Twelve Key Elements of
Practical Personal
Finance
Common Sense Economics
James Gwartney, Richard L. Stroup,
and Dwight R. Lee
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A Personal Financial Epidemic?

Why do Americans live under so much
financial stress when their incomes are higher
than ever?

Financial insecurity is the result of the
choices we make rather than the income
we earn.

The principles that lead to financial security
are largely the same as the ones underlying a
prosperous economy.
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Who Needs Money?
There is more to a good
life than making
money!!!
But the desire for more
wealth unseemly!!!
Our life objectives are
easier to achieve if we
have more wealth.
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Practical Element #1
Discover your
comparative advantage.
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Comparative Advantage

We are all relatively more productive in some areas
than in others.

Your comparative advantage is determined by your
comparative abilities, not your absolute abilities.
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What’s Your Comparative
Advantage?

Even if you’re better at doing
everything, you shouldn’t.

Specialize in what you are
relatively the best at…for which
you give up the least.

Allow others’ work to be to your
advantage.

Self-sufficiency is for novels, not
real life!
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Practical Element #2
Be entrepreneurial.
In a market economy, people get
ahead by helping others and
discovering better ways of doing
things.
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Who are Entrepreneurs?

People adept at
discovering better ways
of doing things and
acting on these
opportunities.

Disproportionately
wealthy… 2/3 of
American millionaires
are entrepreneurs.
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Entrepreneurs’ Success:
1.
Entrepreneurial talent: the ability to
discover innovative new products, costreducing production methods, and profitable
opportunities that have been overlooked by
others.
2.
Tolerance for risk: Self-employment is
more risky, but greater risk and higher
returns go together.
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Entrepreneurs’ Success (cont.)
3.
4.
High Savings Rates: Investing in their businesses
adds to entrepreneurs’ wealth.
Hard Work …Business owners tend to work
longer hours.
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Practical Element #3
Spend less than you earn.
Begin a regular savings
program now.
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Why Save?
•
Saving is necessary to
accumulate the capital needed
to produce wealth.
•
This is just as true for
individuals as for nations.
•
The most effective way to
begin saving is by identifying
and eliminating some
discretionary spending.
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Don’t Wait!!!

If you don’t exert the willpower to save now, it is
unlikely that you will do so later.

If you wait to save until your income goes up, it is
extremely costly in terms of the amount of money
you will end up with at retirement.
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There’s No Need to Suffer!

Congress has made it possible to save
with before-tax dollars.



Savings is deducted from your taxable income, thereby reducing
your taxable income.
Many types of tax-deferred savings plans: IRAs, 401(k) plans,
403(b) plans, etc.
There are MANY creative ways to spend
less.


Pay yourself first! Make saving a regular expense.
“Just do it!”
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Practical Element #4
Don’t finance anything for
longer than its useful life.
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Financing Consumption

Why continue to pay for
something- a car, a
vacation, a television- that
you are no longer able to
use and enjoy?

Purchase on credit only
when buying a long-lasting
asset with short-lasting
financing.
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When should you buy on credit?
What goods and services can you
pay for while you use them?



homes
automobiles (depending on lifespan)
education
Some assets even generate income
or further service even after you
finish paying for them…these can
enhance your net worth!!!
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Practical Element #5
Two ways to get more out of
your money:
Avoid credit card debt and
consider purchasing
used items.
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Don’t Undermine Your Future!!!

The opportunity cost of saving for tomorrow is
spending (and enjoying!) today.

You CAN have more in the future while still
enjoying today…
“…ordinary people can have lots of nice things
and still accumulate a lot of money.”
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Credit Card Convenience

Paying with a credit card is NOT
spending your own money, but
borrowing someone else’s.

Interest charged on credit cards
outstrips returns that could be
earned on investments!!!

Think of your credit card as an
extension of your checking
account…Use your credit card
only to access those funds.
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The World’s Most Expensive
Vacation

Sean charges $1,500 for a trip to the Bahamas.

He pays the minimum payment ($26.63 at 8%
interest) each month.

10 YEARS LATER this trip has cost Sean
$3,195.40, and all he has left are faded photos.
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It Pays to Buy Used!

Can a used item satisfy you as well as a new
item?

Balance the time it takes to search for these
items with the value of your time.
There
are savings to
be had without having
to sacrifice consumer
satisfaction!
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Practical Element #6
Begin paying into a “realworld” savings account
every month.
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Rainy Days & the Real World

Life is full of surprises, and
they’re usually expensive!

The surprise is only in the
timing…So it IS possible to
plan for these surprises!

Purchase “peace of mind” by
building a cushion…Make this
a regular and mandatory
expense!
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Practical Element #7
Put the power of
compound interest to
work for you.
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It’s a Miracle!!!

Getting a head start
brings a HUGE
payoff.

Compounding occurs
when the interest
you’ve already earned
earns even more
interest on itself.
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Practical Element #8
Diversify- don’t put
all of your eggs in
one basket.
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Risk vs. Return





There are many types of
risk that come with
investing:
Market risk
Inflation risk
Financial risk
Fraud risk

There is no such
thing as a guaranteed
return!

Diversification is the
practice of holding a
large number of
unrelated assets.
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The Law of Large Numbers

Mutual funds are one way of diversifying investments in the
stock market.

While diversification cannot reduce the volatility of the stock
market, it WILL reduce the volatility of your investment in it.

When some firms do poorly, others do well.

Business cycles have differential effects on companies.
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Double Jeopardy




Does your employer offer a company stock-based
retirement program?
IF you have confidence in the company, take
advantage of the opportunity.
As soon as the plan permits, sell these shares to
purchase other investments.
Failure to do so puts you in double jeopardy …You
are now beholden to your employer both for your job
and your retirement investment. You are NOT
diversified!!!
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Practical Element #9
Indexed equity funds can help
you beat the experts without
taking excessive risk.
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The Random Walk Theory

No one can predict the future of
the stock market.

The random walk theory
suggests that current stock
prices are the best reflection of
the market’s value.

The future price of a stock is
driven by unforeseeable events.

Since we can only see the
present, it is impossible to “beat
the market”.
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Practical Element #10
Invest in stocks for long-run
objectives;
as the need for money
approaches, increase the
proportion of bonds.
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What About Diversification?

Merely an extension of the
diversification concept…

Because the stock market is
volatile, you want to reduce
your risk when you know you
need a cash stash.

Avoid selling off stocks when
the market is at a low point.
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So Why Not Just Hold Bonds?

Bonds offer a lower return
than stocks, but with less
risk.

Inflation risk and interest
rate risk are larger problems
with bonds.

Buy bonds that mature at the
time you anticipate needing
the cash.

Transfer capital gradually
from stocks to bonds.
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Practical Element #11
Beware of investment
schemes promising high
returns with little or no risk.
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There’s no such thing as a free
lunch!!!

If it’s such a good deal, why do
they need to sell it to you???

The principal-agent problem
makes you vulnerable.

A potential conflict exists between
the investor and the agent being
paid to do something for the
investor…Because the agent has
more information about the
product than you, you are at a
disadvantage.
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Tips for Avoiding Investment Fraud
1.
2.
3.
4.
5.
6.
If it looks too good to be true, it probably is.
Deal only with parties that have a reputation to
protect.
Never purchase an investment solicited by
telephone or email.
Do not allow yourself to be forced into a quick
decision.
Do not allow friendship to influence an investment
decision.
If high-pressure marketing is involved, grab your
checkbook and run!!!
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Practical Element #12
Teach your children how to
earn money and spend it
wisely.
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Teach Your Children Well

Teach children money is earned
…It doesn’t grow on trees!

Money both helps us get what
we want, AND helps others get
what they want.

Success in general is realized by
setting goals and working hard to
achieve them…Financial
success is no different!
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