Efficiency in personal finance

03 Nov 2020

Working in the software engineering field one of the concepts we often speak about is efficiency. It would be no surprise to many that we can apply efficiency to our personal finance as well. Credits by Eva K, CC BY-SA 2.5

This blogpost shares what you can do in terms of financial optimisation, money and finances in general. I am assuming a certain level of income, as it is impossible to optimise spendings if you can’t afford to.

Note: A big part of this article was written pre-Covid, my hope that this article can help people who can optimise their spendings be more effective and by no means written to hurt those who unfortunately can’t at the moment. Opinions expressed here are mine alone, not those of any bank, credit card issuer, employer, and have not been reviewed, approved or otherwise endorsed by any of these entities. Please do your own research and take this on your own risk. Nothing here should be construed as financial advice, and it is your own responsibility to ensure that anything mentioned is right for your circumstances.

Key optimisation tips:

• Get a credit card that offers a cashback, try to use this card for all your spendings, you get around 1% cashback as well as sign-up bonus in many cases (some offer £100-250 worth of sign up bonus in points). One of the risks with credit cards is that the interest rate on some is very high, some are 75%! Do make sure to read Terms and Conditions
• Use current account switch bonuses regularly (at the moment of writing NatWest offers £125 for new account switching).
• Do use websites like hotukdeals and CamelCamelCamel and cashback websites when shopping online. Hotukdeals shows your discounts on products and CamelCamelCamel shows price history for Amazon products. One feature I like on camelcamelcamel is “Alerts”, if you are happy to wait for a particular item to drop in price you can set up a price alert and get a notification when it becomes a certain price.
• Cashback websites - they will give you a nice cashback in many cases, make sure to shop around
• Make your own coffee! Seriously, you save so much money and I bet your coffee will be better quality too! Should have learned this earlier. Invest into equipment and it will pay off in 2-3 month. I personally have a Bialetti Mokka pot and Hario Mill Mini Plus. https://www.bialetti.com/it_en/
• Do open and use an ISA (Individual Savings Accounts) https://www.gov.uk/individual-savings-accounts
• Switch your providers regularly - internet, gas, electricity. You often get good deals and bonuses.
• Mix and match shopping - if possible buy from different shopping chains, ie meat from a more premium supermarket while everything from discount ones. Make sure to do a comparison between more and less expensive supermarkets, for example “Tesco vs Aldi vs Waitrose(surprise!)”. When doing personal calculations and taking into account certain peculiarity of each one of them (For example Waitrose does free delivery over certain amount, will often substitute items for items for the higher amount/price(for free) if selected item isn’t available, give items for free if they have a short end date) I found that for me in particular online grocery shopping with Waitrose is 5-10% more expensive compared to Tesco/Sainsburys, while I prefer the taste of Waitrose food much more. Aldi/Lidl is generally cheaper compared to other retailers but they are not available everywhere and you generally need a car to get to them, which makes it more difficult for many.

Additionally, my friend Jonas, who works as a money manager, shared some investment tips

Investment optimisation

You probably already have heard the famous investing rules of legendary investor Warren Buffet:

“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”

Of course, easier said than done, but why is this rule so important? The answer has many layers, but first of all, let’s start with a point which is often neglected in your everyday finance: the power of compounding interest. To illustrate this, assume you invest 100$ into the stock-market with the 10y average annual return of the last 140 years, which is 9,2% according to Goldman Sachs (1). In just 10 years this would have grown to 241,12, in 20 years to 581,37$ and in 30 years to 1401,78$. Naturally this is just the plain number without inflation and costs, but still an overall very impressive 1401% gain over the three decades. Now let’s assume you lose 50$ right at the start and you are able to make it back a year later. After another 9 years you only have 230,96$, resulting in a loss of 10,18$ just on compounded interest. I hope with this example you understand that losing money, your future compounding gains are severely reduced severely.

The second point I want to touch on is also very common knowledge, but it is important to be reminded every once in a while: The order of Percentage-wise gains and losses can result in very different outcomes. A trade with an equivalent percentage loss and a gain in succession is losing you money, while in the reverse order the result is a net-profit. Moreover this effect has a negative imbalance, meaning losses weigh more than gains. For example a trading win of +70% with a consecutive loss of just 50% still sums up to a net loss of 12,5%. I suggest to either keep record currency-wise or be sure to remind yourself regularly of this fact.

Let’s quickly dive into the psychology of finance and investing. But let’s begin with the most essential: before you use any of your money (and this not only applies to finance), don’t buy the “cat in the bag”. That means make yourself knowledgeable. It also always helped me to extensively make myself familiar with the fundamentals of the asset as well as the likelihood of negative outcomes, over a considerable period of time. If you can afford this luxury it is also a good idea to step aways and come back later (sleep over it!). Often I was able to find something I did not consider before. Just be sure to make yourself comfortable in a position. Meaning always only takes as much risk as you can handle. So positions moving against you do neither impact your financial nor your physical health. If you find yourself in a position where you lose sleep over it, or constantly have the urge to check your position, you most likely have overstepped your risk tolerance. If that is the case, hedge your position or simply reduce your exposure.

Another reason to not lose money: winnings and losses are differently experienced. As an illustration consider the following two examples and choose the one you like best. Scenario A is the following: “You get 100$ immediately. Immediately after, there is a 50% chance, that you lose half of it.” In Scenario B: ” You get 50$ and have the chance of a 50% to win another 50$“. It is quite obvious that these scenarios virtually equivalent, but are interpreted in the human mind differently. Losses are psychological more taxing than gains are rewarding. This was researched to a great extent and summarized by psychologist Daniel Kahneman (2).

Let’s come back to the power of compounding interest. As I earlier illustrated, a small amount of money does make a considerable difference over time. John C. Bogle founder and former chairman of the Vanguard Group (one of the largest registered investment advisors) more or less dedicated a whole book to this topic (1). He touches on various topics and the one I find more (not less!) important is the significance of reducing your costs. You might think: well that was great advice in his time since it does not apply anymore, because nowadays many trading/finance platforms reduced their trading fees to zero. However, there is a saying: “if you don’t know what the product is that means you are the product”. Companies such Robinhood or Charles Schwab make money from interest on customer deposited stocks, fees on margins, or selling customer order-flow to high frequency trader and market maker. While the later costs, you do not see directly, since your trade just gets a worse execution, it significantly worsens the price of your position. On top of that, costs of assets heavily reduce the yield of the underlying and great effort should be taken to select the cheapest one among its peers. So make sure you know where and what your costs are, and pay attention to them since they add up quickly especially with the losses in compounding interest.

Lastly, take advantage of Tax Code if you can (since this is different in each country I won’t go into it here), otherwise at least take advantage of your employment retirement fund benefits. If you don’t know whether your company does offer something like that just ask HR.

In conclusion: while on one hand money is important and since Time=Money, you should use it wisely. On the other hand you should enjoy your life to the fullest, since you don’t need it when you are dead.

[1] https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/s-p-500-returns-to-halve-in-coming-decade-8211-goldman-sachs-59439981

[2] Thinking fast and slow by Daniel Kahneman

The little Book of Common Sense Investing by John C. Bogle