By Eniola Daniella
There’s a heck of a lot of financial ignorance going around, and financial ignorance is costly. Women may have even more to lose than men, since they tend to earn less, are more likely to have interrupted careers and live longer. Understanding economics and personal finance doesn’t mean you won’t make mistakes or face financial disasters. But you can lessen the odds and repair the damage faster if you know the rules of the game and all around us we are beginning to get more nifty and helpful money concepts but these nine are among my favorites.
1. The Difference Between Needs And Wants
Our actual needs are pretty limited: food, shelter, clothing, companionship. Just about everything else is a “want,” and our wants are essentially endless. Because our resources are limited, we have to make choices about which wants to fulfill. Also, the way we fulfill our needs involves a lot of choice. Shelter, for example, can be a one room dorm or a multi million mansion. I’ve discovered many people believe they have to spend money in certain ways or in certain amounts, when in reality their spending is a choice — or is at least based on choices they made earlier. Taking responsibility for our choices can be scary, but it should also be empowering. After all, if you have choices, you’re not just a victim of circumstance.
2. Scarcity Makes Your Choices For You
It’s lovely to believe in a world of endless abundance, but the reality is that at any given point in time, our resources have limits. Whether it’s oil in the ground, our time here on Earth or the cash in our pockets, there’s only so much available to be spent. People who ignore this reality are the ones who run out of paycheck and may have to rely on loans and credits to sustain their life choices, and the odds are pretty good they’ll wind up old and broke.
3. Happiness Goes Beyond Your Wallet
We quickly adjust to improved circumstances. A raise at work or a new possession may make us happy for a little while, but we soon take our situation for granted. Our expectations continue to rise: if only I could get another raise, or a better car, or a bigger house. Should those expectations be satisfied, again we’d adjust and quickly want more. This has a lot of implications for personal finance and the economy, but here’s something to consider: Maybe we need to look beyond our wallets for true happiness.
4. Every Money Decision Has A Cost Of Its Own
“Opportunity cost,” very simply, means what we give up to get something else. In every choice, there’s an opportunity cost. If you decide to go to college, for example, you’re giving up the income you could have earned by working full-time during those years plus whatever you could have purchased with the money used to attend school. Understanding that our choices have opportunity costs, and examining what those costs are, should help us make better economic decisions.
5. Why Supply And Demand Rule
For the most part, prices are set by the interaction between supply and demand. If demand for something suddenly shoots up and the available supply of that something doesn’t change, then prices will increase. If demand drops or supply increases, prices typically fall. If we have rare skills that are in high demand by employers, we can negotiate higher pay. If, on the other hand, a lot of people can do what we do or the employer need for what we do is limited, our incomes are likely to be stunted.
6. Throw No Good Money After Bad
“Sunk costs” are expenses that have already been incurred and can’t be recovered to any appreciable extent. “Sunk cost fallacy” means an irrational belief that a further investment of time, money or effort will somehow resurrect the value that’s already disappeared. By hanging on to some old beliefs or love for something that doesn’t give you much joy. You’re also giving up the opportunity to get happiness elsewhere at a profit.
7. The Role Risk Play
Every human endeavor carries some risk, and investments are no exception. What differs is the amount and type of risk and how you’re compensated for taking it. Here’s what you should take away: You’ll almost certainly need to take some market risk if you want to grow your wealth. But note if and when an investment or business idea looks very promising or seems coated in gold, you’re taking some risk, and you should understand that risk before proceeding.
8. The Time Value Of Money
This boils down to a relatively simple proposition: that the dollar I get today is worth more than a dollar I’m promised sometime in the future. There are several reasons for this. One is the “bird in the hand” reality: the dollar I get today is real, but the dollar I’m promised in the future likely will be worth less (because of inflation), or I might not get it at all (you might renege on your promise to give it to me, or die, or cease operations if you’re an employer or business). Also, the dollar I get today can be invested to create more dollars in the future.
9. The Miracle Of Compound Interest
This is a concept best illustrated by example. Let’s say I give you a penny today, and promise to double the amount every day for a full month. How much money would I be giving you on the 31st day? The answer: $10.7 million. Each day, the “interest” I paid you the previous day earns more interest. At the beginning, the amounts are nominal, but by the end we’re talking big bucks. This concept explains how people who save relatively small amounts over the years can build rather substantial nest eggs. After a few decades, their actual contributions represent only a small part of their burgeoning wealth — it’s mostly their returns that are earning returns. But this also illustrates how debts can quickly balloon out of control. If you’re paying interest, rather than incurring it, and you’re not diligent about paying off the finance charges in full every month, the unpaid amount will incur additional interest charges, increasing the total amount that you owe.
