For some reason, when I woke up this morning, I couldn’t stop thinking about the principles that drive people, particularly those related to personal finance and investing. It’s fascinating to me that there are so many different approaches that can all wind up leading to the same place, prosperity. That is the goal for most of us, right? I don’t really think of wealth in terms of acquiring assets. For me, the goal of long-term wealth building is an overall state of abundance, security, and happiness and I think that’s probably true for many people.
When an idea gets its hooks in me I have to get it out of my head onto paper or I won’t be able to concentrate on anything else, so today let’s talk about The Basic Principles of Personal Finance and Investing.
Anyone that is serious about managing their money well and planning for the future has a set of principles that guide their behavior. This doesn’t mean that they carry around a list that they refer to every time they’re about to make a purchase or an investment. In fact, most successful long-term wealth builders would probably have trouble putting their personal finance and investing principles into words.
Some wealth builders follow a set of beliefs and behaviors that are so ingrained and that they’ve been adhering to for so long that they no longer have to think about them. For this lucky group of people, building wealth comes as naturally as breathing. At the opposite end of the spectrum are those that actually keep a list. Usually the list consists of personal finance and investing wisdom that they’ve accumulated over the years and that they review on occasion to make sure they’re still on track. These examples are extreme, most wealth builders fall somewhere in between. You have to be pretty anal to keep an updated list of your investing and personal finance principles… and yes, I have a list. I guess if I’m confessing I might as well admit the whole truth, I actually have TWO lists.
I thought that today I would share my lists in the hopes that you will add a few of your own principles or expand on mine in the comment section. Below are the 10 Investing Principles and 10 Personal Finance Principles that I adhere to. These lists aren’t meant to contain every important concept, only those principles that I feel are critical to success. I wanted to keep this post relatively short, so every item on the list is a link to an article that will give you a much more detailed description. If you want to discuss any particular principle or if you want to add ideas, please post here rather than on one of the link pages so that everyone can benefit from your insight.
Since I spend a lot of time giving financial and investing advice my list is pretty dynamic, I constantly review and refine it. On rare occasion, when I run across something new and interesting, I add to it.
Odd’s 10 Basic Principles of Investing
- Start Right Now: When you have money to invest, put it to work. Don’t wait for the perfect moment or the perfect stock because they may never come.
- Diversify: A fancy way to say don’t put all your eggs in one basket. If you diversify properly across several asset types, industries and geographies, you can lower risk AND improve returns at the same time.
- Dollar-Cost Averaging: Invest a fixed amount of money on a regular basis. This helps you form the habit of investing, lowers your cost basis, and helps you avoid the buying-high and selling-low syndrome common to beginning investors.
- Manage Expenses: Don’t let transaction costs, mutual fund fees, taxes and investing advice expenses eat up your earnings. This is particularly important for people with smaller portfolios, these expenses can take a big chunk out of your returns.
- Compare to an Appropriate Benchmark: Regardless of your goals or strategy, you should always compare your performance to a benchmark. That’s the easiest way to determine how well you’re implementing your strategy and whether or not you’re improving as an investor. Watch the indexes that track the types of securities that you invest in, and if you can’t beat ‘em, join’ em by becoming an Index Investor.
- Be Diligent: During long bullish periods, many investors tend to get overconfident and complacent. They stop learning about investing, stop adjusting their strategy, begin ignoring risk management principles, and lose touch with the current market and economic conditions. Diligence is your vaccine.
- Investor Psychology, Don’t Follow the Herd: It seems that most investors are willing to follow each other up mountains and off cliffs simply because that’s what everyone else is doing. Control your psychological impulses. Follow your strategy, don’t follow the herd.
- Keep it Simple, Invest in What You Know: Warren Buffet pushes new investors to stick to simpler strategies that are easier to master and Peter Lynch encourages investors to learn a great deal about an investment before risking any money. These are two of the most successful investors of all time. I trust them, and you should too. This is great advice for those of us that don’t have the time to learn complicated methods of research and analysis or read financial reports as thick as a phone book.
- Don’t Throw Good Money After Bad: Many investors tend to ride losers down because they hate taking a loss and because they’re always sure it’s “about to turn around”. These same investors also frequently take a profit too quickly out of fear that a stock can’t go up any further. Don’t throw good money after bad, hold on to your winners as long as they still meet your “buy” criteria and sell your losers when they don’t.
- Choose One Strategy and Work Hard to Master It: When you combine strategies with different (often opposing) goals and selection criteria, you are virtually guaranteed to trail the market. Really, that bad? Yes, that bad. Over 80% of professional fund managers and investing advisors lag the S&P 500. You have to excel to beat the indexes and to excel you have to master your strategy.
Odd’s 10 Basic Principles of Personal Finance
- Live Beneath Your Means: Regardless of your income, you should always strive to spend considerably less than you make. Form good habits that will help reinforce this behavior like paying cash, sleeping on large purchases, and paying off your entire credit card balance every month.
- Make Your Money Work for You, Invest It: Money stuffed in the mattress or stashed in a low-yield savings account will just get moldy and die a slow horrible inflation death. Invest your money so that it can grow.
- Preserve Your Capital: This principle follows “Make Your Money Work for You, Invest It” for good reason. There’s a big difference between gamblers and investors, make sure you’re the latter. This is your nest egg, you will need it for retirement. You won’t get a mulligan if you lose a lot of money on a stupid gamble.
- Personal Finance is More Than Numbers: People tend to associate personal finance with numbers but many personal finance mistakes are emotional, not numerical. Do you have the discipline to save every month? Can you master your impulse purchase urges? Will you stick with your investing strategy through good markets and bad? These are emotional, not mathematical, barriers to building wealth. Work as hard on your financial and investing discipline as you work on understanding and implementing each principle.
- Save at least 15% of Your Gross Income: I bumped the old 10% rule of thumb up to 15%. Why? Planning for retirement falls squarely in the individual’s lap today, people don’t get near as much help as they used to. Pensions are nearly extinct and social security may begin to shrink in the near future. In addition, stock market volatility has been much higher than the historical norm ever since the tech boom of the 90’s, and the 15% gives you a much needed cushion.
- Own, Don’t Rent: For anyone planning to live somewhere for two or more years, there is no worse way to spend money than to throw it away on rent. Rent isn’t tax deductible and every day in an apartment is a day you could have been earning equity. If you’re a first time home buyer, there has never been a better opportunity to buy than right now. Don’t interpret this as encouragement to splurge, rule #1 is still important. Buy much less house than you can afford.
- Take Advantage of Free Money: There are a lot of free money opportunities out there, take advantage of them. One of the best is the 401k Match which ranges from $2,500 to $5,000 at many companies. This dollar for dollar savings match is a free and instant 100% return on your money. IRAs and Roth IRAs are also great opportunities, they provide free money in the form of tax breaks and tax free investing. Mail in rebates, going to the library for books and movies, the list is basically neverending. Please post your favorite free money idea in the comment section below so we can all take advantage.
- Avoid Debt: Carrying a lot of debt is a sure way to add stress to your life and delay retirement. Wouldn’t you rather enjoy your money then send it to banks and credit card companies each month? Can you even remember what you bought? And don’t even get me started on paying interest, you might as well just burn your money. Try to limit your borrowing to a house and a car when you’re younger and just a house when you’re older. If you’re already in debt and need to dig out, my favorite approach is the snowball method.
- Increase Your Ability to Earn: One of the easiest ways to speed your way to retirement is to increase your earning ability and this is easier than most people realize. You don’t necessarily have to go back to school to get another degree (although that is enormously helpful). A common and effective method of increasing earning potential is to take on new and unfamiliar projects at work. This can help you build new skill sets, take on additional responsibility and provide networking opportunities with senior managers and others that you wouldn’t ordinarily have the chance to interact with.
- Protect Your Family by Planning for the Future: Families used to live closer together and tended to be larger. The notion of a patriarch and matriarch were common and I wish it wasn’t a concept that seems to be fading into history. Take the initiative, be the patriarch or matriarch of your family by teaching the younger generations and planning for their future. There are plenty of wonderful and powerful tools to help you; wills, estates and trusts to ensure your money is passed on as you wish it to be, 529 plans for college savings, and life insurance to guarantee future income for your spouse if you should die to name a few.