Money. We all use it. We all know how important it is. But how many of us actually know enough about it?
No, not the fact that the echidna is on the 5c piece. I mean, that's useful, especially when my 6 year old son wants to know 'How many echidnas' he needs to buy a toy (Answer: A lot more.)
Instead, how much do we know about how money behaves? What's 'good' or 'bad' when it comes to money, What defines success?
And no, I'm not talking about vague economic concepts like the money supply, the velocity of money or even, God forbid, the NAIRU (that's the non-accelerating inflation rate of unemployment, just to prove I know at least a little of what I'm talking about!).
I'm talking about the rules of thumb that can be the difference between financial freedom and, well, working for the man. For way longer than you'd like.
You use rules of thumb every day. Things like 'If you're having computer problems, 90% of them can be solved by turning it off and on again'. Or the 80/20 rule, known as the Pareto principle, which suggests 80% of any outcome stems from 20% of the work (or workers!). One of my personal favourites is Moore's Law, which holds that computing power doubles every two years or so. The details are somewhat more specific than that, but for lay people, it's a good enough summary!
Then, of course, there's the famed five-second rule, pertaining to food that falls on the floor. If you have kids, you know this isn't really a rule, but it's handy to pretend…
But back to money.
There are some very real — and very, very valuable rules of thumb you need to know.
And each has its own number.
3.6
3.6%, to be precise. I've said it before, I'll say it now, and I'll keep saying it until I'm blue in the face: If you're paying more than 3.8% on your mortgage (at the current time, anyway), you're being ripped off. And if you're paying more than 3.6%, you're paying more than you should be.
There are at least 4 reputable financial institutions offering loans for less than 3.7%. They are, alphabetically, HSBC, IMB, SCU and UBank. Two of those are at 3.59%.
If you have good credit and a good deposit/equity, ask your bank to match them. If it won't, or won't get close enough, switch. Yes, it's a pain, but do it anyway.
A 0.5% reduction in your rate, on a $500,000 mortgage, could be worth $50,000 by the end of a 30-year loan. That's the price of two small new cars you're donating to your bank if you're not getting the best rate.
Do they really deserve your charity?
No, I didn't think so.
25,000
Doing anything just to 'pay less tax' is dumb. It's a con-man's trick to win your business, preying on our innate desire to give less money to the government.
It's been used to sell accountancy services, investments in crappy emu farms and timber plantations, contributions to finance movies and awful property investments where the spruiker makes a double-digit cut on your "investment".
The clever, capital-F Foolish person knows that 'maximising after-tax returns' is the slightly less catchy, but infinitely smarter approach.
The single best version of 'maximising after-tax returns' is to do what you already know is smart, but in a way, that means the tax man gets a smaller slice of your hard-earned. The most obvious example is Superannuation.
The average working Australian can contribute up to $25,000 per year (including contributions from your employer) into concessionally-taxed Super. The value of that benefit depends on your tax bracket, but suffice it to say it's as close to 'free money' as you'll get.
The catch, of course, is that you can't touch it until you retire. But trust me, your future self will thank you for it.
(As always, tax rules are tricky and specifics matter. But, armed with this information, you can ask your accountant some good questions, and she can get you on the right track).
10
Some things just tend to be true. Like the 80/20 principle that has no physical reason for being so, but just end up being accurate, most of the time.
Over any extended period of time, the stock market tends to average around 10% per annum, compounded. Individual years vary — sometimes wildly. 5- and sometimes 10-year periods can be quite different, too.
But over multi-decade periods, across the developed world, the average stockmarket return tends to be about 10% per year, give or take.
Now, compare that to cash. Or term deposits. Or property (over more than just the last 30 years). Or gold. Or pretty much any other serious asset class.
So what? Well, I think it could be reasonably argued that once you have enough 'rainy day' cash socked away in a high-interest savings account, any money you don't need for 5 years or more, and that you want to use as a nest egg (or even to draw from, slowly, in retirement) should be in a diversified share portfolio (or an ETF).
The future may not look like the past. There are no guarantees, but the odds are very good, in my opinion.
72
Perhaps the best-known rule of thumb, when it comes to money, is the 'Rule of 72'.
If you want to know how long it'll take your money to double, divide your rate of return (interest rate, total share market return, etc etc), into 72.
Getting an average of 6% per year? Your money will double in 12 years (72 divided by 6)
Earning 9%? That'll take 8 years to double. (72 divided by 9)
And you'll double your money every 7-and-a-bit-years if you compound at the aforementioned 10%.
Like all rules of thumb, it's not exact. It breaks down at the extremes. And just because you can calculate it, doesn't mean you can achieve it (a 36% return would double my money in 24 months using the Rule of 72%, but even Warren Buffett can't average 36% per year).
It's eye-opening, though. And shows you just how important both your timeframe and rate of return are.
Let's say you do earn 10%. And you start with $10,000
At the end of year 7, you'll have $20,000
Year 14: $40,000
Year 21: $80,000
Year 28: $160,000
Year 35: $320,000
Which means, if you're 30 and you can invest $32,000, you could have $1 million at age 65, without adding an extra dollar.
Again, those are all hypotheticals — your mileage will vary. But you see the point. And the power of the Rule of 72.
Foolish takeaway
The old adage holds that 'A little knowledge is dangerous'. I'm sure that's true if you work with explosives, scalpels or heavy machinery.
But if you can latch onto those four money rules of thumb, and put them into action, I have no doubt you'll reap the benefit for decades to come.
