“The art is not in making money, but in keeping it” is a famous proverb that speaks of a frame of mind – that the acquisition of money is relatively easier than the long-standing art of keeping it with you.
At this juncture in life, I have had some good and bad/relevant and non-relevant/important and non-important experiences and life learnings. So, I have decided to gather all these thoughts and penned them for anyone who wants to gear up for their path to success. Why do I feel like sharing this? Because my 22-year-old self, too, needed a helping hand of money management tips like these. Gen Z has already accomplished so much, which seemed impossible to Gen X and Y back then. This generation has complete access to information but if you want to hear about experiences and learn a thing or two, I am here to share some money management tips for millennials.
Beginning the series, I would like to share my learnings about “money management in early life”. Whether we realise it or not, many of our medium to long term goals depend on what financial decisions we make in our early earning life. I must admit that ironically even after a CFA degree, I was not quite prudent in my personal money matters and could have taken better-investing decisions in early life. I always thought I was doing well financially but when I quit the cushy corporate job to start my entrepreneurial journey, I suddenly realized I have a lot of illiquid assets and very less allocation to liquid assets.On paper, things seemed well but in reality, I had very little stable income to support my family lifestyle. Then I sorted it all out and it worked well for me. That’s the process of learning, you face challenges you never thought you will stumble upon and then you emerge as a warrior out of them.
So, in a recent project, I got the opportunity to work with a bunch of young professionals bursting with talent, dedication and passion but very little understanding of financial matters. Which is why you’re here reading this because the importance of money management can’t be stressed enough. It is all in our hands to write our financial destiny.
Let me start with some proven concepts in money management that have passed the test of time and are extremely effective if implemented sincerely. These are profound concepts and I will be exploring each of these later but let’s spend some time getting familiar with each of them before deep diving.
The first one and the most powerful one is:
The Power of Compounding
Compounding is one of the most important money management tips that is not much spoken about. Starting early and investing regularly will create all the difference. It doesn’t matter how small the investment values are as far as you invest with certain periodicity and don’t redeem. The famous quote of Albert Einstein “Compounding is the 8th Wonder” is a true wonder. The power of long-term compounding, as well as the reality that it is counter-intuitive, is the core reason why certain people have grown so rich over time.
Almost everyone cares more about the rate of return than the length of time. However, in order to profit from compound growth, all considerations need to be weighed – is the willingness to adjust the investment period much stronger than your ability to change the long-term rate of return?
“Buy right and hold tight” is the motto that one should embrace.
I would like to use a simple example to explain the incredible power of compounding. Imagine you and your friend work for a tech company and have got a similar windfall as it got acquired at a significant premium and encashed your holdings. Both of you decided depositing it in a bank is the safe move. Bank A offers a high-yield savings account with 10% simple annual interest. On the other hand, Bank B offers a high-yield savings account with 8% compound annual interest. *Disclaimer: No, these rates are not real.
Your friend will see the 10% rate from Bank A and open an account, by depositing his money. You, on the other hand, have read Einstein’s quote on compound interest, and decided to open an account at Bank B. So, what happens next?
Your friend’s 10% simple interest will become 1.1X and your 8% compound interest will become 1.08X the 1st year and 1.16X the 2nd year (8% on 1.08), etc. You earn more interest every year while your friend earns the same amount.
By year 7, you have leapfrogged him. By year 20, he has 3X to your 4.7X and by year 30, he has 4X to your 10X.
The key here is that with compounding, you receive the rate of return on both the principal and the accumulated interest. It creates a snowball effect, of sorts. Have faith in Einstein, whether with savings, investments, or knowledge. Let it compound!
Unfortunately, there is no school curriculum for Personal Finance for non-finance students, sometimes even for finance students there are none, but you have to be able to lead yourself in all things including finance before you lead others. A good education does not necessarily mean you know about money management too but it is essential to learn these concepts and their applicability. Some of the simple ones are:
Maintain a Personal Balance Sheet
A balance sheet is a simple account of the asset/liability table which shows how much you own in the form of cash, investments, home equity etc. and how much you owe to the world in the form of education loans, home, car or personal loans.
In other words, it’s more about the medium you choose to long term financial health on a yearly basis. If you keep earning more than you spend, it keeps getting accumulated in the form of reserves on the liability side and in the form of cash or investments on the asset side. On the other hand, if you spend more than you earn, your balance sheet will keep shrinking.
How do you make a balance sheet for yourself?
To start off, you need to jot down all the assets that you own at the moment and note their current value. The assets may be in the form of cash, car, house, land, or any other investments.
Post that write down the account of debt that you owe at the moment. These are your liabilities. These liabilities may be mortgage, credit card bills, personal loans etc.
Whatever you are left with now, after writing your assets and liabilities is your equity.
The mantra is Assets – Liabilities = Equity.
If your liabilities are more than your assets, your equity is negative vis-à-vis if you have more assets than the liabilities, your equity is positive.
As you might have guessed by now, negative equity is unhealthy, and positive equity is super healthy.
Keep an Account of Yearly Profit & Loss
P&L is a concept to be followed on a monthly basis for the entire year. It’s a simple account of how much you will earn in that particular year in the form of salary, dividends, investment returns and how much is your financial commitment in the form of loan EMIs, monthly bills, rent, holidays etc. It should remain positive as much as possible and if that’s not the case, you need to look into your spending habits. The idea is to try and not to borrow for your monthly expenses as it’s lost money and you will have to work extra hard to repay the loans.
Why should you go with the P&L concept? The most important reason is that it can mitigate operational efficiency since your direct/indirect costs and revenue are part of P&L accounting.
By P&L you can analyze how much tax you have to pay on the money you’ve made.
You can monitor market results and make better choices in the future.
It works as a financial statement and by utilizing this knowledge, you can predict your financial wellbeing correctly.
I am sure you all would have heard about “Not putting all your eggs in one basket”. If followed well from an early stage, this can create a well-cushioned portfolio to handle extreme volatility of markets, the economy and job insecurities.
The simplest way to understand and follow this is: Every asset class comes with their own risks and rewards and every % point of return comes with commensurate risk attached to it. Having a well-balanced portfolio of equity/debt and real estate proves much more resilient in difficult times as most of the time one provides the hedge against the other.
I made the mistake of a highly concentrated real estate portfolio in the early age and was always confident of the wealth effect in the long run but when I quit my job to start on my own, the monthly cash flow (salary) dried up and I needed cash to sustain my monthly expenses. Unfortunately, the real estate comes with illiquidity and if the markets are not favourable, it’s extremely difficult to find an exit.
Understand Risk & Reward
You might find a stack of “how to manage your money wisely tips” on the internet giving off the same ‘ol advice of saving and spending less. In reality, you don’t have to study finance or maths to understand this simple concept that I am going to talk about. If you want higher returns, you have to take a higher risk which means you can also lose out on the principle.
For example, if you invest in gold, it is highly unlikely that its value will erode. It will only give you inflation hedge king of returns. On the other side, if you invest in direct equities, your returns will be higher but that will come with volatility.
A thumb rule very common in the investing world is (100 – your age) is the amount of money you should invest into equities, meaning having higher allocation in early life and tapering off as you grow old. I, as any other young professional with a CFA degree and financial sector job, thought myself to be an equity expert and started investing in direct equities. The very 2nd year of my career met with the year 2002 global market crash and I lost most of my money. However, I stayed invested and recovered and earned significant returns when the markets recovered in the next 3-4 years. Thus, it is important to understand the underlying risk and reward of the asset class one is investing in, to avoid any shocks.
Use the Concept of Probability
How do some investment advisors reliably forecast short-term movements?
If you toss a coin, you have a 50 percent head chance and a 50 percent tail probability. If you ask 100 people to determine the result of a single coin flip, the likelihood is that 50 percent will predict right and 50 percent will get it wrong.
Toss a coin twice, and chances are only 25% of predictors will guess both the flips correctly. For each additional coin flip, the precision would decrease.
At the conclusion of 10 coin flips, the chances are that just 1 in 1,000 can accurately estimate any coin flip. That is why it is so important to understand the concept of probability. I consider this has relevance in our lives in all sorts of decision making whether financial or anything else. In the money management tips context, the probability of you achieving targeted return in fixed deposit returns is multi fold higher than buying a lottery ticket and hoping to win.
Lastly, Let the Experts Do Their Job
If you are young, this is one of the most valuable money management tips for students. Having an understanding of all aspects of investing and managing finances is essential but what is must, is to have an expert guiding you through this maze run. It’s very easy to get carried away by the sayings of investment prudence of your friend and following his/her advice but it’s the biggest risk you take for your portfolios. Has your friend ever come back and told you about a bad investment decision or losing money in difficult markets?
Give it time to set your goals right and stick to it with utmost discipline. Everyone has a different one and that’s where an expert can help you. Remember, it doesn’t absolve you from the responsibility of monitoring your own portfolio on a regular basis and rebalancing it from time to time.
Here, I tried to explain the big, complex world of investing in very simple terms which can be a good starting point for anyone who is looking out for investment prospects. The earlier you start, the more financial freedom you will have to enjoy things like a happy early retirement, following your own path, jumping into an entrepreneurial journey if you wish to embark on one.
My advice to all young and old friends is that a days’ progress will add to the big result, therefore you must develop a habit of going over your finances. Tell yourself you deserve to be rich and work hard to protect your wealth. I wish you all the best with your investing adventures.