Our younger generations have had to grow up amid some difficult economic times. Many millennials entered the workforce right around the Great Recession. Today, Gen Z is doing the same in the shadow of the pandemic.
These experiences can exert a strong influence on the attitudes and behavior of an entire cohort. Often, the takeaway is that you should learn to adjust your lifestyle. But as we face an uncertain future, frugality alone isn’t enough.
Businesses understand this; they can’t afford to stand still and cut costs during chaotic times. They manage unnecessary risks with the help of safety consulting firms, but they also take calculated risks that have the potential to improve their position. So how can you apply a similar approach to personal finance?
Recognize the limitations of cash
If you grew up with a focus on minimizing expenses, you’ve probably been told that cash is king. Due to compound interest, loans can get anyone in trouble if they can’t make timely payments. And lines of credit are equivalent to a temptation to spend freely.
Stick with cash, and leave your credit cards at home if you haven’t already cut up and discarded them. That’s certainly one way to ensure that you spend within your means.
However, the value of cash isn’t constant. Sure, every penny saved is a penny earned. And the dollar is the world’s reserve currency; other nations’ money is measured against our economic performance. But that cash you’ve been saving is subject to inflation.
Over time, the cost of living increases. Millennials have already felt its bite, even in the recovery years after the Great Recession. We’ll rebound from 2020, but the things we spend on will continue to become more expensive.
Grapple with dynamics
The first takeaway is that holding on to cash reserves does you no good in the long run. Of course, you should have something set aside for emergency expenses. But keeping the excess in cash form will only lock you into a guaranteed, depreciating future.
When you’re starting in life, the conventional path seems simple. You pursue education to whatever extent falls within your capabilities. Then you start looking for work that’s in line with what you’ve learned. Work hard, and you’ll get noticed. Eventually, you’ll be promoted and earn enough money to enjoy a comfortable retirement.
But that model doesn’t hold up to the test of real-life experience. It shatters easily. Few people are lucky enough to find jobs that pay well, let alone those that offer straightforward career advancement.
For most employees today, career progress is more like a lattice, or even a set of monkey bars. That’s why so many young professionals are still struggling to pay off student debt. Meanwhile, there are startup founders who dropped out of college, took risks, and are reaping the rewards.
These things happen because life is a dynamic system, like the weather. We can only forecast accurately a few days in advance, and even then, we can get the details wrong. Eventually, we all learn to put away our models of how life is supposed to unfold, and instead learn to deal with its dynamics.
Working with risk
Thus, the second takeaway is that dealing with risk is already built into the fabric of life itself. We simply fool ourselves into believing otherwise. And it makes no sense to let your financial management be governed by a crippling fear of risks when you effectively manage them throughout your life.
Whatever excess money you have built up by soundly managing your expenses now needs to be converted into a form that scales over time. For a lot of people, that means taking money out of your savings account and buying shares of stock.
Stock investment is a great way for anyone to build up their risk tolerance in the financial realm. Unlike cash, the value of stocks will fluctuate along with the economy. With tried-and-tested strategies, such as dollar-cost averaging, you reduce your exposure to volatility and improve your financial position regardless of future developments.
Next, diversify your portfolio of investments. This applies to the stock market, but also outside of it. You can consider following a barbell strategy. Secure your position in relatively stable, low-risk investments. Then, you can afford to take risks with the rest, about 10% of your total wealth.
That 10% can go towards funding startups, or even bootstrapping your own business. What matters is that even if things go south, you’ll survive comfortably. But if things work out, you could grow your wealth exponentially. This way, you won’t just be risk-tolerant; you’ll be taking risks that improve your odds of success.