There is this thing called the Dunning-Kruger effect. I’m going to hopelessly oversimplify now, but basically it’s when people with little skills in a field hopelessly overestimate their abilities.
It goes hand-in-hand with the so-called knowledge-confidence index. Because in other words: initially you know little about something, and you approach it with deep faith in yourself.
Over time, you realize how little you know, and your confidence in yourself falls, until you gain more experience, and face things with confidence again.
Much has been written about this (here and here for example), and I think our first instinct will be to imagine your favorite politician’s relationship with this.
I bring this up because even though we think we are immune to this, it affects us all. From our men who at 40 think we can still open the bowling for the Proteas if the need arises, to how our parents think our children will fare, unlike all other children before them, from the very beginning liking vegetables more than chocolate.
(The other side of this is of course that highly capable people can doubt themselves, but that’s a conversation for another day.)
Now, it’s important to be aware of your mistakes, and work on them. But it is also the case that there are certain things that you can teach yourself. You don’t need to learn contract law like lawyers, but if you run a business it would make sense to understand just some of the principles.
So it is with personal finances. It is sometimes deeply complex, yes. By way of analogy, however: you can learn to hammer in a nail before you build the house yourself.
What I mean by that is: you can learn some of the skills yourself; or at least arm yourself so that you look at things with new eyes.
It is of course the case that this is a wide field, and I am only looking at a specific part, and that there is much more to say than in a 1,200-word column. After reading here, you are not going to know more than your broker or friend who works at the investment house as a quantitative analyst. These are also considered principles, and not necessarily applicable to your specific situation.
But it’s a step towards empowerment. And the basic theory is not that fundamentally complex; how you apply it may well be.
(I just want to add, it’s not me who is so cute to think everything up myself. The concepts are quite well known; this is just my own take on it.)
It’s great to want to redo your home’s kitchen, and just put in that indoor grill.
But if your home is moving down a cliff due to clay soil, it might be wise to fix that first. You’re probably going to get more value out of your kitchen if your house hasn’t fallen off the cliff yet.
Or if I can use rugby as an example, on the eve of the World Cup tournament: it helps dates you score four beautiful tries, but you give up 10 because you dive your opponents like vegetarians eat meat – it’s not at all.
On a personal finance level, this means protecting what you have first. In other words, start with a will, so that what you have can go to whoever should get it, should you die.
If you can, get yourself medical in place (we’ll talk about that next month); with luck it’s part of your work package.
And then you look at insurance, short and long term.
Insurance is of course a grudge buy, and yes, there are policy peddlers out there who will sell you things you don’t make. Or companies that will try to convince you that you need more than you do.
But it’s degrees, rather than need. Because as you sit here and read, and especially when you are young, the most important asset you have is your ability to generate an income. In other words to be able to work.
So look for income protection from the day you start working (remember, most don’t cover you against layoffs). Also check if it’s not already part of your package – don’t duplicate stuff unnecessarily. Your broker, who hopefully has moved further up the knowledge-confidence graph, can help with what and where. Because if you lose your arms in a cheese-cutting accident at 25 and can never work again, your expenses unfortunately do not stop.
Also look at cover for your belongings (house, car, so on) – so short-term insurance. But also after cover for your body – life cover, dreaded illness, disability and so on. Especially if you have relatives you want to take care of, or have large debts such as mortgages to pay off.
(We will talk more about this in the next section.)
And then you start saving. First for an emergency fund, to cover those unexpected expenses, such as leaky gutters on your house or brandy stains on your car (please don’t drink and drive), or if you lose your job.
One could even argue, and strongly so, that one should first kick off with an emergency fund, before looking at other things.
Nevertheless, start with what you can, but initially aim for one month’s expenses, then three, then six. Maybe store it somewhere where the money is not exposed to terrible market fluctuations, and is relatively quickly accessible, but will also at least keep up with inflation, or nearly so. Think about things like your home mortgage (if you have a flexi option), or maybe a money market fund.
Then save for retirement. Hopefully this is also part of your package at work, and you start with it from day one. Don’t touch this money if you can avoid it. That’s why you build up that emergency fund that we mentioned above.
(Things are still going to change here with the upcoming two pot retirement system. The exact impact on a practical level is not yet completely clear in all facets; we will also talk about this in a next column.)
Keep saving until you stop working. Future You are going to resign. You can work out the amount and so on with your financial advisor.
After you have provided for retirement, you start investing for the long term. These could be unit trusts or shares or property or whatever. Everything has pros and cons, and you have to find what works for you. The detail is beyond the scope of this column.
And then you plow back
I think gratitude is a virtue. Comparison steals joy, while gratitude in turn helps cultivate it.
You can also show it practically, by contributing where it is needed. Donate to the church, or the local library, or one of the legions of organizations out there that need help. Of course, it doesn’t have to be money, but it also helps.
And if you then donate money, and you can get 10% back from taxes for it, you can donate that 10% again. It’s like compound interest for donations!
It is also of course important to budget before all this – I have already written a lot about it. Look at your income and try to cut your expenses. There are also quite a lot of sensible rules of thumb out there about how much of your income you should allocate where – just adjust it for your own situation.
And it is also the case that not everyone has to walk the same path. Your situation is just that – yours.
So filter this, and any other advice, through your own lens. But also be receptive to meaningful input.
Your financial advisor also has a role to play. You can of course teach yourself everything, just as I can teach myself how to grow rooibos tea myself. But is this a good use of our time? I would rather buy a package at the supermarket and spend my time where it is of more value to me, like with my family.
And remember: knowledge in itself is not wisdom, it’s just one building block of it. A little knowledge can easily make you fall into the Dunning-Kruger effect’s hole.
- Leon-Ben is a writer, musician and financial advisor from Wellington.
- This series of columns follows from the community research of Solidarity Helping Hand. Visit Helping Hand’s website to download the full research reports.
- Also read “Most SA’ers use a third of salary for debt” on RNews.