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  • Writer's pictureHorațiu Groza

Your Path to Financial Education (Thunder Talks #4)

Many of us likely didn't grow up in families that considered financial education an important or worthwhile topic, and rightly so. During their time, options for non-essential items like perfumes, clothes, and electronics were not as abundant, and the economic situation became increasingly worrisome, needing a focus on financial education.

Financial education

Understanding why financial education matters is crucial today. With so many products, constant ads and various sales strategies, our feelings often guide our choices. Having financial know-how is like a powerful tool for making smart decisions, especially when tempted to spend on things like a trendy smartwatch. 

Before we dig into why we feel this urge, let's talk about the reason it's so important to know about finances, especially when it comes to making smart investments.

What Is Financial Education?

The term "financial education" is broad and encompasses a range of topics, including savings, investments, effective debt management, strategies for debt reduction, understanding taxation, acquiring knowledge of fundamental financial concepts, and personal budgeting. 

While this subject may appear intricate and nuanced, exploring it is truly worthwhile. It bears a direct impact not only on our individual well-being but also on the fabric of the society we inhabit. The study of financial education is an investment in both personal prosperity and the collective welfare of our community.

When most people come across the concept of financial education, their minds immediately gravitate toward the pursuit of wealth. However, I'm not particularly fond of the term "rich" due to its inherent subjectivity. What defines richness? Is it when one possesses a wealth exceeding 500,000 euros? Perhaps more than 1,000,000 or even 10,000,000 euros? 

Personally, I find the term "financial independence" more fitting the point you no longer find yourself driven to work for money and can sustain your lifestyle solely from the returns on your investments.

This approach not only ensures financial peace but also grants you the invaluable commodity of time. Time to engage in activities that genuinely fuel your passions. After all, time stands out as our most precious resource. 

So, instead of fixating on the elusive notion of wealth, let's focus on achieving financial independence – a state where you not only have economic peace but also the freedom to invest your time in pursuits that truly resonate with you.

As we delve more into the article, I aim to underscore the primary reasons why it's worthwhile to place greater emphasis on our financial education. I'll explore the advantages it offers, as well as the adverse effects that emerge when such education is lacking.

Why Financial Education Is Important?

Firstly, the greater our knowledge of financial education, the more informed decisions we can make about money. Developing the skills to manage expenses, save strategically, and make insightful investment choices contributes to a quicker journey toward achieving financial independence.

Secondly, our individual benefits are intertwined with the broader gains for society. A financially educated community not only enhances our personal well-being but also fosters prosperity at a societal level. Through the prudent use of public funds, such a society optimizes its economic resources, resulting in stability and health. This, in turn, creates an environment where everyone can partake in the shared joy of a thriving economy.

In contrast, the absence of financial literacy can have profound and lasting consequences. Unfortunately, a substantial number of individuals reach their retirement years only to discover that their pensions fall short, compelling them to prolong their presence in the workforce. 

This predicament arises due to the inadequacy of pension funds, forcing many to grapple with the harsh reality that their hard-earned later years are burdened by financial strain.

A considerable portion of the populace turns to banks, accumulating substantial debts in the pursuit of financial solace. However, this seemingly pragmatic solution often backfires, culminating in a scenario where individuals find themselves unable to meet their financial obligations. As a consequence, they are compelled to relinquish essential assets—the very foundation of their livelihoods.

This financial situation not only strains individual lives but also casts a shadow over familial bonds. Money, or the lack thereof, emerges as a silent protagonist in the narratives of many families, contributing significantly to their unraveling. 

It serves as a sobering reminder that financial decisions are not isolated choices but rather threads intricately woven into the fabric of our life stories.

Whether we like it or not, money directly and indirectly influences significant aspects of our lives, including education, health, social life, and family. If we fail to manage the money we earn, all the aspects mentioned above may suffer. 

Conversely, by exerting a minimum effort over an extended period, we can strive for financial prosperity and attain the life many desire—one where the burden of financial concerns is lifted.

How Do We Better Manage Money?

Optimizing our expenses requires a clear understanding of where our money is allocated. This necessitates meticulous tracking of our personal budget. The simplest and most efficient way to achieve this is by using a mobile app, such as "Monefy," that enables us to manually record all incoming and outgoing finances. Alternatively, there are options that allow automatic tracking by connecting our credit cards.

Once we have a comprehensive view of our budget, the ultimate aim is to adhere to the 50-20-30 rule:

  • Allocate 50% of the budget to essentials (rent/mortgage, utilities, food)

  • Dedicate 20% of the budget to investments, putting our money to work for future gains

  • Reserve 30% of the budget for discretionary spending and entertainment.

While this budget breakdown serves as a guideline, channeling more funds into investments accelerates the journey to financial independence.

Next, it's crucial to establish an emergency fund—a financial cushion designed to cover our living expenses for a span of 6-12 months. The unpredictable nature of the future makes it wise to have a safety net in place. 

This fund proves invaluable in scenarios such as facing health issues that impede our ability to work or experiencing a period of job loss. Having this financial buffer provides a sense of security during unforeseen challenges, ensuring we can navigate through uncertainties without undue financial strain.

I recommend adopting a more discerning approach towards spending funds. It is not uncommon to observe individuals acquiring items that lack genuine necessity, succumbing to the allure of consumerism. In particular, the pursuit of trendy and often costly possessions can lead to a cycle of capital consumerism, where the constant desire for the latest and most expensive items becomes a habitual pattern.

To avoid falling into the trap of capital consumerism, it is advisable to exercise patience and engage in reflective decision-making before committing to a purchase. Consider whether the desired item truly aligns with practical needs and long-term goals rather than succumbing to momentary impulses. 

This thoughtful approach can contribute to a more intentional and sustainable consumer behavior.

How Do We Invest Money?

After establishing a robust emergency fund covering expenses for 6-12 months and consistently setting aside a portion of our income each month, we're prepared to explore the realm of investing and allow our money to start working for us. The question arises: where should we direct our investments, and how should we go about it?

In reality, a diverse array of financial instruments and strategies await us in terms of investment. Delving into each one individually could be overwhelming, so let's narrow our focus to the stock market and an investment strategy designed to alleviate financial strain without demanding an excessive time commitment.

When building a strategy, it's essential to consider various factors, including defining our goal, specifying the timeframe for achievement, gauging risk tolerance, and estimating the annual return on investments. These parameters can vary widely, shaping strategies uniquely for each case. The strategy I propose encompasses the following key aspects:

Objective: Achieving financial independence (with returns exceeding expenses)

Timeframe: 15+ years

Annual Return: Targeting 10%

Risk Tolerance: Moderately low

By adhering to these parameters, the proposed strategy aims to navigate the journey towards financial independence effectively.

Some may claim that a 15-year timeline is excessively long, but even if we were to commence our investment journey at the age of 45, we would still achieve financial independence sooner than relying solely on the state pension – and with greater financial resources. Therefore, I suggest that the wait is worthwhile, especially if we initiate this path as early as, for instance, at the age of 25.

We've defined our goal, and set a timeframe. Now let's discuss how we structure our budget. 

Let me introduce you to the 75-25 rule: from our monthly salary, we allocate 75% for personal use, covering both expenses and desires. The remaining 25% is then invested in a financial instrument aiming for that 10% annual return. 

If we consistently follow this approach for 15 years, the accumulated investments will eventually yield a monthly income equal to or surpassing the initial 75% used for our living expenses. In essence, this leads us to financial independence.

Total savings following the 75-25 rule over 15 years

Let’s take as example a salary of 1000 euros. We allocate 750 euros for day-to-day expenses and invest the remaining 250 euros at a 10% return. As depicted in the graph above, over 15 years, we have accumulated savings of 45,000 euros. However, thanks to the 10% return and the power of compound interest, in the 15th year, our savings grew to 95,317 euros. 

With a 10% annual return of 95,000 euros, we're looking at 9,500 euros, translating to a monthly income of 791 euros. Hence, we've reached the point where the returns on our investments cover our monthly expenses of 750 euros.

Granted, this calculation doesn't factor in inflation or taxes, but it also doesn't consider potential salary increases over the period. If, at some point, we have the opportunity to invest more than 25%, we could reach our financial goals even faster. All in all, this scenario appears quite realistic and attainable for the majority of individuals.

Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn't… pays it. ― Albert Einstein

Total savings following the 75-25 rule over 30 years

We've seen how we can double our money in just 15 years, going from 45,000 euros to 95,000 euros. However, the compound interest effect becomes even more significant as we extend the investment period. If, after the initial 15 years, we continue investing in the same manner for another 15 years, our total contributions would reach 90,000 euros. 

Yet, the total savings value would skyrocket to 493,000 euros. In simpler terms, this could potentially result in a passive monthly income of 4,108 euros—five times greater than if we had halted our investments after the initial 15 years.

So far, everything seems promising, right? But the burning question you likely have is: where can we secure an annual return of 10%? As previously mentioned, a range of financial instruments awaits for investment — bank deposits, government bonds, real estate, precious metals, stocks, cryptocurrencies, and more. 

I'll explore the distinct advantages of the stock market, as it often stands out as the most optimal investment choice. What’s more, I’ll investigate how we can not only benefit from its unique advantages but also achieve the desired annual return of 10%.

Best Ways to Invest Money

In Romania, the stock market remains a taboo topic. Many people hold misconceptions, linking the stock exchange with gambling or scams like Caritas. Consequently, the number of Romanians actively investing in stocks is quite low. The Bucharest Stock Exchange (BVB) reports only 160,000 registered accounts, with an even smaller number of active investors. 

This figure pales in comparison to the United States, where 61% of the population engages in the stock market.

As a fundamental guide to effective and stress-free investing, it's essential to adhere to three core principles:

  1. Diversification: Embracing the saying "Don't put all your eggs in one basket" is key. The more diverse our investments, the lower the risk of financial loss. This strategy acknowledges that the likelihood of all investments declining simultaneously is minimal.

  2. Granular Investments: Opting for "granular" investments enables better risk management and provides flexibility to adjust your portfolio based on market changes or financial goals. For instance, allocating 1,000 euros for investments throughout the year can be more effective by investing 83 euros each month, minimizing the risk associated with timing the market.

  3. Consistency: Consistent investment and unwavering commitment to our strategy are crucial. Regardless of fluctuations in the value of our investments, attempting to time the market precisely often leads to lower returns or even financial losses. Therefore, maintaining a steady and disciplined approach proves more beneficial in the long run.

Fortunately for us, the stock market allows us to follow all three principles mentioned earlier. We can start with small amounts, choose from a wide range of stocks to diversify our portfolio, and numerous platforms offer the option to automate recurring investments. 

This way, we can maintain consistency month after month, aligning seamlessly with the fundamental principles of diversification, granular investments, and consistency in our approach.

In examining the potential returns within the dynamic landscape of the stock market, a key indicator is the S&P 500—a thoughtfully selected compilation encompassing the largest 500 companies in the United States. 

Over the last 100 years, the S&P 500 has demonstrated a noteworthy average return of around 10%, illustrating its resilience and reliability as a barometer for market health. This historical performance serves as a compelling factor for investors seeking a diversified and stable avenue for long-term investment.

A particularly accessible gateway to tap into the potential of the S&P 500 is through Exchange-Traded Funds (ETFs). These funds, designed to mirror the performance of the S&P 500, empower investors to acquire shares representing a diversified portfolio within this index. 

ETFs offer a practical and efficient means for individuals to participate in the growth of the S&P 500 without the complexity of individually acquiring stocks from each constituent company. This not only presents a more manageable and diversified investment strategy but also provides investors with exposure to the broader movements of the U.S. stock market.

Attempting to time the market involves predicting optimal entry or exit points based on short-term trends, a challenging and risky strategy due to the inherent difficulty of accurately predicting market movements. 

Investors employing this strategy may miss crucial growth periods or be exposed to downturns. Prioritizing a steadfast, long-term approach enables individuals to leverage the market's inherent ability to recover and generate sustained returns over extended horizons.

So, successful investing hinges on three key principles: diversification, granular investments, and consistency. The stock market conveniently accommodates these principles, offering a seamless approach for investors.

The S&P 500, with its historical average return of 10%, stands as a reliable indicator, and Exchange-Traded Funds (ETFs) provide a practical means to tap into its potential. In contrast to risky market timing, a steadfast, long-term approach aligns with the market's resilience, guiding us toward sustained returns.

Financial Education Never Stops

It's essential to acknowledge that, due to time constraints, I've opted for a more concise overview, merely scratching the surface of the presented information. The main goal remains to emphasize the crucial role financial education plays in our lives and inspire you to initiate your journey into the world of investments.

It is crucial to understand that the information shared here doesn’t constitute financial advice, and I strongly discourage making investment decisions based solely on hearsay. Everyone should do their own research in order to make well-informed decisions.

As a source of inspiration for most of the information presented here is Iancu Guda’s book “Banii în mișcare. Prosperitate în 10 pași”, which I highly recommend.

This book offers comprehensive insights into the topics covered in this article and beyond, serving as a great source of knowledge for those who want to start their financial journey. Another worth reading book is Your Money or Your Life, by Vicki Robin and Joe Dominguez.

In closing, remember, education never stops, especially in the world of finance which is constantly changing.


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