What Matters In Personal Finance?
We have all heard stories about people who compounded wealth over decades by buying stocks from their monthly paycheck. Take the usual example of the Janitor who died with more than 8 million dollars. Everyone was surprised. Such stories are common where you find people leaving massive fortunes behind. They influence us and make us want to believe that we can create such intergenerational wealth too. However, we really do not have so much bandwidth to change the way we think about money.
Lesson number one of personal finance is that fortune can only be created with a time horizon of decades and a solid base to begin with. How do you think the ice ages happened in the past? Ice age is a phenomena that happens because of the gravitational pull of the sun and the moon that gently affects the Earth’s motion. This causes moderately cool summers that does not melt the previous winter’s snow. Summers continue to become moderately cooler never allowing the ice to melt from the previous winters which causes even more accumulation of snow. This solid base of snow reflects most of the sun ray’s which increases cooling and brings more snowfall. The cycle goes on for hundreds of years causing the whole earth to be covered in ice and snow. A little change initially can cause enormous long term impact. Same goes with wealth creation. You need to make those little changes.
To begin with, you need to spend less than you earn. This is a fairly simple concept to understand. However, what’s more difficult is the action that you take with the money you saved. Most of us start with figuring out the best investment out there to ensure that the returns are maximised. If you are doing this, like I did, you are a fool, like I was. Without a solid base, it does not matter if you generate 10% returns on your money or 100%. What matters is how much you can save and for how many years.
Take the example of Mr. A & Mr. B. If Mr. A saved Rs. 10,000 for every month and generated a return of 12% after spending a lot of time figuring the best investment possible, he would end up with Rs. 8.16 lakhs in 5 years. Then there is Mr. B who did not bother about finding the best investment possible but saved 20% more and was able to generate only 8%. Who do you think would end up with more money?
Mr. B would end up with almost 8% more money than Mr. A. Of course, in the long term, if Mr. A is able to sustain his performance, he would outperform Mr. B. However, the question to ask is how much would be the annual income of Mr. A who spent most of his time in finding the best investments against Mr. B who spent his time focusing on his job, delivering great results, and upskilling himself. The answer is obvious. Mr. B would win again because he would be earning more money and feeding in more capital towards his investments.
What should a beginner do then? Here is a very simple checklist -
Spend less than you earn.
Have an emergency fund.
Have adequate life and health insurance.
Invest in a diversified portfolio of stocks a.k.a. mutual funds.
There is barely any need to find the best investment possible. You would do well even if you kept things simple.
