In
all walks of life there are few things
that people find more confusing than dealing
with money. The numbers, the jargon, the
rules and regulations - it's all too much.
And yet,,,
And
yet, everyone knows in their heart of
hearts that they should pay more attention
to it. It doesn't matter whether you're
running a business, organising a charity
or just trying to keep your own personal
life afloat, we all need - somehow - to
get a handle on it. The ostrich approach
just can't work for very long.
So,
here we're going to take you through some
of the basic ideas of managing money.
The basic ideas are actually quite straightforward,
so always keep them in mind. Only as we
move into the detail do they have the
tendency to become technically complex.
The
meaning of 'wealth' and its creation
In
the UK, the society in which we live has
developed over many centuries, much of
it by trial and error. In terms of its
approach, its processes and its institutions,
there is much which is admired by other
countries around the world.
Generally,
to be wealthy a nation must create wealth
on an ongoing basis and incentivise its
people to do so. Thereafter, most of the
debate surrounds just how much freedom
there should be to create that wealth
and what safeguards are necessary and,
then, how that wealth should be distributed
across the population. Provided that people
are not exploited or cheated then most
would agree that the creation of wealth
is good. Much of the political debate
and how we decide to vote then surrounds
the distribution of wealth. Should it
go to providers of capital, to workers,
in taxes for the good of the nation for
schools, hospitals etc?
What
is wealth? In the world of finance wealth
is the ability to buy things, in other
words purchasing power. In essence it
translates into "money". But here we must
think a little further. Receiving a salary
is fairly obvious. We work, we are rewarded
and it arrives in the form of cash or
money in the bank. But what about the
profit from running a business? Profit
is an amount calculated from taking our
expenses away from our income and should
be reflected in an increase in our wealth.
However, unless we manage our business
properly that wealth may be tied up in
assets, in stocks or in our customers
owing us money for bills they should have
settled.
Likewise,
we may achieve an increase in wealth because
the price of our house increases. However,
telling the cashier at Tesco that you
live in a big house does not usually cut
much ice. They prefer cash or a credit
card. So the pure creation of wealth is
not the only important aspect. Cash flow
and the ability to meet our financial
obligations matter as much.
How
much wealth?
Having
thought about what wealth is we might
now ask ourselves how much do we want?
As much as possible I hear you say. It
is not as easy as that. Commercial organisations
may wish to earn large profits and that
is certainly the fundamental assumption
behind business and behind the operation
of the stock exchange.
However,
even that must be tempered somewhat. First,
there are all kinds of ethical and moral
considerations such as monopoly power,
the exploitation of labour, health and
safety, pollution. The list goes on. Second,
for many the ambition may not be purely
financial - involving maximising profits
and returns. It may include factors such
as continued employment, self-fulfilment,
self-esteem, independence and the satisfaction
that comes from being your own boss.
For
other organisations, such as charities,
not-for-profit enterprises or the recently
introduced community interest companies,
profit will not be the prime motive. Nevertheless,
they will be subject to rules and regulations
and will also need to manage themselves
sensibly from a financial point of view.
Then
there is the question of personal lifestyle.
Without becoming too Dickensian, how much
we need to earn depends on how much we
want to spend. If we have a lavish lifestyle
we need to earn lots. If we live modestly
then we don't need to generate so much
income. This is an important consideration
in deciding, for example, how much pension
we need to save for, how hard we need
to work, and whether or not we can survive
through the early years of starting a
business when it may not be making much
money.
The
transfer of wealth across time
In
a financially sophisticated country like
ours there exist many financial institutions,
the stock exchange, banks, pension companies
and insurance companies, to name a few.
These allow a number of activities to
take place. First, in a market economy
they allow money to flow freely towards
new, profitable ideas and away from older,
worn out ideas. Second, they allow people
and institutions to transfer wealth across
time.
During
our lives sometimes we produce more wealth
than we consume while at other times we
consume more wealth than we are producing.
So we need some form of storing mechanism.
For example, when we first buy a house
with the help of a mortgage we are consuming
more wealth than we are producing at that
time and so we borrow that extra wealth,
the cost of which is the interest we pay,
and we pay it back over time.
Conversely,
when we're working we choose to delay
some consumption by investing in a pension
to prepare ourselves for the day when
we retire and are no longer producing
but are still consuming. So we invest,
directly or indirectly, in shares or deposit
accounts and the price of us letting others
use our money is the return we get.
Risk
and return
All
investment is inherently risky, the safest
for us probably being investing with the
UK government (though not all governments).
Thereafter, risk increases depending on
the type of investment we undertake.
Investing
involves confidence and is a great act
of faith. We are entrusting money that
we have now, for uncertain future gains
probably dealing with people we do not
know. We are, therefore, assuming that
they are honest and competent and that
their ideas are financially sound. That
being so, it is a fundamental rule of
investing that the more risk we are prepared
to take the greater will be the reward
that we should expect.
Likewise,
the longer we are prepared to tie up our
money the more reward we can expect for
making that sacrifice. For example, a
notice account at a building society would
normally expect to earn more interest
than an instant access account.
Choosing
our investments
Where
does that get us in thinking about how
to organise our investments? That means
shares, bank accounts, house, insurance
policies, paintings, stamp collections
- in fact anything like that. Even our
own knowledge and skills that we've worked
to acquire is an investment that we hope
will pay off.
First,
we must consider our liquidity needs,
that is our cash needs over many different
time horizons. What do we need next week,
next year, or in 10 years' time? Second,
we must think about our attitude to risk
and how easily we wish to sleep at nights.
We are all individuals and different in
terms of the risks we're prepared to take
and also the need for cash at any particular
point in our lives. So, we must each do
our own thinking and decision-making.
Another
major aspect is protecting ourselves as
much as possible by spreading our investments
in case any one of them should go wrong.
Not putting all your eggs in one basket
is another fundamental principle of investing.
How
does all this help us?
Now
that we have established an outline we
can start to think through some of the
implications.
The
most fundamental piece of thinking when
considering any organisational activity
of any kind, or our personal investment
decisions, is to consider in great depth
what our objectives are.
What
are we trying to achieve? Only by clearly
understanding that can we see how our
new decisions are going to fit in with
everything else and how best can we take
those decisions forward.
On
the inmyprime website we separate those
issues which surround running or being
part of an organisation from what we might
do with our money in personal terms.
However,
as far as the world of finance is concerned
they should be seen as two sides of the
same coin. When we are part of an organisation
we are on the inside looking out. We are
using other people's money. When we are
investing in an organisation we are on
the outside looking in. Others are using
our money. Same issues, different perspectives.
Many
of the implications of what we have described
above are examined in other factsheets
alongside advice on how they should be
managed and taken forward.
Some
things you may wish to do yourselves,
others you may wish to leave to professionals.
The choice is yours. We will guide you
where we feel able.
