Marco's Blog

Here you can find my thoughts

Personal Finance 1.0

Definition

Personal finance deals with the management of personal money, therefore income and expenses. The goal of personal finance is to have awareness and knowledge of money, of one’s own money! Of what the main mechanisms that govern the economy that personally affects us.

Step 1: data collection

The first step for intelligent management of one’s assets is knowledge of income and expenses. Regardless of whether you are an employee, freelancer, hybrid, or other, it is essential to know your income and expenses.

Income

Surely for VAT numbers and freelancers, this part is difficult, not all months are the same, and not even all years. Even as an employee it is necessary to know the division into 12-13 or 14 monthly payments which mean extra income in certain periods of the year.

Expenses

We all know them there are expenses

  • Periodic or Fixed: all those expenses that we have to face every week/month/year. Mortgage, rent, bills, car stamp duty, subscriptions, insurance, groceries;
  • Variable: all those expenses that depend on us, on the period, and on various external factors. Meals out, clothes, entertainment, accessory purchases, events, holidays, unforeseen events.

The first step is to have the numbers and know how much goes into the bank account and how much comes out. If you have multiple accounts, things get slightly more complex, but the philosophy is the same, you need to have all the numbers in plain sight.

What I recommend and what I do is write everything down in an app, choose your favorite one, and then throw all the data into an Excel sheet. Iterate this habit over time and you will have full awareness of what is happening.

Step 2: analysis and planning

Once all the information has been collected you have full control of your budget. With the data in your possession, you can understand what is working and what is not, where to make cuts, where to indulge in something and how. What a good overview of the situation it becomes easier to plan.

He who fails to plan is planning to fail

Winston Churchill

Planning does not only mean an expense, a mortgage, but also investments, accumulation plans, pension plans, masters for training, and holidays. Before moving on to the next step, I think it is necessary to give some guidelines and reference numbers. The most well-known expense breakdown is 50/30/20

  • 50% for essential expenses: healthcare, rent, bills, and food expenses;
  • 30% for superfluous expenses: eating out, hobbies, travel, clothes;
  • 20% savings and investments: savings account, investment portfolio, emergency fund.

As far as I’m concerned, I think it’s necessary to make a more conservative choice. and change the percentages.

  • 50% for essential expenses;
  • 20% for superfluous expenses;
  • 20% for an emergency fund;
  • 10% for investments.

NOTE: I would like to reiterate that the percentages are relative to each of us depending on our risk appetite and our income. Too low income, for example, does not allow investing/emergency cushion. That said, let’s take a closer look at the above-mentioned elements.

Emergency fund

This fund represents a treasure that we have set aside and that we must never touch. This is not the nest egg that we accumulate for vacation, for a new car or something else, it is an emergency fund! We need it for emergencies, we lose our job, a serious event, or something else. If not in cases more unique than rare, it is not to be touched.

Some features
  • Not easily accessible: ideally the account is different from the classic one, without a credit/debit card at hand. We increase the “difficulty” in using it;
  • 18 Months: should include an amount of about 6-18 months of lifestyle. For example, if our monthly expenses are €1,000 it means having €6-18,000. This depends on individual stress tolerance;
  • Automation: once the amount to be accumulated month by month has been chosen, automate the transfer from the current account to this account. Some banks offer the possibility of making recurring/automatic transfers, this is the best use we can make of it.
  • Extra Income: the first thing to do with extra income is to increase the emergency fund.

The goal is to let it untouched

Necessary premise; when you invest there is the possibility that you will lose everything, you must know this! What is often read, in fact, is the following statement.

You should invest the amount you are okay to lose

Continuing, this topic deserves separate treatment. To hyper-simplify what I do, I am NOT a financial advisor, so take your own decisions with total autonomy, is the following thing:

  • Diversification: rule number 1 is to minimize losses. Essential is to diversify. Diversifying is complex, but with this term, I mean:
    • Asset: bonds, cash, ETFs, Shares, etc.;
    • Geography: emerging countries, developed countries, world, China, etc.;
    • Sector: technology, pharmaceuticals, raw materials, etc…
  • PAC: accumulation plan. Decide on a monthly amount and invest consistently, taking advantage of the dollar-cost averaging approach, below in the links is a useful article.
  • Attention to costs: be careful of the management costs of your investments, typically banks have very high management costs;
  • Dependent and independent financial advisors: the name already describes the difference. A dependent advisor tends to favor your purchase of products that they themselves manage, independent ones have no “ulterior motives” and earn from your earnings. They work because they earn;
  • ETFs: are the simplest tool, with a low cost. There are different ETFs that underlie different sectors, assets, and geographies. There are distribution and accumulation ETFs. Learn more here;
  • Taxation: if you use a broker other than your bank, there are two types of brokers: tax substitutes and non-tax substitutes, each has its advantages and disadvantages, it’s up to you to choose. Remember that you still have to pay taxes on profits.

Step 3: act

Now we have the complete picture in front of us. We have our data, on who we are, what our behaviors are, and the basic tools to be able to change our situation.

We are already well on our way, the first steps have been taken, and now we need to trigger the habits that will help us get where we want to go. What to do and when to do it is really too personal to cover all cases, but here are the practical actions that I find most useful, I confess that I can’t do all these things myself, but they are a good reminder.

Tips

  • Frugality: the first step to improving your finances is saving. Save where you can, this does not mean buying low-quality food or depriving yourself of experiences, the mentality must be: “Do I need this thing or do I actually not want it”. A good rule of thumb, when you’re undecided, is:

If it cost 5 times as much, would I still buy it?

  • Increase income: if the first step is to save, the second is to earn more. Certainly, with a “low” income it will be difficult to create an emergency fund and impossible to start investing. The idea is to have one/more secondary incomes;
  • Training: it is the first field in which to spend and invest your money, especially when young and if your skills are not very high;
  • Spreadsheet: keep track of everything, data is essential. Splitwise is an app that allows you to add expenses and income, plus there is the possibility of extracting data in Excel and adding it to your own personalized one. If you prefer use Excel directly or the good old sheet of paper;
  • Separate accounts: create an account for your emergency fund. Try to automate and make this transfer as easy as possible. On the other hand, try to make it difficult to use that money. Ex. don’t get a card, you can only use that money by going to the bank or on the web page;
  • PAC: start an accumulation plan, even with a Robo-advisor. The fees are for sure higher but the effort is zero and it’s automatic.

Now?

I hope I have provided you with some basic knowledge and have piqued your curiosity enough to get you started!

Explore the topic further because everything written above deserves more than one separate article.

Help others to have more awareness of money, which must remain a means and not an end. To do this, we must know it well.

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