Investing and personal finance. Part I: How investment money comes into being

Where to find money for investments and how to invest so that financial well-being grows? We have prepared answers to these and other questions in a special series of materials. In this part, we will dwell in detail on the first steps from consumption to investment.

What you need to invest for
The life cycle of personal finance

Throughout our lives we deal with money. We earn and spend it, try to save and increase it, think about where to get it from and where to invest it later. With all the diversity, the financial history of most people is as follows:

After the start of labor activity, income rises, reaching a peak between the ages of 35 and 50, after which it gradually declines. This means that capital is necessary for a secure old age. There is a popular expression: “In the first years, the student works for the credit, and in the last years, the credit works for the student”. The same is true for investing. First, the investor works for the capital, so that later the capital provides the investor. And the earlier you start your investment journey, the more abundant life you can afford in the future.

Financial cushion

Sometimes circumstances force us to spend more than our monthly income on an unplanned basis. Emergency treatment, car or home repairs, loss – all of these can knock you out of your financial rut. For such an eventuality, it is useful to have a cash buffer of 3-6 months’ income. Such a cushion will provide not only protection from financial difficulties, but also psychological comfort due to the very fact of its presence.

Passive income

Buying an apartment and renting it out is the simplest way of additional passive income. When part of the monthly expenses is covered by income that does not depend on direct labor, it noticeably increases the quality of life and psychological comfort. Real estate is an expensive asset. But it is possible to receive interest on bonds or dividends on shares from much more modest investments. The amount of 1 million $, placed at 8% per annum, can bring a little more than 6,500$ monthly. Any ideas how you can spend this money?

Saving up for a Tesla

In the past, you saved up for a Ferrari, now the “green” Tesla is in fashion. In principle, you can imagine any purchase that does not fit within the monthly budget, be it an apartment, a car, a summer house, a trip to Europe or a Play Station 5. Saving can be made more effective by putting money aside at interest. Over the long haul, the compound interest effect will be especially useful.

From consumption to investment

The recipe for accumulating funds is simple: earn more than you spend and invest the difference. Following this scheme, it is easy to identify three main ways to increase the efficiency of capital formation:

Cost reduction
Increase in revenues
Increased return on investment
Nothing complicated in theory, but in practice it is not so easy to ensure a stable delta between income and expenses. If there was money, there would always be something to spend it on. Surplus is rarely formed, so it is necessary to create it artificially.

For this purpose, the contribution to the piggy bank should be made immediately after receiving income. Then you won’t be able to spend everything you earned. Make a rule: immediately after receiving a salary/premium/business profit, set aside 10% or another comfortable amount. It is recommended to set aside 50% to 100% of non-plan income, such as bonuses, gifts, inheritance, sale of unnecessary things.

This simple rule is the key to capital formation. It allows you to develop a useful habit of saving money and planning large purchases.

What we spend money on

It is very important to start keeping statistics on your income and expenses. This is a chore, but today there are a lot of tools that make this process easier. A wide range of mobile apps make it easier to keep records. Most of them allow you to visualize a diagram of expenses and assess where the leaks are, through which cash flows are leaking out of your wallet.

In general, all expenses can be divided into three broad categories:

1. Fixed expenses – expenses that are stable from month to month: housing and utilities services, loan payments, internet and cell phone charges, fitness subscriptions, etc.

Review your mobile and internet tariffs – they can often be easily reduced by 10-20%. For gasoline, fitness and other narrow categories, you can often find cards with an attractive cashback of 5-7%. Evaluate the possibility of refinancing your loan at a lower rate.

The savings here will be small, but they will not require much effort. It is enough to review your fixed expenses once a year and optimize them so that you spend less without a significant loss in quality of life. The money you save can be added to the amount you have set aside.

2. Variable expenses are those that are recurring from month to month, but their size may fluctuate: food, entertainment, clothing, inexpensive appliances, car maintenance, gifts to relatives, etc. The variable expenses are those that are repeated from month to month, but their size may fluctuate.

This is where the greatest potential for cost reduction lies. This is especially true in the categories of “food” and “entertainment”. According to statistics, impulse purchases in the style of “I’ll treat myself to a tasty treat” or “I’ll buy that cool thing over there” take up about 10-15% of the monthly budget. It is often more rational to put this money aside to spend on more important things.

Budgeting is a good tool here. Set aside a certain amount of money for these categories for the month and divide it into 4 weeks. Then, if possible, this amount can be carefully reduced, refusing useless expenses and finding stores with lower prices.

3. Major expenses include purchases that do not fit within the monthly budget: expensive furniture and appliances, a trip, a car, real estate.

These things can have a much bigger impact on quality of life than household expenses. However, they are the things that money is often not left for when you are not in the habit of setting aside a portion of your income. As capital grows, such purchases will become more and more affordable.

Before making major purchases, you should carefully study the market and choose the best value for money offer. While in the past this might have taken a lot of time, nowadays you can get all the information by giving up social networks for an hour and carefully running your eyes over the offers on the Internet and thematic blogs.

Don’t be shy about asking for a discount — very often the opportunity to buy cheaper exists, even if it is a purchase from a large retail chain. Sometimes you just need to ask. In the case of expensive purchases, plus or minus 1% already makes a difference.

We have dealt with where free money for investments can come from. To learn how to set financial goals and invest in a way that makes them easy to achieve, read the second part of this series on personal finance. Stay tuned to our publications!