The Five Principles of Finance
What are the 5 principles of finance and how do these components lead to economic freedom? Interestingly, none of them have to do with the stock market, or with investing.
Doug: Those who seek economic freedom want to win. In order to win, you must know the rules. Episode 2 of The Science of Economic Freedom is about the principles to follow in order to achieve our goals.
Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment perspectives carefully before making any changes to your investment portfolio.
This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc is the parent company of Mercer Global Advisors Inc and is not involved with investment services.
Doug: Welcome to the Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is all about helping you achieve your financial dreams. We call that economic freedom. This program is about your journey to achieve economic freedom for yourself and your loved ones.
Today we want to help you identify your next step in that journey. This is episode 2, The Principles of Economic Freedom. When learning a new subject, one has to understand the basic rules of the game so you can win. We all want to win. If you’re listening to this podcast, you want economic freedom.
What we are going to tell you today is not hard to understand. It’s easy, it’s logical, it’s straightforward. Now let’s begin with the word “principles.” What does that mean? Principles mean rules of conduct. Know the rules and you increase your chances of winning. Break the rules and lose. The easiest action to take with money is to lose it. We don’t like to lose. We can’t achieve our goals losing. That does not mean that our investments will never go down. Certainly they will, but if we stick to our principles, we will not lose the game. These principles are broken down into two categories, the principles of finance and the principles of human behavior.
The five principles of finance
Seed capital is your savings. Seed capital is your surplus money. You cannot build wealth without seed capital. You should be saving money every month. You’ve probably heard that saving 10% of what you make is a good goal; 20% is even better. When you’re just starting out, 20% may seem ridiculous, but economic freedom starts with saving money. Remember, the path to freedom for most of us is to spend less than you make. Windfalls like bonuses, proceeds from the sale of an asset, or inheritance, are all sources of additional seed capital.
Time is going to pass by anyway—every day, every week, every month, and every year. You must use time to your advantage. Time is a powerful component in the formula for compounding your savings. Time is an advantage when you’re young because you have more years to grow your investment. Time allows you to save more money every month. Time allows your investments to grow longer before you need them. Time is also a factor when you have achieved economic freedom. You may be in retirement 30 years or more. Time also allows you to have an impact on the world, to contribute to it, and economic freedom will allow you to enjoy your time.
Albert Einstein called compounded growth the eighth wonder of the world. Compounding is a geometric progression. When a rate of return is projected into the future over and over again, what may seem like a small rate of return, oh [Phonetic 00:04:15] say 5%, is powerful when compounded over 30 years. Compounding gives you exponential growth, growth on your growth. Now, compounding can also work against you through inflation. Holding money in a bank at a zero rate of return will not allow you to achieve economic freedom.
Diversification is a common term used in finance to describe the ownership of multiple assets. This could mean diversification of stocks via a mutual fund, or diversification across asset classes like owning real estate stocks and bonds. Asset allocation is another meaning of diversification. Diversification lowers risk. If one asset goes down, then another can go up. Diversification gives your investments balance.
Friction of fees
Fees are embedded into finance everywhere: bank charges, transaction fees, expenses for investment products, management fees, and commissions. Everyone and every institution that touches your money charges a fee. We call these fees friction. They rub against your returns. They lower your returns. Fees must be understood, qualified in terms of the value and services you receive, and quantified in dollar terms to make them real.
Those are the five principles of finance that you need to know and remember to win the game. Here they are again: seed capital, time, compounded growth, diversification, and fees.
The five principles of human behavior
Now we must add you to the equation. People are all unique. They have different life experiences and start down the path to economic freedom with varying assets, income, and baggage. People are emotional. They make mistakes. They act on their emotions, most of the time to their detriment. They make choices based in fear or in greed. Controlling your emotions is an important factor to achieving your goals.
These five principles of human behavior will help you keep your emotions in check.
The dictionary definition of knowledge is an acquaintance with facts, truths, or principles from study or investigation. Another definition, a body of truth accumulated over time. We have a 70% financial illiteracy problem in America. Financial knowledge must be acquired. Now, this is part of our mission at the Science of Economic Freedom. We have collected the knowledge, we have the research, the proven science of achievement, and we want to share it with you.
Wisdom is defined as the knowledge of what is true and right coupled with judgment, having the power to judge properly as to what is right for you. You are central to the equation of economic freedom. You get to define it for you. You get to judge which solution is right for you. To have wisdom, you first need knowledge. Knowledge first, wisdom second.
Discipline means behavior in accordance with the rules of conduct, training in accordance to the rules. Discipline equals freedom. This is where many people lose control and never achieve economic freedom. They freak out, they panic, they allow their fear to control their decisions and they lose their discipline. Along with it, they may lose their economic freedom. Discipline requires focus, training, and coaching.
Open to change
Are you the kind of person who is open to change, open to changing your mind if the facts or the reality changes? We hope so. Part of the journey to economic freedom requires a change in yourself. You may need to unlearn what you already know about finances. You must reflect on past actions that did not get you the results you expected. We must be open to new ideas and arguments that are based in science and facts.
All of us are goal-oriented, but few of us set goals. You must decide what economic freedom is for you. Once you do that, we can map out a plan to achieve it. We must focus on reaching a specific objective and take personal responsibility for getting there. If you know where you want to go, we can help you get there.
There you have it, the five human behavior principles of economic freedom: knowledge, wisdom, discipline, open-minded, and goal-oriented. Understanding these principles is part of the foundation to your future achievement of economic freedom.
Now, here are the action steps from today’s program. These principles will work for you every day, but you have to remember them. Visit thescienceofeconomicfreedom.com and on the Resources page, download these guiding principles of economic freedom. Print these out. Post them in a place where you will be reminded of the journey you are on and you will gain inspiration from them. We know what economic freedom is. We now know the principles. Next up are the formulas to achieving economic freedom.
Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.
This program is sponsored by Mercer Advisors. Mercer Global Advisors, Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors, Inc. is the parent company of Mercer Global Advisors, Inc., and is not involved with investment services.