Cash. It’s by far the most important piece of wealth management. And yet it is often the very last thing most people want to focus on. Time and time again, when I sit down with a new client, the first thing on their agenda is reviewing their account statements, while the first thing on my agenda—always—is to take a look at how they’re spending and saving their hard-earned cash. It’s not the sexy part of finance, but much like building that less-than-beautiful foundation to support your beautiful home, careful attention to cash flow and cash management is vital to building and preserving long-term wealth.
Tonya and Ray came to meet with me last week. In their mid-50s, they want to be sure they’re on track by saving enough for retirement and making smart choices about pre- and post-retirement taxation. They’ve also decided it’s time to get help with their investments (better late than never!). They came armed with lots of documentation: account statements, tax returns, and even a monthly budget. They seemed to have all their ducks in a row.
Then I took a closer look at the budget they had set in front of me. There were buckets for mortgage, utilities, insurance, and car payments. But everything I saw listed was a fixed expense. These are the expenses that are predictable and unchangeable. What was missing were buckets for their non-fixed expenses—the very items we can manage to achieve the two biggest goals of wealth management: eliminating debt and growing assets.
I asked the obvious question: “How are you spending your cash?” Tonya was quick with an answer: “It’s right there, in the ‘credit card’ bucket. We charge everything so we can easily keep track of it all.” Sure enough, there was a line item labeled ‘credit card’ with a budgeted amount of $2,000/month. “Ok, I asked, but where is that $2,000 going? Exactly?” They both chimed in with a lot of answers. Groceries. Gas. Restaurants. Car maintenance. Pet food. Prescriptions. Theatre tickets. Clothes. And they were clearly very proud that it was all contained in one manageable bucket. They assured me this method was working well for them.
But was it?
Luckily, in Tonya and Ray’s case, because these expenses were all on a single statement, we were able to track every expense. We drilled down into the details and looked at just a single month to see exactly where their cash was going. The numbers surprised us all. While they guessed they had spent $1,000 a month on meals and entertainment with another $1,000 slotted for necessities, the numbers told a different story. Two concert tickets at $125 each; monthly gym memberships of $120 each; one movie night at $36; four rounds of golf at $195 each (which they assured me was an unusual splurge), including two lunches at the resort for $90 a pop. While they were limiting themselves to one “nice” dinner out each week, they had spent $485 in that category, plus they’d added a handful of less extravagant meals, lunches, and lattes that racked up to $530. Total on meals and entertainment: $2,501. When we added in the other items included in the ‘credit card’ bucket (plus a few other surprises like $260 for housekeeping and $100 on supplements), what they were spending was more than double their original $2,000 monthly budget. Clearly, the budget wasn’t working after all. Without a method for closely managing cash, Tonya and Ray had been blind to the enormous rippling effect of their lack of daily money management and their invisible spending habits.
Tonya and Ray are not alone. All too often I find that even the most financially diligent investors fail to have a basic financial planning document that includes a detailed record of their cash flow. Twisting arms doesn’t work (trust me, I’ve tried!), but by biting the bullet and following these three steps, they (and you) may finally get on the right path:
Identify your top 3 goals—and make building an emergency cash fund #1. Regardless of the state of your finances, having cash on hand to cover unbudgeted expenses is key. Having an emergency fund equal to at least three months of your total household income is essential to avoid having to take on new debt in the future. Goals #2 and #3 might include paying off credit card debt, saving for a car, or funding next year’s vacation. (Read more on the power of an emergency fund in my blog When did it become ok to be financially illiterate?)
Identify your income and your fixed expenses. Income is what you’re bringing home each month—salary, distributions, etc. Fixed expenses include mortgage or rent payments, insurance, utilities, and non-credit-card debt such as car payments. Be sure you know what’s coming in and what’s going out every month.
Build your detailed budget. Err on the side of too much detail, and create a line item for every expense category. Separate your needs from your wants, and keep an eye on your top 3 goals from Step 1, includingcontributing to your emergency savings and paying yourself first for retirement (see my blog Getting back to basics in the New Year for more on this important topic).Be specific, and be certain your expenses don’t exceed your income! I encourage you to use a basic household budget worksheet like this one from Kiplinger. While there are apps available to help, none of them can do this work for you, and they can be more of a distraction than a benefit.
If the word “budget” reeks of giving up your spending freedom, rest assured that careful management of your cash flow is certain to have the opposite effect. By parsing your spending, aligning your spending habits with your personal goals, and projecting your cash flow into the future, you will gain the financial freedom you’ve been seeking all along—guaranteed. And the effects are long lasting too. When done well year after year, you’ll slowly but surely develop a comfort level with your actual life costs. You’ll realize you know whether something is “in the budget” without having to look at the numbers. And when changes happen like buying a home, changing jobs, growing a family, or ending a relationship? It will be that much easier to adjust to life’s transitions, whatever they may be, and rest easy knowing you (finally!) have your cold, hard cash under control.