The basics of finance: What is money?

Many studies, such as that by the National Financial Educators Conference,  have shown that many young adults have a poor financial literacy.  As a result, many adults have no savings; many college students are moving back home after graduation; and student loan debt when leaving college is averaging over $25,000 per year.  To help address this need, The Small Investor is starting a series of posts on difference aspects of finance to help provide the basic financial background needed to be successful financially in life.  These will all be in the category of “Financial Basics.”  The first post will start with the very basics:

What is money?

Most people do not really understand what money is.  They know they like money.  They know that they like having money.   But they do not understand the very fundamental concept of what money is.  As a result, they believe myths like money is finite and that you need to take from one person for another to grow wealthier.  Truly learn what money is, and you’ll understand that everyone can have money.  One person does not need to become poor for another to become wealthy.

Perhaps you’ve heard the expression “Time is money”, but in actuality,

Money is time.

A twenty dollar bill or a jar of pennies is an IOU for something you want.  If you want something like an ice cream cone, your home cleaned, or a new car, you give some of those IOUs to someone else in exchange for the thing you want.  In exchange for those IOUs, you get some of someone else’s time – time to make the ice cream and the cone, time to clean your home, or time to dig up the materials and make a new car.

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To gain those IOUs, you provide your time to other people, doing things that they want.  They give you an IOU for your time, which they received in exchange for providing some of their time to someone else.  You don’t usually get IOUs from other people for doing something just you want to do, even though many artists feel that they should paint, or write, or sing what they want and others should pay them to do so.  Likewise, I can write about things I want to write about, but people won’t read the blog (and hopefully buy a book or click on an ad so that I can receive some money for my time) unless I write about things they want to read about.  By giving you money, people are giving away some of the time that they spent doing things for other people, and they want to get something they want in return.  Likewise, people producing things for you do so because they want to be able to get something they want for their time.  For example, if I don’t sell enough books or get enough money from advertising on this blog, I’ll probably eventually stop writing it and do something else with my time.  Likewise, an artist who is painting pictures you like but who is not paid much money for them may decide to paint things they like instead.

Note that money takes the place of direct exchange.  In the past, you would need to find something someone else wanted that had the thing you wanted so that you could trade.  If you grew a bushel of corn and wanted a box of nails, you had to find someone with a box of nails who wanted corn, and wanted it right now.  With money, you can produce a bushel of corn today and trade it to someone who wants corn now, get a “gift certificate” good for virtually any other item called “money,’  then exchange it for the item you want when you’re ready.

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Just because you’re getting money instead of goods doesn’t mean that you don’t need to produce something to get money.  Just as you couldn’t go to the person with the nails and get them without producing the bushel of corn for them, you can’t expect to get money from someone without producing something in exchange.  Sometimes people might just decide to give you something (or give you money so that you can exchange it for what you need) because they feel like you need help.  This is charity.  Also, you might just take something or some money  from someone else, but this is called robbery.  Finally, you might get the government to go and take things from other people, but if the people who the government is taking these things from do not really want to give it to you, that is still robbery, even if it is legal.

You are taking people’s time from them when you take their money and don’t provide anything in exchange.  If you take too much of the time that people spent producing things and giving them nothing in exchange, particularly if they are forced to give it to you, either because you threaten them with a weapon if they don’t hand over money, or the government threatens them with prison if they don’t pay taxes, they will stop spending their time producing things.  They certainly will stop producing more than they absolutely need for themselves, so there will be nothing left to give away as charity.

Likewise, you cannot expect to get paid more than what you provide is worth to someone else.  To do so would be asking someone to give you more of their time than you are providing to them in value.  Would you spend the time and the energy to make a double-decker cheeseburger with special sauce, fries, and a coke for someone else in exchange for a cup of tepid tap water?  Would you agree to spend three hours cleaning someone else’s whole home in exchange for them spending a half hour cleaning one room in yours?  This is exactly what you’re doing if you expect to get paid more than the market is willing to pay for your job by legislative decree.  If you try to force others to give you more of their time than what you’re providing is worth, they will stop agreeing to trade with you.  You will then no longer have a job.

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Because money is an IOU for doing work and producing something that someone else wants, it is not finite.  There is no fixed amount of wealth in the world – it grows or shrinks depending on whether people as a whole are producing things or consuming things faster. Just because I go and build a house and increase my wealth by one house does not mean that someone else will lose a house when I do so.  If we both put in the time to build a house, we will both end up with houses.  Just because the wealthy increase their incomes does not mean that they are taking money from middle class and poor people.  They may have developed a way to do things more efficiently, which means they produce more things per unit time, causing their income rate to grow.

Many wealthy people also set up something like a business and then hire people to produce things.  The person working does so because the wealthy person has already set up the product, the location, and the methodology to produce things, along with advertising the product and filling out all of the government forms, meaning all the worker needs to do is show up and produce or sell the products and he/she gets to keep much of the money made in producing/selling the product.  In exchange for the work the wealthy person  did in setting everything up and maintaining the ability of the working person to make/sell things, he/she gets a small percentage of the money from selling the products.  The wealthy person makes money by hiring more workers, not because he/she is taking an unfair share of the wealth produced by the person working.

Understand also that the value of something is not based on the actual amount of  time the person giving it to you spent making it;

To you, things are worth the time you would be willing to exchange for them.

Someone might spend a week carving a bowl from a log by hand, but that does not mean someone else will be willing to pay a week’s salary for it.  There may be someone willing to pay that much, but someone else may only be willing to pay a hour’s salary, or maybe nothing at all.  Someone may also be able to create things very quickly that other people would be willing to spend a lot of time to acquire because they have special abilities, have created tools to make them more efficient, or because they have even created a factory or a company to make those things quickly.  This leads to the final truth about money:

People who are more productive through things they learn and tools they make can earn more of other people’s time than they provide in exchange.

People who put in the effort and time becoming doctors, lawyers, or engineers are able to provide things that people are willing to exchange a lot of their time for because the things they provide are very valuable to the other people.  They can therefore earn a lot more money per unit of time than many other people who provide less-valuable things.  A person who has a tractor and can cut a lawn in five minutes, and therefore can cut five lawns in the time needed for someone who has a push mower to cut one lawn, can make five times as much as the person with the push mower.

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To review:

1.  To make more money, become more productive through skills and tools.

2.  You cannot expect to get paid more than the value of what you produce.

3.  You make money by spending your time doing things that other people want, not what you want.  People who do the things that many other people desire get the most money.

4.  You cannot expect people to continue spending their time doing things that you want unless you provide them with IOUs to regain that time getting something that they wish to acquire.

If you feel that this article is valuable to you and worth some of your time, consider purchasing a book (which hopefully will also be valuable) or clicking on an ad and buying something you want from Amazon.  Doing so will provide me incentive to continue spending my time writing similar articles.  Then again, if this article is not valuable to you, you would probably have stopped reading by this time anyway, and I should therefore not expect to receive any of your time in exchange.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @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.

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