Understanding personal finance requires more than a regular checking of balances and a paying of bills. It requires:
- Conscientious recognition of all inputs and outputs of your personal financial system
- Analytical recognition of the internal and external factors that contribute to changes in your personal finance system
- Deliberate manipulation of the controllable factors when your short and long-term financial strategies dictate necessary change(s)
- Careful planning for and reaction to the uncontrollable factors in order to mitigate risks to your system and strategy
Personal finance can be depicted as a system because, well, it’s a system. There are inputs and outputs to your system. You make and you spend. You gain and you lose. There are internal and external factors that can change its overall state. Markets fluctuate. Rates change. Job success merits a wage increase. A loss of a job diminishes income. A health problem or car accident can lead to unintended expenses. The state of your system is directly affected by the collective impact of both controllable and uncontrollable factors.
Fortunately, this system is quantifiable and is readily measured. Through various ways and means, you can determine the state of your system at any present moment. For the oh-so-organized, you can determine the state of your system at any moment in the past. And for the oh-so-very enabled (I think you know where I’m going with this), you can peer into the state of your system for any multitude of moments in the future.
With this notion, there should be an overall strategy to your system – a place where you want to be financially and how you aim to get there. Your aim will be based on the financial knowledge you have built over time, with regards to the controllable and uncontrollable factors contributing to your system. And to your benefit, your knowledge will only increase over time, making your strategy more targeted and the desired future state that much more accurate and achievable.
So you recognize that there’s more to understanding your finances than the ATM and your wallet. Where should you start? Perhaps with what I call “reasonable economic fasting”.
What is your financial baseline? In other words, how can you determine the bottom line steady state of your system? Without needless purchases and expenditures, how much do you have, how much comes in, and how much goes out? Spend as little as possible, and organize your bottom line financial system.
For a specified period of time (a week, two weeks, one month, etc), don’t make those needless purchases. Do carry on with your basic grocery, health care, and sufficient living expenses. But don’t get those Don Mattingly rookie cards off eBay (although I would call them a basic need), trade a book with someone rather than buy a new one, and cook your own steak and potatoes rather than dish out $35 for a nice plating. Find your financial baseline, and I guarantee you’ll gain some new knowledge with regards to your personal finance system:
- The Value of Money – How much is a dollar worth to you? How much is a dollar worth to you compared to yesterday?
- The Value of Saving – How much is a dollar saved worth to you? Given your baseline, what is your maximum savable amount per pay period (the least hopefully not being less than $0.00)? A dollar can go a long way if it goes away for a long time.
- The Value of Spending – How much is a dollar spent worth to you? Do all your baseline expenses amount to what you pay for them?
- Controllable & Uncontrollable Factors – At your financial baseline, you should be able to determine which fluctuations in your bottom line are a result of uncontrollable factors versus controllable ones. Which expenses sustain your desired lifestyle, and which are a result of it?
In the end, it comes down to simple recognition and organization. Take the time to understand what goes in and comes out of your personal finance system, and try to analyze the impact of key controllable and uncontrollable factors affecting that system. If needed, find your financial baseline as a starting spot, and use some intuitive planning to craft your strategy. After all, thought planning is free.