Ah, the million dollar question: “What exactly is financial IQ?”
The sad truth is that if you happen to be asking this question, just by asking it, you have put yourself ahead of at least 90% of the world’s population (so congrats!).
This is because most people are only concerned about earning money through their labor and then quickly spending that hard-earned cash on products or services which actively make them poorer.
Anyway, I believe Financial IQ is more of a process than a goal.
It is something only the affluent seem to care about.
Simply put, financial IQ is all about:
- Controlling your expenses & cash flow but most importantly,
- Helping you increase your wealth, just by thinking of money in a different manner.
Now, I understand this sounds abstract and artsy so let’s discuss this a little more.
It’s A Sad, Sad World
At least 90 out of 100 people absolutely lack financial IQ. If I am allowed to be a little more cynical (and realistic), no more than 3 people out of a 100 really know how the name of the game of money.
Yes, these statistics are definitely depressing and are the major cause of the rich getting richer while the middle-class and the poor suffer.
Most people have almost zero control over their income and expenses, live pay check to pay check, do not have a lot of net worth and are essentially dependent on their primary job (or business) their entire life.
In recent times, a lot of people are now realizing that the retirement age of 65 is just a dream for them. They probably will have to work till they are 69 or 70 in order to “afford” to not work anymore. I feel even working till 70 might not be enough.
I personally believe that not being able to retire is less related to a lack of money and more related to how you make that money work for you.
Yes, you might get a kick out of purchasing a brand new Ford F-150 pick up truck for over $55,000 that you just want to show off to your friends but that “kick” is probably for a couple of months.
This apparently small mistake will haunt you for months to come in the form of a large monthly payment of around $550, increased car insurance, fuel & maintenance costs, not to mention the time it has taken away from using the same amount of money to make healthy investments.
A couple of years down the road, when you try to sell the truck, you realize it will go for only $34,000 since being an automobile it is a highly depreciating asset.
See, this is where financial IQ comes in.
Technically, a household in Canada living on a median yearly income of $76,000 can easily afford to become financially free & retire way before hitting 65, if they know how to manage their money.
Unfortunately, most people would rather spend their credit into oblivion & watch TV than learn about how to manage money & make it work for you.
Financially Educated Ryan:
So let’s take a step back and understand how Ryan, an intelligent guy with a high financial IQ thinks:
- Income: Ryan knows that income generated from his primary job is “earned income” and taxed at the highest rates. He actively tries investing for “portfolio income” and “passive income”, which are taxed at much lower rates since they entail using your or someone else’s money to increase your income (as opposed to just using your labor to earn income). Ryan might purchase stocks which provide dividends, purchase an investment property that he leases out to a tenant or might start take a company public in order to benefit from licensing or royalties.
- Expenses: Ryan knows that expenses are a necessity of life. After all, no one wants to drive a 30 year old car which is on the verge of breaking down. Also, no one (if they have a choice) wants to live under a bridge. However, Ryan almost never takes on bad debt unless he really has to. Bad debt is any consumer debt which makes you poorer. A Range Rover, an expensive BMW or Mercedes and a 100-inch TV screen are normally off of Ryan’s wishlist because purchasing these luxuries will force him to work harder and lose money.
- Shopping sprees: Ryan shops but he keeps it under control. Yes he might buy a premium Diesel jeans for around $300-350, but only if he really likes it. He will also make sure he uses the jeans for at least 2 or 3 years to “recover” his cost.
- Investments: Ryan knows that investing in real estate generally helps increase a person’s net worth since doing so allows him a lot of deductions, appreciation in value & less or almost non-existent taxes. He looks forward to growing his real estate portfolio by purchasing duplexes, apartment units & townhouses and renting them out over a long period of time.
- Debt: Ryan understands that saving $500,000 will take a really long time but borrowing $500,000 is a piece of cake (comparatively). Ryan keeps an eye on interest rates & borrows capital from the bank at 5% regularly in order to make anywhere between 25-150% return on his investment every single year, primarily by investing in real estate.
- Credit cards: Contrary to popular believe, Ryan doesn’t turn down new credit cards. In fact he welcomes them. He just makes sure they have no annual fee & hidden charges. To Ryan, a credit card is not a license to binge shop, buy a ton of clothes in order to impress the ladies. A credit card is a hedge against unforeseen expenses & to use when an opportunity to invest arrives. He always makes sure the credit card is paid off before the due date every single month so the interest rates being charged are pretty much irrelevant.
- Retirement funds: Ryan keeps contributing a good chunk of cash into his RRSP (4o1k) account in order to keep that money safe & available for later use. In the last 10 years, he has never missed a contribution payment.
- Mindset: Ryan absolutely loves good debt, debt which increases someone’s net worth. The “amount” of debt doesn’t really upset Ryan, even though it is in the millions. He just makes sure that the debt he takes on is easily repaid and helps him make more money. In short, he grows richer because of taking on debt, as opposed to the masses which grow poorer because of their poor choices.
Increase Your Financial IQ:
The good thing is financial IQ isn’t a gift you are born with; you have to develop it.
All you have to do is try to nurture it for a couple of weeks and it will start growing on you.
Here are a couple of practical ways of increasing your financial IQ:
- First, understand how developed economies work, what their pitfalls are & how they created money. I have created a detailed post about it here.
- Next, read some financial news everyday for as little as 10-15 minutes. This is priceless in terms of educating you. Check out Forbes, Bloomberg, CNN Money and The Motley Fool for starters.
- Lastly, keep an eye out for all kinds of financial deals. All you have to do is stay vigilant. If you are at the mall. pay attention to which outlets get the most business and why that happens. If you are driving around, try to figure out which properties for sale are good deals. You get the idea.
In the coming posts, I will let you know more ways of improving your financial IQ.
If you have any questions or comments, please be sure to mention them below.