Finally get your money in order with these 5 financial resolutions – forever!

Dry January, veganuary, more sport or all of the above? As sensible as these and other resolutions may be, unfortunately they are often short-lived. We want to change that, at least for your money, with these five financial resolutions. Because once your finances are properly organized, they will run like clockwork for decades. In this article, we’ll show you how you can increase your wealth steadily and automatically while keeping a full overview of your current expenses. But that’s not all: you’ll find out why the right money mindset is such a crucial success factor on the path to financial freedom.   

First things first

Asset accumulation is not an end in itself. Nor do we want to use these financial principles to promote petty ragging or to cut back on sensible expenditure such as donations. For us, it is clear that finances are not the focus of our lives, but should help us to live our lives the way we want to. A worthwhile goal for us is a self-reliant life outside the hamster wheel.

No matter what goals you are pursuing, if you are financially secure, life is simply more carefree, whether at work, when traveling or when you once again feel the need to freely express your opinion.

These five financial resolutions, which we discuss in more detail in this article, should pave the way for financial freedom and a self-determined life:

• Financial resolution no. 1: Acquire money education
• Financial resolution no. 2: Know your finances
• Financial resolution no. 3: Increase savings rate
• Financial resolution no. 4: Pay off debts and build up a nest egg
• Financial resolution no. 5: Invest regularly

Financial resolution no. 1: Acquire money education

Why should I do that?

Let’s start with the most general of all financial resolutions: your financial education. The main motivation, as mentioned at the beginning, is that financial security is a decisive factor for a carefree, free life. On an “operational level”, a solid financial education gives you stability in your investment decisions and prevents you from making rash decisions. In concrete terms: if you have internalized a few financial basics, you will not sell all your securities at a loss at the first major stock market dip out of panic.

The challenge is therefore primarily of a mental nature or is related to the “right” money mindset and only secondarily to the correct practical implementation.

How do I implement this?

Our preferred passive investment strategy with broadly diversified equity ETFs is scientifically sound and easy to implement. But it doesn’t work entirely without money education. Specifically, you should at least take the following three “financial wisdoms” to heart:

Understanding the interplay between risk and return

Without risk, there is no return. But that’s not all: no return also means that your assets will steadily lose value due to inflation. To maintain purchasing power, you would currently have to earn around 1.5% interest on your savings in Switzerland. You can hardly achieve even this modest return target with low-risk investments such as a deposit-backed bank account.

And yet: such secure and liquid investments are exactly the right thing for current expenses and a nest egg. This is because the focus is not on returns, but on values such as security (i.e. no risk in the form of fluctuations in value) and immediate availability.

The situation is different for long-term asset accumulation, which also includes the third pillar of retirement provision. Here, short-term fluctuations in value can easily be accepted. This means that without risky asset classes such as equities, it is simply not possible to preserve your assets in real terms, let alone increase them. In contrast to individual shares, broadly diversified equity ETFs protect you from the bulk risk of “total loss”, which is why they are our preferred investment vehicle.

Let’s summarize: Every investment, however different it may be, can only fulfill a maximum of two of the three values “return”, “security” and “availability”, but never all three.

You can find out more about the interplay between return, security (risk) and availability in our article The magic triangle of investing.

Understanding the powerful effect of compound interest

Albert Einstein is said to have once said: “The compound interest effect is the eighth wonder of the world. Whoever understands it earns from it, everyone else pays for it.” The compound interest effect is indeed one of the most important supporters of long-term wealth accumulation. Many people know this, but only a few can actually imagine how much compound interest actually affects their investment. The two factors of interest and time play a decisive role in compound interest: the higher the interest rate and the longer the holding period, the more powerful the compound interest effect, as the illustration below clearly shows.

Compound interest has an even more drastic effect with higher initial assets of CHF 100,000 and an annual increase in value of 8%: After the first 10 years, you have already accumulated CHF 215,892 (+116%) in assets, after a further 10 years a proud CHF 466,096 (+366%) and after a further 10 years or after a total of three decades, yes, then you are a millionaire! Unbelievable: you can achieve this feat without having invested a single franc in the meantime.

In the article Behavioral Finance: How to avoid the 13 biggest investment mistakes , we described misjudging the compound interest effect as the most serious investment mistake.

Understanding the benefits of passive investing

Passive investing means index-based investing. This in turn means that you have to be satisfied with the (global) market return and cannot beat the market. In the “equities” asset class, the average annual market return over the long term is around 8%.

So if you assume that global company values will continue to rise in the long term thanks to innovation and productivity (with setbacks), then broadly diversified equity ETFs should be high on your list of favorites. Because passive investing is easiest and cheapest to implement with ETFs.

In contrast, traditional asset managers prefer active investing, which is more lucrative (for them). Good for the bank, bad for you: Because with active management of your assets, you have to reckon with costs that are around ten times higher (fees of 1 – 2% p.a.) than with ETFs. It is therefore not surprising that hardly any asset manager can beat the market in the long term and after costs.

You can find out why we are so enthusiastic about ETFs in more detail in the article ETFs: The investment revolution. If you would like to deepen your money education further, we recommend our series of articles Learn to invest – in 8 lessons.

Financial resolution no. 2: Know your finances

Why should I do that?

A well-founded assessment will provide you with clarity about your financial situation. But that’s not all: you will also find out what your biggest expenses are and where the greatest savings potential naturally lies dormant.

How do I implement this?

When taking stock of your finances, you need to determine your income streams (active income such as earned income and passive income such as dividends), your most important expenditure items and your savings rate as the difference. With a monthly disposable household income of CHF 10,000 and expenditure of CHF 8,000, the savings rate is CHF 2,000 or the savings ratio is 20% (=2,000/10,000).

You also calculate your assets (essentially consisting of your cash, securities and real estate), any debts (e.g. education and consumer loans, mortgages) and the difference in your net assets. We consider net assets to be the most important and meaningful financial indicator on the path to financial freedom. This is because, unlike a high income, a high net wealth is associated with financial security, often in combination with passive income streams such as dividends.

In order to achieve financial freedom, it is less important how much money you earn than how much you save – and invest profitably so that your wealth can grow steadily. This brings us to the next resolution.

Financial resolution no. 3: Increase savings rate

Why should I do that?

If you want to become financially free, there is no way around an ambitious savings rate. Your motivation: the higher you set it, the sooner you will be financially free or independent of your actively earned income. We have described how quickly this can happen in the article Financial freedom – hype or a goal worth striving for?

How do I implement this?

Now that you know your current financial situation according to financial resolution no. 2, the next step is to increase your savings rate. As a reminder, the savings rate is expressed as a percentage and relates the savings rate (in CHF) to your total income.

So how can I increase my savings rate just like that? Admittedly, this is easier said than done. Nevertheless, we are convinced that everyone can increase their savings rate. You have two levers at your disposal to achieve this goal: Firstly, increase your income and secondly, reduce your spending.

The easiest and most effective way to increase your savings rate in special life situations is not to participate in the income-dependent increase in consumption. This states that as income increases, consumption also increases (and the savings rate falls by the wayside). This correlation has been scientifically confirmed, as we will explain later, and probably applies to most people. However, as an individual, there is hardly a greater opportunity in life for you to achieve financial freedom during your lifetime than in precisely such situations characterized by wage jumps!

An example from our own experience

When we were students, a modest lifestyle was mandatory. With our limited financial resources at the time, there was simply no alternative. After graduating, we started earning “properly” for the first time, but barely raised our standard of living for a few years afterwards. (Stefan still doesn’t own a car decades later.) This is because we became accustomed to a modest lifestyle during our studies. After such life stage changes, it is relatively easy to increase your savings rate from 0 to 50% or more from one day to the next. The reverse case, i.e. a downgrade in living standards, is of course much more difficult to accept and savings are often perceived as painful cuts.

As mentioned, these are selected and rather rare, if not unique, opportunities. Let us now turn our attention to more common situations in which we can increase our savings rate or our investments.

When it comes to earned income, you are dependent on the goodwill of your boss and your negotiating skills. In the longer term, you can also increase your income in the traditional way through further training and – based on this – by taking on more responsible or better-paid tasks.

The spending lever as an immediate savings rate booster

The spending lever has the advantage that you can achieve a quicker effect, for example by cutting back on consumption immediately. So why don’t you go through the identified expenditure items from financial resolution no. 2 and focus on the larger items. Because that’s where the greatest savings potential lies dormant.

It is often worth canceling contracts for cell phones and the like as a precaution. This gives you a better basis for negotiation or keeps the option of changing provider open. A no-brainer in Switzerland is changing health insurance provider. As the benefits catalog for basic insurance is set by the state, you can switch to the cheapest health insurance company every year without any loss of benefits. What’s more, for most people it’s worth choosing the maximum deductible of CHF 2,500, provided they have a nest egg set aside just in case, which brings us to the next financial resolution.

Financial resolution no. 4: Pay off debts and build up a nest egg

Why should I do that?

If you live free of (consumer) debt, have existential risks insured and have a sufficient nest egg ready for uninsured, unforeseen events, the foundation for a carefree life has been laid. So you can enjoy the pleasant side of life and devote yourself to the non-financial challenges.

How do I implement this?

By increasing your savings rate, you should first reduce any debts. The focus here is on high-interest consumer debt, the interest on which is usually significantly higher than the expected increase in value of equity ETFs. Specifically:

• Repay consumer loans as quickly as possible with funds from the savings pot or at least switch to another lender with better conditions (debt restructuring).
• Deactivate installment payment options for credit cards and replace them with free LSV (for example, the popular Certo! credit card from Cembra has a high interest rate of 12.95% p.a.) or
• generally only use debit cards (without overdraft function) instead of credit cards.

Once the consumer debt has been paid off, we consider it sensible to save a so-called nest egg for unforeseen events such as a high dentist bill or an unexpected replacement of the washing machine. Depending on your income and risk assessment, this reserve could amount to two to three months’ salary, for example.

Important: In Switzerland, you are covered by law for many events that could threaten your livelihood, such as job loss, illness or accident. In addition to the compulsory insurance, it is worth taking out private liability insurance, which can also protect you from financial ruin. However, other insurance policies that cover relatively minor financial risks (e.g. “all-round protection for your cell phone”) should be canceled and covered by your nest egg or current budget in the event of a claim.

We don’t think it makes sense to set the nest egg too high. After all, with a nest egg you are deliberately foregoing returns. Instead, it should be available at all times and secure (i.e. without risk or fluctuations in value).

In our experience, the smartphone bank Yuh is particularly suitable for storing your nest egg: secure, available at any time and with a relatively good interest rate. What’s more, account management is free. (With our promotional code YUHSFB you can currently secure 50 CHF trading credits and support our blog at the same time).

Financial resolution no. 5: Invest regularly

Why should I do that?

Finally, here comes the most important part of a financially carefree life: investing. It is not only the most important part, but also the one with the highest priority (motto: “Invest today, consume tomorrow”). Because the sooner you start, the more the compound interest effect will help you build up your wealth (see financial principle no. 1).

If you don’t prioritize investing, there will be a thousand reasons to allocate your savings to consumption. Incidentally, this behavior has been scientifically proven and is called Parkinson’s Law. According to this law, we tend to use up all available resources. In the context of money, this means that we consume everything regardless of how much we earn – unless we have a well thought-out plan, which we want to provide you with these five financial resolutions.

How do I implement this?

Once we know our financial situation, any consumer debt has been paid off and we have saved up a nest egg (see financial resolutions no. 2 and 4), we can finally start investing. Based on the savings rate that we determined with financial resolution no. 2 and increased with no. 3, we now need to invest the money we have saved profitably.

Once you have implemented the financial principles described above and with an investment horizon of ten years or more, you can invest your savings installment or parts of it or use it to build up a broadly diversified portfolio of equity ETFs month by month. This should definitely be rule-based and automated using an ETF savings plan.

Specifically, you set up a standing order with your bank to top up your securities portfolio at the beginning of each month, whether with an online broker or a robo-advisor. In addition, you activate another standing order, which you use each month to top up your securities-based 3rd pillar of retirement provision (e.g. with Viac) up to the maximum permitted annual amount.

In the next article, we will build on these financial principles and explore the topic of “ETF savings plan Switzerland” in more detail.

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Conclusion on the financial resolutions

We consider the implementation of these five financial resolutions to be the foundation for your financial freedom. Success therefore depends on your money mindset on the one hand and on how you organize your finances on the other. You develop and hone the former through financial education and practical experience as an investor. You can achieve the latter by understanding your financial situation, automating your investments using an ETF savings plan and, last but not least, by making a smart choice of financial partners/products that are suitable for you.

As mentioned at the beginning, our financial resolutions are not about raking in as much money as possible for the sake of raking in money. Instead, a high net worth should enable you to lead a financially carefree, self-determined life beyond the hamster wheel. A worthwhile goal, in our opinion.

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Disclaimer

Disclaimer: Investing involves risks of loss. You must decide for yourself whether you want to bear these risks or not.

Errors excepted: We have written this article on five financial resolutions for the new year to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, if we have made any mistakes, forgotten any important aspects and/or are no longer up to date, we would be grateful if you could let us know.