The following post draws heavily from the personal finance classic ‘The Richest Man in Babylon” written by George S. Clason. The book was first published in 1926, but is as relevant today as it was then. The book highlights various methods to enjoy life and yet achieve financial success by following easy to follow steps.
Following are the steps which can help us achieve financial success:
1. Start Saving Now
Each of us in the working age starts earning an income as soon as we complete our education or become an entrepreneur and start a business. The moment we get our first cheque of earning (salary or profit) the first thought that comes to mind is ‘Let me throw a grand party to celebrate my start of career’. How many of us continue to crave for new gadgets, clothes once we start earning an income?
Its important to realize that while we need to spend to feel happy, its equally important to save. Make a rule to spend only 90% of what you earn, and save the rest 10%.
"This, my students, was the first cure I did discover for my lean purse: 'For each ten coins I put in, to spend but nine.” – Quote from the book
2. Budget your expenditures:
How can we save wisely and spend wisely. Budgeting expenses and income is a method we can adopt to achieve smart planning.
You can follow the following steps:
Start by just writing down income and details of various expenses incurred over a year. If you cannot remember, look at your bank and credit card statements to find about your spending pattern.
Create various groups of expenses like Food, Health, Clothing, Taxi, Entertainment, Home improvement, Pets, Gifts, etc.
Now, start to tag each expense item as Need (I need this item, cannot survive without it) and Want (I like to have this item, it makes me happy, but I can survive without it).
Next take all the ‘Wants’ and sort them by the money spent on them, with the most expensive “Want” at the top.
Now start to prioritize. You may still like to spend on all ‘Wants’, but still try to eliminate the most expensive want which does not give you ‘bang for buck’.
“Let thy motto be one hundred percent of appreciated value demanded for each coin spent.
Therefore, engrave upon the clay each thing for which thou desireth to spend. Select those that are necessary and others that are possible through the expenditure of nine- tenths of thy income. Cross out the rest and consider them but a part of that great multitude of desires that must go unsatisfied and regret them not. Budget then thy necessary expenses.
This, then, is the second cure for a lean purse. Budget thy expenses that thou mayest have coins to pay for thy necessities, to pay for thy enjoyments and to gratify thy worthwhile desires without spending more than nine-tenths of thy earnings." - Quote from the book
3. Invest regularly:
Albert Einstein is reported claimed to have said that ‘Compound Interest is the Eight Wonder of the World. No sooner you start to save your hard earned money, you should start investing it. Investopedia defines Investment as follows: an investment is an asset or an item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth.
All investments are done to produce streams of additional income in future. This additional income, if once again invested further produces additional income. This is the process of compounding, which over longer periods of time produces a magical effect of large gains.
"I tell you, my students, a man's wealth is not in the coins he carries in his purse; it is the income he buildeth, the golden stream that continually floweth into his purse and keepeth it always bulging.
"Behold, from my humble earnings I had begotten a hoard of golden slaves, each laboring and earning more gold. As they labored for me, so their children also labored and their children's children until great was the income from their combined efforts.
"This, then, is the third cure for a lean purse: to put each coin to laboring that it may reproduce its kind even as the flocks of the field and help bring to thee income, a stream of wealth that shall flow constantly into thy purse." – Quote from the book
4. Manage Risk:
Once you decide to invest your money, you are faced with various choices to do so. You may choose to invest in Stocks, Bonds (debt given to companies or governments), Art, Gold, Property, etc. How do evaluate which option to invest. There are mainly two considerations which should drive any investment decision – a) Return and b) Risk
a) Return on Investment is usually the most sought after reason driving most investors allocation to various investment options. It is the primary reasons why most investors end up making investments in fraudulent schemes, overvalued stocks or below investment grade bonds. However, due consideration must be given to the other element also while making such decisions.
b) Risk in Investment is defined as chances of permanently losing capital in any investment operation. According to Warren Buffett, there are just two rules of investing; Rule #1 Never lose money and Rule #2 Never forget Rule #1. While a higher return on capital can seduce you into investing in highly risky assets, a permanent loss of capital can sharply bring down your future investment corpus.
The first sound principle of investment is security for thy principal. Is it wise to be intrigued by larger earnings when thy principal may be lost? I say not. The penalty of risk is probable loss."This, then, is the fourth cure for a lean purse, and of great importance if it prevent thy purse from being emptied once it has become well filled. Guard thy treasure from loss by investing only where thy principal is safe, where it may be reclaimed if desirable, and where thou will not fail to collect a fair rental. Consult with wise men. Secure the advice of those experienced in the profitable handling of gold. Let their wisdom protect thy treasure from unsafe investments." – Quote from the book
5. Own Your House
Ancient wisdom recommends ownership of house property in which we live. The rationale is that it saves one from paying rental and also saves oneself from paying a higher price for property in the future. However, according to us, this is debatable and can depend on circumstances. If the properties are priced dearly compared to rental which can be paid to rent a property, it makes sense to stay on rent. Thus, till the rental yield (annual rent / market value of property) is low, one can take advantage to rent a property and once the yield crosses your home loan borrowing rate, it is sensible to own a property even by taking a home loan. Own home gives a strong sense of emotional satisfaction to us and hence it makes immense sense, at some point in ones life, to own the home in which you want to live in.
"Thus come many blessings to the man who owneth his own house. And greatly will it reduce his cost of living, making available more of his earnings for pleasures and the gratification of his desires. This, then, is the fifth cure for a lean purse: Own thy own home"– Quote from the book
6. Create a nest egg for your retirement
One of the prime objectives of saving and investing should be to create a ‘nest egg’ to help you manage finances after your retirement. Each one of us need a steady stream of income to maintain our standard of living, even after retirement. However, by definition, we cannot earn an income by serving someone else after retirement. Thus, to meet our expenses post retirement, we need to depend on income from our investments or the income from our ‘nest egg’ we saved while we were enjoying our prime earning years.
"This, then, is the sixth cure for a lean purse. Provide in advance for the needs of thy growing age and the protection of thy family." – Quote from the book
7. Improve your earnings power
We should all remember to constantly upgrade our earnings power by learning new skills, acquiring new knowledge. Remember that the best investment we can make is in our self. If we improve our ability to do work done by our superiors, are able to take higher responsibilities and perform more complex roles, we can improve our earning power. Thus, with the same effort, we can increase our income, save more and invest more and thus create a virtuous cycle of increasing incomes.
"Thus the seventh and last remedy for a lean purse is to cultivate thy own powers, to study and become wiser, to become more skillful, to so act as to respect thyself. – Quote from the book