Having talked about investing, planning for pensions and the types of insurances and protections available, I want to now go back to the roots of it all, and I’m going deep into the ‘First Principles’ of finance. These are the fundamentals, not the basics, and I want to get really stuck into what they are and how best to apply them into your daily financial lives.
When engaging in financial planning at any level, we need to start with the end in mind, or as far as possible. Very few people can visualise in detail where they hope to be in five years’ time, let alone 25, or 35 years when they retire. You need to define for yourself what retirement is, and what it means to be wealthy.
The second of my first principles is all about control. Essentially, you need to control your money or it will control you. Money is not an inert force. It moves about, and often disappears quickly enough.
Portfolios can go out of whack, star funds can become dogs, markets move of their own volition. But there are some areas where you have complete control, and we understand what they are and how to impose that control for your own benefit.
No discussion of personal finance is complete without a thorough understanding of how compounding works. While most of us have a sense of the basics, there are ways you can accelerate compounding to your distinct advantage.
To be successful, you need to understand the practical benefits not just of compounding returns, but controlling the negative compounding of costs and tax. It’s also helpful to get to grips with compounding the benefits of some good behavioural tactics. Add this stuff together and it’s a formidable arsenal – you won’t believe the difference in the figures.
Anyone with any experience of investing knows that risk is a necessary part of wealth-building success. Risk is a fantastic thing. It is a lever we can pull for our own benefit; we just need to re-centre our relationship to it. If we can do that, we can learn to welcome and even celebrate market downturns and see them as opportunities, not reasons to panic.
Inflation is, for many of us, a theoretical concept. The main reason for that is that while you are working, your earnings generally rise ahead of inflation. That’s in a healthy employment market.
Inflation is an essential thing to get your head around as you plan into the future. When you’re projecting your plans towards retirement, you need to know how to account for it and how it can affect your investment portfolio.
Achieving growth in any portfolio is essentially simple – you need to invest in equities. An investment in shares is an investment into capitalism, the system which, while far from perfect, is the only one we’ve got that can secure your financial future. You need to understand the impact of diluting equities with other holdings, and why it still is a good idea to do so.
We all tend to think of that in terms of compound interest and growing our money exponentially, but the negative compounding of costs is profoundly important to understand and will influence how you invest. Cost has an impact at all levels of an investment portfolio, and tax is a massive cost you need to try and eliminate to the best of your abilities.
I think that understanding behavioural finance is hugely important, and it’s something I talk about with my podcast guests. I’d like to point you to my interviews with Greg Davies of Centapse, because I think it’s the most helpful conversation I’ve had. NB – this interview is in two parts.
Getting our behaviour right is so, SO important – it’s hard to overstate it. You need to have a clear overview of again the main biases and tendencies we bring to our finances and have some ideas of how to overcome them.
True financial success is about blending an understanding and proactive activity under all these headings, and you need to take some high-level actions to maintain the momentum of your progress towards financial freedom.
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