Money is simple. But people make it complicated.
If you’re just learning about how money works, you’ll definitely come across terms such as investing, debt, inflation, rate of return, risk, savings, assets, liabilities, income replacement, protection, index funds, stocks, bonds, trading, forex, options, CFDs, fixed deposits, unit trusts, mutual funds, and so on. This is enough to scare away anyone who wants to learn about money.
But money is actually very simple to understand. I have spent the last 10 years learning about how money works. Let me show you the 3 simple rules that govern personal finances:
Rule #1: Income – Expenses = Savings
Savings is the crucial thing in this equation. But most people are interested only in increasing income. The trouble is, for most people, when their income goes up, their expenses go up too. This is not good, and I will explain why shortly.
The goal is not to increase income, but to increase savings. To increase savings, you can either increase income, or reduce expenses, or both.
Some people say that they don’t want to focus on reducing expenses because there’s a limit to how low your expenses can go.
The limit is zero. There are people who actually have reduced their expenses to zero. Further down, I will show you how to achieve this.
So the goal is to increase savings. Some people increase their income, but their expenses increase correspondingly, and their savings do not. This is not good.
Other people reduce their expenses but their income reduces accordingly. This is also not good, but this is better than the previous outcome.
The best way to increase savings is to increase income while at the same time reducing expenses. To learn more ways to save money, come for our Saving Money Meetup taking place tonight.
Rule #2: Savings → Investment → Passive income
Savings is what we used to achieve all our life goals. From paying off debt, to paying for specific items. Cultivating a savings habit is essential when in personal finances. If a person cannot save money, he will never get anywhere financially even if he makes a million dollars. Because he will spend that million dollars and not be better off than before he earned it.
Beyond paying for other life goals, savings is channelled into investments. Not any kind of investments, but those that generate passive income. Naturally, the less risky the investment, the better it tends to be. In my money philosophy, I go for low-risk investments.
High-risk investments can mean potentially making more money, but it often tends to also mean a higher potential of losing capital. That is not what we are looking for when we want passive income. I’ll explain why in the next part.
We don’t want high-risk investment because risk is best diversified across time. But if you have a short time to invest, then you may not want to take on that kind of risk.
Why do we have a short time to invest? Because this formula can help you reach retirement in under 10 years. Most high-risk investments are done over time spans of more than 10 years.
Because this formula can help you reach financial freedom in under 10 years. Most high-risk investments are done either over time spans of more than 10 years, or done with the aim of increasing income while increasing expenses. The losses from high-risk investments are expenses incurred to obtain that income.
So the goal is to channel savings into low-risk investments that will generate passive income. This passive income can be one way of increasing income (in Rule #1), so as to increase savings, without increasing expenses.
Rule #3: Passive income > Expenses = Financial freedom
The purpose of building passive income is to increase it to the level that it exceeds your expenses. Naturally, the lower your expenses, the more quickly you will reach this goal. This is why I said earlier that lower income – lower expenses is better than higher income – higher expenses.
Higher expenses mean you need more savings, which means more investments, which means more passive income needed to fund your expenses.
The reason why you don’t want high-risk investments is because these mean that you stand a higher chance of not getting your passive income. Imagine a scenario where you have achieved financial freedom for a while now, but then you lose your capital because of the high-risk investment you made. Then you also lose your financial freedom.
Freedom is a very expensive prize. Don’t gamble it away with speculative investments.
How to have zero expenses
The reason why many people prefer to increase income instead of reducing expenses is because they have been conditioned to believe that the only way of getting things is to buy them.
What they do not realise is that many things that they use money to buy can actually be obtained for free, and quite easily too. If you want to know more, check out the Freegan in Singapore Facebook group. You will be amazed at what you can get for free.
Before I learnt about freeganism, I was spending about $300 a month on food alone. In my first month as a freegan, I reduced my food expenses by 10x to $33. In my second month as a freegan, I reduced my food expenses by another 10x to $4. In my third month as a freegan, I got all my food for free.
My personal expenses per month right now are lower than how much I used to spend on food every month in the past. And yet I have more than enough of everything and have want of nothing. I no longer worry about money, and I no longer have wants that are not met. I do not scrimp and save as I used to, suppressing my desires as I get almost everything I need for free.
This allows me to channel my savings into the things that cannot be obtained for free, and paying off my mortgage.
One more thing. Because I get a lot of things for free, I have an excess of stuff. I either give or sell these away. The stuff I sell gets me about $200 to $300 a month, which pays for the things I can’t get for free.
Therefore my personal expenses have been reduced to zero.
The non-freegan route
Freegan living is not for everyone. To receive free gifts, you need to set aside your ego. This can be very hard for some people.You’ll be amazed to discover how many people cannot bring themselves to receive free gifts.
As a result, these people still use money to get things. If you’re one of these people, then the best way to achieve your goals and achieving financial freedom is to plan your finances.
Take note, however, that this is, by far, the more difficult route. Because you will need to work many more decades to build up enough savings to turn into investments that generate you sufficient passive income to offset your expenses.
While freegans can reach financial freedom in under 10 years, you will likely have to work for 30 or 40 years to reach the same level of freedom. It is true – if you wish to send your children to overseas universities, to live in a big house, to travel overseas for holidays frequently – then freegan living may not be for you.
For that, you have to be prepared to work very hard for your money for many, many years. And you have to be careful not to waste your money in bad investments and buying things that don’t really help you to reach your goals or create lasting value for you.
To do this, you need to plan your finances carefully, making sure you don’t miss out anything.