We will discuss the principles of finance with a clear plan to financial success. We will give you a guide for how to get out of debt, save money and invest for retirement.
What are the Principles of Finance?
Better yet, what is “finance? It’s important that we define what we mean by the term finance first and then we can dive into the details of how to be successful at the principles of finance.
Investopedia.com defines finance as,
.. the process of budgeting, saving, investing, spending or otherwise overseeing the capital usage of an individual or group. -Investopedia.com
Individual vs. Group Finance
Managing money and learning the principles of finance can involve both individual (personal finance) and groups. In this article we address personal finance and how the individual manages money. But many of the ideas discussed here can carry over into group finance as well. Many of these finance ideas are indeed universal truths.
The first step in learning the principles of finance should be to determine what your financial goals are and what you wish to accomplish. Where do you see yourself in 5, 10, 20 or even 30 years?
Write Down Your Goals
If you want to be retired, living on a beach in Costa Rica in 20 years, then you need to write that down as part of your goals. We recommend creating a notebook, journal or even a spreadsheet where you list exactly what you have planned for the future. This serves two purposes. Writing down your goals makes what you want explicitly clear. It gives you a starting point and also provides you with the details that you will need to determine how you will reach your goals.
The second purpose of planning out your financial goals on paper (or electronically) is that you are signaling to the universe what you want. History has proven that the psychology of desire and intention is a powerful tool in accomplishing goals for mastering the principles of finance.
Review Your Goals Regularly
Once you’ve written down your goals for the principles of finance, you should return to the goals frequently to review them. Some people even find it helpful to place a copy of the written goals in a location near them where they see the goals daily, like on your bathroom mirror or near your workspace. It can also be helpful to visualize your goals through imagery. Is one of your goals to own a beach house? Place a picture of the beach house that you want on your wall. Again, the power of intention is great and tends to help you focus your energy on exactly what you want.
Create a Budget
Now that you have established your goals, it’s time to create a budget. Budgeting requires a great deal of self-discipline, so if you don’t follow your budget, then it can wreck your plans! When you create a budget, start by writing down in detail what your expenses are each month. Spreadsheets are great for budgeting, but not required. There are also budgeting apps to choose from that can be helpful. For now, you need to know where you spend your money. Provide as much detail as possible when listing your expenses. You may find it helpful to review past bank statements and receipts.
Once you have an idea of where you spend your money each month, it’s time to take a hard look at your budget and cut some expenses. Many people find making cuts to spending a difficult task. But making cuts now will help you reach your financial goals quicker. Finally, creating a budget is a critical step toward mastering the principles of finance.
What Budget Items to Cut
When looking at expenses, determine what expenses are necessary and which are not. For example, purchases from the grocery store are typically necessary; eating out at restaurants is not necessary. In particular, focus on cutting things like cable bills, eating out, subscriptions to news/media, luxury items like spa packages, and the like. Pretend your income has been cut in half and you can only maintain budget items that are necessary to survive, like electricity, food, water, etc. This is an extreme measure, but cutting the unnecessary items from your budget now will make getting ahead in the future easier and more enjoyable. Cutting budget items down to core expenses will help you in your principles of finance.
Living Below Your Means
After cutting your expenses down to the bear minimum, you should be living below your means (hopefully). Unfortunately, living below your means is a philosophy that most people don’t follow these days. Living below your means requires that you spend less than what you make. For example, if your take home pay is $1,500 per month, then living below your means is only spending $1,000 per month.
The extra money that you have from living below your means will serve two purposes. At first the extra money will be used to pay down debts quickly. Getting ahead requires that all debt be paid off first. Secondly, after the debt has been paid off, you will then use the positive cash flow to fund your emergency fund, savings and investments. Each of these is part of your net worth and the buffer between you and poverty. The more you can grow your savings and investment, the simpler and easier life gets.
Pay Off All Debts
Before you can start saving money and master the principles of finance, you must pay off all debts. Now that you’ve established your budget, cut personal spending to the bare minimum. You will take extra money that you have leftover in your budget and use it to pay down debts. Create a list or accounting of your debts, the corresponding balances and interest rates that you maintain. Use this information to help you keep track of your progress as you pay down debts.
If you are young and just starting out, hopefully your debts are minimal. Having minimal or no debt when you begin your journey toward wealth creation is a huge advantage. Paying off debt can take years and a great deal of sacrifice. So, if you have little or no debt, congratulations! For the rest of us, it’s time to get to work paying off debt.
Work Extra to Pay Down Debt Faster
How do you quickly pay off debt? One of the recommendations made by finance guru Dave Ramsey is to take on a second job. Deliver pizzas, wait tables or pick up an extra shift at your job to earn extra money. Taking on extra work is a temporary measure so it doesn’t really matter what you do. The point is to bring in more money quickly to pay off your debt and be debt-free. Just make sure you’ve truly minimized your expenses first!
The Shocking Truth About Saving Money
According to a December 2019 article by GoBankingRates, approximately 70% of Americans have less than $1,000 in savings!
This is a shocking statistic that shows how access to credit cards and lending have dominated our society. Unfortunately, Americans have adopted the idea that borrowing money for most things is normal. Yet, just a few generations ago in the early 20th century, people learned the hard way during the Great Depression that borrowing can lead to financial ruin. Having no savings puts you in a dangerous financial place.
Make Saving a Habit
Saving is a habit that can be learned over time and simply requires discipline. Become determined to reach your financial goals. Your personal determination to win at the money game will help you develop the discipline to save.
In addition, develop good habits of saving money. In the classic personal finance book, “The Richest Man in Babylon” by George Clason, the author implores the reader to set aside at least 10% of your earnings. This is a great rule of thumb for saving and investing because removing only a fraction of your income each month will likely not even be noticed or missed. Yet, this small amount of money is the seed needed to grow wealth.
Create an Emergency Fund
The first thing to do when you have paid off debt is to start saving for an emergency. Many people think that saving for an emergency is not necessary, until life proves them wrong and an unexpected event happens. Unfortunately, we all have emergencies during life: job loss, medical issues, natural disasters, home repairs, car problems, etc. Life is expensive and it pays to be prepared.
At a minimum, you want to have at least $1,000 in your emergency fund. In reality, your emergency fund should cover 3-6 months of expenses. For most people this number should probably be between $5,000 – $20,000. Keep in mind that in the worst case scenario you want to be able to pay all your bills and eat for 3-6 months, in the event that you lose your job.
Invest 10-15% of Income
Once you’ve fully funded your emergency fund, you can start investing. And if you have made it this far, then congratulations! You are ahead of the pack and well on your way to wealth building.
As stated previously, we recommend that you invest 10-15% of your income monthly. The earlier that you get started saving and investing, the better off you will be in the long run. In fact, the most powerful tool that will be working for you during investing is compounding interest, and it works like magic. How do you turn $1,000 into $62,000? The answer may be simpler than you think.
The Magic of Compounding Interest.
Here’s an example of how compounding interest works for an investor: you invest $1,000 into an investment fund (let’s assume it’s stocks, for simplicity) that earns 5% per year. You begin to contribute $50 each month for 20 years. After 20 years, compounding interest will have earned you approximately $62,000! Don’t believe me? Check out the handy compound interest calculator below and enter in your own numbers.
The US Securities and Exchange Commission (SEC) has a created a free compounding interest calculator for you. The calculator can help you determine future outcomes with your money and determine how much you need to contribute each month to reach your financial goals over time. It’s a power investment tool and it’s free.
So, You Are an Investor – Now What?
Now you must continue to earn money to fund your investments, and more importantly, protect what you have.
According to Warren Buffet, one of the most famous investors of all time, the most important rules of investing are:
Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.
Intelligent investors diversify their holdings. They typically don’t just invest in one thing; they spread their money around in different asset classes, such as stocks, bonds, real estate, commodities like gold/silver, bitcoin, cash, etc. Investments go up and down in natural cycles. You don’t want to put all of your eggs in one basket, so to speak. Take Warren Buffet’s advice: Never lose money. Protect your investments.
Surround Yourself with Professionals
Investing is a complicated activity that requires expertise and fiduciary commitment. We recommend that you surround yourself with a team of experts that you trust with your money. Expert advice that you will likely need will be in fields such as investing, taxes and legal services. Finding experts to manage your money costs money, but it can save you time, headaches and ultimately pay you back. For example, you may spend several hundred dollars working with a CPA who specializes in tax law, but they may be able to help you minimize your tax burden on your investments, ultimately a net savings in the long term.
Due Diligence: Beware of Salesmen
Spend some time finding the best professionals in your area. Check for online reviews of experts in the investment, tax and legal fields. Ask friends or family for references or recommendations. Beware of “experts” who promise too much or don’t have the correct training or certification. It’s important to know that there are many “investment advisors” out there who are nothing more than salesmen who may be steering you toward investments that are not in your best interest. Exhaustive due diligence is a must when acquiring professional assistance.
Final Notes: Investment Maintenance
Continue to monitor your investments at least quarterly. During market cycles your investments will gain and lose value; but overall, you should see gains in the long term. If you have a concern, don’t hesitate to contact your team and ask questions. You can always change team members out if things are not going as you planned. Remember: you are the boss!
Continue to monitor your credit score and credit history. Unless you are a millionaire, credit score matters. If you decide to re-finance in the future, buy property or even use credit to buy a car, you want to know that your credit is good. Having good credit determines your interest rate and directly affects your payments. Monitor for fraud as well.
Improve Your Ability to Earn Money
It is recommended that you improve your earning power over time. Increasing your annual earnings speeds up your ability to grow your net worth and overall wealth. Earning power can be improved by promotions at your job, adding a side hustle job or by starting a new business. This is optional and is based on your level of ambition.
Are you interested in reading more about personal finance from the industry leaders? Check out our post detailing The Best Investing Books of All Time!
Wrap Up of Principles of Finance
Hopefully this article has helped you better understand the steps required to master the principles of finance. Establishing goals and implementing a plan with consistent budgeting and saving is the key to any successful financial goals.
It is important to note that Piggy Bank Coins does not provide financial advice. We don’t endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals and some equities.
In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, in order to help you make the best choice for you.