Before we start, I’m going to address two very important factors:
The Political
When some people hear the word "personal finance", "investing", "stocks", they recoil in horror at the "capitalism" of it all.
To this reaction I have two things to say:
While you might be horror-stricken at the idea of investing, markets are a real thing and money is important to survival, regardless of how much you or I may dislike that. I believe it is in your best interest to use the tools available to ensure that you are financially sound so that you and your future children can operate within the current system without financial anxiety or dread. It’s better to be a socialist with money than a socialist without.
There is a significant difference between individuals investing to preserve their money and to help solidify a retirement and large institutions (hedge funds) using algorithmic trading techniques to manipulate the market.
Warning
I AM NOT YOUR FINANCIAL ADVISOR NOR RESPONSIBLE FOR ANY OF YOUR DECISIONS.
This is merely a collection of information that I have learned and collected into one document to help others. The information in this document is subject to change. Please think critically before you make any financial decision, I’m not responsible for you losing all your money. Don’t be an idiot.
Introduction
- Learning goal: I want you to start thinking about your personal finances in terms of a system, not just a single input / output.
Most people have a poor understanding of personal finances, so their personal financial systems are simplistic and useless. Personal financial systems don’t need to be complex, but by increasing the level of complexity of your system just slightly, a world of opportunities is made available.
For right now, I won’t be explaining specific details of how 401Ks work or how index funds work. Instead, I want you to think about personal finance from an abstract framework. By understanding how a financial system should work for you in the abstract, it makes implementation and the nitty-gritty details easier.
In order to understand what SHOULD be done, we need to understand what is currently being done and why it sucks.
Single-Input System (Not Good)
Most people think about their finances in a small scope. They may have a savings account, possibly a checking account, and may invest a couple hundred dollars into a 401k every now and then. In this type of set-up we have what I call a single-input system.
The main issue with this type of system is that we only have one stream of input, the salary. In order for the system to work, the individual must maintain a salary that provides all of the money that the system uses. The salary goes into the system, and the salary is then used to pay bills, groceries, etc. In order for the system to grow (meaning in order for you to have more money), the salary must grow. In real life terms, that means if you ever want to be financially independent, you need to always be working. You will always be reliant on a salary.
If we stick with this model, there are things you can do to improve your situation. You could get a second job or find more ways to make money. This means that there would be multiple input streams going into your savings account. While this is better than a single input stream,it means you are still relying on forces outside the system to bring money into the system.
Multi-Input System (Better)
In the world of personal finance, there are tools that people can use to grow their money. Examples of such tools are investment buckets such as 401ks and IRAs as well as investment instruments such index funds, bonds, and CDs. For right now, the specifics of these tools aren’t important, we’ll discuss them later on in the document. What is important right now is to realize that there are tools available that grow money.
What does it mean to grow money?
The idea is that the individual will place a certain amount of money into any given tool, and that tool when left alone over a period of time will increase the amount of money originally placed in it. So for example if an individual puts $1,000 in a 401k, over a long amount of time that $1,000 could turn into $2,000, $3,000, or even $8,000.
As mentioned before, the inner mechanisms of how this works isn’t important right now. What I want you to take from this that there are tools out there that will grow your money without you doing much effort, and that’s stupidly powerful for creating long term wealth and stable personal financial systems.
Here is an example of a multi-input system:
In the above system we have three financial tools that we are using to grow our money: a 401k, an IRA, and a brokerage account. Again, how these things work isn’t important. Think of them as magic money multiplying boxes for the sake of this section.
So what’s different about this system? First, our money isn’t going straight into our savings and living there forever. Instead, the main input into the system (salary) is getting split up and placed in multiple different places. We are using the salary to fund these magic money multiplying boxes. In turn, those magic boxes are adding additional input streams back into themselves.
Let’s compare this to the single-input system. In that system, we have one large input into the system (the salary). In order to increase the amount of total money in that system, we have to put more money into that system from external sources (salary, side hustles, etc). In this multi-input system, we put money from external sources into the system and by putting that money in different magic boxes, our money is increased and multiplied by internal sources (the magic boxes).
The internal sources created a positive feedback loop, the more money you put in those boxes, the more money the boxes will return to you. So unlike the single-input source, your salary isn’t the only factor that scales your system!
Conclusion
In this first entry of the series, we talked about two systems. The first is the single-input system that requires external forces to scale. The second is the multi-input system. In a multi-input system, we initially need external sources of input but once the system gets up and running it is possible for the system to be self-sustaining without external forces.
What does it mean for a system to be self-sustaining? Well here’s an interesting idea: what if all of your bills and spending could be covered by the returns from your magic boxes? Well that would mean that you wouldn’t need any external factors to help your system, you don’t need a salary anymore. Removing reliance on your salary is called Financial Independence and we’ll talk about that later in the series. Next let’s talk about the actual components of the system you’ll be building.