Written By Kevin Burkle, CFP®, CSLP® | Founder of HCP Wealth Planning
Cash flow analysis should be one of the first steps in any plan to achieve financial wellness. It's the heartbeat of your financial plan. If you ever meet with a financial advisor who immediately wants to talk about how you should invest, before reviewing your cash flow and understanding your priorities, this should be a red flag. Studies show that those who have a formal plan in place to track their spending are twice as likely to report having no financial worries. By having a documented plan for how to allocate your income, you are more likely to connect the money you have with the lives you truly want to live.
At this point most of you are probably thinking, "Budgeting Sucks". Yep, the word "budget" gets a bad rap. But a lot of that has to do with how people think about budgeting. If you think of it as an exercise in figuring out how to spend less money on the things you like, of course that doesn't sound fun. But I know from personal experience that once you really start to track your spending, you are likely to discover that a lot of it is wasted on things that really aren't all that important to you. This is because its so easy to lose track of our spending when nowadays we just mindlessly reach for credit cards whenever we make a purchase instead of using cash. And don't get me started on the 1-click "Buy Now" button in the Amazon app. I'm a longtime CFP® and I'll be the first to admit that thing got the best of me for a while until I deleted the app.
The most effective way to approach this process to tell yourself that you aren't going to focus on spending any less, you are simply going to reallocate your hard earned cash to the things in your life that will lead to the most fulfillment. So how do you go about creating a plan to optimize your cash flow?
The Cash Flow Optimization Process:
- Determine Your Goals: Really, this is the first step overall in the financial planning process, not just the budgeting process. This doesn't have to be an extremely formal process. It can be as simple as writing out a list of goals and then prioritizing them by assigning a number 1-10 with "10" being the most important. If you plan with a significant other, this is a great exercise which encourages you to have an open conversation about your goals and helps you to come up with a plan that balances both of your priorities. The key here is not to make all of your goals purely financial. For example, when our clients go through this process, in addition to having them rank priorities such as saving for retirement and paying off student loan debt, we include goals such as spending more time with family, scheduling more date nights, traveling more, and pursuing hobbies and interests (of course these might temporarily look a little different until we get past this pandemic).
- Do A Deep Dive Into Current Spending Habits: This is where you want track your purchases for at least 30 days, but ideally 90, and assign them to categories, i.e groceries, utilities, online shopping, etc. You can do this the old fashioned way with an excel spreadsheet but nowadays their are a ton of apps like MINT, Dollarbird, YNAB, and Pocketguard that can simplify this process for you. I haven't reviewed these personally since we use our own budgeting portal with our clients, but any of them should get the job done. You can either just pick a day and start tracking your purchases moving forward, or look back retroactively at the past 30-90 days of expenses using one of those apps and/or your transaction history for your credit and debt cards.
- Determine if you have a monthly deficit or surplus in your cash flow: It's important here not to compare your total monthly expenses to your gross pay. You need to compare them to your take home pay after your taxes, health insurance premiums, retirement plan contributions, etc have been deducted from your paycheck. This amount is usually what ends up being automatically deposited to your bank account. If there is a bit of a deficit, try not to panic. This is where you want to review how much you spent in various categories and see if there is a place where you can cut back. If the deficit is at least partially due to having to make high monthly payments on credit card debt, or student loan debt, now is the time to explore debt management strategies. For high interest credit cards balances, you may want to see if you can transfer the balance to a new card with a 0% promotional interest rate on balance transfers. Warning: In most cases when you see a card offering a 0% promotional rate on balance transfers, they charge you a one time balance transfer fee that can typically range from 3% to 5%. There are a few credit cards that offer both a promotional 0% interest rate AND no balance transfer fees. Try to see if you can qualify for those first before exploring other options.
- If you do have a monthly cash flow surplus, It's time to start spending! OK, that's a bit misleading. Don't reinstall that Amazon app just yet. What I mean by this is you should compare your goals from step one to your spending habits in step two. Then start spending more on the priorities that appear to be underfunded and less on the stuff you don't really care about. For example, if one of your goals is to have more frequent date nights with your spouse once this pandemic is over, allocate some of your surplus to a "date night fund". The more money you have in that fund, the less likely you will use lack of time as an excuse not to go out together. As you go through this process, ask yourself if there are any surprises. When my wife and went through this process a while ago we were astounded by just how much we were spending on dining out (those $7-8 beers and house wines really add up). This, even though we knew we would rather have spent that money on travel and on boosting retirement plan contributions. Very few of those meals were even memorable, they were mostly out of convenience.
The end goal is to have what is known as a zero-sum budget. This means at the end of each month, you don't have a cash flow deficit or surplus. Every dollar is allocated towards a goal and has a "job". Some of it goes into short and long term financial goals and the rest is allocated towards different spending categories. Always make sure that you have an emergency fund goal. This is a dollar amount set aside in a safe place that won't lose value like an investment potentially can, and can be used to cover unexpected expenses. A common rule of thumb is to have an emergency fund that can cover 6 months of essential living expenses if you are a single income household, and 3 months if you are a dual income household.
5 Mind Tricks to Help You Stop Buying Stuff You Don't Really Need
Simpy ask yourself before you buy, "Is this a want or a need?"
The stranger test: Imagine you are considering the purchase of an item. Lets say that item costs 30 bucks. Now imagine a stranger appears in front of you out of nowhere. In one hand they are holding the item. In the other hand they are holding $30 in cash. They tell you they will give you either one, no strings attached. Ask yourself which one you would choose. If it's cash, you probably shouldn't buy the item.
Stop yourself from making impulse purchases by waiting 1 day for every $100 in price.
Automate your savings. You already do this with with your 401(k) or 403(b), but try it for other goals as well. If for example being able to afford to travel is one of your main priorities, open a savings account and have your travel budget money directly deposited out of your paycheck into that savings account. This way you never see it in your checking account.
Know how much you earn per hour after taxes, and think of prices in hours. Do you really want to buy that bottle of wine that costs you two hours at work?
Whether you are fortunate enough that your income has not been affected by the Coronavirus pandemic, or you have had your income impacted in any way, these tips can help make sure money is going towards the things that are most important to you. One thing you can be certain of, is that your priorities will change over time. So a best practice is to go through this exercise on a regular basis as you life changes and throws you curveballs.
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