This week, our colleague Tung prepared a fascinating article about money management. As money management is the most crucial part of trading and we at FTMO are looking for good money managers in the first place, we highly recommend you to spend a few minutes to read the article!
Forget everything and focus on one thing: Money Management
In this blog post, I would like to address one of the most important factors, habits, plans, or whatever you fancy calling it. It’s the topic that you would rarely see people discussing it, and even people who do discuss it, hardly ever practice it and that might make you wonder at times whether the topic of money management isn’t a sacred practice.
Have you ever thought about getting better with your money? If you have ever wondered how rich people manage their money as I have; or maybe you do not come from a wealthy family like myself but want to become wealthy, then this blog post might be just right for you.
We are talking about acquiring wealth by creating a system that we will constantly improve and follow with discipline. It is a set of basic rules that we create and follow, which will eventually lead to a set of habits that will create wealth for us in the long run.
Needless to say that a proper money management system is not only important within your personal finances but it is twice as important when it comes to Forex Trading. In this article, we will focus on the very basic aspect of Money management and that is the money management in personal finances.
Money Management in Personal Finances
Let’s start at the beginning and learn what money management is. Although it might sound like rocket science to some, managing money in your personal finances is actually very easy and helpful as it incorporates some basic habits that will put you in the position of most of the wealthiest people in the world.
With that being said, let’s dive into the importance of money management in your personal finances.
Have you ever wondered why you lack cash at the end of the first week after your first paycheck? Do you find yourself short of cash when it is really needed? Well, guess what, it is the lack of money management that puts you in those uncomfortable situations. Moreover, with a good money management system, you will be able to manage larger amounts of money once you acquire it. How do you want to manage a million dollars when you can’t even manage a few hundred or a few thousand dollars, right?
Plan your Budget
Needless to express the importance of your Budget. It basically teaches you how to distribute your income into aspects of your life. In the long run, once you master the skill of budgeting, you will also master the skill of distributing the money, and eventually, it will lead you to better decision-making when it comes to Investing. Complexities aside, let’s focus back on the basics of budgeting.
As the rule of thumb, and according to Investopedia, as well as many other Financial planners, Investors, Entrepreneurs, and Financial gurus that I have encountered, they all mentioned the rule of 50/30/20.
- 50% of your net income is devoted to your living expenses. The things that you cannot live without such as housing, food, electricity, transportation, etc. Basically all the basic needs for your survival.
- 30% goes to your hobbies, lifestyle, entertainment. Basically the things that make you, you. Things that differentiate you from others.
- 20% is devoted to your future that includes saving for retirement, paying off some debts, and for emergencies.
To help you get better managing your personal finances, with the advancing technology, there are numerous applications that allow you to precisely track your finances.
As you go along you will find that you have already created the emergency fund in the first step, however, this is actually where all the fun begins. It is said that an emergency fund should be enough to cover up to 6 months of your living expenses. Imagine an unpleasant situation that would occur and you might lose your job, and all of a sudden that would immediately affect your net income. With the recent example with the Coronavirus, people who have already established money management before the Health Crisis, should be well off and secured during the pandemic as they certainly have the Emergency fund to cover the difficult times.
Moreover, if you have already devoted enough for the emergency fund, keep going. As I said, this is actually where all the fun begins. Once you have secured your finances with a sufficient amount for emergencies, keep devoting 20% of your net income further for savings.
Get rid of the Debts
Getting rid of your debts is good because just as your savings have compound interest, your debts have (most of the time) an interest rate too! However, it is important here to distinguish the good debts from the bad debts. Now you are wondering how debt can be a good debt? Well, good debt is a debt that generates income for you. The important keyword to be remembered when it comes to a good debt is an asset. So imagine you had an opportunity to take a loan from the bank to buy a house on mortgage or leasing and you would use that house to rent out to people and you would acquire some kind of return on investment. That is considered good debt. A debt that would eventually lead to a capital gain over time.
Bad debt, on the other hand, is a debt that takes away money from you that you will never see it again. Basically any type of spending that doesn’t create any value in terms of return on investment but rather eats-off of your cash. The important keyword for it is a liability. It is your credit card, your car, things that require maintenance fees, etc.
Plan for your retirement
Once your investment runs steadily and you would acquire more money, or you might not necessarily acquire more money but you will have a habit of putting aside 20% of your net income, it is then up to you to decide what you will do with that money. Whether you decide to invest further into stocks, in education, or just simply securing a future with your spouse, that is purely based on your decision. However, if you don’t know what else to do, you can plan your retirement. There are plenty of options on how you can secure your retirement, but the most important thing to remember here is compound interest. I will not dive deep into this topic, but long story short, it is basically interest on an investment that already has an interest in it. For better visualization see the picture below:
Now that you see the difference between the regular interest and compound interest, it is clear that compound interest can make a huge impact on your finances. It is again, up to your decision what type of investment vehicle you will choose as there are plenty to choose from. So go out there, find it out, and acquire it.
Have some fun
Last but not least, go out and have some fun from time to time. It is important to reward yourself with the fruits that you have taken the effort to acquire to keep you motivated. Understanding that we are humans is crucial and as robots need maintenance from time to time, we need a break as well. So go spend some of your hard-earned money on that new suit, watches, or whatever you fancy.
The final note
In this article, we have covered the importance of money management in real life. Money management is nothing else than a process of planning, budgeting, distributing, spending, and saving a person’s finances. It is important to incorporate these habits into your daily life in order to achieve your financial goals in the long run. If you are not born into a wealthy family (like me), or if you are not married to a wealthy family (like me as well), chances are you will need to implement money management eventually.
As you have noticed, money management is a nice theory for creating wealth by distributing your finances correctly into different jars. However, in order to consistently follow the set of rules you have laid out, it will take you a lot of discipline and self-awareness.
The good news is, by focusing on money management you can potentially eliminate some of the psychological barriers such as emotional attacks. Moreover, Psychology decides 80% of your success rate especially when it comes to Forex Trading and that is the topic that I would like to cover in the next episode. So watch out for my next detailed blog post about Money Management in Forex Trading and you might learn a thing or two. See you then!