The 4 Principles of Money Decisions

Managing money is simpler when we stick to a few principles.

Given that life can throw anything at us, it’s impossible to anticipate exactly what to do in every scenario. Principles serve as helpful guideposts. They allows us to stay true to what matters. They help us recognize the noise so we don’t get distracted.

Simple isn’t the same as easy. It’s like exercising. The benefits of exercising are clear. It improves every aspect of my lives. I should move our body every day. It’s simple, but it takes work. Even though it is simple, I don’t do it enough.

Simple does mean doing less. It involves doing a few things right. In return, it offers us clarity and peace.

The four following principles came together as I learned more about myself and my relationship with money over the years.

These principles are designed to spend the least amount of time on money matters over the long term so that I can redirect my energy to other aspects of my life.

Principle #1: Save With Conscious Spending

Saving involves two components: income and spend. It’s about managing the relationship between the two.

To save means to spend less than your income. If your income is $10k and you spend $9k, you save $1k (a savings rate of 10%).

When you have savings, you build your wealth. Wealth gives you options. It helps you weather the uncertainties in life.

When your savings rate is negative, you withdraw from your wealth. Sometimes that is unavoidable with accidents or major life events. But dipping into your savings due to recklessness is unsustainable over the long run.

How much you have left at the end of the the day matters more than how much you make. You can make $100k, but spend $200k. When that happens, you are enslaved by your own spending.

In Practice

In the short term, you have more control over your spend than you income.

You first need to see your spend. Download your bank or credit card statements. Separate your spend by category: housing, food, shopping, etc.

Pay attention to the discretionary spend. Do you really need that fancy phone, a daily coffee run, and those new clothes? Do you need to eat out four times a week (I’m speaking to my past self on this one)?

Pay attention to the recurring spend. Do you really need five entertainment subscription services on top of your TV + Internet package? Do you even use them? Do they add value to your life or take away your life?

The question to ask is, “Does this spend align with my values?”

Saving is not penny-pinching. It’s about being mindful of what you are spending on, and why.

You may conclude that your grocery bill is a bit high but reasonable, since you get fresh food that nourishes your body. It aligns with your values to stay healthy, use less plastic, and consume sustainably. It can be a wonderful, conscious choice.

Can you increase your savings rate by 1 point this month by making more deliberate choices?

Principle #2: Invest Now/Early

The most powerful force in investing is the amount of time it has to grow.

If you invested $100 in the S&P 500 in 1990, your investment would have grown to $2,500 as of February 2022, with an annual return of 11%. If you invested the same $100 in 2010 instead, your investment would now have a value of $500, even though the annual return would have been higher at 15%.

Why Time Is Important

First, time allows for compounding.

Compounding means the gains from an investment are reinvested for further gains. Say an investment of $100 in 1990 becomes $108 in 1991. If the return on investment is 8% in 1992, it applies to not only to the original $100 you invested, but the entire balance of $108.

The difference is not obvious in the first couple of years. But the math snowballs. The difference over the years add up to a staggering amount.

Second, time smoothes out fluctuations. The world is unpredictable. Every few years we see major events: economics crises, pandemics, and geopolitical conflicts. But if your time horizon is long because you started early, then these blips don’t matter as much.

Despite many recessions, wars, and inflation concerns, the S&P 500 grew an average of 9% annually since 1930, even though there were many years with negative return in between. Over the long term, the economy recovers. Innovation happens. Confidence returns.

What To Invest In

If you are convinced by the benefit of investing early, the next question is what to invest in.

What you invest in is a deeply personal choice.

My choice is simple. My investments are mostly S&P 500 index funds (I use Vanguard and Fidelity), which means that I am investing in 500 companies through one investment.

The long term trend of the American economy in the last 80 years has proved to be persistent. This gives me confidence to hold these investments indefinitely, and let time do the work.

I also like that I can contribute as little as $200, or as much as I want. These funds are also highly liquid, which means they can be converted to cash easily.

I have little interest in spending time on researching the stock market. I tried, but I didn’t enjoy it. I’d rather spend the time elsewhere. That is just me.

While I say start early, don’t feel beat up and look at what you have missed in the past (speaking to myself again on this). What matters is what you choose to do now. Today is nothing but yesterday’s tomorrow.

Whatever you decide, start small to test the water, and go from there.

Principle #3: Evaluate the Trade-offs

Money decisions come with two trade-offs: risks and time.

The Risk Trade-off

You can pour every dollar into Bitcoin. You can borrow money you don’t have (known as a margin loan) to buy stocks. You can play with financial derivatives to speculate the market. Your return can be spectacular if you get it right. But you can also be ruined.

Nothing is free. Higher returns mean higher risks. Risks mean that someone gets lucky and others don’t. The only thing that matters is whether you can accept it.

It doesn’t mean to always go with the lowest risk decision. If you park 100% of your money in cash, the risk is the lowest, but the money loses value due to inflation. Your money is worth less every year.

A rule of thumb is to take risks that will allow you sleep at night. Money decisions shouldn’t come at the expense of your peace of mind. You should know what the risks are. You should ensure that you won’t lose your mind even if the outcome goes wrong.

The Time Trade-off

Contrary to the common saying, time is not money. Time is your life. It’s a non-renewable resource. Every second that passes is a second you don’t get back.

At multiple points in you life, you will face an opportunity to trade more time for more money. A classic example is a new job opportunity or a promotion. You will get paid more, but you need to put more time in. Should you take it?

Sometimes you should. Sometimes you shouldn’t.

If you find the new work fulfilling, it may make sense to trade the extra time with better pay as a bonus. If you already don’t have enough time for your family, spending more time on the job will make everyone more miserable. If the job is going to be demanding but only for a defined amount of time, maybe it is still acceptable because it allows for more freedom and independence down the road.

These decisions are not clear cut. No one can answer for you whether a choice is right or wrong. There is only the choice that makes sense to you after you consider the trade-offs at this point in time.

Principle #4: Create Joy With Money

If you manage to build up a bit of savings or investment, congratulations! Here comes another important aspect of money: spend it to create joy. After all, we are human beings, not human savings.

If I ask what matters to you in your life, you will likely say some combination of work, family, friends, community, growth, well-being, spirituality, or impact to the world. Even if you say money is important, what you really mean is what money enables you to do in these important areas of your life.

Money is not the end goal. That would be silly. Money itself has no intrinsic value. It’s a piece of paper, a number on a screen. The value resides in what it can be exchanged for.

Joy is the simplest, most readily available indicator of what matters to you. It’s in your heart. You can feel it.

Let me give you more examples.

If family is important: Hire a babysitter so you can go on a date with your spouse. Pay for a gardener so you have time to take your kids to a local museum. Take a family trip so you can spend quality time together.

If friends are important: Treat your friends to a nice dinner. Take them to a concert they will enjoy. Buy a fun game so you can play together.

If community is important: Donate to your local church or favorite charity. Sponsor a child’s education in a less advantaged area. Give money to someone truly in need. Expect no repayment.

You get the idea.

These examples involve other people. That’s the point. Joy comes about when we spend money (and energy) on other people.

Focus on creating opportunities for time and experience together. Buy time with money. Stuff doesn’t give us lasting joy. Memories and presence with each other do.

All of the above can also be done with little money. A “trip” can be a local park or museum. Your donation can be $10. A dinner may cost $50. Your intent matters more. Do what you can.

Unlike money, the scorecard of the areas that matter to you don’t show up in a bank statement. They show up in the face of your friends and family members. They show up in the result of your physical check-up. They show up in how you feel when you wake up in the morning and when you go to bed at night.

The ROI of creating joy is infinite. Isn’t that what matters the most at the end of the day?