Fundamentals of Personal Finance: Part I

Have you ever wanted to get your finances organized and your money invested, but you did not know where to start?

This three-part personal finance series is for you!

Saving money is simple.  Making financial goals is doable.  However, once we start thinking about the details, we can get stuck.  We think: “Oh, it’s 11:45am… I can take an early lunch break.  A grilled cheese sandwich will help me focus.  Oh, and the weather is just so pleasant.  It’s supposed to rain tomorrow.  It would be prudent to spend the afternoon on the patio with a cup of tea and get back to this financial project when I’m blocked in by the impending downpour”.

The complexity of personal financial planning hinders us.  

Whether you are a seasoned financial professional, a stock-tinkering hobbyist, or an artist who only sees numbers (and promptly covers them up) in paint-by-numbers, we all must know one indispensable principle:

Time is critical to investing.  

Therefore, we cannot let the complexity of personal financial planning daunt us and cause delay.  

Let’s begin with a story.

Thinking about this topic reminded me of my visit to beloved London, England.  I was only there for a couple of days, and I just had to see Abbey Road.  It was just four miles away from my hotel; getting there seemed feasible.  The only thing was, with no car and just a short time available, I had to plan an air-tight itinerary and execute it perfectly.

dsc01328London is well outfitted with the Underground, the Overground, and is decked out with red buses.  I could certainly make it work–no problem.  And everyone here speaks English–this is where English was invented.  I just needed to get a map, a schedule, a ticket, and go.  After talking with the hotel concierge and reviewing a map the night before, I determined that I had two chances to catch the Southern line at Shepherd’s Bush, the nearby station.  I really needed to make the first train, but the next one would get me back with just a few minutes to spare.

I was soon to learn how navigating London by rail was a lot like investing money.  

Marching down the blocks, I found Shepherd’s Bush.  But wait, I thought, I know I’m not looking for a Shepherd or a Bush, I’m certainly not looking for this oddly marked edifice either.  Where was I?  I remember it making so much sense on the map.  This can’t be a station, can it?  Pretty soon my march turned into meander.  Tick…tick…tick…  In the distance, I peered at a platform.  Is that it?  Rolling into a run, and after many stoppings-and-goings and turnings-around, I made it.  I needed to catch the train and my breath, but the train first.  Figuring out the platforms and turnstiles proved to be just as confusing.  My watch–only enough time to make the second train which would be cutting it so close!    

What happened?  Well, you’ll need to keep reading to find out.  I’ll tell you.  In the meantime, we need to get to the boring stuff that’s hindering our complexities, or something like that.  Investing!

As I said, navigating London by rail is quite like managing personal finances.  From dsc01322Bakerloo to Waterloo, the eleven lines of London’s Underground cover 250 miles.  Punctuated by 381 stations, that amount of track makes it the third longest metro system in the world.  Color-coded, it seems deceptively simple from a distance but very confusing up close.  Similarly, in finance, there are so many definitions to know, principles to understand, nuances to compare, and choices to make.  It is so complicated, but we have no choice but to learn it if we want to get where we want to go.  Like my dream of getting to Abbey Road, our financial goal is to earn money by investing it.

Comparing the London metro system with investing, we’re going to use this analogy to make these principles easy to grasp and minimize boredom as much as possible.  

We’ll publish it in three parts:

Part I: Understanding the Map (Fundamentals of Finance)
Part II: Planning your Trip (Making Goals and Choosing Investments)
Part III: Riding the Train (Implementing your Plan)

Part 1: Understanding the Map

The rail lines are like financial strategies.

Financial strategies are ways you can invest your money.  Besides saving cash, you can invest your money by buying commodities, bonds, and stocks.  All of these things make up a portfolio.  Each rail line represents a portfolio, which is an allocation of cash, commodities, bonds, and stocks:

  • Cash is money that is available to make purchases.
  • Commodities are bulk goods and raw materials, including things like metals, cotton, livestock, and sugar that are used to make consumer products.  
  • Bonds are debt instruments.  When you buy a bond, you loan money to a company or government.  The amount of money you pay for the bond is the amount of money you are loaning to a company or government.  The bond you own entitles you to receive interest over specific period.  When the period ends, the company or government that borrowed the money returns it to you.  You end up with the money you loaned and you’ve earned a stable stream of interest along the way.
  • Stocks are a type of an investment that represents ownership in a company.  When you own a stock, you have a claim on that company’s assets and earnings.  When the company succeeds, you succeed.  When the company loses, you lose.

Example:  Buy one share of stock for $4.77. If the company makes a profit, the price of the share could rise to $7.47.  You’ve earned $2.70!

The train stations are like significant life events.

Between your point of origin and your destination, you can expect to pass through many checkpoints, and you might even stop along the way.  These events include things like attending college or graduate school, getting married, buying a house, adopting a child, changing jobs, taking a big trip, or retiring.  It is at these points when you make changes and progress.  Here, you might adjust your plans.

The train schedule represents timing in investing.

Not only do trains depart and arrive at different times on different days, they also are limited in operation.  Some lines might run through the night, while others retire at 9pm.  These parameters are much like those in finance.  If you leave on an earlier train, you have more time.  You can travel farther or you can arrive at your destination earlier.  More options are available—you can even take the scenic route and enjoy more sites.  Leaving early also allows you to correct a mistake if you take a wrong turn.  If you leave late, you might miss the last train, or you will not get as far as you would have liked to go.  Putting this principle in terms of the train timetable certainly makes it very simple, but it is one of the most important of all.  Start your trip early.

Example:  At an interest rate of 7%, compounded quarterly:

If you have 30 years…. $1,000 invested earns $7,019.

If you have 10 years… you need $3,510 to reach $7,019!

If you have 5 years… you need $5,013 to reach $7,019!!!

See how you can earn more with a smaller initial investment if you have more time?

Okay.  Enough for today!  Want to learn more?  Have questions?  Stayed tuned for more rail stories and investing adventures!

Money Can’t Buy Me Love, but it sure is useful in getting a Ticket to Ride!

20100503rachel-portrait-106Author Bio: Rachel is a Christian and serves her church. She enjoys thinking of puns during long trail runs. If she had to choose between cheese and chocolate, she wonders what she couldn’t live without.

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