Do you live pay cheque to pay cheque every month? How about your credit bills, do you pay just the bare minimum at the end of every month? Would you end up borrowing money if a recession hits us tomorrow?
If your answer to the above is yes, then you might have a problem, especially if you intend to start investing a large portion of your currently available money.
The Bogleheads’ Guide to Investing, a book written by a group of investors heavily influenced by Vanguard Group Founder John “Jack” Bogle, advocates these three important steps any investor should take before starting off their journey to financial freedom.
1. Stop Living Pay Cheque to Pay Cheque; Think About Long-term Net Worth
Most of us grow up to believe that earning a fat pay cheque every month would make us rich. But as the Boglehead authors wrote, “society conditions us to confuse income with wealth.”
Income is the amount of money one earns in a given period of time. For example, our monthly salary, dividends from stocks, any form of money that enters our bank accounts because we earned it.
Wealth, on the other hand, is the amount of money one keeps. For example, if you were to save at least ten percent of your monthly income, that amount is added to your overall wealth – or net worth.
Doctors, lawyers, businessmen can earn tens of thousands of dollars every month. However, if they are not able to keep (at least) some of that money in their bank accounts to let their wealth accumulate and grow, they probably won’t have a high net worth.
Without money in one’s bank account, how can one invest? Sure, one can always trade or invest on leverage, but the losses will only keep us further away from our financial goals. Worse still, we might be debt-ridden.
2. Consistently Clear Monthly Credit Card Bills
Apart from money that one keeps, one needs to pay close attention to the money one owes. A quote from filmmaker and author Nathan W. Morris puts it very aptly, “Every time you borrow money, you’re robbing your future self.”
Spending borrowed money or money you haven’t earned, essentially depletes your total net worth slowly, especially when you consider the ridiculous interest rates from credit card companies.
It is in your best interest that you try your best not to have outstanding credit card bills. If you’re afraid you might go out of control, cancel the credit card and use a debit card instead.
This includes high-interest debts. One of the few loans most of us Singaporeans should have is our housing loans. The Bogleheads also mentioned about cars. While cars in the US are a lot cheaper, we can consider their suggestion – second-hand cars.
Lesser (low-interest) debts or no debts at all would mean that more of what you keep adds to your net worth.
3. Set Up an Emergency Fund
A lot of things can happen in a lifetime. Bad things tend to hit us like a truck when we least expect it, almost every single time. Instead of telling oneself how “suay” and unlucky one is, think about preparing for unexpected events.
The Boglehead authors wrote about insurance, which is one of the best and direct ways to deal with unexpected events. But let’s focus more on saving in this article.
The size of the emergency fund depends very much on one’s net worth and job stability. If one is in an “iron bowl” job, which includes public sectors and other professions where layoffs are rare, three months worth of living expenses would suffice.
However, for entrepreneurs and employees working in volatile and uncertain industries, such as the oil & gas sector currently, six months to a year’s worth is a safer bet.
Knowing that one has an emergency fund stashed away, safe and liquid in a savings account, one would be able to sleep a lot better at night. Also, when you’re investing towards your long-term financial goal in the future, the last thing you’ll want to do is to sell your holdings to survive.
1. Save at least ten percent of your monthly income every month.
2. Clear your credit card bills monthly, if not, just use a debit card or cash.
3. Set aside an amount of at least six months to a year of expenses.