Hi RIP friends,
Welcome to yet another post about “basics financial tactics” on the internet. I’d like to show my suggested strategy to face and solve your financial problems, trying to offer my unique point of view.
First of all, what kind of financial problems do people have?
Given that everyone has their own individual problems, let’s try to cluster them in few groups:
- People struggling with debts, who have hard time keeping the head above the water.
- People with a very tight cash flow, to whom any unexpected expense is a nightmare and won’t make them sleep well.
- People with no job or a very unstable one.
- People with no immediate financial problem, but locked into a job they don’t like.
- People with apparently no financial problems, seeking for ways to improve quality of their lives.
Well, the list may go on and on but to keep the post readable let’s focus on the above mentioned categories.
What are the basic steps you should take to improve your situation? Let’s take a look!
Step 1: where are you?
First step should always be: write your financial self assessment. Where are you? What’s your actual financial situation? Instead of running after emergencies and panicking, take your time. Breathe. Sit down, set 2-4 hours aside and start your financial self assessment.
Understand and quantify your monetary assets. Sum up your valuable assets. Do you own a house? A car? A valuable collection? Money on your bank accounts? Other kind of equities/securities? Art pieces? Precious metals? Pension funds? Savings? Piggybanks? Lottery winning tickets?
Be realistic: only track assets you can actually monetise and track them at their expected resell value. I suggest to skip tracking minor stuff whose selling process may end up being more expensive than the item’s value itself.
Remember that over time some of your assets will depreciate (your used car, your jewelry, your used golf clubs set) while other may appreciate, like your house, your pension fund and your Coca Cola Company stocks. Note: there’s no guarantee that any of your asset will appreciate.
Understand and quantify your liabilities.
Do you have debts? Mortgages? Loans? Credit cards debts? Family debts? Unpaid bills?
Write all of them down. Write the full amount due and – aside – the interest rate you’re paying on each liability. The interest rate is not useful in this self assessment phase, but it will soon be when we’ll talk about taking actions.
Produce your Net Worth document.
Your Net Worth is a number that tell you “where you are” on the financial path.
If you’re below zero it means you have more debts than assets. It means a homeless, or even a kitten, is richer than you.
Obviously that doesn’t mean the kitten will have an easier financial life than you: you probably have other non monetary assets that provide opportunities to change your trajectory, like your skills and your social/professional network.
I have my NW document publicly shared. Feel free to take a look and be inspired.
Before running to any conclusion, ask yourself few questions: did you expect to be where your NW shows you actually are? Do you feel relaxed? That’s good. Do you feel anxious? That’s good too.
Anyway, congratulations! You’ve taken first step toward a path that leads to improve your permanent well being. Who cares if your scale says you weight too much on day zero of your diet? It’s actually better, more room for improvements!
Step 2: where are you going to?
You now have a snapshot of your financial situation. It’s like a single frame in your lifelong financial movie. It tells you something but not everything.
Start tracking your Net Worth over time.
Your assets will change their value, your liabilities will increase/decrease. Track your first magic number over time, on a monthly/quarterly/yearly basis. Or have some mechanism in place to track it in real time, like financial apps (personal capital, mint, …) or a simple spreadsheet – and a nerdy attitude.
Tracking your NW will tell your wealth derivative: the rate of change of your NW. Is it increasing month by month? Is it decreasing? Where do you expect to be in a year if you do nothing? Does it scare you?
Let’s go further, let’s try to anticipate the future.
Take expectations into account.
Are there any financially impactful events expected to happen in the near future? Do you have huge bills expected to come? Do you have kids leaving your home and lowering your expenses? Do you have an expected inheritance coming sooner or later?
Try to do a qualitative analysis and see how these events will change your financial situation.
Take desires into account.
Are you planning for an expensive summer vacation next year? Do you want to buy a new car soon-ish? Do you want to have a kid? Do you want to move to a bigger home with your (possibly growing) family?
Play with numbers and try to do a quantitative analysis of the impacts of your desires on your Net Worth. Can you afford them? Are they worth? Most of them will surely be, some of them maybe not.
Understand unknowns and try to take them into account.
What if you lost your job today? What if you had an unexpected 1000 Euro expense tomorrow? What if your landlord wanted to evict you at the end of the month?
Do these questions terrify you? Sorry friend, you need to face them. Life will happen.
How to take them into account, though? It’s hard to understand the impact of the unknowns based solely on your Net Worth.
Step 3: why are you going there?
We’ve seen how to understand what’s your movie about, by analysing some frames and speculating over few known events. We don’t actually understand why things are happening, we’re passive spectators at the theatre, who just opened their eyes and discovered that’s an horror movie the one we’re looking at, not a Pixar’s one!
Track your cash flow.
Track down each of your income streams and each of your expenses. Make a budget. Understand where your money is actually going. Track this over time.
Do you have a positive or negative cash flow? Assuming your assets don’t change their values, if you have a negative cash flow your NW is going to decrease. If you keep having a negative cash flow you’ll have to sell some of them in order to pay your bills.
Do you have a negative cash flow due to low earnings or high expenses (or both)? Do you understand the impact of each entry in your cash flow?
I know tracking expenses may be a lot of work, but it’s an extremely valuable tool if you’re seeking for financial help. Whoever tells you how to fix your situation without looking at how you currently spend your money is a liar.
Tracking individual expenses is not always necessary, though. For example I’ve been lazily skipping that for a very long time, but I’ve always been in amazing financial shape and without big spending troubles. I belong to the category of those with “apparently no financial problems, seeking for ways to improve quality of their lives“. I restarted tracking my expenses when I started this blog (June 2016), with the goal of improving further my finances to reach earlier my goals.
Even if you don’t want to track individual expenses, I strongly recommend you to understand the total amount spent and to get a rough idea of your main expense categories.
Ok, now you have knowledge and awareness over your finances. You don’t just passively observe that “your NW increased by 500 Euro last month“, you knew and predicted that because “your earnings were 300 Euro greater than your expenses and your other assets appreciated by 200 Euro“. You can finally explain why your NW is changing over time.
… You achieved Financial Intelligence, congratulations! You’re fully aware of your current situation, your directions and the impact of each one of your choices.
You understand what’s happening on the movie so you can stop laughing when others are and actually understand the jokes instead!
Step 4: where else could you go?
This movie is a good one isn’t it? I like the characters, I understand their behavior, I can anticipate what’s happening… but are they taking the right actions? Are they driving the plot toward a nice ending? How many different finale can you imagine for the movie? How many interesting paths were left unfollowed so far?
Understand your tools.
Which tools can you use if you want to change your financial direction? You may have a job. You may have few other income streams, or potential income streams like business ideas. You have skills. You have passions. You have a social network. No, I’m not talking about facebook. I mean people who care about you: your friends, your lover and your family. You have a professional network. Well, yes, I’m also talking about linkedin here. But I mainly mean people who endorse you because of your skills, people who witnessed your quality and would help you changing your job/career.
What about your Net Worth, again? What about repeating the game of playing with desires and with unknowns? Is this the right time to buy a new car? Is this the right size of a mortgage? What if soon after purchasing this dream house interest rates go up and your mortgage’s interest rate raises by 20%? Can you still afford it?
Wait, now we’ve bound actions to consequences! What if Walter White just accepted Gretchen and Elliott’s help?
Can you think alternative scripts for your movie?
You’ve been tracking your numbers since few months now and you’re able to play with them and with your imagination. Is there only one possible future? Of course not! Well, unless you believe in predetermined fate. In that case you can keep complaining with your bad luck and do nothing to change your situation. You’re in good company, that’s what the vast majority of people do!
Step 5: where do you want to go?
We’ve played with characters in your movie, we understand what they do and what they could do instead. We can make hypothesis and expect outcomes… but how would you want the movie to end? If you were the main character, what would you want to achieve? You’re in a Horror movie, are you ok with that? Do you want to make it an action movie? a romantic one? Would is your favorite genre?
Define your financial goals.
Individuals have different goals, different ambitions. Take your time to define what matters to you. Without a goal there would be no way to suggest you the right actions. There would be no right action. Whoever tells you how to fix your situation without asking what are your goals is a liar.
It doesn’t have to be a long term goal, can also be a simple milestone or the end of a chapter in your life. It actually works better if the goal is small and reachable at first.
For example: “be able to make ends meet this month”, “get rid of debts”, “buy a house and not go broke”, “quit my job”, “have 10K Euro saved”, “be able to afford 6 months of unemployment”, “increase my saving rate by 10%”, “reduce expenses by 300 euro per month”, “get a raise”, “reach financial independence” and so on.
- Specific: avoid vague or indirect goals like “be able to sleep at night”. A sleeping pill will do the job and you’re still broke.
- Measurable: avoid “reduce expenses”, prefer “reduce expenses below 2K per month”.
- Assignable: usually assignable to you. If you’re part of a family or a community working together to reach your goals be sure each member has a role in this.
- Realistic: avoid “spend less than 100 Euro per month”, prefer “spend 100 Euro less per month”.
- Time related: avoid “quit my job”, prefer “quit my job before July 2017”.
there is no favorable wind for the sailor who doesn’t know where to go. (Seneca)
Step 6: what are you going to do to go there?
You’re no more a spectator of the movie, you’re the main character. You happen to be in a movie you didn’t plot – actually you did, but you lost control over time – but now you choose to be active and drive the plot. Maybe you’re in a drama or a Horror movie and you don’t like it. You envisioned your preferred finale, or what you think it would be a nice scene: “I’m gonna kill the dragon and kiss the princess before the end of the first act!”. Ok, cool, how are you going to do it?
- Force yourself to have a positive cash flow, i.e. spend less than you earn.
If you’re driving your car against a wall you can push the accelerator or the brake. If you want to avoid the collision you need to brake. Depending on your speed and the distance between you and the wall, it may not be enough to brake softly.
Same is true with money. Main rule is: spend less than you earn. No matter how tough it is, no matter how many sacrifices you need to do, how thrifty your life needs to become. Spend less than you earn.
It’s a mantra. Repeat again: spend less than you earn.
- Spend less, i.e. reduce your expenses.
The Philosophical way: you’re not your purchases. Embrace minimalism and simplify your life. Take your budget, understand where your money are going and check if the expenses match your values. Cut expenses that bring marginal value to your life. Maybe cutting the top 100 Euro on your monthly grocery bill won’t sensibly impact your happiness while cutting more will. Then cut just 100 Euro.
The Psychological way: Don’t keep up with the joneses, don’t try to impress people you don’t like. Learn how to recognize differences between your wants and your needs. Avoid impulsive spending, apply the 10 seconds rule before an impulsive purchase. Invest enough time for major purchases, apply the One hour per 100 Dollars rule and the 30 days rule. Guess the price of an item (or the price you’d be willing to pay for it) before looking at its actual price. Get rid of those dangerous cognitive biases like Anchoring, Bandwagon effect and System justification.
The Pragmatical way: Embrace frugality, think long term. Buy used stuff. Learn DIY skills and get out of your comfort zone. Don’t throw money at problems, throw skills. Become a reinassance man.
The Funny way: it doesn’t have to feel miserable, make it fun! Gamify the process: find a community, join a shared challenge (like the uber frugal month challenge). Challenge yourself, see if you can live with zero for a week.
- Earn more, i.e. increase your earnings.
On your current job: work harder, work more, work overtime, get better at it, be reliable, be autonomous, be proactive, show competence, show leadership, show impact, take more responsibilities, ask for feedback, document your progresses, negotiate a raise, get a promotion.
On your next job: always do interviews, don’t stay too much in a place you don’t like, change company when you think you’re not learning anything new, learn how to negotiate a salary, learn how to negotiate a severance package, get out of your comfort zone.
On your next career: learn new skills, be curious, become an idea machine, start a side hustle, fail, start another one, don’t care about revenues for the first 2 years, don’t care about revenues after two years, create value, get these thousand true fans, quit your job, go solo, think long term.
Don’t look for jobs, attract them. (Marco Montemagno)
Once your cash flow is greater than zero, amazing things happens. You now have a saving rate (i.e. savings/earnings), your financial situation is getting better month after month! It can be as low as 1% and as high as 70% or more, it doesn’t matter too much for now.
What to do next?
- If don’t have one, build an emergency fund.
Cash is king. Without cash at hand you may need to sell some assets or get high interest debts. Without cash how would you feed your family in case you lose your job tomorrow? Do not rely on social security, your state can cut unemployment supports tomorrow if it needs be.
Build an emergency fund, sized between 2 and 6 months of your current expenses depending on your tolerance to risks and unemployment support in your country.
With a fat fund in your bank account you can take risks, you can sleep at night, you can bring food on the table tomorrow.
Don’t exaggerate though, too much money sitting in a low earning saving account looks like a bunch of wasted opportunities. Send your green army to fight for you instead!
You should learn how to invest but first…
- Pay off your debts, always start from those with highest interest rates.
Once you have few months ‘stashed away and you can face bad news without panicking, it’s time to make your money go to work for you, bringing back more of the same.
What you want to maximize with your invested capital is the return on investment (ROI), i.e. how much (in percentage) that capital grows after a fixed amount of time. A commonly used metric is the yearly return on investment. If a dollar invested today becomes two dollars in a year, it’s 100% ROI. Pretty hard to achieve.
Lending money to you is a nice way to invest for your creditors. A nice way to get a good ROI is paying off your debts. If you have a 10% interest loan, paying it back is completely equivalent to invest the same amount and obtain a 10% return. Paying back a 10% loan is an investment with guaranteed 10% ROI.
10% ROI is very high and you can’t get anything better without risks. Credit cards debts, personal loans, payday loans, car loans… all these category of debts are usually in that range and should be killed before even start investing.
So kill your debts as a first priority once the previous steps have been taken. As a nice side effect, paying off your debts will reduce your total monthly expenses and improve your cash flow and your saving rate.
There’s a debate toward repaying low interest debts though. Mortgages, student loans… I don’t really have a position here, I’ve never been in debt.
If you think low interest debts are good, look at your debts and try to revert the question: “Would I borrow money at that interest rate to reinvest it? Which amount?”
I suggest to pay off any debt whose interest rate is greater than half your expected investments return. My expected investments return is the equivalent guaranteed return I’d take for not investing. If someone comes to me tomorrow with this offer: “Borrow me all your invested money, I’ll return it to you in a year with X% interest, guaranteed“, which is X would you accept? I don’t know you but I’d take 6% for sure.
So my suggestion is to get rid asap of debts with interest rate greater than (put your number here) 3% and limit exposure to “healthier” debts to no more than 10-30% of your Net Worth.
Once no high interests debt (possibly any debt) is hunting you down you have to find other ways to make your little green soldiers (what a cool name!) work for you, i.e. you have to invest your money.
There’s a lot of common ground but in the end “how to invest” is strongly country specific. Learn about your country taxation, opportunities and synergies.
You can actively invest your time and energy along with your money to hope for a greater return or, as I’d suggest to beginners, just go passive and join a fund.
Anyway, by no means you should jump on something you don’t fully understand! Learn the basics, understand risks and expectations, build your own model and validate it against reality.
Read some books, like “The Simple Path to Wealth“, “The richest Man in Babylon“, “The Bogleheads’ Guide to Investing“, “A Random Walk Down Wall Street“.
Once you’ve enough confidence, write down your Assets Allocation policy and your Investor Policy Statement. State your goals, your strategy, your exit strategy, your failure conditions, your withdraw policy.
Then invest! Go for it!
There are well known investment instruments like: financial instruments (bonds, stocks, funds, options…), real estates (flipping, renting), precious metals, art pieces, businesses and a lot of other atypical opportunities.
I just discovered someone is still making a living by producing digital dresses and selling them on secondlife!
You don’t have to pick only one of them, you can – and should – differentiate in order to reduce risks.
Seek out tax advantage investments, like pension funds. Max contributions out and – given the right conditions – do extra voluntary payments!
And finally, invest in yourself! Choose Yourself! As James Altucher (the author) always says: investing a Dollar on yourself is likely to give you a 50x better ROI than anything else. True story!
- Increase your saving rate
You’re already in the amazing world of the “positive cashflowers” (what an amazing name?? I gave you too many nerdy tips so far!) things will naturally keep getting better and better over time.
Reducing debts will lower your expenses and improving your cash flow. Investing will increase your earnings and improving your cash flow. Why not push the pedal down even more? Like with sports or with a diet: you see good results and you push harder! Let the positive feedback loop spiral you up!
Aim to increase your saving rate. Your SR is your best friend. It’s the number that matters the most when evaluating one’s financial situation. The higher your saving rate, the stronger the spiral force will push you up.
And it’s incredibly easy to reach SR of 20-50%. It’s easy for you, my financial intelligent reader, that quit luxury and useless stuff to embrace happy and funny frugality!
- Differentiate & Automate
Do you have all of your eggs into the same basket? Bad!
Don’t get in love with a single strategy. Don’t rely on a single income stream. Don’t invest in a single asset. Don’t rely on a single currency. Don’t rely on a single bank/broker.
Differentiate. The more the better.
Differentiate your skills too, don’t become ultra specialist on a single task. Always be learning new skills and put them into work. Start a side project, start ten of them. Create more income streams.
You want to fail 100 times with your new projects and ideas to learn and iterate faster, but you don’t want to fail once with your wealth!
Make your savings and investing as automatic as possible. Save life energies (like your time) for things you like more.
Make your income streams as much passive as you can. Automate your earnings. Get your stocks dividends while comfortably sitting on your couch. Create, and let your creations work for you while you’re getting tanned on the beach.
Again, think long term.
… congratulation, you achieved financial integrity! Financial Integrity is “taking actions” and you now master it. You’re a machine, you no more have financial problems, you have financial goals!
Is that all?
The movie never ends. You’ve reached the finale you think you wanted but spectators are not leaving the theatre! You may realize that’s not a finale, that’s just the beginning of another movie. Or you may want to change your mind and rewrite the entire story. You’re confident in your tools and you have so much control that you can start experimenting. If things go south who cares, you can fix them and write another script. You’re now more a screenwriter than a simple character of that movie.
Happiness & Freedom
Here’s when money starts fading in background. You’re in awesome financial shape and headed toward never have to care about financial issues anymore. What’s next? It’s up to you. What do you value most? What makes you feel happy? Do you like your job? Do you like your house? Do you like the country you’re living in? You have tons of options. Here’s where you realize that money is the tool, the enabler. Once you have anything enabled money doesn’t matter anymore. Anything, not everything like the Joneses want to make you believe.
Intelligence is giving yourself more options, and I wholeheartedly believe that. As your financial situation gets better you can take important decisions like: taking a less paying but more interesting job, reducing your working time, retiring earlier than normal, retiring extremely earlier than normal, travel more, launch a business, fulfilling your dreams, seeking happiness and find your purpose in life. Achieve self-actualization.
My personal goals can be summarised as follows:
- Pleasure: spend time with people I love (care).
- Passion: learning as much as possible (curiosity).
- Purpose: building something that positively impacts other people’s lives (creativity).
Spending too much life energy working on a job (even though I have the best job in the world) won’t bring me there, that’s why my next natural goal is to reach Financial Independence and quit the rat race as soon as possible.
Have a nice journey!
I finally found the “FI for dummies” article I was expecting from the beginning. Well done mr. Rip.
You’re welcome DIP!