In a world where we’re told that “everything’s relative,” there are some truths we cannot ignore. We can fool ourselves into thinking we’re able to ignore them, but we can never ignore them for very long. There’s a lot of financial and economic ignorance going around, so I thought I’d highlight a few financial and economic truths we won’t be ignoring, no matter how much we think our sophistication and brilliance supersedes these truths.
1. Everyone Faces Trade Offs
To get something, you have to give up something else. Making decisions requires trading off one goal against another. You trade your hours for dollars at your job, then trade those dollars for goods and services, such as food, fuel, housing, or dry cleaning.
2. Debt Is A Disaster
The downward spiral of using debt to fund the consumption of items that instantly depreciate in value is a personal financial disaster. High interest charges and fees are designed to keep the money flowing to the lender and to keep the borrower in slavery.
3. The Real Value of Something Is What Someone Is Willing To Pay For It
Your home may be “appraised” at $250,000 but if no one will pay more than $225,000 — it’s only worth $225,000. You may think you’re worth $75,000 to an employer, but if no one is willing to pay you more than $65,000 …
4. Money Is Worth More Today Than Tomorrow
The dollar I receive today is worth more than a dollar I’m promised sometime in the future. The dollar I get today is real, but the dollar I’m promised in the future will be worth less because of inflation, or I might not get it at all. After all, companies fold, people declare bankruptcy, or a lawsuit may wipe out my ability to collect. Also, the dollar I get today can be invested to create more dollars in the future.
5. Smart People Think at the Margin
A thinking person takes action only if the marginal benefit of the action exceeds the marginal cost. If a graduate degree is worth only another $2,000 per year at your job, but costs $35,000, it doesn’t take a rocket scientist to see that you’re going in the hole.
6. Compound Interest Is The Eighth Wonder Of The World
To think that a $1,000 investment (at 8 percent interest and compounded quarterly) when a child is born can be worth over $172,000 with NO other deposits when that child turns 65 really IS amazing. Put the power of compound interest to work FOR you rather than against you.
7. People Respond to Incentives
Whatever gets rewarded, gets done because behavior changes when costs or benefits change. Companies frequently ignore this truth and find that their incentive programs only cause people to perform in a way that will produce the incentive but still not produce the desired behavior.
8. Free Trade Makes Everyone Better Off
Imagine if all 50 states refused to trade with each other without tariffs, import/export quotas, or other barriers. The ability for all 50 states to trade with each other was one of the reasons the US became such an economic powerhouse. Free trade allows each person or nation to specialize in the activities he or she does best. By trading with others, people and nations can buy a greater variety of goods or services. Besides, nations who are trading partners have strong incentives to avoid wars with each other.
9. Markets Organize Economic Activity Better Than Bureaucrats
Households and firms that interact in market economies act as if they are guided by an “invisible hand” that leads the market to allocate resources efficiently. Begin central planning by government bureaucrats and you get the opposite effect: inefficient allocation of resources, shortages, and surpluses. No one understands how best to spend money than the people directly affected by it.
“In a free market, firms would be smaller and less hierarchical, more local and more numerous (and many would probably be employee-owned); prices would be lower and wages higher; and corporate power would be in shambles.” –Robert Long, The CATO Institute
10. Your Standard of Living Depends on Your Ability to Produce Results
Countries with productive workers creating a large quantity of desirable goods or services per unit of time enjoy a higher standard of living than nations with lower productivity. As a nation’s productivity grows, so does its average income. Individuals who can consistently produce desired results will always be in demand.
The beauty of truths, laws, and principles isn’t that they’re restrictive, it’s that once you understand how they work, you can use them to your advantage.
photo credit: randomduck
Note: this post was included in The Carnival of Personal Finance: Cyber Monday Edition at Mighty Bargain Hunter.