Financial management is not a simple task for most people. There’s no shame in admitting that. It’s the first step towards overcoming the challenge of building wealth as opposed to living from paycheck to paycheck.
One thing that contributes to the level of difficulty is the fact that many of us start off at a disadvantage. Few people are trained in financial literacy from childhood. When we realize that we want to turn things around, we’re already in the middle of a tangled mess.
So even if it’s actually a complicated situation, your best bet is to start by simplifying things. With basic math, you can start tackling an intimidating problem.
Your income needs to exceed your expenses. It’s just arithmetic. Add more than you subtract. Do that, and you can’t fail to set aside some extra cash each month. Ignore the equation, and there’s no way you can build wealth.
If you’re overwhelmed by trying to grasp the whole picture, don’t even try. Just focus on improving in specific aspects. Use the kaizen philosophy; take small steps to get better each day.
Seemingly minor changes to your lifestyle can have a domino effect and help your finances in multiple ways. Make it a routine to get a good night’s sleep, wake up at the same time each morning, and exercise at home for half an hour. Your health will improve without spending on gym fees, you’ll feel more energetic without buying stimulants, and your medical expenses will go down.
Look for opportunities to apply similar changes that bring value in multiple areas around the home. A simple swap of your current ceiling lights for a LED panel, for instance, lowers energy consumption for illumination. But it also emits less heat and thus reduces the workload on your AC. Smart purchases will go a long way without complicating your decisions.
Measuring your value
When you have a stable cash flow, you can begin to worry about some more advanced operations. This covers the area of increasing your revenue streams.
Employees earn money on the basis of exchanging their time and effort for compensation. You can leverage this in two ways. If you’re involved in doing something specialized and valuable, employers will be more willing to raise your wages.
But if that’s not an option, you usually work with another approach: exchanging more time and energy. And there’s a mathematical limit on that. We only get 24 hours each day.
The math involved here isn’t so simple, because you’re no longer just balancing incomes and expenses. You’re converting one form of resource (time and sweat equity) into another (money). And unlike foreign currency, there’s no standard exchange rate to guide you.
It might not seem like a problem at first. You take on a side hustle; any extra income is good, after all. But then you start feeling exhausted at the end of each day. You begin spending more on small conveniences, rewarding yourself to feel better. Those gigs can end up being counter-productive.
Solving this problem first requires you to clearly define the value of your time and effort. Use your day job as a baseline. Get the total amount of your take-home pay, and divide it by the total number of hours you spent earning that money, including unpaid but work-related time such as commuting.
The result will be a measure of your value on an hourly basis. It will guide you in deciding whether it’s worth your while to take on an additional gig. It also helps you to re-evaluate your purchases and investments.
Taking calculated risks
The last bit of math involves dealing with probabilities. With some practices, you can eventually set aside enough money to consider investing. But people who are impatient or impulsive with money tend to seek high-risk, high-reward opportunities.
Some form of investment is better than none at all. Historically, the stock market has offered nearly 10% returns on average over a 10-year period. That’s way better than a savings account or CD. But it might prove too slow for your goals and timelines of building wealth.
The Pareto principle offers a reasonable rule of thumb when managing risk. Most of your money can remain in a happy, mediocre, low-risk fund. But a small percentage can go into more speculative investments.
The same guideline can apply to starting a business, which has the potential to earn far more money than you make at your day job. Don’t quit your regular source of income just yet. Split your time between the two, and see how things work out.
With risk-taking, nothing’s guaranteed. But if you’re smart about it, you can make small bets with potentially high rewards, and not stand to lose everything.