Six Simple Rules of Financial Literacy


 

IMG_0123

Handling your finances need not be that difficult.  In fact, you can simply practice some basic behaviors and end up far better off than your peers.  These behaviours are not hard – they’re quite simple, in fact.  Here are six simple rules that will put you on the right path for financial success:

1.  Spend less than you make.  Very simple advice that most people ignore.  In fact, if you look at spending at any income level, ranging from the checker making $25,000 per year to the executive making $250,000, you’ll find that most people increase their spending until all of the money they make in a month goes out the door to bills and frivolous expenses.  NBA stars quickly go bankrupt after they retire unless they get an apparel deal just as quickly as the clerk at the local gas station does when she loses her job.

If you want to build wealth and develop financial security, you need to spend less than you make, putting money away every month.  This provides you with a safety net when you lose a job or just need to get the car repaired.  It also allows you to increase your income through investments.  Don’t forget also that you have retirement coming some day.  You’ll need to save up enough money to live another 30 years without working.  that is done one paycheck at a time.

2.  When you borrow money, you decrease your effective income.  When you work and are paid, you are trading hours of your labor for hours of other people’s labor.  When you work and save, you can get something that takes a long time to make, because you spent a lot of time working to save up the money you needed to buy it.  Things like houses take thousands of hours for people to build, and therefore can take thousands of hours of work to afford.

People borrow money in order to get something they want right now instead of waiting until they have worked enough to afford it.  You get your new car now instead of working for six years, saving up, and paying cash.  In fact, by the time those six years are up and you’ve paid for the car it may be time to sell it and buy another one.

The trouble with doing this is that you pay more for things.  If you buy a car on credit instead of paying cash, you’ll end up paying thousands of dollars more for the same car as someone who paid cash.  Those are hours that you worked for which you don’t get any benefit — unless you consider getting the car faster worth the extra hours you give up.  If you choose to wait instead, however, it gets a lot easier to pay for things like retirement and college since you’ll be able to use more of your money and lose less to interest.

3.  Make your money work for you.  When you borrow money, you end up paying more for things than you would if you paid cash.  When you save and lend money, you end up getting things for less than their cost – sometimes even for free.  Put $10,000 in a set of 6% bonds and you can take a $600 trip every year without needing to work at all to afford it.  Plus in the end, you still have the original $10,000!

4.  Put the power of compounding in your favor.  When you’re deep in debt and making the minimum payments, the interest generated each month basically wipes out any money that you send in and your debt levels don’t seem to decrease at all.  When you have a small debt, you can pay it off easily because the amount of interest you owe is also very small.

With investing and saving it works just the opposite way.   For example, if you put away $100 per month, in a year you’ll have put $1200 away and maybe made $50 in interest/investment return.  If you’re really lucky you may make $100.  In twenty years, however, the $1200 per year you put away will be nothing compared to the amount of income your investments generate since you may be getting $200,000 per year in interest.  Over long periods of time, the money that your investments generate gets compounded – your money makes money on the money your money’s money made.  It starts slow but it builds up fast.

5.  Limit your spending on things that decline in value.  Cars go down in value over time.  So do boats, mobile homes, campers, clothes, and motorcycles.  Money you put for these things gets used up and is no longer available.  You are destroying wealth when you buy them.  If you limit the amount of money you put towards these things over time, the more wealth you will accumulate.  Spend your money when you buy things like land, quality furniture, and ownership in companies.  Limit your spending when you buy other things.

6.  Be a lazy investor.  People reduce their returns substantially when they spend a lot of time fiddling around with their investments.  This is because most of the return in the stock market is made on just a few days and weeks over a period of many years.  Be out of the markets when one of these periods happens because you heard from CNBC that stocks are overpriced and you’ll cut your future net worth considerably.  The best investors are lazy investors.  Just get an investment plan and stick to it, maybe rebalancing once per year.  Otherwise, find other hobbies.

Got an investing question? Please leave a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s