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Nothing that you can do today is going to change your finances today, but each financial decision you make can make a small difference to your finances. Enough of the correct small decisions and you will make a big difference to your financial decision. It is important to have a clear picture of what you want in your finances, and then to stick to these goals.
2. Live within your means
Actually, you need to live below your means. The most important way to generate wealth is to live below your means. It stands to reason: if you're spending all the money you make, how are you going to make your money work for you?
By living within your means we mean you need to curb your expenditure to less than 80% of your income. That way, you can use the other 20% or more to pay off debt fast, and save and invest for your wealth.
3. Stay out of credit card debt
If you can afford something, buy it using cash. If you have to use your credit card, then you're spending money you don't have. The interest rates on credit cards are very high, usually 5 – 12% above the prime rate of interest. This makes it very expensive. Many people who have a high outstanding balance on their credit card simply feel that it is hopeless trying to pay it off, so they don't try too hard, sending the outstanding balance even higher.
4. Maintain a spotless credit record
Your credit record contains all the information that your creditors are maintaining on the way that you make payment of the financial obligations you enter into. As such, it is your financial reputation. It is also a strong indicator of your financial habits. If your credit record contains lots of negative information, it tells us that you don't have very good financial habits.
5. Rationalize your spending
You may really want that new car or cell phone, or latest gadget. It tells others that you've arrived, doesn't it? But the truth is that you don't have to have the latest car, cellphone or iPod. You can do without it, at least until you can afford to pay for it in cash, or to buy it out of savings you have created by spending your money wisely, and saving and investing the balance.
6. Understanding opportunity costs
Opportunity cost is defined as the cost of pursuing one opportunity over another. For example, if you are considering buying a bicycle which costs R1000, the opportunity cost would be defined as the lost opportunity of doing something else with this money, like investing it in a 32-day notice savings account. If you buy the bicycle, then in a year's time it may be worth R250. If, however, you had taken this money and invested it in a savings account at 7%, it would be worth R1070 after 1 year. The difference between the first option and the second option is R820 (R1070 less R250) – the opportunity cost of not buying the bicycle.
7. Understanding the time value of money
Suppose you invest R1000 in a savings account today, at a 7% interest rate. In a year's time, your investment will be worth R1070. Therefore, if you can choose to have R1000 today or R1000 in one year's time, you would always want it today instead of some time in the future.
Now let's look at the reverse of this, to see how the time value of money can work against you. Suppose instead of receiving R1000 that you spent R10000 by buying something on your credit card. Remember that a rand today is worth more than a rand tomorrow, so in this case, you will have lost money because you will need to pay off your credit card using money from the future (which is worth less than money today). In addition to having to pay with future money, you will also have to pay the interest expense. So, in this case, if you paid off the credit card in one year (assuming 20% interest), you'd have to pay R1200.
8. Understanding the compound effect of money
Suppose you invest R1000 in a savings account at an annual return of 7%. In one year's time, your investment will be worth R1070 (R1000 + (R1000 x 7%)), effectively yielding a R70 gain. However, at the end of year 2, the same initial investment is worth R1144.90 (R1000 + (R1000 x 7%) + (R1070 x 7%), yielding a R74.90 gain. In year 3, the same initial investment would be worth R1225.04, yielding a gain of R80.14. By year 10 the initial investment would be worth R1967.15, and by year 25 it would be worth R5427.43.
From this example, you can see that investing R1000 today is much more valuable that investing R1000 in a few years time. In order to build wealth, you need to utilize the benefits of the time-value of money and the compound effect of money.
9. Take appropriate risks
If you want to make money, you will need to take some risks. But how much risk should you be taking? You've heard that the higher the risk the higher the reward.
Does that mean you should be taking the most risk possible?
The answer to these questions is that you need to be taking the risks that are appropriate to you. This will depend on two things, namely your time horizon and your aversion to risk. Your time horizon means the time frame that you will require the money to be available in. If you are close to retirement, you will typically have a short time horizon, as you will require access to your investments shortly. You will also typically have a strong aversion to risk, and will want to be in less risky investments.
10. Save money
You've heard the saying:"A penny saved is a penny earned". This is very true. To build wealth you need to start saving. You can do this in many ways. Find every way possible. One way of saving is to forego a purchase today that you can put off until tomorrow, or next year, or in five years time. The point is this; you need to start saving today.
