Money management, I feel it is the basic foundation to all wealth creation strategies, it must be easily repeatable and built upon solid principals. I will break money management down into 3 stages that will hopefully lay solid groundwork for future investing. Each stage will have it’s own post.
The first stage of money management as I see it are CASHFLOW PROTECTION & BUDGETING. If you don’t have sufficient and regular cashflow it’s a pretty hard slog in today’s society, also if you don’t plan your future cashflow’s you’ll inevitably find yourself short or at the very least to unable pay some large bill that you hadn’t accounted for previously.
Ok then, this is how I began my “cashflow protection”. I basically started by deciding how much I would need to ensure that I had a buffer against the majority of unforseen events which may require a large payment ie things like car breakdowns, medical bills etc. The figure I came up with was $3500, which was approximately 1 months worth of expenses for my wife and I. Each person’s/families circumstances are different so you’ll have to make the decision on how much you’ll need to put aside as a cashflow buffer.
To get the ball rolling, I bit the bullet and actually sold my CD collection, at the time I had approximately 150 CDs in my collection, I sold each one on ebay for approximately $7 on average. Note, before I began selling the cds off, I burnt a copy of them onto my computer hardrive into MP3 format, I figured I can make a personal copy since I already purchased the originals and scanned the cd covers. So 150 Cds at $7 each gave me a jump start lump sum of $1,050 not to bad a start.
That gave me another $2450 I had to dig from somewhere, I had shares I could have sold off, but in Australia the markets where climbing to all time highs, I didn’t think it wise to start selling off now. So once again I bit the bullet and apportioned a set percentage from the monthly family after tax income (perhaps I should have used pre-tax income figures but the difference wasn’t that great), 10% was the figure which amounted to $520 per month I would set aside BEFORE I budgeted for normal expenses.
By setting aside a total of $520 BEFORE I budgeted for normal expenses meant that I was ensuring I would keep to the plan. I used my banks internet banking to setup an automatic deduction as the paychecks went into our account. Money went in from the employer, and the money went out automatically, so the decision was out of my hands each month, no room for human error there and the plan wouldn’t be subjected to the old “I’ll just use some of the money this month and i’ll put in extra next month” syndrome, that strategy never works, I know I tried it for years hehehe.
So after about 5 months we had our buffer set up, we decided to put it into our mortgage interest saver account, a basic mortgage offset account which would decrease the interest we would pay on our mortgage by decreasing the daily balance from which interest was calculated. Eg 150,000 mortgage @ 6.7% monthly interest totals $826, with $3,500 in a mortgage offset account the interest was only calculatd on 146,500 so monthly interest reduced to $806. Saving of $20 per month, not that much but it adds up, and the interest saved is akin to earning interest, but the beauty is you don’t pay tax on it like you would if the interest was earned in a normal interest bearing account. Using a mortage offset can signficantly reduce the time it takes to pay down a mortgage.
Take this for example, $150,000 mortgage @ 6.7% 25 year term you put your paychecks directly into the account and keept building it up on average you can pay off the loan in only 11 years rather than 25, a saving of 14 years and about $96,000 in bank interest. It’s a sweet deal I reckon.
Anyways back to the issue at hand. So $3,500 was now saved as a cashflow buffer, we now had to find an effective way to budget our monthly expenses and other “large” expenses like rates/electricity/car repairs/car rego etc which only happened every few months or irregularly.
We found the easiest way was to as usual write down all the regular bills we had monthly, like food/groceries, fuel, mobilephones, home phones, internet etc all the regular expenses of today’s living. An amount was set aside for each.
Then we looked at those expenses which we knew would come sometime like Car Registration which would typically be about $700 per year, I drive a HONDA ACCORD EURO/TSX. Now knowing that this was the case we simply split the bill up over 12 months or however many months we had left till it typically fell due and added to our MONTHLY EXPENSES budget. This would ensure that when the time came up there was definitely enough money set aside to pay for the bill when it came due. Simple but effective.
To automate the whole process, my wife and I decided to use MONEY. We liked it because it provided a very nice function called CASHFLOW REVIEW. It basically showed graphically how your main account fluctuate as each bill became due during the month, it showed whether you would be “negative” balance one day or whether it would keep building up in balance over time. The advantage of this is that you can keep re-adjusting your budget so that you smooth out any “negative” balance days which may pop up early in the piece, this is particularly the case early on as you try and build up your cashflow buffer.
One VERY important thing we tried and managed to do was keep ALL expenses down to at most 70% of our cashflow each month and we’ll keep trying to whittle this down further as we pay off our “personal” debts and mortgage, this amount may vary depending on your personal circumstances but I definitely would encourage you to at the very least maintain 10% for yourself to at build up your cash buffer then work towards decreasing the expenses percentage when you can.
So there it is my cashflow protection and budgeting in a nutshell.
Let’s summarize the whole thing.
- BUILD A CASHFLOW BUFFER
- MAKE IT AUTOMATIC BY USING AUTOMATIC DEDUCTIONS SETUP THROUGH INTERNET BANKING OR YOUR BANK BRANCH
- SET OUT ALL YOUR REGULAR MONTHLY EXPENSES AND FIND OUT WHEN EACH ARE DUE. GIVE EACH EXPENSE A BUDGETED AMOUNT
- FIGURE AT AS MANY LARGE NONE REGULAR BILLS LIKE CAR REPAIRS OR HOME RATES/ELECTRICITY AND SPLIT THE BILL UP INTO MONTHLY PAYMENTS
- TRY TO ONLY BUDGET A MAX OF 70% OF YOUR MONTHLY CASHFLOW TOWARDS EXPENSE
- 10% USED TO BUILD UP A CASH BUFFER AND ULTIMATELY PAY YOURSELF FIRST (HOW VERY DAVID BACH OF ME)
- WE’LL FIGURE OUT HOW TO SPEND/INVEST THE OTHER PORTIONS IN LATER POSTS.
STEP 2 we’ll address the all important PERSONAL DEBT ELIMINATION.
BigBuddha – Financial Knowledge is the key to Financial Prosperity