Much like the doctor who gets asked “Have you ever seen a rash like that?” at every barbecue, financial advisers also get cornered at social events for free advice.
While doctors get asked all sorts of gross and very personal things, as a financial adviser I have found all the various questions I get asked really boil down to this single question:
“What’s your hot finance tip at the moment?”
The person is looking for that secret of the inner circle, the thing that no one else knows that they can act on and instantly become rich. They are looking for astounding insight and wisdom that could change their lives forever.
For starters, if there was such a thing, a profound financial truth that instantly delivers massive wealth, I always wonder why someone would think I would share that, for free, with a complete stranger?
Luckily I am a fan of the karmic school of social etiquette – sharing without any expectation of return – and so I happily lean in and provide them with the single truth that will transform their lives . . . but perhaps not in the way they expect.
“Spend less than you earn.”
The reactions are priceless.
However I am deadly serious. This rule is so profound that if I was ever to actually get a quote tattooed on my body it would be this.
Interestingly, this rule was once an unspoken law of the universe, right up there with the sun rises, the sky is blue and after thirty, the body has a mind of its own (many thanks to Bette Midler).
The generations that lived through the World Wars and the Great Depression learnt this the hard way. Rationing was brought in under various guises by governments at the time, trying to manage scarce resources and curtail spending to ensure any savings could be invested in war bonds.
I think each of us, myself included, would rail against limits being placed on our needs and wants. We feel we are entitled to eat what we want and to buy and own what we desire.
So wrap your head around this – during World War 2, the rations assigned to each Briton per week included:
1 egg
2 – 3 rashers of bacon X 50g butter
2 – 3 pints of milk
50g cheese
225g meat
225g sugar
Fruit and fish weren’t rationed, and you of course were allowed to grow your own fruit and vegetable supplies at home to supplement the rations.
At first blush some of these don’t sound so bad . . . until you break it down. The meat portion would be close to what most of us would serve at a single meal, so you would really only have meat once a week. We’d blow the sugar ration with a bowl of cereal with milk, two slices of bread, and a can of coke.
So what was the by-product of rationing, aside from getting countries through the scarcity of war?
The key outcome is that an entire generation learnt:
Al things have limits;
You may not always be able to get what you want or need;
By paying attention to what you have and limiting waste, you can make a little go a long way; and
The special things in life (birthday gifts, treats) can only be achieved by giving up a little bit of the day-to-day.
Essentially, you need to spend less than you earn. So what happened? Why do we all (myself included) seem to have lost this instinct? Say thank you to the introduction of easy-access debt. With the advent of credit cards, leases and personal loans, suddenly we could put off the “pain” of saving for things we really wanted – new cars, overseas holidays, houses – until after we’d already enjoyed the item. Then we realised it didn’t just have to be big-ticket items that we bought with credit – we could buy all the little day-to-day stuff too! This is where things got really out of hand.
While we were purchasing one-off big ticket items, it was possible to manage the debt. You bought the item, like a car, used it and while you were using it you would be making repayments. You might then decide to upgrade your car; however, no one in their right mind would do that before the first car loan was paid off. It wasn’t necessarily the best way to go, but it was manageable.
When we started using credit for day-to-day items, we started to unknowingly live lives we simply couldn’t afford. And the gap between what we earned and what we were spending wasn’t one big ticket item, it was hundreds of little items. In fact, for many of us, there didn’t seem to be any perceived cost to these items, as using our cards came so easily and so quickly. Then, when we started to think it would be a good idea to curtail our spending, it became difficult to identify where, as each little thing on its own didn’t sound so bad.
What sort of impact could reducing my cable bill by $20 a month possibly make? Is cutting back my cappuccinos from three to one a day really going to get me on top of things?
The answer is, in fact, YES. However, when you are in that state, nothing seems big enough to effect change, and so it seems crazy that you can’t continue to do those things.
And the credit card debt builds and builds until the minimum payments on the card become more than you can afford each month. And here’s a tip – the minimum repayments aren’t designed to help you pay off the credit card. Even if you stop spending on the card, the massive interest will cause the debt to be an ever-present drain on your life and your hip pocket. You have entered the credit-card-debt merry go round or, for some, the credit card black hole (more on that in Rule #6).
Now, I imagine you are wondering why I gave you that personal finance history lesson.
A couple of reasons really. First, if you aren’t already aware you are caught in the credit card trap, then perhaps this would highlight it for you. Second, I believe we need to acknowledge that, for most of us, we are actually living a life of plenty.
We have at our disposal great food, an awesome array of entertainment and, for many people, comfortable places to live. In World War 2 they frequently cut lighting to combat air raids, hot water was severely limited to save on energy resources, and they had fairly limited food rations.
Yet, in this environment, not only did they survive, they remained pretty healthy and even managed to juggle their rations and limited income to put away enough to buy small gifts for each other.
If they were able to do that in such an environment, then surely we could get on top of how much we earn, work towards spending within those limits, and then even manage to get to the point of having a bit left over?
Let’s get back to you then, and start with identifying where your “Income – Spending” equation sits.
Income - Spending = Debt (or negative)
Income - Spending = Breaking even (or zero)
Income - Spending = Savings (or positive)
To make things even easier, let’s break them down:
Spending MORE than you earn – you probably have a building credit card debt, and even if you have refinanced this into a personal loan, your credit card or personal debt keeps growing.
Spending is EQUAL to what you earn – you are living pay cheque to pay cheque, and even if you manage to put a little bit away, it ends up being required to get a service done on the car, or some other larger, one-off expense.
Spending LESS than you earn – at the end of each month you have excess cash left over and, even after lumpy annual expenses, you have a growing savings account.
So, why is it important to know where you stand in the Income - Spending equation? Perhaps you were thinking your mission was to buy an investment property. Well, any investment you might consider generally requires you to have some excess money to “invest”, therefore, if you are in any category aside from the third one, then perhaps you have a mini mission to get yourself on the right side of this equation.
For those of us who fall into options 1 or 2, then hopefully you have come to the realisation that some changes need to be made. And luckily we have some real life Action Heroes to guide us – the World War 2 survivors. Let’s go back to some of the behaviours they learnt from that difficult time:
All things have limits;
You may not always be able to get what you want or need;
By paying attention to what you have and limiting waste you can make a little go a long way; and
The special things in life (birthday gifts, treats) can only be achieved by giving up a little bit of the day-to-day.