You could say that personal finance is a scientific art. On the one hand, it is about money and math. On the other, it’s about values, goals, and self-control. It’s easy to say that the key to financial security is to spend less than you make. Surely, subtracting a smaller spending number from your larger income number will result in a remainder which can be saved or invested. But that is not so simple. The components that make up those income and spending numbers are varied and based a lot on personal choices or available opportunities. Hence, personal finance is a mix of hard facts and figures and the creative mix of choices we all make with those numbers.
Let’s take a closer look at some of these components:
The Art
Job choice– The career you choose broadly defines your income and usually tops out at a maximum income ability based on experience, education, and opportunity. Everyone has a different pairing of these three. For example, while someone may have the education and experience, they lack the opportunity to work in their selected industry due to a lack of available employment in their location or it is a very small field. Also, we may make choices not to pursue our passion because the industry lacks opportunity or enough pay (ie. the stereotypical starving artist), so we choose another industry purely for the economic potential. And our earnings are often capped by our education, experience, and comparable salaries in our locality.
Location– Speaking of locality, it makes a huge difference to your overall financial viability. You may make $80,000 a year in a job in Baton Rouge, Louisiana which could give you the ability to comfortably afford a single family home and cover your expenses comfortably. But take that same salary to San Diego, California and you will struggle to afford a comparable lifestyle. Even if you do the same work for the same pay, where you live can make the difference between whether you can sink or swim.
Marriage– Who you choose to marry can have major financial implications as well. Perhaps you marry someone who makes the same or higher salary than you do. Perhaps they make no salary and you financially support them. Your spouse’s money values also contribute to your family’s financial solvency. If they are a spendthrift you will have much higher outflow of funds than if they are a pinch penny.
Family size– The size of the family you financially support is a major cost contributor. If you have no children and two working spouses, you can have a high amount of discretionary spending. But if you have several children and only one working parent then your discretionary spending will be lower as you have higher overhead with a larger home and larger expenses for the care, feeding, and education of your family members. The same principle rings true in multi-generational households. If you are caring for an adult family member or parent that also increases your spending costs.
Goal Setting– Your financial goals will determine how you use your income. If you choose stringent retirement savings goals, your budget belt may be tightened now but you will likely be able to retire with comfort earlier due to your increased savings rate. Alternatively, perhaps your goals are to travel as much as possible and hence your discretionary income is jettisoned to pay for airplane tickets and hotel stays. Your short term and long term goals will inform your current spending and you can artfully tweak each category based on your needs.
The Science
Bank accounts– Compound interest is your friend and your investment and retirement accounts will grow at calculated, measurable rates. This is the science, the mathematical formula part of personal finance. If you have a target amount you are looking to have saved by the time you retire, you can calculate exactly how much money you need to invest at certain interest rates over a specific number of years. There’s an art to calculate how much you think you will need at retirement, but getting there is simple math.
Insurance– Insurance is another mathematical advantage you can claim over your finances. You can calculate exactly how much coverage you will need and secure it at a reasonable rate. Purchasing life insurance can financially protect your family in the event of your demise and that insurance payout should be enough to pay off your debts and home, cover lost wages, and fund access to childcare to assist your surviving spouse. You can calculate how much those amounts will add up to and secure a term policy for that amount. Health insurance and disability insurance are other forms of financial protection for you and your family, transferring the risk of catastrophic injury and illness bills to the insurance company while you are only responsible for the monthly premium, copays, and coinsurance amounts.
Wills– Drawing up a will need not be a complicated and emotional process. Simply put, it can be broken down into a mathematical process wherein your assets are divided among your surviving loved ones. Determining a plan to divide those assets, form a trust for minor children, and set terms for care of those children for most people can be drawn up simply and easily by an attorney. Most families do not have an extremely complicated financial situation and the process is usually not burdensome or expensive.
Building a portfolio- Diversification is the name of the game. Buy low, sell high, and hold a good investment for the long term, preferably while earning dividends. The rules for investing are fairly straightforward and though selecting which stocks and mutual funds you will choose may be artful, you can outsource that creative discipline to a skilled financial advisor. Building a diverse and strong portfolio can protect your investment in the event of a downturn in any market, so as to not sink you wholly if you get some water into your boat.
Financial success is the intertwining of the art and science of financial planning. Personal finance is not just about math, it’s about wants, needs, goals, habits, and all those other factors that are difficult to quantify. Mixed together into a scientific art, your personal financial goals can be met by following a plan to take advantage of interest and diversification while following your budget and giving you some of the things you want and covering your needs.
