WHAT DOES IT TAKE to manage money prudently? Yes, we should save diligently, favor stocks, diversify broadly, hold down investment costs, buy the right insurance and so on. But all these smart financial moves stem from key assumptions we make about our lives and the world around us.
What assumptions? I believe prudent money management starts with five core notions—which, as you’ll discover below, sometimes contradict one another:
1. We’ll live a long life. For our hunter-gatherer ancestors, life was nasty, brutish and short. Many folks continue to behave as though that’s still the case. They spend too much today and save too little for tomorrow. They impulsively borrow money, only to struggle with the resulting debt payments. They claim Social Security early and eschew immediate annuities that pay lifetime income.
But if we’re to manage money prudently, we need to keep our gaze firmly fixed on the future, including the very distant future. That means assuming we’ll make it to retirement and saving accordingly, and then—once we reach retirement—plan on living into our 90s and perhaps beyond.
This might sound like a prescription for constantly deferred gratification. But in truth, focusing on the distant future from the time we enter the workforce is not only a recipe for a plump nest egg that’ll make for a more comfortable retirement, but it’ll likely also mean far less financial stress than that suffered by those who focus solely on today and end up living paycheck to paycheck.
2. Death could come at any time. Even as we manage our money as though we’ll one day be age 95 or 100, we should also behave as though the next bus has our name on it.
For those who have young children and a spouse who depend on them financially, that means getting enough life insurance, preferably low-cost term insurance. It also means keeping our financial affairs reasonably well organized and ensuring we’ve done at least the estate-planning basics, including getting a will and making sure we have the right beneficiaries listed on retirement accounts and life insurance.
3. Good things will happen to the economy. This year, folks are fretting about inflation, lofty stock market valuations and rampant speculation among fringe investments, including meme stocks, cryptocurrencies and special purpose acquisition companies. But the fact is, every year there are reasons not to own stocks—and those who get spooked often end up missing out on the market’s astonishing long-run gains.
My advice: Bet on humanity’s unquenchable desire for progress. Every day, billions of people wake up, trying to figure out how to make their life better. That restlessness drives economic growth—and those who own broadly diversified stock portfolios stand to benefit.
4. Bad things will happen to us. While we should be optimists about the economy and the stock market, we should be pessimistic about our own prospects. This is the reason to rig up a robust safety net, one that includes an emergency fund and all necessary insurance. We should protect our assets with home, renter’s, auto and umbrella liability insurance, and protect ourselves and our family with health, life, disability and long-term-care insurance.
Fingers crossed, all this will prove unnecessary. If we reach Dec. 31 with our emergency fund untapped and no insurance claims, that’s a sign we’ve had a good year. Because the hope is that these precautions will prove unnecessary, we should keep them to a minimum. We shouldn’t sit on too much cash and we should only purchase the insurance coverage we really need. And for the policies we do need, we should figure out how to hold down the cost by opting for higher deductibles and longer elimination periods.
5. We’re terrible at forecasting. It’s all but impossible to predict the direction of interest rates and the stock market, and it’s extraordinarily difficult to pick market-beating stocks and funds. This is why we should settle on an asset allocation—our basic mix of stocks, bonds and other assets—and then build our desired portfolio using index funds.
Our ineptitude at forecasting extends beyond the financial markets. We expect tomorrow to look like today—and yet our lives are thrown into turmoil with surprising frequency. Think about all those disruptive life events: We move homes, change jobs, have children, crash the car, get divorced, face a medical emergency, and need to help our adult children or elderly parents.
We also believe we can forecast what will make us happy, and yet many of our choices leave us dissatisfied and hankering for something else. Want to make smarter spending and investment choices? We shouldn’t be so confident we know what the future will bring or what we truly want—and, as a result, we should be leery of making bold decisions.