More Information about Better Money Management

Doing Well

There is so much to be said about how to manage your money, so here are some more tips I have learned. Money management can be broken down into three areas: income, expenses, and investments. I'll discuss each area appropriately.

Income

In accounting terms you would think of "income" as "revenue". The basic accounting formulas are given as:

  1. (Profit or Loss) = Income - Expenses
  2. Owner's Equity = Assets - Liabilities

In personal money management terms people equate "profit" with being "above water" or "ahead" and they equate "loss" with being "under water" or "behind". It's really all the same thing. You need to make sure that your income exceeds your expenses, which is not always possible.

In personal finance people usually speak of their "net worth" but that is the same thing as "owner's equity". How much do you own versus how much you owe? Your monthly budget determines your profit or loss. Your investments minus outstanding loan / credit balances determines your net work. An investment can be anything you own: cash in your wallet, a bank account, a home, a car, a boat, land in the middle of a swamp, etc.

We think of "income" in a very narrow sense. Ask your friends and relatives where their income is derived and they will almost all tell you exactly the same thing: their paychecks. Your job is responsible for a large part of your income but you would be surprised at other ways we have for making money. Here is a clever article that explains how you earn money while helping your friends save. Another way people earn money is by gambling, although most people lose money when they gamble. I don't recommend that you try gambling but if you're curious all that then read this article on earning money through gambling. It's an eye-opener.

Making money is easier than we think although we don't always make very much money. That is the secret of wealthy people. They find ways to get others to help them make money. This article from the Huffington Post critizes Jeff Bezos for not rewarding the people who made him rich. This is a story that is played out over and over again. Wealthy people become wealthy by monetizing the work of others and sharing less of the income those people make than they would receive if they were equal partners.

One way to make money is to borrow freely from other people, use their money to invest in a successful deal, and then pay them back with no interest. Warren Buffett does that all the time. He uses what is called "float", the money that insurance customers pay to GEICO as premiums before it is paid back to settle their claims. This article explains how you use float to make money. Anyone can do this. You just have to find legal ways to borrow money without paying interest or fees.

Your end goal is to increase your income.

Expenses

Of course, the other variable in the equation of making a profit or loss is the sum total of your monthly expenses. You can fake a profitable month by not paying some bills. That is a real business practice, by the way. They call it "managing cash flow" and the way it works is that the business collects payments up front from its customers and defers paying its bills until the very end of billing cycles. This is one way that many businesses create a small amount of "float". Unless you have a large income and a lot of bills, though, you won't be able to do much with the float. Assuming you could earn 0.25% interest (a 3% annual rate of return) in 28 days of float, you could earn $25 on a $10,000 float. In other words, if you have $10,000 in monthly bill payments and you make $10,000 a month, in theory you could add another $25 to your income by collecting interest on the $10,000 before you use it to pay your bills.

While $25 does not seem like much it does add up over time. You can earn $300 a year and $3000 in ten years just by saving $25 from your monthly expenses. If you invest that money it will grow over time and as you add to your investment you'll earn more money.

There is more to managing money than just paying your bills as late as possible without incurring late fees. For example, you want to pay more than the minimum balance on any interest-accruing debt. That is because if you only pay the minimum balance it will take you many years to pay off the debt. Even if you decide to pay off one credit card first you should pay more than the minimum balance on your other credit accounts.

Debt is not the only kind of expense you need to manage carefully. For example, you need to learn how to save money on grocery bills. Food is the most important monthly expense because we need food to survive. You can survive if you lose your home. You won't last long without food. We tend to waste money on bad food and we pay too much for food in many cases. Better management of your grocery bills can help you reduce your expenses.

Your end goal is to reduce your expenses.

Investments

As I mentioned above investments are anything and everything you own. Some investments lose value over time. Your clothes represent an investment that has both tangible (monetary) and intangible (health, social) value. Your home and your car are investments. But when we speak about investments people usually think of stocks, bonds, savings accounts, and "securities".

Investing is not for everyone. I believe that most people who try to invest in the stock market either lose money or don't make much. Stock investments are expensive and the "cost of entry" is prohibitive to millions of Americans. You can learn how to use microinvesting services to get involved in stocks, but that should not be your only strategy. "Buy what appreciates, lease what depreciates" is an old adage my father used to tell me when I was a kid. He heard it somewhere but I don't remember where. Appreciation and depreciation are two concepts from business accounting that we should learn to use in our personal finance management.

For me, personal investing begins with a basic savings account. Get the money out of your sight. If you cannot see it you are not tempted to spend it. If you don't spend then your cash is invested. Now, this is not an income-producing investment but at least you're invested in something.

Also, if you are serious about making investments in any way, you should study economic theory. I won't say it's not hard but it's not something that the average person cannot understand. We've all heard about "too many dollars chasing too few items" and "supply and demand". Those are aspects of economic theory that are easy to grasp. You don't have to learn about the deeper stuff but you should understand what is happening in the world at large.

One of the neat things about investing is that you are looking for investments that produce income. There are two kinds of investments: those that accrue in value over time (because demand exceeds supply) and those that produce income. You can learn how to make money on the Internet and find ways to invest in income-producing Websites. That's easier said than done. It requires patience and a lot of hard work. But you can do it. A Website that produces income every month is an asset that helps you for as long as you own it.

When you look at a potential investment you should ask yourself the following questions:

We need to be realistic about making investments. Without risk there is usually no reward. The whole point of making any kind of investment is to grow your money. Even a savings account pays you a little bit of interest. Leaving cash in your wallet is not a good investment because there is a very good chance you will spend it, it won't earn any money on its own, and you could be robbed or lose your wallet.

There are short-term investments (six months or less) like lending money to a friend or relative. There are mid-term investments (1 to 5 years) like owning a house or a stock. And there are long-term investments (6 years or longer). Some people would put the house into the latter category but it depends on how long you keep it. Many Americans move about once every five years.

How do you decide what kinds of investments to make? You could assume that you keep reinvesting whatever you earn from short-term investments but they don't often repeat themselves. Still, suppose you can earn 5% on a short-term investment of $5000. That means you could make about $500 a year if you keep turning over that investment. Will a long-term investment for ten years pay you back $5000? If you buy a good house in the right neighborhood, your home value could double in ten years. So it doesn't necessarily make sense to put all your eggs into the short-term investment basket. But neither do you want your house to be your sole investment because you may not be able to wait ten years to reap that financial reward.