Written By: Tom Gates, CFP
Some of the most asked questions at JPP are about what advice to give young people about saving and investment: How much should I save? Where should I invest my savings? What rate of return should I expect? Should I pay-off all of my debt before I save? And on and on.
Unfortunately, there is no silver bullet answer. These personal finance issues are rooted in all facets of our personality, such as our posture on security and risk; personal goals, centered primarily around the maximization of our earning potential (i.e., human capital); life’s outlook, in terms of being an optimist or pessimist about future opportunities; and lifestyle choices, such as marriage, family and material wants.
Therefore, the first thing I counsel young people to do is gain perspective on these factors as much as possible. A good start to the process is investing in Jonathan Clements, “The Little Book of Main Street Money: 21 Simple Truths that Help Real People Make Real Money.” Clements starts this “how-to” book on investing by laying out seven philosophical personal financial beliefs (I add an 8th personal belief of my own) that I feel are critical to building a foundation of individual perspective:
1) Money is a means to an end. If we don’t know what our goals are we may not settle on the right strategy and will be less inclined to make the necessary sacrifices. What do we mean by sacrifices? The definition of savings is not spending. If we are not committed to a specific, monetized and time-oriented goal we are less likely to save for that goal. In saving, time is your biggest friend, or can be your worst enemy.
2) We should not neglect today. Financial goals are often distant achievements. We should also strive for peace today. This means having our debts under control, living comfortably within our means, ensuring we have the right insurance, a plan for financial emergencies, and spending our money on the things that matter the most to us. If we take care of today, we will likely find that we are taking care of tomorrow.
3) We need to think harder about what we want. As we take care of today and prepare for tomorrow, we need to think much harder about how to spend our money and how we spend our time.
4) Money is emotional. If we are going to be contented stewards of our money, we need to settle on strategies that will get us to our goals and that we will stick with along the way.
5) Our financial lives are bigger than we think. Managing and investing money isn’t just about stocks, bonds, mutual funds and savings accounts. There are also debts, homes, financial promises to self and family, our human capital, or income earning capabilities, and more. To handle our finances wisely we should consider the whole as well as the parts in order to make key trade-offs, spot opportunities, and figure out what is missing.
6) We should focus on the things we can control. We cannot influence economic and market factors, but we can control how much to save and spend, how much we pay in investment costs and taxes, how much investment risk we take, and how we, as investors, react to the volatility of markets.
7) Simplicity is one of the great financial virtues. It is possible to make good money investing using straightforward strategies and plain vanilla mutual funds. In fact, simpler is usually better, because it will often involve lower costs and less chance for foolishness. Moreover, if we stick to simple strategies and investments we will have a better understanding of what we own.
8) There is no such thing as a free lunch. This is one of my own personal finance beliefs. Risk and return have an inverse relationship; therefore, the more risk that an investment has, the higher should be the return. This maxim can be complicated but the one test we can always apply is: If it sounds too good to be true, then it probably is.
Once young people begin thinking about some of the issues raised in these beliefs and obtain a greater degree of perspective then they are ready to begin goal setting and looking at what resources will be required to achieve or fund these goals. In my next blog post, I will describe the difficult but rewarding task of goal setting. From there we will look at how to set a savings and investment plan.
Written By: Tom Gates, CFP