Whether you make $40,000 or $400,000/year, prudently managing your cashflow is the single most important financial thing you can do. You know you should live within your means, but why is it so difficult? Learn how we help our clients finally gain control of their income/spending, while saving them time and stress along the way.
What is cashflow?
In today’s world, cashflow is the fuel that powers our financial engine. We are more dependent than ever on others to supply the things we need to live - housing, transportation, food, utilities, entertainment, savings, taxes and so on. We enjoy these things by using the cash earned from our work(or stored resources) to pay for the things we need (and want). Cashflow is simply the inflow and outflow of money in our financial world.
It seems simple that we must live within our means--a world where income > expenses. The only place where this doesn’t seem to apply is in our federal government, but that’s a discussion for another day.
If it’s so straightforward that we should spend less than we earn, why is it so difficult, even for some with high incomes?
The High Cost of Poor Cash Management
As society advances, the list of things needed to keep pace with today’s standards of living is ever growing--technology, vehicles, bigger homes, personal services for maintaining our health & home, higher cost food, entertainment, travel, growing education costs for our kids, funding increased life expectancy, health care costs and so much more. We want these things, but it may not be realistic to have all of them, at least in the short term.
We know that the stress of either not being able to fund all these desires or that by getting them through borrowed money is significant. It’s the cause of most of our money troubles. In fact, the American Psychological Association, lists money as the number one cause of stress in America. This stress can cause marital issues (the biggest cause of divorce), trouble at work, poor health choices and host of other issues.
In addition to the immediate stress effects, you're obviously also hurting the chances of reaching your longer term financial goals (think retirement, kids' education, travel, etc.) when you don't allow room for savings in your cashflow. Your future goals depend on the day-to-day and week-to-week decisions you make with your spending.
Why We Get it Wrong
One of the biggest financial issues we see is called ‘Lifestyle Creep’. It’s our tendency to let expenses grow as fast (or faster) than income as we progress in our careers. We tend to think that we’ll make up for lack of saving today by saving more later. This is flawed logic, however, because we’re missing out on the power of compound interest. Also, we rarely reach that point where we can magically begin aggressively saving. Here’s some startling information that shows how dismal we are when it comes to saving: the median working age family had only $5,000 saved as of 2013, according to this Economic Policy Institute Study.
Another issue is that traditional budgeting doesn’t work for most. We may start out with great intentions, but like a plan to stick to a strict diet, most eventually fade. We look to tools like mint.com, but these things have one big problem - they’re backward looking. Rather than help us decide what we should do with our money over the next week, month or year, these tools simply give us insight into what went wrong in the past. In order to improve, we must look forward and plan for the dollars that will come to us in the future. Knowing where we have a tendency to overspend based on past behavior is helpful, but not as much as being intentional about what we do with our next dollar.
And finally, who is it that teaches responsible spending habits? Many parents have their own insecurities about how they handle their own money, so they don’t talk about it with their kids. Schools certainly don’t teach us how to handle money. You could be extremely well educated and not have taken one personal finance course in your life. To top it off, even financial advisors don’t spend much time helping people with cashflow because most get paid for selling products, not creating budgets. We’re left in many cases to go it alone when it comes to managing our money.
My Personal Experience
Late in 2014, I decided to quit my job to start Modern Dollar. This meant my wife and I would be going from two salaries to one overnight. We had done our best to create a financial cushion for the income gap, but it still meant we needed to change our lifestyle.
What we didn't plan for, however, was that after my daughter was born in July 2015, my wife made the choice to cut back her hours after maternity leave. So we went from two full time salaries to less than one, with another mouth to feed. The only way to weather the storm was for us to carefully manage our income/expenses.
Using the system I describe below, we were able to do just that. My wife was hesitant at first, but now describes this system as the most financially liberating, confidence-building thing we've done.
A Different Approach - Buckets, NOT budgets
At Modern Dollar we don’t believe in traditional budgets. They’re time consuming, painful and people rarely stick to them. Instead, we want them to look forward, rather than backwards when making decisions about their cashflow. We also want our clients to automate as much of their financial life as possible. We don’t want them to have any question about whether they can or cannot afford to buy something. Our aim is to create a very clear, intentional system when it comes to their financial decisions.
We do this by encouraging our clients to think about their financial needs in three buckets--their past commitments, current needs and future goals. We then set up different buckets(accounts) to manage these varying needs and create automatic flows into each of these buckets. It looks like this:
First, we calculate what our clients need to cover their fixed, past commitments--things like housing, debt payments, subscriptions, utilities, insurance payments, etc. The income that flows into our main checking account is used to cover these expenses--nothing novel here.
We then create a weekly flow of cash into a separate checking account to cover day-to-day spending decisions that trip many of us up. This account then becomes a clear determinant for whether we can afford to purchase something that isn’t being funded as a past commitment or future goal. For couples, you may also consider having individual small buckets for each spouse. That way, each spouse gets something they're free to spend on just themselves. (My wife and I love having these buckets.)
Finally, we’ve also made sure that we’re working toward our mid- and long-term goals by automating flows to our goal buckets, like an emergency fund, a vacation account, a gift account or general wealth building. These accounts could be checking, online savings or brokerage accounts, depending on the time horizon for the money.
The result is a very clear financial picture. We can rest easier knowing our needs our covered, we’re working toward future goals and we know what we can spend today.
I can personally attest to the benefits of this system for organizing my own financial life. My wife I were able to go from two full time salaries down to less than one as we started the business and she pulled back her schedule to care for our first child. Here are a few of the benefits of this system:
Gain Clarity on Your Priorities - When you list your financial goals, it becomes very clear what’s important to you and makes it easier to forgo the trivial things (Starbucks, for example) we’re tempted to buy if it means accomplishing more meaningful goals, like taking a family vacation or saving for children’s education.
Reduce Money Arguments Within Couples - when your financial life becomes much more black and white, you’re less likely to have financial disagreements with your spouse.
Enjoy What You Purchase - because you know that your needs and goals are taken care of, you feel better about spending money on fun things because you know you aren’t compromising your longer term financial health.
Actually Make Progress Toward Big Goals - No longer will you be saying, ‘I’ll save when…’ while you wait for a bonus or promotion. With automation to goal accounts, you’re progressing every month.
Automate & Save Time - Because all the legwork of determining account and transfer flows is done up front, using this system means you’ll actually spend LESS time thinking about finances once it’s up and running. One of my clients spoke to this specifically: “Now I don’t spend every Sunday morning reviewing all of our spending and budgets.”
Lower Your Stress - with this system in place, financial stress is significantly diminished.
We believe strongly that intentional, disciplined use of our cashflow is the most important thing anyone can do to stay financially healthy. If you’ve struggled with this and thought there might be a better way, there is. You really can feel in control of your money.
If you'd like help building a cash flow system that works for you, let's talk. We've helped deploy this system for busy executives with young families, physicians, CRNA's, pharmacists and more.
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