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Smarter and Less Smart Ways To Go Broke

It's not quite an axiom, but it seems like people unused to money who come to have a lot of it, shortly thereafter have no money again.

It's easy to understand why someone who wins the lottery and fritters it away goes down that path, but cash is just as dangerous in the hands of someone who is legitimately disciplined and working hard for their money, putting together good transactions, and building up a base of cash.

Money does all sorts of strange things to your psychology. Here are three big ones:

*It makes you think you're smarter than you are: when you've earned well, you tend to think it's because you're brilliant. You systematically underestimate the effects of market conditions and being in the right place at the right time, both of which can be tricky to replicate without large amounts of experience (and, even then).

*It makes you think you've reached a new level permanently: once you've gotten good at earning money, it's therefore permanently easier. This may or may not actually be true, and almost never to the extent you think with the first successes you have.

Saving more than you spend

On Ideas

One of the biggest mistakes I see young people making is spending their money capriciously and not saving. If your bank account or investment portfolios aren't growing, or you are not expecting them to grow something is awfully wrong. S&P 500 has been shown to go up around 10% every year in the long run. There are treasury bonds and other investment vehicles as well which can ensure that your money is at the very least keeping up with inflation.

When I started earning some money last year I ended up investing or saving up 4/5 of it, and kept spending my money frugally and only splurged once or twice. Being frugal, saving up, and thinking about the future is crucial, especially at a young age because you have so much time for compound intrest to take hold

One of the clearest ways to picture this was an example given in the book the slightest edge, whereby two young post-graduates at the age of 24 agree decide that they want to retire millionaires and will invest 2,000 a year into an 12% account every year until they can make it a reality.5 years later they meet each other and ask how its been going. One of them has followed the investing religiously, while the other hasn't. The one who hasn't asks the other how close he is to his investment goal and the the other friend says "I'm done". It turns out that with just 6 years of investing, the compounding interest will be sufficient enough to get him to 1 million at retirement. The other friend decides he has to get to it, but when he does the math, he realizes he has to invest 2,000 a year for the next 33 years!

This story underscores two things. One the cost of waiting, how waiting to long to do something keeps you from taking advantage on the magic of compounding interest. and second how important investing and not overspending is.

The biggest reason by far not to overspend though, is so you can increase your freedom. I'm not saying money always equals freedoms, but having a good amount of money in the bank significantly opens your options and lowers your anxiety levels. Living paycheck by paycheck, or not having a clear long term financial goal can lead to distress and insecurity.

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