So I was speaking with an acquaintance after having written my blog post “Plight of the Average American”. I explained that I was inspirited to write that post because I was very surprised at the statistic that nearly 2/3s of all Americans live paycheck to paycheck. The person I speak of is a well educated professional with a good job making a decent income. His complaint to me was his scant savings. After chatting with this fellow it became apparent to me that while there are many educated people out there with good jobs, a high percentage of them have no money management skills. So I decided to write this blog post which is just a starting point to suggest some concepts to help with money management. As an investment advisor representative I feel it is imperative to help people understand their monetary situation before even thinking about investing.
The first thing to do is to look at your inflows of cash. Inflows are generally pretty easy as most people receive a paycheck and know what the after tax amount is.
The second thing to do is more complicated as you need to document all your outgoing funds. This means that you will need to gather up all the bills you have paid over the last year so you can figure your annual expenditures and see what the average monthly expense is in each category. After you annualize the bills it would also be an opportune time to see where your money is going and make some decisions about that. I think you might be surprised to know how much is spent on what. You should look at these figures and see if there are items that can be eliminated or services that could be shopped around like cable TV or the mortgage. It is important to make certain that inflows are greater than or equal to outflows, if not a different discussion needs to occur.
Making the assumption that you have more money coming in than going out, we can proceed.
The reason for averaging the bills is that while some like your mortgage are static meaning it is the same amount every month, others can fluctuate significantly like your electric bill after having to run the AC for days on end in the summer. If you are careful about setting aside money for your bills each month the average should cover the high bills, since the cash allocated for that item will be less in some months leaving a surplus.
After you have figured out the monthly average and subtracted that from your total inflow, you are left with your disposable income. This is the point at which most people make the biggest mistake, they look at the balance and think to themselves …cool I have plenty of money to spend. The reality is that you should shoot to save at least 5% of your income, but 10% or more would be even better. Of course if you can’t afford to save these percentages it is still important to save whatever you can not only to build up savings but also to develop the habit.
The second mistake people make is not paying themselves’ first. What this means is, when the check comes in and you have taken out your budgetary items you should automatically remove your predetermined savings before any discretionary spending. Ideally, you should move that amount out of your main account to a savings vehicle of some kind as to avoid temptation and or comingling. It is unfortunate that at the time of the writing of this blog post the FED is punishing savers with incredibly miniscule interest rates well below the rate of true inflation. Until you have 3 – 6 months of living expenses saved you should not be outrageously concerned with the return on this capital but more with the return of the capital. Your emergency fund should be in something very safe and liquid as you need to be able to count on it being there. After your emergency fund is filled then you can look at other areas to park your money that could generate better returns and the risk factor will not keep you up at night. If you follow these steps you can take giant steps away from living paycheck to paycheck and buy yourself some breathing room. Of course there could be setbacks that are unforeseen such as a home or car repair which could cause you to tap in to savings, but hopefully you will have a cushion to fall back on. Just don’t forget to continue the savings program and you will find life to be less stressful knowing you have some insurance even if you can only set aside a few bucks at a time.