A blog post by Daniel Snover
April is Financial Literacy Month and a great time to bring awareness to your financial well-being. Many of us wait until major life events like buying a house, changing jobs, or even nearing retirement to begin thinking about financial commitments, but it takes time and conscientious planning to attain financial freedom.
The good news is that a few simple principles can put you on the right path to saving and investing. The bad news is that simple does not always mean easy.
Think of these tips as cairns, or guideposts, to follow along your financial journey.
Pay yourself first.
You cannot invest without first saving, but why does it seem so difficult to build savings?
The breakthrough is a mental shift from including savings in your budget to “paying yourself first”. Don’t wait until the end of the month to see what is left over – that’s paying yourself last. Set aside a portion of your income before spending on discretionary items.
You’ll be amazed at how quickly your savings account will begin to grow.
Consistency is everything.
What is the opportunity cost?
Should you invest in the stock market or pay off that credit card debt? Should you make extra mortgage payments to reduce the principal balance?
Think in terms of opportunity cost to improve your decision-making and to avoid emotional mistakes.
Your stock account is not likely to average more than the 16% your credit card is charging you in interest. The wise thing would be to pay down the credit card debt before investing in the market, effectively guaranteeing a 16% rate of return since you’re not paying that interest to the credit card company.
On the other hand, if your mortgage interest rate is 4% and is tax deductible, then you’re probably better off investing than paying down the mortgage principal.
Try not to overthink it.
The miracle of compound interest
Compound interest is the greatest builder of wealth and “the most powerful force in the universe” according to Einstein. Compound interest is the addition of interest to the principal sum of a loan or deposit.
Let the Rule of 72 put the miracle of compounding interest into perspective. So, how long will it take an account earning 10% a year to double? (Hint: it’s not 10 years)
Here’s the rule: Take 72, divide it by your annual return (10%) and it will tell you the number of years to double your money (7.2 years). While unlikely to achieve, a 20% annual return would double your money every 3.6 years. However, if your money is sitting in the bank earning a 1% annual return, you will effectively never double your money.
Building wealth requires taking risks along the way. You’ll be grateful you did.
Are you scared to look at your credit score? Or total up how much you spent on restaurants last month?
Don’t be. Fear and denial are likely holding you back from addressing the obstacles to success. Make things easier by downloading a free financial planning app, such as Mint, to track your account balances, credit score, and spending habits. Awareness will help prevent the “where did all my money go?” and “how did I get in this position?” moments.
Financial freedom is a journey, not a destination. Learn to enjoy the process.
Don’t get discouraged when life seems to knock you off the path. Think long term to soothe anxieties about the journey ahead. Don’t compare yourself to others – we all start in different positions and encounter different circumstances.