Life is essentially unpredictable. This does not mean there are no things that are within our control. There are many things which are within our control as well as many things that are not within our control. This post, which is my reflections and personal notes from the book, ” Your Money Milestones by Moshe A. Milevsky” looks at how we can deal with the 9 most important money milestones in our lives and the controllable factors.
The 9 money milestones are:
- Saving and Spending
- Marriages and Kids
- Housing: Buy or Rent
Let us look at them in a bit more detail:
When we educate ourselves or others like our kids, there is a cost for that education. The financial cost is the money you pay for that education. This money can be paid from what you already have or you borrow it from somebody. The financial advantage of education is that there is a possibility that the education will lead to better jobs with higher pay which increases throughout your life. This can potentially increase your standard of living through your whole life. Some degrees and jobs will do this to a greater extent than others. But for the education to be of value, two things should be satisfied. One is financial value: the amount you earn as a result of your education should be significantly greater than the amount you spend for it. The other is satisfaction value: you need to be happy learning what you are learning and you should be happy in your job as well. There is no point in having a lot of financial value if there is no satisfaction value. Sometimes, or perhaps many times, you may have to compromise between the two values to a certain extent. That is a purely personal choice.
Saving and Spending
We all need money to spend for the necessities, comforts, pleasures and luxuries for life. We may get the money for these things by saving, earning, investing or borrowing. We also need to spend. The amount we spend and what we deem as necessities, comforts, pleasures or luxuries varies from person to person and is a choice we all make. If we do not have enough money for a certain thing, we work for it, wait for it by investing or saving, or borrow. None of these is bad. Only when we go to extremes, we lose a lot of balance. Spending less helps a lot because then you do not need to have a lot of money; but you have to be careful you don’t live a unhappy and miserable life by forcing yourself to spend less. Unhappiness and miserableness also is a personal view-point and what may be luxury for someone may be miserable for another. Borrowing is okay as long as you can pay it comfortably and easily without becoming unhappy or miserable. Another important thing is that we have to balance our spending, saving and borrowing throughout our living life so that we can be comfortable throughout; rather than be miserable initially and have a lot of money when you are 70 years old. This then means that it is all about balance and enoughness- which are personal choices. But it would be wise to remember that money only to a certain extent makes us more happy and once you have a decent amount of money, more money does not make you necessarily more happier and this can help us smooth our consumption throughout our lives.
We all borrow money for some reason at some point in our lives. We all save and invest money also. You have to the see the rates at which you borrow money and the rate at which you save money. If you borrow at a rate of 3% per annum and invest it in something that is guaranteed to give a return of 10% per annum then borrowing may be a very good strategy. The key word here is “guaranteed”. On the other hand, it does not make sense if you borrow at 10% using a credit card while your savings are growing at 1% in a deposit account at the bank. It is also not wise to borrow at different rates. You are better off having an overdraft loan at 10% rather than credit card debt at 20% and it may be wise to lump all your loans if possible to the loan with the cheapest rate. One very important question that can help you make this decision is:
- Do not ask: Can I afford this purchase?
- Ask: Will today’s purchase, which might be financed by high cost and long-term debt, reduce my future standard of living by more than the purchase will increase my present standard of living?
- If the answer is yes, do not borrow. If the answer is no, you can borrow.
Marriages and Kids
Kids can be expensive initially. But they can also be investments if they earn well and take care of their parents later on. If we have more kids, then they will be usually working when they become big and hence the state will have higher taxes, which they can use to fund pensions for the old; these are the benefits of a higher fertility rate. Marriages can increase the expenses in one sense, but if both are working they may help to increase the income as well. Even if one is not working, it will create a lot of balance in family life and other expenses may be less and family may be more happier and peaceful, even if they do not have a lot of money.
Look at everything from an after-tax basis: your salary, your savings, your investments, etc. Do not pay too much tax upfront and then get a refund, because you are essentially giving an interest free loan to the government.
Housing: Buy or Rent
When you buy a house, usually most people borrow. This means if the house increases in value, they make a lot of money. But if the house decreases in value, then they lose a lot of money. Yes, you pay rent but the mortgage payment you make every month is similar to rent in a way, especially if interest rates are variable. So you have to remember that your house is part consumption and may be part investment if the prices rise. In true financial reality you may be better off renting but a house does give some sense of stability in life; but do not view it as something that will definitely give you great returns financially. Sometimes, investing in stocks and real estate investment trusts(REITs) while renting can make sense for a lot of people both financially and personally.
When you want to take insurance, you have consider a few things:
- Whether the event being insured will cause an enormous disruption to your standard of living?
- What is the probability of this event happening?
- What is the magnitude of the disruption if the event happens?
Deal with insurance in this way:
- Buy insurance only for events that have a potentially disruptive impact on your lifestyle and only if they have a low probability of occurring.
- For other events, set up your own insurance reserve fund with the money you save by saving the unpaid premiums.
- Don’t be emotional or fear driven when buying insurance
In investing, nothing is guaranteed. Sometimes even over long periods of time bonds can outperform equities. But so far, even during the periods when bonds outperform, they outperform only by a minor amount whereas when equities outperform, they outperform significantly.
The other important thing to consider while investing is the nature of your job: is it like a stock or like a bond and whether you can flexibly increase your working hours or not. Bond like jobs are those that are not sensitive to the economic environment while stock like jobs are sensitive to the economic environment.
If you have a bond like job, then you can invest more in risky investments such as stocks and if you have a stock like job you must invest more in bonds.
Retirement can be thought of as the point when your human capital has largely expired and you have to live with the financial capital you so far accumulated. Defined benefit pensions are the best. Fixed annuities may be useful. If you have a lot of money and you have invested it in 60% stocks and 40% bonds and can live on 2% of the amount then that is also a good strategy.
The important principles in making decisions for all the above milestones are:
- Identify the true value of all your financial and human capital resources. Remember that your human capital is the your most valuable asset for the most of your working life. You change human capital to financial capital as you work by saving and investing. Add your human capital to your financial capital to truly understand your financial position in life. This is the principle of ADDITION.
- Recognise and budget for all the hidden liabilities in your future, like marriage and children, the loss of your capability to make money and others. Don’t add assets without subtracting any corresponding liabilities. This is the principle of SUBTRACTION.
- Plan to spend your total resources evenly and smoothly over time. It makes little sense to starve for decades so that you can enjoy life later or live it up today without any consideration for tomorrow. Be balanced and think long-term and avoid forseeable disruptions by budgeting for all predictable liabilities. This is the principle of DIVISION.
- Prepare for many alternative and unexpected universes. Anything may happen in the future. Try to prepare for them as much as you can by smoothing consumption and insuring against all catastrophic and unforeseeable disruptions. Be a smooth operator over time and space. This is the principle of MULTIPLICATION.