I hear you want to improve financial literacy.
That’s a great goal. But there are two problems.
(1) It is boring. (2) Results are slow. Reminds me of fitness.
Wanting is easy. Doing is hard. Everyone wants a healthy body and everyone wants a big investment portfolio. But few actually do what it takes.
When it comes to learning, it’s the doing that counts. By doing, I mean reading, making mistakes, and learning from those mistakes.
In this post, I cover two ways to self-motivate and ease the process of learning to improve financial literacy.
After all, the fun lies in the process, not in reaching the end-state.
Table of Contents
An Overview of Financial Literacy
The term financial literacy is thrown around a lot.
Before digging into learning, I want to cover financial literacy. I’ll cover what it means and why it’s good to pursue it.
Why Pursue Financial Literacy?
Financial literacy makes life better.
Guess what the #1 stressor is in the US and Canada? It’s not health, work or relationships.
It’s money. Finances are the #1 stressor.
Most of this money stress disappears when consumer debt is paid off and an emergency fund is built.
After this, you can grow net worth (wealth) through index investing. I view net worth as a tool that can better life in a few ways:
- Investment assets can generate passive investment income. This buys you time and flexibility as you don’t need to work to earn this income.
- You can outsource unpleasant activities. This buys you time, similar to investment income.
- Money can be used to buy experiences.
- Most importantly, net worth can be used to expand your ability to make a positive impact on the world through giving or starting a business.
What Is Financial Literacy?
I define financial literacy as knowledge and the ability to apply knowledge to meet your unique money goals.
Knowledge is useless without the motivation, habits, and confidence to apply it. For knowledge to be useful, you need to apply it.
This is in line with the more formal definition from the Organization for Economic Cooperation and Development (OECD).
“a combination of awareness, knowledge, skill, attitude, and behavior necessary to make sound financial decisions and ultimately achieve individual financial wellbeing”
I view habits as critical to skills, attitudes, and behavior. These strong habits can only be done by doing.
As for knowledge, I like the approach in a paper by Annamaria Lusardi (2019). She roots financial literacy in three fundamental concepts:
- Numeracy, as it relates to interest rate calculations, and understanding of interest compounding.
- Understanding of inflation.
- Understanding risk diversification.
Financial Literacy Topics Are Boring
Some things are more exciting to learn than others.
I remember I loved learning about engines and aircraft. Learning about taxes is a bit different. It’s boring.
Most money stuff is boring, like life insurance, taxes, inflation, emergency funds, and insurance. Pretending otherwise would be a lie.
What about investing? Isn’t it exciting to grow your money?
I found investing exciting 7 years ago when I first started. But the more I learned, the more boring (and less speculative) my investing became.
After 5 years, my investing approach converged on index investing. It’s the most boring form of investing.
I learned that good investing is boring. Bad investing is fun, like gambling.
The “boring factor” of personal finance topics may be your greatest obstacle. To overcome these obstacles, you must fuel your learning with purpose.
The rest of this post will cover how to do this.
Tie Learning To Financial Goals
Goal setting is the key to motivating learning. Goals fuel your learning with a “why”. They give your learning a reason.
This works out well since goals are the first step of the financial planning process (FP Canada). Different professional financial planning organizations have different financial planning “steps”, but they all agree that goal setting is the first step.
I believe everyone should have written down financial goals.
These goals are powerful to promote learning. Here is the process:
- Step 1: Set your life goals.
- Step 2: Use your life goals to set big-money goals.
- Step 3: Break down your big-money goals into small-money goals. This process forces you to learn, structures your learning and generates small manageable goals that you can action with ease.
The three steps listed are abstract. Examples will help to root this in reality. I’ll cover a few examples in each of the three steps.
Step 1: Set Life Goals
Life goals relate to time, flexibility, and experiences that will improve your well-being. These guys are unique to you and your values. Often, money is the tool to reach these life goals.
When setting life goals, it’s helpful to understand the psychology around human well-being. I cover this in my post on Money, Happiness, and Well-being.
Common “life-goals” may include:
- Flexibility to move into a new career field that better aligns with your strengths, or the ability to say goodbye to a bad boss.
- Reduce all non-essential stressors to pinpoint your energy/time on the important things in life.
- To gain control over your time so you can work on a business, improve your fitness or build your close relationships.
- Buying a second property down South because the cold is your enemy.
- Maximizing opportunities for your kids, or future kids.
These life-goals can be used to define your money goals.
Step 2: Translate Life Goals Into Big Money Goals
Life goals often require money. Let’s take the life goals and turn em into money goals. I call these “big money goals” because they are big.
Big goals are a problem because they are too bulky to act upon. They need to be broken down into small goals. Otherwise, you’ll just procrastinate.
Here are some examples of big-money goals that came about from the life goals.
| In two years, I want the flexibility to move careers. | fully fund emergency fund and pay down all consumer debt in two years. A large investment nest egg builds further flexibility into your employment situation. |
|---|---|
| I want full control over my time and want work to be 100% optional by age 45. | Reach financial independence by age 45. |
| I want to maximize future opportunities for my kids. | Invest $1,000 per month in a total world index fund that will be used for my kids. |
I am tired of hearing about SMART goals, but I admit they are useful. “SMART” goals are Specific, Measurable, Attainable, Realistic, and Time-Bound. Very smart.
Here are some examples of SMART Big Money Goals that come about from the life goals above:
- Become debt free with a fully funded emergency fund in 2 years.
- Once debt free, with an emergency fund, I want to start investing.
- I want to have a $1,000,000 investment portfolio by age 45.
- I want to reach financial independence by age 47 so that work is 100% optional. Learn how to reach financial independence in this post.
Step 3: Break Down Big Money Goals Into Mini Money Goals
The “big money” goals above are too monstrous to execute on their own. They result in procrastination and minimal action. Disappointment will follow.
Small goals are different. They have a clear end-state and can be accomplished quickly. These goals are not overwhelming.
Think of a video game. A series of little achievements keeps you motivated and engaged while you pursue some larger end goal.
Small goals make the process fun. The journey towards your big goal is more rewarding than reaching the final destination.
Goal Breakdown Forces Learning
The process of goal breakdown doesn’t just help you execute. It also forces you to learn and makes learning meaningful by tying learning efforts to your big life goals.
Goal breakdown forces you to think about all the little tasks that are needed to achieve the big goal. This exposes areas where you don’t yet know enough.
Now you know what you don’t know. Such exploration is needed for learning.
Once you have a breakdown of small goals, you can order them in a way that allows you to achieve the big goal. Ordering your mini-goals also forces you to learn.
Now you have a series of manageable steps to meet your big goal. You formed a structure that you can follow. This will crush procrastination and motivate action.
I view this as similar to the value that is added by a school. You can find all info to get a degree online. But a school structures the degree into courses and bite-sized assignments.
Example: Goal Breakdown And Financial Literacy
Let me introduce Fred. He is 20 with $5,000 in credit card debt, no emergency fund, and no investments.
Fred has a life goal to make work optional by age 45. He sets a big-money goal to have an annual investment income of $60,000 per year at age 45.
Let’s break down Freddy’s goal. First, he needs to get to a place where he is ready to invest. So Fred sets his budget straight to cut spending to pay down consumer debt.
Once Fred pays down consumer debt, he builds an emergency fund worth 4 months of essential expenses. He keeps this money in a high-interest savings account.
Now it’s time for Fred to start learning about investing.
By learning about safe withdrawal rates (SWR), Fred leans that he’ll need a $2 million portfolio by age 45. He will be able to pull $60,000 of income, forever, adjusted for inflation. Fred used a conservative 3% SWR.
Fred now learns needs to figure out how much to invest monthly. To do this, he must learn about expected returns and types of investments.
After learning about risk tolerance, Fred determines that a global index portfolio of stocks is best suited to his unique needs. In addition, Fred researches historical investment returns and sees that the global stock market has returned about 8% annually for the last 122 years (5.3% before inflation).
He uses 8% as his estimated return for the next 20 years. A quick visit to a compound growth calculator tells Fred that he needs to invest $3,200 monthly for the next 20 years to produce a $2,000,000 portfolio by age 45.
Now that Fred has a monthly investing target, he can set mini-goals for expenses and income. He thinks it is realistic to save $3,200 per month if he is frugal and starts a side hustle that brings in $1,500 per month.
Fred learned about debt paydown, index investing, risk tolerance, compound growth, and safe withdrawal rates to break down this big goal into little goals. All of these learning efforts were directly tied to his desired end goal.
The Internal Locus of Control
The process of breaking down goals into manageable chunks helps you determine what is within your control. Efforts spent on areas outside of your control are wasted efforts.
Fred can focus on his budgeting and income efforts to meet his micro-goal of investing $3,200 monthly. That’s within his control.
Investment outcomes are unpredictable by nature. Fred knows this, so he ignores the fluctuations in the value of his portfolio and instead focuses on the process of saving and investing his target amount of $3,200 per month.
To Learn Is To Make Links
In the book How To Take Smart Notes, the author discusses learning.
Learning is not the memorization of raw information. It’s instead the ability to make connections to previously understood topics and concepts. This includes topics that aren’t clearly related.
Raw information devoid of meaning is quickly lost in short-term memory. By associating new concepts with already understood information, you actually learn.
This is exactly what “memory” artists do. They associate new random info with known things, such as associating cards in a deck with items in their home. When it comes time to puke up the info, they walk around their homes.
Learning is best done through natural curiosity. This curiosity is stimulated when you have to learn for a reason. Approaching learning in this way makes financial literacy fun.
Get Your Skin In The Game
What Is Skin in The Game?
Skin In The Game refers to a state where risk and rewards are aligned. More specifically, you have Skin In The Game when you are responsible for the risks of your actions.
The term is from the book Skin In The Game by Nissim Taleb.
Consider a manager who owns shares (stock) of the company where she works. Her wealth will decline if she does a poor job managing the company. That manager has skin in the game.
Now consider a mutual fund manager with no skin in the game. This manager gets a flat salary no matter the performance of the fund but is paid more if the fund does very well.
The fund manager is motivated to invest 100% of the fund’s money in speculative assets. There are no personal consequences of loss.
All risks fall on the investors and not the fund manager. The system is broken. I would not touch such a fund.
With personal finance, you naturally have skin in the game.
How Skin In The Game Can Motivate Financial Literacy
Skin in the game motivates learning, especially with investing. When you put your money on the line, a lack of financial knowledge can result in loss. And the pain of loss is magnified due to loss aversion.
Pain motivates learning. This prevents you from repeating mistakes in the future. Natural motivation occurs when the pain of remaining the same exceeds the pain of learning.
By putting your money on the line by starting to invest, you have Skin In The Game. There are consequences for your bad investment decisions. Dumping your money into a monkey NFT will likely cause pain. This will prevent you from putting all your money into a Monkey NFT in the future.
You can engineer Skin In The Game by other actions like creating a budget. A budget now provides you with a reference point to measure failure against. Knowing you failed is hard.
The act of holding yourself accountable to your budget motivates the betterment of your habits if you miss the target.
Conclusion
Learning about money is hard, and topics can be boring.
Setting large goals and breaking them down into smaller goals focuses you to learn.
Plus, the structure of bite-sized goals provides a sense of accomplishment and fuels your learning with meaning.
Once you have goals set, it’s time to get skin in the game by doing. This produces a state where errors result in pain.
That pain can motivate further learning. By having your money at risk in investing, you will have a reason to continue to learn about investing. The only case where this doesn’t hold true is when you give up. That’s the only form of true failure.
Jake out.