First-principles thinking helps reverse-engineer complicated problems.
The idea is to break something down to its base elements. We can then reassemble them from the ground up. This approach was used by the philosopher Aristotle. Elon Musk and Charlie Munger are among those who use it now. It allows them to cut through the fog of shoddy reasoning and inadequate analogies to see opportunities that others miss.
A first principle is something that stands alone. We cannot further break it down into anything else.
So, what are some of the first principles of looking after your money?
If you do not control your money, it will control you. True financial success is about understanding what you need to do and doing it. This is easier said than done.
You need to have an understanding of how the vagaries of the markets, the news, and everything surrounding money can cause you to lose control. You need to have strategies to prevent you from overreacting to events and taking irrational decisions with your financial future.
If you do not grow your money in line with inflation its true value will go down. Many financial plans need the money to grow at a rate higher than inflation to succeed.
Achieving long term growth is simple. You need to invest in stocks & shares. An investment in shares is an investment in capitalism. While it is far from perfect, capitalism is the only system we have got to secure your financial future.
You need to leave your money invested for a long time to achieve the returns most financial plans need. Compounding and the exponential growth it creates is key to long term financial success. This works both ways so look to minimise the drag of costs and taxes on your money.
You need to understand the higher the return you try to get the less certain it will be that you achieve it. You need to understand the impact of mixing equities with asset types, and why it might be a good idea if you are unwilling, or unable, to take too much risk with your money.
Also, you need to think about the risks to yourselves and your family. Think about how you would cope financially if the worst happened to you.
Are any of these the first principle of financial planning?
These are effective things to thinking about managing your finances.
To find the first principle of financial planning, I believe you must go deeper. By this, I am talking about values.
These are a set of operating principles which are part of our very being. They will guide you through difficult decisions and point you towards the course of action.
An example would be building a house. You may be so excited about having a house built you may not think to express your desire for building it in a certain way. You may not know the extent of the options available to you. Hopefully, your architect would discuss your preferences and discuss the trade-offs with you. If they did not you may find that you have not built your dream house. You may find you have built someone else’s.
A financial plan is no different. What is important to you about money should be the driving force behind your financial plan. To use another building analogy, building a financial plan without taking someone’s values into account could be like building a house on sand.