Many times, we require advice or recommendations from others in order to make a decision on some aspect of our life. We receive opinions based on others’ expertise and experience in order to help us decide a course of action. On many occasions, the person we ask advice from has professional expertise and a formal education, which then qualifies them to provide us with the advice. This is the case with personal finance as it is with our professions such as medicine. When accepting professional advice, a challenge is having a foundation of knowledge that provides enough data to process the information necessary to make a decision that is right for you and your unique situation, goals and priorities. This requires education, which is the general knowledge necessary for reasoning and judging, and for understanding the implications, pros, cons and consequences of a decision.

Why is it important to understand the difference? Because financial education was not formally taught to people who are already established financially today. We developed our knowledge on the job and, therefore, in many cases actually lack the foundation of knowledge necessary to confidently make a financial decision. Worse, however, is that most people who are established financially are not even aware that they don’t know what they don’t know. This means that the uncertainty and intimidation that creates skepticism from financial advice is really a clue that there is a knowledge gap. This is not necessarily in the product or service or advice being inappropriate, fraudulent or unrealistic. It is important to be aware that the financial marketplace has become more complicated and, therefore, requires more knowledge. Fear, uncertainty and doubt are good indicators that perhaps there are additional questions that need to be asked, not necessarily that the advice isn’t good for you.

There is a business phrase that says, “You can’t manage what you can’t measure.” When it comes to finance, this is particularly critical. Whether it is activities or actual results, if you don’t have a way to measure your progress, you won’t be able to effectively manage your progress against your expected results. In fact, you might not even be able to determine if your results have been reached if you haven’t previously articulated what form of measurement you will use. Managing financial results means you have to determine what specific results you are looking for and in what time frame. These can be a dollar figure, or a series of regular activities that you expect will provide you with your pre-determined result. For this to be effective, you will need to have a way to track your progress so you can also analyze your data to effectively manage your progress. Rarely will tracking only single figures provide you with adequate data to make informed decisions. This means that if your only form of tracking your financial state is to look at the bank or investment balance, you might be able to chart out your ups and downs, but that doesn’t put you in a position of control, or provide you with much information to manage ongoing decisions.

What do you need to track to effectively manage your financial progress? In business, financial statements are produced to show income, expenses, assets and liabilities and how these change over time. With this information, you are able to pull various figures to perform analysis to show how well current income and assets are being used to effectively grow the business. To effectively manage household finances, you need to be able to analyze your financial data like a business. This means you have to collect the data then understand what various financial ratios will tell you. This is not simply measuring how well you stuck to a budget. This is cash flow analysis and net worth monitoring. This is debt to equity, income to assets, interest coverage, working capital, etc. When you start with your personal finances, you can then apply the measurements of a business to create and analyze your progress the way a business does. This will help you understand the value of information and what it conveys to help you make, not only personal financial decisions, but also business and investment decisions from more detailed and advanced financial statements.

There are different ways of earning money from investments besides buying low and selling high. In fact, an investment that produces immediate income, rather than increasing in value is an example of a sideways view of the market, and an investment that made money in a dropping market is an example of a decreasing view.

Where could you find out more? You don’t have to jump into every opportunity you hear about. In fact, you don’t have to invest in any of them, but you can start to ask different advisors from different backgrounds in different industries about possibilities for alternative or creative investing. For example, securities options, futures, commodities, foreign exchange, derivatives, initial public offerings, private companies, etc. are all more creative investments.  There are different types of returns and different types of risks. When you have a proper financial foundation including knowledge and skills these types of investments can be appropriate. Without a proper foundation, they might look attractive and sound appealing and to some people these are low risk investments. When everything else is in place – have fun – there is great diversity, wonderful opportunities to make great returns, and make a difference while you’re at it.

Risk means different things to different people. We most commonly refer to it as the probability of loss. It is important to know ahead of time what your ability to withstand loss is. For example, no one is going to realistically invest money with the possibility of losing everything. Instead, they will invest with a percentage of assets they feel comfortable risking.

How do you know how much to risk? If $10,000 was invested, you might decide you could reasonably withstand a $1,000 loss, therefore you would have a ten percent risk. This then becomes the foundation of your exit plan. If you are close to losing ten percent of your money, you have already decided this is the point when you leave that particular investment. This concept is the same for investments that increase in price as well. If you have a nice gain on paper, you simply apply the same percentage to the price increase. If your original $10,000 investment increases to $20,000, your new amount of money at risk would likely be $2,000 or ten percent of the new price. There are other factors to consider such as the overall value of an investment relative to your total investments and whether you have already recaptured your original investment capital in a previous transaction, but the concept is that you establish the exit parameters ahead of time and you pre-determine how much of an investment is at risk at any given time.