(03) 9020 2905Debt Man column – The West Australian (Money? Or News?)
For: January 11, 2010.
Bruce Brammall
Debt Man
A new year a whole new wad of money to look forward to blowing. Woo-hoo!
No? So you’ve promised to do something sensible and begin a personal financial renovation this year. How’s that New Year’s resolution going then? Apparently, 75 per cent of resolutions are dead already.
If your financial resolution is already looking about as healthy as the fried peanut butter and jelly sandwiches that finally flattened Elvis, you need a new strategy.
Time to learn “The rules of money”.
Not the “The Color of Money”. Hustling pool is limited to finding suckers. You have to be able to play pool like Vincent Lauria (Tom Cruise). And despite youthful years squandered in smoky pool halls, I appreciate my lack of talent.
Money’s rules are little more than a recipe. The hardest part is exercising a bit of self control.
There are five universal rules of money (as far as I’m concerned). They’ll work anywhere on the planet. They don’t change according to the colour of your passport. These five rules are understood inately by everyone who is financially successful.
Delayed gratification
An experiment conducted in the late 60s by scientist Walter Mischel showed the concept of delayed gratification brilliantly.
Mischel put four-year-olds into a room with a marshmallow on the table. He said that if the marshmallow was still there when he returned, the child could have two marshmallows.
Some kids tried to fall asleep. Some tried to sniff it and put it down. Some would lick it. Some would touch it and lick their fingers. That’s just teasing yourself! All of these efforts ended in failure.
However, about 10 per cent of kids were able to hold out and get two marshmallows. As that research was done 40 years ago, they’ve been able to follow those kids through life and they have done better (better educated, higher paying jobs, etc).
The first rule of money is delayed gratification. There has to be some sacrifice. Some of everything you earn needs to be put away for the future, so that you can turn $1000 into $2000 and then more.
Risk versus return
Cash, bonds, property, shares. As you read along those assets, the risk increases, but so do the potential returns.
The bigger the return you want, the more risk you will have to take. If the idea of watching the value of your investments go up and down like a yo-yo is not okay with you, then shares and property may well make you want to puke.
History shows the greatest long-term returns are achieved by shares and property. And anyone looking to invest for their future should have a portion of their money in growth assets.
It then comes down to how much you allocate to which asset class, which requires a personal risk profile. Which leads to …
Diversification
Eggs and baskets. If you had everything in the stock market in late 2007, you’d have lost, from peak to trough, about 55 per cent of your dough.
However, if you had it spread across several asset classes, according to your risk profile, then you wouldn’t have done anywhere near that badly. Diversification is about risk reduction.
Compounding growth
The longer you invest, the more it will grow.
The true benefits of investment come with time – getting growth on last year’s growth. You need to start young. Some won’t be young, but that’s not an excuse. And delaying things will only make things harder.
The power of leverage
Debt supercharges investment returns. If markets are falling, you’ll lose more. If they’re rising, your gains will be considerably larger.
Debt has earned itself a bad reputation recently. But debt-based investing can be appropriate for the right investors – those with youth on their side and an appetite for risk.
Leverage is the most powerful force in investing. It needs to be used wisely, by the right people (young and higher risk takers), with the right timeframes in mind (seven years or more).
Make this year the year you changed your financial destiny. Start by learning the “rules of money”. Doing something and perhaps losing a bit early is far better in the long run than doing nothing and never winning.
Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au) and a licensed financial adviser. bruce@debtman.com.au .