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What should all young people know about managing personal finance? This is a very important question, because as it stands, there is expected to be a $30 trillion wealth transfer from Boomers to Millennials over the coming decades – and only 22% of Millennials demonstrate “basic” financial knowledge.
However, this particular question is tough to answer in one place because there are many facets to personal finance and managing money to consider.
I won’t dive into anything too specific here, but instead I will relay a few of the powerful concepts that I think can be crucial tools in thinking about personal finance and wealth.
Time-Value of Money: Money today is worth more than money a year from now – and this effect can compound over time. Why? Because you could have invested it to get more money in the future, or you could have paid off a loan/credit card, saving you future expenses.
Opportunity Cost: Understanding time-value of money helps you calculate opportunity cost, or what you are potentially “missing” out on when you spend money. Let’s say that instead of spending $2,000 to take a course that will increase your earnings, you take a vacation to Mexico. That’s not just a $2,000 difference in your budget – the cost is actually $2,000, plus the income you could have made during that week of vacation, plus all future additional income that you would have made from furthering your career with the course.
Value of Time: Also place an hourly value on your time that relates to what you could be making if you were doing a side hustle or furthering your skills. This works both ways: it makes it easier to get up an hour early if you know you can make money during that time – and conversely, it also makes you realize some things in life are priceless.
Risk Tolerance: Know yourself. Understand how much of a risk taker you are, and build your finances around that. I know that even if I take big risks and fail, that I have a great network of people and family to fall back on. I’m lucky in that way, and it helps to fuel my entrepreneurial lifestyle.
As a side nugget: Stoics philosophers often contemplated what life would look like if they lost everything. It sounds dramatic, but what a practice like this does is it helps you realize that you’d still survive even in a worst case scenario. This makes it easier to take risks in the meantime.
Diversification: This applies to stock market portfolios, but all other assets as well. Many people have their wealth tied up in their house – well what happens if real estate values plunge? Think about where your money is allocated, and spread it around to many assets: equities, bonds, gold, cash, etc. to ensure that it survives and thrives.
Side Hustles: One of the most exciting developments of the internet age is that we can work on the side to make extra money in ways never before possible. Even if you are already working full-time, you could put hours towards a side business (affiliate business, e-commerce, etc.), building expertise and thought leadership in an area, or working for extra dollars as a freelancer.
We have an infographic here about five online businesses to start in 2017 that may help with ideas for this.
Having a side hustle can not only supplement income, but it can also turn into your full-time job or an income stream for years to come.
Time Arbitrage: This is my favorite concept – and I think I first heard about it on Sam Altman’s blog. The idea is that everybody wants instant gratification, and as a result very few people are thinking and working toward long-term goals.
It means there is significant opportunity in playing the long game, and that taking advantage of time arbitrage can have returns far more sizable than any short-term actions.
Income vs. Wealth: Understand the difference between income and wealth. A doctor that makes $200k a year may be perceived as “rich”, but if they blow all that money, they may not be wealthy. Likewise, someone that makes $50k can also save and make smart decisions that make them wealthy in the long-term.
The funny thing is, there is less of a relationship between income and wealth than one would think.
Here’s a chart we published on it about a year ago:
Net worth (wealth) is mostly tied to income in your late 30s, but after that the relationship drops significantly.
Market Cycles: Understanding that the markets move in cycles is also crucial. The current bull market (since the 2009 crisis) in stocks is the longest in 100 years – and at the same time, countries like Canada are in credit bubbles (in this case, with real estate).
Part of being smart with personal finance is understanding that things move in cycles, and being prepared to face downside (or upside) risks.
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