A difficult question that many people on their mission to financial independence quickly encounter is “where they should get their money to work for them”: You’ve managed to cut down a little on your expenses, or to up your income or earnings from a side hustle. But the question as to what to do with the extra money you now have remains. Let’s review some of the avenues on how to “make money with your money” that we have looked at on this mission:
Paying off debt – saves you money on interest and compounded interested paid over the years.
Saving – generates money due to interest received and the power of compounding interest over the years.
Investing – generates money due to capital gains, interest received or dividends.
Pensions – builds up the income you’ll receive after your retirement age
Personal capital – increases your earning potential as a professional or entrepreneur.
These are the most common strategies to pursue in order to leverage what your money can do for you.
But where to start? Say you saved $100 this month and that you are happy to invest this money into your future and future earnings, where do you actually put this money? Which of the above options do you choose? And how do you mix these strategies?
If you haven’t yet fully read the previous steps on the above mentioned strategies, I invite you to read those first before continuing reading this step, to better understand all the pros and cons of each strategy. Just come back once you’re done!
The question of where to allocate your money doesn’t have to imply an “either …or…” situation. You can start investing whilst still having a mortgage. You’ll want to save an emergency fund together whilst still paying off credit card debt. And once you start investing in your personal capital, you’ll likely want to keep that up on a fairly regular basis and the fact that you are investing in the market doesn’t rule out this option. Continue reading “Step 85: Plan your Money Allocation Strategy”→
After all these steps on cutting expenses, building up savings and investing to build a pension, it can become easy to dismiss any investing in yourself at all, especially in your intellectual abilities as a professional.
You might have got to a point where you’ve got all your daily costs taken care of: you’ve got a good, solid budget that you are happy with and able to stick to, you have short-term savings goals set up that you contribute to monthly such as a holiday or a new laptop and you even have your long-term savings on track in the form of pensions, paying off your mortgage and / or investing in the stock market.
When you get to this point it becomes easy to get completely taken up by this popular personal finance motto:
Earn more, reduce your spending, invest the difference.
And whilst there is nothing wrong on paper with the above guideline, it is easy to get a little too distracted by this, to become too frugal and forget what else is important in life. In step 75 we looked at how spending a little on yourself every now and again is important to not forget the importance of “YOU” and to make space in your budget to reward or treat yourself.
But what about your intellectual or professional development? When you get too sucked up by financial independence, be careful not to overlook the importance of individual capital and the need to invest in this aspect of yourself, over putting the money into more investing or savings. Continue reading “Step 83: Invest in your Individual Capital”→
“Pay Yourself First”, one of the biggest motto’s in the personal finance world, is a hugely empowering and motivating concept that stimulates you to keep your savings goals at the top of your list. It’s origins are attributed to George Clason’s famous book The Richest Man in Babylon and although the book is nearly a century old, many of its lessons are still extremely valuable today.
I can hear objections already “But I am not a business owner, I can’t pay myself”, or maybe you do own your own company and think: “I need to pay my people first before I can pay myself”. Then yes you are totally right in both cases. But that is not what this concept is about.
Pay yourself first has nothing to do with your salary. It has all to do with priorities. You can be on a regular pay roll and get paid by your boss but still pay yourself first. Or you can be a business owner and pay your employees before anybody else, then pay all your creditors but still pay yourself first.
Pay yourself first has everything to do with setting priorities for your finances. Let’s complete a mental exercise about the road that your money takes every month. It of course starts with pay-day: you receive your paycheck. The first thing that happens even before you receive that money are the taxes taken out of it. Then you receive whatever is left over and probably one of the first things you need to pay are the rent or the mortgage. Then there’s the car your paying off, insurance to pay, utility and food bills and you’re in desperate need for a new coat and of course you’re joining your co-workers for a Friday afternoon drink after work. You likely have some more to add. So the list continues until there’s hardly anything left at the end, right?
So let’s see who’s being paid here then, as it certainly wasn’t you!
taxes of course are payments to the state;
rent – there’s your landlord getting paid;
mortgage – that will be your bank manager getting paid;
car payments – another one for your bank manager or car dealer;
insurance – the insurance company will have that, thank you very much!
water and electricity bills – your utilities companies cashing in
a new coat – that’s your shop assistant and retailer getting paid.
Friday afternoon drink – the bar owner will happily hold out his hand.
And the list of course goes on and on. So where’s your payment? How do you benefit from the money that you earned? Of course you’re able to buy yourself a shelter over your head with that income by paying off you mortgage or paying rent, but that money is being paid to somebody else. With your pay you are also able to buy food and clothes and security in the form of insurance, but whilst you are purchasing these items, somebody else is also benefiting from you buying these products: they are getting paid by you. The one person who doesn’t seem to be being paid is YOU.
Now it would be ridiculous to say that you shouldn’t buy these items and stop paying other people, as you probably wouldn’t survive very long or have a miserable life living at the margins. That’s why this step isn’t called “Stop paying others”. Our society and economy are based on exchanging goods and services for money and it is a key part to survival, happiness and life. Instead “Pay yourself First” encourages you to – before anything else – pay yourself first before you start giving away your money to others.
Although you might not be able to change so much about the fact that taxes are taken out of your pay first (although of course there are some pension funds that will let you invest tax-free and then you could always consider moving to a lower tax state or country), you can pretty much make sure that as soon as you receive your net pay, that you pay yourself first.
How to pay yourself first? By setting aside money for you – to build a secure financial future, to grow your capital and net worth, to reduce debt and to improve your general financial situation, so that you and your family little by little gain more financial security and freedom. By assigning an amount of money to go to you, you give your future self an income, instead of spending it all and giving it away to others, you make sure that some of it comes back to you later.
This means that instead of having to work indefinitely in order to keep up with all of your creditors every single month, you can at some point stop working and enjoy the money you have set aside for your future self. It means that you have paid yourself forward and secured yourself a future income.
Whenever you get paid, think about how to pay yourself first. Set aside money in a savings account, invest the money in a pension fund, or pay down your debt so that you free yourself of those monthly creditor payments. Don’t allow yourself to come up with excuses like: “I don’t make enough” or “my bills are too high”. Find ways to reduce your expenses, to increase your income and remember that starting small is always better than not starting at all. Even small contributions add up over time, and by starting small you build a habit that when you finally reduce those expenses or increase your income, you can instantly increase contributions.
Step 82 – Pay Yourself First – in detail:
Brainstorm a list of how you already pay yourself first. How do you use your money to improve your finances?
Saving money for a specific goal to avoid future debt.
Look at your overview of your fixed, variable and discretionary expenses, go through the list and identify one by one who you are paying every time you make any of these payments. Go through the full exercise and write down the beneficiary for every single expense. See how many people are being paid over you!
Give yourself a score of how well you are doing on a monthly basis out of 10, with 10 being “excellent” and 1 “poor”.
Set yourself a target monthly contribution or grading on how much to pay yourself each month.
Refer to Step 12 which gives a further breakdown on how to set yourself specific savings goals on a practical level.
Once you become familiar with the “Pay yourself first” concept and start internalizing this more, you’ll discover the true power of this wisdom that will keep you focussed on your mission to financial independence.
In the previous step we’ve looked at asset allocation and using the yearly rebalancing technique to keep the right balance between your various assets in your portfolio, even if some of your assets grew more than others, thereby taking up a bigger percentage of your portfolio. In step 73 we’ll look at how rebalancing your portfolio can also help to readjust your portfolio when you get closer to your goals. In the examples below I mainly use retirement as a goal, but it can of course be other goals too that you might have in mind for your investments, such as a college fund for a (grand)child, a down-payment for a house etc.
Let’s assume that you have a 70/30 shares / bonds allocation to start off with in your portfolio and that the main goal for that portfolio is to use it as (an addition to) your pension provision. With time when you start nearing retirement, you might become a little nervous about the possible volatility of this portfolio however. What happens if there is a sudden crash in the market and you lose a big chunk of the money in your portfolio right before or after you were planning to retire? It means you suddenly wouldn’t have the same amount of money available that you maybe planned to have, which would probably compromise some of your pension plans. Of course when you’re 30 or 40, having a portfolio with a bigger risk factor doesn’t matter as much as your portfolio still has time to recover after a possible crash before your retire. But when you’re close to retirement age, you don’t have the same luxury of time and you probably don’t want that same volatility anymore as when you were younger. Continue reading “Step 73: Lifestyle Investing Option”→
This and the next step look at managing your assets in your portfolio on a long-term basis to ensure they remain aligned with your goals. With time some assets might grow faster than others, goals might change or you might want to change the risk level of your portfolio the closer you get to your goals. In all cases this can be dealt with by rebalancing your portfolio and re-allocation your assets. Similar to the investing principle of “buy when everybody else is selling”, which we discussed in step 54, the rebalancing of your portfolio is another investing concept which is easy to understand and execute logically, but can be difficult to implement psychologically.
The yearly rebalancing of your portfolio ensures that if one area of your portfolio does really well in one particular year, you don’t deviate too much from the original asset allocation that you had in mind for your portfolio. If one assets grows much more than another, it might make your portfolio too volatile or too safe for your goals and risk tolerance.
Let’s look at an example and assume that you want a 70% shares and 30% bonds allocation in your portfolio. You put in $10.000 and the moment you enter the market both bonds and shares happen to be $100 per unit. Ignoring costs for the sake of this example, that means you’d have $7.000 in shares and $3.000 in bonds. A year later the shares have far outperformed the bonds, and even though both have gone up in prices, your bonds are now worth $3150 (a 5% increase), whereas your shares are now worth $8050 (an increase of 15%). The stocks and bonds allocation is now no longer 70/30 but 72/28. Not a huge difference you might think but if the shares keep outperforming bonds by that much for a few years, you might end up with an 80/20 portfolio in just a few years. Continue reading “Step 72: Rebalance your Portfolio”→
Once you’ve got a taste for investing, you’ll likely want to investigate other options that allow you to invest some money, either to diversify your portfolio, support a small start-up, increase returns or simply for fun to see what happens.
A hugely popular new way of investing (or indeed raising money if you are on the other side of it) is crowdfunding. Crowdfunding is a way for companies, entrepreneurs and start-ups to get together a sum of money to set up a business, launch a new product or expand and open a new project or department.
Types of crowdfunding
There are different types of crowdfunding:
In P2P (peer-to-peer) lending, capital is raised by getting many different loans of small amounts together. Instead of getting one loan of $30.000 from the bank, entrepreneur(s) might get as many as 200 different people lending them amounts between $50 and $1000 for example. Like with a bank loan, the entrepreneurs are then paying the loans back over time with interest to their investors.
Pre-sales in which people can pre-order even before a product has been produced. Those initial investors will get a first release or even a small present several times a year (for example a new exclusive wine or another small new release).
Selling shares and having people invest in your company in return for a small ownership in your company.
I admit that this step should have probably been way earlier on in the list, since if you share your household and finances with your partner, then discussing money matters and making sure you have the same short-term and long-term goals in mind is essential to not only achieving your financial goals but also keeping your relationship healthy and happy. At the end of the day if you are trying to save, invest or grow your capital whilst your partner is more of the “let’s spend it all now” school, you likely both wind up frustrated with each other, meaning both your financial goals and your relationship happiness will take a hit and suffer at some point.
Sad but true: finances and a lack of shared financial goals or financial compatibility are not uncommon reasons for people to end a relationship, so let’s get this sorted once and for all and make sure that you and your partner discuss your individual and joint financial beliefs and goals. You might not have exactly the same ideas about how to spend or save your money, but discussing will at least create more understanding and hopefully pave the way to an agreement that satisfies both and leaves some (financial) room for both to do your own thing.
Of course it might be that your partner is not into finances at all and is happy for you to take control of the (majority) of the money decisions and responsibilities. If that is the case, it might sound easier in the short-term to simply assume that role not inform or even consult your partner, but remember that long-term this might not be in the interest of neither your relationship nor of your finances. Continue reading “Step 55: Discuss Finances with your Partner”→
Now, as I’ve mentioned a few times before, by no means am I an expert on investing (yet..), but there are a few concepts that I have picked up along the way and that I’d like to share at this stage. These are to do with the practicalities when it comes to investing on a day-to-day (or year-to-year) basis.
As I have said before, I – and with me many others on their way to financial independence -, see index investing as the safest, easiest and surest way to invest. It is boring, but most likely to get decent results. Of course not everybody agrees, there are many who prefer other ways to invest, (or of course to not invest at all), so make sure you choose what is good for you. With that said, I am mainly referring to index investing in this step, so not everything might be applicable to the other ways of investing.
Bull & Bear Markets
Let’s first start with two definitions in the investing world: bull and bear markets. During a bull market, the general market does well: prices are on the rise, investors feel confident, every day more people want to buy shares which pushes the prices further up as demand exceeds supply, people see their portfolio grow and demand increases even further.. Continue reading “Step 54: Bull & Bear Markets”→
The big question is of course whether you should or shouldn’t start investing. Ask anybody and you are likely to get very different answers, some saying they can recommend putting in some money monthly, others saying only the really wealthy or dumb invest in the market, whilst still others see it as their main way to (early) retirement.
The truth is, whether or not to invest depends entirely on you, your personal (and financial) situation, and the reasons you might want to invest in the first place. In this step I’ll try to give you some pointers to think about to help you determine whether or not you should invest, but the ultimate decision is yours and you have to feel comfortable and happy with that decision.
My boyfriend at the time (he’s my husband now), suggested we’d start investing in 2009 when the market was at a low. Now I wish we had, as we would have been able to buy lots of really cheap shares, but at the time I didn’t know anything about money and didn’t feel comfortable putting money into something that I didn’t understand. Of course I regret not having bought those cheap shares now, but I don’t regret not putting in money without knowing what I was doing and whether I really wanted to invest. Continue reading “Step 53: To invest or not to invest”→
It is now time for an introduction to the third main way of investing. As you were able to appreciate in step 50 on handpicking stocks and step 51 on mutual / collective funds, both ways have some very strong advantages, most notably the possibility of making lots of money on the stock market. Yet the opposite unfortunately is also the case and rather more likely than the first scenario… As we’ll see below, the third way of investing aims to find a middle ground between making money on the market and avoiding losses.
Index investing – an overview
Imagine looking at a long list of all the stocks and shares in a particular market – an index (such as the S&P 500) – and buying shares of every single company in that index in the same proportion as their relative size in the market. By buying all the shares of all the companies in the index, you basically copy the market and therefore will almost exactly get the same returns as the market average. (It will normally be just a fraction below due to the small fees you pay). If the index goes up by 8% your return will be around 7.8%, if it goes up by 13% your returns will be around 12.8% etc. That’s what index investing does. Sounds simple and indeed it is simple.