Over the next couple of weeks, I will be posting a series of articles intended to get everyone caught up on basic financial education. I know from personal experience that highly intelligent individuals with highly specialized skills can know pretty much nothing when it comes to money. Doctors, lawyers, dentists…pretty much anyone who goes to school for something that doesn’t revolve entirely around the financial markets stands to benefit from these posts. Basic financial education, unfortunately, seems to be ignored in our education system. In my opinion, it should be part of any professional training–even medical school.
Before I begin with our first topic, I must provide you with a warning. BASIC FINANCIAL EDUCATION IS NOT ALWAYS THAT EXCITING TO READ. These posts are not intended to be provocative or give you any great ideas like most of my posts. Think of basic financial education like learning a language. The learning process might not be that exciting but having this new “language” will allow you to go places where you couldn’t go before and create new opportunities that you did not previously have. I also think of basic financial education as “the rules”. It’s ok to break the rules if you know them to begin with. Otherwise, you can get yourself in trouble.
For those of you who know all this stuff, you might need to read some of my other posts for a while and catch up with my more advanced ideas. The basic financial education bootcamp begins now!
What’s Your Financial Plan?
It’s hard to hit a target when you’re unsure of what or where it is. That’s why it’s wise to develop a financial plan. In devising such a plan, you establish the targets that you want to reach and decide when you will need to reach each one, be it a down payment on a house, money for a child’s education, retirement income, or some other aspiration. And you put it in writing so that you can revisit it—ideally once a year—to determine if a change in your situation requires a modification in your plan.
Our financial goals are as individual as we are, and we all have differing sets of constraints that need to be considered as we set out to meet those goals. These include investment horizons, risk tolerance levels, liquidity needs, tax considerations, and existing regulations. Combined, our goals and our constraints determine the types of assets in which we should invest and the percentage of our investment funds to invest in each. The choices include everything from the mundane to the more exotic–savings accounts, individual stocks and bonds, professionally managed funds, real estate, fine art, precious metals, and antiques, among them.
Unfortunately, socking all your money away in a savings account or some bank certificates of deposits (CDs)—assets with which you may be most familiar–will not help you reach your goals. Certainly, some of your money should be in liquid assets similar to these to meet your immediate needs for cash. However, at present the highest rate offered on bank savings account deposits is less than 1% per annum, while the most recently reported 12-month inflation rate (as of November 2012) is 1.8%.
So, let’s assume you deposit $1,000 in a bank account that pays 0.9%. At the end of the year, you will have a whopping $1,009 in that account. But an item that cost $1,000 at the beginning of the year might now cost $1,018 because the rate of inflation exceeds the interest you accumulated from the bank—or more, since the price of goods in some categories increased more than the average for all items. For example, the price of “food away from home” increased 2.5% in the 12-month period ending November 2012 and “shelter” increased 2.2% in that same 12-month period. Translation: you have lost purchasing power. BY KEEPING MONEY IN THE BANK, YOU ARE ACTUALLY “LOSING” MONEY.
You may be thinking, I really don’t have time for this. I make enough money in my chosen career to hire a professional to worry about these things for me. And hiring a professional may well be a good option for you in the final analysis. But remember that in every profession there are those who have graduated at the bottom of their class and have barely passed the certification exam that permits them to put a string of letters, such as CFP, CFA, and/or CPA, at the end of their names. There are also those who may have been worthy of such a designation at one time, but who have become sloppy and negligent. And, sadly, there are those who are unscrupulous and will choose to line their own pockets at your expense.
It is up to you to protect yourself and your hard-earned money by arming yourself with some basic knowledge that will enable you to ask some relevant questions. When you start learning the language, you will realize that a lot of these “experts” don’t really seem to know what they are talking about. I am not advocating for you to do everything yourself but just be careful who you delegate.
I like to think of basic personal finance the same way I think about running a business. You have to figure out how to be profitable. You have to cut unnecessary expenses if you are low on funds. And you have to delegate when appropriate. However, just like you wouldn’t let someone unqualified run your business, you should also make sure that you throughly vett the person who manages your personal money if that’s the decision you make. In order to to do that you will have to interview them and ask them relavent questions to make sure their skills and values are in line with what you are look for. If you don’t speak the financial language, however, it will be like interviewing someone in a foreign language that you don’t know.
After you learn all this, you might decide that you are your own best financial advisor. However at that point, you are making an informed decision. Admittedly, that’s the choice that I have made. In doing so, I hold myself accountable for whether or not I meet my own financial goals.
Your action plan today should be to write out some kind of basic financial plan. Start with: 1) Where do you want to be financially in 1 year, 3 years, and 5 years 2) What are the things for which you must save (house, kids college, etc) 3) What are you doing to get there and is your current trajectory going to realistically get you where you want to be.
If the answer to #3 is no–don’t panic. Take the time to educate yourself through these posts and other resources and come up with a better plan. Knowledge is power–right?
Consider today a light day at bootcamp–just a few stretches and an easy jog and some mindset preparation. Tomorrow, we get into the meat! Stay tuned for my next post on the basics of the stock market.
In the meantime, please let me know if there are topics on basic financial education that you would like me to cover–I’m sure I will miss something important without your feedback.