We tend to have rules for most areas of our life: how much to eat, how much to use TV, Netflix, or social media, how many hours to sleep, etc. Such rules help us stay disciplined in our lives. Similarly, following specific rules about saving money, spending money, and investing money can help us better manage our finances.
This blog will describe 7 rules of money that you can apply to manage your finances smartly and prudently.
1. Understand What Type Of Investor You Are
There are several types of people who invest in the market. The list includes speculators, intra-day traders, short-term investors, long-term investors, and so on. They all want to achieve different rates of return, take different levels of risk, and their approach vastly vary from one another.
Let’s understand how they are different in terms of their approach with an example.
Google is one of the best companies in the world. Its stock prices have risen by more than 240% in the last five years. Now, ask yourself, at what price will you buy Google stocks today?
The answer will depend on who you are. If you are a long-term investor planning to invest for 10-15 years, then it wouldn’t bother you if the stock price of Google has risen or fallen by 0.5% or 1% in a day. However, if you want to buy and sell that stock on the same day, even the 0.5% rise or fall in the stock’s prices could be a crucial consideration.
Therefore, you must recognize what kind of investor you want to be in this market and stick to that process.
“Define the game you are playing and make sure that people playing a different game don’t influence your actions.” – Morgan Housel.
2. Increasing Time Horizon Is The Best Strategy To Grow Money
Most of us have come across books, blogs, and videos that term Warren Buffett as the most successful investor of all time. His net worth is over $100 billion, making him one of the top 10 richest persons. However, Buffett is not the greatest investor in terms of the rate of return he has delivered.
Buffett’s average annual return is less than 25%. At the same time, Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. Yet, Simons is 75% less wealthy than Buffett.
What is the reason for this difference? The simple answer is time. Simons started his investment journey very late. And he has had less than half as many years to compound as Buffett. Therefore, good investing need not be earning the highest returns. Good investing can also be making pretty good returns and staying invested for the longest period possible. That is when ‘Time’ becomes your friend and brings the magic of compounding with it.
“Compound interest is the eighth wonder of the world. He, who understands it, earns it. He, who doesn’t understand it, pays it.” – Albert Einstein.
3. Your Behavior Decides Your Success In Investing
Investing is easy when you keep it simple. Invest long-term, create a diversified portfolio, watch your costs, and let compounding work its magic. It is quite a simple process, right?
However, this simple process of investing becomes difficult, as emotions like fear and greed often drive our investment decisions. Fear tempts us to sell during market corrections. Greed prompts us to step up investments during market rallies to earn more returns. And as a result, these emotions become a hindrance to our financial goals.
If you manage these emotions, you are all set to excel in investing. You will stay disciplined. And the focus will be on achieving your goals instead of falling prey to short-term volatility or noise in the market.
“Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.” – Vanguard Group Founder John Bogle.
4. Risk And Returns Go Hand In Hand
The trade-off between risk and return is pretty straightforward. With higher returns come higher risks. While investments like FDs carry minimal risk, the post-tax returns barely beat inflation. Creating wealth requires beating inflation with a good margin, and that is why taking the risk of investing in assets like equities is essential.
That said, you must be careful about how much risk you are taking. Too much of anything isn’t a good idea either. Ask yourself how much loss you can see in your portfolio and take a path to grow your money based on that answer.
“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.” – Author and American Hedge Fund Manager Seth Klarman.
5. Budgeting Is Simple: Spend Less Than You Earn
Every lesson on personal finance begins with the need to spend less, save more, and trade current pleasures for future comfort. But does that mean living a miserly life? Where should you draw the line?
The answer is not that complicated. It lies in the simple rules of Budgeting. All that you need to ensure is that your income is more than your expenses. It’s that easy! You need not live a miserly life. You can buy a car, house or any other thing or experience as long as you can afford it. The simple formula to remain financially healthy is to spend less than you earn and save enough for the future.
A prudent way to save is to make savings a target and not a residue. It means you should save first and spend later rather than spending first and saving later. There are multiple ways to do it. You can create different bank accounts for different purposes or start SIPs. The choice is yours.
How much you need to save can depend on your age, stage, primary financial goals, family situation, etc. If you are not clear about how to consider all the above variables and how much you need to save, our blog, ‘How Much Should You Invest,’ can be helpful.
“Never spend your money before you have it.” – Thomas Jefferson.
6. Never Borrow Money To Invest In The Market
Borrowing money to invest might be tempting, but it involves substantial risk. Markets are always unpredictable. And even the most reliable stocks can fall in the short term due to a rumor or world event which has little to do with their business. So if a company’s stock prices aren’t in their control in the short term, why should you take the risk of relying on them to pay back your loans on time?
In addition, nobody can predict how far stocks can fall in a short period. Following a plunge, the stock market may take 5-7 years to recover its losses. Such situations are undesirable, as you will have to pay the loan back with interest while your investment has also lost value. You can easily avoid all this hardship if you don’t borrow money to invest in the market.
“It is insane to risk what you have and need in order to obtain what you don’t need.” – Warren Buffett.
7. Invest In Yourself
All successful investors invest in educating themselves. If you constantly make efforts to learn new things about investing, you will also know more about the correct investing methods. Moreover, you will avoid making costly mistakes. You will process information correctly and separate noise from the news. No rumors, click-bait headlines, or market “expert” yelling the loudest will influence your decisions.
Simply put, your efforts to improve your knowledge will give you the confidence to stick to the basic principles of investments. And this process will automatically translate into sound investment decisions.
“An investment in knowledge pays the best interest.” — Benjamin Franklin.
Bottomline
Now that you know the essential rules about managing money, you can make them a part of your life. When these financial rules become a natural part of spending, saving, and investing money, they will surely go a long way in achieving financial success.
