Principles of personal finance

#1 Don’t Compare Yourself To Others

Don't Compare Yourself to OthersAnimals possess an evolutionary tendency to compare themselves to other animals. The social comparison theory states that there is a drive within animals to gain accurate self-evaluations by comparing themselves to others in order to reduce uncertainty and define self.

In order to reduce uncertainty we compare, which inevitably leads to an explosion of options. “We can continue to do this, or we can start doing that, that, or that.” Our imagination grows as we realize the existence of things we did not know existed.

Conventional wisdom tells us options are good. But are more options better? There is a point where options quit liberating us and start to debilitate us.

Imagination is not the only thing to grow when given more options– expectations and opportunity costs grow as well.

Every decision we make means we can’t make another decision that we now know could be our greatest decision. The more options available make it less likely to be satisfied with the actual option we choose.

Comparison to others is the thief of satisfaction because it’s easier to focus on a hypothetical great decision than it is to focus on an actual good decision – because it was only good. Our expectations grow to the point where good decisions simply meet our expectation, and never exceed them.

We are less likely to find happiness and contentment while comparing ourselves to others because the key to happiness and contentment is lowered expectations.

So how do we lower our expectations, and at the same time continue to push towards improvement? We compare…just not to others! Our tendency to compare to gain accurate self-evaluations is not the problem. What we are comparing to is the problem. Comparing yourself to others gives an unrealistic expectation. We understate our value and overstate another’s, with no road map to close the gap.

Comparison is essential for growth. We all need benchmarks and tools to gauge our emotional, spiritual, physical, and financial wellness. But it has to be something we control.

The best tool used for financial comparison is our own budget (AKA financial plan), which uses our own priorities and our own goals. Referencing a plan throughout the year gives us feedback, and more importantly the ability to change something we don’t like.

Over the course of one’s life there are always going to be new and exciting things to do with our money. It’s easy to veer off course when given too many options without a plan. But mastering the game of money is not about more; it’s about less.

Make your own goals that are important to you and ignore the rest. Contrary to popular belief, the goal is to consistently make “good enough” choices! We are guaranteed to have less stress and experience greater satisfaction and effectiveness from the options we do choose.

Minimize comparisons to maximize contentment.

#2 Spend Less Than You Make

Spend Less Than You MakeThis sounds like such trivial advice. The principle is remarkably easy to comprehend. It’s also remarkable that a lot of people can’t seem to follow it.

If you spend less than you make, you only buy things that you can afford. That means you don’t have credit card debt, you don’t have a car payment. If you could afford that car, why would you need to finance it?

Spending less than you make is the first step in saving. It’s the first step in eliminating your debt. It’s the first step in reducing stress. It’s the first step in reducing risk. It’s the first step in increasing power. It’s the first step in avoiding curses and capitalizing opportunities.

It’s impossible to say this is bad advice. Yet many people still spend more than they make! The scary part is that they don’t even know it. The problem for most of us is not that we are reckless with our money, but rather wasteful with our money! Living recklessly is obvious, living wastefully goes unnoticed.

The easiest way to solve this problem is to create and follow a budget. A budget is a necessary part of being an adult because it forces us to be accountable. As a mature adult, there is no choice but to be accountable with your money and life.

#3 Get out of Debt, Then Avoid It

Get Out of DebtThe key to financial fitness is reducing risk and increasing power.

All of these principles have a somewhat indirect impact to this theme, except this one. Becoming debt-free is directly related to reducing risk and increasing power. For every dollar we owe, we increase or risk and reduce our power.

Why is this important? It’s the difference between being free or enslaved, mobile or hemmed, able to participate in our passions or prevented from doing so. We all go to work year after year to provide. But who are we providing for? Are we providing for our family? Or are we providing for Bank of America? Look at your bank statement. Where is your money going? I hope it’s going to the things that are most important to you. And I doubt your bank is one of them.

Imagine having no debt. Every dollar you earned went EXACTLY WHERE YOU WANTED IT TO GO! Think of the possibilities. You could do anything you wanted to! There would be no risk of failure, and no lack of power to change your life.

Debt is a future burden hidden as current benefit. Debt trades time for money that your future self will take care. Every time we swipe a credit card a hidden note is posted: “Hi Future Luke, this is Present Luke. I hope you don’t mind paying this. I hope you are doing well. Oh, and it will actually cost a lot more than what it is now. But it is totally worth it.”

I sure hope future Luke isn’t taking care of a terminally ill family member. I hope he’s not looking for a medical expert across the country for his son. I hope’s he’s able to work. I hope he likes stress. I hope he doesn’t want to retire. I hope he’s still alive and Megan doesn’t have to deal with this. I hope he likes living the exact same life year after year after year.

From a math perspective, debt never stops stealing from us. They call it interest. Would you be mad if someone came to your house every month and demanded you gave them $100? Heck yeah! But no one seems to mind when the bank takes out $100 on their own. That’s what makes debt so dangerous – we don’t know it’s dangerous!

Is interest our problem? No. Is debt our problem? No. Debt is the symptom of a much larger behavioral problem; behavior that makes it impossible to improve your life. We cannot let a destructive pattern persist without real consequences. If you continue to let debt be a part of your life, the best case scenario is that you’re broke (regardless of your income). The worse, most likely scenario is you miss an opportunity that you regret for the rest of your life.

We do not become financially fit to look at our bank account. We become financially fit to do the things that are most important to us. Debt prevents us from those things by increasing our risks and reducing our power to change.

#4 Build Margin

Warren BuffettMargin is the amount allowed beyond that of which is actually needed. Our margin exceeds our limits so emergencies become mere inconveniences. There is peace, then there is maaaaaaaarrrrggin, and then there is anxiety!

There are many areas we can all work on improving our margin – emotional, physical, time and financial margin. However, each of these areas are not weighted the same. Financial margin is intertwined in all of these areas. Without financial margin, all the other areas are hard to address. Have you ever met a calm individual going through a foreclosure?

Margin is a fancy word for opportunity and safety. Without financial margin we can’t be receptive to the things that mean most to us. It’s hard enough finding a passion in life; imagine finding that passion but not being able to capitalize on it because you lack financial margin. An opportunity with margin is a blessing. An opportunity without financial margin is a curse.

Most of us live a marginless life. We live paycheck to paycheck, decision to decision. Living paycheck to paycheck might work in your favor if you’re world-renowned for your abilities in telepathy. Living without a monthly budget is often a sign you lack no self-confidence in clairvoyance.

For those of us without extrasensory perception, we do not have the luxury of foregoing margin. One thing that I am positive about is not everything will be positive. There will be hard times, there will be sad times, and there will be times to worry. Your margin is a down-payment for these times!

A car breaking down should be an inconvenience, not a complete catastrophe. Having a sick child should be a worrisome event because your child is sick, not because your child is sick and it cost money to treat a child that is sick. Working an extra shift at the hospital is a bummer, not an emotional rollercoaster that you don’t want to be on but have to because you are desperate for the money. A leaky roof should be a pain-in-the-butt, not the event that turns you into someone else’s pain-in-the-butt.

In a culture that glorifies 110%, it is rare to see a life prescheduled to only 80%. How could you? 80% is for the under-achievers!

110% is for the competitive. 80% is for the winners! Winners leave a margin to respond to the unexpected – the unexpected that so happens to be expected.

#5 Protect Your Wealth through Investing

Protecting wealth through investing!Spending less than you make, getting out of debt, and building margin are how we create wealth. We should see a natural financial progression as we start to manage our behavior with money. We have a goal that makes it easier to be content, which makes it easier to save money, which makes it easier to become and stay debt-free, which makes it easier to build an adequate financial margin to buffer life’s curveballs.

There’s purposely no mention of investing. Saving, becoming debt-free and building margin give us a life. Investing simply protects it. That’s why it’s the last principle.

Wealth is created by things we control; not by what the stock market is doing. We cannot become wealthy by only investing.

Understanding this helps us make better financial decisions. We don’t fall into the lie that investing is comparable to, say, getting out of debt. One creates wealth. The other protects it.

We don’t fall into the lie that investing is magic. We don’t search for exotic asset allocations that everyone would follow if only they could understand it. We aren’t looking for some new IPO in Silicon Valley to make us millions. All we are looking for is an easy to understand diversified investment vehicle that preserves the wealth we accumulated. I don’t care about the magazine articles we read while waiting 20 minutes in the self-checkout line at Wal-Mart. If we can’t easily explain it, we don’t do it. There are no secrets.

We spend too much time on things we can’t control, and not enough the things we can. Should we invest? YES! But only when we have something to protect! There are much more important things to worry about like spending less than we make, getting out of debt, and building margin. After those are mastered, we invest.

Don’t build a roof if you haven’t built any walls.

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