Financial Planning: Why You Just Can’t Focus On Investing Alone

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Consistent investment results are critical for your long term financial health. However, no matter how strong your returns, there’s another critical part of the equation that may not get as much attention as it should: that’s your spending.

Because the fact is that even if you do get consistent returns and avoid big losses, you won’t make any financial headway if continue to increase your spending as your income and gains rise.

We’ve all seen this, or maybe we’ve done it ourselves:  we start doing well, so we reward ourselves:

  • Bigger car
  • Bigger house
  • Second or third home

The old adage tells it all… “it’s not what you make, it’s what you keep”.

Living At or Above Your Means

If you continue to increase your spending as your income rises, you’re not getting farther ahead.  And if there’s any type of downturn or setback, you’ll actually be in worse shape.  Overspending makes you less agile and less able to weather the unexpected.  So along with paying attention to your investment strategy, make sure your financial advisor or financial planner also spends time helping you analyze and improve your spending.

Think of it like weight control. No matter how much you work out, if you consistently overeat, there’s no way to outrun a bad diet. And with money, your ongoing spending habits are more important than your investing returns. If you spend too much, you can’t always “out-earn” those over-the-top expenses.

Think of it this way:

If your measure of how much you should eat is based on how loosely your pants fit, and you change into larger pants, you may have more wiggle room for a little while, but soon your waist will likely expand to fit your new clothes.

It’s the same thing with your budget. If $200,000 a year feels tight for your family, and a promotion at works bumps you to $300,000, the good times may roll for a little while, but soon you’ll feel just as squeezed at $300k as you did at $200k.

How does this happen?

It’s simple math: More money means more ability to spend. So when you find yourself with an unexpected windfall, or a promotion that comes with a handsome raise, your first instinct is to think about all the things you can afford now that you couldn’t before. A new kitchen? A vacation home? That sports car you’ve always wanted? Sure…you deserve it!

But eventually, the upgraded lifestyle will lose its novelty, and reverting to your earlier spending habits would feel like too much of a sacrifice.

Even worse, more “stuff” can take away your freedom.  While that second home in the mountains sounded great in year one, your family is now a bit bored going there.  But now you basically have to go there, since you’ve got to check in on the property.  And you’re paying property taxes, insurance and maintenance every month so it needs to get use. And that third car…now you’ve got one other car to insure, keep tires on and keep the oil changed.

The solution?

When times are good and money is coming in, think before you spend.  Sure, reward yourself, but do it in a way that is a small one-time thing, that doesn’t then become an ongoing drain.  Is there a smaller luxury that will feel like a reward?  Then, take the remainder and sock it away.  If the money disappears before you even see it in your checking account, you probably won’t even miss it. And it will be doing more for you if you invest it in retirement accounts or other tax-advantaged vehicles – growing, compounding, reinvesting, all with tax advantages – than it would if you were to absorb it into your monthly spending habits.

Be careful, though: The more you invest, the quicker investment fees and commissions can add up. Always keep your eye on fees and costs.  If you’re working with a fee only financial advisor, make sure he or she is one that chooses the lowest cost investment options.  And always make sure you’re working with a fiduciary whose job is to put your financial needs first.

You can’t control every turn of the stock market, but if you can control your own impulses to buy more by making sure that new money stays out of sight, you’ll thank yourself later when your financial future is secure.