Good financial planning is about exercising control over income, expenses and investments over time to achieve what you desire in life. Exercising control over those three areas pays off when you focus your efforts pulling levers that have an impact. While people seem to understand what the levers are that both matter and are under their control when it comes to income and expenses, they too often ignore or fail to understand what matters and what is controllable when it comes to investments. This failure too often leads to poor investment choices, risking all the hard work done in the other two areas.
When it comes to income, you can choose your career path, choose how hard you work, choose how much time you dedicate to work. While sometimes it may feel like you have no control at least you know what levers you can pull if you want to make changes. You can get a new job, relocate, try to get a promotion, etc. In the long run, almost everything can change if you really want it to.
When it comes to controlling expenses, it’s the same. While you may not be able to change some of your fixed expenses in the short term and some people just have a higher cost base than others due to where they live, the size of their family or personal spending preferences, again, at least you know what levers you can pull within reason to makes changes to your situation. In the long run, almost all costs are variable.
When it comes to investing, however, people aren’t as aware and easily led astray. Fortunately there are only two things that both matter and are in your control. Those two things are 1) how much risk you take, 2) how much cost or fees you incur.
But what about picking the right stocks? What about picking the fund manager that outperforms? While those things clearly matter with hindsight, they are very difficult to control for in advance and certainly not worth paying for. Overwhelming evidence suggests the only determinants of future investment returns are risk and cost. And by risk we mean the relative weighting of broad asset classes (eg. stocks versus bonds), not which individual stock bets or market timing calls you make.
To serve your best interest, choose a mix of well diversified low cost investment funds that is suitable for your risk tolerance and financial situation. Other risks are costly and the evidence shows you won’t be rewarded for taking them. You will of course encounter those offering advice on how to beat the market or generate higher returns with less risk. Fortunately it is also within your control to ignore bad advice.
What does it mean for good financial planning? It means focus on what you can control and what matters. If your life goals and desires mean you need more than you can achieve with your current income, expenses and investments, focus your time and energy on spending less or earning more. Don’t be swayed by charlatans who say they can solve your problems with superior investment returns.
On the other hand, if you can already deliver what is important to you and what you desire with your existing income, expenses and a sensible and disciplined investment plan, congratulations, you’re on track – just don’t get greedy and risk what you have for what you don’t need to make you happy.
If you’re not sure which group you fall into, it’s worth doing the work to find out.