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Your Financial Paradigm

Hopefully the recent downturn in economic affairs has caused you to question your level of economic knowledge as well as evaluate your personal finances with more scrutiny. Unfortunately, evidenced by our recent recession, personal finance education and awareness is an area that needs much more attention in our nation. A wealth of information is available, but sifting through it all, determining what elements will work best for your personal situation and then applying the knowledge can be overwhelming.

But that is no reason to keep yourself in the dark. Perhaps a simple paradigm shift, changing the way you think about money, is the kick start you need to get your finances more stable. The following concepts should be ingrained in the mindset of every money-making, money-spending member of society.

Spend less than you earn

This is such a simple concept, but it is amazing how many consumers throw this basic, tried and true principle out the window. How much money do you owe to credit card companies, banks, friends and family, or, heaven forbid, payday lenders? For what reason did you borrow so much money? Seriously contemplate this question. Every time you borrow money, from any source, you are spending more than you earn. Continue this habit and not only will you end up paying far more for things than their actual value, you will never achieve financial security.

Books like Stanley and Danko's The Millionaire Next Door make it abundantly clear that it's not a high income that leads to wealth — though it doesn't hurt — it's the ability to save. Those who become wealthy do so by spending less than they earn.

Despite how cliché the term 'living within your means' has become, make it a permanent element in your mind-set; your financial stability depends on it.

Get serious about wants vs. needs

Our society has developed a very skewed vision of what 'needs' are. Just because something is more convenient, like a dishwasher, a cell phone or car, does not make it a need. Television, especially cable; while nice to have, is by no means a need. (As a landlord, it baffles me how many of our tenants will pay their cable or cell phone bill before they pay rent. Shelter is a need, but so many people put that secondary to their wants - astounding).

How much debt have you incurred due to wants? What do you currently pay on that you could do away with? Is it worth your financial health and security? Maybe this year would be a great year to clean house and simplify your spending. See if you can go this entire month spending on nothing but needs, and make sure they truly are needs.

Understand the power of compound interest

Compound interest, according to Einstein, is one the greatest mathematical formulas of our time. Interest can be a wonderful or a terrible thing depending on whether you collect it or owe it. Either way, the principle is still the same. Each day balances grow with accumulating interest.

The message: if you don't want to owe interest, don't borrow money. If you already have debt, pay it off as quickly as possible. If you want to earn interest, start saving money. Even the smallest amount of money will start to accrue interest the day it is placed in an interest bearing account. The sooner you get started the better.

Avoid the trap of sunk costs

A sunk cost is money that has been spent and cannot be recovered. "Sunk cost fallacy" is the irrational belief that a further investment of time, money or effort will somehow resurrect the value that's already disappeared. Some examples are:

  • Clothes. You bought a pair of $100 shoes, but after wearing them around you find that they hurt your feet horribly. Do you continue to wear them anyway?
  • Consumer Products. Sometimes companies will continue to plow money into a project even though they know it will be a failure, simply because millions have already been spent on it. It's important to know when to cut your losses.
  • Investing. Many people hate selling their shares for less than they paid for it. However, once you've executed the trade, that shouldn't matter anymore. All that should matter are the current prospects for the stock.
  • Human lives. This idea has even been extended to the Vietnam War and more recently the Iraq War, when the loss of previous lives has been used as justification for continued fighting.

How much money you have already sunk into an investment should not be the determining factor for hanging onto it if there is no clear evidence of recouping money spent. There comes a time when you simply need to cut your losses and focus on what's ahead, not what's behind, and move on.

Be careful of rising expectations

It's great to have goals and realize achievements and raised standards of living. However, there is a thin line between self-improvement and chasing happiness. There tends to be a pervasive societal mentality, "I'll be happy when…". This holds especially true with our finances. "I'll be happy when I get a better job, when I get a house (or a bigger house), when I get a new car", etc, etc. Think of the goals you have achieved, yes they felt good, for a little while, but how long before you are dissatisfied and chasing after the next 'happiness creator'?

There is wisdom in the saying "be in the moment". Find, or better yet, create, happiness now. And look beyond the material world which is so temperamental and fleeting. Find joy and contentment in the things that really matter.