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Personal Finance Manifesto

Personal finance is a much more simple topic than most people think.  Entire blogs are dedicated to simple personal finance topics that typically are nothing more than common sense and a few basic principles.  Well, I’m going to simplify personal finance for you into eight easy-to-understand principles.  Understand these principles, put them into action, and you will be good to go.  Then, you can focus on more complex topics regarding your money such as investing strategies, additional income streams, etc.  Additionally, I can focus on writing daily blog content on these more complex, more interseting topics.  I get bored quickly with basic personal finance.  I hope you agree.

With that said, here are the eight principles of personal finance.  These are important and are the backbone of your financial life.  The earlier you master these, the better.

#1 – Get Out Of Debt

This is very simple.  All of your financial goals are pretty much on hold until you get out of debt.  While a reasonable amount of mortgage debt is acceptable (more on this later), any high interest debt delays all of your financial progress.  Simply put, you must get out of debt and get out of debt as fast as possible.  I often encourage people to take extreme measures to get out of debt.  If you are single and have no dependents, you can get pretty crazy in terms of cutting expenses so that you can allocate the majority of your income towards your debt.  Get extreme.  Put as much money as possible towards paying off your debt.  When you’re debt free, you’re ready to proceed.

Getting out of debt is tough.  Paying off $10,000 in debt is much harder than saving $10,000 because you’re paying interest payments while trying to accumulate that amount.  As such, paying off $10,000  may be more equivalent to saving something like $13,000.  All the more reason to get extreme and pay that balance off fast.

#2 – Minimize Your Expenses

This is a definite cornerstone of personal finance.  How do you expect to build wealth without having money “left over” each month?  By minimizing your expenses, you are able to save money.  Saving money leads to wealth.

I like to break down my expenses into three categories: fixed expenses, regular expenses and irregular expenses.  By breaking them down into various categories, you are better able to track them and suppress them.

Your fixed expenses are things such as your mortgage or rent, utilities, auto payment, internet, etc.  These expenses for the most part are not affected by your day-to-day lifestyle.  Unfortunately, many people make the mistake of “locking” themselves in to high fixed expenses by buying an expensive house or signing a lease for an expensive apartment.  This can definitely be a case where a past mistake can harm your personal finances for years to come.  Before you make a bad decision, make sure that you seriously consider lower cost alternatives.  You might end up saving yourself hundreds of dollars a month for years to come.

Your regular expenses are your day-to-day expenses that are consistent such as food, entertainment, gas, gym membership, etc.  This is typically the area where most people target to minimize their expenses.  While this is a great idea, cutting out your daily Starbucks latte won’t mean much if you’re spending 50% of your income on your mortgage; therefore, make sure you address your fixed expenses as well as your regular expenses.

Your irregular expenses are the one-time expenses that are typically unexpected such as an auto repair or replacing an air conditioner.  Or perhaps, an annual life insurance premium.  By tracking your spending in great detail, you can look at what you spent over the course of a year on these types of expenses, then determine a monthly amount to set aside to pay for these expenses as they occur.  Doing so will ensure you’re always prepared and don’t have to use a credit card to pay for something unexpected.

#3 – Increase Your Income

The second half of the core strategy is to increase your income.  Combined with minimizing your expenses, increasing your income will result in a strong financial position.  There are a few ways you can work to increase your income.  First, maximizing your career or your main income should be your main focus.  If you don’t see upside potential and future opportunity in your current career path, you may need to consider a change.  If there is growth opportunities, work hard, find ways to take on additional responsibility and shine for your boss or employer.  By demonstrating additional capabilities, you set yourself up for promotion and an increase in income.

Once you are in the “groove” with your career, you can use your time outside of work to develop and grow additional income streams.  By keeping your expenses in check with regards to your main income, establishing a second income stream results in 100% pure cash flow for your savings and/or investments.  Working to develop secondary income streams is a big focus for this blog, 20smoney.com.

To sum up, keep your expenses constant and grow your income.  This is the formula for big things to happen in your financial life.

#4 – Housing Is An Expense, Not An Investment

We have covered the basic, core issues.  Now let’s address a few specifics.  Your money allocated to housing is an expense, not an investment.  You require shelter just like you require food.  Therefore, you should attempt to spend as little as possible on housing expenses since if we refer to #2 above, we want to keep our expenses low.  In order to do this, you need to analyze all housing related expenses such as maintenance, lawn care, utilities (how much will it cost to cool a house this size?), home owners association fees, taxes, insurance, etc.  Even with home values decreasing in recent years, in most cases it is still cheaper to rent than own.  For 90% of people, I would recommend renting.  If you’re young, you should almost 100% rent since you should not be locking yourself into such an illiquid asset such as a house.

When determining the course of action for your housing, you need to run the numbers.  Include in your analysis everything I mentioned above, and everything else you can think of.  What is the least expensive option?  Be sure to keep your emotions in check as emotions will often come into play especially when shopping for a home to buy.

#5 – Understand The True Cost Of “Things”

It is important to avoid falling into the trap that most people fall into with regards to consumption and accumulating “things”.  Most Americans simply have too much stuff.  They don’t realize the added cost in these things.  Whether it’s an expensive car or owning a few hundred DVDs, it takes money to store, maintain and own “things”.  Rather than spending your money on things that become obsolete a year later, you should put your money into assets.  Assets will pay you money.  Owning things will cost you money.

By having a more simple lifestyle with fewer things, you can probably own a smaller house which will cost less and cost less money to maintain and live in.

#6 – Understand Compounding Interest

As you get in the habit of saving money, hopefully an increasing amount of money on a regular basis, your focus will begin to turn to earning a return on your savings/investments.  You need to have an understanding of the power of compounding interest.  If you understand compounding interest, you are much more likely to start this personal finance journey earlier on in your life because you will recognize the necessity of starting early.  Go to any savings calculator or retirement calculator and you will see the drastic difference between starting your saving at 25 versus starting your saving at 35.  You will be shocked to see how huge the difference will be.

Compounding interest basically says that you will make interest on your interest.  The interest you earn on your money this year becomes the balance next year on which you will earn interest.  The same goes for next year.  Add continued savings during each year, and your money will grow faster than you think.  I started this blog because I wanted to encourage people to start early.  Your 20s are the ideal time to start the saving and investing in your life.

#7 – Work To Increase Your Rate Of Return

After fully grasping compounding interest, it’s time to work on increasing the rate of return on your money and your investments.  By increasing the rate, the power of compounding interest increases even more.  So, how do you increase your rate of return?  You can browse the various online banks and find a CD that is pay .01% better than another CD, but that will only get you so far.  Eventually, you will have to turn to the world of investing, for most people the world of the stock market.

If you want to increase your rate of return, eventually you will have to learn how to invest.  This does not mean participating in a 401(k) plan where investments are chosen for you.  This means opening up a brokerage account, depositing your own money, and finding individual positions (stocks, ETFs) to buy.  You must eventually get into active investing.  Now, with that said, our goal here isn’t 20% a year (would be great); instead, perhaps our goal is only a few percentage points more than other asset returns.  Maybe 8% is your goal, or maybe it’s 12%.  Both are do-able in my opinion.

I firmly believe that it takes several years of active investing to even begin to understand investing.  After that, you will learn the rest of your investing career.  If you’re nervous about losing money in the beginning, consider sticking to broad ETFs like the S&P ETF (SPY) or maybe a sector ETF (i.e. technology or energy).  After that, begin to follow the stock of a company that you’re already familiar with – Apple (AAPL) is a common choice for many people.  Just get into the game.

As you gain experience, you should begin to develop a portfolio and/or a trading strategy that earns you a nice return each year.  As you refine your strategy, you may even begin to outperform the market on a fairly consistent basis.

#8 – Be Cash Flow Focused, Not Speculation Focused

As you become a more sophisticated investor, you will want to develop a portfolio of cash flowing assets.  While dividend yielding stocks are a definite option, there are additional options such as rental income from real estate.  Cash flow should be the cornerstone of your investing.  If you are counting on capital appreciation, it requires a buy and a sell (and the sell must be at a higher price than the buy); if you’re focusing on cash flow, you can simply buy an asset at an attractive price and sit back and bring in the cash flow.

Some of the best performing stocks over long periods of time (multiple decades) are stocks such as Philip Morris Int’l (PM) that a long history of increasing its dividends.  Investors that reinvested those dividends (essentially compounding interest) saw very large returns over many years.   Some cash flowing companies might not be as sexy as the latest biotech stock, but there is nothing more sexier than consistent cash flow.