While the direst predictions over the world economy have failed to pass, it is nevertheless a fact that many of us did it tough, and in fact are still doing it tough today. But outside of losing a job any pain was most likely, to a large extent at least, self inflicted. That’s a little harsh, but the truth isn’t always nice.
The fact is that every day we all make choices that affect our general level of wealth, and in turn our susceptibility to economic hardship; it’s just that some of us make better choices than others. I’m not just talking about serious financial decisions relating to investments and mortgage repayments either. The habits of wealthy people make a lot of common sense, but as they say common sense isn’t all that common.
The secrets of making the most of your lot in life, financially at least, are outlined here. If they sound obvious, don't be too surprised. They are.
1. Spend less than what you earn
Do you really need to be told this? Unbelievably, it seems that most of us fail to understand this most fundamental of truths. In the mid eighties average household debt in Australia was about 44% of disposable income. Around 20 years later it’s above 160% and rising. In the US, about 44% of Americans spend more than what they earn in a given financial year. Even a credit crisis has failed to make us see sense.
Squirrels don't spend a lot of time and energy storing nuts for the fun of it. And just as they are smart enough to plan for the future, so too should you. If you need elaboration on this point, you really are doomed to a life of poverty.
2. Save your money
This flows directly from the first point. But here we aren’t just talking about spending less than you earn, but allowing what you save to build up. I’m not saying you shouldn’t enjoy life and splash out every now and then, just budget for it and ensure that at the end of the day you are slowly growing your piggy bank.
How much you save will be the single biggest factor in determining your long term wealth. Read that sentence again (it’s important). So if you desire great wealth, you better plan to save as much as you can. A good rule of thumb, where possible, is to plan to save at least 10% of your income.
Without going into a long and boring lesson in economic theory, we can still appreciate that a dollar today is worth more than a dollar in the future. That’s because you can invest a dollar and grow it over time.
There are countless ways to invest your money, so let’s just go to the heart of the matter. Regardless of whether you are talking about stocks, property, term deposits or emu farms, there is one underlying rule when it comes to investing. That is: risk = return.
Don't mistake this for meaning you will get great returns if you take great risks. It means that if you want great returns you must take great risks. And by definition risk is “the possibility of incurring loss or misfortune”. In other words, instead of making a great profit you could suffer a crippling loss. Let’s just say that it is a good idea to understand the risk involved with any investment and consider the worst case scenario. If you can’t take the worst case, don't do it!
The important thing is that your money is being put to work and is growing over time. If it’s not, it will become less and less valuable due to the effects of inflation.
4. Borrow wisely
Debt isn’t always a bad thing. Most of us will need to borrow money to buy a house and sensibly using borrowed money can enhance our investment returns. What really matters is the level of debt and what we do with the borrowed money.
Debt needs to be repaid at some point and it will cost you interest along the way. The longer your debts are outstanding the more expensive they are, so if your debt is a high proportion of your income it will take you a very long time to repay. Also, the more debt you have the lower the level of your disposable income, because more income will be used to pay the interest.
Of course, if we take the borrowed money and use it to make sensible investments we can make more money than what the loan costs us. Over the long term this has been the case with property and shares, but to my knowledge most people haven’t made good returns on a boat or car, and certainly not on clothes and holidays.
I’m not saying we walk everywhere naked and never take a holiday, but I am saying that borrowing for these things ends up costing you a lot more than simply saving up for them in the first place. Just be patient and budget for the things you want.
5. There’s no such thing as get rich quick
If it sounds too good to be true, it probably is. Anyone who is offering the “opportunity” to make great sums of money with low risk is most usually a fraud. After all, if it were that easy wouldn’t they just do it themselves? So no matter how impressive the sales pitch, no matter how nice the guy’s suit is, if you are being offered massive returns with low risk, just walk away.
6. Be patient
If you can’t get rich quick, you might as well get rich slow. Thankfully this is rather easy, provided you are resolute and patient. Most people argue they don't have any investments because they can’t afford it, but most of us should be able to save at least $20 week.
At the end of the first year you will have over $1,000 and if you keep saving $20/week and invest your money at 6%pa along the way you will have over $15,000 in 10 years. Because of the effects of compounding, that’s a 50% total return! Granted you won’t be buying a new Porsche with that, and 10 years is a long time, but it’s money that you otherwise wouldn’t have.
Furthermore, if you can save more and get a better return the numbers get even better. If we instead save $50 week and invest this into the share market every year, we will have $53,000 in 10 years and $212,000 after 20 years (based on the past 30 year annualised total return of the Australian market).
Put simply, the longer we wait, the better off we will be. The point is that even average returns and modest savings will do you well if given half the chance. Just be patient.
7. Insure yourself
No matter how clever we are with our financial planning, life can have a way of messing things up. It’s not something you like to dwell on but it is something you should consider. Insuring things like your house, car, income and even your life means that you can meet any financial challenge, no matter what trouble you find yourself in.
Of course while insurance offers great peace of mind, it also costs money. So don't tick every extras box that comes your way and just cover the basics and shop around. Hopefully you’ll never need it!
So that’s pretty much it. Not rocket science, but many of us ignore these most basic of rules: don't be one of them. In ten year’s time you’ll thank me.
Make the markets work for you