Chapter 22. The 20 Rules of Personal Finance

PICTURE YOURSELF GETTING ready for a family summer road trip.

You have an itinerary all laid out for every stop along the way including the hotels you’ll stay at, the sites you’ll see and you’ve checked the Google reviews for the various restaurants you plan to eat at on your trip.

The day finally arrives when you plan to depart. The anticipation for a trip is often more exciting than the vacation itself, so your entire family is hyped up and ready to go.

Everyone piles into the family car, ready to go, until someone realises Dad forgot to fill up with petrol, no one packed their suitcases, someone forgot to bring the snacks and there isn’t a single iPad on board to keep the kids happy in the backseat.

The finance equivalent here is coming up with the world’s greatest investment strategy without first realising the importance of personal financial planning. Yes, investing is important if you would like to compound your wealth over time, but it doesn’t matter if you can’t save money and get your financial house in order first.

Here are 20 basic rules to put you on a sound financial footing:

1. Avoid credit card debt like the plague. The first rule of personal finance is never carry a credit card balance. Credit card borrowing rates are egregiously high and paying those rates is an easy way to negatively compound your net worth. Not all debt is necessarily bad, but credit card debt is by far the worst. If you have credit card debt, you’re not ready to invest your money in the markets.

2. Building credit is important. The biggest expense over your lifetime will probably be interest costs on your mortgage, car loans and student loans. Having a solid credit score can save you tens or even hundreds of thousands of pounds by lowering your borrowing costs. Use credit cards to build a solid credit history by always paying off the balance each month. Putting all of your automated bills on a card that’s automatically paid off each month is a good place to start.

3. Income is not the same as savings. There is a huge difference between making a lot of money and becoming wealthy, because your net worth is more important than how much money you make. It’s amazing how many people don’t realise this simple truth. Having a high income does not automatically make you rich; having a low income does not automatically make you poor. All that matters is how much of your income you set aside, not how much you spend. Anyone can spend money to appear wealthy, but true wealth comes from the absence of spending in the form of saving.

4. Saving is more important than investing. Pay yourself first is such simple advice, but so few people do this. The best investment decision you can make is setting a high savings rate because it gives you a huge margin of safety in life. You have no control over the level of interest rates, stock market performance or the timing of recessions and bear markets, but you can control your savings rate.

5. Live below your means, not within your means. The only way to get ahead financially is to consistently stay behind your own earnings power. Living within or above your means is how you end up going from paycheck to paycheck without ever truly building wealth. The only way to get ahead is by living below your means and setting aside a portion of your income for the future. Delayed gratification is poor branding so just think about this in terms of the time you can buy yourself in the future to do what you want, when you want to do it.

6. If you want to understand your priorities look at where you spend money each month. You have to understand your spending habits if you ever wish to gain control of your finances. The goal is to spend money on things that are important to you but cut back everywhere else. And if you pay yourself first you don’t have to worry about budgeting, you just spend whatever’s left over on the things that truly matter to you.

7. Automate everything. The best way to save more, avoid late fees, and make your life easier is to automate as much of your financial life as possible. The goal is to make the big decisions up front so you don’t need to waste so much time and energy tending to your finances. If the bulk of your family’s financial life is on autopilot, it should only take you an hour or so each month to keep track of everything.

8. Get the big purchases right. Do you really need a house with four or five bedrooms? Or a top-of-the-range four-by-four if most of your journeys are to and from your place of work? Personal finance experts love to debate the minutiae of shop-bought sandwiches and lattes, but the most important purchases in terms of keeping your finances in order will be the big ones – housing and cars. Overextending yourself on these two purchases can be a killer because they represent fixed costs and come with more ancillary expenses than most people realise.

9. Build up your liquid savings account. Your monthly spending levels should take into account the fact that there are infrequent, yet predictable, expenses you’ll need to take care of on occasion. Weddings, holidays, car repairs and health scares never occur on a set schedule, but you can plan on paying for these events by setting aside small amounts of money each month to better prepare yourself when life inevitably gets in the way.

10. Cover your insurable needs. This is another personal finance margin of safety item. Some people have too much insurance and others too little. Focus on the biggest risks that you and your loved ones face. Most importantly, consider the impact on your business or family if you were to die or become disabled. The idea is to measure that impact in pounds, and if possible, insure against it. Just remember that insurance is about protecting wealth, not building it.

11. Take full advantage of employer contributions. Again, it’s important to pay as much into your pension as you reasonably can. But this is especially important for those in company schemes where the employer agrees to match the amount the employee puts in. Ideally you should aim to invest the maximum amount that your company is willing to match. Failing to do so is like turning down a pay rise. No one in their right mind does that.

12. Save a little more each year. Our suggestion is that you aim to save between 10% to 20% of your income. The trick is to increase your savings rate every time you receive a pay rise so you’ll never even notice you had more money to begin with. Avoiding lifestyle creep can be difficult, but that’s how you build wealth. And the sooner you begin setting money aside, the less you end up realising it never made it to your bank account to be spent in the first place.

13. Choose your friends, neighbourhood and spouse wisely. Robert Cialdini has written extensively on the concept of social proof and how we mirror the actions of others to gain acceptance. Trying to keep up with spendthrift friends or neighbours is a never-ending game with no true winners. Find people to spend your life with who have similar money views as you and it will save you a lot of unnecessary stress, envy and wasteful spending. Don’t worry about keeping up with the Joneses as much as following your own path.

14. Talk about money more often. It takes all of five minutes before people start talking about politics in almost any conversation these days, but somehow money is still a taboo subject. Talk to your spouse about money. Ask others for help. Don’t allow financial problems to linger and get worse. Money is a topic that impacts almost every aspect of your life in some way. It’s too important to ignore and sweep under the carpet.

15. Material purchases won’t make you happier in the long run. There is something of a short-term dopamine hit we get through retail therapy, but it wears off. Buying stuff won’t make you happier or wealthier because true wealth is all of the stuff you don’t waste money on. Experiences give you a better bang for your buck and time spent with the people you love is one of the best investments you can make.

16. Read a book or ten. There are countless personal finance books out there. If it bores you to death then at least skim through a few and pick out the best pieces of advice from a few different sources to test out. This stuff should be taught in every secondary school and college, but it isn’t. So you have to take the initiative. No one is going to care more about your money decisions than you. Invest some money, time, and energy into yourself. It’s the best investment you can make.

17. Know where you stand. Everyone should have a back-of-the-envelope idea of their true net worth. Before knowing where you want to go you have to know where you are. That means adding up all of your assets and subtracting any debts. This way you can set some general expectations about savings rates, market returns and portfolio growth to give yourself some goalposts in the future. Since reality doesn’t always sync up with expectations, this allows you to make course corrections along the way to your savings rate, investment strategy or financial plan.

18. Taxes matter. Tax issues can be maddeningly complicated, but it’s important to have a basic grasp of how the system works. The most important thing is to use accounts that allow you to save and invest free of tax. Also take advantage of tax relief on your pension contributions. As long as you’re willing not to have access to it until you stop working, this is effectively free money going begging.

19. Make more money. Saving and/or cutting back is a great way to get ahead, but it’s an incomplete strategy if you’re not trying to earn more by enhancing your career. Too many people are stuck in the mindset that there’s nothing they can do to get a better job, take on more responsibilities or earn higher pay. You must learn how to sell yourself, improve your skills and negotiate a higher income over time. A £10,000 pay rise could be worth hundreds of thousands of pounds over the course of your career.

20. The goal is financial independence. The goal shouldn’t be about making it to a certain age so you can ride off into the sunset, but rather getting to the point where you don’t have to worry about money any more. Time is the most important asset in the world because you can’t manufacture more of it. Becoming financially independent allows you to make decisions about how you spend your time on your own terms.

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