Advice and advisors are plentiful for individuals who have surplus funds—at least in the low hundreds of thousands of dollars—to invest. But it is easy to forget that the majority of the working population would not consider themselves “rich” or “wealthy”. Instead, the majority earn a normal income, have a small or limited savings pool, and face normal money challenges and choices in order to grow their savings. At CariDollarsAndSense, we focus on helping the majority build wealth and achieve Financial Freedom by providing practical tips and guidance about everyday financial situations and challenges as well as by offering customized financial advice.
We believe Financial Freedom for everyone is definitely possible and have put together a few suggested “rules” to guide you to achieve your goals.
It is a sad truth, however, that too many of us work 22 days (or more) a month to earn our income, yet find it difficult to set aside a small amount of time to find and understand ways to keep it.
The rules are listed in the order in which we believe they should generally be followed.
No budget? No chance
If you know anyone who is having financial difficulties, it is a reasonable bet that they do not have a budget. Yes, it is true most people tend to have an idea of their monthly income and expenses, and they believe this information is effectively their budget. But this is far from correct: a budget is not about what you earn and spend right now, but what you should earn or spend. Your budget is therefore your plan to achieve a targeted level of savings each year. You use this accumulated savings to meet your long-term financial goals (e.g. retirement).
We provide lots of guidance in our Budgeting Series.
Live on 70% of your means
You must have heard the expression “Live below your means”, which effectively means your living expenses should not be greater than your income. We have a more specific recommendation: live on approximately 70% of your after-tax income and save 30%.
You cannot achieve Financial Freedom by earning $100 and spending $105. This is obvious. But you also cannot be successful if you spend $95, although it is less than $100. We recommend pretending you only make 70% i.e. $70 and only spend $70. This is not impossible, once you are able to separate your needs from your wants.
Needs are basic food, clothes, shelter, etc.; wants are everything else. Most times, our wants take over and dominate our spending because finding things to spend our hard-earned money on is very easy. But you need to be disciplined to make a proper assessment whether you truly need to make a purchase or is it just a want.
If you are currently spending more than 70% of your after-tax income, then use your budget to make a plan to gradually cut back to reach the 70% target.
Learn more in Creating Your Budget (33/33/33).
Build an emergency fund
Even for persons who do attempt to control their finances, sometimes one of the bigger problems is that it doesn’t matter how well you plan. Life happens from time to time: unforeseen events occur. While you are not able to identify them in advance, you can be sure something will happen e.g. you lose your job or are temporarily unable to earn income, doctor bills, a major necessary appliance needs to be replaced, a car accident not worth claiming for insurance, you sat on your glasses and broke them, etc. The list is endless.
So how do you cater for this problem? Easy. If we know something will eventually come up, then it just makes sense to ensure we have funds available to meet it by building an emergency fund. This is simply a pool of money saved for a rainy day i.e. an emergency, not a sudden deep desire for a new phone, tv, or hand bag (these are all wants).
By doing this, if the worst event happens, let’s say you lose your job, you know you can at least live comfortably for this period while you search for a new job.
Bottom line: If we know we can financially absorb most unexpected events, it is very liberating. And when something bad does happen, we take it in stride.
Learn more in the post Build an Emergency Fund.
Be debt free
One of the biggest causes of stress is debt. Even if you are currently meeting your obligations, the imperative to comply with the loan terms dominates all your decision making. The underlying issue with most debt is that it represents consumption brought forward, meaning instead of waiting and saving to buy something cash, you borrow now for the purchase. There are two problems with this.
Firstly, most persons do not know how to evaluate how much debt is right for them, so they tend to over-borrow. Secondly, the cost of taking a loan for individuals tends to be expensive, and the high interest rate you pay is one of the worst hits you can take in your effort to build wealth.
If you are already indebted, after you follow our earlier rules, your singular focus should be to repay as much debt as possible, if not all.
Credit card debt requires special mention. The approach is simple: never get into credit card debt. If you already have credit card debt, then after creating your budget, your only priority should be to repay it immediately. [Update: To learn more, check out our post Understanding Credit Card Debt.]
Yes, there are exceptions when debt is not necessarily bad (e.g. borrowing to buy a home). But if you are unable to evaluate whether taking a loan is the right decision, then you should approach debt as if it is radioactive: avoid, avoid, avoid.
The more income you earn, the greater your opportunity for wealth creation. For most of us, you achieve this in two ways. Firstly, manage your career upwards. Notice we did not say continuously look for higher paying jobs. Job-hopping is eventually a losing proposition because at some point you stall. Unless your skills and experience are increasing steadily, you simply will run out of employers who are willing to pay more to hire you. Instead of job-hopping, focus on developing your career. This is the more profitable approach in the long run.
Check out this section of the website to learn how to Manage Your Career.
Secondly, earn another income. Let’s make sure we agree that your best working years are your thirties to fifties. We are not saying this is when you make the most income. We mean these are the years when we have the most energy to work; therefore, we need to maximize on those years by trying to earn a second income.
We suggest that the second “job” should be something fun, ideally related to either a passion you already have or a hobby you enjoy. In this way, it does not feel like work. You aren’t necessarily trying to get rich from your second “job” (although that will be great!); you are trying to get another income stream, which you can ideally just save. With a little thought, most pastimes can be turned into a revenue-earner. And if after trying, it does not become a money-maker, it does not really matter because you were doing something you enjoy anyway.
Plan for major life events
Life events include entering into long-term relationships, having children, buying a car, buying a home, etc. While these events are emotionally rewarding, they also have substantial, potentially multi-year financial implications. When they occur in an unplanned way, they can easily become a source of stress. Ideally, these events should be considered carefully and you should evaluate how the new expenses would change your finances.
In many cases, we may choose to accept a short-term constraint (e.g. lower savings), but this should be an “eyes-wide-open” decision, with a plan to revert to a position that will allow you to achieve your long-term financial goals.
We cover several scenarios in the section Life Events & Decisions.
Once your finances are on a path of sustainable improvement, it would be extremely unwise to risk losing your hard work, or place a burden on your dependents, if an unfortunate event occurs (early death, serious illness, catastrophes, etc). These personal risks are managed by buying insurance.
The “problem” with insurance is it requires you to make a decision now about events that either may not occur, or if they do, they could occur well into the future. Most of us find this uncertainty too difficult to evaluate and therefore either ignore it or over-insure; both have the potential to unfavourably affect your ability to create wealth.
The general approach should be to answer three questions:
- Firstly, what should you insure? The answer is you should insure what you cannot afford to replace (and of course, what is required by law e.g. car insurance).
- Secondly, how much risk are you willing to accept? This requires a common sense approach to balance how much you can afford with what risk you want to insure. Covering all risks could be expensive, so try to list the risks you face in order of importance, and then decide which ones you actually need to cover.
- Thirdly, how much should you insure, meaning what is the right amount of coverage? Again, the simple approach is do not try to “make money” from insurance (which is impossible, by the way); make the coverage the minimum amount you need to cover the risk.
After following the previous rules, you’ll eventually have a pool of savings that is steadily growing. For clarity, these funds are to meet your long-term financial goals (usually your retirement), so they should not be funds that you need to live on today. You probably have read or heard about investing rules, asset classes, how to increase portfolio returns, and various other complicated-sounding descriptions.
In our view, these are generally not relevant to the majority of us, given the reality that our investable assets (savings) are not sufficiently large to apply some of these principles. Instead, relatively small savings pools should follow these guidelines:
- Do not put all your eggs in one basket;
- Do not put your money in an investment you cannot understand;
- Keep your principal safe. Stay away from volatile investments unless you can handle the roller coaster;
- Do not spend income from your investments (interest and dividends), instead reinvest and let them compound;
- Understand any fee you have to pay and try to reduce or eliminate it;
- Do not blindly trust anyone who is selling something – listen politely, do your own research, and then make your own decision;
- Historical performance is just that, history. It is no guarantee of the future; and
- If something sounds too good to be true, then you should probably walk away.
Plan for retirement
The above rules will help you lay the foundation for a successful retirement, where you are truly financially free by not having to rely on anyone. The relative “luxury” in which you wish to retire would obviously determine the emphasis you place on the various rules, but only you can decide this.
There are two main points to note about retirement. Firstly, we’ve not heard retirees say that they have put aside too much for retirement; it is usually the opposite: they have not saved enough. As retirement is inevitable, start saving as soon as you can and as much as you can, which for most persons is when they have stabilized their career. The second point to note is the best retirement strategies take advantage of two opportunities: tax-free investments and “free money” through employer contributions to either pension plans or employee share option plans (ESOPs). While these opportunities are not as plentiful as we would like, they do exist.
It will take time to see the benefits of following the rules we identified. There is no short-cut. Start now; be patient; and remember our central theme that you work hard for your money, and therefore, you should work equally hard to keep it. In our experience, when persons try our first rule and create their personal budget, the results are so illuminating that they become immediately motivated to take control of their finances, and the rest of the rules follow naturally.
We hope you find our rules helpful and various sections of the website examine each of these in more detail to help you apply them.
We’d love to hear your thoughts or experiences. Do you have “rules” you’d like to share? Let us know in the comments below!