To start, we need to clarify something.
Being rich (financially wealthy) is about your income.
How much money you have coming in.
However, being broke is about your spending.
How much money you have going out.
It really has very little to do with income.
Hmmm…, does this mean it is possible to be both rich and broke at the same time?
Good question. Yes it does mean that actually.
As a number of top sportsmen, actors or musicians who have gone bankrupt at the peak of their careers can attest.
The problem definitely wasn’t their income, it was their spending.
There are two rules to learn to begin to get a good handle on this:
Rule 1: Money is volatile.
Like perfume or nail varnish, it will evaporate easily if given the chance.
For instance, do you remember the last time you pulled a note from the cash machine (Let’s say a £10 note) because you needed cash to pay for something small (a 75p bag of peanuts)?
You probably bought the item and put the change in your pocket right?
By the end of that week, do you remember how much of that change was still left?
Do you have any idea where the rest of the money went?
Or consider the last time you received some money you weren’t expecting (maybe you received a cash gift, unexpected bonus or just found some money in the pocket of a forgotten jacket).
If you’re like me you probably thought “Whoa cool, I can do a lot with this!”
How long did that money actually last though?
How much of the “a lot” were you actually able to get done?
Probably not much, right?
This is because, anytime we have an amount of money that we think of as “available for spending”, it will immediately begin to evaporate, rapidly!
And it will do this whether we consciously decide what to spend it on or not. Usually, by the time it is gone, we really won’t have anything worthwhile to show for it.
A key part of all money management systems is to understand that no money is simply “available”.
Every time you spend a pound on one thing, you are choosing not to spend that same pound on anything else.
Everything you pay for, is at the cost of everything else you could have paid for with that same money.
Being aware of this helps you remember to carefully close the perfume bottle each time you open it. Preventing your valuable funds from evaporating into thin air.
Rule 2: Borrowing is bad!
Now, I rarely label things as “good” or “bad”.
Here however, it is necessary.
Borrowing money today, is basically choosing to be poorer tomorrow.
If you live in a country where you have easy access to loans, store credit and credit cards, you probably already have many different balances running across many of them.
In that case, let’s do a quick exercise together.
Let’s add up the total amount we are paying each month on all of them right now.
That includes store credit, credit cards and personal loans (Excluding the mortgage).
Have we got that total number? Good.
That is how much poorer we currently are each month, because of the money we borrowed in the past.
Now, let’s take a look around at our life today and try to remember the reason we borrowed all that money.
Would you say you are getting the value, the satisfaction, the pleasure, or the peace of mind, from all those things you borrowed the money for, to make it worth the amount of poverty that borrowing is currently bringing to you?
Okay, that does sound a bit harsh. But I am being harsh for a reason.
Personal borrowing is often marketed as the solution to our money problem when, in reality, it is usually making the problem much worse.
We work so hard to improve our credit rating that, when we finally succeed to qualify for that big loan from the bank, we feel like we have won something!
We don’t realise that we are actually taking that loan from our future selves.
Putting a weight around our neck that we will probably have to carry for years until the loan is paid off.
Remember rule 1? Which says any money you see as “available” will evaporate?
Well, credit cards and loan companies encourage us to see money that we will struggle and sweat to earn in the future, as already available today.
That way our future income can begin to evaporate as well. Before we have even earned it!
How many times have you heard a story of someone in deep poverty? Someone who is struggling to pay rent or buy food to eat. How often does that story mention the phrase “crippling debt”?
Okay, I don’t want to over flog it.
Hopefully, you understand, and you agree.
Now, that I have made that clear, I need to also clarify another side of it.
You will meet certain people (good, smart, successful people) who will tell you that debt is actually one of the best things you can have when investing or starting a business.
They may use words like “leveraging”, “exposure” and “risk”.
You may wonder “What’s the deal with that?”, “Are they all working for loan companies trying to get your hard-earned money?”
Not necessarily.
If you look closely, you will find they all have one thing in common (the good and smart ones at least)?
That is that they all have more than 3 months of savings in their bank accounts.
They are able play with fire (aka debt) because they have more than enough water within arm’s reach.
As we established at the beginning of this post, we don’t.
When we have a nice chunk of savings and we are wondering how best to use it, perhaps their advice will be helpful.
For now, those opinions won’t help us.
Great! Now that we know these rules, let’s see what we can do about them.
The full “Getting More Value from Your Money” series
>> Prologue
>> Part 1: On Being broke
>> Part 2: Measure, Measure, Measure
>> Part 3: The power is yours
>> Part 4: The YNAB method
>> Part 5: Catalysts
>> Epilogue
For Further Study
The Money Principle – Do you have too much debt. At first was a feeling
The Money Principle – How to pay off debt and stay debt free forever
The Money Principle is a blog by a lady who had racked up a massive debt of £100k without realizing it, and how she (and her husband) managed to pay it off completely in 3 years. In these posts, she talks about the signs that you may be on the brink of drowning in debt and what you can do about it.
As they say look after the pennies and the pounds look after themselves.
However, I think one thing is missing from your analysis, the criticality of whether it is worth getting oneself into debt! You ask how!?
Maybe one gets a loan to fulfill dream of a loved one who has only weeks to live. Then your rules do not apply.
I hope your blog will benefit from adding dimensions on how to make a balancing act between neccesity of spend vs saving and being frugal.
Thanks Zahra,
I totally agree about the example you have given.
In that case, the same rules apply.
Borrowing money to help a loved one will still make us poorer in future.
And we can do the same test.
Is the poverty I am currently suffering every month worth the reward of that money I borrowed for my loved one?
The answer may be yes, if the value of joy brought to that loved one was great
Or it may be no, if the loved one used it for a few minutes and forgot about it.
As long as we are properly aware of the cost and risk attached to borrowing, we can make better decisions about it.
However, the goal of this series is to reach a place where we can deal with such emergencies without even needing to borrow. I hope the next few posts will show how.