Recently Anitha and I were talking about whether someone we knew was “good with money” and we disagreed. We were momentarily confused until we realized our definitions of that phrase were different.
When I said “good with money,” I meant behaviorally. For example, we know a couple who are a perfect example of the point I’m trying to make. For several years when they were young, the wife stayed home with their first child while the husband worked a blue-collar job that was seasonal. Since he was going to be laid off for four months every year, they saved half his pay during the months when he was working steadily. (If you are doing the math and thinking that doesn’t work out – to levelize spending they should save a third of the income – you are correct, but that is what they did.) Then, during the four months of no income (aside from odd jobs), they still never touched the savings. In other words, they had enough left over from the “spending” half to make it through the four months of little or no income without touching the half they had put away for that purpose!
Conversely, when Anitha used the phrase, “good with money,” she meant technically. In other words, does someone have the knowledge to invest the funds wisely in a well-diversified, low-cost portfolio, take advantage of tax-advantaged retirement vehicles such as IRAs and 401(k) plans, etc. And the folks in the example above left their savings in a bank savings account for decades – imagine if it had been invested! They were not “good with money” in a technical sense.
But of course those folks are doing just fine in retirement because of their frugal lifestyle.
Conversely, if someone possessed all the technical knowledge to optimize their financial planning, but they stayed perpetually in debt and never saved, their retirement would probably be a disaster.
So, there are two versions of “good with money”:
- Behavioral – which is mostly the ability to delay gratification (i.e. have income exceed outgo by a reasonable amount).
- Technical – efficient portfolio construction, optimal tax strategies, etc.
In other words, simply increasing savings is clearly a more effective road to financial success than conducting an in-depth analysis of the investment choices offered in a 401(k) plan while not contributing. Far too many people focus on improving their finances by the second definition without realizing the first is usually much more important to their financial future.
It sounds trite, but not spending is a prerequisite to wise investing.