One of the reasons I started this blog, was to help people become better at managing their own money. Most people don’t receive any formal education on personal finance and just tend to follow what everybody else does, which is terrible!
About 75% of people in the U.S. are living paycheck to paycheck! Which means they have basically nothing saved up for emergencies, retirement, and let alone financial independence. This is sad because personal finance is one of the most powerful things we can learn and master in order to improve our lives. Through some of my personal experiences, I will share some of the basic money lessons that set me on the path to financial independence.
What are the key concepts and how did I learned them?
Money does not grow on trees: when I was about 11 years old, my dad had me help him teach a tennis lesson. After the one hour lesson was over, the client paid my dad about $8. He gave them to me and said: “this for you for you, you earned it“. This was the first time that I really appreciated money as a finite resource, and it taught me that it takes time and effort to make money.
Spend less than what you have: just a couple of years later I started to travel alone to tennis tournaments around Colombia and other countries in South America. My parents gave some cash to cover my meals, and other essentials during the trips. This taught me a great deal about budgeting. If I went and spent all my money on an Xbox, I would have no money left to eat for the rest of the trip. I would then have to call my parents for more money, which I guess is an option (although a very embarrassing one, and especially as you get older).
If you can’t measure it, you can’t improve it: in 2008 I moved to the U.S. to attend college on a tennis scholarship. I studied Finance and Economics and then did an MBA. I learned a lot of cool things about money and managing business. Sadly, I didn’t have a business to manage so I started playing with managing my own finances. By keeping track of my income and my expenses I new exactly where was money was going. This allowed me to cut back on some expenses that were growing out my laziness (eating out almost everyday is a good example). Had I not tracked my expenses back then, I would have wasted thousands of dollars over the years. Those very same dollars, are now invested and working for me. Where is your money going? Are those expenses making you happier over the long-term?
Download this free budget spreadsheet to start tracking your own spending.
The sooner you start the better: have you heard the phrase “time is money”? saving an investing sooner rather than later, and doing so more aggressively, can have a big impact on how soon you reach your financial goals. This is because of the power of compounding interest. Compounding interest is powerful because you earn a return on your initial investment AND on any interest that accumulates over time. To illustrate the power of compounding interest let’s look at the following example:
Table 1. Understanding the time value of money (Example)
|Scenario 1||Scenario 2||Scenario 3||Scenario 4|
|Annual Rate of Return||7%||7%||7%||7%|
|Time Frame||20 years||20 years||25 years||25 years|
As you can see, in scenario 1 you will have $147,584 in 20 years by investing $300 per month (or $3,600 per year) during 20 years. On scenario 2, by just increasing your monthly contribution to $400 per month and keeping everything else the same you will have $311,431. That is nearly $49,204 more by just increasing your monthly contribution by $100! On scenario 3 your monthly contribution is again $300 but let’s assume you start 5 years earlier for a total time frame of 25 years. In this case you will end up with $227,697, that is $80,113 more by just starting to invest 5 years earlier. Lastly, scenario 4 assumes that you increase both your monthly contribution by $100 and start 5 years earlier. In this case, you end up with $303,595. That is $156,011 more than in the original scenario! This is twice as much that you get by saving and investing $100 more today instead of 5 years from now.
And this is just scratching the surface. What happens when you invest $1,000 per month instead of $300 or $400? It grows into $759,000 in 25 years!