Making Sense of Financial Compromise
What is financial compromise? Financial compromise is a term I use often to emphasize the fact that we do not have trees in our back yard to grow unlimited amounts of money. For most of us, we have limited amounts of money to try to do all of the things we want to do.
For example, this summer we did some landscaping in our back yard. I want very little maintenance, which is another term for no grass to mow. My wife wants a yard for the kids to play in safely. My son loves swings, slides and swimming pools. We had to make some compromises in terms of what we want for everyday enjoyment and also to make decisions as to how much we want to spend on grass, trees, sand, rocks, bricks and the deck. Landscaping can be expensive and the challenge was to spend an amount that still allowed us to do all the things we need to do financially like buy RRSPs, invest in RESPs, pay down debts and still have enough money for enjoyment.
Take all the things you want to do or buy with your money. Develop your wish or dream list and at the end of the list (if there is an end) when you total everything up, often, the total exceeds the money you have and the money you make. Financially, we compromise everyday. If we spend too much on the landscaping in our back yard, it means we have to compromise in other areas like delaying the next major holiday or car purchase or investing in RESPs. Every purchase has some form of compromise attached to it.
Budgeting is the solution
How do you make the most with what you have? Most people do not do any planning therefore, do not have a true quantification of what financial compromise means. Do you know how much money you spend from day to day, month to month or year to year? If you don’t you need to know. It is one of the basic principles of financial planning.
In today’s world, not enough people budget. Alternatively, Canadians are going into too much debt and not saving enough money for the future. In a recent study by CIBC, Canadians have a negative savings rate which is the lowest level since the 1920s.
Studies have shown that successful people know where their money is going. They do some form of budgeting on a regular basis. They can tell you how much of their money is going towards their financial assets vs. personal spending.
Budgeting has some negative connotations because it often means that you have to restrict your spending. Don’t we all? Isn’t financial compromise always part of all of our lives? We really are not alone in this. The fact remains that budgeting helps us to know some very important things:
- Where we spend our money
- Where we might be able to alter our spending habits
- Develop a spending and savings plan for the future.
Another type of financial compromise relates to retirement planning. Retirement compromise is really about balancing living for today vs. living for tomorrow. Typically, if you want to prepare properly for retirement, you will need to force yourself to get on a disciplined long term savings plans. Government benefits today will only give you about $15,000 per year at most. For younger Canadians, these figures are likely to get smaller not bigger. The compromise comes in that to save for the future we are likely to have to forgo some of the luxuries we would like to experience today.
Those that do not have any savings in order to maintain their current lifestyle will find that they may have to do a lot more compromising in the future.
If you have put forth some longer-term savings and have an investment portfolio, you will then face another type of compromise called investment compromise.
In the world of investing, we all want the highest return possible with the least amount of risk possible. Unfortunately, this relationship is pretty rare. More often, risk and reward go together. If you want higher returns, you will have to take a little more risk. If you want to avoid or minimize risk, then you will have to accept lower returns. The risk-return relationship is the investment compromise. Which are you willing to compromise more? Risk or return?
No perfect solution
Unfortunately, when it comes to financial compromise, there is no perfect solution. Everybody has different values and finding the right balance between extremes can be a challenge. Like any challenge, the first step is to be aware of financial compromise every time you make an investment, retirement or financial decision.