When speaking with friends and family recently, many of them are extremely bummed out by what’s going on in the market these days. Whether it’s an uncle who’s lost 40% of his net worth as he’s approaching retirement or a friend who bought her house in late 2006 and is now 15% underwater, the worries are the same. The troubles they are having made me realize this: if you want to have control of your life, you must control your money. You must understand the following:

1. where your money is coming from
2. where your money is being spent, and
3. where your money is being invested and saved

Not appreciating any one of these three fully will lead to problems at some point. Let’s work our way through each item to see how things can go wrong and how best to manage them.

Where does it come from?
This is probably the item that people have the most control over. For most people, their money comes from one primary source: their job. Other sources of income include dividends, interest income, partnerships, tips, gambling or lottery winnings, or your blog, even. Taking control means being able to reasonably estimate the amount you’ll earn by taking into account the stability and quality of the income. For instance, interest that one earns on US government bonds is probably the most stable and reliable form of income you can get. On the other hand, gambling winnings are probably your least stable form of income unless you are a professional poker player. Your job falls somewhere in between these two and furthermore, various jobs have wide ranges of stability.  If you are a handyman with an established client base, you can be pretty certain that you’ll have a steady job with a steady stream of relatively predictable income as people need your services over the course of the year. If you are an investment banker, you can be pretty certain that it will be feast or famine. Your earnings will be highly variable, your bonus will be unpredictable from year to year, and (currently) you can’t even be sure that your industry will exist in the same form a few years from now. Taking control of the situation requires that you make an honest assessment of how stable your income is. Ask yourself these questions:

1. Who pays my paycheck? Is it the government, a private company, a public company, an individual, or my own business?
2. How much variability is there in my income? Is it commission-based, hourly pay, bonus heavy?
3. How strong is my employer’s ability to pay? Can they withstand a prolonged slowdown in business? (Think: homebuilders, bankers, retailers)

The biggest mistake people make is that they mistake their stellar performance at work for the stability of their job. You may be a star performer but still lose your job if you don’t see the end of the road for your company or industry as a whole. This happens often in the hedge fund world. It’s called netting risk. One guy makes a lot of money and everyone else loses money so at the end of the year no one gets a bonus. You would feel cheated if your performance was up to snuff and you were left out in the cold.

Understand the risks to your income and you can help yourself prepare for changes when they come.

Where do I spend it?
I won’t spend a lot of time talking about this because there are countless articles on the web about budgeting and spending on a daily, weekly, monthly, and yearly basis. My only insight here is to behave like a corporation when it comes to managing your finances, especially if you are a family. This means separating your expenses into fixed costs, variable costs, and one-time/extraordinary costs. Fixed costs are things like your mortgage, property taxes, and insurance; anything that you can’t avoid paying. Variable costs are those things which are easy to substitute for or cut out completely such as restaurants, travel, HBO, designer shoes, etc. One-time or extraordinary costs are things that may happen either out of the blue or very rarely or both such as a down payment for a house, a wedding ring, or a new car.

You should be able to categorize all your expenses into one of these categories. It’ll help you when you decide you need to cut back or you want to let loose a little bit.

Where am I investing/saving it?
You have two choices with money either to spend it now or spend it later. If you choose to spend it later, you have a choice of keeping it in cash or investing it in any asset you choose, preferably one that goes up in value while you wait.

In the case of keeping it in cash, here are a few rules to follow:

1. Find a bank with low fees
2. Make sure your accounts are fully-insured by the governmental agency in your country
3. Try to have a savings account that pays a high rate of interest (sometimes it even makes sense to keep money at a bank that will probably go under because it will probably pay very high interest rates in an effort to attract deposits but still be FDIC-insured – WaMu was paying 4% on all deposits right before the end while Chase was paying less than 0.50% so I never moved my money out of WaMu)

In the case of investing your money, it is your job to investigate every asset that you put your money into. You are voluntarily giving up control of your money when you allow someone else to make decisions for you without understanding the risks fully. As you all know, some people have found that their houses are worth 50% less than 2 years ago. Others have found that AAA-rated municipal bonds may not be so safe and so liquid as they once thought. I can’t stress enough how important it is to pay attention to where you are investing your money. It is not acceptable to leave the job to someone else and then be upset when the performance is not as good as you thought it might be. You have the final say.

One related anecdote: I hear 50-100 ideas every week about stocks I should buy or short for my portfolio. People always love one idea or the other. In the end, if I put on one of these trades, it is my decision. The worst kind of trader/investor is the one who blames others for his losses and take credit for his gains. Pointing to Jim Cramer or Suze Orman when you lose money and to yourself when you make money are no-nos. Be an independent thinker and take responsibility.

In conclusion, I hope I’ve motivated you in some small way to think deeply about your money, what you are doing to it, and what it is doing for you. Over the next few weeks, I’ll talk more about the investing side of the equation as that’s where my expertise lies.

Take control of your money.