A couple of weeks ago, one of my readers mentioned that he/she had read most of my posts (50 and counting) and asked if I would consider writing some basic personal finance concepts posts. After reading that comment, something struck me right in the face and made me realized that I had made a really bad assumption.
I had been assuming that the majority of my readers have a similar level of personal financial knowledge as me. This had made me realized that I may have neglected some readers that really wanted to learn the basics. I haven’t written many basic personal finance concepts posts on my blog at all. To make up for that mistake, I will dedicate the next series of posts to help motivated individuals to understand and master the basic personal finance concepts. I will show them how to start managing their money responsibly.
If I am able to travel back in time to coach my younger self, these are the concepts that I want to mentor my younger self to set him up for future financial success. I will take him under wings and train him to become a disciplined saver, a responsible spender, an intelligent investor and a personal finance Jedi (I had to put the last one in. I am huge Star Wars fan.) Let’s hop into my imaginary time capsule and travel back in time to meet the younger Leo T. Ly and start his basic personal finance Jedi training.
Everything Revolve Around Money
Once I have headed back in time, I would like to find an opportune time to have a meaningful conversation with my younger self. The first thing that I would want him to understand about personal finance is that everything revolves around money. It’s what makes the world go round (by that, I mean you can travel around the world easily), allows us to buy food, live in nice houses and drive fancy cars. Let’s face it, most of us can’t live without money.
Since money is such a powerful and useful tool, learning how to manage it responsibly and harness its power to work for us would make life a lot less stressful. We want to be the master of money and have it working us. Have our money make more money for us rather than us being the slave of money by continuously working for money.
Happiness Vs Choice
Would money be able to solve all your problems and relieve your everyday stress? No. With money and financial independence, would that make you happy? Not necessarily. Money can’t buy you happiness nor solve all of your problems. What money can do is: it can give you choices and the freedom to do what you want to do. Hopefully, with more freedom, it’ll allow you to pursue the activities that’ll make you happy.
The Pay Yourself First Budgeting
For the majority of us, we were not born wealthy and would most likely have to build our own wealth from the ground up. Regardless if you are good with numbers or not, you will need to have a basic understanding of budgeting concepts. To build wealth, you need to know how much you are earning monthly/annually, the amount of money that you’ll save and what’s left to pay for your everyday expenses.
Did you notice that I put savings before expenses? When it comes to your money, make sure that you are the first one in line to receive it. This is called “paying yourself first”, save and spend what’s left of your income. For starters, I would recommend you to save at least five percent of your income automatically. Once you’ve gained more experience and momentum, I would recommend that you gradually increase the saving percentage. The best way to increase your savings is to save your annual bonuses and pay raises if you receive them.
Substitudes And TradeOffs
Putting in the numbers and adding them up in a budget spreadsheet is only half of the battle. The second half of the battle is to execute your budget plan and stay within it. To do that, you’ll need to develop some money management disciplines and be able to distinguish between wants and needs. Sometimes, you’ll need to make tradeoffs if you are going to stay within your budget. Being able to find substitute items that’ll give you similar values as the original item that you want but cost you a lot less, will help you stretch your budget a lot further.
For example, I substitute my purchases all the time when I am doing grocery shopping, such as buying fruits. If apples or pears are not in season, I can always buy other fruits like oranges. This allows me to spend less money but still have fruits in my diet. Another way is to shop at less expensive stores to buy the same thing. Instead of going to Loblaws, I often try to buy my groceries at No Frills as it’s a bit less expensive for the same items.
Appreciating VS Depreciating Assets
To take the substitutes and trade-offs concept to the next level, we apply this to the assets that we buy. These are the things that have values. Over time, the value of these things can either increase (appreciating assets) or decrease (depreciating assets). What am I referring to? I am referring to your house, car, flat screen TV, computers, stocks, bonds, rental property and anything of value that you own.
The key to increasing your net worth is to buy more assets that have the potential to increase in value over time. Assets such as rental properties, stocks and bonds will have the potential to increase their value. In addition, spend less on assets that decrease in value over time like cars, boats, flat screen TVs, tablets, etc.. By minimizing these spendings, you’ll have more money to allocate to purchase appreciating assets.
Emergency Fund Vs Access To Funds
Some experts recommend three months of expenses saved and dedicated as your emergency fund. Other experts recommend six months of expenses or even 12 months of expenses saved. Whatever the amount that allows you to feel secured and worry less about unexpected events that can throw a financial curve ball into your life, save that amount. Sometimes, $h!ts happened and it’s best to have the financial wherewithal to withstand and overcome these events. So it’s best to be prepared.
For me, I borrow money to invest. Financially, it’s not very efficient to keep my money in a savings/emergency fund account and earn peanuts of an interest rate. At the same time, I am paying a higher interest rate for funds that I use to invest to earn more passive income. However, I still believe that I need a plan to protect myself if a costly emergency happened. To do this, I created access to funds of about $100,000 that will allow me to deal with 99% of any unexpected emergencies. Hence, I don’t keep an emergency fund.
Cost Of Debts
When I built my access to funds, it allowed me to become familiar with the different forms of debt and their cost. Even if I have access to borrow that many funds, I would not want to borrow from institutions that charge me a rate greater than 6% per annum. I would rather sell my stocks holdings to pay for my emergency than to borrow money from a high-interest credit card.
Even though I have confidence that I can earn an average annual return of more than 6%, I would not put my money at risk by investing while I am carrying debt that costs 6% or more per year. Hence, if you have high-interest credit card debt, I would recommend that you pay it off as soon as you can. It’s very unlikely that you’ll be able to find a long-term investment that pays you a guaranteed 20% annual return.
Credit History And Score
For some people, their credit history and score are not high priority items on their personal finance list. However, I would argue that by having a pristine credit history and an excellent credit score will do wonders for your personal finance. It can save you thousands of dollars when you need to obtain a mortgage for your home. As a borrower with great credit history and credit score, financial institutions will view your application favorably and are willing to offer you better rates to secure you as a long-term client.
Using myself as an example, I built my strong credit history and score in a variety of ways. First, I always pay all my bills in full and on time every month. Second, my access to credit is always more than ten times the amount that I’ll ever need. Third, I often keep my credit usage to about 20% or less of my total available credit. Because of my superior credit profile, I often have a lot of negotiating power when I borrow money to invest. So don’t under estimate and ignore the power of your credit history and score.
Retirement Savings Vs Financial Independence
When some people hear about retirement savings, they often ignore it. Either they don’t want to think about it or it’s too far into the future and they want to live in the present. Sometimes, it’s quite difficult to plan that far ahead with so many uncertainties. Two of modern day’s mantra: you only live once (YOLO) and fear of missing out (FOMO) is not helping retirement savings build its case either.
For me, I also ignore retirement savings because I am approaching it from a different view – the financial independence view. The way how I see my savings is that it’s my ticket to freedom. It can be tomorrow, nine years or twenty years from now. Once I have accumulated a net worth of $2M, that’s when I can buy my own freedom as I have achieved financial independence. I no longer need to work for money. If retirement savings is not for you, why not give the financial independence concept a try?
Saving money is hard work and it requires a lot of discipline. Sometimes, it even sucked if you have to fight the urge to satisfy your need for consumption on a regular basis. I totally understand that. Who doesn’t want to live life to the fullest and splurge a little? To counter the negative feeling, I motivate myself by giving myself less work and have my money work harder than me. I don’t need to contribute a 100% of what I save. I only contribute a portion of my savings and take advantage of free money to contribute the rest.
To grow your savings, it’s not just about saving diligently. It’s also about taking advantage of free money and use it to further compound your savings. Free money is out there, available and waiting for you to claim it. Give my “How to make money the easy way” post a try to get a few ideas on how you can get more free money too. You don’t have to work more to claim these free money. You just have to change the way how you are doing things.
One of the simplest and beautiful concepts in personal finance is compound interest. Albert Einstein called it the eighth wonder of the world. It starts with you saving your money and investing in an investment that pays you an income. You use the income generated to generate more income. Again, using more income to generate even more income. To see the power of compound interest on full display, check out the third step to saving a million post.
The best partner for compound interest is time. The longer these two work together, the more growth that your money will experience. This is why all personal finance experts recommend everyone to start investing early and often. So, if you have not started, the best time to do it is now. Wait, I mean right after you’ve finished reading this post.
My Two Cents
Money is a medium of exchange that we, humans have been using for centuries and will continue to use it for centuries to come. By learning how to use money as a tool and harness its power will definitely help us transform our personal finance for the better. If we mastered the basic personal finance concepts, we’ll be able to use our money to work for us rather than us working for money.
So, what basic personal finance concepts do you think is important for everyone to master? Do you have any success personal finance story that you would like to share with this community?