Getting Framed

Jonathan Clements

WE ALL HAVE LIMITED time and limited money. How can we make the most of these two scarce resources?

More than anything, the answer lies in getting the big picture right. That means thinking through the tradeoffs involved, so we don’t allocate too much time and money to some parts of our financial life, while neglecting others.

On that score, it’s hard to offer hard-and-fast rules because personal preferences play a key role. Still, here are two frameworks—one for money, the other for time—that I find useful.

Allocating money. In deciding how to divvy up our money between spending, investments, insurance and so on, the key factor is our human capital or the lack thereof. What’s human capital? That’s how economists refer to our income-earning ability.

Our human capital has four major implications for how we manage our money. First, while it’s reasonable to borrow early in our adult life to buy, say, a home or a college education, we should endeavor to pay off this debt by retirement, because—at that juncture—we’ll no longer have a paycheck to service these loans.

Second, we should take steps to ensure we’re healthy enough to collect a paycheck, and to protect ourselves and our family if we can’t. That means having health, disability and life insurance, as well as an emergency fund. Third, we should take part of each paycheck and set it aside for retirement, so we’ll be financially prepared for the day our paycheck disappears.

Finally, until we get within a decade or so of retirement, we should consider investing heavily in stocks, knowing we don’t need money from our portfolio because we have a paycheck to cover our living costs. We can view our human capital as similar to a bond—both generate regular income—which we then diversify by investing in stocks.

Here’s another way to think about the issue: Let’s say you’re age 45, you have $200,000 in stocks and nothing in conservative investments, and you save $10,000 every year. It might seem like you’re being super-aggressive, with your 100% stock portfolio. But between now and age 65, you’ll add $200,000 in new savings to your nest egg. You can view that $200,000 as cash in your portfolio. Result? Arguably, your overall investment mix is quite conservative, with 50% stocks and 50% cash, thanks to the savings you’ve yet to invest.

Your human capital dictates what you should be doing with your money. Doing all that you ought? You should feel free to use your remaining money as you wish, whether it’s vacations, dining out, helping your kids with college or whatever else you value. But what do you value? That brings us to a framework for thinking about time.

Allocating time. For some folks, managing money is an all-consuming hobby to which they happily devote endless hours. This investment of time probably won’t be well rewarded—especially if it’s spent guessing which stocks will outperform or which way markets are headed—but I assume these folks get great pleasure from trying.

What about the rest of us? If financial media coverage is any guide, 90% of our thoughts about money revolve around investing, especially the market’s daily action. This is almost certainly a gigantic waste of time. The evidence makes clear that the smart strategy is to settle on an appropriate mix of stocks, bonds and cash investments, and then implement that asset allocation using low-cost index funds. This should consume no more than an hour each year.

If we aren’t going to fret over the markets and our investments, how should we use our time? There are three aspects of our financial life where a little effort can yield far greater rewards.

First, we should look beyond our portfolio and spend time thinking about other financial issues. What size home should we buy? How can we minimize taxes? Do we have the right insurance? How can we hold down our borrowing costs? When should we claim Social Security? Do we have the right estate-planning documents? Perhaps most important, are we saving enough? These are all areas where some serious thought (or a top-notch fee-only financial advisor) can make a huge difference—and certainly do far more for our finances than worrying about the direction of stocks and interest rates.

Second, we should focus on improving our financial behavior. As with eating healthily and exercising regularly, the big struggle isn’t figuring out the right thing to do with our money. Instead, the problem is getting ourselves to do what we know is right. How can we get ourselves to stop procrastinating, so we get a will, buy term life insurance and sell those underperforming actively managed funds? How can we get ourselves to spend less, save more and stop fiddling with our portfolio? The key to a better financial future typically isn’t more knowledge, but rather a firmer grip on our meandering minds.

Third, we should spend time thinking about what we want from our life—and how money can help. Three things I focus on: Doing work I find meaningful, avoiding financial stress and spending time with those I love. This is where our thoughts about allocating money and allocating time come together.

There are certain things we ought to do with our money—and that’s driven by our human capital. There are certain things we ought to do with our time—both in terms of managing money and, of course, in terms of earning the stuff. Fulfilled those obligations? What’s left is discretionary. Fingers crossed, if we think hard about what we want from our discretionary time and money, we’ll be a little wiser in how we spend those two precious resources.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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