September 7, 2018

Basic Heuristics for Personal Finance

Financial information can be complex and overwhelming, but I think some relatively simple rules can get you the vast majority of the benefits for minimal effort. I’ve tried to boil down the most salient information I’ve learned from reading things like The Simple Path to Wealth, The Compound Effect, Mr. Money Mustache and various other sources. There’s nothing groundbreaking here; that’s the point.

I hope you find this helpful, but obviously I’m not a professional, so please seek expert advice if you need it!

  • The compound effect is powerful. Start saving as soon as you can. Building wealth is simple if you leverage time.
  • Cutting spending is usually more effective than trying to increase income. Consider minimalism.
  • Stocks are volatile but have higher returns (good for accumulation). Bonds are stabler but have lower returns (good for preservation).
  • When you’re younger, focus on accumulation (favor high risk, high return). When you’re older, focus on preservation (favor stability).
  • Because of opportunity cost, anything you spend today (that you could have invested) is effectively costing you 5 times as much in 20 years. Remember this when assessing if something is worth buying.
  • Your savings rate can be used to estimate the number of years until you are financially independent.
  • You are financially independent when you can live on 4% of your pot (the Safe Withdrawal Rate’).
  • Actively managed funds almost always underperform passive funds that track the market, and they are more expensive. Instead, go with index funds and robo-investing
  • Invest, then leave it alone. Don’t tinker. Don’t try to time the market. Don’t panic if the market dips, it makes stocks cheaper to buy and they will go up over time. Over a long enough horizon, the market always goes up.

Putting it into action

Do things in this order:

  1. Start tracking your finances. Tools like YNAB, Mint, Personal Capital, etc., can help.
  2. Cut your spending. You can probably live on less than you think.
  3. Pay off all debt except mortgages (and student loans if from the UK).
  4. Pay into your employer retirement plan. They often match your contributions (up to a point) and have tax benefits.
  5. Start another pot. Use robo-investing services like Betterment (US) or Nutmeg (UK). — Property is not as good an investment as stocks and shares. Don’t buy a house unless you really want to live in it.

Updated Jul, 02 2020

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