Whether you are new to finance or an experienced professional I hope this series helps provide a basic understanding of financial concepts. If you enjoy what you read, be sure to check out the next posts, Neglected Finance and Strategic Finance.
Andrew Lo, finance professor at MIT, defines finance as "the management of money through risk over time." Of course he was talking to future CEO's, CFO's, and business executives at the MIT Sloan school of management, but everyone manages money to some degree. The amounts may differ, the values behind the manager may differ, but anyone who spends, saves, invests, borrows, gives or pays with money is surrounded by “finance.”
Finance by its very definition limits itself to the management of money, but what is money? The best answer I've heard came from the respected pastor John Piper, who in an interview noted, "money signifies what we value." Therefore, the discipline of finance is not simply the management of money, but at a core level focuses on discerning how to use our resources for what we value. In fact I argue any time an exchange of some value occurs (ie. time or effort for money, materials for commodities, emotions for relationships…) the macro principles of "finance" apply. Over the past few years I have identified key financial concepts that could help us live purposefully in many different areas of life.
Know what you have vs. what you spend (ie: time, work, material, emotions, money…)
Identify Values (does your spending of resources maximize or minimize what you truly value)
Build a Map (create a strategy to organize time, effort, and resources in a way that properly prioritizes what is most valuable)
Step one might be obvious, an experienced DIY planner probably has this step down already, and it is pivotal to complete before steps two and three. This is where we ask the question of accountability, “How much can we spend and where is it being used?” You can ask this question to a variety of finite topics such as time, money, effort, emotions... whatever it may be, this question can help identify potential areas of "expense" that don't contribute to attaining what you value.
When it comes to tracking money, dozens of apps and budgeting tools are available to help build a base understanding, when it comes to tracking time there may be just as many apps available. Once the data has been gathered, and a rough financial sketch has been drawn, step two comes into play.
The main question step two tries to address, “Do I really value this category as much as I am spending on it?” This is where some real financial principles such as valuation enter the picture. In a financial setting, money serves as a tool to measure value and provides agreed upon units to measure that value in the form of currency. With these measurements come all kinds of financial equations, but at the core of valuation lies the necessity for honesty and objectivity. Without those qualities, all planning will be skewed away from what you truly value. It may be a good idea asking a friend or trusted adviser to help question and identify these values. If you are married or make decisions that impact more than your own finances, it may be a good idea to hold a meeting discussing values and prioritization. Step two intends to add a little depth the financial sketch from step one. Once we know what we value and how we use our resources, we are ready to start asking, "How can I manage my resources in a way that reflects what I value?"
At this point a financial professional may offer goal based planning or comprehensive wealth management. They may even show a nice picture called the six spoke wheel of on-going advice. However, if you meet with someone who offers goal based planning, do not neglect step 1 mentioned above, or the very principles of step two. Today, goal based planning, may not even include step one or two. When financial returns are considered an end instead of a means, unnecessary risk and neglect often clouds the strategy. Its important to identify values as a guide for strategy, especially if its for education, retirement, estate preservation or accumulation. Each of these objectives have clear ways that maximally benefit those ends.
Once you've got the basics of steps one and two taking a look at Neglected Finance, could help before moving on to step three, Strategic Finance.