The Ten Financial Commandments, Part One
These top ten commandments come from Andy Hart, a previous guest on the Meaningful Money podcast and a financial planner over at Maven Adviser. He uses these as a hook in review meetings with clients, and I found them helpful.
The commandments form a framework for thinking about money and challenge many of the automatic assumptions that people make, including me. Think of them as timeless truths of finance.
1. The Stock Market Rewards the Patient, and Punishes the Rest
This is a succinct way of putting across the idea that it’s not about timing the market, but time in the market.
You can try to move in and out of the market, timing your trades according to what you think is going to happen. At the sharp end, this is known as day trading, and it means going into and out of the market, sometimes several times in one day. In my opinion, day traders are idiots with money to burn, and this is not the way for most people to get rich.
To build wealth, you need to do slowly and patiently. It doesn’t sound like fun, but it is when you can see money building.
When you’re in the market for a long time, you get the benefit of compounding of dividends – if you’re holding shares in a company and they make a profit, they issue a dividend and that’s income for you.
If you roll those dividends back in and buy more shares, there’s a fantastic compounding effect, which makes a huge difference over time.
Nobody can foresee what will happen in a market, so it’s better to be in it for a long time, harness the power of compounding dividends and let time even out the ups and downs.
2. Rising prices (Inflation) can be your best friend and your worst enemy
Inflation is necessary for a healthy economy. Prices should rise steadily each year, which is fine so long as earnings rise faster than inflation – then you get a little better off every year. The companies selling what you’re buying are also making more money, because of the rising prices, so everybody wins.
The problems arise when earnings don’t rise faster than inflation. This is something that public sector workers have experienced in the recent past, as there have been freezes to prevent pay rises. Those with a level pension will also know that its buying power will go down each year – it doesn’t rise.
Inflation is a particular problem for those in retirement, often because people have opted for static income levels. In retirement, most money is spent on food and fuel, which generally go up in price faster than the headline rate.
You may be aware of the regular updates about inflation, which uses either the Consumer Prices Index or the Retail Prices Index to measure the changes. These look a basket of goods with an average price – they assess whether the prices of the items have gone up or down. The problem is, you may not spend money on those average goods, so inflation could look better or worse for you.
When it comes to investments, inflation can work in your favour, because when everything is normal and healthy, companies do better and their shares will go up. Money held in index-linked bonds will also benefit.
Don’t forget, when we’re talking about returns, we’re looking at after-inflation returns, because that’s where it matters.
3. Long-term returns come from investing in the great companies of the world
Investing in shares is the best way to secure long-term returns, especially if you reinvest the dividends. There are other good ways to invest of course, such as property and fixed-interest investments.
I always preach multi-asset investing, which means you should have a bit of everything. This provides balance for ordinary people, and you shouldn’t be invested fully in shares, but in other assets too.
What you choose to invest in depends on your goals, tolerance for risk and timescale you have, because it makes your investing journey more predictable, which is a better place to be.
4. All saving needs to be automatic, or it won’t happen
Few of us have the discipline to get our income in at the start of the month, spend only what we need and have some left over. Expenditure rises to meet income, so instead of saving whatever is left, we spend it.
Instead, what we should do is immediately put some money to one side, and budget with what’s left – doing it the other way round won’t work. Do this as soon as you can in your pay cycle, and set up standing orders to your savings or investments accounts.
5. Having and updating your financial plan is paramount – Having a portfolio is not a plan, and outperformance is not a goal
The financial plan is of the utmost importance, not the money which underlies it. Most people come to me for help and say: “I’ve got some money, what should I do with it?” And I always say: “WHY do you want to invest it?” If you don’t have a good enough reason, just spend it.
Think of the money as the fuel to get you to your destination, but the plan is the road you’re driving on. Sometimes, you might take a wrong turn, or circumstances arise which force you to change course mid-journey, but this is why you should review and update your plan.
In next week’s post, we’ll be looking at the last five financial commandments.