A slightly more business than geek topic, but I believe a timely one given the current economic conditions. Again we encounter the recurring theme of short term versus long term thinking and how what looks like it will give immediate benefit is to our own longer term detriment. Part of our nature is also that we act like things are going to stay the same even when we know they aren't. We also are more likely to trust what we have seen then what we can reason.
This mix of observation, belief and self interest drive more of our investment decisions than they should and form a part of why we have booms that outlive their rationality. Remember in the dot-com days when people started to invent rationalisations as to why the boom would continue "It's a new economy that justifies 50+ P/E ratios". We see this exceptionally clearly in housing booms. As house prices go up people that are looking for houses get stressed as they are priced out of areas they were looking in and have to re-assess. Couple that with some easy access to credit and some people start to get silly and pay more than they should to secure the house. Typically you then hear the justification that its ok because the value of the property will rise.
No sane person should be taking on some of the 2/28 loans that were on offer, and it is pure madness to be financing 100% of a home. But for some reason otherwise perfectly rational people will make these types of decisions. We all make these type of decisions sometimes (although not always of this magnitude) and it is typically when we cannot separate our emotional attachment to a thing from our buying decision. It is not necessarily a bad thing, it just is but we need to make sure it doesn't send us into bankruptcy or cost a relationship. I keep hearing about and meeting people that earn high salaries but are barely paying the bills I am not a financial adviser, but I wanted to share with you some financial wisdom that has helped me.
An anecdote to start. I started my first full time job in 1989 on an unimpressive 18K a year salary. Making ends meet on this was pretty hard but doable in 1989. 3 years later I had landed myself a job in IT, shown an aptitude for it and was earning 30K. I found I then had enough money to meet all the bills and have a lot of fun, going out more often and being able to buy the occasional luxury without having to worry. A few years further on and I had a new promotion with a new 50K salary and was very impressed with myself. I moved to a new place, bought a new car and some new goodies for the house. After a couple of months though I found that the bills were starting to get ahead of me and one day found myself at the supermarket register with my groceries for the week, no cash and a rejected credit card which was one of the more embarrassing things that has happened to me.
So why could I live like a king at 30K and struggle at 50K. When I was on 30K I was living a lifestyle set up for an 18K salary. When I was at 50K I 'increased' my lifestyle, and ended up going too far. The salary was greater but so was the cost of my lifestyle. As stressful as it was at the time it was also a great life lesson. The core of my financial philosophy now is to live below my means, and to work out what is really important to me. While I have not made a fortune from this philosophy I have never again worried about where the money was coming from to pay a bill.
- Know what is important to you. If you have a plan of what you want you can more easily make the small decisions that you come across.
- Only borrow as much as you can easily payback in 10 years. If that means you can't afford that house let it go.
- Have a budget. Track your spending over a couple of months, or even a year so you know where your money is going.
- Have 3-6 months salary in the bank or in a safe, easy to sell investment fund. If you lose your job this gives you a good buffer so you don't need to stress in getting another one. It also is a reserve for emergencies, but top it back up if you use it.
- Cars are the worst waste of money out there, it is incredible how much money they can burn for no return, find a reasonably priced one. This is one of the hardest for me to follow as I am a car nut and would love a shiny new fast car, but I calculated once how much money I had spent on cars in the past and almost choked.
- Store credit and delayed payment schemes are for suckers. If you can't afford it now save for it and buy it when you can. Prioritise what you want.
- Always pay off your credit cards in the interest free period.
- Talk to a financial planner. They do this for a living and know more than you do, try and find one you like, and is preferably at least semi independent.
Above all trust your head and your common sense. If a market, whether that be housing or stock, seems to be higher than it should be then it probably is. As we have seen time and time again booms can have a life of their own where even the most sensible pundits and the media start to wonder whether this time it might be different from every other. It won't be. Houses cannot keep growing faster than peoples ability to afford them, stocks cannot maintain hypergrowth indefinitely, and a countries currency cannot remain strong despite a huge debt load.
I don't offer you advise only anecdote, but I have shared what has worked for me and I hope they get a few people to think about how they use their money.
