Pareto in Personal Finance

A couple of weeks ago I wrote about relativity in personal finance -the way things seem to go really slowly until one day you wake up and there have been enormous changes, seemingly overnight.

Today’s post is similar.

At first personal finance seems baffling, overwhelming. We don’t learn it in school and most of us don’t learn it at home either. Clearly we should leave it to the pros.

But in personal finance, like in many other fields, the Pareto Principle applies. This says that you can get most of the benefit from a small amount of effort.

I often mention this in seminars: at first you can start with some simple rules of thumb, then you learn all sorts of new information and ideas, which confirm that the initial rules of thumb were right after all 😉

There is an additional benefit too. Initial small successes often encourage people, so they end up making more effort and learning more as the whole process becomes more fun and interesting. Nothing succeeds like success.

So what are the really effective simple things we can start with? Well, here is my top ten ways to get started with personal finance and transform your life.

1. Decide to change. I also call this waking up. This is probably the most important thing you can do and it can be triggered by almost anything: a life event (for me losing my job was a big one), reading a book (Your Money or Your Life for me), just waking up one day and realizing that your life isn’t going anywhere, or a combination.
2. Figure out what’s going on. Most people have no idea what they spend their money on. I didn’t either, until I started keeping track of my spending. This is really worth doing, at least for a month or two, and there are many ways of doing it. You can keep receipts, write things down in a notebook, but the easiest has to be to put all your spending on a credit card and use Money Tree to track it.
3. Start saving every month. I was never a saver, but setting a really easy goal (a few thousand a month) and going from there makes it easy to create a saving habit. Some key tactics: have a separate account to save in, take the money out as soon as you get paid, and track your savings pot. Every so often increase the monthly amount. You’ll be saving more than you believe possible in no time.
4. Optimize spending. I used to spend money on things that baffle me now. Figuring out what is important to you and what isn’t is the key to personal finance. Once you know this you can then spend more money on the things that truly make you happy while spending less money overall. And don’t say everything is important: if everything is important then nothing is 😉
5. Optimize your home. For most people rent or mortgage is their biggest expense, so it makes sense to get it right. Some things that made my life better: deliberately trying to reduce my commute and make it more pleasant, moving to a much smaller place (we had to get rid of a lot of crap and it’s much easier to clean, not to mention cheaper), and making home improvements to make it more livable and economic (insulation).
6. Start investing. Most people don’t understand investing and find it intimidating. The natural inclination is to hire an expert to do it for you. After all, this is how we approach almost everything else in our lives, from medicine to plumbing. Unfortunately, this is generally a bad idea with investing. The experts are not necessarily any better at investing than amateurs, and there are big incentives for them to recommend expensive products to you in order to get commissions. On the other hand, investing is a big piece of keeping and growing your wealth over time without losing too much to inflation. The best place to start is to open an iDeCo account if it makes sense for you, or to use a robo-advisor.
7. Sort out your insurance. Japan spends eye-watering amounts of money on insurance, much of it unnecessary. Do you know how much you are paying for insurance? Do you know what you are being promised in return? Are you aware of the alternatives? It is well worth taking some time to think about your options and make sure you are paying for insurance you need. This is one area where a financial planner can really help, as long as they are independent and working for you (as opposed to working on commission for an insurance company). I’m also planning to take a look at this topic soon on the blog.
8. Think about the future. Do you have a road map for your life? Do you have a rough idea of what you think will happen, and how much money you will need at various stages? This is called a life plan, and most of the time things won’t turn out exactly as you planned, but at least if you have a plan you’ll have thought about things before they happen and have a better chance of responding well to life events. I also find that making a plan tends to help good things happen, even if they aren’t the exact things you planned.
9. Talk to your family. You can have the best personal finance habits in the world, but they’ll be useless if your family isn’t on board. My wife finds investing dreadfully boring, but we sit down every few months and I walk her through what we are doing and why. I also make sure she has all the account numbers and logins for our accounts. After all, I could get hit by a taxi tomorrow. It’s also important to be on the same page in terms of spending, etc. Even if you track your spending and focus on optimizing it, but the rest of your family spends wildly you won’t get to where you want to be. My wife and I are thinking about building a house, but we’re still talking through the details.
10. Give money away. It is possible to get too caught up in saving, cutting spending, being careful with money. Not thinking about it at all is dangerous, but too much is also less than ideal. One easy solution is to start giving money away. There seems to be all sorts of research that says that the best way to use money to increase happiness is to spend it on others. Spending on people around you or giving to charity (as part of your budget) is a way to make yourself feel better, think about the important things in life, and make the world a little warmer.

I think most people could do some or all of these really easily and make a big difference to their lives.

How about you? How many of these are you doing? Anything to add to my list?
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