For most of us, wealth accumulation is essential for living a life of tranquility, even if we don’t dream of becoming multimillionaires or owning a Lamborghini. It’s essential to learn the basic laws of money. Unfortunately, there are lots of misconceptions regarding this topic. I’ll be outlining the primary lessons I’ve learned to address some […]
For most of us, wealth accumulation is essential for living a life of tranquility, even if we don’t dream of becoming multimillionaires or owning a Lamborghini. It’s essential to learn the basic laws of money.
Unfortunately, there are lots of misconceptions regarding this topic.
I’ll be outlining the primary lessons I’ve learned to address some of the misinformation out there. Hopefully, they can help you develop a better understanding of your finances!
Money is a Tool
This one might sound obvious, but in my experience, most people fail to grasp it. We often say “money is the root of all evil” or that desiring wealth makes us terrible people; these types of beliefs are unhelpful.
Money isn’t inherently “good” or “evil” — it’s a tool we can use to achieve good, evil, or anything in between.
It’s up to you whether you use your money to build a homeless shelter or buy yourself a mansion. If you’re spending your life living paycheck to paycheck, you probably won’t have the mental energy to help anyone.
Since money is a means to an end rather than an end itself, anyone who hoards money also doesn’t appreciate this rule. Focus on why you want to accumulate wealth.
Call me weird, but I enjoy learning about taxes. I appreciate that I'm in the minority here, but even if taxes aren’t your idea of a fun subject, you shouldn’t dismiss their importance.
Educating yourself on this will help you save a non-negligible amount of money. There are many (legal) loopholes you can take advantage of, including rebates and deductions.
It can seem daunting when you’re starting from a knowledge base of zero, but it doesn’t take long to get your head around the basics. Put one day aside for learning this stuff and I guarantee your future self will thank you!
Money won’t follow you to the grave
We all know that money is useless to us once we die, so why do we act like we want to leave the world with a healthy bank account? Okay, maybe you want to leave something behind for your loved ones, but that’s hardly the point.
Finance “gurus” are always complaining about frivolous spenders, yet they don’t mention that money hoarders are almost as bad.
It’s great to be frugal, but it can become an addiction. Once you’ve built a financial safety net, you need to draw the line somewhere. Instead of squirreling away every last penny, why not enjoy it?
Money is a tool, after all. Whether you want to use it to build that homeless shelter or to buy yourself an expensive vacation, I’m not here to judge.
Law of Capital
In simple terms, there are two types of capital: human and physical. We spend a lot of time thinking about physical capital, be it gold, real estate, or something else.
We’ll choose a higher-paying job that doesn’t give us any skills so we can make more money in the short term, forgetting that expertise and career capital will help us earn more in the future.
Or, we’ll buy a plane ticket with a long changeover to save a few bucks, failing to realize we sacrificed time spent increasing or exercising our human capital.
Investing in human capital is a significant shift in thinking. How can you start?
One of my favorite — and arguably the most simple — is by reading books. 27% of Americans haven’t picked up a book in the last 12 months, meaning you can easily build a knowledge advantage this way.
If you’re worried you don’t have the time, AudioBooks.com boasts a selection of audiobooks you can listen to whilst exercising, commuting, or doing your housework. The free trial includes two downloads. For recommendations, check out my suggestions:
Debt can be good or bad
Forget everything you thought you knew about debt. Contrary to popular belief, it’s not all bad.
Many entrepreneurs successfully use debt as leverage and make money. Real estate investment is a prime example — unless you just so happen to have millions of dollars sitting idle in your back pocket, you’ll probably need to use loans.
As a general rule, I’d define “good debt” as anything that will increase your human capital or give you good returns. Student loans come under this category as they grow your earning potential — on average, a college degree has an annual return of 15%.
Anything that generates returns, like real estate, is also good debt. Of course, you have to know what you’re doing, or it could all go horribly wrong — housing bubbles can burst.
Bad debt is anything that has a high interest rate or isn’t secured. This includes personal loans, payday loans, and any kind of consumer debt.
Even if you find a loan with a good interest rate, you should still be mindful of what you’re using the money for. If you want to buy a television, you’ll receive no returns on your investment, so proceed with caution.
Even though I’m an advocate of good debt, I’d advise anyone who has a bad history with debt to be more cautious.
No matter how much money you make, it’s impossible to accumulate wealth unless you live within your means. The numerical value of your salary is nothing but bragging rights if you spend it all.
Many professional athletes and lottery winners go broke because they make huge sums of money but never learn this crucial law. These tales of rags to riches might sound extreme, but lifestyle creep can be even more pernicious if you start off with a modest salary that grows over time.
Just because you get a raise at work, it doesn’t mean you have to buy a new car or rent a more expensive property. Besides, it’s unlikely to make you happier, thanks to hedonic adaptation.
There’s some nuance here — no need to live like a broke college student for the rest of your life. It’s fine to enjoy your money once you have a safety net, and sometimes spending money can help you save time or earn more. Just don’t waste everything on frivolous items.
I’ve increased my spending along with my income to a certain extent, but I try to avoid lifestyle creep where possible.
Understand your loans
Knowing the difference between good and bad debt isn’t all you need to know. Most people have a few distinct types of loans and they’re not sure what to prioritize, so it’s essential to understand loan structures too.
The size of your monthly payment might be the most alarming part of your loan, but it’s not the most important. Focus on your interest rate.
If you’re paying $500 toward your student loan each month and your interest rate is 5%, and you have a monthly credit card bill of $50 but the interest rate is 25%, most people would advise you to prioritize your credit card.
However, there are different approaches you can take. Two of the most popular are the debt snowball — made famous by Dave Ramsey — and the debt avalanche. I’ve outlined them both in the video below.
Above all, choose a game plan and stick to it.
Combat impulse purchases you’ll regret later with the 24-hour rule. It’s the simplest idea on this list: when you come across something you want to buy, wait 24 hours before you buy it. That’s it.
This rule works best for big-ticket items. You don’t need to apply it every time you go grocery shopping unless you want to make your life difficult.
Rule of 72
Another money law involving numbers. Don’t say I’m not good to you.
The Rule of 72 illustrates how long it will take to double your initial investment (as long as you know interest rate). Take the number 72 and divide it by your interest rate to find out how many years it will take you to have twice the amount of money you started with.
Let’s look at an example. If you’re hoping to get a return of 9% (the average return of the S&P 500 over time), it would take you eight years to double your money since 72/9=8.
Is that quicker than you expected? If this doesn’t motivate you to get saving your money I don’t know what will!
Of course, it’s not always that simple. If you invest a lump sum in the markets a few weeks before a recession hits, it will take longer for your money to grow.
Don’t buy anything that rusts, rots, or depreciates
If you’re still unsure whether you want to buy something after implementing the 24-hour rule, here’s another heuristic for you.
Avoid buying anything that will rust, rot, or depreciate.
Some results might seem counterintuitive. We often think of jewelry and handbags as frivolous expenses, yet certain items keep their value well. For instance, Birkin bags increased in value by 13% in 2019 and Rolex watches always remain valuable.
Conversely, the value of cars depreciates depressingly fast.
So, before you make a big purchase, ask yourself what its value will be in five years' time. At times you’ll need to buy things that break this rule, but it’s still helpful to think about.
Wealth accumulation isn’t a secret reserved for a few people “in the know” — it’s a path available to us all if we dedicate some time to learning about how money works.
These laws of money should leave you feeling empowered and in control of your finances.