Attitude
Take a look in the
mirror and remember this: any action you take with your finances is for the
person right there in front of you. It is not for a paragon of financial
virtues who always acts logically and rationally. It is for YOU. And you must
take your acknowledged failings into account as well as your strengths.
We all have different attitudes to money, just as we have to clothes, sport, sex, religion or whatever. You may be a Prudent Prudence or Happy-go-lucky Harry. Most likely you are neither of these extremes although you may well possess a measure of each of them. For example, you may penny pinch on clothes but spend a lot on entertainment. Accept it.
Similarly, you may be an avid reader of the financial pages in your newspaper or regard the subject as an utter bore. In the latter case you would be foolish to take on a strategy which involves keeping a regular watch on the stockmarket.
Try to curb your excesses but at the same time adopt Shakespeare's maxim: "To thine own self be true". Never take any action that goes against your basic temperament.
Opportunity knocks once
There
is an important financial measure called "opportunity cost." Basically, this
means that if you spend money on something you automatically lose the
opportunity to spend it on something else. Or, as my Dad use to say "You can't
spend the same money twice."
Looking at it in investment terms let us suppose that you can invest £500 with a bank for a year at 6 per cent net. At the end of the year your money will have grown to £530. But if you do something else with your £500 you lose the opportunity to earn the £30. Thus 6 per cent is the opportunity cost of your money and it makes sense to use your money in other ways only if you think you can get a better return than 6 per cent.
For example, if you buy an antique doll for £500 in the hope of selling it at a profit after a year you will need to sell it for more than £530 to make the deal worthwhile.
Of course, there are other values in life than purely monetary ones and spending a £1,000 on a holiday may be a good investment if it improves your health and happiness. Nevertheless, calculating the opportunity cost is a key to spending your hard earned money wisely.
Realise there is no such thing as a safe
investment
The rock bottom solid safe investment does not
exist. You cannot avoid some risk and it is important to take this on board
from the start. Hopefully the following pages will help you to minimise the
risks and develop ways to make your money work for you. You can be sure that if
don't put your money to work someone else will and take the profit for
themselves. But never think that you can put your money into a so-called risk
free investment and forget about it.
Learn to limit your losses
You
are almost certain to pick a dud investment sometime. The secret then is to cut
your loss as soon as possible. Unfortunately, most people find this very
difficult to do. No-one likes to think that they have made a mistake and there
is a big temptation to hold on and hope for better days. But there is almost
always a time when an investment starts to turn sour that you can get out with
only a small loss. If you hold on you could be on a losing wicket for many
years and then lose even more money in the end.
Having the courage to admit that you were wrong is an essential technique of successful investment as well as in other aspects of life. A Swiss banker put it rather well: "If you are losing a tug-of-war with a tiger, give him the rope before he gets your arm. You can always buy a new rope."
Appreciate the time value of money
"Money goes to money," my Dad used to say. Certainly, compound interest is
a marvellous invention. It can work for you or against you. When you invest it
works for you. When you borrow it works against you.
You can become financially secure by winning the lottery but your chance is millions to one against. The surer way is to save money, invest it and let it compound.
To calculate the future value of a lump sum over time use the rule of 72. Divide 72 by the interest rate and the answer will be the number of years it will take for your money to double, e.g. money invested at 6 per cent (6/72=12) will double in 12 years. Divide 115 by the interest rate to see how long it will take to treble your money.
Which would you rather have:
a) £1,000 every day for 28 days
or (b) A penny doubled-up every day for the same time?
Answer: (a) Would give you £28,000. (b) £125,299,152. Such is the power of compounding.
Pay yourself first
My youngest
son Clive says: "Hold on Dad. Before you go on about investing and making a
fortune I'm skint. How do I get the money to invest?"
Answer: "You save it."
A bank manager's standard advice is to budget. Does the very word give you bad vibes? It does me.
Budgeting can be very helpful because it shows you what happens to your money and from this information you can decide where to reduce your expenditure. So, if you are the kind of person who is capable of preparing a budget and sticking to it go ahead and good luck to you.
The trouble is there are people like Clive and I who find it too tedious
and give up after a few weeks.
But there is one sure way to save money.
Take a fixed percentage of your monthly income - I suggest a minimum of 5 per cent, preferably 10 per cent - and put it into an investment or savings account. Make the transfer every month on the day your salary is paid. Or, if you are freelance and receive irregular payments take a percentage from each. Do it before you spend anything. It has first call on your income.
This is not a new idea. It goes back to the days of Babylon the wealthiest city in the ancient world whose money laws are just as valid today.
Most people pay everyone first and save anything left over. The trouble is there is often nothing left over. Reverse the process. Remember: it's not what you make it's what you keep.
Cash is King
Always keep
sufficient funds on an instant access account
to meet an emergency, e.g. repairs to your car, your home or a sudden trip to a
sick relative. This may be obvious to you but from my experience I can tell you
that the number of people who fail to keep this simple rule is truly amazing.
If you are forced to sell an asset in order to raise the money to meet a sudden expense you will invariably get a poor deal.
Only you can decide how much to hold on this account. It all depends on your overheads and personal circumstances. Obviously, a couple with a home and a family will need to keep a larger balance than a single person living at home or in a bed-sit. A sum equal to three or four weeks of your family's income should help you to sleep soundly at nights. This money will, of course, be gaining interest.
But do not take any risks. Use one of the well-known banks or building societies and make sure that the funds can be withdrawn on demand or at most one week's notice. Do not be tempted by higher interest offered by an institution you have never heard of. Remember, the higher the rate of interest the greater the risk.
Stay flexible
An important test
of any investment, or borrowing agreement, is its flexibility. For example,
many people tie themselves into long-term insurance endowment policies or
savings plans they don't want, don't need and cannot afford.
They cash them in, often within two or three years, and suffer a big loss because of the heavy up-front charges and commissiion on these packages.
Take cover against disasters
Take out insurance cover for the risks you could not meet yourself and would
alter your lifestyle, e.g. your house burning down, serious accident etc.
The rich rule over the poor and the borrower is
the servant to the lender
I have seen so much misery and
unhappiness caused by borrowing that I implore you to keep the above words of
Proverbs 22 verse 7 in your mind.
It will probably be sensible for you to take out a loan sometime during your lifetime and you'll find some guidance on this subject in a later chapter. But remember whenever you commit yourself to pay money you have not yet created you destroy a part of your financial future.
The financial industry will do its best to try to persuade you to borrow by using such terms as "the spending power available to you." What this really means is the amount that particular financial institution will allow you to be in debit to them on a regular basis. Nice business if you can get it. And they do. That is how they make their massive profits.
Action
© Copyright Harold Baldwin 1998, 1999, 2003