In the investing
world there is a number known as “beta”. Investopedia
defines beta as follows:
A measure of a security’s
or portfolio’s volatility, or systematic risk, in
comparison to the market as a whole. Also known as “beta
coefficient.”
Beta is calculated using
regression analysis, and you can think of beta as
the tendency of a security’s returns to respond to
swings in the market. A beta of 1 indicates that
the security’s price will move with the market. A
beta less than 1 means that the security will be less volatile
than the market. A beta greater than 1 indicates that the
security’s price will be more volatile than the market.
For example, if a stock’s beta is 1.2 it’s theoretically
20% more volatile than the market. (emphasis added)
The other day I was studying
something entirely unrelated to personal finance when the
concept of beta jumped into my head. Only this time, I wasn’t
thinking of beta as relating to a stock, I was thinking of
beta as it relates to how to manage your money.
I’m not talking about
a fund manager asking himself how to manage your money. I’m
talking about you asking yourself that question.
Notice the bolded part of
the quote above: “you can think of beta as the tendency
of a security’s returns to respond to swings in the
market”. Let’s replace a few words and restate
it:
You can think of beta as the
tendency of your finances to respond to swings in life..
What’s your personal
beta?
Nobody (well, almost nobody),
wants a personal beta that deviates far from one. It causes
stress on the job, at home, in your marriage, family, and
other relationships. It can possibly keep you in a job you
don’t want, doing something you don’t like, for
people who treat you lousy.
The best way to move your
personal beta toward one is to set up a personal budget. A
budget reduces risk in your personal finances. It smoothes
your income and expenses, and decreases the height of the
crest and depth of the trough in the financial waves that
may bear down upon you.
A budget is a benevolent dictator
when it comes to how to manage your money. It is firm when
it feels its power being taken from it, but it will also give
you some slack - when asked politely.
Did you notice the term “systematic
risk” in the definition above? Let’s go into that
a bit deeper with another definition:
The risk inherent to the entire
market or entire market segment. Also known as “un-diversifiable
risk” or “market risk.”
In order to apply this to
your personal finance situation, we’ll alter the definition
again slightly:
The risk inherent to your
finances or entire life. Also known as “un-budgetable
risk” or “uncontrollable risk.”
This is a fancy way of saying
its the risk of living day to day. It’s the risk that
will always be there no matter what you do. You’ll notice
as you learn how to manage your money better and better that
your personal beta does go down - it gets pretty darn close
to one if you really work on it. You’ll notice an improvement
from your former, volatile self. This is the unsystematic
risk that has declined. It is also sometimes called “specific
risk”. And it’s something particular to you, that
can be taken care of if you learn how to manage your money
a little better - bring things in a little tighter - pay a
bit of heed to that benevolent dictator.
However, even the best money
managers cannot get rid of risk entirely. No matter how you
manage your money, you will still be subjected to the systematic
risk of life. You cannot reduce it. You cannot ignore it.
Before you get down on yourself,
or maybe even feel a bit depressed about this supposed risky
situation that you live in, let me assure you of one thing:
Unsystematic risk makes up the large, large, bulk of the stress
you may feel when you’ve slacked on your money management.
The systematic risk inherent in life is small - tiny - minute.
When your personal beta is one, you are feeling good! Life
is good! The grass is green! The sky is blue! On your side
of the fence!
The budget will show you how
to manage your money. It will show you how to reduce your
unsystematic risk to nothing. It will get your personal beta
down to one. It is the solution to money management stress
and worry.
What’s your personal
beta?
More Articles On How To Manage Your Money
(How
To manage Your Money - Your Personal 'Beta')
(How
To Manage Your Money Part 1)
(How
To Manage Your Money Part 2) |
