Taking personal finance seriously

Money is scare. If you take that idea seriously, how should you act?

Core Principles

Thinking differently

The first thing you learn in Personal Finance is budgeting, but budgeting can lead you to making common mistakes.

Think in cost-per-use terms, not total cost

If a car costs $500 a month, you may reason that it is within your budget, but you should think about the cost per use. For example, you need a car to transport yourself, but even if you get a car, you will not be using it for 90%+ of the time. Anything you only use 10% of the time you should look to acquire economically if at all. I call this strategy "utilization prioritization." This logic challenges many things Americans spend money on, most notably cars and housing.

Money represents time

If you accept the premise that money is time (because you traded your time for money), there are interesting implications. Most notably, if your money represents time, you should prioritize spending it on things that scale—items you buy once that provide enduring value. A good example is a robot vacuum or lawn mower because the upkeep costs are low, and they remove repetitive tasks from your weekly/monthly to-do list.

Understand what you're actually paying for

Another important thing is to understand where the value of your purchase is coming from. For example, a lot of people go to Starbucks every morning and get coffee for $2-3 a cup. What they're paying for is: 1) the caffeine, 2) the beans, and 3) the packaging and establishment (overhead). I imagine a lot of people are okay with their money going to these sub-products, but I believe that many would just prefer to buy 100mg caffeine pills off Amazon for 6 cents a pill (bottles of 500 100mg pills go for $20).

Understanding the economics of your purchases is a major unlock in your financial journey. Another important example is clothing. You can have two shirts—one with a Nike logo and one with a Hanes logo—and they'll cost different prices because Nike is selling their brand as a fashion statement + the shirt, while Hanes is just selling the shirt. Of course, many people would be willing to buy the Nike shirt over the Hanes shirt, but by doing so, they are voting on their values: fashion/additional cost is more important than utility/lower cost.

Also, note that if you purchase a product because of the fashion element, you're buying a depreciating asset unless you truly like it without the fashion prestige. My last example is sports drinks: Gatorade bottles often sell for 200% more than electrolyte packet competitors. Gatorade is selling you the packaging (nicer plastic + brand) with the electrolytes, plus sugar and dyes. Most of the time, buying Gatorade is a suboptimal purchase because you would not buy the sub-products (the components making up the whole product) separately. This leads to rule #3 of money: you never buy one product—you buy everything that went into that product.

Maximize consumer surplus

The first law of personal finance is to maximize consumer surplus—the positive difference between what you would pay for something and what it is actually sold for. For example, if I'm a big fan of Tesla and I'd be happy to pay $100k to get the new Cybertruck, but its actual price is $60k, my surplus is at least $40k. This idea is similar to the decision heuristic: "If it is not a heck yes, it is a heck no."

Practical tips to maximize consumer surplus:

1)Make saving your default instead of spending

2)It's not what you make, it's what you keep

A job that pays you $30k for minimal effort is better than a job that pays you $100k but requires 12-hour days and a long commute (assuming all else is equal). Don't just think about how much you can get from your job; think about how much you can keep—considering income, lifestyle, experience, and benefits. (A job that pays (even a penny) for nothing is the best job because it allows you to work another job and imparts no costs)

If you're young, your biggest asset is your work life. A good thought experiment: how many companies would pay you $1 million to have you as a permanent employee (for a 40-year career)? If you're making $40k a year, the value of your work over your lifetime is at least $1.5 million (without assuming pay increases).

Consider depreciation

For larger purchases, consider the rate of depreciation. If driving a car once decreases its value by 50%, then you should have paid half of what you did to own it. Seek things that:

1) Do not depreciate much

2)Are durable enough to last many years

Depreciation is affected by industrial progress. In industries with fast progress (like smartphones), you should consider alternatives to outright purchasing the newest model. In industries with slow progress, buying outright often makes more sense (Furniture).

High standards for spending

Money is easy to spend and hard to make, so your burden of proof for spending should be high. Different purchases require different levels of justification—life essentials need less justification than luxuries.

Wealth over income

The goal is not a high income but high wealth and quality of life. A person who works 8 hours a day to make $50k may be far richer than someone who gives up 24 hours to make $150k.

Savings rate determines retirement timeline

Your savings rate, not your income, determines when you can retire. Someone earning $40k and saving 50% will retire at the same time as someone making $200k and saving 50%. Someone making $50k and saving 60% will actually retire faster than someone making $200k and saving 50%(given that they both plan to earn their existing income in retirement).

Practical Application

Money as a voting mechanism

If you divide your paycheck into categories like housing, transportation, and food, you reveal your preferences and priorities. The goal of intelligent financial management is to align these revealed preferences with your rational preferences (what truly makes you fulfilled).

Ideally, your largest expense as a percentage of income should be the item that creates the most utility or enables the creation of the greatest amount of utility for you.

Focus on value, not just cutting costs

When getting your spending under control, focus on maximizing pleasure per dollar spent rather than cutting everything. Often, the best value comes from products under $100 and subscriptions that you use everyday .

Summary

Personal finance done well is a means of voting on your values. You first need to understand your values to get the most out of your life and money. Two practical ways to improve your finances

1)Write down your core values

2)Track your expenses and income