The biggest danger of solid financial planning can also make you financially independent: other people’s money. It all depends on how you use it. If you see it as an unexpected grant and regularly put it aside, you can save up a cushion without having to invest your own money. On the other hand, if you always spend it, you quickly become dependent on chance. – and may stumble into a debt trap. Three steps will help you avoid debt and instead become financially independent.
Step 1: Focus on net income
About the psychology of money Author Morgan Housel describes other people’s money as everything we don’t earn ourselves, especially an inheritance or money gifts from parents. If you get used to your parents helping with the rent, you’ll quickly find yourself living in a larger apartment than you can actually afford.
Those who live off other people’s money are overstretching their standard of living. If the flow of money dries up, only uncomfortable decisions can prevent bankruptcy: smaller car, smaller apartment. Friends then ask: “What happened?” Uncomfortable. Many people don’t bring themselves to do this. That’s why other people’s money is one of the most common reasons for financial problems.
Solid financial planning means financing all expenses from your net income. For large expenses such as cars and vacations, it is worth setting aside money in sub-accounts. Only those who manage their money in this way are really on solid ground.
Step 2: Let money work for you – instead of spending it
Most people receive money from other people in their lives. If they don’t spend it, the question remains: what do they do with the money?
The answer is: invest! ETFs, fixed-term deposits, bonds. The main thing is to let the money work for you instead of adding it to the main budget.
This shows why the trick of using other people’s money is not a sacrifice, but actually allows you to spend more: the American S&P 500 index has achieved an average return of around ten percent per year since 1992. Anyone who invests other people’s money in an ETF on the S&P 500 is therefore increasing it with solid returns. Experts have calculated that investors can withdraw four to five percent of their total portfolio without ever running out of money.
Example:
- Let’s assume you inherit 20,000 euros.
- If you invest the money in a new car and scrap it ten years later, the money is gone.
- If you invest the money in an ETF, you can spend at least 1,000 euros of it every year without your assets ever falling below the initial value. That’s enough for a few extra days on the beach every year for the rest of your life.
- Over the years, this amount will most likely increase. However, you will still keep the 20,000 euros plus the return that you do not spend immediately.
- Instead of overstretching their lifestyle, they transform the gift of money into the foundation of long-term prosperity.
Step 3: Extend the trick to salary
Gifts and inheritances are the most obvious examples of other people’s money. But this is so insidious because it includes much more:
- Companies often pay employees regular bonuses that they do not necessarily have to pay them. Some link Christmas bonuses and vacation pay to company goals, while others provide a notice that these voluntary benefits can be canceled at any time.
- Bonuses for weekend and shift work depend on an employee’s ability to work at these times. If the employee can no longer do this because, for example, parents need to be cared for or children need to be looked after, the additional salary is no longer paid.
- Part-time jobs and earnings from hobbies such as playing in bands or writing books often provide irregular income that can also dry up.
The problem is similar to that of your parents’ money: if you base your standard of living on these payments, you risk falling into debt if you default. It is better to pay all expenses from your current budget. If you do get a bonus, it goes into a savings account or deposit.
Those who have patience will soon be in a much better position
If you save other people’s money and don’t touch it, you will build up a solid financial position over the years that no one can take away from you. All great.
The reason many people don’t do it is because this type of money management requires something that many people find difficult: postponing rewards. Instead of buying a car now, staying on holiday a little longer each year sounds like a clear trade-off. But in tests, most people opt for 500 euros now instead of 1000 euros in a few weeks.
Those who have the patience to delay their rewards will soon find themselves in a much better position.
