6 Concepts You Need to Learn to Be Great with Money
Updated: Aug 4, 2020
Money is an intimidating topic for many people. They believe that managing their finances requires a lot of technical knowledge that is way above their heads. I am here to tell you that it is not true.
You don’t need a degree in finance to manage your money. In fact, there are only six concepts you need to learn to be great with money.
Tracking where your money is going
Building a strong emergency fund
Paying off debt
Adopting a simple investment strategy
Create a goals-based budget.
Pull the two levers of financial independence
1. Tracking where your money is going
How can you better manage your money if you have no idea where your money is currently going every month? You can’t, money is a zero-sum game. Any money you spend is money that can’t be used to save, invest, or pay off debt.
I’m not saying that spending money is bad. What kind of life would you have if you saved every penny? Not a very fulfilling one. Life is about more than hoarding money.
What matters is what you spend your money on
A dollar spent on the things you value most in life is not only a good use of money, but you could also argue it’s the only use of money. The point of saving and investing is to ensure you will be able to continue spending money on things you value in the future.
A dollar spent on “stuff” that provides no value to your life and does not move you closer to your goals is a dollar waster.
The question you need to ask yourself is, how much money are you spending on the things you value, and how much of it are you pissing away on useless “stuff?”
If you’re not tracking where your money is going, you have no way to answer that question. That is why the first concept you need to learn and adapt is tracking where your money is going.
Tracking your spending is not complicated. All you need to do is review your financial records like bank and credit card statements and tally up your monthly spending into categories.
I break all of my spendings down into one of three categories.
The “big 3”. Essential spending on housing, transportation, and food.
Values. Any money you spend on things that make you happy.
“Stuff.” Any non-essential spending that does not provide any real value.
Tracking your spending is a lot of work. Which is why most people don’t do it. Herein lies the problem; managing money is both challenging and straightforward, which is why the right mindset is more important than technical knowledge.
2. Building a strong emergency fund
When people think about managing money, they typically think of investing or paying down debt. You might be surprised to learn that the first thing you need to do once you’ve started tracking where your money is going is to build an emergency fund of cash savings.
Even if you have a pile of debt that you are eager to pay off, that needs to take a backseat until you have built up an adequate emergency fund.
Your goal is not merely to pay off debt as quickly as possible. Your goal is to pay off your debt and never fall back into debt again. To ensure you don’t fall back into debt, you need financial stability, which means having some cash set aside in case of an emergency.
Life is going to pull the rug out from under you at some point. The problem is, we don’t know when. What happens if you have unexpected costs come up, and you don’t have any cash on hand?
You will need to borrow money and go back into debt.
If there is one thing that is worst than living in debt, it’s getting out of debt and experiencing what that freedom feels like, only to fall back into debt again. To avoid that fate, we need cash on hand.
The next question is, “how much do I need in an emergency fund?”. Most financial experts recommend having 3–6 months’ worth of basic living expenses in your emergency fund.
While those rules of thumb are helpful, the size of your emergency fund will be dependent upon your preferences and personal circumstances, including your job security. The less secure you feel your job is, the more critical an emergency fund is.
3. Paying off debt
There are two tried and true strategies that anyone struggling with debt needs to know.
The snowball method
The avalanche method
The Snowball method
The “snowball method” prioritizes paying off your loans with the smallest balance. It is a four-step process.
Step 1: List your debts from smallest to largest.
Step 2: Make minimum payments on all your debts except the smallest.
Step 3: Pay as much as possible on your smallest debt.
Step 4: Repeat until each debt is paid in full.
The avalanche method
The “avalanche method” prioritizes paying off your loans with the highest interest rate. It is also a four-step process.
Step 1: List all your debts from the highest interest rate to the lowest interest rate.
Step 2: Make minimum payments on all your debts except the debt with the highest interest rate.
Step 3: Pay as much as possible on your debt with the highest interest rate.
Step 4: Repeat until each debt is paid in full.
Each method has it’s tradeoffs.
The snowball method is based on the psychology of experiencing small wins. By focusing on the loan with the smallest balance, you get to feel a “win” by paying off a loan in full rather quickly. This can give you the confidence to keep going.
The avalanche method is the most mathematically efficient way to pay off your debt. By paying off the loan with the highest interest rate first, you pay the least amount of interest and potentially get out of debt quicker.
Whichever method works for you will depend on how much motivation you believe you will need to see the debt repayment process through to the end.
4. Adopting a simple investment strategy
With most things in life, the more effort, attention, and time you dedicate to something, the better your results are likely to be. You’ve heard it a thousand times, “practice makes perfect.” If you want to be great at something, you need to dedicate yourself to mastering your craft.
The exception to this rule is investing. The more effort you put into becoming a “good investor,” the worse your results are likely to be.
If you accept that the stock market is reasonably efficient, then you will also accept that picking and choosing stocks to try and outperform the general stock market is a waste of time and money.
Rather than picking stocks or paying a mutual fund manager to pick stocks for me, I “buy the whole stock market” by investing in a handful of low-cost index funds.
Whatever investment strategy you choose, make sure you minimize risk through proper diversification.
Diversify by asset class. That means investing in multiple types of investments like stocks, bonds, and real estate.
Diversify by geography. That means investing internationally as well as domestically.
Diversifying your investments is a smart and simple way to manage investment risk.
One of the biggest risks to your investments is what is called behavioral risk. The risk that when your investments go down, you panic and sell at the bottom.
The simplest way to avoid behavioral risk is to not check your portfolio balance. People who check in on their investments every day and follow daily stock market events are more likely to make investment decisions based on what’s happening today. If this is money you don’t need until decades into the future, what happens today is of little or no consequence.
To become a successful investor, focus on diversification, minimize your investment fees, and don’t worry about only check in on your portfolio a few times a year.
If you want to increase your wealth, focus on how to find more money to invest than don’t worry about what’s happening in the market day today.
5. Create a budget that locks in your goals
If there’s one thing people hate more than tracking their spending, it’s budgeting.
I am not a fan of traditional budget templates. Arbitrary rules like “dedicate 10% of your income to saving” don’t resonate. This makes budgeting feel like a chore, and people avoid it entirely.
I prefer a looser approach to budgeting that focuses on your financial goals.
If you’re just getting started three goals you want to consider are;
Building a strong emergency fund.
Paying off debt.
Saving for retirement.
Once you figure out how much you need to set aside each month to accomplish those goals, you simply subtract that amount from your monthly take-home pay, and whatever is left is how much you have to spend.
A simple goal based budget example
Let’s say your monthly take-home pay is $4,000.
After crunching the numbers, you determine that you need to set aside the following amount of money each month to achieve your financial goals.
$200 towards your emergency fund.
$600 towards your debt.
$850 towards retirement.
That’s a total of $1,650 required to achieve your financial goals. That leaves $2,350 left to spend on your remaining living expenses.
From a financial perspective, how you spend the remaining $2,350 does not really matter.
However, if you want to live a more fulfilling life, you will want to spend more money on the things you value most in life. That is why when I track my spending, I break everything down into “the big 3”, “values,” and “stuff.”
If I can minimize the amount I spend on the big 3 and stuff, the more money will be left over after putting money aside for my financial goals.
6. The two levers of financial independence
By the time you finish paying for the big 3 essential expenses and allocating money towards your financial goals, you are likely to find that you don’t have much money leftover.
One option you might consider is lowering your financial goals. If your willing to live in debt longer and push back your retirement by several years, you would need to dedicate less money every month to achieve those goals.
Before you lower your goals, you might consider pulling one of the two levers of financial independence.
Saving more money.
Making more money.
Saving more of the money you already have will require you to make some lifestyle sacrifices. Yeah, you could save a few bucks by cutting out your daily latte. But, if your serious about saving money, that means spending less on your big 3 expenses of housing, transportation, and food.
If you’re unwilling to scale back your standard of living, you’ll need to find a way to make more money.
There are three ways to make more money.
Make more money per hour.
Work more hours.
Start a business.
The more you can increase your take-home pay, the higher margin of error you give yourself within your budget.
That’s all you need to know
To be great at managing money, you don’t need to be Warren Buffett. You just need to learn six simple concepts.
Tracking your money.
Building a strong emergency fund.
Paying off debt.
Adopting a simple investment strategy.
Taking a simple “goals-based” approach to budgeting.
Tilting the numbers in your favor.
I’ll leave you with one final thought, which is that the “technical knowledge” discussed in this article is only half the battle. To become great at managing your money, you also need the right money mindset to ensure you stick with your plan through the good times and the bad. If you can learn these simple concepts and adopt the right mindset, nothing is stopping you from having a successful relationship with money.
If you're ready to master your money, don't forget to enroll in my video-based personal finance course, "Millionaire In The Making: The 30-Day blueprint" Click here to enroll.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decision