totally phased out (because $293,000 married minus a $23,500 contribution for each partner is that upper $246,000 limit).

Why a Roth IRA is worth your time

Besides tax-free growth and withdrawals, the Roth IRA allows you to access the principal at any time before age 59.5 with no penalties (the growth on that principal is treated differently, though). 

Because of this easy-access feature, Roth IRAs are a super flexible investment vehicle for retirement (and even more flexible if you’re planning to be an early retiree, thanks to the whole “no penalties on your own contributions before you’re gray” thing). 

But what should you do if you’re unable to contribute to a Roth IRA because you make too much money? The Backdoor Roth IRA.

You should be able to pull this off without any tax penalties, but there’s one scenario to be aware of that might trigger a tax bill that I note at the end of the steps below. Make sure to read through to the end, because it will likely determine whether or not you choose to attempt this.

(You might also wonder if a taxable brokerage account is a better fit—and it might be, but think about the main similarity between a Roth IRA and a regular ol’ taxable investing account: You’re already using post-tax dollars. Where you may otherwise jump straight to taxable investing after your 401(k), this is a way to sock away $7,000 post-tax dollars in an account that’ll grow and be accessible tax-free forever.)

“Backdoor Roth IRA”: the TL;DR

In a Backdoor Roth IRA (the potential for sexual innuendos abound!), you create a Traditional IRA and make a non-deductible contribution (in other words, you’re using money you’ve already paid taxes on, which likely means it’s just the money sitting in your checking or savings account).

You’re probably like, “What’s the point of a Traditional IRA if the main benefit of the account doesn’t work for me?” But the ability to convert IRAs from Traditional to Roth is your bread and butter here. 

Here’s how it works:

1. Open a Traditional IRA account with your brokerage firm of choice. Open a Roth IRA with the same firm, if you don’t have one with them yet.

2. Fund the Traditional IRA to the 2024 IRA contribution limit (assuming that’s your plan for the year): $7,000. Leave the funds in the money market/cash balance; don’t invest it yet!

3. Wait a few days for the funds to settle.

4. Convert the cash to Roth (big brokerage firms know how to do this; if you need help, you can ask! There should literally be a button that says “Convert to Roth”). Because the funds aren’t invested yet, there will be no gains to pay taxes on. You already have a Roth IRA ready and waiting from Step #1.

5. Invest in the index funds of your choice within the Roth IRA with the funds you converted.

And…that’s it.

There’s just one small snafu to note, per my earlier comments about being able to access contributions at any time: When you convert funds to Roth in the Backdoor Roth IRA process, you now have to wait five years before you can access the principal (hopefully this is no showstopper for someone with their other financial ducks in a row).

When does this make sense?

If you meet the qualifications above and you’re feeling comfortable so far, I’d consult an accountant for one last gut-check, then give it a go. However, one thing to note from a tax optimization standpoint is that this process should probably come after you’re able to contribute the maximum to your 401(k) for the year. 

You can do them simultaneously, of course, but if you’re not getting the most tax-deferred bang for your buck at your income level, the Backdoor Roth IRA probably shouldn’t be priority #1, in my opinion.

When shouldn’t you do a Backdoor Roth IRA?

If you already have Traditional IRAs lying around like discarded Fiji water bottles (I assume you drink Fiji water because…well, you know), you’re going to be subject to this convoluted thing called the IRS pro rata rule, which will result in a tax bill. 

I spent about an hour reading IRS.gov articles about this rule, and now, all I’m (kind of) confident about is this: The breakdown between your existing pre- and post-tax dollars in your existing Traditional IRAs will determine the amount of your Roth conversion that’s taxable.

Yeah, I didn’t get that either. Let’s do an example.

If you already have $50,000 in a Traditional IRA that you created with deductible, pre-tax contributions (before you were a high roller) and you add another $7,000 post-tax with the intention of converting it to Roth, only about 11.5% of the total amount in your Traditional IRAs is post-tax ($6,555 of the $57,000).

As such, 11.5% of your Roth conversion will be tax-free—but you’ll be taxed on the other 88.5% of the conversion. If you’re in the 24% income bracket, you’d pay $1,570 in taxes on the conversion of post-tax dollars to Roth (the 88.5% of your conversion ($6,555) x 24%). 

TL;DR: Depending on how much money you’ve got in those other IRAs, your tax bracket, and how much you’re trying to roll over, this could create a hefty tax bill come April.

For that reason, I’d really only attempt this (on your own) if you do not have a big balance in a Traditional IRA already (including SEP IRAs, rollover IRAs, etc.—and to be super clear, your Traditional 401(k) doesn’t count!).

Is it the S&P 500’s performance over time? 

Close! It represents searches for the term “S&P 500” over time. 

Why am I looking at this? Well, mostly because I don’t have other empirical ways to get a pulse check on public awareness of a phenomenon beyond Google Trends data. I’m using increasing search volume as a proxy for public interest in the S&P 500 (the index that measures the performance of the 500-odd largest American companies by market capitalization).

Now, we could explain away this increase a few different ways:

• The Google search trends data (and the methodology that Emperor Google uses to measure search trends) have changed over time, calling into question the accuracy of such a graph.

• Personal finance education has become more popular in the last decade, in part due to the internet and social media.

In short, we could explain the increasing interest in the S&P 500 over the last few years with other stories. Or we could compare searches with actual performance:

Note the delineation for 2004, where the search trend data above begins. 

Correlation does not equal causation, but there’s a simple explanation I’d like to offer here: Recency bias.

Line goes up. People take notice. New investors are attracted. Narrative is formed. (Also known as: Fund flows tend to follow—that is, chase—returns. When something is performing well, it attracts a ton of new cash (Cathie Wood’s ARKK being the most recent, microcosmic example.)

Because the S&P 500 has performed exceptionally well in the last decade (and we’ll get into that shortly), it’s a fan favorite for investors everywhere.

Over time, a very cozy narrative has developed around the S&P 500 and its annualized 9% returns, lulling investors into a dangerous “expectation trap.”

When money is cheap, growth stocks generally pop off

There’s a general consensus in the investing world that there’s a correlation between the Federal Reserve’s monetary policy (specifically, interest rates) and stock market performance. For example, this analysis from BlackRock demonstrates how S&P 500 P/E ratios map to interest rates over the last 12 years; when rates are negative, P/E ratios tend to be higher, and vice versa.

When the cost of borrowing money is cheap, the thinking goes, we expect future earnings—and returns on stocks, the securitized devices that represent a company and its earnings—to be higher. 

When the cost of borrowing money rises, we expect future earnings and stock returns to be lower.

There’s a loosely inverse relationship. 

And what do we know about the last 10 years? A picture’s worth a thousand words! Below, you’ll see the Federal Funds Effective Rate—a bunch of fancy words that basically mean, “How expensive is it to borrow money?”

The higher the line on the graph, the more expensive money is. Check out the line post-2008, especially relative to the previous 60 years:

Things have been awfully ZIRP-y. 

(ZIRP is the acronym for “Zero Interest Rate Policy,” an approach to monetary policy that tries to jumpstart economic activity by making borrowing money really cheap. In other words, the interest rate is at, near, or sometimes even below zero.)

It’s true that this correlation (between high returns and low rates) exists, but it’s also true that—at other points in history—reality flouted this expectation. Between 1940 and 1969, rates rose and the S&P 500 had positive real returns.

In that sense, it’s not quite as simple as “one goes up, the other goes down,” though this intuitive narrative is very powerful.

I don’t want to get into the ~economic theory~ or effectiveness of ZIRP, or how it played out for us. That would be fun (really!), but what I’m more interested in is exploring how a new era of higher interest rates is likely to shift the narrative sentiment (and therefore, investor behavior) around things like the S&P 500. 

Is narrative sentiment more powerful than data?

Do ~vibes~ and public opinion matter more than reality itself? Do vibes create our reality?! (I feel like I’m at Burning Man.)

To dig a little deeper into our earlier note about positive real returns amidst rising rates, LPL Financial released some data in March 2022 that showed the average annualized S&P 500 return during Fed rate hike cycles was 4% (in other words, lower than the historical average, but still positive) since the 1940s. 

In fairness, the data doesn’t appear to be inflation-adjusted, and you probably don’t really give a shit if your stocks are up on a nominal basis if they can buy less bacon at the store than they could last year.

For example, a quick review of S&P 500 returns at this site (where you can easily adjust time periods and include or exclude inflation) paints a very different picture of the period between 1977 and 1980 than the LPL data does:

Regardless, it almost doesn’t matter if rate hikes don’t actually meaningfully impact S&P 500 returns, if everyone investing in the stock market thinks (and behaves!) as though they do.

Data is often no match for the narrative that forms around the data. A compelling, intuitive story is often more powerful than fact.

The end of an era: The “safe bet” of the S&P 500 might be over, for now

When rates are continuously ripping and J-Pow refuses to step away from the “CHAOS & VIOLENCE” button that adds another 50 basis points to the Fed funds rate every few months, we’re going to see a gradual narrative shift in investing circles that moves away from presenting the S&P 500 as a “safe” option. 

This is probably a good thing. While you’re historically likely to see real returns over any given 20-year period you’re invested in the S&P 500, we humans have a tendency to take a look at recent history and extrapolate it forward.

Writer and investor Nick Maggiulli points out why this is a dangerous inclination in his recent piece, “How Much Growth Can You Expect?”:

“I wanted to share these results because there are many personal finance gurus who will advertise expected growth numbers far in excess of [real returns] and it can be quite misleading. Most of the expected growth numbers I see tend to be inflated for a few key reasons:

They don’t examine people investing over time (i.e. DCA)

They don’t include bonds in the portfolios (it’s 100% stocks which is unrealistic)

They don’t include Global stocks (they focus solely on U.S. stocks)

They don’t usually adjust for inflation.”

To quote myself five minutes ago, you’re probably more interested in a realistic estimate for future returns that’ll accurately reflect the type of life they’ll enable you to live than some pie-in-the-sky, relatively unlikely outcome.

Am I going to save as aggressively if I think I’ll get 11% annualized returns? No, probably not. 

What if I plan as though I’m only going to realistically 2x my savings over 20 years (around 4.5% real annualized returns)? Well, I’d probably save a little differently. 

Again, this is a good thing.

“Save like a pessimist and invest like an optimist,”

wrote Morgan Housel, the connoisseur of “human behavior really jacks up our finances, huh?” hot takes.

While I’m sure we all enjoyed the era of S&P 500 dominance (also correlated with the Alabama dynasty of Saban’s joyless murderball, I might add!), realistic expectations for the future matter, because they influence how we behave, plan, and save.

And diversification beyond a single asset class really matters, because the S&P 500 alone is not a surefire bet, even over relatively long periods of time (despite what our recency bias-tainted amygdalas may tell us)—go back just one more decade and we can learn that lesson clearly:

This is real S&P 500 performance from 2000 to the end of 2011, though as Nicky Numbers pointed out above, this represents one lump sum of cash invested at the beginning, rather than a more realistic dollar-cost averaging approach.

Accurate or not, it’s high time for a narrative shift so this new generation of investors can benefit twofold

A more realistic set of expectations for future S&P 500 returns—and, by extension, a more realistic appreciation for diversification beyond it—is good for improving saving behavior, whether the narrative driving this behavior is data-driven or not. 

Moreover, deep downturns provide buying opportunities for younger generations (in both the stock market and housing markets) that aren’t possible when ZIRP pushes things to new, outlandish all-time highs every six weeks—anyone sitting on dry powder in 2008 went on an asset shopping spree that likely propped up the rest of their financial lives. 

Without these economic blowups and subsequent recessions, the rich stay rich and the young (and broke) get farther and farther behind.

So no, the S&P 500 isn’t “safe”—but if you save aggressively and diversify beyond it, you’d be hard-pressed to find a better way to build wealth. 

Our brains are hardwired to perceive negativity as more truthful, more intelligent, and as a result, fear-mongering tends to run rampant when things seem like they are Going Very Badly. 

The alarmists are harmonizing the refrains of their favorite Sunday hymnal, This Time It’s Different, explaining (some with earnestly positive intentions, to be fair) that investing in the stock market right now would be a no good, very bad idea. This is usually followed by something about “fiat, bitcoin fixes this, whole life insurance or bust” on a droning loop. They shoot down messages of optimism as uninformed or unsophisticated. 

Oh, how quickly we devolved from “Software is eating the world!” to “The only safe assets are physical bars of gold and Costco cans of Bush’s Baked Beans.”  

When the vibes are off, it can feel safer to heed our gut instincts that something dire is afoot, pause our contributions to our brokerage accounts, and wait it out on the sidelines. 

There’s only one problem: Our perception of danger in the markets is highly uncorrelated with how dangerous the market actually is at any given time. 

But…is it a “no good, very bad” outlook?

A few weeks ago, I saw a comment entitled “Hard Lessons Will Be Learned” from an Anonymous Internet Opiner. They declared with certainty: “The next 40 years will not look like the last 40 years because of where we are in the big debt cycle.”

Ray Dalio has entered the chat. 

“This lacks an understanding of macroeconomic trends.”

As soon as the tide turned from headlines of jpgs of rocks selling for $3 million to monkey-themed fan clubs to “the world is definitely ending” in nine months flat, it seemed internet comment sections were suddenly glutted with classically trained macro economists. 

r/WallStreetBets called; it wants its analysts back. 

But uh, do you know when we weren’t constantly wading through accusations of economic incompetence? When frequent conversations across the web didn’t co-opt Dalio’s talking points? When people weren’t beating the end-times drums? 

In 2020 and 2021, when—as my friend Jack pointed out in this brilliant piece—risk was technically much higher than it is today.

That’s the problem with our perception of danger. We think it’s a lead indicator—a warning sign that something bad is going to happen, and we should act (or stop acting). 

Unfortunately, fear is an emotion that functions on a lag. By the time we retail investors perceive the risk, it’s usually too late to do anything about it.

Back then, it was, “Have fun staying poor.” Today, it’s, “Macro trends tell us we’re headed for a flat decade.” 

The critical, pessimistic sentiment online tends to be late to the party. It probably would’ve been a lot more helpful to spread a word of caution in 2021, when the S&P 500’s PE ratio was pushing 40, just about as high as it gets, rather than now, when we’re already down 25% YTD and the S&P 500 is roughly half as expensive as it was last year, with a PE ratio of around 18. 

Right now, stocks are within one standard deviation of the historical average and are considered fairly valued by most measures. If anything, now would be the time to fire up the chorus of have fun staying poor, since the last two decades have proven that investing in something is just about the only chance regular people have of escaping chronic wage stagnation and declining purchasing power.

Of course, that’s not to say the market won’t go lower. That’s not to say there isn’t some macroeconomic trouble on the horizon. That’s not even to say this time it won’t be different, or that we aren’t headed for a flat decade—just that, all things considered, most of these doomsday Paul Reveres are about a year late. And ultimately? Nobody actually knows. 

Even if bad things are ahead (like catastrophic events of the past that preceded recessions from which the stock market eventually recovered—a Great Depression, a housing market implosion, a massive terrorist attack, a Gulf War, an oil embargo, or…well, I think you get the picture), we have a relatively solid idea of what typically happens when shit goes awry at scale, thanks to the last 100 years.

Stock market returns through recessions are less predictable than you’d probably expect

As much as I wish past performance was indicative of future returns…it’s not. That said, history is just about the only (hazy) crystal ball we’ve got for understanding a probable range of outcomes.

Moreover, the stock market is forward-looking—it’s not reacting to what’s already happened in the same way that our flighty amygdalas are. It’s anticipating what’ll happen six or 12 months down the road, which means it usually goes down before a recession actually starts (and usually improves before a recession ends). 

And one of the key recession indicators—high unemployment—isn’t really happening yet. (The technical language for this phenomenon is the “recession isn’t recessioning,” and J-Pow & the Fed Boiz are probably going to keep hiking rates until it does.)

This is why a strong jobs report actually made the stock market react negatively, because a strong-ish economy probably means more rate hikes. The market—comprising a bunch of smart, greedy people—is pricing in something it’s expecting to happen in the next few months. (You’ll never convince me the stock market isn’t just a mood ring in the short term.)

The chart below shows us that the range of drawdowns during recessionary periods in the last 72 years was between -14% and -57% (woof). But it also shows us the returns on cash invested at or around the low point two years after each “bottom,” ranging from 5% to 99%. (This means a dollar invested during the market’s lowest point in a recessionary plunge returned anywhere from 5% to 99% in the two years that followed.)

These ranges are about as wide as they come. The median drawdown, however, is -24%, which is approximately where we are right now. 

The point isn’t to estimate how bad it’s going to get—there are far too many variables for that—but to exemplify the fact that it’s almost impossible to know. There’s no discernible pattern to extrapolate forward. 

Is this the bottom? Who knows? The macro buffs would tell you we have much farther to fall (because of money printing, because of war, because of inflation, because of Jerome…or because negative press is what gets clicks), but nobody actually knows.

The one thing that is clear from this data is that the money you invested through every recessionary bottom in history always looks all right two years later, and the only way to guarantee you invest at the bottom is to invest through all of it.

Might as well bet on 100 years of historical precedent if you’re going to bet on anything. As Jack Raines wrote: “Risk is highest when we forget it exists, and lowest when it’s all we can think about.”

Maybe the Bear Bros will rejoice from their alternative asset classes that they were right and the dumb, optimistic masses were wrong—but if you’re coming to that conclusion in October 2022, you’re probably too late to do anything about it anyway.

On the other hand, I can read graphs like these, documenting the rampant wealth inequality in our country that’s been steadily worsening since 1975. Today, the top 10% of earners take home 50% of the total income, leaving the remaining 90% to share the other 50%. It feels like an uphill battle. 

Surely information alone is not enough to close this gap, right? I’d think to myself in varying degrees of despair: Does what I do even matter?

Maybe that’s why—when I stumbled upon the two academic papers we’ll be exploring today—my self-preserving confirmation bias sprang into action: Yes, it must matter!

To be sure, it’s certainly not enough to close the gap or solve the problem on its own. But we do have empirical data (from the National Bureau of Economic Research and the University of Pennsylvania) that prove financial literacy has a direct impact on financial outcomes.

Optimism! 

My own experience with financial literacy

This is where I’ll regale you with my metaphoric before-and-after pictures, à la Jenny Craig infomercial. 

But honestly, it’s not that deep. Financial literacy just played a pretty substantial role in my money (and life) glow-up. (Because it turns out having more money does, in fact, improve your life. “Money can’t buy happiness” merely means there are diminishing returns on happiness from accumulating excess wealth, not that having more money doesn’t make your life objectively easier.)

For the first year I worked, I had no plan. I didn’t understand investing. I saved haphazardly. I couldn’t have explained the logic behind a Roth IRA even if you had threatened to submerge me in hot queso (which I happened to eat a lot at the time, since I was going out to lunch every day). 

After working for a year and earning a salary around $52,000, I had about $12,000 in savings—meaning I spent the other $33,240 of after-tax income on…well, I’m not sure, since my rent was only $800/month and I didn’t have a car payment. 

But once I started learning about how to manage money (how to save it, how to invest it, how to track where it was going), I quickly amassed a net worth of around $100,000 in a little over two years. Without a doubt, learning the basics had a profound impact on my financial picture. 

My income hadn’t changed, but my approach did—and as a result, I was able to plug all the holes in my monthly balance sheet and institute a more formulaic strategy that included:

• Increasing my 401(k) contribution to 15%

• Contributing $500/month to a Roth IRA

• Contributing $200/month to a taxable brokerage account 

• Focusing more intently on increasing my income, though that took a few more years

I had a surprising realization after several months: “Wait, this isn’t that hard.”

Sure, it was challenging to cut back. It wasn’t always easy to prioritize and allocate my scarce resource to investing when what I really wanted to do was tie one on at the bar down the street and ride the mechanical bull 14 times in a row at five bucks a pop. 

But it wasn’t (and isn’t) rocket science. It surprised me how quickly I grasped the basics (and how few “basics” there really were), and I was thrilled watching my net worth creep upward every month. It became addictive!

Yet this optimism is balanced with a healthy dose of reality: Some people really don’t have the extra income to invest (see also: the chart linked above that demonstrates the bottom 50% of our country has an average income of $20,000/year). 

When you’re earning an average or above-average income (north of $50,000), you’re at an advantage—though with the unaffordability crisis in this country (the average rent is now $1,700 for a one-bedroom, which would’ve been more than half of my monthly income at the time I’m describing and a big reason why I’ve always had a roommate), it’s not hard to see why people often feel strapped. 

So how much does financial literacy really matter?

Well, it turns out…quite a bit.

(Existential crisis avoided! Phew.)

Annamaria Lusardi and Olivia S. Mitchell found in their paper, Financial Literacy and Planning: Implications for Retirement Wellbeing, that “while several prior studies offer suggestions about why people fail to plan for retirement, few examine the roles that planning and information costs might play in affecting retirement saving decisions.” (emphasis mine)

Translation from academia: This is the first study that attempted to answer whether or not “planning” and “knowing what you’re doing” has a material difference on someone’s financial outcomes. When you know better, do you do better?

While other papers “have offered evidence on related topics; for instance Calvert, Campbell, and Sodini (2007) show that more sophisticated households are more likely to buy equities and invest more efficiently, and Hilgerth, Hogarth, and Beverly (2003) and Lusardi and Mitchell (2009) demonstrate strong links between financial knowledge and financial behavior,” this study attempted to answer the question directly—and their results were encouraging for financial content creators everywhere! collective sigh of relief

Note the language here around “sophisticated households,” i.e., those with financial education: They’re more likely to invest in stocks. Put simply, when you have basic financial literacy, you’re more likely to invest in income-producing assets that will—you guessed it—continue to produce income for you later in life.

In the sample group studied, fewer than one-third had even attempted to plan for retirement, despite being only a few years away from leaving the workforce (!!). Though the majority of respondents hadn’t attempted to make a plan, Lusardi and Mitchell found that roughly 75% tracked their spending. This surprised me.

My assumption? They’re tracking their spending to ensure they don’t run out of money before the end of the month or, in other words, navigating the short term. It’s a little bit like what Gaby Dunn shared in their interview on the show: Those who are the best at budgeting are usually those with low incomes, because they have to budget to make ends meet. 

Paradoxically, the very rich rarely track their spending closely (because they…you know…don’t need to).

Here’s the golden takeaway, though: “Prior work has established that planning has important implications for wealth accumulation…to this end, we report the distribution of total net worth across different planning types…and emphasize that, at the median, planners accumulate three times the amount of wealth than non-planners.”

Translation? Those with a plan accumulated roughly 3x as much as those without one. 

My earlier anecdotal, microcosmic example—one year working with no plan followed by two years working with a financial plan I devised myself—illustrates this point well. 

“If financial illiteracy leads to poor or no planning, it may also affect wealth accumulation. Lusardi (2003) finds that those who plan accumulate more wealth before retirement and are more likely to invest in stocks. Moreover, planners are more likely to experience a satisfying retirement, perhaps because they have higher financial resources to rely on after they stop working.”

And what do you need to make a plan? Say it with me: financial knowledge

Their findings kept circling back to one key similarity between the planners. The planners invested. 

It sounds simple, but it’s worth explicitly stating: It’s not enough just to save your money, you need your money to go make more money for you. 

Why would a plan be correlated to stock investing? Well, I think it comes down to knowledge: “When asked how much risk respondents are willing to take, a large majority (more than 60 percent) state they are unwilling to take any financial risk. This may be due not only to strong risk aversion, but also to the fact that many respondents feel they simply do not understand risk diversification.” 

If you had asked me five years ago how “risky” I was with my money, I would’ve told you not at all. I am completely risk-averse. As a result, I wasn’t interested in stocks. They felt like gambling, because I didn’t know any better! (Because remember: Nobody pops out the womb with a deep understanding of proper risk diversification and equity risk premiums.)

But the more I learned, the more I understood: Not investing in stocks is riskier than investing in stocks in the long term. 

As Nick Maggiulli writes in his piece “Risking, Fast and Slow”—between 1926 and 2021, the S&P 500 had a near 0% chance of being down 5% over any given 20-year period. Holding cash, on the other hand, meant you’d face a 31% chance of being down by 5% or more in real terms (that is, 31% of the time, your cash’s purchasing power would’ve been down 5% or more in real terms). 

In the short-term, holding cash feels safe. In the long run, nothing could be riskier. 

But in order to know that and internalize it, one must first be exposed to the information (then you’ve gotta act on it—which is a different beast—but it starts with knowledge).

Youth is wasted on the young—so are good returns

In a 2017 paper for the University of Pennsylvania, Lusardi, Mitchell, and Michaud found something else: “The trend toward more individual responsibility means that people’s financial decisions made early in life can have long-term consequences.”

Unlike a bad tattoo that can be removed or the juvenile arrest outside a Lady A concert (guilty) that can be expunged, bad financial behavior early in life is harder to undo. It compounds.

And it’s not so much what you do that you’ll be punished for, it’s what you don’t do: Because time is your most valuable asset, in more ways than one.

It is precisely because you can’t get the time back that the decisions are so important—when you invest as a young person, you’re locking in a long time horizon. Your money has decades upon decades to compound. You can take more risk. 

Exponential growth requires time and—importantly—defies logic, which makes it hard for us mere mortals to intuitively grasp. 

Consider those brain twisters that demonstrate compounding by doubling a grain of rice every day for a month: On Day 1, you start with 1 grain. Day 2? You’ve got 2. Day 3? You’ve got 4.

…and so on and so forth. By Day 30, you’ve got 536 million grains of rice. 

By Day 31, you have more than a billion. 

By Day 20, you only have 524,288. You’ll more than 1,000x your rice grains in the last 10 days of compounding alone. While this is an extreme example, it illustrates nicely why even small returns on large amounts of money (e.g., a billionaire’s wealth) begins compounding out of control rather quickly. 

The time that passes in the first 10 days and the time that passes in the last 10 days are not created equal.  

This is why starting early matters—because time matters.

Of course, young people also usually happen to make less money than their older counterparts, which makes it tempting to throw reason and data to the wind and say, “Fuck it, I’d rather enjoy my life now and worry about this retirement racket later when I’ve got more money. I don’t have enough income now for it to matter anyway.” 

Ironically, “Venti and Wise (2001) show that permanent income differences and chance alone can explain only 30–40 percent of observed differences in retirement wealth.”

In other words, differences in income between people and “chance” explain less than half of the difference between those studied. 

Here’s a doozy of a dissertation-level sentence for you: “By introducing endogenous variation in the returns that people can obtain on their savings, particularly on information-intensive assets, we can attribute another 30–40 percent of wealth inequality to financial knowledge.”

I’m not even going to pretend to know what “endogenous variation” means, but what I do know is that the researchers’ conclusion after 49 pages of…that…is that 30–40% of wealth inequality can be chalked up to a lack of knowledge.

When you know better, you do better.

The time you spend learning more will 3x your returns later in life

In a funny way, this post is a little full-circle for me: When I first started writing about personal finance in 2018, I believed knowledge alone could solve everyone’s problems, and I saw firsthand how merely mastering the basics propelled me to a six-figure net worth relatively quickly. 

But eventually I learned there are factors at play that make the equation far more complicated than I had initially expected, and a sense of cynicism and hopelessness set in. I began to doubt that knowledge was the answer.

Now, I’m finding myself somewhere in the middle: Is knowledge enough to solve everything? No, of course not—but if we’re to believe the researchers behind these papers, it’s enough to make sure you’ve got roughly 3x as much later. I’ll take those odds any day. 

But that stuff is boring and you may already know it, so let’s jump to what investing actually is

“Investing” in the broadest sense just means using your money (read: cash) to buy assets that you think will go up in value. You can invest in real estate, the stock market, and a lot of other things.

Today, we’re going to talk about stock market investing in particular (as distinct from day trading and other arbitrage attempts), as I believe that has the lowest barrier to entry. I can’t start a rental property empire right now with $20 and an internet connection, but I can use those two things to start investing in the stock market in the next 20 minutes.

What’s the stock market?

The stock market is just a big collection of companies that have decided they want money from the public in return for the promise that they’ll produce profits they’ll share with the public.

In order to be offered on this thing called the stock market, a company has to “go public”—which means revealing a lot of intimate details about how it’s spending and earning, how much it’s paying its executives, and more. Companies want to look good to the public so more people will say, “Yep, I’ll give that company my money in exchange for a small piece of it, because I think it’s going to do well and I’ll get a good return on my investment.”

Going public is a big deal, and it happens in something called an “IPO,” or “Initial Public Offering.” It’s the company saying, “All right, world—you are now able to exchange your dollars for a small piece of me, and you should exchange your dollars for a small piece of me because I’m going to produce profits that’ll make the piece of me that you own more valuable over time.” Like NFTs, but you know, actually profitable.

IPOs aside, that’s why the value of a stock goes up—because that stock (or rather, your “share” of the stock) represents a small piece of a company that’s theoretically creating real value in the world and generating real income.

But just like people, companies die

Even good companies may eventually die, because the world changes, the public’s needs change, and hopefully, innovation keeps pushing us forward.

Back in 1896, this dude named Charles Dow selected a group of 12 leading stocks from American industries to create his index. You’ve probably heard of it: the Dow Jones Industrial Average.

Today, there are 30 stocks in the Dow Jones Industrial Average, or DJIA.

Do you know how many of the original 12 are still in it? None. Most of the stocks in it today didn’t even exist when he started. Things change.

But that’s the cool thing about indexes (or indices): They adapt, too. Since they’re prescribed to include only stocks that meet certain requirements (like size, or growth, etc.), the holdings in an index change as the companies do.

For example, if I created an index that was supposed to measure the 10 biggest companies in the US based on profits, as soon as the tenth company was usurped by another one, it would be replaced on my index.

You’re saying “index” a lot, Katie—is this where index funds come in?

An index fund is a collection of stocks designed to track one of these indices. The index fund allows you to invest in a certain index, like the DJIA.

The benefit of using something like an index fund is that you’re saying, “I don’t care what the top 10 biggest companies are, I just want shares of the top 10 biggest companies at any given time.” Just like above, as those companies change on the index, so too does what you own.

Compare that to deciding, for example, that you think one particular company is going to do well. You might be right, but you also might be wrong. If you invest in a company that ends up not producing the profits they say they will, you’d be disappointed in the return on the dollars you handed to the company.

You can probably connect the dots now about why index funds are so popular. They eliminate a lot of guesswork. Popularized in the 1970s by the founder of Vanguard, John Bogle, the index fund is a dope invention and John Bogle is considered a genius.

Without getting too deep into the weeds today, it’s probably useful to mention that—in general—only about 10% of investors who try to actively beat the performance of major indexes like the S&P 500 actually do so over any 15-year period.

(The S&P 500, or “Standard & Poor’s 500,” is an index that tracks the 500 biggest companies in the United States. It’s a popular one, especially in the last decade, as it’s done very well.)

And while I’m not telling you that you shouldn’t invest in individual stocks if you want to, I am telling you that almost 90% of professionals who do it for a living (to try to outperform the total stock market) fail. Do with that information what you will.

Why does the stock market tend to go up over time?

A stock is just a small piece of a company.

It’s not just a piece of paper or numbers on a screen. A stock represents a real company producing real value and generating real income.

It’d be like if I started Money with Katie and asked you, dear reader, to invest the first $100 used to pay for the website. Let’s say we split ownership of the company, 50/50, so you owned half of Money with Katie. There are two shares of stock, valued at $50 each.

In Money with Katie’s first year of business, it made about $10,000.

You put in $50 to own 50% of Money with Katie, and it generated $10,000 in revenue, meaning you’re entitled to $5,000.

Not bad, huh?

As long as Money with Katie makes money, so do you.

But if it lost money—if it never made a dime—your $50 is worthless.

That’s why (rather than investing all $50 in Money with Katie’s stock) you’d probably be wise to spread that $50 around over, say, 50 different personal finance blogs, giving them each $1.

Of the 50, at least a couple are bound to do well, so your “shares” in the successful ones will do well.

Actionable advice to start investing today

Some people try to day trade individual stocks to earn a profit on a sort of arbitrage—I’m not advocating for that, and I wouldn’t call that “investing.” Instead, set that shit on easy mode. Buy and hold low-cost index funds for the next 30 years. 

I know it’s incredibly annoying to have someone tell you, “Okay! Cool. Now go buy some index funds,” and then walk away without another word.

People go to school and spend their entire careers figuring out which funds to invest in, so I realize that’s not super useful.

That’s why I always recommend people consider investing with a brokerage firm or roboadvisors (Betterment, Wealthfront, M1 Finance, etc.), where your only “job” is to deposit cash, and an algorithm determines how to invest it based on your goals. It couldn’t be easier—and you get a low-cost, diversified portfolio of exchange-traded funds (ETFs) that represent the US stock market, international market, fixed income, emerging markets, and more.

This provides exposure to other categories that outperform the S&P 500 sometimes (yes, really) and it’s likely to your benefit to diversify beyond large, US companies—check out the Callan Periodic Table of Investment Returns if you’re skeptical, where you’ll see that in the last 20 years, the S&P 500 was only the top performer 15% of the time.

What’s an appropriate amount to invest?

Remember how we noted those ducks we wanted in a row prior to starting? If you’ve already eliminated all high-interest debt and your emergency fund is straight chillin’ on the sidelines, it’s wise to focus your future “saving” efforts (and excess cash flow) on investing so you can build wealth. 

You may also like these posts:

• Why You Probably Have Too Much in Your Emergency Fund

• Why Index Funds & ETFs are a Better Bet for Successful Investing

• Setting Up My Perfect Financial System: Money Mapping

• How Your Investments are Taxed

Whether or not it’s actually simpler is subjective, but this conversation was the first time I realized that my very American obsession with amassing enough wealth to retire was not shared by my brethren down under.

The truth? Supporting an aging population that can no longer work is a problem that every country faces (like post-one-child-policy China, which is rapidly approaching the point at which they don’t have enough young people to work to support the old people).

America’s version of Australia’s defined contribution plans and old age pension schemes? Social Security and the 401(k). If we continue down the path we’re on, the two trust funds that support Social Security will run out of money by 2037—and new retirees will only receive roughly 80% of the benefits they’re owed. This is—to put it lightly—an impending clusterfuck, as many Americans rely on Social Security for most (if not all) of their income in retirement, and the average payments don’t exactly leave room for a whole lot of discretionary fun (or, worse, heightened medical bills).

As of July 2022, the average person receives a Social Security check worth $1,544 each month. That’s…roughly enough to pay my half of our rent. (There’s this handy tool you can use that will estimate your benefits; for some reason, it always tells me it “can’t process the request,” though, so try at your own willingness to waste time.)

The reality is that—unless you are extremely frugal and own a paid-off home—Social Security will likely not be enough to retire on whether now or post-2037, even if we get the full 100% (not the predicted 80%) we’re owed. *Cue a meme about how the millennials get the shortest end of every stick imaginable.*

Whose retirement is it anyway?

It’s easy to accept retirement as a fact of life when your whole job is blogging about personal finance (hello!), but “retirement” as a concept is actually fairly new in human history—for most of human history, people just worked until they died. Fun!

“The idea that employees should have some kind of a defined benefit in retirement gained traction during the boom decades that followed World War II. Large corporate employers took a paternal approach to their workers and offered pensions as part of their talent recruitment and retention efforts,” says Workforce, a SaaS company with a shockingly robust blog. 

But guess what? It worked! People stayed at the same company their entire career because Corporate Daddy was writing the checks in the Golden Years. (My dad worked at Dow Chemical for his entire career and now gets a juicy pension payment. He was in the crossover generation that benefited from both pensions and 401(k) availability. Lucky bastard! Love you, dad.)

Speaking of the 401(k), Workforce also notes, “The ’70s brought America staggering inflation, disco, and legislation that changed retirement forever. In 1978, Congress passed The Revenue Act of 1978 in which Section 401(k) cleared the way for the establishment of defined contribution plans.” Damnit. 

While we all know that tax advantages get me adequately hot ‘n bothered, the reality was that this new legislation quietly shifted the burden from the employer to the employee to guarantee their own financial future. Pensions slowly fell out of favor, and now, if you tell me you have a pension plan, I’ll probably quietly curse your name in a mix of envy and awe. 

The TL;DR? It’s kinda no surprise that today’s American workers are under-saving, since funding your own retirement is a relatively new hurdle. 401(k)s and IRAs are not a naturally occurring phenomenon in nature—they were legislated into existence in the last 50 years, and the people we (millennials) took financial advice from growing up (our parents, most likely) used them as supplemental boat funds on top of their pensions, not as their main source of retirement income.

Second- and third-order effects of self-funded retirement

One popular conspiracy theory I see floated in the back alleys and seedy underbellies of Personal Finance Twitter is that the Fed can’t let the stock market fail, because the majority of US citizens’ retirement hinges on its success.

While this is…oddly comforting, I’m not sure it passes the sniff test of…well, what the Fed was doing in Q1 and Q2 of this year. 

It might be conspiratorial to suggest Yellen will swoop in to prop up the market if shit goes south, but there’s a seedling of truth to the sentiment: A lot of Americans will be up a creek when there’s a prolonged nosedive, because practically the entire millennial workforce (at least, those of the 72 million who aren’t teachers employed by the state or career military) is relying on nothing but their investments and scraps of Social Security to get by in retirement.

Realistically, this could create dire third-order effects—a boom in houselessness, hunger, and, in some cases, extreme poverty that could send our economy as a whole into a death spiral (if you can’t even afford a roof over your head, you likely won’t be able to support your local economy through consuming other goods and services).

I published a podcast episode a few months ago about why you may need to save less for retirement than you think, mostly because I know many in my audience are highly responsible, highly neurotic (hello again!) individuals who are more likely to subvert their current desires for the promise of a magical future. (And because I think balance is important to preach in the online personal finance world in which it’s easy to favor extremes.)

Make no mistake, though: The power of compounding is powerful, but only if you’re feeding the compounding engine enough fodder.

Calculating your own needs based on your age

Ah, the moment where the rubber meets the road! The point at which many are tempted to avert their eyes!

Fear not, dear Rich Girl—whether you’re just starting out and have all the time in the world or you’re rounding the corner to 50 and realizing your impending retirement may be underfunded, we can use some relatively simple math to understand how much we need to be saving.

Why does this matter? For starters, only 22% of people currently approaching retirement age believe they’ll have enough money to maintain a comfortable standard of living, down from 26% a year ago. 56% of people say they expect to have less than $500,000 by the time they retire (providing an annual income of $20,000 per year, according to the 4% rule). Supplement that with the average Social Security check, and that’s about $3,200/month to live on, at best.

That’s not terrible, to be sure; I lived on less when I was 22 and starting work—but in my Golden Years? After working for the majority of my adult life? I’m not trying to cosplay my “roommates and Top Ramen” phase of life again. 

The same study found that only 3% of retirees deemed they were “living the dream” (while around 35% said they were comfortable). I want all of Rich Girl Nation to live the dream, y’all. All of you. So let’s talk about how to get there.

Taking matters into our own hands, as it appears that’s the only option most of us have

Alright, so let’s get the obvious out of the way first: The earlier you start, the better. There’s really no getting around this. 

For every decade that you delay starting, you need to roughly double your monthly investment contributions. As Nick Maggiulli points out, over half of your final portfolio value is saved in the first decade (example for a 40-year investing timeline). 

The idea that “you’ll invest when you earn more” is largely a myth, as some surprising studies have revealed that those who earn more often end up with more credit card debt than when they earned less. The reality? When we earn more, we spend more—especially if we haven’t already reflexively built the saving and investing muscle into our monthly cash flow. 

Encouraging people to start early was one of the major reasons I started Money with Katie, because after being exposed to chart after chart in the financial independence world, I realized that learning (and implementing) this information in your twenties would change the trajectory of someone’s life. 

So if you’re like, “But Katie, I don’t make enough money to invest,” remember: No amount of money is too little to start building the habit, even if it’s $5 a month. 

What number should we shoot for? Well, the problem I see with traditional retirement advice is that it suggests aiming for 75-80% of your pre-retirement income (under the assumption that you’ll pay less in taxes as a retiree, stop saving, and benefit from other cost cuts)—which is all fine and dandy, except for the fact that almost nobody makes the same amount of money throughout their entire career. My income has ranged anywhere from $12/hour to $400,000/year.

Instead, it’s more useful to use your spending as your guidepost.

If you earn $50,000 per year but live on $30,000, that’s worthwhile information—if you earn $500,000 per year but live on $50,000, that’s equally helpful to know.

The challenging part about spending is that it, too, fluctuates through different life stages, and it’ll be impacted by factors like where you live, how many kids you have, and if you have any medical or financial needs outside of the ordinary (she types as she fights an erroneous $80 bill from a doctor’s office for a routine checkup). 

A range can be helpful. For example, I know when I was single I lived on about $3,000 per month. When I got married, my half of our monthly spending jumped up to about $4,000 per month. When we have kids, it might go up to $5,000 or $6,000 (for just my “half,” for consistency’s sake). This means our “dual income” each month needs to range anywhere from $6,000 to $12,000 per month. 

I can use those numbers to tell me quite a bit. If I multiply by 12, I get our annual spending: Somewhere between $72,000 and $144,000 per year. 

If I multiply those numbers by 28, I get the “portfolio target” that’ll allow for a safe withdrawal rate of roughly 3.5% (slightly more conservative than the 4% rule as an extra buffer). That’s anywhere between $2mm and $4mm, which is—to be fair—quite a wide range.

But when we’re talking about the ~world of compounding~ 30 years from now, it’s actually not all that wide (and we’re obviously using super generous monthly spending allowances based on a world in which we have multiple children). 

Now that I know we need between $2mm and $4mm to retire (depending on our chosen lifestyle at retirement), we can work backwards to figure out what it’s going to take to get there. 

This is where I like to use a tool like the Financial Independence Planner to make the math a little bit easier. The good news? A lot of this is proportional. A household earning $50,000 per year is likely not spending $12,000 per month, unless they’re financing their lifestyle with a thick stack of Mastercards.

For example…

A household spending $5,000 per month with $120,000 in earnings (two earners making $60,000, for example) will reach financial independence and be retirement-eligible in 26 years, assuming they’ve got $50,000 invested already (a number I chose arbitrarily). The tool considers all of these inputs and then tells you when you’d be at that blessed work-optional point. 

The best way to actually enact something like this? Try to invest every single month. Whether it’s a set amount of money based on a percentage of your income or a percentage of a variable income that’ll go up or down depending on how much you earn, making it a monthly, recurring habit is the best way to limit your risk and benefit from the ups and downs of the market as they occur.

In summary…

The TL;DR: It’s very easy to calculate how much you’ll likely need to ~live the dream~, and with a little help from Excel, it’s even easier to figure out how long it’ll take to reach it based on how you’re earning, spending, and saving currently. 

As long as we live in the Late Stage Capitalist US of A, we have to take our futures into our own hands—as much as I wish someone would do it all for us. Though, I suppose if that were true, Money with Katie wouldn’t exist (a true chicken or egg conundrum!).

Taking accountability for your own #dream can be fun, though—you don’t have to live on a state-sponsored defined benefit plan. You can create the retirement you actually want for yourself by investing early and often. 

This Twitter user (whom I don’t know, but their tweet was suggested to me) makes a good point: We’re throwing around the word “recession” a lot for an economic reality that doesn’t seem to mirror typical recessionary conditions. 

And to quote one exchange in the replies: “What’s the difference? If things are more expensive for households, why shouldn’t people consider this a recession?”

The answer? “The members of the households in question haven’t lost their jobs.”

In all our concern about our dollar not going as far, we forget: The Federal Reserve has created this environment by design. They want you to buy less. Their hope is that you, the consumer, will be able to afford less—and therefore buy less—to lessen demand and give supply a chance to catch up. (Which will, yes, lower inflation.)

Of course, it doesn’t feel good, in the same way that committing to a New Year’s resolution to “eat better” after three straight weeks of chugging spiked eggnog and devouring Christmas cookies by the tubful doesn’t feel good. The party’s gotta end at some point, right? And if the aforementioned “party” was mostly just due to printing trillions of dollars and—now—things are slowing down because we’ve stopped printing? That’s (probably) a good thing. 

Oh yeah, and about all that printing…

In a way, the stock prices we saw last year were fake—much like the “growth” was kind of fake. Maybe that’s why now it feels like we’re reverting to a less fun “normal,” to price-to-earnings ratios that exist in a realm of reality that’s sustainable.

Why do price-to-earnings (P/E) ratios matter? Well, they’re not the only thing that matters, to be sure, but they’re a decent way to determine how undervalued, fairly valued, or overvalued the stock market is at any given moment—the P/E ratio answers the question, “How much do I need to spend in order to earn a certain amount?” 

Since the prevailing theory (that I’ve come across, at least) is that modern monetary theory and its subsequent quantitative easing got us into this mess, then it stands to reason that looking at the price-to-earnings ratios pre-money printing would represent “normal”—the undistorted price signal. Once we get back to those P/E ratios, then we’d be back to “normal.” 

So what would that look like? Quantitative easing kicked off in March 2009. As soon as the banks started writing off the bad mortgage-backed securities debt in 2009, the P/E ratio skyrocketed (because earnings were low or negative), jumping from a median of around 15 to a staggering 123 in May 2009. But to figure out what was “normal,” we can probably use the P/E of around 15—the average before the Great Financial Crisis and the subsequent Fed triage. 

And now? Our current P/E ratio is about 19. This isn’t a huge difference compared to historical highs (hello, low-40s in the peak of the dotcom bubble), but it’s still far off enough that I’m prepared to make…

My unhinged thought experiment about the bottom that shouldn’t be taken seriously

In order to reach the “equilibrium” of the pre-QE world (assuming that really was equilibrium), S&P 500 would have to come down from 3,825 points to about 3,200 points, assuming earnings per share stay consistent at the current 12-month average of $207. If earnings go down, it would have to drop below 3,200 points. But—and here’s the bull case—if earnings per share go up, the drop back towards “normal” may not have to be as precipitous. 

How much would earnings per share have to go up in order for prices to remain at 3,800 points and hit a P/E ratio of 15? From $207 per share to about $250 per share, or an increase of about 21%.

Earnings have never been anywhere close to that high—in fact, somewhere around $207 is the highest they’ve ever been—but if the S&P 500 increases profits (perhaps by finding new customers in other countries, identifying efficiencies, or simply doing more with less), a further drop could be mitigated. 

But the wealth destruction is already underway, and if your theory is that “QE broke the markets,” we have a decent guess of how much further we have to fall to un-break it (the S&P 500 at roughly 3,200 points). We could always start by eliminating excess like this, documented in a “day in the life at LinkedIn!” TikTok that got absolutely incinerated on Twitter.

To put it in perspective, a fall to 3,200 points would be an approximate 16% drop from where we are now. At the time of this writing, we’re already down 20% from the start of the year; all in all, it’d be a 33% drop from where we started the year; coincidentally more or less in line with the average drawdown of 33.5%. Once we reach a P/E ratio of 15, we’d be back at the “equilibrium state” of the pre-QE world (or rather, what we could consider “undervalued” to “fair value”—but these terms are starting to feel like the same thing).

The actual issue? Wage stagnation

“Oh, great, Katie’s fetishized socialism and liberal woke politics have entered the chat!” Not so, my friends. These circumstances are connected, and it’s all in the name of (a) improving quality of life for workers and (b) boosting profits and growth. Stick with me!

Here’s the thing: The recession label bugs me because it distracts from the actual reason people are struggling: wage stagnation and worsening wealth inequality. 

If the price of your gas increasing by 53% from the start of the year is enough to force you into living paycheck-to-paycheck (or worse, into debt), you were already way too close to the edge and probably underpaid. For many, this is not an issue of irresponsible spending or poor money management—the “bottom 50%” of Americans have an average annual pre-tax salary of $19,000. Yeah. 

Roughly half the country being unable to afford living (and working) in it much longer simply isn’t sustainable, and we have to find a way to balance shareholder interest with the broader employable workforce’s interests. Sure, we want corporate profits to increase in the name of the almighty shareholder—but if the price is great at the expense of a fair wage for the employees? We’re robbing Peter to pay Paul.

The solution to both of these problems is the same thing

How do we do it? Hear me out: We treat employees better, not just hope that those same underpaid employees hold stock. Need an example of what happens when you put employees first, compensate them fairly, and provide job security?

Look no further than Southwest Airlines. Southwest Airlines is one of the only domestic airlines that’s never gone bankrupt and—up until the global Pamela Anderson—had 47 years of consecutive profitability, a feat that’s unheard of in the airline industry. They’re the quintessential MBA business case study.

How does Southwest do it? Well, for starters, they committed early to a disruptive, scrappy business model, and their late founder, Herb Kelleher, was creative. One of his main beliefs in business was that your employees need to come first. They’ve never furloughed employees. The pay is fair. They treat people well. They have a 9.3% dollar-for-dollar 401(k) match and other excellent benefits, including great health insurance, free flights, and profit-sharing. Maybe that’s why they were ranked in Glassdoor’s “Top 10 Best Places to Work” for 10 years in a row. (Can confirm these things; I worked there for five years.)

Southwest is in a league of its own when it comes to impressive, sustained growth and profitability and being known for treating employees excellently, if not a little irritating during Group C boarding (IYKYK). Their employees are known for consistently going above and beyond, flying in the face (pun intended) of the stereotypical “rude and overworked airline employee” trope (though, not without the occasional disappointing mess, to be fair).

A workforce that’s paid well and happy must not be very productive, right? All those benefits must come at significant expense to the company, huh? Well, it’s a long-term game, and Southwest is winning. LUV (Southwest’s ticker symbol) has been one of the best-performing stocks in the S&P 500 over its 40+ year history. 

When you treat employees well and pay them fairly, they’re loyal to you. They work hard for you—kinda like the four employees responsible for ingeniously hedging fuel prices to save the company $1.2 billion this year alone. 

Contrast this with Amazon’s current hiring dilemma: They’re running out of people to hire because their turnover rates are so high. It’s projected that—if they continue business as usual—they’ll run out of new employees by 2024.

Amazon is a hot growth stock, but it’s not sustainable. White-hot growth doesn’t last forever when you treat your employees like garbage.

The economic growth we need will not come from a workforce that’s overworked, underpaid, and considered expendable. For our classic American innovation and ingenuity to get us out of this one, we must do as Kelleher said, and make an “audacious commitment” to “put employees first, customers second, and shareholders third.” Turns out it’s pretty good for sustained profitability.

The good news? While the stock market and supply chains will likely continue correcting, the job market is still strong—and by fixing the way we treat (and compensate) workers, we’ll likely see these other economic growth factors improve, too. A win-win. Maybe things have to get worse before they can get better; the metaphoric Amazon has to run out of workers (or rather, realize that’s where they’re headed) before their labor practices will turn the corner. 

Either way, there’s reason to believe we’re in the worst of it now—and avoiding a true recession is entirely possible, if not probable.