Finding the middle way with your money

As a somewhat inexperienced cross-country skier, I had ample time to assess my technique while sprawled on my back on the Gunflint Trail. I realized that I ran into trouble in two ways: I would look straight down confirming that I was in the grooves or I would stare too far ahead, losing track of what was right in front of me. As the days went on, I achieved a modest degree of success by paying attention to the middle way — that place between each extreme.

Are you incorporating the middle way with your money? The first financial effort that people often make to start the new year is setting up a budget. They assiduously look at their spending and, in a feat of superhuman sacrifice, say that they are going to give up lattes. Nice try. Choosing to have a latte once a week rather than every day will probably not secure your retirement.

Think about it this way: an extra scoop of ice cream while watching Downton Abbey costs many of the caloric benefits from a grueling half-hour on the treadmill. It is the same with spending. Giving up lattes may create a sense of discipline for you, but your budget is most likely getting blown by the occasional "I deserve" impulsive catalog clothing purchase — the financial equivalent of a month's worth of Frappuccinos.

Everyone has certain large expenses over which they may not have a lot of control and are probably difficult to cut — housing, health insurance, education. And we all have small indulgences that we can omit, but probably won't save us much. Where most people get caught is in the in-between, spontaneous items that are justifiably indulgent. "Look at all the money I saved by buying this on sale!" You only saved money if you had intended to buy this item, not because it cost less than it normally does.

The middle way with spending is developing a program around allocating your dollars intentionally. Some people use actual envelopes (or a program. Like mint.com) as a way to moderate their impulsiveness. Almost everyone needs to create some system to manage their spending. I know many people who are highly disciplined but lack self-control — they can deny something completely, but if they do it a little, they want to do it a lot. The way around this is through establishing a realistic cash flow program that enables you to spend reasonably, but not freely.

The middle way often gets ignored as people plan for their retirement. Many are really good at delaying gratification — the essence of investing. But they become so good at it that they permanently delay it. Clients who have been excellent savers are often terrible spenders. It is a different muscle that atrophies from excessive discipline. Yet live-for-the moment spenders also run into trouble in planning for their future.

The middle way is setting money aside regularly in the most advantageous programs: the company 401(k) up to the match, a Roth IRA if your current tax bracket is 28 percent or lower, and debt retirement. But it also involves spending on things that create lasting benefits such as memories or preventing things that are continuous burdens like long commutes. This type of approach has several advantages. You develop moderation skills with spending. When you retire, you don't need to replace income, you replace spending. You also develop a healthier relationship with your money.

It has been difficult the last couple of years to think about the middle way in investing. U.S. stocks have performed extremely well, causing virtually any other investment option to drag returns. It is easy to justify investing in this asset class — the U.S. economy is currently the strongest in the world, there is so much geopolitical strife that international investments seem risky, interest rates are going up so bonds make little sense. But diversifying is the ultimate middle way. You never capture the complete return of the best performing category nor suffer the full effects of the loss from the worst investment. Diversification automatically moderates your returns so that they become more predictable.

Investments like bonds that independently may not seem to have much potential form a core holding in a diversified portfolio because if the equity markets are unstable, quality bonds tend to hold up well. They can later be sold and added to categories that have fallen. International stocks provided the majority of stock market gains for the last decade; their poor performance this decade is most likely a precursor for stronger relative performance going forward. With the middle way, you don't need to be right on big bets, you just need to be consistent and strategic.

One can also think about the middle way with taxes. While retiring to Florida saves state income tax, it may also mean leaving grandchildren, stellar health care, and a comfortable way of life. But many people could have tax benefits here, just through simple planning. Effectively using retirement plans, tax-aware investing, and withdrawal strategies in retirement can create significant tax benefits, even in Minnesota.

I didn't always get very far skiing when I was falling, but once I found the middle way, my experience was vastly more enjoyable. It's the same with money.

Ross Levin is the founding principal of Accredited Investors Inc. in Edina.