One of biggest challenges ALL young professionals and families have to deal with is managing what comes in and what goes out every month. Even though we have been doing it for centuries, I believe this vital skill has failed us in more recent times.
We now have been hit new challenges on how to do this successfully. We have been forced to learn a new way and our attempts at this are in general pretty ordinary at best. This will get worse i believe as cash leaves our society forever.
Today it is a consumer world, we love to spend money. Over the past fifty years there has been an explosion of credit cards and the ability to spend what we want.
In the past 10 years, there has also been a second explosion. We are now dealing with the rapid migration from paying by cold hard cash to card, phone or perhaps finger prints one day.
“Back in the day” the boss would arrive with your weekly pay check in an envelope every Friday afternoon. The hopefully thick envelope would be filled with $10 bills and you would go home feeling happy and financially rewarded for your weeks work.
Happiness however was quickly cooled as you understood that you had to be careful. It may not be wise to pop down to the pub or off clothes shopping on the way home. There are many things you need to take care of before you can begin to play and have fun.
After skipping through the front door the process would begin of allocating your income to different pots. One pot would be for rent or the mortgage. Pot two would be for food, bills and living expenses. Pot three would be for a rainy day and the future and hopefully there would be some left over for pot four.
This was the fun pot. This and only this amount would be what you could spend with your family. Perhaps you could choose to have an evening of entertainment at the drive-in cinema, maybe you would take the family ten pin bowling or maybe you would put it away with the view of buying some new g-plan Danish furniture next month. Families could only spend what they had left over and if they did have any leftover, they knew they had to make the most of it.
While this was a long time ago, I believe for a large amount of Australians this would still be the best way to be paid. Sounds crazy but imagine getting $5,000 in $50 notes each month.
I argue the easy and fast electronic way of today creates all sorts of problems. It benefits society more than the family themselves that have worked all month for it.
When we are paid electronically it's hard for us to associate a days work with a days pay. We are paid weekly, fortnightly or monthly and it hits our bank account in one large payment. Our minds do not break it down and allocate it as $250/day for 20 days work. It’s just $5,000 to us.
The number originally feels huge as we have just been paid for a months work. Perhaps it is $2,000, $5,000, $10,000 or $15,000. The number itself does not really have any meaning. We fail to think through what we actually did to get it - 160 hours of work perhaps and go on living our lives as we are now rich again.
This mental process I believe is the first common mistake people make towards managing their cash flow.
If you did just get paid $5,000, I would like to know just how much of it is truly in the final box. How much can you spend on a weekend away with friends or should you invite them over for a game of Monopoly?
Warren Buffetts has many famous quotes but this one I particularly like.
Do not save what is left after spending but spend what is left after savings
It sounds like Warren was referencing the system we once followed when we got paid by actual cash each week. A system we all had to follow and one that we grew up only knowing.
This undoubtably is one of the biggest and most fundamental mistakes society is making in regards to challenge of achieving true financial freedom.
As a young one, the oldies definitely knew what they were doing. They knew the formula and they spent what was left each week after they had allocated money to rent, bills and savings. This is something I believe is very rare today for most Australians.
The first credit card was released back in 1946 by the National Bank of Brooklyn. While the demand started off slow, by the time 1970s was finished credit cards were flying.
As you can see below, credit cards (and banks on the back of them) have had a wonderful time growing for around 35 years now. You’ll notice salaries have only been growing at a steady rate however and that could create a slight problem?
The major problem with purchasing or spending on credit is the truth behind what you are actually doing.
The ability to buy something on debt allows you to bring forward the savings you have planned to save in the future and allows you to spend the savings today.
What a great invention the credit card is.
In other words, what you are forcing yourself to do is allocate the money you are planning on saving for the future and forcing yourself to pay off that wonderful new purchase.
Furthermore, you are now no longer able to save for the future as you have to pay off the debt. The interest compounds this situation and instead of it being two years worth of savings it is now becomes three.
This "NEW" pot is part of the reason we are struggling at managing our cash flow.
The credit card breaks all the rules of good cash flow management as we initially discussed.
It has added another level of complexity and adds another pot to consider in the equation.
If I have to pay off the credit card from savings and I also want to save for the future, what do I need to do?" Save more!
How do I save more? Well I need to spend less or earn more.
I believe credit cards and the consumer society we live in today makes it very difficult for us to spend less. We can always choose to pay the minimum repayment and continue on with our lives as normal. That is what a lot of us continue to do.
Cash to Nothing
The final part that has made this equation all too difficult to manage is now card payments.
Tap and go, pay wave, Apple pay, Paypal, online shopping and all the wonderful inventions we continue to come up with to make it easier to spend and harder to save.
Gone are the days when we had a $100 in our wallet for the week. We now have 3 credit cards all getting different frequent flyer points and we tap away like we still have $100 left till we actually have $100 left.
The problem with electronic payments is we conveniently forget what we spend.
Like all good things on Linkedin, I will give you a maths problem.
If you had a $100 for the week and spent $10 on lunch, $3 on parking, $2 on a newspaper and $15 on a birthday gift – the wallet would have $65 left yes?
Ok there is $70. Good to see you are still awake. The good thing about the wallet is that it never lies.
Now I argue if you paid for all that on your funky new phone tap and go, you would not have guessed $70. You would have forgot 1 thing at least. I have not got the research on this (I'm sure it is out there) but fundamentally we all know that there are only so many things our brains can remember.
Spending money is not something we usually want to remember.
So what am I getting at here you might be thinking?
One of the most confronting exercises I do with new and existing clients is help them think through their lifestyle pot. How much of their $5,000 or $20,000 a month that comes in do they have left over?
Unfortunately it’s a scary exercise for most and the $15,000 that comes in may only have $3,000 left over.
Sydney is expensive, living here is expensive but what is the biggest problem is the way we choose to spend it.
I challenge you to do one exercise and make this article not go to waste.
It’s simple. It may take you 15 minutes but I assure you it will make you look at your hard work each month a totally different way. You may even decide to say bugger it and get out of this rat race altogether.
Step one: Write down your monthly wage/s. = IE: $10,000.
Step two: Write a list of all the expenditure you have to spend to survive or continue to live your current life. Note: this is not anything you don't fundamentally need to spend.
IE: Rent, Interest on your mortgage, bills, car, basic goods.
For example this may be $5,000.
Step three: Calculate all short term debt owing like credit cards and divide it by 12 = $10,000/12 = $850.
Step four: Now if we say your goal was to save around 20% of what you earn month. Leaving you the ability to spend 80%.
In this case it was $2,000.
Step five: What is left
You actually only have $2,150 left for the month. This is amount you have left to play with and to cover everything.
The $10,000 each month no longer exists. It’s now only $2,150. That is what you earn. That is what really hits your bank account each month not $10,000. It's best to forget about the $10,000 and realise you earn $2,150 now.
So my question is what do you really earn?
Do you believe it is $10,000 a month or is it $2,150?