This article is an ongoing collection of what I consider to be key principles for successfully managing your personal finances and reaching financial independence. Think of this as my personal take on some of the most valuable advice I’ve collected. Here goes:
Principle 1: Behavioural over Analytical
This principle states that managing the behavioural side of personal finance is actually more important than the analytical number crunching. Things like saving on investment fees are very important (see Principles #3 and #6) but they are meaningless if you never establish a habit of regular saving in the first place. Another application of this principle is making a personal finance decision that has an optimal (or rational) choice based purely on the math. But you might pick the sub-optimal choice that let’s you sleep soundly at night. Many of the other principles are extensions of this one.
Principle 2: Simple over Complex
Closely related to the importance of behaviours (see Principle #1), simple approaches to personal finance that you can understand and stick to are more important than complex account setups or financial instruments that are difficult to understand. That’s not to say some people don’t have complex situations (e.g. corporations, split/hybrid families, etc.) but that’s all the more reason to keep your personal finances as simple as they need to be.
Principle 3: Controllable over Uncontrollable
This principle reinforces that you should focus on the factors in your personal finance that you can control. Controllable factors are things like your savings rates, investment fees and taxes (to some extent). By comparison uncontrollable factors are things like the stock market returns and central bank interest rates. The personal “return on investment” for your time and money is far greater on controllable factors than uncontrollable factors. You can spend all the time and effort in the world fretting about interest rates but ultimately they are outside your control, so all that time and effort produces zero return.
Principle 4: Automate, Automate, Automate
Another principle that is built up on the previous ones – this one says you should automate as much as possible about your personal finances. Automation solves many of the challenges around the first three principles. If you’re regularly and automatically transferring money from your paycheque to long term retirement savings, you’ve already got a good start on consistent, simple and controllable behaviour.
Principle 5: Data is Inevitable
This might be the most painful part for most people, but without data on your personal finances it’s impossible to analyze your situation and make projections. So despite what I just said in Principle #1, you need to do some work on things like tracking your spending, summarizing your assets/liabilities and calculating your net worth. That doesn’t mean we all need to be accountants and chase down ever dollar and cent. Still in the spirit of Principles #1 and #2, we can take simple approaches to this that are easier to stick with but still provide meaningful results. We just can’t avoid it completely.
Principle 6: Investing is Solved
This one is definitely not original but it’s so important that it has to go on the list. It’s a common catchphrase in the personal finance world that essentially means we already know the optimal solution to investing. The solution is select a globally diversified mix of assets using low cost index funds. This doesn’t mean there aren’t investment decisions to be made. For example, the asset allocation (or mix) is an important decision you need to make based on your capacity and tolerance for risk. But focus your effort on those decisions vs. which individual stock you should buy. The corollary to this principle is that investing is also pretty boring. Learn to enjoy that boredom.