We already discussed the 4 rules to get started with personal finance but let’s take a closer look at getting a better grip on your financial situation. Knowing that you want to achieve financial independence is great because it gives you a goal. But in order to achieve that goal you need to know what your starting position is.

Map out the status quo

Grab a piece of paper and a pen or pull up a spreadsheet. And now write down

• how much do you earn?
• how much do you spend?
• how much do you have in assets (stocks, bonds, real estate etc.)?
• how much do you have in debt?

This doesn’t have to be perfectly accurate but should give you a ball park figure. You can also research what people your age/in your area/in your profession earn to get a better understanding of where you should be. Are you earning below average but save more than other people, that’s great! Do you earn way more than others but at the end of the months all your money is gone again, then you might suffer from lifestyle inflation and you are living beyond your means.

Looking at the numbers above, how do you feel? If you drill down a bit on your spending you’ll probably be surprised how much you spend on certain things.

Identify the Musts

When you look at your expenses, there are certain things that you just can’t avoid paying. That usually includes taxes that get taking our of your paycheck right away, rent, utilities, groceries…. Apart from taxes which usually depend on your income and are automatically calculated, these categories are “must” categories but they do have some savings potential. The important thing is to identify which items you spend money on that bring you happiness versus which ones don’t. All other categories are usually discretionary spending and you have free reign over how much money you spend. That includes shopping, any other kind of hobby, dinners, drinks, vacations etc. While these categories do improve your quality of living, they are not “must” categories and you shouldn’t spend much here before attacking the next two points.

Pay of Debt – ASAP

Debt bears interest. If you don’t pay off your debt as soon as possible, it will stick with you for a long long time and you’ll end up paying back way more than you originally borrowed. Paying off debt is highest priority! The only exception might be cases where the interest rate is so low that you might as well invest some money and make more money there than you have to pay in interest. For example, the interest rate for a mortgage in Japan is below 1% right now (variable, as of Feb 2019) that you might as well 1) reap the tax benefits from the mortgage for the first 10 years and 2) invest your money in index funds where you’ll definitely make more than 1% after taxes and fees. But this is an exception. For every other debt – PAY IT OFF AS SOON AS POSSIBLE.

Create a Safety Net

If you lost your job tomorrow, how long would you financially survive? How much money do you have available or can you make available on short notice? What if your car breaks down or you have to undergo an expensive medical treatment? That’s where your financial safety net or emergency fund comes in. Before even looking at investments, make sure you have an emergency fund ready that you can easily access.

My recommendation would be to have at least 6-12 months worth of expenses in your emergency fund. That should allow you to cover all your “must” categories including rent, utilities, taxes, loan payments. You can ignore discretionary spending for a moment as getting the new iPhone should not be a priority when you are in financial distress. The more volatile your income is the bigger your emergency fund should be.

Time to Invest

If you made it this far, it’s time to look at investing. Investing means you use your money to earn more money for you. I’m not talking about picking particular stocks or timing the market. That has not proven successful not even for professional portfolio managers. The best thing you can do is invest in low fee index funds. Without going into too much detail, I recommend you pick up a book by John Bogle the inventor of index funds. Index funds allow you to invest in a wide variety of companies across markets. In the short term, they might not skyrocket but long term they are proven to be a very successful investment tool. You can either put in money monthly, quarterly or biannually whatever works best for you. That also allows you to benefit from dollar cost averaging which maximizes returns over the long term.

In order to invest in stocks & bonds you need to set up a brokerage account. Personally, I’m all about online services as they provide more convenience and lower fees. For Japan that would be Rakuten, SBI and Monex.

What’s Next?

Once you get it set up properly, it’s all about staying the course. It’s not about day trading, timing the markets, picking the next stock that’ll skyrocket. We are in it for the long term. Set it up, automate as much as possible, review monthly or quarterly if you want, and see your money grow.

Now, occasionally your investments will go down in value as they drop with the market (especially when you invest in index funds). However, know that long term it’ll always come back and recover – always, always, always. Do not check your portfolio everyday and do not trade out of fear or greed.