In recent weeks, I’ve discussed the election and cautioned against timing the market. But if market timing isn’t recommended, then what is?
Last week, I suggested one answer: that you review your finances through the lenses of leverage, liquidity and cash flow. This week I’d like to share another framework—and this is one you could employ at any time, not just in times of worry. Financial educator Brian Portnoy (not to be confused with day trader David Portnoy) offers this perspective: In the world of finance, he says, most of the discussion focuses on investments. And while investments are important, that is just one of the seven dimensions of money that he sees as equally important. The other six are:
I like this approach, but it isn’t necessarily easy. It requires each individual, or family, to find a balance among these seven considerations. How should you tackle this? I would start with the three areas that involve outflows—spending, saving and giving—since there is normally a trade-off among them. The other areas are also important, but topics for another day.
1. Saving: I would start with the topic of saving because, for many people, saving is just a byproduct and not budgeted in advance. In many households, if not most, money is saved only after taxes are subtracted and the bills are paid. Ideally, though, you would budget for savings up front. If you have a 401(k) or other retirement plan, this is much easier because those plans make saving automatic. But if your employer doesn’t provide a plan or you want to save more than your plan allows, how should you work out a savings budget? I would start by asking three questions:
- How much do I need to save?
- How much can I save?
- How much do I want to save?
The answer to the first question is largely mathematical. If you can quantify your future goals, then you can estimate, within a range, how much you’ll need to put away each year. The second question is even more mathematical: Given your income and expenses, how much would you be able to save? The third question, on the other hand, is entirely subjective and personal. Some people love living frugally and enjoy saving—almost as an end in itself. Others take the opposite view: Why unnecessarily deprive myself if I don’t have to?
It may take some work, but these questions can be answered, and that’s where I’d start—by deciding on a savings budget. I recognize that this may seem counter-intuitive since, as noted earlier, household savings budgets are usually just determined by what’s left over each year. And because paying the bills today is usually the priority, I also recognize that this approach may take time to implement. That’s not a problem. This framework isn’t all-or-nothing; it’s just a structure I’d move toward over time.
2. Giving: Once you’ve determined a savings budget, then I would move on to giving. Again, this may seem counter-intuitive. For most people, charitable contributions are ad hoc and not formally budgeted. In some religions, there is a requirement to tithe—often 10%. That can make life easier because it’s very specific. But if you’re not working with any specific requirement, then this may be even harder than deciding on a savings budget. Going back to the three questions above, you don’t need to give any specific amount. As a result, your charitable budget is governed only by the amount you can afford and by the amount that you want to give.
What I normally recommend for a giving budget is to start with the amount you donated last year. This can be found easily on your tax return. Then, if cash flow permits, I would contribute that entire amount, all at once, to a donor-advised fund at the beginning of each year (or perhaps in December). Donor-advised funds carry a small cost, but they make charitable giving immeasurably easier to track and to manage. On their websites, donor-advised funds will tell you at a glance how much you have put in and how much you have contributed to charities year-to-date. This makes it much easier to ensure you are hitting your charitable goals each year.
3. Spending: For all but the most disciplined people, it’s awfully hard to formulate and to stick to a household budget. I certainly acknowledge that to be the case in my house. But if you use this approach, then I have good news: You don’t actually need a budget. If you’ve already set aside the amounts you’ll need for savings and for giving, then you can, in theory, freely spend the remainder.
Many people find this liberating. The reality is that when your income is limited, you have a pretty good idea of whether you can afford a specific purchase or not. But if your income is higher and there is more latitude in your budget, it can be hard to know where to draw the line. In my work as a financial planner, people express this sentiment frequently. The question normally sounds like this: “If a Tesla costs nearly six figures, and I have the money, is it okay to buy one? How much is too much?” My answer is always the same, and it’s based on this framework: If you’ve set aside the amounts you need for the other two categories—and of course for the IRS—then the answer is yes, it’s okay.