The Ordering of Financial Goals
We often pursue our financial goals from the top down, for instance wanting a certain amount of money in retirement and then working our way back to what we need to do in order to achieve this.
While this may seem to be helpful, and certainly beats having no plan at all, it is far better to start from the bottom up, starting with what we may achieve at our point of action and then working that out to discover where that may lead us.
There may not seem to be much of a difference at all between these two approaches, but the risk of the top down approach is that it might not address the point of action enough, as well as create feelings of discouragement should our best efforts not be able to realistically achieve our goals.
When we start with an end goal, this will end up setting it based upon need, but it doesn’t really address matters of capacity. Maybe we need 2 million dollars in retirement and we’re at age 50 with nothing saved up yet. We still may need this much money, but it may not be possible for us to save that much over this period of time, and we may come away with a feeling that it is hopeless and have our sense of discouragement affect our motivation to save as much as we could had we not become so disappointed.
The important thing isn’t saving a certain amount or not, it’s saving all we reasonably can if we cannot achieve this preferred goal. If we can achieve the goal without a lot of trouble, then setting this amount can be perfectly fine, but this may also limit the amount that we will save and our needs may expand in the meantime.
We therefore may miss out on saving additional amounts that end up being needed and could have been saved up if not for us allowing this projected number to guide us completely, where the number ended up being short.
Another big issue when we do this is to stop at the act of saving itself, as in we need to save a certain amount of our income for the future. This in itself isn’t a plan, it’s just a proclamation, and the more important thing is how we are going to achieve this.
Savings isn’t really an activity, it is the result of a process, how much money is left over after our spending has run its course. Any discussions about saving will always involve ones involving spending less because that’s how savings happen.
Planning For the Future Requires That We Start with the Present
When we set our goals as needing a certain amount in the future and then needing to save a certain amount along the way, this often does not align very well with putting all of this into action. What often happens is that we tell ourselves that we cannot save as much as we have decided we need to, and people very often will tell us that they know they need to save more but just can’t manage it.
This may indeed be the case, but we’re never going to really know what we can accomplish without examining the situation properly, which needs to take us beyond the savings goal and into how we might accomplish this or why we seemingly cannot do so.
Even people of the most meager means, those on welfare for instance, can usually stand to examine all of this more, and they still may be not spending their money wisely even though they have so little.
What we really need to be looking at is how we are spending our money, and then deciding how much of this spending is justified compared to the benefits of our setting some of this aside for down the road.
While the term “pay yourself” is sometimes used to describe our saving money, in most cases we are paying ourselves when we spend our money as well, insofar as we are enjoying the fruits of our earnings. What we want to focus on instead is striving to pay ourselves the most, in the same way as we may set aside earnings for a few years while we study, with the goal of making more during our lifetimes due to the higher earning power that higher education promises.
To do this, we’re going to need a reference point, just like the higher average earnings that come with a degree guide our decisions to pursue more education. In this case, this will be more a matter of utility than sheer wealth, what we will get out of this money later, including additional amounts earned over this time from investing.
It is only when we have gone through the process of examining both the present and the future sufficiently that we can make a fair comparison between them, and this always needs to start with the present. While doing this may not be that simple of a matter, as long as we are entertaining the future as well as the present in our spending decisions, we will at least be in a good position to decide these things and a far better one than if we just use the stimulus response type of decision making that we often use, with very little or no thought behind it.
Planning Our Investments
Saving money is only one part of building wealth for the future, and what we do with these savings will matter quite a bit as well. This is far less the case if we just choose the road well- traveled, and this can even serve to make the investment side of the equation a constant, but it need not be if we are adept enough.
If we are married to the idea of investing in index funds, perhaps sprinkled with some bond positions to look to dampen down both returns and risk, then how our investments do is not going to really be within our purview, aside from the ability to alter this plan or pursue a different one, which we’ve chosen not to exercise.
This can certainly serve to simplify things, where all we really need to be concerned about is how much money we are pumping into these investments, and having the outcome of them decided purely by external factors, in this case the performance of the instruments we’ve chosen, but this may not be the best approach.
The alternative isn’t going off on our own and seeking to choose stocks that will outperform the market and hope for the best, and this is generally a terrible idea unless one is extremely skilled at such things. People will generally do themselves more harm than good with such an approach, and especially not realize the difficulty involved in doing this properly and end up learning this lesson the hard way.
The main goal of any intervention that may take us away from the standard approach to investing needs to be not to necessarily outperform the market but to better manage the risks that playing the market involve, without sacrificing performance too much like watering down our portfolio with a static hedge like long term bond positions do. Buy and hold investing doesn’t seek to manage risk at all, and this is by far the biggest issue with it, so if we can reduce this risk, that’s a worthy goal.
Making changes to our investment strategies always needs to involve planning, and significant planning at that. This is what a lot of people don’t understand when they just jump into these things and look to learn and plan as they go, as this doesn’t usually work out too well.
The problem with standard investment strategies isn’t that they aren’t planned out, it’s that the strategy is completely static. If we’re going to manage risk, we will need a much more dynamic plan, one that adjusts according to how an investment is performing and the degree of risk present.
Circumstances do change though and can change a lot, and there may be times where we don’t want to be in the investments that we’re in at all, or at least to a reduced degree, when they are performing poorly.
We do need a plan and a clear one to look to manage this though, and we should not ever just be looking to fly by the seat of our pants when it comes to making these important decisions that will influence our financial future considerably.
This will require a fair bit of effort and thinking but if we’re prepared to do this, we can learn why we may benefit from this additional planning, in addition to coming up with ideas that will better protect our savings from less desirable situations in the market while looking to improve our overall results at the same time.
There is a lot to plan for when it comes to personal financial management, and this is indeed a serious form of management and does require real effort to do right. Provided that we take this job seriously enough, we can really outdistance the pack and end up putting ourselves in a much better position in the future than would have otherwise been possible.