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Wednesday, April 4, 2012

What Makes a Good Investment?

Spend even a couple minutes reading personal finance books or blogs and you will come across a ton of mentions of 'investments' of all shapes and sizes, and hear all sorts of purchases and activities referred to as investments. So what is an investment, really? And what makes a good investment?

The dictionary definition of invest is:
to put (money) to use, by purchase or expenditure, in something offering potential profitable returns, as interest, income, or appreciation in value

So a stock can be an investment. Or a rental property. Even buying artwork or antiques counts as an investment. The problem with today's standard financial advice is to invest almost entirely in the category of "appreciation in value" , as opposed to something that actually produces regular income. I have never understood why I would want to own part of a company and not get a share of the profits. Which is what most stock ownership is like today. The buyers are literally only buying because they think (hope) that somebody else will buy that share from them later at a higher price. But they get nothing in the meantime. That is why Dividend investing is much more appealing to me, as is rental properties, and other investments that produce actual income.  

I am just getting started learning the ins and outs of dividend investing, so if you want more info on the subject check out Dividend Mantra, he's got some great info on the subject and always posts the changes to his personal portfolio. 

- The Money Monk

Sunday, April 1, 2012

Find the sweet spot with your spending

Some people seem to find joy in the mere act of being frugal. For most of us however, it is a means to an end, and any joy we get out of it is because we know we working towards our specific goals. This isn't to say frugality is painful, just that frugality isn't the goal in and of itself.

So there is always a trade-off with savings vs quality of life, and I have written before that my personal strategy is to save in the areas you don't care as much about so you can spend on the things that really matter to you and that make a difference in your daily quality of life.

An important concept to think about when trying to determine the optimal balance of frugality/quality of life is the concept of diminishing marginal utility. This is a term from economics, where 'utility' is usually used to simply mean the enjoyment or usefulness you get from an item

Diminishing marginal utility is the idea that the enjoyment you get from something is less for each additional unit of whatever that thing is.

An example that is often used is pizza. If you are hungry, a piece of pizza may be just awesome. A second piece of pizza will be great too, but not quite as good as that first piece. A third piece will be ok, but now you are starting to get full and don't really feel like pizza anymore, so the enjoyment from that additional piece is not that much. by the time you eat 5 or 6 pieces you probably won't enjoy it at all.

This concept works with money too. If you are making $0 a month, $500 will make a huge difference. If you are making 10,000 a month, you might not even notice an extra $500.

With almost every area of spending you will find that there is a sweet spot where a little bit more spending make a lot of difference in your quality of life. You may really have to suffer to keep your electric bill at $50, but have an easy time keeping it at $75.

SO try to find that sweet spot where you have to consciously control your spending, but where you aren't finding it mentally difficult to do so. If you do this for every category of spending it will automatically maximize your savings vs quality of life. And that will make the your life of frugality a LOT easier.

-The Money Monk