What are the fundamentals of money?
What are the primary sources of financial success – the actions, the habits, the knowledge, the strategies that take you from where you are today to financial freedom in the future?
If you can unlock these foundational pieces of growing wealth, you have what you need to achieve some massive financial goals.
So where do you start? Here’s our take on the fundamentals of money you need to master to increase your net worth.
The Fundamentals of Money and Financial Success
First, a caveat: we don’t feel there’s any one objectively correct answer here, and there’s a specific reason for that.
Everyone begins the process of wealth management from a different starting point. That makes it difficult to nail down core tenets of personal finance that are absolute.
Not everyone earns the same, comes from the same socioeconomic background, or gets the same opportunities. Every person’s starting line is different:
Different depths of pre-existing knowledge. Various degrees of financial literacy. Unique perspectives based on lived experience.
We can’t account for all possible variations. But we can still try to answer the question of, “what are the fundamentals of money that I must understand to reach financial success?”
We can get closer to an understanding of what you need to bring to the project of increasing your net worth.
We can also outline our own unique take on the question based on the experience we have in working with a specific group of financial planning clients.
As financial planners and advisors with decades of collective experience on our team, we’ve seen what works and what doesn’t.
We’ve also seen enough patterns to recognize there are some common core elements grounding our most successful clients.
That’s what we’ve identified here as the fundamentals of money. This is where to start if you want to afford the experiences you want today while still building financial security for the future.
1. Have a Baseline Level of Literacy
You need to be literate in financial advice. Literally!
This sounds simple, or painfully obvious – but this is important. Language matters.
It’s hard to talk about money or act on financial advice if you feel confused about the language in use. You have to know some basic terms and concepts.
You need to understand what someone means when they talk about debt and credit. You have to know that a savings account is different than an investment account (and that the “investment account” is sometimes called a taxable account, or a brokerage account).
You should be familiar with concepts like “compounding returns,” “market volatility,” and “diversification,” and recognize there’s a relationship between risk and reward.
You don’t have to be an expert, or able to give lectures on these topics. But you need to grasp the 101-level definitions if you want to understand how to best use your money to make more of it.
Financial literacy doesn’t mean you know everything and can manage your money by yourself without guidance. It means having a familiarity with the language involved in financial advice.
It also means you know what you don’t know. You recognize when you have a gap in your knowledge, and you seek to fill it.
That means asking good questions, working with experts, and doing your own research.
This could be as simple as running a Google search (i.e., “what is a brokerage account?”). Or, it could mean getting more involved.
You could sign up for a basic financial literacy course (many library or university programs offer these for free – this isn’t necessarily something you need to pay for), read more personal finance books and blogs (Psychology of Money and The One Page Financial Plan are two of our favorites), or subscribe to financial podcasts (might we suggest Beyond Finances?).
You can also work with a financial planner, which is something to consider as your life (and finances) evolves in complexity. It’s one thing to gather and understand information. It is quite another to know how to apply facts to the context of your specific situation.
That’s where a CFP can be of massive value – again, once you get to that level. If you’re not quite there, these steps for starting financial planning yourself might be good to review.
No. 1 in the Fundamentals of Money: Be Financially Literate
- Know basic terms, phrases, and concepts about personal finance
- Seek out personal finance books and financial podcasts
- Recognize when you don’t understand a money concept, then develop the right questions to help you research and find the answer
2. Know How to Save Money (and Prioritize Savings!)
If we had to boil down financial success to just one thing, it might be the ability to prioritize your savings.
The ability to develop and stick with a serious savings habit over time often separates people with the potential to be wealthy…
…and those who actually are wealthy.
You cannot do much to grow wealth if you can’t save. To paraphrase Morgan Housel, wealth is money that you haven’t spent yet.
Your actual wealth is not determined by your income (although there’s no denying that earning more makes everything else easier).
You could earn a million dollars each year – but if you spent it all, you’re not wealthy. You’d have no assets, and nothing to show for all that earning power.
Financially successful people translate income into assets. The primary mechanism for doing so is setting some amount of income aside – saving it – for wealth-building activities.
Without savings, you can’t generate the principle you need to start investing. You won’t have the capital required to engage in any kind of endeavor that could grow your wealth in the future, like buying property or starting a business.
And you won’t have a way to maintain your lifestyle when, eventually, you can’t work or earn an income anymore.
No. 2 in the Fundamental of Money: Save, Save, Save
- Determine how much you need to save; we recommend thinking about this on an annual basis, so you can account for variable income
- Build a budget around what you need to save first, and then you can spend the rest freely, and without guilt
- Make it a habit and automate what you can
3. Control Your Cash Flow
Your cash flow is the money you have coming into your accounts on a regular basis, as well as the money going out.
Typically, your income comprises the “money coming in” part of this equation. “Money going out” is your expenses (bills, liabilities, services, and all other spending).
You can look at your cash flow on a monthly, quarterly, or annual basis. In fact, we recommend doing all three to fully understand how your income and expenses interact!
Controlling your cash flow is one of the major fundamentals of money. You have to master this coordination of inflows and outflows if you want to optimize your financial resources.
Like building a savings habit and prioritizing your ability to save above all else, controlling your cash flow is critical regardless of how much money you make.
Based on the experience we have with our financial planning clients, we’d say cash flow management becomes even more integral to financial success the more you earn.
That’s because the more you earn, the more you have to manage. More income tends to equate to:
- more choices to consider
- more decisions to make
- more ways to allocate the money you hav
- more priorities to address if you want to increase your net worth and protect it too.
This, by the way, is why budgeting is still important no matter how much you make. Maintaining some kind of budget or cash flow tracker is an excellent self awareness tool.
Cash flow management is also critical because this is how you create a gap between what you earn and what you spend. The bigger the gap (i.e., the greater your income is than your spending), the easier and faster you’ll grow wealth.
Managing, paying off, and then avoiding future debt is also part of the cash flow conversation.
If you tie up a significant amount of your cash flow into debt payments or other large fixed costs, it leaves you with less money to use to building assets, rather than just paying back what you borrowed in the past.
No 3. in the Fundamentals of Money: Keep Your Spending Tight and Savings High
- Aim to increase the gap between your income and your expenses; the higher your earnings are over your costs, the easier growing wealth becomes because you have more money at your disposal to direct toward building assets
- Be careful about how many large, fixed costs you plug into your cash flow; for example, we recommend keeping housing costs to no more than 20 percent of your gross income
- Avoid lifestyle inflation and consumer debt
- Align your spending with your values
4. Boost Your Income Potential
Saving is an important habit. You must have the ability to save money if you want the opportunity to increase your net worth…
But it’s what you earn that helps determine how quickly and easily you can build the assets that create wealth.
Many people focus on one side of the equation or the other. Frugal bloggers and proponents of the “FIRE” movement often stress saving massive percentages of income as the surest way to reach financial independence.
Meanwhile, more entrepreneurial-minded people may think mostly of business ventures with the most income potential. They may not consider what portion of those earnings may need to be set aside for the long-term.
The truth is, you need to combine both: you need a solid savings habit and you need earnings power.
Just trying to save more and more money without considering how you can increase your earnings is difficult. You can save lots of money by spending as little as possible, but the problem is this is a very inefficient path to wealth.
And maxing out on income but failing to save brings us back to fundamental #2. Regardless of how much you make, you won’t have wealth if you can’t save some of those earnings for the future.
The more you earn, the more choices you can make with your money. With high earnings, saving large amounts of money becomes not just possible but easy (we recommend saving at least 25-30 percent of income if you’re earning more than $300,000 as a dual-income household).
No. 4 in the Fundamentals of Money: Increase Your Income
- Understand that savings alone is a long, inefficient path to growing wealth; increasing your earnings makes things easier because it accelerates your progress while also giving you more options for enjoying the present
- There are a variety of options for earning more money – the path you should take depends on your skills, experience, opportunities, and circumstances
- Look for ways to optimize earnings: always negotiate salary at new positions, for example, or consider career paths that might offer more than just regular salary (can you look for or negotiate bonuses, commissions, or equity?)
5. Leverage Compounding Returns
You need to consider how you can increase your income so that you have more money to work with. More dollars coming in = more opportunities to direct those funds in ways that create even more money.
One of those opportunities is the ability to invest.
Investing wisely means allocating your money in a way that allows you to take just enough risk to earn what you need to meet your goals. Meanwhile, you avoid taking on too much risk, or risk that you didn’t actually need to take).
Wise investing is also defined by implementing a proven strategy – and then sticking to that strategy over time, rather than hopping from one thing to another.
A good strategy, well-executed, will likely yield better results than the “perfect” strategy poorly implemented and not sustained.
Being able to take advantage of the possibility of compounding returns is fundamental to financial success. Beyond that, investment management done well gets very complex – but you can learn more about that with:
- Our podcast series on strategic planning for your personal finances
- Some stock market basics to know before you get started
- This podcast episode on what it takes to manage investments well
- A few thoughts on how to become a better investor
No. 5 in the Fundamentals of Money: Invest Wisely
- Investing is so important because of the power of compounding returns; it’s the engine that drives growth in your financial plan
- Consider investing for the long term, avoid market timing, and don’t fool yourself into thinking you can beat the market
6. Expect the Unexpected
You can do all the right things consistently over time, follow all the best advice, have the greatest financial plan in the world – but if you don’t consider how you will protect yourself and your assets from risk, you and your wealth is vulnerable.
This is why thinking through a protection plan is part of this list of money fundamentals. You don’t want to leave things to chance, which is where different kinds of insurance can come into play.
That includes health insurance, life insurance, and disability insurance. The right coverage for you is very much based on your individual circumstances.
You can even self-insure. Most people do this via an emergency fund, or a pool of cash reserves to use for unforeseen events that would otherwise wreck your monthly budget.
You might have enough coverage via the group plan you can access through your employee benefits at your company. Or, you may need to look into private policies (which is certainly the case if you’re self-employed).
The answer to what the right insurance configuration looks like for you is firmly in “it depends” territory.
Working with a fee-only financial advisor is one way to evaluate your true needs. Fee-only firms do not sell these products and don’t receive commission or kickbacks. They can focus on simply giving you the advice, and then you can take that recommendation to an independent insurance broker.
Another aspect of protection planning to consider is estate planning. And no, estate planning is not just for the ultra-rich. Everyone has an “estate,” regardless of its tangible value.
An estate plan refers to the set legal documents that defines what should happen not just if you were to pass away but also in circumstances where you are alive but unable to make sound financial or health decisions for yourself. This includes documents like wills, trusts, healthcare proxies, and powers of attorney.
Establishing an estate plan is an important aspect of proper planning, because it protects you, your assets, as well as your designated heirs. It clears up ambiguities and creates a legal path for the transfer of wealth (or for your wishes to be carried out to your standards).
Don’t do all the work of getting to financial success only to pull up short before you’ve considered how to protect that position. Think through your insurance and legal needs, and make sure you account for those as part of the process of growing and maintaining wealth.
No. 6 in the Fundamentals of Money: Protect Yourself and Your Assets
- Protect yourself (and any financial dependents) with the proper amount and type of insurance; some amount of term life insurance and disability insurance is usually worth considering
- Establish an estate plan that determines what would happen to your assets should you pass away – or to you, if you’re unable to make decisions for yourself
7. Know Your “Enough”
These fundamentals are all critical to increasing your net worth. But before you dive headlong into the pursuit of “more,” you should also take time to define “enough.”
What does enough money look like? When do you know you’ve actually achieved a massive goal like financial freedom?
Once again, we’re back to a place where there is no one, objective, absolute right answer. Your Enough will look different from someone else’s Enough.
“Enough” is based somewhat on your desires and your goals, but very largely on an understanding of yourself and what makes you genuinely happy.
Happiness and satisfaction often come not from the accomplishment of some external thing, but the work toward that thing. It’s the process of hiking up the mountain, the progress of making it farther along the trail, that often brings us the most delight – not necessarily reaching the very top.
Progress is often the most wonderful source of fulfillment, and that’s important to consider when trying to build wealth. There’s no one destination to arrive at that makes you say, “that’s it, I’m here; I’ve arrived!”
You’re never going to feel like you’ve “made it” until you decide that for yourself.
It’s a philosophical idea. It’s far from tangible in the way that a properly-allocated and diversified investment portfolio is. That’s black and white. Determining the end goal, and what “enough” looks like, is anything but.
That’s why our financial planning process starts with values and priorities, and builds out specific strategies from there.
If you want to learn more about putting the fundamentals of money to work for you, request a complimentary consultation and one-page financial plan from the financial professionals at BYH by going to www.beyondyourhammock.com/schedule