ESSENTIAL RULES OF FINANCE

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Three simple rules in life: If you do not go after what you want, you’ll never have it. If you do not ask, the answer will always be no. If you do not step forward, you will always be in the same place. -Anonymous 

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If you repeatedly break Soccer rules, you’ll receive a Red Card and be ejected from the game. In personal finance, if you repeatedly break the rules the penalty is much harsher. There are several basic and essential rules of personal finance that should be learned and followed.

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NO ONE wants to reach retirement age with little or no money, and no way to catch up!

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Let’s Explore Some of These Basic Rules of Personal Finance:

Saving & Emergency Fund: I’ve always dedicated a portion of my monthly income to saving and building an emergency fund. Early in my career, my friends considered a flat tire an emergency. They lived from paycheck to paycheck and had no funds dedicated to life‘s eventual emergencies. They went to work each day for their “dollars” instead of building a savings account and having their “dollars” work for them.

• Pay Yourself First: Prioritize saving a portion of your income before paying bills or other expenses. I found that paying myself first was the easiest and least painful way to save. When I removed and saved a portion of my paycheck first, I never missed that money because I never had access to it in the first place. If I received $3000 in monthly income and saved $500, I considered my monthly income to be $2500 and lived on that amount. Some people might say saving is easier with larger incomes and that may be true. My wife and I saved a small portion of our income, even when our monthly income was under $500 during my dental school years.
• Build an Emergency Fund: Aim to save 3-6 months’ worth of living expenses in an easily accessible account to cover unexpected costs. For more information on this subject see PREPARING FOR THE UNEXPECTED: THE IMPORTANCE OF AN EMERGENCY FUND.
• Automate Savings: Set up automatic transfers from your checking account to your savings or investment accounts to make saving a consistent habit. This is part B of the saving “Easy Button.” Once you dedicate a portion of your income to pay yourself, the easiest and most consistent way to accomplish this task is to automate the process. Decide how much you want to save each month and make automatic withdrawal provisions for that amount at the beginning of each month. This sounds counterintuitive, as someone may need to retain those funds for an emergency. But isn’t that why you’re carving out some of your earnings? Aren’t these funds being dedicated to savings and to building an emergency fund in the first place? See what I mean! Starting and continuing an automated savings plan is about mindset.

Budgeting & Spending:

• Spend Less Than You Earn: This is a fundamental rule! Living below your means allows you to save and avoid accumulating debt. I remember hearing a radio talk show host say that losing weight was easy. A person had to accomplish two things. Someone only had to eat less and move more. This rule is similar because it’s easy to understand but harder to implement.
• Track Your Expenses: Understanding where your money goes is crucial for effective budgeting. Tools like budgeting apps and spreadsheets can be helpful. Understanding where your money is spent is the first step in understanding how to spend money. To save, you must spend less than you earn (see above). Budgeting apps categorize and clarify where each dollar is spent. Knowing how and where money is spent helps to formulate a plan to maximize efficient spending.
• Differentiate Needs vs. Wants: Prioritize essential expenses (needs) over discretionary spending (wants). Most people get this wrong! To remain within budgetary bounds, one needs to prioritize spending on needed things and minimize spending on the things one wants but doesn’t need.
• Use a Budgeting Method: Explore different budgeting approaches, like the 50/30/20 rule (50% needs, 30% wants, 20% savings) or a zero-based budget, to find one that suits your lifestyle. A zero-based budget is a financial planning method where every dollar of your income is assigned a specific purpose, whether for expenses, savings, or debt payments. This means that your total income minus your total allocated expenses equals zero. It’s about proactively deciding where your money goes instead of letting it be spent passively. 
• Avoid Lifestyle Inflation: As your income increases, resist the urge to increase spending. Instead of using a raise to justify increased spending, use the extra money to increase one’s savings rate. Most people increase their spending rate, but not their saving rate. A close friend was able to retire early using this approach. He and his wife both had moderate incomes. All of his pay increases, went directly to increasing their savings rate, while all of her pay increases offset inflationary cost-of-living increases. Their children were educated in public school, and they lived in the same house they bought after they were married. They retained vehicles for extended periods and took moderate family vacations. My friend and his wife went to work shortly after graduating high school. Because of their moderate lifestyle, savings rate, and company retirement plans, they retired in their early 50s.

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Debt Management:

• Avoid High-Interest Debt: Steer clear of credit card debt and other forms of high-interest borrowing. Credit cards are probably the worst offender here. Payday loan interest normally surpasses the interest on credit card debt, but payday loans are less widely utilized. Credit Card debt is more prevalent and is encouraged by credit card issuers. Credit card companies encourage more debt by increasing credit card borrowing limits and only requiring minimum payments which leave a high balance subject to interest. Credit card companies also charge a penalty fee for late payments. The charges can quickly add up for credit card balances not paid in full each month.
• Pay Down Debt Strategically: Prioritize paying off high-interest debt first, while making minimum payments on other debts. In a recent podcast titled “WHY NOT NOW?“ I spoke about Dave Ramsey‘s Debt Snowball method where the smallest debts are paid off first. Mr. Ramsey recommends this strategy because it creates a mindset of accomplishment, not because it is most efficient financially. Let’s consider two loans with simple interest charges. The first loan is $150 with a monthly interest rate of 30%. The second loan is $50 with a monthly interest rate of 10%. Mr. Ramsey would recommend paying off the $50 loan first and adding the retired loan payments to the second debt to create a snowball effect. Although this technique does create a feeling of accomplishment, the $50 loan generates a $5 interest charge each month, while the $150 loan being ignored generates a $45 interest charge each month. Ignoring the higher interest debt creates a situation where the interest charges almost match the entire first debt balance that a person is trying to pay off. This example outlines the financial problem of using the snowball Debt method.
• Use Credit Wisely: Use credit cards responsibly, pay balances in full each month, and avoid maxing out your credit limits. As stated above, credit card companies are good about extending credit and providing loose repayment policies to encourage greater debt with lower required debt payments. Credit limits and annual interest rates are irrelevant if the balance is paid in full each month.

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Investing:

• Start Early: The earlier you begin investing, the more time your money has to grow through the power of compound interest. Compound interest has been referred to as the eighth wonder of the world. But, compound interest is most effective over longer periods. For more information on compound interest see COMPOUNDING MAGIC: HARNESSING THE EIGHTH WONDER IN YOUR FINANCES.
• Diversify Your Investments: Don’t put all your eggs in one basket. Spread your investments across different asset classes (stocks, bonds, real estate, etc.) to reduce risk. See: MASTERING THE PORTFOLIO: UNDERSTANDING THE NUTS AND BOLTS, and STOCK INVESTING 101: FROM BASICS TO BUYING STRATEGIES. 
• Invest for the Long-Term: Focus on long-term financial goals and avoid trying to time the market. See: LONG-TERM INVESTMENT STRATEGIES: SEPARATING FACT FROM OPINION. Every investor should be focused on maximizing their time in the market instead of trying to time the market. Investors who move in and out of the market based on emotions about the direction of the stock market must make a correct decision when deciding when to get out of the market and then subsequently must make a second correct timing decision about the optimal time to get back into the market. Most investors cannot correctly guess the first timing decision much less both. Since the market has historically gone up three out of every four years, wisdom dictates that remaining invested over a long period will provide better long-term returns than moving in and out of the market in an attempt to guess market direction.
• Understand Risk and Return: Higher potential returns often come with higher risks. Assess your risk tolerance before making investment decisions.  Many years ago I was presented with the opportunity to invest in a program with an extraordinarily high rate of return that also carried an extraordinarily low amount of risk. After considering the proposal, I decided to decline the investment. After several years, the program imploded and investors learned that their investment program was a sophisticated Ponzi scheme. I avoided this investment scheme because the risk/return ratio was too low. The return was too good to be true without accompanying risk. Avoiding this investment saved a lot of heartache and money!

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Financial Planning & Goals:

• Set Financial Goals: Establish clear short-term and long-term financial goals to guide your decisions. A good explanation comes from the book “Alice in Wonderland” by Lewis Carroll. One of the book’s popular characters is the Cheshire Cat. In one paragraph of the book, Alice questions the Cheshire Cat, and the exchange goes something like this:  Alice: Would you tell me, please, which way I ought to go from here?  The Cheshire Cat: That depends a good deal on where you want to get to.  Alice: I don’t much care where.  The Cheshire Cat: Then it doesn’t much matter which way you go.  Having a Vision creates a future direction. To Alice‘s statement that she doesn’t care where she wants to get to, the Cheshire Cat replies that it doesn’t matter which way you go. Alice has no vision of her future and how she wants her life to proceed. Because she has no Vision, she has no preferred path forward, and every direction replicates the same lack of vision and forethought.  See: AVOIDING A FINANCIAL HURRICANE BY CREATING AND UNDERSTANDING A FINANCIAL PLAN. 
• Create a Financial Plan: Develop a comprehensive plan that outlines your financial goals, strategies, and timelines. What Alice needed was a Vision and a Plan. I had created a Vision. I needed a workable Plan. My Plan had to clarify what things were important, were relevant, and would enhance my future life. I needed to isolate and identify the “Yes” things of greater importance than the “No” things. What things would I feel were more worthy of spending money? The whole concept of retirement is using the dollars saved during your working career. It is much easier to visualize retirement money as deferred spending rather than funds that need to be saved and not spent.  See: MAPPING YOUR FUTURE: DO YOU HAVE A SOLID PLAN?
• Review your Plan and Adjust Regularly: Revisit your budget, financial plan, and investment strategy periodically to ensure they align with your goals and circumstances.  How often should this occur? For most people, an annual review will be sufficient. Life-changing events may prompt more frequent reviews.

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Insurance & Protection:

• Have Adequate Insurance Coverage: Protect yourself and your assets with appropriate insurance policies (health, life, auto, homeowners/renters). Remember, the object of insurance is to provide additional financial protection against catastrophic losses. Securing life insurance to protect your family against the loss of a person‘s income in the case of death makes sense. Purchasing insurance to protect against the loss of a television set rarely makes sense because it can be replaced without undue financial hardship.
• Shop Around for Insurance: Compare quotes from different insurance providers to find the best coverage at a competitive price. 

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Final Thoughts

Each person’s needs are different and personal finance is personal.

The rules that I provided are general guidelines. Everyone should tailor guidelines to their circumstances, goals, and risk tolerance.

Seek advice from a qualified financial advisor. Even if this advice is a one-time financial plan review, it can be critical in confirming a person’s plan is sound and they are on the right financial path to Retirement.

Even though this blog concerns, financial rules, it’s also important to consider what activities will occupy your time in retirement. A general rule is that most people spend 90% of their time thinking about finance before retirement, but only 10% of their time considering finance after retirement. After retirement, most planning time is spent on retirement activities and not financial planning. I feel it is critically important to think about and consider what will bring joy and contentment in retirement. It is also important to evaluate and think about retirement activities before retiring. It is not impossible to establish a joyful retirement once retired, it is more problematic. 

I’ve often heard the phrase: “I’ll just figure it out after I retire.” This is not impossible to do, just harder. 

It becomes more difficult because retiring usually entails financial decisions, work decisions, and life decisions. These decisions are complicated and the outcome of these decisions will affect the rest of your life. Why wait until retirement to address such important topics?

Most of the information covered in this blog covers basic financial rules. Even though these rules are basic, following them is essential to providing a solid financial foundation.

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