We have all been there: overlooked small but important things in our daily lives thanks to bigger, more vital day-to-day problems at work, school, family, etc. A lot of times these panic-striking things have had something to do with our finances. As widely known, young people more often than not find themselves to be on tight budgets with limited sources of income. We are at the stage when we either have a lot of time on hand but little money, or little time and rather modest amounts of inflows. This is especially true for students or young professionals. And maybe it is a good thing. This discomfort can be turned into an opportunity to learn how to manage money on an early stage with small risks and repercussions. As they say, it is not how much you make but how much you keep. A couple of implications follow this principle. First, if you are lucky to be on the top of the food chain early in your life, it does not mean that you settled, or well-off: making a lot of money from your job does not immediately translate into financial freedom in the foreseeable future. Economics tells us that the more people make the more they consume. Oftentimes, the growth in spending supersedes the positive change in income. No wonder many yuppies find themselves paying off their credit cards with year-end bonuses. Secondly, take a look at the net numbers. People tend be overly optimistic and they oversimplify things when it comes to budgeting. I have been there myself. One tends to overestimate cash inflows and underestimate expenses. Of course, sometimes there are one-time, unforeseen expenditures that are mandatory and cannot be factored in early enough. However, this established practice more or less has to do with how our minds work: we do not welcome stress and cannot endure negativity for too long. Hence, the simplest thing we can do is to make a deal with ourselves and postpone bad things to a later date. This is especially true for those that have had a long experience in solving problems successfully with ad hoc decisions.
I do have a few pieces of advice that shall help people of my age learn about good habits in money management. Having tried many of them myself, I can assure you they do work. It is just a matter of habit to implement the principles in daily routine and stay true to them and a continuous basis.
1. Inflows Should Be Greater Than Outflows
Yes, I know it is obvious. But hey, it is usually the simple rules that we stumble upon the most. The problem is not usually with the math. After all, we would not be in the numbers-heavy industry, had we not been good with calculations. It has to do with mental accounting: we try to do things the easy way and prefer not to bother with using pen and paper when doing P&L ourselves. This invariably leads to either overspending or suboptimal saving patterns. Allocate some time to creating a spreadsheet in Excel (we are all good at it, aren’t we) and set realistic saving targets. Reward yourself upon reaching them in the end of the period. If companies reward key people when they surpass specific milestones, why would not you pat yourself on the shoulder, too?
2. Pay Yourself First
Okay, you are a pro in spreadsheets and forecasting. You have even included contingencies in your nice little model and spent the last half an hour formatting the table with colour schemes and fonts so that it looks appealing the next time you open it. However, as life has taught us, paper plans often deviate from the reality. The question is: how do you move the carefully calculated numbers on your computer screen to your bank account? In my opinion, and what I have tried myself, the best way to do so is by setting aside a portion of a cash inflow immediately. You do not need an offshore account top make this strategy succeed: oftentimes, banks offer that option themselves. The practical thing is to transfer a portion of the money right away to an account in a different bank so that it will be a cumbersome task to retrieve it when you give in to temptation to buy a new widget. Usually, the best way is to set a constant percentage of income that goes to savings. Now that the money is gone, you may spend the rest any way you want.
3. Prioritize Your Savings
It is equally frustrating to be forced to sell your investments in a fire sale when you suddenly need cash or to see money sitting in your account earning interest that does not keep up with inflation. The key is to set up a number of funds serving specific purposes in various situations in life. Emergency fund should be the #1 account your savings go into. Once this one is filled up, you can start contributing to an investment account or
towards saving for a big purchase, such a car, a condo, or a piece of equipment. You may even start thinking about retirement (time flies, you know)! This type of waterfall structure ensures that you withdraw money from your emergency fund, which is typically liquid, first, during unforeseen circumstances. The size of each fund is discretionary: you do the math. Conventionally, aim to save 3 to 6 month worth of salary in your emergency fund, first.
4. Pay Cash More Often
You cannot run into an overdraft if you pay cash. It is also easier to keep track of expenditures when see money leaving your pocket physically. It is tempting to use credit and debit cards that offer air miles or cashbacks but it is equally difficult to keep track of numbers. Yes, it is more secure to have a wallet full of plastic than paper money: if you lose it or it gets stolen, you do not lose anything other than peace of mind. This is not the case with cash. But honestly, how many times in your life have you lost a wallet? None for me.
5. It is Not Material, Why Bother?
We are lazy creatures. Sometimes, we just do not feel like spending extra couple of minutes to find a cheaper deal online or collect that debt from our friends. In our opinion, the amounts “are not worth my time”. I am not going to run an inflation-adjusted NPV on the total amount you “could have saved, had you…” This is too cliché. Try this: start getting more for your buck and do some quick math in your head every time you save. In the end of the week, month, or any other time period, add up these totals and buy yourself something you truly enjoy but consider unnecessar y under other circumstances. We are short-term oriented, and this little trick will help develop a healthy money habit for the future.
6. Stop Buying Stuff You Do Not Need
Seriously, the less you have the more you enjoy your possessions. What’s the point of having a wardrobe stuffed with clothing which you almost never wear? I mean, there is a set of things you wear or use continually but the other half is redundant, to put bluntly. Make a wish list of things you want to have now or in the foreseeable future and stick to it. Cross out an item on the list when you purchase it. This should help build a sense of accomplishment and will help resist spontaneous buying.
7. Pay Off Debt First
Debt is not bad if and only if it serves for investment purposes. Everything else is worth waiting and saving for. I know there are situations when there is no other optimal solution but I am talking about consumer credit. Problem with debt is that it is interest-bearing. And typically, the interest is rather high so that you cannot exploit arbitrage opportunities in borrowing and lending like banks do. If you have a debt balance, pay it off before you save for yourself. Even though it is more pleasant to see your savings account grow than your debt balance reducing, technically, you should be indifferent because the net effect is the same. On the other hand, there is no point in a growing balance sheet when your net worth is deteriorating. Imagine, your savings grow slower than your debt thanks to the miserable interest earned in your personal accounts. The faster you become debt-free the sooner you will be able to lend yourself at a zero cost from your own bank account!
I could go on and get into detail of each one of these steps and add other common sense principles but I should stop here at a magic seven. Step by step, these ways will transform you into what economists call “rational consumers”, even though the truth is, few of us are.
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