Download Twelve Key Elements of Practical Personal Finance

Twelve Key Elements of
Practical Personal Finance
Common Sense Economics
James Gwartney, Richard L. Stroup,
and Dwight R. Lee
CommonSenseEconomics.com
CommonSenseEconomics.com
A Personal Financial Epidemic?
• Why do Americans live under so much financial
stress when their incomes are higher than ever?
• Financial insecurity is the result of the choices
we make rather than the income we earn.
• The principles that lead to financial security are
largely the same as the ones underlying a
prosperous economy.
Practical Element #1
Discover your comparative
advantage.
Comparative Advantage
• We are all relatively more productive in some areas than
in others.
• Your comparative advantage is determined by your
comparative abilities, not your absolute abilities.
What’s Your Comparative Advantage?
• Even if you’re better at doing
everything, you shouldn’t do
everything.
• Specialize in what you are
relatively the best at.
Practical Element #2
Consider being
entrepreneurial.
In a market economy, people get
ahead by helping others and
discovering better ways of doing
things.
Who are Entrepreneurs?
• People adept at
discovering better ways
of doing things and
acting on these
opportunities.
• Disproportionately
wealthy… 2/3 of
American millionaires
are entrepreneurs.
Entrepreneurs’ Success:
1. Entrepreneurial talent: the ability to discover
innovative new products, cost-reducing
production methods, and profitable
opportunities that have been overlooked by
others.
2. Tolerance for risk: Self-employment is more
risky, but greater risk and higher returns go
together.
Is being an entrepreneur for you?
Entrepreneurs’ Success (cont.)
3.
High Savings RatesKeep in mind
4.
Hard Work …Business owners tend to work longer
hours.
Practical Element #3
Spend less than you earn.
Begin a regular savings
program now.
Why Save?
• Saving is necessary to
accumulate the capital needed
to produce wealth.
• This is just as true for
individuals as for nations.
• The most effective way to
begin saving is by identifying
and eliminating some
discretionary spending.
Don’t Wait!!!
• If you don’t exert the willpower to save now, it is
unlikely that you will do so later.
• If you wait to save until your income goes up, it is
extremely costly in terms of the amount of money you
will end up with at retirement.
There’s No Need to
Suffer!
There are MANY creative ways to spend less.
Ø Pay yourself first! Make saving a regular expense.
Ø “Just do it!”
Practical Element #4
Don’t finance anything
for
longer than its useful life.
Financing Consumption
•
Why continue to pay for
something- a car, a vacation, a
television- that you are no
longer able to use and enjoy?
•
Purchase on credit only when
buying a long-lasting asset
with short-lasting financing.
When should you buy on credit?
What goods and services can you
pay for while you use them?
– homes
– automobiles (depending on lifespan)
– education
Some assets even generate income or
further service even after you finish
paying for them…these can enhance
your net worth!!!
Practical Element #5
Two ways to get more out of
your money:
Avoid credit card debt
and consider purchasing
used items.
Don’t Undermine Your Future!!!
•
The opportunity cost of saving for tomorrow is
spending (and enjoying!) today.
•
You CAN have more in the future while still enjoying
today…
“…ordinary people can have lots of nice things
and still accumulate a lot of money.”
Credit Card Convenience
• Paying with a credit card is NOT
spending your own money, but
borrowing someone else’s.
• Interest charged on credit cards
outstrips returns that could be
earned on investments!!!
• Think of your credit card as an
extension of your checking
account…Use your credit card only
to access those funds.
The World’s Most Expensive Vacation
• Sean charges $1,500 for a trip to the Bahamas.
• He pays the minimum payment ($26.63 at 8% interest)
each month.
• 10 YEARS LATER this trip has cost Sean $3,195.40, and
all he has left are faded photos.
It Pays to Buy Used!
• Can a used item satisfy you as well as a new
item?
• Balance the time it takes to search for these items
with the value of your time.
lThere
are savings to
be had without having
to sacrifice consumer
satisfaction!
Practical Element #6
Begin paying into a “realworld” savings account
every month.
Rainy Days & the Real World
•
Life is full of surprises, and
they’re usually expensive!
•
The surprise is only in the
timing…So it IS possible to plan
for these surprises!
•
Purchase “peace of mind” by
building a cushion…Make this a
regular and mandatory expense!
Practical Element #7
Put the power of
compound interest to
work for you.
It’s a Miracle!!!
• Getting a head start
brings a HUGE
payoff.
• Compounding occurs
when the interest
you’ve already
earned earns even
more interest on itself.
Practical Element #8
Diversify- don’t put
all of your eggs in
one basket.
Risk vs. Return
•
There is no such thing as
a guaranteed return!
•
Diversification is the
practice of holding a
large number of
unrelated assets.
–
–
–
–
Stocks
Bonds
Cash
Property
Double Jeopardy (Things to consider
when you work for a large company)
• Does your employer offer a company stock-based
retirement program?
• IF you have confidence in the company, take
advantage of the opportunity.
• As soon as the plan permits, sell these shares to
purchase other investments.
• Failure to do so puts you in double jeopardy …You
are now beholden to your employer both for your
job and your retirement investment. You are NOT
diversified!!!
Practical Element #9
Considering buying mutual
funds?
Indexed equity funds can
help you beat the experts
without taking excessive
risk.
The Random Walk Theory
• No one can predict the future of
the stock market.
• The random walk theory suggests
that current stock prices are the
best reflection of the market’s
value.
• The future price of a stock is driven
by unforeseeable events.
• Since we can only see the present,
it is impossible to “beat the
market”.
Practical Element #10
Invest in stocks for long-run
objectives;
as the need for money
approaches, increase the
proportion of bonds.
So Why Not Just Hold Bonds?
• Bonds offer a lower return than
stocks, but with less risk.
• Inflation risk and interest rate
risk are larger problems with
bonds.
• Buy bonds that mature at the
time you anticipate needing the
cash.
• Transfer capital gradually from
stocks to bonds.
Practical Element #11
Beware of investment
schemes promising high
returns with little or no
risk.
There’s no such thing as a free lunch!!!
• If it’s such a good deal, why do they
need to sell it to you???
• The principal-agent problem
makes you vulnerable.
– A potential conflict exists between
the investor and the agent being
paid to do something for the
investor…Because the agent has
more information about the product
than you, you are at a disadvantage.
Practical Element #12
Teach your children how to
earn money and spend it
wisely.
Teach Your Children Well
• Teach children money is earned …It
doesn’t grow on trees!
• Money both helps us get what we
want, AND helps others get what
they want.
• Success in general is realized by
setting goals and working hard to
achieve them…Financial success is
no different!