Building Financial Flexibility

…or “eff you money” as it’s called by many.

The surest way to put yourself in the penalty box in your career is to not get control of your personal finances. Asked to do something you find unseemly, it’s a lot easier to say no if your car or mortgage payment isn’t riding on the next paycheck.

I define my personal goal as “financial flexibility” because for most of us “independence” isn’t realistic. Independence implies “I don’t need to work anymore”. For those of you who can get there, good for you. For the rest of us I’ll focus on building a cushion that allows you to make the choices you want to without having to compromise your principles or your soul.

Why does financial flexibility matter?

1 – Because life is messy.

Think of it as insuring options. If you have a substantial nest egg (relative to your age and needs) then you can leave jobs, handle unexpected expenses and generally survive the lean times w/o losing everything. It also gives you choices.

Last Fall, a group of senior executives told my students numerous stories of friends and peers in their 40s and 50s who had lost everything during the downturn. They were making >$250K per year on average, but spending more by borrowing.

I’m struck by how many people build themselves gilded cages. Nobody “needs” expensive cars, 5000 sq ft homes etc.  If you ramp your cost basis at the same rate you ramp your revenue (or worse even faster), you will remain a slave to the dollar. All your choices will be constrained by “but I have to make at least $XX”. That is not a happy place at 50 (or 25 for that matter).

2 – Because if things go well, it makes life much nicer in the long run.

I think of an old investment firm commercial that features a family saving diligently for college over the years. One day their daughter comes home and announces her full scholarship to college. Cut to them on a yacht name “College Fund”.

If you save for a rainy day and it never rains, then that money essentially falls from the sky for you. But if it does rain, you’re prepared.

So what should I be doing?

 1 – Save. A lot.

I like the concept of “pay yourself first” that many personal finance commentators advocate. Take whatever free money is available to you through and employer match in 401K or similar program. You’re an idiot if you don’t. It’s free!

Then set up automated withdrawals to an investment account you establish at a credible financial services firm. I don’t care about what you invest in as long as you are setting aside real money. Index it, whatever. It’s more important to maintain a high savings rate than to max out your return in any year (particularly in this economy).

Why? Two reasons I can think of. First, research suggests savings rate is really important, especially with dollar cost averaging over time. Second (and less obvious) is if you have a high savings rate, you are “squeezing the lemon”. As long as you aren’t taking on debt, you can’t be spending too much and building up a high cost basis in your life if you are really saving.

You can create multiple accounts for different goals/targets. Retirement is an obvious one, but you should have one for things like “car” or other bigger ticket items that can’t just be funded out of monthly cash flow (at least not mine).

1a. Save inexpensively. Don’t get fleeced by an adviser or broker who gets paid on your trades or on what product you buy. They are working for their interests, not yours. It’s a simple incentives problem. If I only get paid for selling you American funds at >1% expense ratio (which helps fund my commission), I’m a lot less likely to advocate indexing at .1% expense ratio.

2 – Don’t take on stupid debt.

I love when it gets called “leverage”. I think that makes it sound cooler and more sophisticated. Sounds way more thoughtful than “buying stuff you can’t afford”.

I have a former student who had a nice 3 year old (paid for) sports car who was contemplating buying a new cooler sports car when he graduated. I wasn’t very polite when I commented on his plans. He didn’t buy the car. He’s currently happy he didn’t.

We all need to relearn delayed gratification and to not fall into the consumerist trap. It will gunk up your career and your life.

Try this for a month. Only pay cash for stuff. If you don’t have cash (or savings to cover), you can’t buy it. Then note what you did/didn’t buy.

At a minimum, even if you aren’t saving; please, please, please avoid debt.

3 – Be careful, even with “Good debt”

Loans for school are often considered responsible and can pay off (my MBA loans certainly did), but be deliberate in deciding even to take these on. Ask yourself about what it will take to cover. $100K in loans may be justified for law, medical or MBA degrees with high earning potential, but you’ll never get out from under it if you are considering many less lucrative paths.

Do the math.

4 – Have good insurance.

I don’t see this talked about much, but a health problem, car accident or other dramatic event can kill you if you don’t have coverage. I’m a big believer in covering these risks.

I have health insurance through work (which makes me fortunate), home and car insurance (which is common), but have also taken out substantial term life insurance (so the family isn’t permanently crushed financially if the sole breadwinner goes down) and an “umbrella policy” that I think of as our “we couldn’t think of it, but something weird might come up” policy.

Your needs will change based on your life stage and situation, but think it through and have appropriate protection in place.

5 – Set targets and track progress.

If you are starting out or are in decent shape, you should be saving at least 20%. More is better. I frequently see advice like 10%. I don’t see how 10% gets you where you need to be. Unless you’re starting with some family money or a lump sum of some sort you will take a long time to build up the assets to purchase a home, fund college for children etc.

Check your progress and develop a financial plan that works for you. I am not a super market aficionado, so have more of an indexing approach that doesn’t require daily monitoring. But if you’re into it, that’s great. Just don’t get too caught up in fads and kill yourself on trading too much.

In closing…

I’m a cynical Gen X-er who doubts the likelihood of my ever seeing a social security check in the amount currently promised. Most of us won’t have a pension or other reliable income. So you need to save, save, save to have flexibility as you move through your career. Control your own destiny to the extent that you can.

Please do.

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