10 Most Important Lessons in Economics and Finance
Financial education is the key to effectively dealing with tough times.
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"Financial education." This was my condensed response to a question in a recent Publishers Weekly interview: "What could have helped improved the lives of so many people during the Covid-19 crisis?" If more people had a deeper knowledge of finance, probably there would have been more planning and saving by the masses for this unforeseen emergency. But what are some of the most important lessons that someone (especially an entrepreneur) can learn from the science of finance?
The following is a small sample of 10 (out of 218 principles) of the most important lessons in finance adapted from my 2014 book The Most Important Lessons in Economics and Finance. Please note that these financial lessons are in no particular order of importance and that each one might be more or less applicable to you at different stages of your life. Which ones were (or could have been) the most useful to you during the Great Pandemic Depression?
1. Maximize wealth to stay alive and prosper
Principle 22: "The primary goal of any business should be to maximize the owner's wealth."
This lesson never seemed to sit well with many of my former finance students as it contains a sad dose of reality—without wealth, your business will eventually die.
This concept was expanded more in my 2016 book The Survival of the Richest by listing the three major wealth management possibilities: Minimize wealth below the level of the bare minimum survival essentials necessary to survive (I called this level "the edge of survival"); Live on the edge of survival, which is where an entity has just enough wealth to survive; or to maximize wealth above the level of the bare minimum survival essentials necessary to survive (Criniti, p. 162). Out of all of these three options, maximizing wealth is the only one that will protect you and your business the best for the short and the long term.
Please note that Principle 22 does not give a free pass to make money by all means necessary; there are other lessons on business ethics that will eventually weed out the unethical…some faster than others. This is why it is best to maximize your wealth "ethically" to ensure that you keep your good reputation (and your future wealth) in check.
2. Diversification can maximize return and minimize risk for your investments
Principle 38: "Diversification can be applied to everything."
The vast evidence demonstrating the usefulness of diversification is one of the hallmarks of the science of finance. This subject traces its roots to the beginning of modern finance with Harry Markowitz's Portfolio Selection book.
Mutual funds are a prime example of this concept. Why hold only one or two stocks when you can have a mutual fund with hundreds of different kinds of stocks for about the same investment amount? Diversification should not only be applied to stocks and bonds but ultimately to all types of investments (including real estate and collectibles). We can even apply diversification to other areas of life, for example, diversifying our friends and hobbies.
3. Every job can be valuable
Principle 57: "Every laborer can make this world a better place to live and love."
The Great Pandemic Depression has taught us to appreciate difficult jobs even if they don't appear to be desirable. Most people want their children to become lawyers and doctors when they grow up. Let's face it though—these occupations are not for everybody. Simple jobs like working at a supermarket or grocery store have gained the respect of many recently. If it wasn't for these laborers (our modern heroes), who would have helped service the food that we needed for our homes while in quarantine?
4. The Great Pandemic Depression will change the financial thought process of every survivor
Principle 64: "Major economic events generally cause everlasting impressions on the future financial affairs of its survivors."
Like many other major events before this (The Great Recession, The Internet Bubble, and, of course, The Great Depression), people are learning the true importance of financial education.
With so many businesses that have collapsed or that have downsized their labor force, unemployment is rampant. By many people learning to live on less, these behaviors are more than likely to continue even if conditions improve. The spirit of the living is being tested daily. There is no doubt that there will be a residual of numerous financial scars to permanently remind us of these darker moments.
5. Finance teaches you to take control of your wealth
Principle 71: "Mastering the science of finance can help you to control your own wealth."
The first step to learn how to manage your money is to learn from experience, from what finance teaches you, or both. When you learn from science, you are learning from many others who already made mistakes and derived a solution. By studying financially successful people, you can save valuable money and time by learning the correct ways to manage your wealth. In science, we call this "standing on the shoulders of giants." Why reinvent the wheel for no reason?
6. People who control the money are the root of most evil and good
Principle 135: "Money is not the root of all evil and good."
Did you ever hear the expression: "Money is the root of all good and evil?" How could this be true? Money is just a tool that we use to accomplish certain tasks like buying goods or services. Money does not have a conscience — actually its power lies in our minds. Thus, it is people who control the money who can decide to do right or wrong with it; and it is people who can use their money to protect or destroy our planet.
7. Poverty experiences hold value
Principle 152: "The experience of poverty can provide a lifetime of invaluable lessons."
In some ways, being poor is a blessing—you can learn things about money never even conceivable to those without this experience. With that said, this lesson is not an advertisement for "staying" poor, only to highlight the value gained from "being" it. Those who have been poor before in their life are generally the best prepared to deal with future unexpected major losses of wealth.
8. Rich people who help others understand the real purpose of excess wealth
Principle 163: "You can't take your wealth with you when you die."
Do you know anyone rich who is greedy with her or his money; you know the Ebenezer Scrooge type? This financial lesson was created especially for wealthy people who never use their money to help others. As hard as it is to believe, there are individuals worth tens of millions, even billions, of dollars who never give to charity and/ or use their money to help other people—even their own immediate family.
When you have more assets than your "prosperity tipping point" (a concept created in The Survival of the Richest book) that highlights the exact amount where additional wealth will add little increased benefit to an entity), all of the excess wealth would be best utilized if reserved for other people or causes during your life or immediately after. With this strategy, at least you can control who gets your assets when you die. What is the point of having more money than you will ever need if you can never use it to make a positive impact on this world? The real truth is that if a rich person dies as a cold-hearted miser, then that perception will become her or his real legacy.
9. Building families are expensive
Principle 167: "The total cost to live for an individual is magnified for a family."
This lesson is the most beneficial to those who are planning to marry and/or have children. Life is expensive for every individual. You need money for basic necessities like food, water, and utilities.
When you add just one more person to your family, you will now have to add all of her or his bills to yours (including potentially negative spending habits). When children are adding to this equation, many additional unique bills will need to be accounted for (especially schooling). Before you go down this path in life, it is best to set up the pieces as best as you can to weather the potential financial struggles to come.
10. Save your pennies wisely
Principle 218: "Any money saved may provide you with an option to spend it later."
The old expression "A penny saved is a penny earned" taken literally can potentially ruin your financial life. As investing is a part of saving, if you invest in the wrong financial products, then you could lose everything. Many years of saving plenty of pennies could result in zero earnings during your retirement. Also, let's pretend that you saved all of your money for years and stored it under your bed. If your house burned down tomorrow, all of that money would be gone.
The point of this lesson is to save money for your future—but don't just save for saving's sake. You will also need to ensure that your investment and risk management strategy are aligned well with your goals. The more solid your investments are, the higher the chances that your pennies will be there to work for you when you need them.
Financial literacy is essential
We may never know the exact outcome of the Covid-19 pandemic if the masses were significantly more financially literate. Could many businesses have been saved? How many? However, it is certain that more financial knowledge could have helped make life a little more comfortable for many people in these uncomfortable times. The essence of finance revolves around planning for the future, especially emergencies. By studying the most important lessons in finance, you can be equipped to know how to build wealth better now and in the future. Which one of the above most important lessons in finance has made the biggest impact on your life?