Tuesday, May 6, 2008

Budgeting: Part 2: Creating A Framework

"High achievement always takes place in the framework of high expectations."
- Charles Kettering

In the first part of this series on budgeting, I discussed the importance of starting the budget process by looking at the big picture. Now let's try to bring those lofty ideals down to earth. When I asked myself some significant questions about life (listed in the previous article), I found that some of the things that were important to me were:
  • Travel. (...more specifically, wanderlust. More on that another time!)
  • Learning.
  • New experiences.
  • Diversity of experiences.
  • Family.
  • Service.
I also discovered some things that weren't so important to me:

  • Limited desire for structure.
  • Limited desire for recognition.
  • Limited desire for "things" or "stuff".
I've already generalized quite a bit of my life in constructing the list above, but it can be generalized further. Hopefully you can pick out some common themes in the above list. Newness. People. Independence. Freedom. So let's do one more level of generalization:

Most of what I appreciate in life requires a lot of time, but not a lot of money.

Now, of course, your desires are undoubtedly much different than mine. Maybe you really want to stay in the town where you grew up. Maybe you want to own a luxury boat. Maybe you want to run your own business. The important thing to understand is that with limited time and resources, only some of your goals in life can realistically fulfilled, so it's important to create a framework for what things are most important and work toward them. Otherwise, it's likely you may only achieve things that aren't very important to you, or worse yet, by failing to prioritize, you may not achieve much at all.

So far this all looks great as a theory, but like all theories, there is often a big disconnect when you attempt to apply them to the real world. Suddenly things get messy and you discover that what seemed so consistent in theory can often be quite contradictory in practice! So without ducking the issues any further, as an example, let's attempt to run a very common and very big expenditure through my personal framework. Let's talk about budgeting for a car. (Groan!)

So what kind of car should I buy? According to the above framework, the car shouldn't require too much of my time, or I won't have as much time for other things I want to do. I suppose that means reliability, so perhaps a new car? On the other hand, new cars cost a lot more and I don't care about impressing people with my car. Also, time is money, so buying a new car means spending more hours working so that I can pay for it. Well then, maybe I could take public transportation - it's cheap, and reliability is someone else's problem. But public transportation only runs at certain times to certain destinations, so this is not going to work out very well with the whole freedom and structure goals. At any rate, whenever there are mechanical issues, I should have someone else fix them to save me time, right? That sounds right except that I really like learning about new things and so I might actually enjoying performing the repair.

So it's easy to see that my goals are not always aligned with each other. Sometimes they can be complementary, while at other times they can be contradictory. Goals can also change over time. Prioritizing the goals or creating a hierarchy of importance can help a little, but in the end, everything is not going to be nicely consistent. We can't realistically expect that life can be reduced to a decision tree.

So what good then is the framework? The framework does not give you the answers to your choices in life. The framework is designed to make sure you are asking the right questions. That may not seem very helpful to some people at first blush, but think about how you would answer a friend who asked for your help with an individual purchase.

For example, suppose a friend who knows little about computers asked, "What kind of computer should I buy?" As a helpful response, you would want to ask your friend some questions. "What do you want to use it for? How much do you have to spend? Do you want to be able to take it on trips? Do you want to store photos and music on it?"

As another example, suppose a different friend who knows very little about investing asked, "I have $2,000 to invest, so what should I do?" You would probably continue the conversation along these lines: "When do you need the money back? How comfortable are you with potentially losing some of this money? Are there any special tax considerations with this money?"

In both cases, you simply want to make sure that the right questions are asked. However, there are no automatic answers to the questions and no automatic choices. After your friend has answered the questions, he or she will still have to mentally weigh everything and make a gut decision on the purchase. The best choice will not necessarily be clear and mistakes may be made. Nonetheless, your friend is in a much better position to make a good choice than someone who did not ask and answer these questions.

When making decisions, people often do not ask many questions or they ask the wrong questions. This is what I try to avoid by having a framework. Just as it is helpful to have a decision framework for an individual purchase like a computer or an investment, it is even more helpful to have a framework for the entire budgeting process.