Literacy
Managing money meaningfully involves knowing the principles that guide the practices. Learning the principles helps you know the purpose and value of the practice. Your practices may vary with changes in your circumstances. The principles will remain the same. Be idealistic in principle, while shrewd in practice. Commit to financial literacy. Learn about budgets, financial statements, investing, risk management, and taxes. Your personal financial success depends on sound money management. A basic knowledge of money management principles and practices, or financial literacy, is the ground for your success.
⤠ Ask for wisdom over wealth, and you’ll get both. ⤟
Family
To help yourself with money management, help your family with financial literacy. You won’t succeed if your spouse, children, or other household members are constantly pulling the opposite way. They’ll wear you down, and you’ll give in. Instead, let them see why you are making the decisions you are. Indeed, consult with them. Listen to how your decisions affect them. But also explain how your decisions are serving and protecting them. And explain the principles on which you are acting. Let them see the care you are taking, wisdom you hold, and discipline you practice. Teach sound money principles and practices to those who are most important to you, just as you serve them with other forms of love and care.
Consumption
Manage your consumption. Appetites expand to our ability to fulfill them. The move you have, the more you want. Control that urge. The hungry seek food, while the satisfied seek better food. The homeless seek shelter, while the sheltered seek larger homes, second homes, and luxury homes. Even the highest income earners become debt-ridden and insolvent when failing to manage their consumption. Financial instability comes from consumption exceeding income, whether income is high or low. A sure way to increase financial stability is to reduce consumption. The study The Millionaire Mind reports that most millionaires had never spent more than $41,000 for an automobile, $4,500 for an engagement ring, or $38 for a haircut (including tip). Most of their recreation was inexpensive or free, like watching their children play sports or entertaining friends at home. You need not forever deny yourself purchased pleasure. But you can often delay consumption.
Expenditures by her co-workers surprised Erin, who was always cautious with her money. She winced when she saw a young co-worker driving a new car looking more like the luxury cars senior employees drove than her own high-mileage car or the modest vehicles of the other younger employees. One of her own small class of new employees had just flown to New York City to shop on Fifth Avenue for the weekend. Erin wondered whether she was missing something. She also did not want to stand out. She realized that she was eating lunch out at more-expensive restaurants than she should, mostly to feel accepted by her co-workers. Those expensive lunches troubled her, especially when she saw how much tighter her finances were at the end of the month.
Opportunity
Consumption always involves opportunity costs. When you spend money on one thing, you lose the opportunity to spend the same money on something else. Be sure your money goes toward the things that you value most, like the care and security of your family. See that a poorly timed expensive meal or weekend get-away can keep you from providing for your family and its security. Don’t just consider the gain or loss within the transaction, like whether you will enjoy the meal out or weekend away. Consider also the trade-off you make against things that you value more. Meaningful money management is a matter of making more valuable choices. The author of Rich Dad, Poor Dad, says to know the difference between an asset and liability, and use your earnings to buy assets rather than assume liabilities.
⤠ When you think you’re rich can be when you’re most pitiful. ⤟
Costs
Manage your costs. Watch for hidden costs like charges on checking accounts or money withdrawals. Find free or reduced-cost options. Ask friends and acquaintances for their cost-saving tips. Get a sense of what others pay for rent, phone service, cable television, and vehicle insurance. Watch your household expenses, even when your higher income no longer requires that you do so. Howard Dayton in Your Money Counts says to spend no more than the following percentages of your after-tax, after-giving income: housing 25-38%; food 10-15%; transportation 10-15%; insurance 3-7%; debt 0-10%; entertainment and recreation 4-7%; clothing 4-6%; medical and dental 4-8%; school and childcare 5-10%; investments 0-15%; and savings 5-10%.
Efficiency
Managing costs, though, is not to say that you must be cheap. The study The Millionaire Mind actually found that most millionaires pay professionals rather than do their own service work like plumbing repairs and even lawn maintenance. Do-it-yourself work sometimes takes away time you should be spending with family or earning an income. Done poorly, do-it-yourself work can also cost more than it should and cause other expensive problems. Professionals may do it better and more cost-effectively over the long run.
⤠ Work hard to help those who cannot. ⤟
Frugality
That said, a few frugal practices done together can bring big returns, even for higher-income earners. The same study of millionaires just cited above found that 74% of millionaires never buy from telephone solicitors, 71% write a list before shopping so that they buy only what they need, 70% have shoes resoled or repaired, 57% adjust the thermostat to save on air conditioning, 49% switch telephone/data carriers for lower rates, 49% use discount coupons to save on groceries, and 49% shop at discount bulk-supply warehouses. Likewise, nearly half of millionaires have furniture reupholstered or refinished rather than buying new furniture, 48% pay off their home mortgage early to save on interest, 36% have clothes mended instead of buying new, and 36% leave a department store immediately after a purchase rather than continuing to shop.
Debt
Excess debt is the single greatest threat to financial security. Managing debt is the single greatest opportunity to improve finances, reach financial goals, and avoid financial catastrophe. Debt may sound attractive. Debt leverages future income for present wants or needs. But debt simultaneously increases costs and risk. Debt requires repayment. Borrowers miss the increase in earnings or reduction in consumption they must make to go from borrowing to repaying. Borrowing is far easier than repaying. Scrimp on borrowing, and borrow less, rather than have to scrimp while repaying. Far better to live poor to avoid borrowing than living even poorer to repay. Paying off loan principal is harder than one thinks when borrowing.
⤠ Let no debt remain outstanding, except the debt to love one another. ⤟
Amortization
Borrowing also requires repaying with interest. Repaying a loan’s principal is hard enough. Repaying interest on top of principal makes repayment much harder. A substantial portion of each monthly payment goes to interest rather than principal. Interest increases quickly with the loan’s interest rate and duration. When taking out a loan, check the amortization schedule, or period over which you must pay off the loan. For longer loans, like a 30-year mortgage, you’ll see that by far the greater portion of each early payment goes to interest rather than principal. You may still owe nearly the whole loan amount after the first few years, depending on the interest rate. A longer loan may reduce your monthly payment but means increasing the interest you pay over the life of the loan. It also means increasing your risk of non-payment. Automatic loan repayment from your checking account may avoid late charges. Some banks grant interest rate reductions for automatic account debits.
Pat had a decision to make. The vehicle that had gotten him through night school was finally dead. He had wrung every last mile from it, and it had no more miles to give. Two of his neighbors even took off their caps and bowed their heads in mock memorial as Pat drove it away to the dealer for a trade in. The dealer had offered Pat a choice between the $30,000 vehicle he had always wanted and the $20,000 vehicle he knew he could afford. Pat could easily have financed the $30,000 vehicle. But he knew how much easier it would be to borrow more for the fancy vehicle than it would be to pay a smaller loan back for the modest vehicle. Pat left the dealership with the $20,000 vehicle, the price of which the dealer reduced by another $2,000 when Pat offered to pay more of that affordable price in cash.
Default
Satisfying mounting loans can seem like feeding a ravenously hungry bear. The adage is that the borrower is a slave to the lender. Defaults in repayment lead quickly to increases in the amount owed. Interest accrues, while late charges add to the balance. Default in repayment can also threaten your credit worthiness, affecting not only your ability to borrow and your cost of borrowing but also your ability to rent housing. Collection actions and bankruptcy could even affect your ability to get or keep a job or a professional license.
⤠ Doing secret good brings secret rewards. ⤟
Repayment
Attack debt repayment. Your financial success depends on quickly reducing and then eliminating debt. Devote windfall money, such as overtime pay or a bonus or inheritance, toward loan principal. Small amounts added together can make a big difference. Make a double loan payment now and then, instructing the lender to apply the second payment to principal. Paying off higher-interest-rate loans first makes economic sense. But paying off smaller loans first makes emotional sense, inspiring you to tackle larger debts. Track your debt, using a table like the following. [Table omitted. See print version.]
Consolidation
If you have multiple loans, for instance on several credit cards, then consolidating those debts into one payment may sound attractive. Think again. When debt-consolidation services extend new credit to cover old debt, they may reduce the high interest rates on some of the old debt. Consolidation may offer you a reduced monthly payment. But to lower your monthly payment, the consolidation may extend the debt’s term. You will be in debt longer rather than shorter, thus losing some or all of your modest advantages. Debt consolidation is usually ineffective, often having the opposite effect of leading to additional debt. Pay off debt rather than move it around and extend it.
Erin felt much better when she had finally made the decision. She had recently gotten her first year-end bonus. It was nearly double what she had hoped. Before she received the bonus, Erin had planned to apply it all to her school loans, the principal amount of which had barely budged despite her monthly payments. When she learned that she was getting a much larger bonus than she expected, Erin instantly thought of spending half of it. She had plenty of things, like nicer work clothes and a gym membership, on which to spend it. But then she remembered her school-loan balance, how it had barely declined. Erin decided to apply her full bonus to reducing the loan principal. And suddenly, she felt as if she could see the proverbial light at the end of the tunnel.
Collateralization
With loans, beware cross-collateralization. Lenders like loan security. Vehicle-loan companies, for instance, hold a lien enabling them to repossess the vehicle if necessary to satisfy the loan. Credit-card lenders, though, are generally unsecured. They have only the cardholder’s promise of repayment. Yet high credit-card debt can tempt a homeowner to borrow against the home, with a second mortgage to pay off the credit cards. Cross-collateralization secures debt with an asset the loan did not buy. Avoid cross-collateralization. Cross-collateralization substantially increases your risk. You could lose everything at once. Do not secure other debt using your home unless you are ready to be homeless. Pay off debt rather than move debt around.
Time
Debt is not simply holding another’s money, waiting to pay it back. As long as you owe the debt, the lender forgoes other opportunities. While you hold the money, inflation is also reducing the value of the dollars paying the debt. Interest thus represents the time value of the loaned money. The money’s time value works both ways, not only with debt but also with savings. When you save and invest money, its holder should pay you for its use. That’s why you want to be on the saving side, not the debt side, of the ledger. You are gaining when you save but losing when you borrow.
⤠ Do good with wealth to keep it coming. ⤟
Investing
The time value of money is not only what makes debt so bad but also what makes investing so profitable. For example, if you had $100 to invest today, then you might use $50 of it to expand your business while you invested the other $50 in a mutual fund earning you a 7% annual return. In ten years, your $50 investment would be worth $100, while your business had presumably grown from the other $50 you invested in it. You could have your cake and eat it, too. To put it another way, the present value today of $100 in ten years may be just $50, while the future value in ten years of $100 today may be $200. That’s a four-fold difference between being a borrower and an investor. Be an investor.
Wealth
Get a proper understanding of wealth. Wealth is not enjoying pleasures or accumulating material things. Wealth means resources so abundant as to satisfy one’s own desires while sharing generously. Wealth is in part personal reward but in larger part the means to bless others. You may have grandparents, parents, aunts and uncles, or other older relatives who have been generous with you. You don’t need to plan on being old. Old will happen on its own. But you can plan to be financially successful enough to bless your future generations.
Inheritance
Treat your parents and grandparents well, whether or not you expect an inheritance. If you do anticipate an inheritance, do not rely on it in your financial planning. Things can change, and you don’t want changes in your relatives’ finances to affect your relationships. Simply because a parent has the ability to transfer substantial assets to you while alive or at death does not mean that the parent should do so or will do so. Be cautious of how your financial expectations can distort relationships. The more you expect a gift, the less you deserve it. Plan and provide for your own support, while allowing gifts and inheritances to be the unexpected blessing they should be.
⤠ Enjoy working as your lot in life. ⤟
Mobility
Believe in your ability to improve your finances. Several factors influence economic mobility. Education is chief among those factors. Experience, skill, field, family structure, and locale also influence economic mobility. Learn more from the Pew Charitable Trusts Economic Mobility Project. Yet the biggest influence is you. Your commitment to improving your finances is the single greatest factor. Individuals suffering the worst financial wrecks have reached financial prosperity. Do not look solely to your circumstances. Instead, pursue sound principles and practices for meaningful money management.
Risk
Bad things happen. But you can recognize and manage financial risks to prepare for and minimize their impact. Risk management can make a mere inconvenience out of what would otherwise have been financial disaster. You may decide to accept a risk. We all do. But make informed decisions rather than proceeding blindly. And insure against substantial risks. Health insurance addresses health risks. Disability insurance addresses the risk of income loss from illness or injury. Life insurance addresses the risk of losing a supportive household member. Vehicle insurance addresses vehicle damage and negligence liability. Homeowner’s insurance addresses fire loss and property liability. A chapter below addresses this subject in greater detail.
Accountability
Be accountable to your commitments and to others who depend on your personal finances. Include your spouse in your money management. The study The Millionaire Mind found that nearly all millionaires were married, the vast majority of them long-term. They described their spouses as unselfish, traditional, down to earth, stable, patient, and understanding. Listen to family members, particularly around income, savings, spending, and financial security. Do not spend your time convincing others about the wisdom of your financial practices. Instead, use the advice of others to evaluate and modify your practices. Read about finances, and then use the insight you gain to hold yourself accountable to what you learn.
Pat had just enjoyed his third lunch with Erin. They had first met at a restaurant, where mutual friends introduced them. This third time, though, they had eaten alone, just the two of them. Pat was surprised when, while waiting for the check, they had begun to speak about personal finances. Pat had guessed that Erin was a big spender like others he knew at her company. It pleased him to learn that she was not. Her comments about money resonated with things Pat believed. Likewise, Erin had smiled in appreciation at Pat’s comments. Their exchange made Pat reach and pay for the check when the server brought it, once again surprising and pleasing both Pat and Erin. They both felt good to find someone who saw things the same way. Maybe they would each figure out money management after all, and maybe they would do so together.
Lifestyle
Decide the lifestyle you wish to maintain, based on your commitments. Do not let circumstances unduly dictate your choices. You can always find reasons in your circumstance to work more than your health or family commitments warrant, or less than your finances require. You will never retire at 55, take on a public-interest career at 45, sail around the world at 40, or earn your children’s greatest-mom or greatest-dad award at 30, unless you choose and plan for it. Life happens without choices. The life you want happens only with planning and choices.
⤠ Don’t be proud of your wealth. ⤟
Lifetime
When considering lifetime opportunities, look at your whole lifetime. Who wouldn’t want to join friends in Paris? But putting that trip on a credit card because you can’t afford it right now could increase the trip’s cost by 50%. If instead you took a couple years to save for it, you’d be able to afford another trip. Recognize opportunity costs. One great time too early may cost you more than one great time later. When the question comes to managing your money, delayed gratification can mean greater gratification.
Behavior
Bright minds are constantly at work to make you more inclined to buy and do things in the short term that will not serve your long-term interests. Retailers advertise 70%-off sales to turn your financial sense against you. Perfumed air lures you into the store, where plush carpets soothe your tired feet while product displays work their hypnotic allure. Marketers manipulate your every thought, whether at the store or online. Read Benjamin Barber’s book Consumed: How Markets Corrupt Children, Infantilize Adults, & Swallow Citizens Whole if you have any doubt. Do not let marketers stop you from achieving your money goals. Use your mind to shape your behavior and your income to accomplish your goals.
Tips
Changing your behavior around money sometimes just takes remembering a few tips. The book The Everything Personal Finance in Your 20s & 30s offers a top ten of personal-finance tips. They include only buying what you need but without buying cheap. Save small amounts to help you save large amounts. Budget to control your money. Pay cash to help you realize what things cost. When buying, measure the opportunity cost of what you could instead have bought. Set savings aside out of your paycheck first, not last. Act quickly to control debt. Maintain health insurance to avoid medical debt. Study finances continually. And know that millionaires are only average people who did small money things right.
⤠ Don’t place your security in wealth. ⤟
Survivability
Planning for financial emergencies is another important financial strategy. Your first financial goal should be to ensure that you have enough savings to manage short-term your worst financial setback, meaning in the usual case a complete loss of earnings. First, have at least $1,000 to $2,000 in your checking account at all times. Then, work to save three to six months of living expenses, more like nine months to a year if your circumstances are less flexible. Yet bare survivability is only a preliminary objective, not your ultimate goal. In time, you should develop what JPMorgan CEO Jamie Dimon calls a fortress balance sheet to more responsibly manage life’s inevitable financial surprises and setbacks. The next section on cash flow and budgeting addresses the fortress balance sheet.
The events shocked the new employees in Erin’s company. One of the partners had been acting strange. Occasionally, he would just sit frozen and stare back wordlessly at an employee who came into his office to ask a quick question. The partner had then absentmindedly walked home, leaving his car at the office. He was also dropping files as he walked about the office and knocked over cups of coffee at his desk. Then the full seizure happened one day in the office, requiring emergency personnel to remove the partner on a stretcher. What was more disturbing, though, were the swift events that followed. The partner had no disability insurance and few emergency funds. Creditors descended on him and his family quickly. Their two children had to quit college and return home, and his wife had to sell their fine home and move into an apartment while the partner convalesced at a rehabilitation center. The family’s unraveling made Erin wonder whether the partner might have managed finances differently.
Mistakes
Avoiding mistakes is another principle for sound money management. Some financial failures are predictable. Hindsight may be 20/20, but foresight can be pretty clear, too. Sound money managers avoid classic financial mistakes. Mistakes to avoid include taking on more debt than your income can sustain, especially early in a career. Concentrating risk is another avoidable mistake. Examples are holding assets only in a single class and cross-collateralizing debts, so that a single event results in financial ruin. Good intentions without action is another mistake, like creating elaborate financial plans but failing to implement them. Incorrectly documenting a financial plan is another common mistake, such as by failing to designate the right beneficiaries on accounts or insurances. Inappropriate delegation is another mistake, leaving critical steps to unqualified others who fail to execute them. And undeserved trust is another common mistake, relying on suspect individuals without verifying their performance.
⤠ Open your arms to receive plenty. ⤟
Taxes
Consider taxes in all your money management. Don’t ignore taxes when earning, borrowing, investing, filing returns, retiring, or withdrawing from retirement accounts. Account for taxes with each money decision. Congress enacts tax laws not just to raise revenue but also to affect behavior. Tax laws may seem perverse but often have goals they pursue. Yet while accounting for taxes, don’t make decisions purely because of taxes. Render unto Caesar that which is Caesar’s. But pursue your best plans rather than what the government wants you to pursue.
Giving
While this book is about money, do not construe anything in this book to suggest that money is life’s goal. Money is a cold master. If you serve money, it will make you unable to serve anyone or anything else. It is better to give than receive. Giving satisfies, while taking enlarges appetite. Giving cures the unhealthy pursuit of money. Giving develops character, while spending unravels it. Giving turns your thoughts to those to whom you give, while spending turns your thoughts to yourself. Sound money management enables and enlarges your giving. Order blesses. Chaos curses. Give thoughtfully and regularly, while managing your money the same way. The author of the book Rich Dad, Poor Dad says that the rich are rich because they give generously, not that they give generously because they are rich. If you think you cannot live on less in order to give, then read The Treasure Principle: Unlocking the Secret of Joyful Giving whose author lived at minimum-wage level to give away $500,000 in earnings in three years.
⤠ You are worth far more than the things for which you work. ⤟
Legacy
You can even plan to leave a legacy. To leave a legacy, though, you generally need to plan for it early in your career. Prepare an estate plan. Now. You may have only begun your career. You may have few or no assets. Still, ensure that you have the right people as beneficiaries on life insurance and investment and retirement accounts, plus a simple will. An estate plan can simplify and speed administration of your estate, accomplishing your wishes after you pass. All die, most without a will. Don’t you be one without a will. Your estate plan will remind you that you are not living hand to mouth but to leave a legacy.
Checklist
Reflect, research, investigate, and act until you can confirm each of the following statements summarizing the advice in this section:
I value and intend to pursue financial literacy throughout my life.
I control my personal consumption so that while I enjoy things, I can also readily give them up when unwise financially.
I am not amassing uncontrolled personal debt.
I can explain the value of shorter amortization periods on debt.
I am passionate about ridding myself and my family of the burden of debt.
I can see myself blessing my family’s next generations through wealth that I have accumulated over my life.
Under the right circumstances, my income will make me upwardly mobile and better off.
I accept accountability to the financial wisdom of others who know more about financial success than I do.
I recognize and am able to resist marketing appeals, to shape my lifestyle rather than let others do so for me.
My future will likely present unexpected financial challenges that I can handle with appropriate planning and action now.
I will pay all due taxes while planning for their financial impact.
My financial goals include substantial charitable giving.