When we think about the criteria by which we would measure our financial success, we think about our ability to buy a house, finance a child’s education, or raise enough money to enjoy a comfortable retirement.
The Five Simple Rules of Financial Success , to tell us about these principles and what we need to do to master them.
Your first principle invites us to protect ourselves from the trials of life. Why is this important?
Many people find this first principle strange because they believe that investing or saving for retirement is the first step.
These goals are laudable. However, when 30 years separate you from retirement, multiple serious and permanent tests can come to darken your finances. In the event of loss of income, you will need to end all of your retirement savings plans.
The income you will accumulate throughout your life is your most important asset. This is an unrealized gain that could reach close to $ 1 million and rise to over $ 4 million over your lifetime, depending on your level of education. *
An illness or injury that prevents you from earning this income could seriously affect your retirement, but also your current situation.
So, disability insurance is the first item you should look at. It’s not very exciting, but it’s important. The risk of disability is higher than that of death, regardless of age.
Many employers offer disability insurance. Is it sufficient?
I suggest that you examine the disability insurance policy offered by your employer, in order to know your coverage. If it doesn’t cover a high enough portion of your income or if the length of your contract only allows you to receive benefits, say for five years, not up to age 65, you can purchase a so-called top-up policy.
In the latter case, you could purchase a policy with a five-year waiting period, so that it takes over once your employer’s insurance plan expires. Contact an insurance agent who can help you determine the amount to purchase.
What other things should we consider in order to protect ourselves from the trials of life?
You need to make sure you have sufficient life insurance coverage, a will, a power of attorney for your finances and property, and a power of attorney for your health care.
You should also have an emergency fund. For most people, a sum that equals 3 to 6 months of spending is a good emergency fund, unless you want to give yourself more peace of mind and accumulate more.
You also suggest keeping some cash at home at all times, don’t you?
Today, many transactions are carried out electronically. Your banking institution’s ATM may be crippled by a cyberattack or major outage, like the one that hit North America in 2003.
It is wise to keep a few hundred dollars in cash at home.
Your second principle, which is to spend less than our income, seems obvious. Why did you even need to mention it?
Since this is one of those things that people intuitively know, but don’t do.
If you cannot master the basics of cutting expenses, there are other aspects of your finances that you will need to ignore. You won’t have to worry about the consequences of investment costs if you don’t have any money to invest. You won’t have to plan your estate if you don’t have any assets to distribute.
One way to spend less than your income is to routinely set money aside for yourself by setting up a direct deposit to your savings account on pay days.
Then be careful not to dry up your bank account until the next payday and not to accumulate debt. It will only take a few months for you to get used to it and no longer notice it. Try to increase the amount you save at the start of each year.
Your third principle is to pay off debts. Suggest a good approach to achieve this.
If you have multiple credit cards that have different interest rates and have a balance on them, I suggest paying the minimum amount on each card and allocating any excess money to pay off the smaller balance until full payment. You thus gain an important psychological victory which will give you the motivation to continue.
Do the same with the following credit card. As you repay, you develop this habit that you are more likely to stick with until you have paid off all of your debts.
Another solution is to put any excess money on the card with the highest interest rate, regardless of the balance. This strategy reduces the amount paid in interest, but decreases your chances of success.
The question of money represents 90% psychology and 8% mathematics. And no, the total is not equal to 100%. The missing 2% serves to illustrate how incidental the mathematical element is in personal finance.
Why did you choose to make “small print” your fourth principle?
A salesperson came to the house to offer to replace our water tank with no installation fees or significant acquisition costs. We only had to pay the monthly rental fee. If the heating element breaks, it will be repaired or replaced free of charge.
When I read the fine print, I saw that the contract would have committed us to pay a total amount of $ 5,545. The purchase and installation of a new water heater costs $ 900. I could have bought six new water heaters before this contract made sense.
Here’s another example: I met a couple who told me that they were happy to come to the end of their car loan for which the last payment of $ 600 was due the following month.
A few weeks later, they could hardly hold back their tears when they came back to see me, as they realized that they had to pay a discharge payment of $ 11,000. I examined the contract and found that this discharge payment was clearly mentioned, but concealed on the back of the document.
Many people feel that they irritate the seller if they take the time to read the contract. I suggest starting to read the contract from the end or looking for paragraphs that are written in a smaller typeface, as the smaller print often contains the biggest pitfalls.
Also, never sign a document that you don’t understand. In this case, find someone who will help you decipher it.
Your last principle is to control your spending. How do you get there?
One approach to doing this, as I mention in my book, is to save for large purchases rather than finance them.
Financing a car loan of $ 30,000 over seven years could cost you $ 35,000, including interest. However, if you choose to save, the car could cost you around $ 29,000 because you would have accrued interest on your savings.
When buying a car, if you’ve managed to save $ 30,000, you’ll be more likely to ask the seller to show you the $ 25,000 model. It is much more difficult to spend money earned and put into a savings account than it is to make a purchase funded through various forms of credit.
The opinions expressed in this document are based on the author’s assessment as of the date of first publication (July 24, 2015); they are subject to change without notice and may not represent the views or opinions of Vanguard Investments Canada Inc. The author may not update his analyzes based on new information, new circumstances, future events. or other factors. The forward-looking information contained in this document should be regarded as general information about the investments or the markets, and we cannot guarantee that an investor will obtain returns similar to those mentioned or anticipated in this document.
This document is for informational purposes only. The information it contains should not be relied upon for research, investment or tax advice. This article does not constitute in any way a recommendation, express or implied, an offer or a solicitation to buy or sell units of ETFs or to adopt a specific investment or portfolio strategy. The views and opinions expressed here do not take into account the investment objectives, needs, restrictions or circumstances of a specific investor; therefore, they cannot serve as the basis for a specific investment recommendation. Please speak to a financial or tax advisor for information that applies to your particular situation.