Personal Finance for Beginners
In 2020, the lockdown presented me with an opportunity to finally understand and learn a little more about a selected group of topics. Amongst the ones I picked up, personal finance was something I was looking to get sorted for quite a few years. I spoke to 20+ individuals in my workplace, amongst my friends and family — to understand how people thought about money and what goals were they solving for over 1, 5, and 10-year horizons. I was surprised by some answers, impressed by some, but I never found something to my satisfaction. So I did my own research on the internet, through books, and talking to financial advisors.
What is Personal Finance? Wikipedia defines Personal finance as the management by which an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events. Let's make it easier: Personal Finance has defined the act of managing your income, expenses, your savings, and your investments — each with its own role in your life. Let’s jump right to it!
#1 Savings: Automate your savings/ investments; it saves you a lot of mental stress
Every time I looked at my bank balance, I felt either I did not how much I was saving/ investing or was not happy with how much I had saved in a particular month. The equation that I was solving for was Income — Expenses = Savings; I realized it is very hard to track and improve your saving rate cause your income comes-in on the first day of the month, while you are doing these calculations at the end of the month. Here is something new I tried, I automated debit from my income account to different savings account on day 1 of the month; the monthly equation changed on its head — Income — savings = resulted in an expense pool — which I somehow managed to keep in check over the course of the next 30 days. Then, the decision on spending became more free — as I knew exactly how much I was saving on day 1 of the month, managing the most important thing — my mental stress, allowing me guilt-free spending.
#2 Expenses: Set up pre-determined mental principles for guilt free spending
How do you determine if you are having a fancy lunch, if you should take the MRT or take a Grab trip, or if you really need the upgraded air-pods? There is obviously no best way to solve this and you cant over-engineer your day-to-day expensing, and frankly, it's not really worth your time. If you have to process every such decision in your head, it is too much bandwidth and really exhausting. The alternate is you live rule-based spending which could include pre-determined rules set by you. You can design these principles that can be your guiding rules for day to day purchases.
One such rule that I follow is Depreciated item cost of< $1 per day: Instead of fretting about the big vs small purchases, I calculate the useful life of the object in my head and then determine the per day value of that object. If the object value < $1 then I dont think twice before purchasing it. Some calculations for simple objects are below:
#3 Investing: Staying in the game is the biggest predictitable factor contributing to your investing
Now, that you have the savings accumulated in a separate account, what do you do next with it? How do you grow your capital to make sure that you investing your money appropriately? There is no real right answer for you no matter what you are looking for → cause you are a snowflake and your requirements will be very different. “Psychology of Money” author Morgan Housel talks about how staying invested is one of the biggest drivers of your success in achieving your investing goals. He quotes,
“The historical odds of making money in the US markets is 50/50 over 1 day, 68% in 1 year, 88% in 10 years and 100% in a 20 year period”
He claims that one of the key reasons people don’t meet their investment goals over time is because they are not rational about investing, and how some principles are associated are counter-intuitive to day to day thinking.
- People take out money from investments because they need to solve immediate cash requirements, and cannot time the market for withdrawal. This is because they have a liquidity problem.
- Another reason is that people lose everything in the market. Understanding the downside case scenario of your risk-reward investment in the market is one of the most underestimated factors that people dont see. If there is even a 5% chance of RUIN (defined as losing everything), then maybe no amount of return is not worth it → cause you will not be able to play the game long enough to win, reducing your ability to recoup from your investments.
These principles are just ideas I have accumulated through my research over the pandemic year 2020. As I explore and learn more about personal finance, I am sure my thinking, mental models will evolve over time and this is just my best snapshot review of my learning today. Watch this space for more experience sharing on personal investing in the coming days.
