It is Not More Money You Need, It is More Principles
The Best Personal Finance Lessons I Have Learned from Others
Lyric -
Money
Get away
You get a good job with good pay and you’re okay
(Pink Floyd — Money)
Lesson -
Is a good job with good pay all you need to be okay!?
In my experience, the answer is no. There is more to life than money.
Given the option though, I would rather have more than less money. But I have learned that having more money alone doesn’t suddenly make everything okay.
All that happens, unless you have learned good money management skills, is that the sizes of the mistakes you make increase. And they can seriously damage your financial health.
So the way to improve your financial health is not more money. It is to develop sound principles to help you make better decisions with money.
Principles are beliefs that shape our behaviours, whatever our circumstances.
And as money is exceptional at influencing our behaviours, strong principles are needed to avoid costly mistakes.
This is true whether you are in a good job with good pay, or a bad job with bad pay.
The Argument for Money Principles -
We all have principles. Yours may be subconscious, but you have them. Like beliefs and values, they provide our identity. They are the things we think are right and wrong. The things we stand for.
You might not necessarily associate them with your thoughts about money, but you should.
Money can be complex.
The complexity of money comes from its power to influence our decisions. It brings a tidal wave of emotion that smashes into our fragile barriers of common sense, causing mistake after mistake.
Only those with strong foundations can withstand its force.
Principles provide foundations
Principles provide those foundations, strengthening our resolve to act according to our values over our impulses.
My principles are no more than a regurgitation of other peoples ideas. They are not meant as professional financial advice. I am not qualified to provide this. My advice comes from my experiences of applying these ideas, alongside a whole lot of trial and error. This is how I know they work.
Applying these principles improved my finances. Not overnight, but over time.
Now, instead of having a helpless and reckless disregard for money, I have a chronic unease and mild paranoia that one day I’ll regress to my previous state.
One day I might even relax enough to get over the paranoia. One day.
The scars run deep. But the deepest ones usually teach us the most.
The Money Principles -
The principles I have developed help prioritise my thinking over money. They reflect my beliefs on how to manage money.
They are not intended to make you rich or solve all your money problem, but I believe they will help.
These principles are:
- Liquidity
- Stability
- Growth
Principle 1 — Liquidity
The first principle is liquidity because you will always need access to cash
Unexpected bills always arrive. Calling them unexpected is a misnomer. The only thing unexpected about them is their uncanny ability to make us not expect them!
Unwanted, yes. But unexpected, no.
Things break down. Always.
And when they do, you need cash to pay for them so you can avoid borrowing.
Borrowing delays improvement. If you don’t hold cash, you will struggle to make real progress.
To paraphrase a Warren Buffet quote — “cash is like oxygen, never thought about when present, but the only thing that matters in a crisis”
If the worst crisis you experience is only a flat tyre or a broken TV, be thankful, you will only gasp for air momentarily. But a job loss that threatens your mortgage or rent payment. That may see you scrambling for a ventilator.
The main components of the liquidity principle are holding cash and using cash.
Holding Cash -
Knowing how much cash to hold differs from person to person. But conventional wisdom says to hold 3 to 6 months worth to pay essential bills, in case you lose your income source.
What to do -
Step 1 — Work out how much you need to cover your essential bills and start saving whatever you can afford.
Starting is hard. It feels like you have a mountain to climb. Don’t let that put you off. It is a climb and not a sprint, so be patient. Focus on making progress, one level up at a time.
When you reach a level, reward yourself in a small way, then start again. The mountain top will eventually come into sight.
To help out, consider insurance policies that cover loss of income. They can be a good way to offset the amount of cash you need to hold.
Step 2 — Put this pot of cash out of the way.
You don’t want to be tempted to dip into this pot for convenience.
I have found that using an external bank account (i.e. not with the same place you have your current account) can be a good way to do this.
Step 3 — If possible, keep a small pot of cash at hand to pay the small “unexpected/unwanted” extra bills.
As we discussed, these will arrive, so you should plan for them to avoid using your new emergency fund.
Using Cash -
Essentially, this means not buying something unless you have the cash to pay for it there and then.
What to do -
Step 1 — Stop using store cards and credit cards
Unless you are very disciplined and pay them off in full each month, cut them up or only keep one for emergencies (and that does not mean new shoes!).
This can be a hard habit to break, but it is an essential one if you are to improve your financial situation.
Step 2 — Only buy something if you can justify the time it took to pay for it
One of the best pieces of advice I read about managing your spending probably came from the American philosopher David Henry Thoreau’s quote -
“The price of anything is the amount of life you exchange for it”
We generally get money for exchanging our time — to do a job — for a paycheque.
So before making a purchase, ask yourself, how long will I have to work to pay for this?
If you get paid £500 a week for a regular Monday to Friday job and want to buy something that costs £100, you need to work one whole day to pay for it. (It is more by the time you consider tax but to keep it simple let’s just say one day)
Ask yourself if the thing you are going to buy is worth working a whole day for. If the answer is yes, go for it. But I have found very often when I frame things this way the answer is no.
Principle 2 — Stability
The second principle is stability because you need to know where your money is going
Stability is about understanding your incomings and outgoings with accuracy, and getting your money to the right places. Those right places should make your current and future financial position more secure.
The main component of the stability principle is budgeting
Budgeting helps control spending and keeps us focused on financial goals.
What to do -
Step 1 — Go through your bank statements recording all incomings and outgoings. Do this over several months to a year.
Now you know where all your money goes. Surprised?
Maybe you knew you spent that much on takeaway food already!
Most likely you identified some opportunities to cut costs by dropping subscription services you barely use, or in bills that have crept up over the years that you can renegotiate, or shop around for a better deal.
Step 2 — Develop a budgeting philosophy that works for you
Now you know where you spend your money, you need to align this with where you want to spend your money.
A budgeting philosophy can help with this.
Whilst there are many examples, the one I follow is the 50/30/20 budget.
- 50% of income on essentials bills
- 30% on discretionary spending’s like holidays and social events
- 20% on savings and paying off debts.
As there is a fine line between essential and discretionary spend, you’ll have to decide what is essential for you — and it is probably not the full subscription TV service.
Your budgeting philosophy needs to reflect your goals and therefore, what’s important to you. So you need to build these things into your budget.
Whether it’s family holidays or paying off your mortgage early, you need to be realistic about how you can do this. And that means building the cost into your budget.
What you are looking to do here, is make decisions that provide stability.
It could be that your monthly takeaway bill becomes your holiday or cash savings fund!
Step 3 — Review your budget regularly and repeat steps 1 & 2
Principle 3 — Growth
The third principle is growth because you want your money to work for you, not you working for your money
Growth is about making the most of what you have so the future you is more secure than the current you — financially speaking!
The main component of the growth principle is understanding compound interest
It is often referred to as a magical formula due to its multiplying effect. It can turn small sums of money into very large sums of money over time.
Compound interest is what you get paid when you invest money in the stock market, or savings account.
To understand its full potential play around with a compound interest savings calculator such as this one.
But as a basic example of its magic consider this -
If you were able to save £250 per month and invest into a stock market fund that pays 7% interest on average per year, at the end of the first year you would have £3116.
A £116 profit might not seem much. But what if you left it and continued to invest at the same rate.
In 10 years your fund would be worth £43,500. And in 20 years it would be worth £130,000.
In 20 years, your £250 per month made £70,000 in interest.
This is the magic in compound interest. But, the magic quickly turns to a nightmare when you borrow because the opposite now happens. Now you pay the interest, instead of allowing it to pay you.
If you have either lived through or heard about someone else’s horror story of taking years to pay off a credit card bill, you now know why. Compound interest worked against them, and they did not pay off the amount borrowed quickly.
Failing to understand compound interest will enslave you to a life of paying it. But when you understand its ‘magic’, it will spend its life paying you.
What to do -
Step 1 — Make regular deposits into a savings account that pays compound interest
A works pension scheme or private stocks and shares fund for example. Ideally, you would do both.
A low-cost index tracker fund can be a great way to do this if you are uncomfortable picking and choosing investments. But do some research first before making any commitment.
As the above example shows, a little amount can grow into a big amount over time, so the sooner you start the better.
Step 2 — Diversify your savings
As the old saying goes, ‘don’t put all your eggs in one basket’.
Read up on asset classes for more detail, but essentially you want to hold a mix of things that don’t all react the same way to change. (i.e. a change in interest rates)
Buy an ice-cream shop and an umbrella stall for example…
Step 3 — Invest in yourself as a form of growth
Learn new skills that you can generate an income from.
By taking a few courses, you might be able to teach others how to do things and charge them for it. Or you might be able to get a promotion.
Prioritise Based on Your Principles -
I hope this article helps you think about your relationship with money. And how developing your principles can improve the quality of your decisions.
Principles provide a reference point to help make decisions.
Develop yours based on what’s important to you.
For me, that means prioritising liquidity, and then stability and then growth.
These principles are simple enough to understand but are hard work to follow.
But the effort is worth it.
Whether you are in a good job with good pay, or a bad job with bad pay, sound money management principles will help you to be okay.
Originally published in alessonfromlyrics.com
