Money Bull and Thinking Bear (MBTB) tries to break down the complicated webs of personal finance into simple bite size topics based on ‘First Principles Thinking‘. Conceptually, personal finance is about managing cash flows. Without going into the various specific various streams of cash flows, the basic elements of Personal Finance are :-
- Managing the Cash Flow In
- Managing the Cash Flow Out
- Taking a Decision of Allocation for the net positive balances
From the above understanding, what are the first principles of Money Management that we can derive from it?
Principle 1: Be aware of your money and your relationship with money
I considers this the first principle of money management. In fact, it is a pre-requisite for all money management principles. Without awareness of your financial situation and your relationship with money, money management would be difficult. It is important to understand snapshot of your financial situation including, but not limited to
1.How much am I earning every month?
2. What is my monthly expenditure?
3. How much savings do I have now?
4. What is my net worth of entire portfolio of savings, investments, loans, etc?
If is also important to understand your relationship with money,
1. What are your priorities?
2. Are any emotional or psychological triggers that can affect your money decisions?
3. How do you define financial freedom for yourself?
Only when a good understanding of your financial situation and your relationship with money, then it would be easier to come up with a discipline approach for money management.
Principle 2: Cash Out flow should be less than Cash In flow
This sits as one of the core principles of all financial management. Spending less than you earn is almost common sense, but there are people who are unable to control their urge to spend excessively. There is always a struggle between your present self who prefer to spend on immediate gratification and your future self who prefers to earn and save more for rainy days. Spending less than you earn and saving the rest may not necessary make your rich. But consistently spending more than you earn puts you in debts and could lead to stress in other areas of your life, such as your personal well being and your relationships. Even the wealthy who lives beyond their means may lose their wealth and lose their financial stability.
We also need to be ready for unexpected cash out flows that can come from emergencies and unexpected disruption to our cash in flows i.e. retrenchment.
Principle 3: Put your money to work responsibly
The earlier you start saving the earlier you are going to have money to start investing and put your money to work for you. We assume our audience has a certain level of basic financial knowledge and understands when Albert Einstein says
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
‘Responsibly’ was added at the end of Principle 3 as you might potentially lose all the money you blindly put your money blindly into investments. Risk and Reward are directly correlated. The higher the risks the higher the reward. Thus, it is important to understanding the risk of an investment instrument and diversify the assets in your portfolio. Do not put your eggs in one basket!
With these 3 key principles in mind, we can start our financial journey on the right note!
- Forbes: The only 3 Money Principles you need to know
- Intuit Mint Life: Three Principles of Personal Finance
- Quicken: 10 Basic Principles of Financial Management
- Bearing Point Wealth Partners: 12 Principles of Personal Finance
- Minding the Borderland: What are your first principles of personal finance?
- Plan Smart: 8 principles of personal finance