I don’t think any words make me cringe more than, “It’s not my fault.”
As parents, we have heard that sentence uttered far more than we wish, although the kids will often re-evaluate later and determine what their role may have been in what happened. As a financial planner, I know the feelings of helplessness that clients acknowledge they have when they don’t have a sense of control over their situations.
Yet if all of us want to end up in a place where we are comfortable making money decisions, then we need to understand where we have control and where we don’t. For example, we don’t have any control over how stock markets behave, but we have full authority over our investment and saving decisions. While economic conditions may have changed the nature of our employment, where and how we want to live still falls under our domain. One of the most important things to realize is that it is the things that we can control that will have the biggest impact on our financial lives, not those that we can’t.
In his book, “The Thin Green Line,” New York Times columnist Paul Sullivan writes “[We should] focus less on the most overused measure of investing success — returns — and more on all the other areas that determine if an investing strategy will actually succeed.” This is not to say that returns don’t matter, it simply means that looking at returns is always a backward exercise. They describe what occurred, but may not help with what is happening next. For example, the Bloomberg Business headline on Oct. 31, 2011 was, “Bonds Beat Stocks Over 30 Years for First Time Since 1861.” I handled a number of phone calls from clients who were wondering why stocks should be a part of their portfolio when bonds had done so well. Letting them know that because bonds had done so well increased the prospective relative returns from stocks, seemed out of touch. It wasn’t. Discussions today are why we should own international stocks when the US markets have been so strong. Same song, different words.
The challenge is that if you expect your returns to constantly be market-beating, this will likely result in a market beating. You would be taking on far more risk than is probably prudent. Using Sullivan’s thinking, your focus on investing should involve how you can best put yourself in a position to have the money that you want to spend when you want to spend it. This involves lowering risk through diversification. It also involves controlling your own emotional relationship with your investments. Every time you check your investments, you will have a reaction — positive if they are up, negative if down. The best way to manage your emotions is to develop a sound investment strategy in which you have confidence, and monitor it on a quarterly basis.
Investing isn’t the only area where controlling our emotions can have an important impact on sound financial decisionmaking. “People find it easier to make financial decisions if they put money into fictitious buckets designated for particular expenses,” writes Sullivan. This works for a number of different areas. For example, if you want to save for college costs but don’t feel fully comfortable moving money out of your control into a 529 plan, create a new brokerage account in your name labeled college funding. You can mentally account for this as a college fund and save regularly into it, but it would still be yours if something happened to your financial situation. While you forgo some of the great tax benefits that 529 plans offer, the money stays in your name and control.
This bucket approach works particularly well with cash management. Setting aside your money into various categories each month, including infrequently spent areas like vacations, will give you more control over your spending. If you stick to only spending what is in your bucket, you will find yourself making far more intentional money decisions — the best way to ensure that your money and values are aligned. Check your investments less and your spending more!
Even with investing, buckets may help. Most investors have a combination of stocks, bonds and cash. If you look at your bonds and cash as your safe bucket, then you may be willing to move more to the more volatile stock bucket that should give you higher returns over time.
Staying above Sullivan’s thin green line involves managing today’s needs with the future. He views this as managing consumption vs. bequests. Every dollar that we spend today is one that won’t be available to be spent tomorrow. Strike a balance between living for the known today and preparing for the uncertain future. Taking control over your money choices makes this possible. If you are overspending, it won’t work to go on an austerity budget. Sullivan describes “management, not banishment.”
Rather than eliminating categories, be realistic in how you allocate your resources to them. Save for tomorrow in sensible ways that are automatic — maximizing your 401(k) plan and paying down debt more aggressively. When you are looking at making large spending decisions, consider ongoing costs rather than simply front-end costs — houses have annual taxes, furnishings and maintenance that get overlooked when considering their purchase.
Yes, some things that happen with your money are not your fault. But by preparing for those things that you can control, when those unexpected events occur, you will be ready for them.
Ross Levin is the founding principal of Accredited Investors Inc. in Edina. His e-mail address is firstname.lastname@example.org.