Focusing on what you can control is one of the best ways to manage your money. Investors often fail to recognize the aspects of their financial situation that are within their control. For example, if asked why you don’t have more extra cash leftover each year, what would you say? Many individuals might say they’re underpaid without considering their spending habits.
It’s true: there’s a lot we cannot control in our financial lives. But you can manage your money better by reducing the impact uncontrollable events have on your bottom line. This helps put you back in control over stewarding your own financial future.
To clarify: this is not to say that an individual’s financial circumstances are solely a result of overspending or some fault of their own. Particularly for low-wage workers, a full-time job (or sometimes jobs) doesn’t always pay enough to meet basic human needs. This is more of a societal issue and outside the scope of this article.
The best way to manage your money is to focus on what you can control
There are so many things we can’t really control when it comes to our finances:
- How the market performs
- Changes in tax law
- Changes to the retirement system
- Reduction of benefits offered at work
- Future of entitlement programs like Social Security
- Costs of healthcare
- Job security
- Regulations or innovations impacting the future of certain industries and professions
The list goes on. But before these uncontrollable and unknowable situations make you feel powerless, consider what steps you can take when managing your money to minimize the impact it may have on your financial situation and goals. In another words, make it not matter as much.
You can’t control the market, but you can change how you’re invested
Having the right investment mix is critical to benefit from good times in the markets and help protect your assets during downturns. While you can’t control the ups and downs in the financial markets, you can control how you invest in it. Diversification helps to limit the impact on your portfolio but swings in the financial markets are an uncomfortable (and inevitable) part of being a long-term investor.
Many investors choose to work with a financial advisor instead of trying to manage their money alone. As a DIY investor, you’ll need to decide what percentage of your portfolio to allocate across asset classes, like equity and fixed income. This is a key step towards reducing your exposure to market moves. Investing carries risks, but inherent market risk is not the same as diversifiable risk. Diversifying within asset classes and across geographic regions and investing styles can help by adding negative correlation.
During challenging times in the global financial markets, diversification can help protect investors against significant negative implications for their portfolio, but it’s important to realize that there isn’t always somewhere to hide when the market is down.
Avoiding extreme concentrations in single stocks is another important and often controllable factor. Employees with stock options or awards may have 50% or more of their investable assets in company stock, even though they’re able to sell. If the stock price sinks, you suffer equally and depending on the situation, your job may also be at risk. It’s a one-two punch. Converting paper profits into real gains is a key part of taking control over your finances.
Promote financial flexibility and independence by managing expenses
The easiest way to save money is to spend less of it. Investors often think income is the key to a high savings rate, but thanks to lifestyle inflation, many end up worse off as their top line improves. Maintaining pre-retirement expenses in retirement gets harder as your spending increases, as you’ll need to save more before retirement to afford it. But large outflows to support your lifestyle while you’re working means there’s less left to save.
Here’s a simple example:
One household earns $150,000 and saves $45,000 per year. Another household earns $250,000 per year and saves $60,000. Even though the first household earns $100,000 less, all else equal, they’re going to be in a better financial position because of a higher savings rate (30% vs 24%) relative to the second family.
Aside from taxes, we all make choices about how to spend our money. Homes, vacations, private schools, cars, restaurants…all controllable, voluntary costs. And if you’re managing your spending, it’s much easier to adapt to changes that you cannot control.
For example, if you’re relying on Social Security for a big part of your income in retirement, it’s a risk. But if this income isn’t an essential part of your strategy or you plan to mostly self-fund your needs, you’ll be in a better position to overcome external factors and gain financial independence.
Savings = flexibility
The value of a high savings rate cannot be overstated. Like the financial markets, life doesn’t usually move in a linear fashion. There will always be setbacks, unexpected hurdles. So if you’re only saving the bare minimum across your investment and cash accounts, or haven’t invested outside of your 401(k), you may in a bad spot when things don’t go according to plan.
Examples of how a high savings rate and manageable expenses can help you navigate a challenging situation
- A study from the Urban Institute found over half of full-time workers over 50 experienced involuntary job separation, leading to prolonged unemployment or a pay cut of 50% or more for at least two years. If unemployment benefits don’t cover your expenses, you’ll want to cut costs and still may need to dip into savings. Cutting back is easier without large fixed costs, and an emergency fund can help bridge the gap.
- If you are approached with an early retirement buyout package, the income you need to meet your expenses is key to determining what’s possible. With above average expenses, it might not be feasible to pay for the unexpected costs of medical insurance before Medicare without trying to find a new job or taking your chances by turning down the offer.
- Fixed costs force retirees to keep drawing from their accounts, even in down markets. When your retirement savings peak and you stop contributing, you’re most vulnerable. Typically, spending it also the highest in the years around retirement. One of the best ways to avoid running out of money in retirement is not overspending, especially in the beginning.
Focus on the intersection of what’s important and what you can control
You don’t have an endless amount of time to devote to managing your personal finances. To manage your money better, don’t fixate on things that aren’t important or you can’t control. For example, if you’re looking at your monthly bills and want to cut back, the $30 you spent on coffee doesn’t really seem important relative to $150 in streaming services and a $900 car payment.
Similarly, the potential for tax rates to increase is a source of stress for many taxpayers. Though a valid concern, worrying about it won’t help. Making financial decisions purely for tax reasons isn’t advisable either. Until a bill becomes law, it’s just noise. The good news is no one is forcing you to listen.
This article was written by Darrow advisor Kristin McKenna, CFP® and originally appeared on Forbes.