Three Fundamental Principles Of Personal Finance

A few weeks ago, I wrote about the Three Fundamental Principles of Language Learning on my Spanish blog.  The more I thought about it, however, the more I realized these same three principles can reveal a lot about our personal finance habits as well.  Here are the three fundamental principles of personal finance.

Facility Principle

What You don’t have to do is always easier than what you have to do

Inertia is a powerful force in the universe, as true in the personal finance realm as in the physics realm.  Researchers have discovered time and time again that inertia is the number one thing keeping most people from saving enough for retirement.  Companies that automatically enroll their employees in company-sponsored 401k plans have far higher participation rates than those that don’t, and the default investment options tend to be by far the most popular.  The lesson here is to automate the saving process.  Enroll in your company’s 401k and set up automatic drafting from your checking account to your IRA and savings accounts every month.  Once you make your savings automatic, you’re less likely to cut back your savings plan as a result of perceived emergencies.  No, you don’t need that new plasma TV even though the super bowl is coming up and you won’t be as tempted to divert savings toward consumption if it’s automatic.

Familiarity Principle

Old habits are hard to break

Perhaps you’re having trouble breaking the habit of eating out even though times are tough and you really can’t afford to do it as much anymore (I know I am) or maybe you need to scale back on your cable or telephone bill but are having trouble letting go.  Once you get used to a certain luxury, it’s very difficult to go back.  This is lifestyle inflation in its purest form.  Perhaps the best way to combat lifestyle inflation is to be overly-conservative with your saving habits.  If you are saving 30% of your income, chances are you can afford a small extra luxury.  If you’re only saving 10%, chances are you can’t.  There’s nothing inherently wrong by ramping up your lifestyle over time as you accumulate more financial resources so long as the increases in consumption are outpaced by the increases in wealth.  Accelerate too quickly, however, and you may find yourself stuck in an expensive lifestyle you can’t afford but can’t seem to live without.

Context Principle

Goals are more powerful when put into context

Everybody wants to get rich, but the simple goal of “getting rich” isn’t going to be enough to sustain you through the tough times.  You aren’t going to be able to stay disciplined in the face of temptation for something as abstract as “getting rich.”  Instead, put that goal in to context.  Why do you want to get rich?  It probably has something to do with financial security, enabling you to travel the world, achieve a certain lifestyle, or something of that nature.  Always frame your goals in the context of something concrete and achievable.  That villa on the beach in Italy is going to be much better motivation than having a million dollars in the bank over the long haul.