Take a seat over there, grasshopper
There are basically three things you need to become capable at if you want to do well with your personal finances.
- Earning money.
- Saving money (not spending it all).
- Investing money.
Being good at one of these and bad at the other two is a recipe for poverty. Just ask Mike Tyson, who earned over $400 million and ended up declaring bankruptcy and appearing in sketchy movies to try to pay his debts ;)
If you are good at two out of the three you will do okay and be comfortable.
Master all three though, and amazing things happen.
The interesting thing, and this came up in a Facebook discussion yesterday, is that there seems to be an optimal order in which the three elements should be learned.
Learning to save, to spend mindfully, to become frugal is the base. If you haven't made this a habit yet earning more or investing like a genius won't help as much as it should. This is the reason lottery winners often go broke: they hadn't mastered spending when they got all that money, so they just spent it all. This is also why receiving a large inheritance can be so dangerous for many people who aren't used to managing money.
Once you have figured out how to live below your means and use your money effectively so that it provides happiness for you, earning more turbo-charges the process. If you are happy spending x, then anything you earn over x can be saved or invested without affecting your base happiness. For frugal spenders, earning more has unlimited potential: there is no upper limit on how much you could earn.
Investing is usefully seen as a way to keep your money or grow your money, as opposed to a way to make your money. Trying to invest your way to riches is unlikely to work, and can lead you to make risky decisions.
The safe and steady approach to investing (low cost, diversified, passive) works best with larger amounts of money. It's pointless to focus on investing if you don't have much in the way of savings. Even a world-beating return isn't going to make any practical difference. In a way, this works in our favour: making mistakes with small amounts of money is easy to recover from, and the lessons learned can help you as your net worth gets larger.
What do you think? Have you mastered the three elements? Do you agree that they are best learned in order?