Financial Fundamentals That People Often Overlook
There are advantages to keeping things simple, especially when it comes to money and finances. If simple and straightforward is best, why is it that so many people have trouble organizing their budget, cash flow and debts? Maybe they find it easier to adopt the mindset of: “Someday I’ll be rich, or at least have more than I have now, and all my money problems will go away, so why count every nickel and dime now? Of course, most people who are able to build wealth during heir lifetime do so by following the day-to-day, nickel-and-dime fundamentals of finance.
Some of these basic rules are obvious (don’t spend what you don’t have), but others are not (diversify your investments). Sometimes, stubbornness or carelessness (or simply distraction) cause people to overlook even the most basic money rules.
Here are some of the most important, and most often overlooked, fundamentals of personal finance.
This one is obvious, but people often forget it, especially when it comes to credit cards. The ideal situation would be to not use a card unless you have money in the bank to pay off the balance immediately after making a purchase. Of course, unforeseen problems and emergencies come up. To ween yourself off of credit cards, you can create a savings account for unforeseen expenses rather than relying on credit as a safety net.
I recently saw a flier for a fundraising event for someone whose house had been destroyed by fire. Since their mortgage had been paid in full, the fire victims were not required to have insurance (and had indeed canceled their policy). Had they sold the house before it burned down, they could have pocketed all the cash from the sale. Instead, they had to start over.
It is hard to feel sorry for someone who could have easily protected their asset with insurance. Even if you are not required to have insurance on something valuable, it is often a very good idea to purchase a policy. This is especially true when it comes to home ownership. This fundamental rule could also be extended to include health insurance. Unforeseen illnesses or emergencies can drain your savings accounts and put you into serious debt. At least consider getting basic health insurance with a high deductible so that you don’t get stuck with more than a few thousand in hospital bills should you have to make a trip to the E.R. Of course, you should shop for a decent policy and make sure that you are not over-insured by a policy that covers things that you won’t ever need.
Diversification is almost always a good idea when it comes to money. This rule can be applied in different ways. It could mean anything from having stocks in several different industries to having different forms of investment (stocks, bonds, CDs, money market accounts) to having multiple income streams. Not having to rely on a single thing is always an advantage because it means that the inevitable failures will not hurt so badly. A poker player knows that he should bet his pocket aces every time he gets them, but he also knows that someone could beat him if they draw a straight or a flush or hit three of a kind. So he won’t bet his whole bankroll on that one hand.
Another example: All those people who got burned by Enron. Of course that was an extreme situation, but how sorry can you feel for people who did not protect themselves by diversifying their stock portfolio? Even the most honest, down-to-earth person can get greedy when they see a stock’s price spiking. Keeping yourself diversified, however, will protect you from the unavoidable cycle of big-gain-followed-by-bigger-loss.
This is probably the easiest fundamental of personal finance, but also the one of the most misunderstood. The usual approach is to divide your monthly income out so that you have enough for your bills, buy lunch, etc. Perhaps a better way to think about a budget is dividing your money so that you can afford your current lifestyle. This could mean finding ways to make additional income or cutting expenses in certain areas. Budgeting doesn’t mean cutting all the enjoyment out of life, it means making sure that you can afford to enjoy yourself from time to time.
Taxes suck, there is no nice way to say it. The US has a complex tax code that’s filled with loopholes, but also filled with pitfalls. Yes, it’s a completely broken system, but it is the one that we’re stuck with until that fairy tale time when government simplifies the rules (that’s like waiting for the Chicago Cubs to win the World Series again). Plan to pay taxes, especially if you have your own business or a source of income that doesn’t come from a paycheck that has already had taxes removed.
If you have your own sources of income, don’t forget social security and medicare taxes (so-called self-employment taxes). These can sneak up on you and break your bank come mid-April. You can pay quarterly or at least put money aside to make payments at the end of the year. Also, you can help yourself by learning the rules of this unfair game. If you have more than a pay-check job or if you have lots of investments, it can be worth it to spend a few hundred dollars to consult an accountant. They can advise you about different types of investment accounts, business expense write-offs, and other issues that can help you keep more of your hard-earned dollars from being misspent by the government.
Personal finance certainly isn’t the most glamorous subject that you can spend time thinking about. But getting your financial fundamentals in order can help you enjoy the kind of lifestyle that you want to enjoy without having to worry about money.
About Josh Lew Josh Lew lives in the Midwestern US when he is not traveling. He is a columnist for Gadling and has contributed to Hackwriters and Skive Magazine.