All financial planning begins with cash flow planning – your budget, in other words. Sometimes people recoil from that word - budget. To them the word is fraught with negative connotation: I can't spend! Not in my budget! I'll have to deny myself! Life will become intolerable!
Turn this around, though. If you have a cash flow plan, i.e budget, you have freedom within the form. This spending plan keeps you focused on working toward achieving your financial goals. You know exactly how much you can spend on eating out this month, in other words, and still achieve your monthly savings goal to retire with an income of $X at age 67.
Think this through carefully: How much do I need in my emergency fund? How much debt do I have to repay? What interest rates am I being charged? How much should I accumulate in my retirement accounts?
You might be amazed at where your money actually goes. When we do this exercise with clients we go over three months' of spending and categorize each purchase. Often people were totally unaware of how much unnecessary spending they do, and how much they can tighten up without seriously cutting back on lifestyle.
Anecdotally I can tell you: after just 3 months of budgeting, 8 out of 10 people say they feel more in control of their money. We have a great budget template that we’d be glad to share with you. Send an email to [email protected] with the request and we’ll send it out.
The budget should run out a full year, and include all household expenses. My personal rule of thumb is that if it is a recurring expense of more than $10 per month it goes in the budget. You'll see the cumulative effect over 12 months: either there's money remaining that could be put to use, or there's a shortfall.
Keeping a budget is an exercise in personal awareness. If it’s out of sight, it’s out of mind. If you don’t know where your money is going, this produces stress. So a great way to reduce stress is keeping a written budget. Write down expenses on top and any income at the bottom of a spreadsheet. List your net income, not gross income. That is, the net spendable income you receive in your checking account. When you subtract out the expenses from the income, the result needs to be a positive number – otherwise you’re spending more than you earn. If it is a negative, you have two choices: increase income, or decrease expenses. That’s it.
The family is an economic unit, so the decision-makers in the family should agree together on spending choices. Ideally, the budget will fund all the family’s needs. This Includes the accumulation of an emergency fund, retirement savings, charitable giving, education savings, clothing, entertainment, and vacation. What happens when there’s not enough? Then the non-essentials get cut out. Often that means vacation and eating out.
With that said, it remains true that the greatest pleasures in life remain free, and with a little creativity and self-discipline a family can live within its means and provide for its needs. The recent Coronavirus shelter in place orders have shown us this - without even an opportunity to go and and spend money, families found creative ways to pass time together. A walk/run/bike ride costs nothing. A game of cards or Scrabble cost nothing. Listening to music or reading cost nothing.
And finally, let the old adage inform your cash flow planning: If you fail to plan you plan to fail.
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