5 Simple Finance Principles You Need to Know
And actionable advice to improve your financial wellbeing.
Does thinking about your finances make you feel uncomfortable? Or even stressed?
Do you have a hard time talking about your financial situation?
Ever wonder why?
A hard truth: people simply don’t want to. We slap the “I’ll worry about it later” label on it and push it to the back burner.
Financial stress is prevalent. Anxiety. Insecurity. Fear. Yet, we’re not willing to face the stressors and figure out a solution.
Personal finance doesn’t have to be complicated. Unless you’re doing a deep dive on some intricate concept, it’s pretty straightforward — and an absolute must-know topic if you want stability and independence in your life.
There are a few basic principles that are critical to reaching financial stability, accumulating wealth, and living life to the fullest. Money is transitory, but our society is based around it. You can’t get the things you want, or do the things you want to do without it.
You often need money to get from A (wherever you are now) to B (your goals and desires).
So we’re going to walk through five simple financial principles (and some actionable advice to maximize this knowledge) that will help you get from A to B.
The fundamentals of money, so to speak.
Compound interest is your best friend.
Yep, you heard me. Forget Sam or Catherine or whoever your best friend is. Compound interest now claims this title.
Just kidding, Sam. Relax.
Compound interest is the beautiful process of your money making money over time. It’s the ultimate driver of your wealth’s growth over the course of your lifetime.
Let’s pretend that you start investing for the first time today. If you invested $1,000 every year for the next 40 years, you could be looking at $500,000+ at the end of year 40.
Cha-ching.
How is this even possible? First, the historical average annual return of the market is right around 10%. Next, when you consider annual contributions of $1,000 with 40 years of compound interest at the market’s average annual return since the 19th century — then $500,000 doesn’t sound so unreasonable.
If you want to employ your money (to make more money), wouldn’t you want it to work for as long as possible? That’s why you should be actively saving and investing. And when I say investing, it doesn’t have to be complicated — because I know that’s a loaded word.
There are plenty of funds you can purchase that are designed to mimic the market’s movement.
If you set your money up for success, it’ll work diligently for you for a looong time. And you get to reap the rewards.
Honestly, if you take one lesson away from this, it’s that compound interest is the key to your long-term financial health.
It’s the freakin eighth wonder of the world according to Albert Einstein for goodness sake.
“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t…pays it.” — Albert Freakin Einstein
Actionable Advice: look into opening a brokerage account. The sooner the better. There are plenty of platforms out there: Fidelity, Merrill Edge, E-Trade, etc.
If you can’t make more, spend less.
You may have heard this one before — it’s not like it’s some big secret. Without secondary sources of income, it’s hard to earn more money. Unless you can work more hours (if you’re hourly), make more sales (if you get a commission), or get a raise.
Easier said than done.
Otherwise, that leaves cutting down on your expenses. You could argue this is a lifestyle lesson as much as a financial one. Your monthly expenses are dictated by your lifestyle choices.
Rent/mortgage, dining out, subscriptions, shopping, etc. We spend our money on a countless number of things. We’re consumers.
But there’s a clear difference between necessary and unnecessary expenses.
Necessary expense: paying rent. Having a roof over your head is pretty important.
Unnecessary expense: $100 worth of candles. Candles are pleasant, but not integral to your day-to-day life.
So the goal here is to figure out how to maximize your earnings. It’s a hard balance — you want to be smart about your purchases but still live comfortably and do/buy the things you enjoy. The key is staying within your financial lane and avoiding frivolous or excessive purchases. It’s also important to practice moderation.
Dining out is fine — within an appropriate threshold. Is $400 a month necessary? Maybe. But probably not. That depends on your personal situation. The point: the more you spend, the less you save. The less you save, the less you set aside for your future.
There’s a metric for this: savings rate.
Your savings rate is the percentage of your total pay that you save each year. For example, if you earn $50,000 a year (net of taxes), and you save $5,000 of this amount, your savings rate is 10%. In other words, 10% of your paychecks are set aside for investing.
Why is this important? Your savings rate tells you (1) if you’re cost-efficient (i.e. limiting your cost of living) and (2) how much money you’re setting aside for your future. It plays off of our first lesson about compound interest. When you set money aside, you’re effectively employing it to work for you.
The more money you have working for you, the less you have to work yourself.
Actionable Advice: take a look at your budget and ask yourself: “What can I spend a little less on?”
It doesn’t have to be anything world-breaking or life-altering. For example, there was a point last year I purchased an embarrassing amount of smoothies — to the tune of $145 in one month. You’re probably asking “how did you spend that freaking much on smoothies?”
A very reasonable question.
It was simply a habit. An expensive habit. This was clearly an expense I could (and did) cut back on. It wasn’t necessary, it was a luxury — a luxury I was overindulging in.
But without budgeting, I wouldn’t have necessarily realized the significance of this habit.
If you don’t have a budget, make one. Again, I’m not in the business of overcomplicating things. It’s as simple as downloading your monthly bank statements to excel and categorizing each line item. It’ll take maybe 30–45 minutes at most. This will give you a detailed map of your lifestyle choices/expenses.
Long-term dreams will stay dreams if you don’t prepare
Do you have long-term dreams? Maybe to own a house, or a boat, or just retire and live a comfortable life.
Hard-to-swallow pill incoming: these dreams are going to remain a fantasy forever if you don’t start preparing now.
A goal without a plan is just a dream.
Let’s say you want to buy a house. You need to have answers to several questions.
First and foremost, can you afford this purchase?
How’re you going to make this purchase? A mortgage? All cash? If interest rates are low, debt financing may be the best way to go. Whether you take out a loan or pay all cash, it’s important to understand how this is going to impact your liquidity/cash flow.
When are you going to make this purchase? Three years from now? Five years? Ten years? More time to save beforehand means less financial burden later.
How much money are you setting aside each month for this purchase? Where is this money coming from? Buying a house is a big financial commitment — you need to have the funds to support it.
Do you need to cut back on certain expenses to make this happen? You might have to change some lifestyle habits…like constant smoothie purchases…
Simply put: what’re you going to do to make sure you reach this goal? This thought process can be applied to any significant purchase. Planning is most effective when you have answers to these questions and you lay out quantifiable, realistic steps to achieve your goal.
Actionable Advice: Put together a list of your life goals/milestones that are associated with significant costs (e.g. buying a house, paying for school, traveling, etc.). This may be daunting, but it should put your life’s costs into perspective. Ask yourself the above questions to get the ball rolling.
You can’t always expect the unexpected, but you can be financially prepared
Life is unpredictable. Sometimes we’re hit with hefty unavoidable costs.
I’ve been in four car accidents in my lifetime (three were not my fault) — and two of those happened within a week of each other.
In a two-year span, I broke a finger, a foot, a wrist — and endured a hernia. I don’t recommend.
I’m not mentioning any of this to suggest I’m accident-prone (sigh, although the numbers indicate I am). These are just examples of what life throws at you sometimes.
It isn’t reasonable (or mentally healthy) to expect to get rear-ended every time you get behind the wheel — or to break a bone every time you play sports. But you can be financially prepared.
How? An emergency fund.
Emergency funds are exactly what you’d think — a cash reserve set aside just for life’s unexpected costs. To ensure adequate coverage and minimal life interruption, it’s necessary to maintain an emergency fund with about six months worth of expenses. To maximize interest and keep up with inflation, it’s important to house this fund in a high-yield savings account.
Why is this important? Because, if you’re hit with a big mandatory expense or unforeseeable cost and you’re not prepared to pay it, then you’re put in a tough spot.
You either have to (a) drain your liquidity, (b) ask family/friends for money, or (c) rack up personal debt.
You don’t want to be forced to do any of these things. Without liquidity, you’ll struggle to cover your usual, expected expenses. Asking family or friends for money is awkward and not a desirable reputation. And option C digs you into a deeper and deeper financial hole. It’s a vicious cycle that puts you in an even worse position.
Actionable Advice: remember that handy-dandy budget of yours? Figure out how much money you need to set aside to cover six months of expenses. Then open up a high-yield savings account and start depositing money to build to that amount.
Time is your biggest asset
At the end of the day, time is the most precious asset. You can’t buy time. But money can help you maximize the time you have.
What do you enjoy? Reading? Relaxing by the pool? Learning new skills? Traveling to new places?
When you have more time, you can do what you want to do. But you need money to free up your time.
This lesson is all about perspective. Once you accept money’s role in your life and commit to expanding your financial knowhow, you can start making progress towards your life goals.
In my opinion, you can’t buy happiness — but money grants you more independence and opportunities to make the most of your finite time.
Key Takeaway: Time is king. Being proactive when it comes to your personal finances will free up your time so that you can spend it doing what matters to you.
Wrapping Up
To summarize, the five basic finance principles we’ve covered are:
- Compound interest is your best friend.
- If you can’t make more, spend less.
- Long-term dreams will stay dreams if you don’t prepare.
- You can’t always expect the unexpected, but you can be financially prepared.
- Time is your biggest asset.
The actionable items are:
- Opening a brokerage account
- Create a budget (if you don’t already have one) and figure out some expenses you can reduce or eliminate altogether.
- Write out your list of life goals and the steps you need to take to make those happen.
- Set six-months worth of expenses aside for emergency situations.
- Above all else, more time is the ultimate goal — and being on top of your finances can free up your time.
If you have any questions, thoughts, or opinions, leave a response below!
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