Managing Your Finances Like An Economist
For many people, personal finance is that big and scary concept that confirms to us that we are now adults. We aren’t ready to hear the term or even understand what it means. We would rather live a stress and hassle-free life where wealth just grows and on trees, no less.
However, personal finance doesn’t have to be as complicated as many make it out to be. It is simply ‘the process of planning and managing personal financial activities such as income generation, spending, saving, investing and protection’.
The COVID-19 pandemic has left us scrambling to get a hold of our finances in the face of job losses, furlough, uncertainty about future earning capacity and rising inflation. Resources have become scarce while wants remain unlimited. Cue an economist!
The efficient and effective allocation of limited resources (read as income) amidst unlimited wants (read as expenses) is something economists know a thing or two about. They leverage on their understanding about economic data, trends and outlook to stretch their scant resources as far as it can go.
To effectively manage resources during this period, the following questions and phrases must be asked, contemplated and said out loud as often as possible:
What are the black and grey swans that could affect my finances in the next 12months?
Black Swans – highly improbable event, unpredictable, significant impact
Grey Swans – highly probable event, predictable
The first step to getting a hold of your finances is to identify the threats to inflows of income. Uncertain times such as this requires a ‘hope for the best but prepare for the worst’ strategy. It is a time to consume a diverse and rich array of news that breaks down both the health and economic aspects of this pandemic. Divide the news into ‘Known Unknowns’ and ‘Unknown Unknowns’. What policy changes are you sure will happen but do not know when? Which economic indicators are sure to go south and which are still up in the air? This way you can price in the uncertainties and unknowns into your spending and investing patterns.
- ‘I cannot afford it’
Personal finance management involves an understanding of where you are financially and the value of your assets and liabilities. These factors should be the key drivers of your spending pattern, especially in austerity times. This is no time to allow exogenous influences such as what people think and making a statement on Instagram and Snapchat be the guiding principles for your financial decisions.
Never be ashamed to admit that you simply cannot afford an item. In fact, best practice is for you to say the phrase repeatedly and louder. That way, your wants and needs will fall in line with reality. Prioritise your expenses, be disciplined with your budget, look out for bargain deals and remember, ‘There is always someone that will do it cheaper’.
- ‘I cannot afford it now’
No, this is not the same as the previous point. Maybe, you can afford it but ever heard of deferred gratification? During an economic downturn, a good finance practice is to defer high-ticket purchases such as cars, houses and household appliances. The trick is to spend more on essential items and remember the 50/30/20 rule of budgeting – 50% of your after-tax income on needs (essential items), 30% on wants (discretionary consumption) and 20% for savings.
- ‘Where can I get the best return?’
After cutting off most of your wants, the question is where do you stow away the recommended 20% of your after-tax income? The constant hunt for high yielding investment outlets can leave investors perplexed with no idea which outlet works best for both present and future liquidity needs.
With inflation as high as 12% and Treasury Bills rates at approximately 2%, the fixed income market may not be the most attractive outlet right now but it remains a risk-free option. On the other hand, if you are a risk-taker that understands that the higher the risk, the higher the return, try the stock market. Looking to keep your money where inflation cannot eat away at it? The real estate market is your best bet. Eurobond investments are useful if you have dollar-denominated expenses.
- ‘I need help’
Wealth preservation and growth can be confusing and a lot to take in for most people. You don’t have to navigate the murky landscape by yourself. There are experts that can work you through the process and if you play your cards, you may not have to pay a dime.