The four principles that govern finance

Finance may seem complex, but it’s governed by four core principles.

In his book Succeeding, John Reed wrote one of the smartest things I’ve ever read:

When you first start to study a field, it seems like you have to memorize a zillion things. You don’t. What you need is to identify the core principles — generally three to twelve of them — that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles.

The finance world…

… employs some of the best-educated, highest-paid people on the planet, but everything that matters in the field stems from four core principles:

  1. Live below your means. A tremendous amount of spending is designed to show people how much money you have. Your savings rate is the gap between your ego and your income.
  2. Understand what bet you’re making. If you invest with a short time horizon, you are betting you’ll be able to sell to someone at a higher price. If you invest for the long term, you’re betting companies will innovate, humans will become more productive, and the rewards will accrue to a growing economy.
  3. Everything worthwhile has a cost. In investing, the cost of good long-term returns is putting up with constant volatility.
  4. There is a lot of money to be made in finance. This leads to hucksters, scammers, and charlatans charging egregious fees for little in return. Few things are as critical to financial success as a well-tuned BS detector.

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