The Personal Financier: June 2009

While it may be recommended to manage both a budget and net-worth sometimes focus leads to better results.

I've been keeping a detailed budget for over two years now. My budget served me mostly in tracking my family's expenditures and investments rather than in setting goals but I tried to "course correct" whenever I noticed exaggerated expenditures in any area.

Another aspect of my financial management is tracking my net worth. A budget can be considered more of a profit and loss statement while net worth could be considered the balance sheet of household finances.

Still, since I took my recent job, I had very little time to invest in my budgeting efforts (and writing, unfortunately) and I had to focus my efforts on what I considered most valuable in terms of personal finance management.

My main consideration where the nature of my financial goals, the time and effort required and the marginal contribution I believed these tools had for me. The following discussion presents, in a concise manner the key considerations in net worth management and budget management.

Net worth management or budget management?

As any complex questions the answer is: it depends.

Personal finance management should complement one's lifestyle and financial goals. Considering my own led me to the conclusion net worth management is more suitable than budgeting (Still, had I the time I'd do both). Here are my considerations:

Personal finance management through budgeting is more of a short-term management focusing on specific goals, such as meeting one's financial abilities, paying off a credit card or short-term loan, regaining financial balance and generally meeting timely financial goals such as saving $1,000 a month, for example.

The key considerations for budget management are:

Profit and loss management.
Useful for achieving short term goals.
Requires a significant time investment and management.
Should be performed on a monthly basis, at the most.
Budget management requires attentive analysis of the breakdown of expenses and creative thinking on how to lower them.
Budget management keeps you focused on the savings side, leading to penny pinching and frugality which are good tools for savings as they have a cumulative impact.
Budget management without goal setting is simply tracking expenses with no corrective action.

Personal finance management in terms of net worth is more long-term management focusing on major life goals such as retirement, children savings, portfolio management and others.

The key considerations for net worth management are:

Balance sheet management – Capital as a function of assets and liabilities.
Useful for achieving medium and long term goals.
Requires little maintenance but significant time in portfolio management.
Net worth requires tracking various balances of assets and liabilities on a timely basis - bank balance, deposits, investment portfolio, value of a house on one side and mortgage, loans and other liabilities on the other.
Net worth management is focused on the long term on or growth of capital through investments. Net worth management may ignore the short term and does not aid in managing a budget – Just the bottom line of money saved at each period.
As with budget, net worth management without goal setting is simply tracking various balances.
Net worth management can be performed on a quarterly basis. Shorter periods may lead to frustration as funds and investments take time to grow.

My conclusion

While many recommend financial management which looks at both the short term and long term I believe that one may distract you of the other. For me, time invested in budgeting meant less time to invest in portfolio management and analysis.

Managing net worth when trying to meet a budget and repay loans may very well end in frustration seeing net worth on the negative side of the balance sheet.

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