First Principles, in philosophy, has been used since the time of Aristotle to boil down facts to their bare minimum. First Principles takes a situation, and simplifies it again and again, until we find a truth that is self-evident. A fundamental truth. A truth that is so simple, that no one can doubt it. By boiling a hard situation down to its First Principles, we can make mountains into mole hills. Situations that seemingly have no solution can be solved. So, how does first principles relate to personal finance? With so much information out there, where should we start? The answer is important, because without knowing the principals of a situation, all the methods and tricks to solve this situation will never work. This quote from Ralph Waldo Emerson sums it up perfectly.
First, answer a question. What is it that you want out of you life monetarily? Do you desire wealth? Security? Freedom from debt? No matter what, they are all sides of the same coin. You can read all about how to cut expenditures, hack your electric bill, or clip coupons out of the paper. You can find yourself a new, highfalutin’ well-paying job, start a side-hustle, or invest your money wisely. All of these are great, marvelous things, that are going to help you eliminate that debt, grow your wealth, or provide security for your family. But none of them, by themselves, are the self-evident truth that we seek.
So, once you discover your why, look deeper at the situation. What you are really looking for is to build wealth. If you are trying to dig out of debt, you are trying to get your net-worth back to zero. If you desire security for your family, you are trying to gain enough wealth so that your family will never go without. The answer, is that you are trying to have more money in your pocket each and every month.
Now that we know that our aim, no matter what, is to build wealth, we are growing closer to our fundamental truth; our First Principle. How does one build wealth? Is it through real estate investing? Picking the right stocks? Buying that lottery ticket when the jackpot is up to a billion dollars? Well, these might be the answers. (Okay, probably not the lottery ticket, but someone has gotta win.) The answer is simple. We spend less money than we make. Again, and again, and again. As often as we can, we spend less money than we make. That’s it! Our First Principle. You have just discovered the secret to building real wealth. Essentially, this is how all wealth is built, and the foundation of all strategies related to becoming wealthy.
Building real, lasting wealth, starts with internalizing and accepting this first principle. You have to know that this truth is the foundation of each and every other strategy that you will utilize, and that its the end goal of every tip and trick that you use on your way to financial independence, or whatever your end goal happens to be.
Now that we know the First Principle of personal finance, and accept that it is true, we move on to the next step. The next part of the philosophical tool of First Principles is to use our fundamental truth to decide upon our next step; using this information that we know to be true to solve our next problem. So what is our next problem?
As humans, we are hard-wired to prepare for scarcity, but that hard-wiring also encourages us to use and spend every last resource that we have, and quickly. Think about our ancestors, the cave-men. They would go days without food, and would put themselves at risk each and every time they hunted. Together, they would take down saber-tooth tigers, mammoths, bears, and other exotic and dangerous creatures. But the reward for their struggles was food that they were unable to save for long-periods of time, since they had no reliable means of refrigeration. So, they would eat all that they could, and have to go hunting again.
Does that sound familiar to you? Perhaps it sounds like the rat-race that most people are in; they hunt for two weeks (Go to Work), eventually get their reward, (A Paycheck), spend it all, and have to go hunting again. Its a cycle that for many, is never broken.
But we aren’t cave-men without refrigeration. We have means to save, and we should. So with our First Principle accepted, that we should spend less than we make, we have to overcome our hard-wiring to expend all of our resources, and make our first conclusion from that First Principle. That we should put the excess money to its best, and highest purpose. What does that mean? That depends upon the person. But you should analyze the situation, find the best and highest purpose that the extra money can serve, and apply it to that.
Do you receive a 401(k) match at work? Using a quick example, let’s say that you get a dollar for dollar company match of 6% of your pay. So, if you have an extra $400 a month, and a 25% tax bracket, then putting all of that money in your 401(k) plan will give you a tax deduction of $100, and a company match of $400. Right there, you have a 125% return on your money. Hedge fund managers would strangle a person with their bare hands to get that kind of return. So, that could be the highest and best use of your money. Maybe you don’t get a company match, or you are self-employed with huge credit card debt. The highest and best use of your money could be to pay down your credit card debt. Perhaps you are in tune with your local real estate market, and can consistently get 30% returns on your money. Well, that could be the highest and best use of your money. The next conclusion that you draw will depend on you, but you need to analyze and discover the answer for yourself.
All you have to remember from this article is two things; the foundation of all wealth. Spend less than you make, and put the excess to it’s best purpose. Everything else will fall into place.
What about you? When you find the First Principles of personal finance, do you come to the same conclusion? What’s the best use of your excess money?