The seven eternal truths of personal finance
No matter the business cycle or the trends, there are some things that never change when it comes to saving, building and managing money. Longtime Financial Post columnist JONATHAN CHEVREAU presents the second instalment of the seven eternal truths of per
The second eternal truth of personal finance is closely related to living below your means.
The principle of “paying yourself first” has been enshrined in every major personal finance book since 1926, when George Samuel Clason published The Richest Man in Babylon. It’s the single most powerful message in David Chilton’s bestseller, The Wealthy Barber, and has been incorporated into several more recent books by David Bach, masquerading as The Automatic Millionaire.
Clason started it all by writing a series of pamphlets for American banks and insurance companies about thrift and financial success in the 1920s. This collection of parables was later gathered together to become the book, ostensibly set in ancient Babylon. The richest man was Arkad, who, when entreated by his friends to reveal the secret of his wealth, said he discovered it once he decided that “a part of all I earned was mine to keep.” When the friends naively asked whether they did not already keep all that they earned, Arkad replied in the negative, pointing out that much of what they earned had to go to things like food and clothing.
These days, of course, a good chunk of our paycheques goes to taxes, energy, transportation and so on: We all know the multiple demands on our purse. The key is to “Pay yourself first” by putting aside at least 10 per cent into savings the moment you receive your paycheque or any other money. Arkad told his acolytes that regularly saving at least a tenth of their income (and better yet, more, if they could afford to) and putting that money to work earning interest, would eventually make them wealthy.
Chilton’s mega-bestseller, published in 1989, also advocated paying yourself first. But of course, interest income these days generates hardly any return and is taxed harshly. Chilton’s spin was to “be an owner, not a loaner,” meaning that 10 per cent savings would have a better shot at longterm growth by being invested in stocks instead of cash or bonds. When his book was published, Chilton said equity mutual funds were a good way to diversify stock holdings. This message was gratefully received by the mutual fund industry, which bought multiple copies of the book.
His followup, The Wealthy Barber Returns, is less effusive about mutual funds: like many costconscious personal finance gurus these days, Chilton likes exchangetraded funds, or ETFs.
Bach’s series of books with The Automatic Millionaire line took these concepts and emphasized that the best way to pay yourself first was to automate the process by arranging things so that the 10 per cent was taken from your pay- cheque right off the top through an “automatic draft” that transfers money to your financial institution to be invested, as soon as you’re paid by your employer. In Canada, an automatic draft is usually referred to as a “pre-authorized chequing” arrangement, or PAC.
The effect is similar to what happens when income tax is deducted from your paycheque “at source.” It’s gone before you can spend it and therefore you don’t really miss it. Yes, you may feel a bit “broke” after the double whammy of paying tribute to the taxman as well as paying yourself first, but as the years go by and your wealth steadily mounts, you’ll be glad you embraced this particular truth.
I said at the top that “Pay yourself first” is closely tied to the first eternal truth of “Live within your means.” The reason should be obvious. The only way you can save 10 per cent or more of your paycheque is if you are spending less than you are bringing in. If you’re earning $50,000 a year and spending $50,000 a year, there is no surplus and therefore no way to pay yourself first. And no, using your credit cards to buy investments is definitely not the way to go!
It follows that you need to be frugal enough that you have a surplus between what you earn and what you spend. As Arkad pointed out, if you’re not careful, you’ ll be paying everyone else ahead of yourself. So exercise guerrilla frugality, set up a PAC and invest the savings wisely.
How do you do that? Well, before we tackle that subject, we’ll have to look at our third eternal truth: debt. More on that next time.