How much do you really know about building wealth? This week, Mark Ford explains why we should all learn the fundamentals of finance – and shares the one simple idea that put him on the road to financial success.
Do this one simple thing to get richer every day
By Mark Ford
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My hairdresser and her boyfriend were planning to get married. As her wedding approached, she asked me for financial advice.
I asked her what she knew about money. She likes money, she told me, and found the subject “interesting.” But she didn’t know a lot about “stocks and investing and stuff like that.”
“Do you know the difference between profit and loss?” I asked her.
“When a business makes or loses money?’’ she replied.
“How about the difference between an asset and a liability?”
“How about net worth? Do you know what that means?”
She had no idea.
(Net worth is a measure of a person’s total wealth. It’s the value of all of their assets minus all of their expenses and debts.)
Why everyone should know the basics
A colleague of mine once said that the biggest problem America faces is not political corruption or corporate greed, but ignorance about money.
He may be right.
According to a poll commissioned and conducted in 2016, roughly 6 out of 10 people in the U.S. rated themselves as “financially savvy.” Yet only a third of them knew the annual percentage rate (APR) on their primary credit card.
Among young people, only 13 percent knew the maximum they could put in a 401(k), which is the main retirement savings mechanism for millions of people in the U.S.
In 2016, ABC News reported that Americans tested on 14 basic financial questions got an average score of 40 percent.
Two-thirds of those questioned believed that there is “an organisation that insures you against losing money in the stock market or as the result of investment fraud.”
And nearly half believed diversification is a “guarantee” investments will do well even if the stock market falls.
Six out of 10 people surveyed did not understand the basic concept of inflation. One said, “I know what it is but I can’t explain it.” And another added, laughing, “Inflation? It’s bad.”
Studies in other countries paint a similar picture. The Bank of Japan’s 2016 Financial Literacy Survey asked 25,000 people a series of true/false questions… and the proportion of correct responses came in at just over 55 percent.
This lack of knowledge translates into lots of personal financial misbehavior. For example:
- Only 32 percent of American adults keep a budget and track their spending, and only 30 percent have a long-term financial plan (according to Gallup.)
- Three out of 4 American families say they live paycheck to paycheck (according to CNN.)
- More than one-fourth of American families have no savings at all, and only half have more than three months’ worth of expenses saved (according to Bankrate.)
- Seven percent are either getting calls from collectors or thinking about filing for bankruptcy (according to The 2015 Consumer Financial Literacy Survey.)
- About four out of every 10 adults are not confident that they will have enough money for retirement (according to the Pew Research Center.)
- And nearly one-third of young adults end up moving back home with their parents after graduating from college (according to Pew Social Trends.)
Financial ignorance in America (and elsewhere) is widespread, and it is costly. If you could add up the lost value of all the bad wealth-related decisions made on a daily basis by Americans, the number would be astronomical.
We do know that American consumers owe US$11.5 trillion to lenders and creditors. And we know that this debt burden increases every year. We know that in 2015 alone student loan debt soared by more than 11 percent.
But it’s not just happening in the U.S. Chinese consumers are taking on record levels of debt too: Chinese household debt as a proportion of GDP has more than doubled to just over 40 percent in less than a decade.
There is a reason we are financially illiterate. Less than 5 percent of us get any sort of financial education by the time we graduate high school. College isn’t much better. You can take plenty of courses in economics or accounting, but the fundamentals of personal wealth building?
It’s simply not taught.
I suppose it’s not taught because most teachers — even those who have degrees in accounting, economics and finance — don’t know the first thing about it.
That’s certainly true of most accountants, economists and financial experts I know.
I was thinking about this as Kristin was cutting my hair.
There are really two problems operating simultaneously: Financial illiteracy (which means you don’t know the difference between an asset and a liability) and ignorance of the fundamentals of wealth building (which means you can talk a good financial game but you are secretly broke).
What could I say to Kristin? What could I teach her right then that would be useful to her and her husband for the rest of their lives?
I could have explained terms to her, but she would soon forget them. I’d rather talk about principles and then, if necessary, explain terms.
- I could have explained the difference between saving and investing…
- Or showed her my “golden wells and buckets” illustration and explained how that worked…
- I could have warned her how, with most young couples, their spending tends to rise in lock step with their income…
- I could have told her why she and her husband should avoid buying a nicer house every time they could…
- I might have explained why renting is often smarter than buying…
- Or given her the one stock portfolio I’d recommend to anyone starting out…
- Or explained the enormous advantage of time when you are banking on compound interest…
I could have done all that… if I’d had about 10 hours with her.
But I didn’t. And so I wanted to tell her something that was simpler and more fundamental than all those things. I wanted to tell her the one thing that could make the biggest difference in her and her husband’s future financial life.
The first step to financial success
I thought about it as she was trimming my sideburns, and then I had it. I told her that the most important thing she should know about money is the concept of net worth, and the first and most important rule she and her husband should follow is:
Make sure that your net worth increases — if not every day, then at least modestly every month and significantly every year.
This was a slightly refined version of a thought that hit me many years ago, one I’ve written about before. That thought was that I should “get richer every day.” It was simple and obvious, but it hit me like a bolt of intellectual lightning.
But by making that resolution — that I would do whatever it took to get a bit richer every day — my entire view of investing changed overnight.
Instead of doing what everyone else was doing, I took a different path, where the preservation of my existing net worth was the most important thing, and where to boost that net worth I’d sometimes have to create more income.
Even if your money is conservatively diversified into great stocks and safe bonds, you can still experience a drop in net worth when — as has happened several times in my wealth-building career — stocks and bond returns go down simultaneously.
I realised I needed more diversity. But not in assets that just sit there. I needed assets that would create more income. So I got into rental real estate and direct lending and direct investments in small businesses and tax liens and all these other “off-Wall Street” ways of generating extra income.
And that worked. Since I made that change, my net worth has increased — if not every day, definitely every year. I made that decision about 20 years ago. My net worth has increased almost six-fold since then. And it has never, ever gone down.
So that’s what I said to Kristin. I didn’t brag about my net worth as I just did to you. I didn’t think she needed to hear that. She might have started charging me more (which I would have admired.)
But she got the idea and liked it because, I think, it was so simple and obvious. It’s something everyone can do.