Personal finance begins with budgeting and controlling your money. You need to make sure you are spending less than you make, putting money away for future expenses, keeping some cash around for emergencies, and staying out of debt beyond, perhaps, your home mortgage. Do these things and you’ll be way ahead of 80% of the people out there.
But if you want to become financially independent, meaning that you have enough money tucked away to pay for all of your expenses for the rest of your life, saving isn’t enough unless you have a million dollar per year income and you live on $50,000. Realize that in order to pile up money for a year through work and saving, you need to do enough extra work beyond what you need for daily expenses to replace a future year of work, which takes a lot of time. Think of it this way:
If you were a farmer with a mule, growing food for your family. If you worked really hard, you would probably be able to grow enough food for your family during the year, plus put some food on the shelf for winter. If you really worked the fields from morning to night, growing on all of the ground you could, in a given year you might be able to grow, can, and store enough food to last an extra month or two beyond the start of the next year. Maybe three or four months. This means that it would take you three to five years, working like a dog every day during the growing season (and a lot during the offseason too – farmers work hard) to save up enough extra food to last you a year. If you wanted to save up enough to last you through a twenty-year retirement, that would take you sixty to 100 years. That’s a lot of work, and a couple of crop failures in the middle, or an injury that put you in bed for a few weeks, and you might not make it. Plus, while you might be able to work those hours when you are in your 20s and 30s, you’ll start slowing down and feeling the pain of all of that labor when you are in your fifties and sixties.
Great beginner investment guides.
Working an office job or factory job in the modern age is really the same. If you want to have money to live on when you are not working, you need to put away extra when you are working. Money is just stuff on the shelves – IOUs for someone to give you an hour of labor in exchange for the hour of labor your gave someone else in the past. The trouble is that it is difficult to save up enough money before your sixties or seventies through work alone. You never get that sense of peace that comes with knowing that you don’t need to work to pay the bill until you reach your golden years. And if something happens along the way like a job loss or a major illness, it can set you back and you may never become financially independent.
The answer to becoming financially independent is to get other people to help you. You want to provide others with the ability to make a living without figuring out everything themselves, and in exchange get a little of the income produced by their labor. If you were a farmer, this would be like letting other people farm on your land for a small share of the crops, or letting others borrow your mule and plow for some of what they produce.
One way to do this is to start a business and provide employees with a way that they can make money – feeding people in a restaurant, making something that other people want, or providing places for people to sleep for the night with a hotel – and in exchange you keep a small portion of the money produced through their labor. For them, it means that they can make a living without going through all of the hassle of setting up their own business and figuring out something they can do that will make money. For you, it means that you can make a bigger income using the help of others than you could by doing all of the labor yourself. (Note, another thing you could do is to use machinery or computers to multiply your efforts, but we digress.)
Want all the details? Try The SmallIvy Book of Investing.
Maybe you don’t want to start a business and deal with the hassles and take the risk, however. Maybe you also don’t know how to start and run a business and don’t have the money to invest in a building, equipment, and inventory. Maybe you also would like to just work for someone else and not need to be worried about market conditions, meeting a payroll, or preventing theft.
By investing in stocks, you can effectively own a business – in fact you can own great businesses like Apple, Google, or Amazon – but do so with just a small starting investment. You get the advantages of ownership without all of the hassles of needing to run the business. If you buy a mutual fund or an exchange-traded fund (ETF), you can own little parts of dozens or hundreds of businesses, meaning that you can reduce your risk should a particular business see declining sales or other issues.
So once you get past the initial personal finance issues like maintaining a budget, you really need to look at investing. It can be complicated if you decide to make it that way, but it can also be really simple, in fact downright boring, if you invest through index mutual funds and ETFs. So look into investing, perhaps starting with one of the investing books shown above (I, of course, recommend The SmallIvy Book of Investing). In twenty years when you’re financially independent, you’ll be glad you did.
Have a burning investing question you’d like answered? Please send to firstname.lastname@example.org or leave in 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.