Personal finance is 80 per cent psychology. The maths behind it is simple and all you need is what you learned in primary school: Don’t spend more than you earn, find the cheapest loan, etc. A child could understand it. What’s difficult is cultivating the willpower and motivation to follow through on common sense rules.
Here’s how to do it:
#1 Think of making money as a form of care
If you think of making money in materialistic terms (e.g. I want to own a mansion, I want to own a fleet of cars) you will often lack the willpower and discipline to save or invest. Surprisingly few people are motivated by these things.
Instead, think of making money as a form of caring and saving as a way of “paying yourself first“. If you cannot earn enough money, will you be a burden on your friends and family? If you get sick or cannot work, who will bear the cost? Who pays your medical fees and your mortgage?
Do you have the wealth to deal with it? Or will your retired parents end up having to chip in, your friends having to give loans you know you can’t pay back, and your children having to give up on a university education?
If you cannot make enough money to support yourself, someone you love will pay for it. Keep that in mind, and you will find the willpower to save and to invest.
#2 If your first response to everything is to “budget for it”, you will probably never get rich
Saving is important, and you should never spend more than you can afford. But if something comes up and you need money, your first response should not be to budget. Your first response should be to think of ways to make that money.
If you unexpectedly need S$500 this month, where will the money come from? Do you downgrade the brand of tea that you drink, or cancel a cable subscription?
Those are many ways to make up the cost. But what will you do if one day you unexpectedly need $25,000 for surgery? There is only so much you can budget for.
It’s better to respond to financial needs more proactively. If you require more cash, go out and look for ways to earn more before scrimping and budgeting. Look for side-income jobs, do projects that get you paid, or negotiate for a raise if it’s necessary. Budgeting comes in when all of those attempts fail.
Taking this attitude will propel you to find opportunities to grow your income. Read the biographies of people like Richard Branson. Warren Buffet, or Jack Ma, and you will see this is the quality they all share.
#3 Your financial situation will closely match that of the people you hang around with
Your friends affect your spending habits and mindset more than you realise. If you hang around people with poor financial attitudes, you will develop the same qualities.
Take a look at your “crowd”: are they enterprising and able to brush off setbacks? Or are they mostly poor, and spend all day moaning that they will never get out of their situation? Do they spend money and mire themselves in debt, or are they prudent and make a habit of saving?
Whatever their attitude towards money, you will gradually adapt to match them. Being conscious of this helps to mitigate some of the effects – but you can be proactive too. Seek out acquaintances who understand money and how it works, and hang out with them more often. This doesn’t just mean banker and stockbroker types (in fact, those types can be very bad with personal finance) — it could be a neighbour who is financially prudent.
#4 Plan for the probable, not the potential
Potential is winning the lottery and becoming a millionaire next week. Potential is picking one stock among 5,000 that goes up 700 percent in a quarter. Potential is finding one magic Forex trading course that changes your life forever.
Potential, in other words, is often fantasy. Focusing too much on potential is why people fall for get-rick-quick scams or play the lottery every week hoping to strike it rich.
When you must make a financial decision, focus on the probable and not the potential outcome.
So don’t get excited at the potential returns on a stock investment – do your due diligence and calculate conservatively what is the probable return over your investment time horizon. Don’t ask your property agent how much your condo’s value could potentially go up. Look at the surrounding houses, and the 20-year transaction history of the neighbourhood. That’s the probable appreciation.
When you start dealing in probability rather than potential, you will make better financial decisions. And you will do it faster, and with greater confidence.