Throughout my career, I’ve seen that an overabundance of personal finance instruction is available from a litany of sources. Some of the sources are credible, but they are often conflicted. The result is that many if not most, financial recommendations clamoring for your attention are likely solving the wrong problem.
“The problem with solving the wrong problem is that it feels like success until you get to the bottom,” writes Greg McKeown, author of the outstanding book, Essentialism, and one of just a handful of weekly newsletters to which I subscribe.
McKeown makes the business case against solving the wrong problem through the example of Kodak—the company that went bankrupt doubling down on printed photos when the digital sharing revolution was emerging. They were too focused on solving the wrong problem to identify and solve the real problem.
That made me wonder, what are the wrong problems people attempt to solve in the realm of personal finance?
Considering the vast scope of our subject, I’ll refine our focus by looking through a four-fold lens. There are ultimately only four ways that we can employ money:
We can spend it to live a lifestyle of our design; we can use it to protect that lifestyle, our family, and our property; we can save and invest it to grow, to recreate an income stream in the future, for us and our heirs; or we can give it to the people and causes most important to us.
Let’s look at each of these four receptacles for our money and the wrong problems that we may be trying to solve:
GROW
We start with this category because it’s where some of the most prospective solutions in search of the “problem“ are found. We’re awash in investments. At roughly 132,000, there are more than twice as many mutual funds, as there are stocks in the world, for starters. And that doesn’t include thousands upon thousands more derivatives, deposit products, annuities, crypto (and actual) currencies, and so on. And on.
The wrong problem that many investment product pitchers want to solve is that you need to find a better investment product or service to meet your financial growth goals. “The next great investment is the answer!” they insist. But too many spend too much time searching for the perfect investment when the real problem might be found in your budget, not your balance sheet.
Yes, I am an advocate for wise portfolio construction and sticking with the plan once you have one. Still, the real problem facing most portfolio shortfalls isn’t an investment problem, but a saving problem. Yes, some investment vehicles are better than others, but you are most likely to reach your long-term goals primarily through a dedicated approach to saving.
If you plan to work for 45 to 50 years and are one of the few who manage to live a linear life, you may find the grandfatherly wisdom of saving 10% per year sufficient to replicate your income in retirement. But research suggests that “the linear life is dead,” especially if you hope to enjoy an “early retirement,” when you’ll likely need to save 15 – 20% or more to sustain an extended retirement financially.
PROTECT
Within the realm of personal finance, the word “protect” is generally considered synonymous with insurance of various kinds. And while it’s typically true that insurance can play a vital role in protecting our families, lifestyles, and property, the fixation on insurance can be part of the problem.
The wrong problem to solve here is to connect the dots between every possible risk and the apparently corresponding insurance policy or product. This is because insurance is only one of at least four risk management techniques:
1. Risk Assumption: The first technique of a risk manager is one we likely use most often, whether we know it or not. For example, every time we get in a car, we assume the risk of an automobile accident. From a financial perspective, the fancy phrase we use is “self-insuring,” a technique we use when we keep cash on hand as emergency reserves or choose to increase our deductible on an insurance policy. This is the first line of protection and risk management in financial planning.
2. Risk Elimination: Of course, however inconvenient, we can eliminate the risk of that automobile accident entirely if we simply don’t drive. But this method is not as preferable as…
3. Risk Reduction: Wear a seatbelt, drive the speed limit, don’t drive late at night, upgrade the safety features in your car… you get the idea.
4. Risk Transfer: It’s not until after we’ve assumed, eliminated, and reduced outstanding risks that we finally arrive at the point of transferring risk through insurance.
The real problem in an optimal protection strategy is in determining those risks that can be reasonably managed by methods one through three and focusing the utilization of insurance on those catastrophic risks that we can’t (or would prefer not to) otherwise manage—like a hefty term life insurance policy during your working years to replace your income in the case of an untimely death or a couple million dollars of “umbrella” protection to shield you from a litigious liability.
The wrong problem to solve in the giving arena is to presume this category doesn’t apply to you outright.
· “I don’t have enough to worry about estate planning.”
· “I don’t have enough to consider philanthropy.”
This category is likely the most prone to head-in-the-sand planning—which is to say, no planning—based on our perception. So please allow me to broaden your perspective. The real problem is that you’re giving whether you like it or not, and by ignoring this fact, you’re ceding control of your giving to others.
If you own anything at all, you have an estate, according to your state and the federal government. If you don’t decide what you’d like to happen with your assets—or importantly, whom you would prefer to raise your minor children—in the case of your untimely demise, the government will decide for you.
Think you’re not a giver? Well, if you paid taxes last year, you’re contributing on behalf of your community, state, and country. And interestingly, by paying more attention to prospective giving opportunities, you may even be able to shift the balance from compulsory “gifts” through taxation to non-compulsory gifts to qualified non-profits. (Talk to your tax preparer, of course.)
Yet paradoxically, the greatest gifts of giving are likely non-financial.
LIVE
One could argue that of the four ways we can spend our money, the one we address last should be listed first. And indeed, for many people in the world, the struggle to meet their basic living expenses of food, clothing, and shelter overrides their ability to attend to grow, protect, or give. But if you’re reading this article, the chances are very good that you’re not one of those people.
Therefore, once you meet your basic needs, the wrong problem—and likely the wrong-est of all the financial problems we persistently face—is that if we just had more money, all our problems would be solved.
If we only had more money, we could live better, save more, protect more effectively, and give according to those internal nudges. But.
However natural this instinctive desire for self-sustenance might be, few things hold us back from financial progress more than the notion that money is a satisfactory solution.
The real problem is that more will never be enough. It is through the work and sacrifice of zero-sum allocation of our material resources that we can find a healthy balance amongst all four of the worthy outlets for our money—crafting a livable life of meaning, protecting what we have built from catastrophic risk, growing our wealth in pursuit of financial sustainability, and giving in accordance with our values.
“When you focus on the solution, you focus on only one way to solve a problem,” writes Greg McKoewn. “When you focus on the problem, you can focus on finding the best way to solve a problem.”
Most of what you read about personal finance is solution based, because solutions can be sold. Yet there is no shortage of solutions. The real challenge is in properly identifying the root problem. When you’ve done so, the prospective solutions can be much more easily prioritized and pursued.
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