In reality, when we talk about money management in trading, we’re really talking about risk management.
Look a little closer and you’ll see that risk management is mainly about protecting your funds when you slip into the red.
Whereas the art of money management comes into play when you’re making profits or have a budget to organize.
So what should you do with your profits or your capital?!?
First off, I want to be clear: I have no pretension of telling you how to do this from A to Z, because money management is a deeply personal thing!
Still, I hope to give you a few ideas that I’d follow to the letter… if I were a robot.
Money Management: Invest in What You Love
While I’m at it, here’s a first, very general piece of advice. If you don’t know where to invest, start by focusing on what you love doing or what you enjoy! The sectors you’re passionate about are the ones where you’ll be able to stand out most easily, because motivation there is limitless. Subconsciously, this plays a huge role in learning. We remember what interests us — that’s just how it works!
The usual pattern when you find a lucrative sector or job is to be driven by the goals and the comfort they bring. Unfortunately, that rarely lasts a lifetime, for all sorts of reasons. You don’t have the same energy as you get older, nor the same motivations! A passion, though, never dies — you’ll always be able to reinvent yourself!
Armor Against Negative AND Positive Emotions
The psychological factor plays a major role in trading and investing. Trading can be compared to poker for the emotions it triggers in the trader — namely greed, stress, euphoria, depression, the fear of losing, frustration, panic, and so on.
All these emotions can lead traders — even the most experienced ones — to make irrational decisions and jeopardize their working tool, i.e. their capital. This is where money management comes in. It lets you protect yourself from yourself by setting up a framework of rules.
Always misplacing your keys?
Put a hook right by the front door!
Money Management VS Risk Management
When you’re starting out as an investor or trader, your first instinct is to think about potential gains. Anticipating losses is far less natural. Yet losses are part of trading and investing; you have to accept them.
If you don’t factor in losing, you’ll never be able to win on the financial markets. That’s exactly why you should only invest what you can afford to lose…
Otherwise you’re inevitably driven by fear — and at that point, you can forget about trading!
Losing trades are part of every trader’s daily routine. They’re far less frequent for investors, which is exactly why you need to be all the more vigilant!
You can’t always be right. Your analysis may be the best there is, but you’ll never hold all the cards. And besides, everyone makes mistakes — even you!
Better to be right alone than wrong with the crowd: that’s exactly what trading is!
Money management and risk management exist to handle losing streaks and to stop you from draining your account when you get it wrong.
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Money Management: Start Early, Please
I’d go even further: start as early as you possibly can. Even if you don’t yet know what to do with your savings, don’t hold back. There are a thousand reasons to build up a healthy cash reserve, but here are the three I find most motivating!
- security and peace of mind
- investment opportunities
- your potential is exponential!
I really want to stress the third point, because if you have to deprive yourself slightly in order to set money aside, it’s essential that you know why you’re doing it!
As I hinted earlier, if you’re certain of earning a return on your savings, you need to understand that interest compounded over several years doesn’t grow into multiples — it grows exponentially.
Example of an investment at 5% per year on $1000.
End of year 1 = 1000 x 1.05 | 1050
End of year 2 = 1000 x 1.05² or 1050 x 1.05 | 1102.5
End of year 3 = 1000 x 1.05^3 or 1102.5 | 1157.625
End of year 4 = 1000 x 1.05^4 …..
End of year 20 = 1000 x 1.05^20 | 2653.3
You get the idea: 5% per year isn’t 5% of my initial capital every year — it’s also the accumulated interest earned, which in turn starts to breed interest of its own.
Now let’s look at things from another angle…
In your opinion, if you save $10K every year for 10 years and your neighbor saves double that over 5 years on the same income, which of you comes out on top?!
It’s you, obviously — and by a wide margin…
| Case 1 | You: 10 years, $10K/yr at 5% | ||
| End of year 1 | $10K x 1.05 = | 10 050 |
| End of year 2 | ($10K + $10050K) x 1.05 = | 21 052.5 |
| End of year 3 | 31 052.5 x 1.05 = | 32 605.125 |
| End of year 4 | 42 605.125 x 1.05 = | 44 735.39 |
| End of year 5 | 54 735.39 x 1.05 = | 57 472.15 |
| End of year 6 | 67 472.15 x 1.05 = | 70 845.76 |
| End of year 7 | 80 845.76 x 1.05 = | 84 888.05 |
| End of year 8 | 94 888.05 x 1.05 = | 99 632.45 |
| End of year 9 | 109 632.45 x 1.05 = | 115 114.07 |
| End of year 10 | 125 114.07 x 1.05 = | 131 369.78 |
| Case 2 | Your Neighbor: 5 years, $20K/yr at 5% | ||
| End of year 1 | $20K x 1.05 = | 20100 |
| End of year 2 | ($20K + 20100) x 1.05 | 42105 |
| End of year 3 | 62105 x 1.05 = | 65 210.25 |
| End of year 4 | 85210.25 x 1.05 = | 89 470.76 |
| End of year 5 | 109 470.76 x 1.05 = | 114 944.3 |
No need to spell it out — just pointing you to the fable of the tortoise and the hare says it all, doesn’t it?!
You walk away with more than double the profit compared to your neighbor. The difference is 16425.48 in this specific case.
In short, you get it: one of the best pieces of money management advice I can give you is to get started as early as possible!
Keep Something Aside for a Rainy Day
Having a safety cushion helps soften the falls — don’t neglect it!
You should think of your safety reserve as an investment, for several reasons. It can turn into an investment when a great opportunity comes along, but it also lets you take more risk in your activities and therefore be potentially more profitable.
Avoid Debt!
Only take on debt if you’re certain the borrowed sum will be productive.
Real estate is one of the few near-certainties in this respect. Even buying out a thriving business is no guarantee of success, so be very careful. You only borrow when all the planets are aligned in your favor.
Set Precise, Realistic Goals
If you don’t know what you’re going to do with your money, you’ll run into a few small problems — like not knowing when to stop. Likewise, don’t think too big; set milestones that give you room to take a vacation. You have to find a balance between ambition and rest, otherwise you won’t be able to satisfy either one.
Finding a balance between ambition and rest will ensure your longevity. Remember that when it comes to money, slow and steady wins the race!
Track Your Spending
Careful — I didn’t say to count every last cent every single day, and I’ll be honest with you: this is a part I hate, because I’m quite a spender. Which is exactly why I’d say a good reminder is definitely important.
If you track your spending even a little — even just once a month — you might spot a few “anomalies.” Don’t forget the exponential effect we saw for savings and investments… It also works the other way around, with pointless spending.
To Save, Don’t Wait for the Boom!
Pay yourself, pay yourself, pay yourself..
I can’t say it enough. On every winning trade at first, then every week, and finally every month, set aside a larger or smaller portion.
Likewise, if you want to invest or save, find a way to automate it at the start of each month. Find every possible means to set money aside before you’re faced with chances to spend it. If you reduce your capacity to spend, you automatically become thriftier!
Become the One Who Optimizes, Not the One Who Mixes Everything Together!
Fine-tuning your money management according to specific income streams or activities makes sense. There’s no question of risking one activity for another. When people tell you never to put all your eggs in one basket, it also means: never commingle your funds!
A perfect counter-example would be SBF. I won’t dwell any further on how important it is to NEVER commingle funds. That said, had he let Alameda die and not played around with anything other than his personal funds, FTX and everything that came with it would still be around today…
Back to the point. If you already have several income streams, well done already! Next, know that you can — and should — design a different money management approach depending on the income in question.
In trading, I recommend an ultra-conservative money management approach, because it’s by far the riskiest activity you can practice from behind a computer. If you do just anything, you can lose everything in a matter of moments. Yet your goal — the goal of money management, or risk management — is precisely to let you survive as long as possible in the markets, so you can:
- learn, experiment, and become profitable
- make the most of bullish cycles: the famous bull market
If you’re a salaried worker or already have one or more streams of passive income, this is the easiest case.
At the start of every month, you set a portion aside — “no debate”!
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