The personal finance principles I follow are simple and timeless.
- Spend less than one earns. Live below one's means. Buy only what one needs.
- Save, invest and benefit from the magic of compounding.
- Use debt sparingly and for items that may appreciate (e.g. home and education) and not for everyday expenses.
- Go to college and major in a degree that leads to a profession.
- If it sounds too good to be true, then it is.
What's Not New
If these principles are so good why doesn't everyone follow them? Primarily, because people can always rationalize why the principles are no longer true. Here are some of my thoughts on rationalizations against each of the principles and why I ignore these rationalizations.
- Live for today rationale.Who knows what will happen tomorrow? It would be a shame if one gave up something and didn't benefit from it later. Also, this rationale is concerned about over saving for retirement. Part of the reason may be that 67% of workers today expect to work during retirement. This may be an unrealistic expectation since about 27% of today's retirees actually do work. Reference: Employee Benefit Institute. As a result, the future becomes second priority to the present
I do know that life expectancies are increasing. We try to live below our means today so that we will have a comfortable retirement in the future.
- I have time to start later rationale. For people in their 20s, 40 years seems like a long ways away. Therefore, they feel they can wait before starting saving. Before long, 10, 20, and even 30 years have passed and they still haven't started saving.
I believe that the perception and reality are mismatched. 71% of workers are somewhat (44%) or very (27%) confident about their financial security in retirement. However, 22% of the very confident workers are not currently saving, 39% have less than $50,000 in savings , or 37% have not done a retirement needs estimate.
In fact, today retirement saving is even more self service. In 1985 to 2005, the percentage of companies with defined benefit plans has declined from 91% to 61%. That's why we started in our early twenties and now save over 20% of our salary every month.
- Inflation rationale. This is the belief that money paid back tomorrow will be worth less than money spent today. Therefore, one should borrow, spend as much today, and pay it back with dollars that are worth less in the future. Way save when the money will buy less in the future? This thinking was started in the 70s and 80s, when inflation was relatively high.
I know the average bank is smarter than the average borrower. Banks are in the business making loans and earning money from the interest. In the long run, banks won't lose money due to inflation and the majority of borrowers shouldn't expect to make money long term by arbitraging interest rates and inflation. Because of this belief, the only debt we have is our mortgage.
- Only do something you love rationale. This is based on the belief that one should love what they are doing for work. Or one should convert something one loves into work.
For me, the reality is I would not be paid much for what I love to do, which includes socializing with family and friends, playing sports, reading newspapers, investing in stocks, and blogging. At least, I haven't found that employer yet:-)
However, I do believe people should have a career in an area where they have an interest and a liking for the type of work. That's why I chose an Engineering degree. I liked using math and solving technical problems. Also, it helped me get a great first job, which created the foundation for my career.
- The world is "different" now rationale. When a new idea exceeds people's expectation, some assume it is due to a fundamental change in the world. Recall the technology stock bubble, the commodity bubbles, and the housing bubble. In each case, there were pundits telling us the we were in a "new world" and the past principles were no longer relevant.
In my experience, most deviations in personal finance principles have been temporary. One only needs to consider stock, bond, gold or real estate investments from the past decade. For a short period (about 5 years), it appeared to be a "new world" and people threw out past principles, only to find out the principles were still valid.
What Is Really New
The market is globalized . We are a global economy now, which creates more interdependency and complexity than before. People in Asia and Europe are direct competitors for my job. International currency decisions and international stock markets have more impact on my investments and financial security that before. Most important, unions, tariffs, and other non-market methods are no longer effective at protecting jobs.
Change is happening at a faster pace. New markets, new technologies, new business models and new stuff. The only constant is change and what seems like a sure thing may be tomorrow's failure. So while the approaches may be constant, how to implement the principles will continue to evolve. Not too long ago one could count on a niche business (such as a family business) lasting several decades. Now businesses need to reinvent themselves every 5 to 10 years in order to keep up with the markets.
So while the principles are timeless, the environment is changing. It is now important review progress more often and look at global impacts and other changes that could affect investment and savings approaches.
For more on The Practice of Personal Finance, check back every Wednesday for a new segment.
This is not financial advice. Please consult a professional advisor.
Copyright © 2007 Achievement Catalyst, LLC