Savings and Investing Series: Part II - Building Your Financial Foundation!
In Part - 1 of the Savings and Investing series, Getting in the Mindset, we discussed getting into the proper mindset by establishing specific, targeted goals, as well as the importance of becoming hyper focused on your desired action.
Moving on in our quest to build our financial success we will work our way through the three levels of our financial pyramid. Beginning with the Management Level we will set the groundwork and lay the foundation on which we will build upon. We then will progress to the Savings Level, where we will create and fund specific accounts in order to achieve short term goals and to self-insure from emergencies that may try and throw us off course. Finally, after the stage has been set, we move into the Investment Levels, the third and final stage where we really begin to flex our financial muscle and witness our goals become realities.
Controlling your spending is the first step we need to complete in establishing solid financial management. Think of financial management as a bowl. In this example, financial success is represented by filling the bowl with water. If one lacks the ability to control spending, it is like poking holes in our bowl; the more out of control we are, the more holes there will be.
In this example, there are now only two options to successfully achieve the goal of filling the bowl with water; the first being that we can pour water into the bowl more quickly or with greater volume, the second being that we could simply plug the holes.
The first option represents what the average person would attempt, it is our belief that we can out earn our stupidity, our out of control spending, simply by earning more money. While that certainly creates the illusion of success, the underlying problem still exists.
The moment the water ceases to pour, or the money diverts to a competing interest, the water level will once again begin to drop. If our income were to be reduced, i.e. job change, unpredicted termination, or pregnancy, our accounts, just like the water, would deplete.
If we had an unforeseen emergency, i.e. hospital visit, blown transmission, house fire, you know, the basic things that life throws, we would now have a competing interest that would divert the flow, and once again, reduce our ability to maintain the desired level; once again, our water would drain out!
This leaves us with our second option; simply plugging the holes. If that same individual took an operational pause, plugged those holes, controlled that spending, and then carried on with no change in income, they would find that the bowl fills with water rather steadily. Similarly, the person who has proper financial management will find that they too experience steady success throughout their financial journey.
How do we control our spending? Is there anything that you use that helps you to control yours? Great question and glad you asked! I’m going to use a word that will likely make you cringe. It’s a word that many avoid and leaves others feeling confined and restricted. Are you ready? You need… A budget!
Being honest with yourself, how often do you find yourself with too much month left at the end of your money? How many times have you sat there and wondered just where the heck has all your money gone? I challenge you to perform a quick test. Write down on a piece of paper your total income for one month. Now, off the top of your head, add up all of you living expenses for just one month. Subtract the living expenses from your monthly income and just sit there. Look at that number. That number represents how much money you should have left over at the end of each month; are you even close?
I can hear you right now saying to yourself, in a timid, almost questioning tone “oh, we do a budget!?” I hate to be the one to tell you, but you probably are lying to yourselves.
Doing a budget means more than making guestimations and approximations throughout the month. Doing a budget means sitting down before the start of a new month and planning for all of your upcoming month’s expenses.
If you are Married, you and your spouse will sit down together and together you will decide where your money will be allocated for that upcoming month. This is a must if you are married. You and your spouse MUST be on the same page when it comes to finances especially when considering that financial arguments are the number one cause for divorce.
How accurately do your budgets need to be you might ask? Down to the last dollar! There are many apps and books out there, many of which are over the top and confusing, that’s why we personally use and recommend Dave Ramsey’s free EveryDollar App, available for iOS and Android. They also have a web based version at everydollar.com!
Why do Nelli and I use EveryDollar? Simplicity, connectivity, and highly effective! The EveryDollar budget is based on the zero-based budget system. On the top of the page, you enter your total anticipated income for the upcoming month. Below that you now assign every-dollar, see what they did there, to a specific category for that upcoming month, and as you do, your “remaining income” will begin to lessen.
The goal is to get your income number on top to equal zero, not because you have “spent” all the money, but because you have assigned every-dollar a name, i.e. savings, groceries, debt payments, utilities, etc. The categories are completely customizable and impressively intuitive.
As if that isn’t powerful enough, the app then takes it a step further by doubling as an expense tracker. Every time you make a purchase, you simply hop on the app and enter that purchase in the appropriate category and when you do, your remaining balance for that category lessens to reflect your purchase. It is impressively simple to enter purchases!
The best part is that the app syncs between multiple devices. This means that if we have a monthly food budget of $1,000 (random number to make math easy!) and I go and pick up $250 in groceries, the app on Nelli’s phone will now reflect that we only have $750 remaining in our food budget. This is very helpful in keeping things in order within a household!
When you begin your first budget it will take 2-3 months before you really hone in on how much you spend in each category. I’ll tell you right now, whatever you put down for food, add at least $250 to it because I promise you your initial guess is incorrect! You’ll see!
I know this isn’t exactly the excitement you were looking for however if you were to ask Nelli or I the one thing that we did that led to our financial success it would be our monthly budget meetings and the utilization of this app. It kept us honest to ourselves, honest with one another, and on track to achieving the financial goals we were looking for. These "budget meetings" prevented either of us from going rouge and making the undisciplined impulse purchases we had in the past. This is not to say that we are now unable to purchase items we desire, the budget simply allows us to plan for these expenditures a head of time and allows each of us to ask the questions, "is that really something we need?" "Do we really need that as much as we want to be debt free?" "Do we really want that as much as we want a house, mortgage free?"
The funny thing was, at the end of the day, the thing that was to represent restriction, and confinement, actually became a tool that gave us permission to spend! Through budgeting we became able to live more comfortably with one single income than we had in the past with our dual income family. It became the tool that would eventually guide us into achieving our financial freedom and independence!
I could go on and on regarding the importance of the budget and how to properly utilize the Everydollar app, but I will leave that for a future post!
If you haven’t read my article, Personal Finance Done Right: Breaking Away From the Joneses, I recommend you check it out. In that article I discuss, in detail, the seven steps that Nelli and I followed in order to achieve that financial freedom!
When utilized correctly, a budget is a powerful tool. As you transition from an out of control consumer to a responsible adult, you will likely feel a sense of burden, of guilt, of obligation… This is called responsibility; welcome to adulthood!
“Children do what feels good, adults devise a plan and follow it.” – Dave Ramsey
The next step is ensuring that you have suitable income. If you are working part time what is your per hour wage? How many hours are you working each week? 20? 40? 60+? If you are full time, what is your salary? Can you work overtime? Is a second job necessary? Perhaps you could achieve a new certification and seek a new position with higher income?
How much income one needs is solely dependent on the life that one has decided they wish to live. This is why we call it personal finance as every individual, every family is different. Ask yourself what kind of life you want for you and or your family and then you can best answer the question as to how much income you truly need.
To complete the Management level, you need to have insurance in place. The purpose of Insurance is simply the calculated transfer of risk from you to an insurance company. Insurance is like wearing a helmet. It’s a bit of a hassle when things are going well, however when you fall off your bike, you’re extremely grateful you took the time to prepare.
Without adequate insurance, you take on all the financial risk and, unless you have amassed a significant net worth, are one emergency away from being in significant financial hardship.
The main types of insurance that I recommend are:
Health
Auto
Homeowners/Renters
Long-Term Disability Insurance
Term Life Insurance (NOT whole, universal, or variable life)
Umbrella Policy (if net worth is greater than $500,000)
An upcoming post is in the works where I will discuss insurance more thoroughly. How it works, who needs it, and I will explain my reasoning behind why whole, universal, and variable life are some of the worst financial products on the market today and why many financial experts refer to whole life insurance agents as the “payday lenders of the middle class.” Until then, just trust me when I say that buying your life insurance from the same company you buy baby food from is simply not a good idea!
