It’s not how much you earn, but how much you can save or grow your money.
Even at the same income levels, some people always seem short on money. At the same time, some of their peers always seem flush with cash. The reason isn’t some big financial secret – most of the time, it’s due to small money habits that anyone can learn.
Having a Five Per Cent Rule
It’s a good idea not to throw all your money into high-risk investments. But at the same time, you won’t get far ahead putting money only into low-risk investments – that’s because the higher the risk, the higher the pay-out.
Smart investors have a balance between the two. They don’t subscribe to the idea of only safe investments, or only risky investments – such a view is too simplistic.
The five per cent rules states that five per cent of your portfolio should be in alternatives, which can also be high-risk. For example, if your total portfolio is $30,000, you could put $1,500 into an alternative such as gold, or even a high-risk alternative such as P2P lending.
Alternatives like gold have an inverse relationship to conventional investments, such as stocks and bonds (when the stock market is crashing, gold prices will rise, as people rush to put their money in a “safe” asset). This means that, when your unit trust funds and bonds are not doing well, your gold can compensate.
As for high-risk alternatives, such as P2P lending, the high returns make up for your lower risk assets. For example, if you have a safe investment such as Singapore Savings Bonds (SSBs) appreciating at 2.6 per cent interest per annum, that doesn’t cope well with inflation (about three per cent).
You might put five per cent of your portfolio into a riskier, actively managed fund to get seven per cent per annum. This balances out the low returns of your safe assets – and if your risky assets happen to go wrong, they can’t do too much damage (they only make up five per cent).
Speak to your financial adviser on how to build a balanced portfolio this way.
Learning How to Use Loans Properly
Not all loans are bad. Savvy investors know how to use loans for leverage (i.e. to generate higher returns, that more than pay the cost of the loan).
For example, say you use a loan to purchase a car. This would be a bad loan, as the car is a depreciating asset (the value can fall by as much as 60 per cent in the first year). Barring some circumstances (e.g. you are an Uber driver), the loan probably costs you more money than the car will ever make.
But say you use a loan to get a degree instead. In Singapore, Diploma holders have entry level pay of around S$1,500 to S$2,500 per month, whereas Degree holders have an entry level pay of around S$3,000 to S$3,500 per month. Over the course of the first few years, the difference of S$500 to S$2,000 per month would more than pay off the loan.
Over 15 to 20 years in the workforce, the higher pay – along with a higher income ceiling – would make the cost of the education loan almost irrelevant. That’s an example of a good loan.
Saving and budgeting are important, but it’s just as vital to understand leveraging.
Actively Pursuing Income Growth
A defining difference between the rich and the poor is their attitude to growth. Knowing how to scrimp and save is important, but that alone won’t bring you financial freedom.
The reason is simple: there’s a limit to how much you can save. If you make $3,000 a month and spend $500 on basic necessities, then you can never save more than $2,500.
But if you constantly experiment and try to stretch your income – such as by taking on side jobs or trying to run a side-business, there’s no theoretical limit on how much more you can earn.
The truth is, for most people, a nine-to-five paycheck is never going to result in affluence; only stability. It’s the ones who actively try to grow their income who have a shot at wealth.
A simple guideline is to try and grow your monthly income by 10 per cent, every year. For example, if you made $3,000 per month, try to make $3,300 per month in the coming year. You won’t always succeed, but you should at least make the attempt.
It may sound absurd, but many people spend money on things they don’t actually want.
For example, consider the people who spend money on gym memberships, but then never go. Likewise, there are people who spend more than they have to on the home loan (they don’t refinance even if a cheaper deal is on the market) or buy expensive coffee when a cheaper, equally good cup is right across the street.
This is buying due to novelty or convenience, rather than actual desire. In the above example, we may buy expensive coffee not because we savour that brand, but just because it’s in the same office building.
The financially successful cultivate a high resistance to this behaviour. It’s not they don’t spend – they’re just careful to direct their spending toward things that truly satisfy them.
Avoiding Analysis Paralysis
The financially successful take action. They do their research beforehand of course, but they resolve to undertake a particular action by a certain time. For example, they may not be sure if now is the right time to buy a house – but they will set a date by which they’ll either buy or decide not to.
This avoids “analysis paralysis” – a situation when there are so many options, you end up learning about all of them and doing nothing. A classic example is the person who spends $5,000 on finance books and seminars but doesn’t actually start investing in anything.
The financially savvy know when it’s time to stop looking around, and just act. Give yourself deadlines and rules (e.g. when you’ll make a decision to invest, and under what conditions you’ll pull your money out), and follow them. Otherwise, you’ll never get started.
A version of this article originally appeared on www.singsaver.com.sg, a personal finance comparison site with useful tips and guides to empower everyone in Singapore to make sound financial decisions.