What Science Can Teach Us About Creating Wealth: The Role of Simple
The National Center for Biotechnology Information reports that “Science is valued by society because the application of scientific knowledge helps to satisfy many basic human needs and improve living standards”. So important is simplicity in the philosophy of science that there is principle guiding its application. Occam’s razor states, all other things being equal, the simplest theory is most likely true. In other words, simplicity is a meta-scientific criterion by which scientists evaluate competing theories.
The genius of some of the greatest minds in science was in their ability to explain difficult subjects in a simple manner. Albert Einstein himself said, “the definition of genius is taking the complex and making it simple”.
Does the concept of simplification apply to finance, and specifically creating wealth?
We believe the answer to that question is “yes”.
The Process of Simplifying Finances to Create Wealth
While science can be very complex, simplicity plays an important role in the philosophy of science. The same can be said of personal finance and wealth planning. In most cases, creating wealth is not about creating more income but rather reducing expenses and simplifying the day-to-day financial process.
While there are many wealth-creation and financial independence movements being marketed, they all share the concept of simplification, or making things simpler. Some of the more common movements include:
- Minimalism – Rid yourself of life’s excess in favor of focusing on what is important so you can find happiness, fulfillment, and freedom. If you enjoy standup comedy, check out the skit on “stuff”, stated so eloquently by the late great George Carlin.
- Financial Independence Retire Early (FIRE) – Popular amongst millennials or people in their 30’s, FIRE promotes increasing savings, downsizing lifestyle and investing aggressively.
- Live below your means – A more generic mindset that the key to becoming wealthy is to live on 60 to 80 percent of what you earn, applying 20 to 40 percent to savings.
Clearly, the movements mentioned above are eliminating extra expenses, big or small. Don’t sweat the small stuff, right? Most people waste money without realizing it. Dinner out and a movie for two can easily run over $100.
However, it is the big stuff that can bite you in the butt. It’s the big purchases that will potentially waste thousands of dollars if you don’t understand the finances involved in the costs of big loans like school loan debt, a mortgage and car loans.
What you don’t know can hurt you!
The main issue is controlling money instead of letting it control you. Creating a spending plan is an interesting way to decide what 3-5 things are most important and what things are REALLY required. Everything else on your list can be stopped, changed or altered to minimize or avoid those expenditures. This creates more money in your pocket to invest, achieve your financial goals, and lower your financial stress.
Every situation is unique which is why you should have a professional help educate you on the options and put you on a path to success.
We like to call this improving your “financial fitness”.
Simplify Your Finances with Aggregation
Most of us have our mortgage with one financial institution, a bank account with another, credit cards with a third, retirement accounts with a forth, a car loan and so on. The easiest thing to start simplifying is account aggregation.
Start by documenting your financial relationships, including business and custodian relationships being sure to include the website where you can access your information. This will be needed if you want to use an account aggregation tool, or even just to document in a spreadsheet. Be sure to keep this information in a safe and secure place if you are doing this on your own.
What’s an account aggregator? If a picture is worth a thousand words, the picture below says it all.
An account aggregator is a tool that lists all your account information in one place.
There are several benefits to consolidating all your financial information and organizing your finances.
- Lowering your financial stress.
- Easier to monitor your account activity.
- The ability to see the impact of financial decisions across all accounts.
- The psychological benefit of seeing net worth increase monthly.
Remember: “Garbage in-garbage out” – the quality of the financial decision is only as good as the data that goes into making it. Especially if you are using a financial coach , the more accurate the information, the more equipped they are to help you make better financial decisions.
What is Your “Net Worth” & Why You Should Care
While there are many benefits to aggregating your account activity in one place, the functional goal is to determine your personal net worth.
It’s a critical number to know if you want to improve your financial situation. Surprisingly, this is a number that many people don’t know.
Your net worth is the value of your assets (cash, investments & stuff), minus the total of your liabilities (loans, credit cards & other debt). You can fill out a sample calculator from Bankrate to get an idea of how this equation works.
A positive number means you have more assets than liabilities, but a negative number means you have more debt than assets. For example, having an investment portfolio valued at $200K but a negative net-worth means you have a huge mortgage or school loans – debt that is still hanging out there.
Effectively, if you sold off everything, you would still owe somebody more money!
With a negative net-worth, your money controls you. With a positive net-worth, it is much easier for you to take control your money. Much like your blood pressure, your net worth conveys a great deal of information about your health, in this case, your financial health.
When you visit the doctor for a check-up, one of the first things they do is take your blood pressure. Within a matter of seconds, the doctor can assess your health. If your blood pressure is too low or too high, it is often indicative of a larger problem. The doctor can then run additional tests to come up with a diagnosis for your condition and devise a treatment plan return you to good health.
As with high blood pressure, a negative net-worth can open the door to many bad things including bankruptcy, divorce and health issues because of financial stress and the money mess you have created. With a little bit of help and changes to your spending habits, you can turn things around over time and not stress over money.
Your financial coach can devise a plan to improve your financial health and lower your financial stress. Most importantly, they can help you change the habits that brought about your financial situation.
Remember, there is no need to beat yourself up over past decisions. Most people have never been trained how to successfully navigate their personal finances. Simply put - financial coaching relieves financial stress.
Take a positive action step…
Calculate your net worth to figure out where you are financially. Whether you are building a spreadsheet or using an automated aggregation system with your financial coach, it is the easiest number to track improvements with your financial fitness.
Simplify your Finances with Automation
The next step we recommend is to simplify the process of paying bills and creating automatic savings transactions between accounts to pay yourself first.
Sticking to your financial goals requires a lot of willpower and motivation. Putting a process in place that automates the bill payment process and the moving of money between accounts removes temptations, increasing the likelihood that financial goals will be met.
Your monthly financial activities can be broken down into five different areas. These five areas include:
1. Checking account: This is the center of your financial activities as your checking account funds everything you do. Hopefully, income from paychecks and investments is received by direct deposit.
Make sure you keep a certain amount of money in this account to avoid overdraft fees in case you make a small error. $500 to $1,000 is a good goal to shoot for. It can serve as part of your emergency fund, although we do recommend that be a separate account for the bulk of that savings.
2. Pay yourself first: Since you are doing all the work, it makes sense to pay yourself first. Start by funding your accounts, including:
a) Checking account – If your account fell below your minimum because of a short-term problem or need, fill it back up with your next paycheck.
b) Emergency funds – For life’s unexpected events (3-6 months of living expenses is a good goal)
c) Retirement accounts – 401K, 403B, IRAs, and any taxable long-term savings.
3. Your required expenses: These are your monthly household expenses, including:
b) Groceries (You can still eat out too, it just needs to be part of your spending plan.)
c) Utilities (gas, utilities, etc.,) – keep an eye on your cable bill as they have been increasing across the board. Reality check…cable television is not essential to your survival.
4. Other goals (expenses): These are other financial goals such as birthday & holiday gifts, vacation, and college funds.
5. Everything else (discretionary expenses): These are other expenses that are often entertainment-related. Examples include eating out, movies, etc., This is not a requirement, but everybody needs to have a little fun along the way.
How do you go about simplifying the areas listed above?
Automate your bill payment and check distribution process. Most banks and financial institutions will let you open several accounts that you can ear-mark for different goals or purposes. Some banks and credit unions may offer some of these services. However, they often come with many fees. A product that we prefer is the Fidelity Cash Management option.
Fidelity, TDA, and others may have similar cash management (think checking / savings) features like no-fee ATM (they reimburse you for any bank fee that comes from the ATM owner), an app that lets you make a deposit with a picture of the check, and automated distribution to your household accounts (Emergency fund, holiday gift savings, IRAs and personal retirement accounts not handled by the HR department at work.).
There is simplicity in having your checking, multiple savings accounts, and credit card accounts through the same financial custodian or bank. If that custodian also holds your IRA or other retirement accounts…PRESTO – life simplified.
Mortgages, rent, and utilities can be paid using electronic drafts or your credit card which is paid from your checking account.
Do NOT pay using your credit card unless you are at the point where you can pay off the balance IN FULL every month. Using your credit card is a simplification strategy for an advanced coaching client who has broken bad spending habits.
Financial Coaching Relieves Financial Stress
All too often, whether it be taxes, your credit score, school loans, etc., it’s the information you don’t know that will get you in trouble. There is a process to getting your financial house in order step-by-step over time so that you don’t get overwhelmed.
We work together with our clients to “create | implement | adjust” their financial plan to meet their needs, wants and wishes. Thereby, lowering their financial stress by eliminating the money mess.
As science has shown, often simple is better.
Let us help you create a plan to simplify your personal financial situation. We will help you implement our processes with tasks, emotional support, and educational advice to change bad spending habits and increase your odds of success.
Of course, “life happens”. When it does, we’ll be there to adjust as necessary, whether it be assisting with a big purchase decision or simply adjusting your goals or approaches.
If you’re getting excited about taking control of your financial future, then schedule a conversation with us.