Just last week, I shared my list of fifteen essential personal finance and career books (if you haven’t checked out that list, I highly recommend it). Each of those books has proven to be an inspiration to me in one way or another, but one book stands out because of how the ideas were presented.
William Bernstein’s great book The Four Principles of Investing outlines four extremely valuable (and easy to understand, if you take your time) principles for investing one’s money. Bernstein calls them “pillars,” because almost any investing action you take relies on those core principles.
Since reading that book, I’ve made several attempts to define my own “pillars” of how I look at personal finance. I made a list of fourteen money rules. I put everything you ever really needed to know about personal finance on the back of five business cards.
Each time, though, I found myself really using more words than I wanted to use.
See, sometimes I’m called upon to give presentations on personal finance. I’ve given them to local libraries and community groups in various places (particularly in central Iowa – if you have a group in central Iowa and would like me to present, send me an email at trent at thesimpledollar dot com).
One key lesson I’ve learned about presenting over the years is to keep things simple. A slide full of words is going to make the audience stare at those words instead of listening to you. Both as an audience member and a presenter, I prefer slides with visual impact that also don’t distract the audience from what the speaker is actually saying.
If you take these two impulses together – inspiration from Bernstein’s “pillars” and a desire for a better presentation – it’s easy to see where I’m going. I wanted to define my own “four pillars of personal finance.”
Yet, every time I tried to compress what’s important down to four points, I struggled. I could easily compress things to one pillar – the first one – but I had a hard time coming up with four.
Instead, I found six. I like to think of them with one in the middle – again, the first one – and five around it, aiding in that central money pillar.
So, here they are. These are the six pillars of a strong personal finance foundation, at least in my opinion. The first one is central – the other five merely support it. Everything I do that relates to my money touches on at least one of these pillars, and virtually all of them touch the first pillar.
(I’m still working on my presentation, though. When I’m happy with it and I am able to record a successful presentation, I’ll share the video with you.)
This is the center of everything. If there’s one thing you’re going to do related to finances, this is it.
Spend less than you earn on a consistent basis. Every week. Every month. Every year. You’re not going to be able to be perfect at it in every little segment of time, but you need to be there on almost all of them and you must be there on the larger ones, like the course of a year.
People always view this as a call to frugality for obvious reasons, but it’s actually made up of two parts.
The “spend less” part of the equation is an encouragement to cut your spending and be careful with non-essential purchases. This doesn’t mean subscribing to a life of misery. It means cutting back hard on things that don’t matter to you so that you can afford the things that really do matter.
For example, as long as my teeth are clean, I don’t really care what kind or how much toothpaste I use. So, I’ll often use the free toothpaste from the dentist and I stick with using only as much as is actually recommended, which is a pretty small dot. I don’t need a big wad of toothpaste and I don’t need to buy any at the store.
What’s “hidden” to an extent in the “spend less than you earn” mantra is the value of earning more. Earning more can be even more powerful in supporting the idea of spending less than you earn than frugality can, but it’s often indirect.
The obvious path here is to directly increase your earnings from work, either by moving up in your career path or by taking on additional side jobs. However, you can also earn money through building a side business (like blogging) or through investing, which we’ll talk about with Pillar 4.
Together, these two elements seek to widen the “gap” between how much you spend and how much you earn. The wider that gap, the greater the personal finance success you’ll see in your life and the faster you’ll see the big results that you want.
A big part of frugality is simply questioning every dime that you spend and seeing if you can find a more efficient way to spend that dollar, squeezing more value out of it. It doesn’t mean going without the things you enjoy, but it does mean being very critical of the money you spend on things that don’t matter to you and being at least a little critical of the dollars you spend on “fun” things.
This process also inherently leads to a budgeting system. In fact, if you take this pillar seriously, you basically are budgeting, because the core idea behind budgeting is evaluating the money you’re spending.
If you want to put this into practice, adopt a simple plan of recording every dime you spend for a while. This forces you to consider everything you spend, plus it provides all the material you need to make a truly useful budget.
No Dollar Is Spent Without a Reason
The biggest reason for keeping track of every single dollar spent (and then reviewing all of those expenses) is to make sure that you’re never spending money without a genuinely good reason.
It is often easy to talk ourselves into expenses on the spur of the moment. Sure, it seems like a good idea to buy this item at the gas station. You might find yourself buying a book or something else you didn’t need without thinking about it.
Reviewing those expenses later on will often reveal that the reason was pretty silly, and once you see that, it becomes easier to cut out that expense.
Spending and Spontaneity Isn’t Necessarily Bad
Many people balk against this idea, arguing that it takes all of the spontaneity and pleasurable purchases out of life. It doesn’t do that at all – it just makes sure that when you do those things, you’re actually getting real lasting pleasure out of them.
You want to cut out the things that seem meaningless a few days later. If a purchase still seems meaningful to you in a few days or a week or a month, then it was a worthwhile purchase.
Often, when I buy a book, in a few days I’ll wonder why I didn’t just check it out from the library. Sometimes, though, I’ll find a great deal on a book I really want to own or I’ll get a book signed by one of my favorite authors and I’ll be happy for that purchase.
The trick is knowing the difference between the two, and the only way to get there is to review and be critical about every dollar you spend for a long while.
Experiences Trump Things
A big part of this idea is that experiences trump things. It’s far better to have read a book than to have one on your shelf. It’s far better to have done something you remember and value than to own something.
An experience is internal – it’s always a part of you and it can’t be taken away. You can draw on experiences all the time and they change you.
Things are external – it’s not really a part of you. (It might feel like it, but it only serves to trigger something that’s already inside.)
Focus your energy, time, and money on collecting experiences, not things.
I consider debt elimination the number one priority for anyone who is holding debt. Debt freedom makes much of life incredibly easier. The process itself is pretty straightforward – just build a debt repayment plan and follow it carefully.
There are some things you can do to make the debt repayment easier, such as having a small emergency fund. If you don’t have at least $1,000 in the bank to head off emergencies, I’d recommend getting that money. I simply don’t trust using credit as your emergency fund because, for many people, that can become another downward spiral, plus you’re trusting that the bank will continue to extend credit to you. Cash trumps all of that.
There are also occasional options that have such an enormous return on your money that you shouldn’t skip them, like retirement matching funds from your employer. If your employer offers matching funds, you need to gobble up all of them, because an immediate 50% or 100% return on your money is just too incredible to pass up.
Beyond that, every spare dollar you have should go toward your debts. If you’re taking Pillar 1 to heart, you should have some spare dollars, so you should be making constant progress on your debt repayment plan.
Debt Destroys Cash Flow
The reason I’m opposed to debt isn’t just that you’re giving money to your credit card company in the form of interest and getting nothing in return – that’s bad enough. The reason I’m so opposed to debt is that it just destroys your monthly cash flow. Personal debt means monthly bills, and that means that some of your monthly income is departing just to pay for those bills.
I like to think of this in terms of a business concept known as cash flow. Cash flow refers to the amount of money that comes in as compared to the amount that goes out. The greater the amount that comes in versus going out, the more you can use for profit or for improving the business.
Whenever you have debt, you’ve chosen to increase the amount going out. That means you have less money left over for improving your financial situation in other ways or for simply enjoying life.
Debt is a bill you can get rid of.
Cash Flow Gives You Options
When you eliminate a debt, you eliminate one of those monthly bills. You have less money going out each month and thus have more money flowing into your life and staying there. You’ve made the difference between your monthly income and your required monthly bills larger than before.
If the difference between your monthly income and your required monthly bills is large, then you have a lot of personal options that didn’t exist before. You can now afford a career change or a move to a different part of the country. You don’t have to take an abusive employment situation. You can make the leap into self-employment or an attempt to make a part-time side business into a full-time one. You can choose to spend a year writing a novel.
Getting rid of debt improves your cash flow. A good cash flow gives you powerful life options.
Once your debt is gone, you should have a pretty healthy “gap” or cash flow (depending on how you look at it). That money – or at least a healthy chunk of it – should be used to cement your future goals, whatever they may be.
Investing some of that money makes it possible for you to take on all sorts of big life goals – retiring or switching to a crazy career path extremely early, buying land in the country and building your dream home, starting a small business that you’ve always dreamed of running, traveling around the world.
Whatever it is that you’ve dreamed of doing, putting aside some of your “gap” for the future makes it possible.
Define Your Goals for the Long Term
What do you dream of? What is it that you really want to do with the rest of your life? What do you dream about almost every day?
No matter what you come up with, investing can help you get there. It just requires a commitment to put aside some of the extra money you bring in after your basic expenses are covered – the more the better.
Having a clear goal – ideally, the big thing you’ve always wanted for your life – makes it much easier to choose to invest, plus it can help you decide what exactly to invest in.
Be Passive – Match the Market with Low Costs
Here’s the truth – without a ton of luck, individual small investors like you and me are never going to consistently beat the stock market. That doesn’t happen unless you have a lot of homework, some genuine insider knowledge, and a lot of money to invest.
Your best approach is to just buy a little bit of everything and strive to match the average as inexpensively as you can. Thankfully, many companies make this very easy by offering index funds, which do exactly that – they are made up of little bits of lots and lots and lots of different things. For example, you can buy an index fund that owns a few shares of every publicly traded company in the United States, or an index fund that owns real estate in every major metropolitan area in the country. You move with the whole market, in other words. Not only that, these index funds have very few fees.
If you’re going to invest, I recommend putting all of your money into an index fund or two and then just sitting on it. You might want to own a couple of stock index funds, a bond index fund, and maybe a real estate fund – you can choose them based on your own research. The idea is to simply match the market and be as diverse as possible for very little cost.
Many people think of “retirement” as being very far away. They don’t perceive themselves as being anywhere close to retirement age, so why worry about it?
The truth is that “retirement” can actually be pretty close, depending on how seriously you save for it and how exactly you define it. I see retirement as being, at least in part, a time where I can focus entirely on writing novels without having to worry about whether or not they’re big hits. I also see it as being not too far down the road, so I’m quite willing to save at a high rate to get there.
Know What You Need to Save
How much will you need each year when you “retire,” whenever that might be? Are you going to be supplementing that with Social Security? How about with income from a deeply enjoyable side business? Will your expenses go down if you’re not working (I’m willing to bet that they will)? Are you willing to live a little cheaper to have so much free time?
Everyone has their own way of figuring all of this out, but the truth is that it doesn’t take as much to “retire” as you might think, especially if you have a lot of work expenses, have something else you want to do in “retirement” that can earn a little bit, and plan on spending a little less than you do now.
Some Roth, Some Not
Traditional retirement plans, such as IRAs and 401(k)s, offer tax advantages that will help you out when you reach the threshold age for these plans (usually around 60 years of age). These should absolutely be a part of your planning, but they don’t have to mean a traditional “retirement” at all.
I usually encourage people to follow a very simple recipe for saving. Use your employer’s plan to get every drop of matching that they offer, then max out a Roth IRA. If you have still more you want to save, either switch back to your employer’s plan or just invest outside of retirement.
This way, you should have some money where you pay taxes now – the Roth money – and some where you pay it later – the 401(k) money. Since no one knows for sure where tax rates are headed, this hedges your bets a little.
It is much easier to get distracted and walk away from the other pillars if you don’t have big things in life that you want to achieve. Having big life goals enables you to constantly have something to focus on and makes it easier to see how spending less than you earn can take you there.
Even more than that, having life goals gives you something to fill your hours with that usually doesn’t involve spending much money. Instead, you’re filling your life with meaningful experiences and accomplishments.
Incorporate All Seven Areas of Life
A well-lived life is spread across seven areas in some fashion or another: mental, professional, financial, familial, social, physical, and spiritual. Everything we do touches on at least one of those realms, and a good life finds a balance among all of them.
A good set of life goals incorporates all of these things. I find that, for me, having four or five goals in life (that incorporate these seven areas) gives me something big to always be working towards. Those four or five things are what I want people to say about me at the end of my life.
Big goals like these provide direction. They make it easier to separate what’s important from what isn’t.
Tie Them to Day-to-Day Living
The problem is that it’s often hard to reflect on these big goals and statements in one’s day to day life. This is something I’ve struggled with for a long time.
Over time, I did figure out a great solution that worked well for me. I call it my “life pyramid,” but it’s basically just a system for breaking down those big life statements into things I can take action on today.
Those daily actions feel really meaningful for me, plus they generally don’t involve spending money to entertain myself. I work toward the big things in life and I don’t spend much money. I find that incredibly life-affirming.
Over the last several years of my life, these pillars have stood under almost everything I’ve done. They’ve guided me to make better choices every single day, not just financially but in my life as a whole, and they’ve helped me to realize how being smart with the money that I have makes almost every dream I have become possible.
These pillars work for me. They might not be perfect for you, but I hope that they will at least bring some food for thought into your life.