Congratulations on the yearly raise, and I’m sure you deserve it because of your hard work.
Unfortunately, this doesn’t exempt you from the need of investing. This is because of the so-called
“money illusion”. This is our tendency to think of money in its absolute amount rather than what it can buy.
The Money Illusion
To illustrate the money illusion, let’s consider the story of Roberto. Roberto is a burly construction
worker. He’s very proud of his strength and often boasts that he can carry two sacks of rice on his back.Being very powerful, he is always in demand. In a single day he usually has 2-3 jobs, one in the morning, another one in the afternoon, and the third one before dinner.
With his morning job, Roberto earns P150. This is the money he uses to buy his favorite lunch
meal: the Jollibee Champ. The Champ meal costs exactly P150 pesos, and the money he earns is just enough.
A year later, his morning boss gave him a 10% raise. This increased his pay to P165 per day.
Delighted at the news, he sets aside the extra P15 for his savings. Roberto gives himself a pat on the back for being P15 richer !
That day, Roberto goes to Jollibee and orders the same Jollibee Champ Meal, but it sees in the
menu that it already costs P160. He thinks to himself that it was fortunate he got a raise. So he decides to buy it since he really wants the “one-third pound patty, heavier than a quarter-ponder, 100% purebeef burger”. So Roberto takes the rest from his savings, leaving only P5.
This is an example of the difference of the absolute amount of money vs. what it can buy. Roberto
got a P15 raise, but his food also got more expensive by P10. So in reality, he only got richer by P5. The fortunate thing about this example is that the pay-raise was higher than inflation. Roberto still got wealthier; but it’s not as high as he thought.
If the Raise Is Lower than Inflation
A more upsetting situation is when inflation becomes higher than the pay-raise given.
Let’s consider the same situation, but this time with Kharl (yes with an H). Kharl is Roberto’s coworker and Champ-buddy. Both of them earned P150 per day, and both of them always bought the Champ meal. A year later, Kharl also got a raise. However, his salary was increased to only P155. Nonetheless, Kharl is still happy with the raise.
Kharl then goes to Jollibee with Roberto. At the counter, Kharl also ordered the Champ Meal. He
handed out his money to the cashier, and waited for the receipt. The cashier then said, “Sir, the Champ is already P160. You only gave me P155.”
Kharl was surprised that the Champ already got more expensive. With his mouth wide open, he
looked at the menu, and then stared back at his money. He looked at the menu, then back at his
money. He kept doing this for about a minute, until the guy behind him asked him to hurry up.
So as not to keep the people waiting, Kharl just changed the order to a regular cheeseburger.
Poor Kharl! He was happy that he got a raise. But, he could no longer afford his favorite Champ
Meal. Because his raise was lower than inflation, what he actually got was a pay-cut. Again, this is the effect of the money illusion.
Real Salary Increases
With this, we can say that a salary increase is “real” only if it’s greater than inflation. If there were
no salary increases, the bottom-line effect is that you received a pay-cut equal to the inflation rate. So if your pay-raises over the past years have beaten inflation significantly and consistently, you have a better chance of fighting inflation. However, you will still need to prepare for your retirement.
I’m buried in debt! How can I start investing?
If you’re in debt, getting out of it should be your top priority, not investing. This is because all of
the gains you’ll get in investing will be eaten up by the penalties of being in debt. Inflation works
against you by 5% per year. So if you earn 10% with your investments, you win the battle.
But, credit card debt is much more powerful. It works against you by 40% per year (that’s 3% per
month). This is eight times more powerful than inflation! So even if you earn 40% from your
investments (which by the way is difficult to do on a consistent basis), you end up not earning
anything! This is why your top priority should be to get out of debt first.
How to Get Out of Debt
This isn’t a guide on how to get out of debt but here are some of the most important and practical
things that you can do.
- Record the amount you pay for your debt and the amount you borrow each month.
- Decrease the amount you borrow each month.
- Increase the amount you pay for your debt each month
I’m sure you’ve heard of the advice to stop borrowing, leave the credit cards at home, and start
paying cash for everything. You may have heard the advice before, but are you doing it? Chances are,not yet. The reason is that it’s just too uncomfortable to change old habits! Don’t change too many things at once, you’ll burn out and fall back into old habits. So my advice is just start with 1, follow with 2 and then 3.
Recording how much you’re borrowing and paying back forces you to face the reality of your debt
problem. This is the most important step to solve the problem. If you don’t know how big your
problem is and how well you are solving it, then you’ll never be able to solve it.
Once you know how much you borrow and pay back each month, slowly decrease the amount
you’re borrowing and slowly increase the amount you’re paying back. From borrowing P5,000 per
month from different people, just try and borrow P4,900 this month. From paying back only P3,000
per month, start paying back P3,200. While the changes may appear small, the important thing is
you’re already moving forward to becoming debt free.
I’ll just invest when I’m already rich
This objection is one of my favorites. It’s just so silly! Waiting until you’re rich before you start
investing is like saying:
• When I get promoted, then I’ll work harder.
• When I get a girlfriend, that’s when I’ll cut my hair (a friend of mine who had long and
untidy hair actually said this)
• When I get my big break, I’ll give it my all. (For a long time, I believed this!)
But we all know that it’s the other way around!
When you work hard, that’s when you get promoted. When you give it your all, that’s when you
get your big break. Finally, when you invest, that’s when you’ll be rich. And when you get a haircut.
So where do I invest ?
There are many investments available aside from the stock market. There are time-deposits,
bonds, mutual funds, foreign currency, precious metals and many others. For now, we’ll talk about the most basic ones. As we go through each one, keep in mind that you don’t have to pick just one. In fact,successful investors put their money in different investment vehicles. But when you’re just starting out, it’s easier to learn them one at a time.
Why should I invest in the Stock Market?
I have two categories of reasons why I strongly recommend investing in the stock market. The first
is of a purely economic reason, while the second is about your growth as an investor.
It’s Got Higher Returns
The stock market has historically given higher average returns than bonds and inflation. In the
picture below you’ll see that over a 20-year period, the stock market has outperformed bonds, and
savings accounts. Now, it is important to stress that the stock market doesn’t give guaranteed returns,but over a long period of time, it also has more potential for returns.
Another reason to invest in the stock market is expert partnership. When you buy a stock of a
company, you become part owner in these corporations. So when they make money, you also make money. Just for a few thousand pesos, you get the chance to partner with the owners of SM, Meralco,PLDT, and more.
Lastly, you also get a big bonus: TAX FREE INCOME! If you earn P100,000 from the stock market,
you don’t need to give 30+% of it to the government! You have no legal obligation to pay income
taxes from income generated from the stock market. We’re actually one of the few countries left that has this privilege. However, if you’re a government employee, play it safe and declare this in your SALN.
It’s about Financial Literacy
Now, my favorite reason why I highly encourage investing in the stock market is because you get
to grow more as an investor. Investing in the stock market entails a lot more responsibility than
making a one-time bank deposit. And because it requires a little more responsibility, you get to learn more. As a reward, you also get to earn more.
This is very important to me, because I believe that financial literacy is the solution to poverty. If
every Filipino knew how to manage their money well, how to invest, and ultimately how to create
wealth, we can become a first world nation again.
On the Stock Market
The previous section on investing focused on the “Why” questions. Now, this section focuses on
the “What” and a little bit of “How” in the stock market.
source : Book (A Beginner’s Guide to Investing in the Stock Market)
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