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The 3 Golden Rules of Personal Finance

There are 3 golden rules in personal finance that when followed, will guarantee financial success. It’s not hyperbole to say this will likely be the most valuable advice you’ll ever receive. Below are the 3 golden rules of personal finance.

Rule 1: Spend less than you earn

I realize this principle sounds annoyingly simple and easy to overlook, but as Leonardo da Vinci said, “Simplicity is the ultimate sophistication.” Whatever your income, putting a portion of it aside to pay yourself before all other obligations and making this sacrosanct is the single most powerful money habit you can develop. Pay yourself first before your mortgage, electric bill, or phone bill. Most people forget to do this, and they have no money left to save for themselves at the end of the month.

“A part of all you earn is yours to keep.” - The Richest Man in Babylon

Okay, that's fair enough, but how much do I need to save? According to the great Arkad from the Richest Man in Babylon, it should be no less than 10%, regardless of what you earn. Most financial advisors today suggest saving between 15-20%. But if you’re new to this or have struggled saving in the past, give yourself a little grace and start by saving 1-2% and slowly scale up. You’ll find it’s much easier than you think, and watching your savings grow will provide you with all the motivation and validation you need to continue your momentum.

Whether it’s 1%, 10%, 20%, or 50%, getting in the habit of paying yourself first and spending less than you make is the foundation of personal finance. But saving and paying yourself first is only half of the ‘spend less than you earn’ equation. The other half is limiting your expenses to what remains after you pay yourself and not letting your outflows exceed that amount—no matter what. I’ll get some pushback on the “no matter what” part of that statement, which I will address in a future post.

Using simple numbers, let’s say your household income is $60k, so your monthly take-home pay is $5,000. You pay yourself 10% first ($500), leaving $4,500 for all your remaining expenses. Next, you allocate funds to your core expenses (food, mortgage/rent, utilities, transportation, etc.) and then to your discretionary or ‘lifestyle’ expenses. Defining and identifying what discretionary expenses mean to you (wants versus needs) is a topic that gets hairy, but ultimately, how you spend your time and money reflects your value system. This is the 'personal' side of personal finance. Regardless, if you pay yourself 10% first and keep your core and lifestyle expenses to the remaining 90%, you're well on your way to financial health. Simple, right? Sure is. But simple doesn't mean it's easy. 

Before we move on to the second golden rule of personal finance, I’ll leave you with a quote by Bill Earle that I often hear cited by legendary natural resource investor Rick Rule. It captures this first golden rule well: “If your outgo exceeds your income, then your upkeep will be your downfall.” 

Rule 2: Invest the difference 

Once you’ve built the habit of consistently paying yourself first and spending less than you make, it's time to unlock the money magic: compounding. Compounding is to real life what "Rosebud" was to the Sims. It's like a cheat code for personal finance that virtually guarantees wealth. I'll explain this in detail below, but it can be easily summed up in 3 simple steps: 

  1. Take the portion of your paycheck you are using to pay yourself first (10%)
  2. Auto invest that 10% in a low-cost Vanguard total stock market index fund or ETF (like VTI - Vanguard Total Stock Market Index, or VOO - Vanguard S&P 500)
  3. Wait 30 years, and you're a millionaire 

That's it. It's that simple. J L Collins outlined this perfectly in the Simple Path to Wealth (one of the best personal finance books ever written), and it doesn't need to be and shouldn't be any more complicated than that. 

Using the income from the example in step 1, if we take the 10% that we were paying ourselves ($500 per month) and invest it in a low-cost Vanguard total stock market index fund consistently for 30 years at 10% growth, we end up with a million dollars.

Compound Interest Calculator

Ok...technically, it's only $995,668.84. So, we might have to wait 30 years + a cup of coffee before we hit that $1,000,000.

The S&P 500 has averaged a 10.47% annualized rate of return (with dividends reinvested) over the last 100 years. But if you take issue with me using a 10% rate of return, we can conservatively use 9.07%, which is the annualized rate of return of the total stock market over the last 150 years (with dividends reinvested). Using the 9.07% return rate, it would take 32 years to earn $1,006,315.46. Albert Einstein once said, "Compound interest is the 8th wonder of the world. He who understands it earns it...he who doesn't pays it."

The magic of compounding occurs when you allow your investment to compound. Once enough time passes and your investment reaches a critical threshold, it starts to grow exponentially and becomes self-sustaining in magical ways. To illustrate this concept, let's take our $995,668 nest egg and assume we are no longer contributing to it at all.

Assuming a 4% withdrawal rate per year ($39,828), after 10 straight years of drawing down nearly $40,000 per year from our initial $995,668 nest egg, our new nest egg balance will be...$1,884,330. Yes, you read that correctly. You pulled out nearly $400,000 from your nest egg over the course of 10 years, and not only did your nest egg not go down in value, but it practically doubled.

Take advantage of the magic of compounding by spending less than you earn and invest the difference.  

Rule 3. Avoid debt

Proverbs 22:7 says, "The rich rule over the poor, and the borrower is slave to the lenders." You’re not only enslaved to your lender until you pay off your debts, but you’re also trapped at your employer who you need as the income source to pay off your lender.

If you're taking on debt, you are not spending less than you make and, therefore, violating the first golden rule of personal finance. If saving is about making small and nearly imperceptible sacrifices today so that you can have what's most important to you in the future, taking on debt is about sacrificing what's most important to you in the future to indulge in small and nearly imperceptible pleasures today. It sounds insane when you say it out loud, yet that's exactly what many of us do daily. 

Put simply, we can't afford it if we don't have the cash or money in the bank to pay for it. But in today's Stranger Things-style Upside Down world, debt is promoted and embraced as a perfectly normal part of life. This normalization and acceptance of debt are the biggest reasons why most of us will never achieve financial independence.

It's so confounding when the use of debt is accepted so matter-of-factly that it's almost a challenge to refute. But I'll summarize a few reasons from The Simple Path to Wealth on why debt is financially, emotionally, and psychologically crippling and should be eliminated completely and at almost all costs. 

  • The more of your income you spend on paying your debt, including the interest on your debt, the less you have to take advantage of the wonders of compounding.
  • As mentioned above, being in debt doesn't just make you a slave to your creditors; it also traps you and limits your ability to change jobs or careers or even take advantage of opportunities to follow a passion.
  • When you're in debt, you are under constant stress and duress, and it feels like you are being swallowed whole.
  • Feeling trapped and under debilitating stress can cause you to turn to self-destructive vices to escape, like smoking, drinking, social media, or shopping (which exacerbates the problem).
  • You experience the same types of negative emotions as addicts (shame, guilt, and hopelessness.
  • You enter a state of debt paralysis. Your brain shuts down whenever the subject of debt comes up, and you have this nebulous hope that it will all resolve itself somehow at some point in the future.  

Some may say, “That's exactly how I feel. But I already have the debt, so what can I do about it?” I will share proven strategies and tactics to tackle debt, but that's another topic for another day.

Today's post is about the 3 golden rules of personal finance that I wish l learned much earlier in life than I did (before I took out $65k in student loans and delayed investing for retirement). Had I followed these rules from the time I started working, not only would I be soon approaching a $1,000,000 nest egg, given another 25 years to compound (and assuming I contributed absolutely nothing beyond age 40), that could nest egg would be worth over $10,000,000 at age 65. 

So, I encourage you to follow the 3 golden rules of personal finance and learn from my $10,000,000 mistake. Spend less than you earn, invest the difference, and avoid debt.

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