Transcription
I recently read a book called "Just Keep Buying," and it made me realize four major mistakes I was doing with my money in my early 20s.
Mistake number one: Focusing too much on saving. Let me ask you a question. Which one of these two men do you think burns more calories in a day? I know this is a financial video, but it will all make sense soon, so stay with me, please. The man on the left is a member of the Hadza tribe living in the Savannah in Tanzania, and the man on the right lives in a big city and he spends most of his days sitting in the office or at home behind the computer. However, a member of the Hadza tribe is a hunter-gatherer, which means he has to move all day long just to feed himself and his family. You probably think the one on the left burns more calories, right? Well, that's not true. Both of them actually burn the same amount of calories, despite the fact that one is super active and the other is not. I know it's hard to believe, but there was a scientific study done in the Hadza tribe in 2012 that proves this.
To understand why this is the case, you need to first understand how your body uses energy. 70 to 90% of energy is used just to keep you alive. In other words, your metabolism and food digestion process are the two main energy consumers. On the other hand, physical activity only accounts for 10 to 30% of energy consumption. This is the reason why you struggle to lose weight despite the fact that you go to the gym and stay active all day.
Now, you might ask, "Okay, if both men burn the same amount of calories, then how come people living in the Hadza tribe are very lean and super fit, but the people living in civilized society who sit behind computers are overweight?" The simple answer is they just don't overeat as most of us do. For years, we've been told that if you want to lose weight, you need to exercise and diet. However, the research done in the Hadza tribe proves that exercising isn't a weight loss tool. It's a nice tool for a healthy lifestyle, like quitting cigarettes is, but it isn't a weight loss tool. Your diet matters the most.
Now, why am I telling you all this in a financial video? Well, just like there are two conventional ideas for weight loss—exercise and diet—there are also two conventional ideas for saving more money: cutting costs and increasing income. We just learned that for weight loss, physical activity plays a tiny role, so we need to focus on diet. How about having more money? Would it be possible that one of those two ways is less effective, but we've been told to focus on it? The answer is yes. Cutting costs isn't the way to go, but still, there are tons of articles and books about it.
There are two main problems with cutting costs. Number one, cutting costs has a small impact, just like exercise has on weight loss. After all, there are only a few things you can cut. When you start going to the gym, you lose a few kilos quite fast, but then it stagnates. A similar thing happens with cutting expenses. Number two, it doesn't work at all for low-income people. There are many people who need to borrow at the end of the month to cover their expenses until their salary arrives. If you earn $1,000 a month, but your expenses are $1,100, frankly, where can you cut costs?
All this doesn't mean that we have to completely ignore cutting expenses and the books written about it. No, cut costs where you can and monitor your expenses regularly to make sure you're not throwing away money on unnecessary things, such as forgotten subscriptions. But use your main energy to increase your income. Of course, increasing your income is much harder than reducing your spending, but it is the most effective way.
Mistake number two: Focusing too much on investing. The author says, "When I started to read financial books, I noticed that there were a few pieces of advice that kept getting repeated, such as 'keep your fees low,' 'diversify,' and 'invest for the long run.'" So, as a beginner, I started to follow this advice. After all, they came from reputable investors such as Warren Buffett. Now, this advice wasn't incorrect, but it made me focus on the wrong things.
As a beginner investor, I only had a few thousand in my bank account. Despite having very little money, I spent hundreds of hours analyzing my investment decisions, running calculations in Excel, and thinking about what kind of asset allocation I should have. Should I invest 80% in stocks and 20% in bonds, or vice versa? Should I invest in Bitcoin? How about real estate? Despite overanalyzing my investments, I never spent time analyzing my income and spending. I would regularly go out to dinner with co-workers and easily spend $100 a night. Think about how foolish this behavior was. With only $1,000 of investable assets, even a 10% annual return would have only earned me $100 in a year. Yet, I was regularly blowing that same amount at one night out for dinner. By simply not going out for one night, I could have made the same amount of money as one year's investment returns. Can you see how my financial priorities were messed up?
Now, compare this to someone with $10 million in investable assets. If they were to see just a 10% decline in their portfolio, they would lose $1 million. Do you think they could save $1 million in a year? Highly unlikely, right? This is why someone with $10 million has to spend a lot more time thinking about their investment choices compared to someone with only $1,000. So, as you can see from this comparison, your focus depends on your current financial situation. If you don't have much money invested, then you should focus on saving and increasing your income. The opposite is true if you have a sizable portfolio. To put it simply, saving is for the poor, and investing is for the rich.
Here's a question you might ask: "How can I find out if right now is the time to focus on saving or investing for me?" Here's a simple way. First, find out how much you can comfortably save in the coming year. For example, if you expect to save $1,000 a month, then your expected savings for the entire year should be $12,000. Next, determine how much you expect your investments to bring you in the next year. For example, if you have $10,000 invested and you expect that you will earn a 10% return, then your expected investment earning is $1,000. Finally, compare these two numbers and focus on the one that is higher. If your expected savings are higher, like in the example I just gave, then you need to focus more on saving money and adding it to your investments. However, if the opposite is true, then you should spend more time thinking about how to invest what you already have. If the numbers are in a similar range, then you should focus on both.
The general rule is that as you age, your focus should shift from your savings to your investments because when you are older, you will have more money invested, and that means your returns from investments will surpass your savings. Saving matters a lot early in life; however, later in life, investment dominates.
Mistake number three: Sticking to a fixed percentage of saving rate. If you start researching what is the right amount of money you should save, then you will quickly find advice such as "save 20% of your income," "10% of your income must go to savings," or "you should have this amount saved by this age and that amount saved by that age."
There are two big problems with such advice. First, it assumes that people at all income levels have the ability to save at the same rate, which is not the case. For example, in the USA, earners who are in the bottom 20% save only 1%. On the other hand, earners in the top 20% save around 24% of their income annually. The second problem is that it assumes that income is relatively stable over time, which isn't the case. For example, when you are single, the stability of your income depends on you mainly. But once you get married, it's no longer a single person you who has to worry about losing a job, but two people. This means income becomes more unstable as you move from a one-income household to a two-earner household. Also, your income and expenses fluctuate at different stages of your life, which is why sticking to a single static amount, such as 20%, is very difficult.
For example, when I was studying at the university, I was also working in a company. Since I was a student, I could stay in a dorm in a shared room and eat at the university cafeteria quite cheaply. This meant that I could easily save 50% of my income. However, once I got married and moved to a flat, I could save only 3% at max. This made me feel terrible because I couldn't save as much as I used to, and that's one of the biggest problems with sticking to a fixed saving rate. If life is dynamic, then why should the saving rate be static? That is why the best saving advice is: save what you can. If you're single and can save 40%, then save 40%. If you're married and have kids and can only save 2%, then save 2%. If you follow this advice, then you will experience far less stress and far more overall happiness. In general, money is a stressful topic for many people, and one of the most common financial stressors is whether I can save enough or not. So, lesson number three is: save what you can. And if you'd like to find out how much you should save right at this time in your life, then simply deduct total expenses from total income. Then, whatever is left is your savings.
Mistake number four: Spending my money the wrong way. There are two extremes when it comes to spending money. One group of people spend money guilt-free and never look at the price tag. Another group, on the other hand, feel guilty and anxious about almost every purchase they make. They try to use every tip and trick to cut costs on everything they buy. Neither of these extremes are good. However, today, many financial advisors favor the second group and force you to second-guess everything you buy. They make you feel guilty about everything you buy. You buy a latte, and then you regret it, so you start second-guessing everything you buy, and it creates anxiety around spending. This is no way to live your life. Yes, money is important, but it shouldn't alarm you every time you see a price tag.
The author provides two tips that will allow you to spend without feeling guilty. The first tip is the 2x rule. According to this rule, anytime you want to splurge on something, you have to take the same amount of money and invest it as well. The author says this rule works because it removes the psychological guilt associated with purchases. Since you also make an equal-sized investment, this rule also helps you to re-evaluate the purchase because you are going to save double the amount: half for the purchase itself and half for investing.
The second tip is to spend money on the things that maximize your long-term fulfillment the most. The most difficult part of the course is figuring out what you truly want out of life and what increases your fulfillment. For example, if buying lattes every day increases your productivity and makes you feel great, then according to the author, you should do it. Personally, these days I buy coffee almost every day from Starbucks. I used to feel super guilty about spending $5 on coffee. For a while, I even stopped going to Starbucks, but soon realized that it was a mistake. First of all, I get distracted a lot if I work from home. I am more productive if I work from Starbucks. Starbucks also replaces the need for me to rent an office because every time I buy coffee, I work there for at least 4 hours. So, for me, buying coffee at Starbucks helps me to be productive and increases my fulfillment. For you, it might be something else that you can easily justify the cost of. Of course, we can all use false justification to convince others, but we can't lie to ourselves. Deep down, you will know when the cost isn't justified.
This sounds cliché, but the best spending method is the one that fits you personally. You need to take the time to analyze your expenses to find out which ones increase your happiness and which do not. Research shows that spending money in the following ways is most likely to increase your overall happiness: buying experiences, treating yourself on occasion, buying extra time, paying upfront (such as an all-inclusive vacation), spending on others, etc.
One final tip on spending, which is very similar to the one we just discussed, is from one of my favorite authors, Ramit Sethi. His advice is: "Spend extravagantly on the things you love and cut costs mercilessly on the things you don't." For me personally, this is the best spending advice I have ever received, and I still use it today.
Okay, quickly to summarize everything we just discussed in this video:
Number one: If you want to have more money, focus on earning more rather than cutting costs. Both of them are valid ways to have more money, but increasing your earnings is much more effective.
Number two: If you have little money to invest, it's better to focus on saving and increasing your income rather than overanalyzing your investments and chasing opportunities that give you a few percent higher return.
Number three: Life is dynamic, and the savings rate should be the same. If you can save more, you should save more. If not, then you shouldn't. Don't get stuck with fixed savings rates, such as 10% or 20%.
Number four: The best spending method is the one that fits you. Figure out what makes you happy and spend more on that, and cut costs on other things that don't add any value to your life.
If you enjoyed this video, then I think you will also enjoy the summary of a book called "The Automatic Millionaire." You probably see it on your screen now. Thanks for watching.