- Cash flow analysis should be one of the first steps in any plan to achieve financial wellness. Yes, you should do this even before analyzing your investments. 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. This all goes back to the popular Harvard Business Study about setting goals which revealed the following statistics:
- - 83% of the population does not have goals.
- - 14% have a plan in mind but are unwritten goals.
- - 3% have goals written down.
- - The 14% who have unwritten goals are 10 times more successful than those that don't.
- - The 3% with written goals are 30 times more successful than
those without any goals.
Basically, if you have a documented spending plan, you are much more likely to connect the money you have with the lives you truly want to live. So how do you create one?
The Cash Flow Optimization Process:
1) Determine your financial 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.
"But Budgeting Sucks!"
- Yep, the word "budget" gets a bad rap, but a lot of that has to deal with how people think about budgeting.
- If you think of budgeting as an exercise in figuring out how to spend less money on the things you like, of course that doesn't sound fun.
- But guess what? 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 better way to approach this is 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.
2) 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.
3) Determine if you have a monthly deficit or surplus in 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 most likely what ends up being automatically deposited to your bank account.
- Hopefully, if you are a full time healthcare professional, you won't have a deficit. We may not see you on an episode of Below Deck anytime soon but you most likely aren't in a position where you are racking up credit card debt. I know this because my wife is an RN and we lived off her salary alone for over a year while I was a stay at home dad and was preparing to launch this firm. And we all know RN's aren't exactly overpaid.
- 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 which we will also discuss in this course.
- If you do have a cash flow surplus, this is where the fun begins!
4) Time to go shopping!
- 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, 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 I did this 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.
- 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 Things That Don't Align With Your Priorities
- 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. 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 funds 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?
- Following this process enables every dollar you work so hard to earn to have a purpose.
- Budgeting doesn't have to be about cutting out the little things in life that really make you happy.
- Having a solid foundation for a cash flow strategy will only make the rest of the wealth building process that much more effective.
- If you take these four steps to heart and act on them, even if you don't read any of the other modules, I have no doubt that you will be closer to attaining the peace of mind that comes with achieving financial wellness.