What are some things that someone without a finance background should know in personal finance (Most significant)
Holy cow, but there’s a lot of bad advice here. As a younger man, I was a financial consultant, and here are some truisms about personal finance.
- 1. Do save money from this moment forward. Money and time are compelling, so the younger you are, the better off you can be. Just about anyone can retire at 40 on the same basic income they are earning at 40 and offset inflation for the rest of their lives. It is surprisingly easy to do. Here’s how it works:
STEP 1) Take 10 cents of every dollar and put it away. And don’t ever spend it. This is the foundation of your financial corpus – the body of your financial security. You will invest this in this order:
- Cash (e.g., a jar by the door where you drop it).
- Small interest cash account (e.g., savings account).
- Fixed investments (e.g., CDs or highly rated bonds, some annuity contracts, etc.), conservative blue-chip mutual funds (growth/income), and aggressive mutual funds.
The amount in each will vary with your age (the older you are, the more stable your portfolio needs to be. If you’re young, you might have as much as 25 – 33% in more aggressive investments; if you’re 60, you’ll have tiny, aggressive investments, 1-3%. [notice I am avoiding individual stocks. Mutual funds allow buying into a monitored diversified portfolio with as little as $1,000. Sometimes less. And never, never listen to salespeople (brokers and insurance salespeople). They are only after you money. Invest conservatively in conservative mutual funds, and then don’t freak out when they fluctuate in value. Just keep putting your percentages in.
Put aside this 10% into your first full-time job. If your first full-time job nets you $30,000 a year, you should put aside $3,000 a year and live on the other $27,000.
STEP 2) Put 50% of every raise, bonus, or increase in salary away, so you improve your lifestyle, but only by half of what you have. So, life does get better, just less. Pretend you only got half. You still get a raise, just less than you thought. The other 50% gets added to the corpus of your investments.
If you start at 17-18, the above steps will allow you to retire at 40 on the same salary you earn at 40 and give yourself a 5% raise for the rest of your life – no matter how old you live.
2) You have two factors to track – your NET WORTH and your CASH FLOW.
Net worth: If you sell everything you own and pay off everyone you owe, net worth is the amount left on the table. It is the financial equivalent of how physically healthy you are. A substantial net worth means you are financially solid.
Cash flow: If you take the amount of money coming in and subtract the amount you are spending each month, this is your cash flow. You should always maintain a POSITIVE CASH FLOW, meaning that after you pay your bills, go to the movies, eat out, etc., you have money left over. The higher your positive cash flow, the healthier your spending habits are.
An easy way to understand this is to think about physical health. If you take someone physically fit (so, net solid worth) but have negative cash flow (so, s/he’s eating candy all day and bacon cheeseburgers and not working out), that person will eventually become unhealthy (their net worth will ultimately suffer.
If someone has a negative Net Worth but works out all the time and eats healthy foods and reasonable portions, that positive activity (good cash flow) will eventually make her healthy.
If you have a positive net worth and a positive cash flow, you will eventually build a solid financial foundation.
3) When spending money, differentiate between “value-oriented” expenses and “maintenance” expenses. This is something I used to teach clients. Maintenance expenses are things you buy that become worthless after you buy them or continually decrease in value until they are useless—toilet paper, new cars, video games, eating out, etc. Value-oriented expenses are expenses that have the potential to either 1) go up in value [collectible art, antiques, real estate, investments, etc.] or 2) increase your income [education, for example, or specialized training that could increase your earning potential, thus increase your cash flow].
So, you want to decorate your house. It would help if you had something on the walls. If you go to Walmart and grab some of their poster or pre-painted wall art, you are essentially burning your money because those items only have the potential to become yard sale items. They will only be worth what you paid for them. But, for roughly the same amount of money, you could buy original art by a known artist at some auction. I have seen good art sell for $75 [in a frame!] because it had no reserve, and the bidding was light. Buying the poster will decrease your net worth daily, so you lose money just by hanging it on your wall. If you buy the collectible art, then your net worth goes up. Outfit your house with value-oriented assets, and every day, the stuff on your walls, the chairs you sit in, etc., will increase your financial stability and security.
4) Buy a house. Keep your cash flow manageable to get into a better home – buy one you can afford and then move to a better house every 5-10 years. We purchased a 2/1 townhouse [as an additional house] for $75,000, rented it out to cover the mortgage payments, and sold it a few years later for $130,000. We walked away with over $40,000, so while going about our day-to-day lives, our name on that deed earned us an additional $10,000 a year, which added to our net worth. And there are tax benefits to being a homeowner. Ownership is preferable if you don’t buy stupid, overextend, or overspend.