Editor’s note: This article was first published in February 2017. Rule 3, saying that “at the moment” buying could be more profitable than renting because house prices are low, reflects the Spanish property market in early 2017.
We’ve written about many different financial education topics, so every so often I like to condense the information into the key ideas, as a reminder of the basic concepts of personal finance. In other words, the concepts that really matter and should never be forgotten.
1. A higher salary doesn’t guarantee more “wealth” than a lower one
The money you earn, on its own, doesn’t help you build wealth or achieve financial freedom. What matters is the money you have left over from your salary or income at the end of the month. It seems obvious, but many people forget this simple rule.
The only thing that really matters is how much of your income you manage to save. And to do that, there are only a few paths: save more, spend less or earn more money.
As I always say, if you’re given the choice between earning more money and saving more money, always choose earning more.
2. Everything starts with saving
When we talked about the four fundamental pillars of wealth creation, we had:
- The money you earn.
- The money you save.
- The return you get on your money.
- Time.
The first three pillars can be traded off against each other by adding more to one or another. Let me explain. If you earn more money, you won’t need to focus so much on finding ways to save more. If you lead a frugal lifestyle, you can save more than someone else even while earning less.
In personal finance, the money you save should have only one purpose: investment. If you manage to get a better return on your money thanks to your investing skills, you can also reach the goal while earning less and saving less, but investing better.
In any case, time is the most valuable asset for building wealth. So the sooner you start investing, the better, because that’s how you put the magic of compound interest to work.
But everything starts with saving. If you don’t save anything, you have no money to invest. So focus on increasing the amount of money you have free at the end of the month, with the aim of investing it.
3. Avoid early debt and credit card debt like the plague
This advice is nothing new. If you take on a mortgage while you’re young that eats up more than 30% of your income, you’ll have stacked the odds against achieving financial freedom. That said, at the moment, because house prices are low, buying could at some point be more profitable than renting, as long as you buy a property as an investment, with the idea of earning a return on it later on. We’ll look at this point in more detail another time.
See also: Money and inflation: the number one mistake people make with their money when prices are rising
As for credit cards, they are probably the worst enemies of wealth creation, because the interest they charge us is far higher than the average return we can get from an equity investment. That’s why, if you have credit card debt, the best investment you can make is to pay it off. If you get rid of 15% interest working against you, it’s like earning a 15% return in your favour. Remember: “Money not spent is worth the same as money earned.”
4. Don’t live within your means, live below your means
You need to start distinguishing between wants and needs. Having a car is a need (in most cases). Buying a €35,000 car is probably a want.
Most of the big purchases we make tend to be wants, often driven by the desire to keep up appearances. Those wants, and that urge to show off, seriously damage the real health of our finances.
There are two kinds of people: those who try to look wealthy, and those who are wealthy. As a general rule, the ones who are wealthy got there because they didn’t spend money trying to look it.
So always stay below your capacity to generate income.
5. Where does the money we spend go?
If you want to take control of your personal finances, you need to understand and analyse your spending habits.
There are small money leaks that seem insignificant each month, but by the end of the year they add up to a very valuable sum we could be investing. In other cases, people who lead a frugal lifestyle day to day often make three big purchases that ruin all their saving effort, such as a holiday or an expensive trip.
In any case, and as far as possible, try to know exactly where your money goes each month, and look at where you can cut back.
Most financial education experts talk about cutting small expenses, such as having a coffee at work, but those little pleasures are probably the ones we should keep. Instead, we should put our attention on the big expenses, such as gadgets, cars or luxury homes.
6. Automate everything that can be automated
The best way to save more and make your life easier, even avoiding late payment charges, is to automate everything. If you aren’t disciplined about saving, set up a savings plan in which a fixed amount is automatically deducted from your income every month.
7. Increase either your savings rate or your income every year
When it comes to personal finance, we should think like the managers of a business. A business has to keep growing. If its profits stagnate, what usually comes next is a steady decline.
Increase the amount of money you save every year. To do that, in many cases you’ll need to find alternative ways of generating income, in other words, to start building assets.
8. Friends can also be bad for your finances
The people around us influence every area of our lives, because we can easily pick up their habits. The same happens with personal finance. If you have friends who are big spenders and you try to keep up with them, your finances could suffer.
9. Read and learn about personal finance, investing and so on
Many people say that since they don’t have any money, there’s no point in learning about personal finance. That’s the answer to why they don’t have any money. And the most ironic part is that even if they did have some at some point, they would lose it, because as the saying goes, “a fool and his money are soon parted.”
See also: Why your expensive luxury car doesn’t impress smart people
Financial education has much more to do with psychology and habits than with money. Most big spenders are like that because deep down they aren’t happy, and they try to buy happiness by buying things. Cultivate your mind in every sense, and cultivate it when it comes to finance too.
See also: Books on financial education and personal finance
10. It’s true, money doesn’t buy happiness
Money doesn’t buy happiness, but financial freedom does. Wealth can mean many things, but we could define financial freedom like this:
“When the money we receive without having to work for it can cover our lifestyle for the rest of our lives, and working becomes an option rather than an obligation in order to survive.”
So financial freedom can be achieved with different assets, or by diversifying across several of them. Assets include a business, rental properties, shares and so on.
The road won’t be easy, because to be able to make money while you sleep, you’ll first have to sleep a little less to earn more. We should make this process fun from start to finish.
11. Always think long term
One of the biggest traps our brain falls into is opting for immediate pleasure, and in doing so rejecting long-term pleasure. Let me explain.
Today it’s easier to stay in bed until noon than to get up early. It’s easier to go out partying today than to put in some extra work. It’s easier to do what everyone else does.
But it’s the sacrifices we make today that will give us a more pleasant life tomorrow, while the great majority will have had their immediate pleasure today and will spend the rest of their future making sacrifices.
Featured image: Kurtis Garbutt, CC BY 2.0, via Flickr.
