Newton’s Laws of Finance

Newton’s Laws of Finance

When you were in school, you probably learned about Newton’s Three Laws of Motion.  First published by Sir Isaac Newton in 1687, these laws explain how physical objects move.  They are so important—and easy to understand—that most of us still remember them even decades later.

We were thinking about these laws the other day when we came upon a realization: each of the laws can also be applied to finance.

Now, we know this isn’t quite the same as watching an apple fall from the tree and developing the theory of gravitation.  But we are financial advisors, not scientists, so to us, it’s equally interesting!  That’s why, over the next few months, we’re going to share what we call:

Newton’s Laws of Finance

In this article, let’s look at Newton’s First Law.  Here’s how we all remember the original:

An object at rest tends to stay at rest, and an object in motion tends to stay in motion, unless acted on by an outside force. 

Here’s our version:

A financial plan at rest tends to stay at rest, while a financial plan in motion tends to stay in motion, unless acted on by an outside force. 

What exactly do we mean by “financial plan?”  While there’s no one definition of what a financial plan really is, in general, it works like this:

  1. First, you look at your current financial situation. What is your income, what is your cash flow, how much do you pay in taxes, etc.
  2. Second, you determine what you want your future financial situation to look like. What goals do you want to accomplish?  What treasures (be they people or possessions) do you want to protect?
  3. Finally, you lay out all the individual steps necessary to get you from your current financial situation to your desired financial situation. What exactly do you need to do to reach your goals?  When do you need to do them?

Put these together and you have a basic financial plan.

In our experience, most people agree that having a financial plan is valuable.  But there’s a widespread problem: most people procrastinate when it comes to creating OR implementing a financial plan.  It’s not uncommon to hear excuses like “I’m too busy right now to create a plan; I’ll do it next year when life settles down.”  Or, “I want to wait until I have a better job/the elections are over/the stock market goes up.  There’s just too much uncertainty right now.”

Let’s go back to the First Law of Finance: a financial plan at rest tends to stay at rest.  People who procrastinate, who delay, who act passively, will usually continue to do so indefinitely.  “Next year” never comes.  Life never “settles down.”  Uncertainty never goes away.  And so, a financial plan never gets created, and things just sort of stay the same.  Forever.

The good news is that the First Law of Finance also says: a financial plan in motion tends to stay in motion. 

It’s amazing to see this Law at work.  People who actually get the ball rolling, who act, who put in the energy to create and execute their financial plan … they start to build momentum.  Suddenly, things start happening … and they keep happening!  Their savings grow.  Their tax situation improves.  Their goals are reached, not just once, but over and over.  We’ve literally seen people go from, “I feel like I’ll never retire” to “I retired much sooner than I thought I would!”—all because they stayed in motion.

What we’re really talking about here is inertia.  Whether you’re moving or standing still, people are like all physical objects: they find it easier to keep doing what they’re already doing.  If you procrastinate, you’ll find it easy to keep doing so.  But if you start working toward your goals, you’ll discover it’s much more doable than you ever imagined.

All of this is important because a proper financial plan will help you:

  • Know how much money you’ll need to meet your expenses and reach your goals.
  • Choose the right investments to provide the income you need, at a suitable specific level of risk.
  • Potentially minimize taxes for both yourself and your heirs.
  • See what areas of your finances are stable and which may need improvement.
  • And much more!

Let’s look at the First Law of Finance one more time:

A financial plan at rest tends to stay at rest, while a financial plan in motion tends to stay in motion, unless acted on by an outside force. 

YOU are that outside force.  YOU hold the power in your hands to get the ball rolling.  And it’s a mighty power indeed—because it’s a fundamental law of nature.

Next month, we’ll look at the Second Law of Finance.  In the meantime, be that “outside force!”  If you haven’t already done so, start doing what you need to do to create a financial plan today.

in: News, Weekly Wire