Turning the Page – Financial Reform Part III

This is the third article in this series on personal financial management. These articles are designed to work together to help you achieve control of your finances and better manage your money. If you haven’t read the first two articles yet – please go back and read them before proceeding. You’ll be glad you did.

In “Turning the Page – Part I” we talked about developing a plan to eliminate your debts and tracking your cash flow over a period of time.

• Step One
o Organizing your debts according to the interest rate and developing a plan to pay them off over time. Hopefully you are already making a dent in that mountain of debt you’ve accumulated and are starting to feel better about yourself. Well done! Keep going!

• Step Two
o Recording your expenses (bills & purchases) month by month and sorting them into their respective categories. Hopefully you have been looking at the information you’ve been diligently collecting and have started to notice a few things. If you haven’t done that yet please stop now and fill in the appropriate columns in the spreadsheet.

In Turning the Page -Part II we talked about understanding the how, why and when you spend money.

• Step Three
o Reviewing your cash flow over the past few months to see how your priorities and pattern change now that you understand yourself better. Thinking about when, how and why you spend money and making changes in your spending habits so that your conscious and unconscious priorities are more in line with each other.

o Understanding the 3 key concepts that affect your cash flow:

 Elasticity – some expenses are fixed and some are elastic. The more an expense category changes from month to month the more elastic that expense category is. The more elastic an expense is the more control you have over how you spend your money. The money for what you want to do could be buried in what you are already doing!

 Priorities – how you choose to spend your money tells you what your priorities are. Your conscious priorities are how you think you should be spending your money. Your unconscious priorities are how you are really spending. Ask yourself if you are happy with how you are spending your money!

 Patterns – your cash flow has a pattern. Understanding where the peaks and valleys hit in your cashflow will help you know when you have excess cash to work with and how much you can save to cover the gaps. Having money in your savings will help you break the credit dependency cycle!

Now, in Part III we’re going to talk about setting goals and planning for your future.

I think taking a road trip in your car is a great analogy for life. Before you can figure out which route you need to take, you need to decide where you want to go. The same thing applies to your life. Before you can create a financial plan (or a “financial roadmap”) you need to figure out where you want that plan to take you. I call this your “financial destination”.

Your financial destination can be described using dollars but I find it easier to think of it as a lifestyle. Your lifestyle is made up of your environment (Where are you living? What does your home look like? What community are you living in?) and your activities (What is your profession? What are your hobbies? What are you doing with your time? Are you married? Do you have children?).

• Step Four
o Pick a date that is at least 10 years from now and spend some time thinking about what you would like your lifestyle to be at that point in time. Take a piece of paper and describe your lifestyle at that point of time in the future. Start by answering the questions in the previous paragraph and go from there (point form is fine). This is your destination.

If we go back to the road trip analogy, now that you have figured out what your destination is it is time to create the “road map” that will take you there. Do you see where I’m going with this? When you drive down the highway and you come to a fork in the road the road map tells you which road you need to take to get to your destination. In the same way your financial road map helps you make the decisions that will take you towards your preferred lifestyle instead of away from it. In effect, you are asking yourself: “What do I need to do to get from where I am today to where I want to be in 10 years?”

You can think of those financial forks in the road as your financial goals or choices. Every choice you will face has 3 basic components:

• A description – this is what you need to do.
• A cost – this is how much money it will take to do it.
• A time frame – this is when you need to do it.

Let’s stop here and look at an example:

Description Cost Time frame
Take a vacation $1,200 12 months from now

I picked a vacation for this example because everyone likes to take a holiday. Another simple example is buying a car but we’re going to talk about that exercise in the next article.

So, if I want to take a vacation 12 months from now, how am I going to do it?

If I do like most people I’m going to completely forget about it until 11 months from now and then I’m going to rush out and put the trip on my credit card and pay for it over months and months and months. If I put the trip on my credit card and want to pay it off over 12 months I will need to pay $128 per month (depending on the interest rate). By the time I’m done and the interest is added up that $1,200 trip will have cost me over $1,540.

Instead of putting it on my card and paying it off afterwards I could do this:

Description Cost Time frame Monthly savings
Take a vacation $1,200 12 months from now $100

If I save $100 per month for the next 12 months I will have $1,200 to pay for my holiday. My cost will be $1,200 less the interest that the money earns sitting in my savings account. That may not be a lot of money at the current interest rate but it’s at least $340 better than the alternative, isn’t it? And my monthly payment will be less.

This is a concept that I like to call “eating the elephant”. You can eat a whole elephant if you break it down into bite sized pieces.

• Step Five
o Take some time and think about what things you need to do and want to do over the next 10 years and write them down in a 4 column table like the one above. You might find it easier to think about your financial road map as a timeline and ask yourself: “What do I need/want to do next year, the second year, the third year, etc.?) This will help you organize your goals into short term, medium term and long term goals.

For Example –

Description Cost Time frame Monthly savings
Take a vacation $1,200 12 months $100
Down payment for condo $15,000 5 years $250
Buy a vacation property $60,000 15 years $335
Total monthly savings to reach these goals in the required time frame = $685

What you are aiming for is to have enough money for your general livings expenses and some money left over at the end of each month for your goals. If you have more available to save than what you need to achieve the goals you have set then you can add other goals or reach the existing goals faster. (Shortening the time frame or increasing the cost will increase the amount of monthly savings required.) If you aren’t able to save enough each month then you need to rethink your goals – (increase the time frame or reduce the cost until it works) and look at your cash flow again.

Remember that cash flow tracking sheet you started months ago in Part I and reviewed in Part II. You should be reviewing it every month and making sure you’re not slipping back into old spending habits. You should be seeing an accelerated repayment of your debts and have the end of that mess in sight. Once you’ve eliminated your debt you will have money left over at the end of each month. This money goes into your savings account. Having a savings account serves 2 purposes:
1. An emergency fund – if you have money in the bank then you won’t need to fall back on credit in case of an emergency.
2. Your financial goals – this is where the money comes from for the goals you have set that will get you to your destination.

It’s as simple as that. The choices you make every day about how, when and why you spend money have a direct impact on whether you reach your destination or end up somewhere else.

Now we have:

Your destination – what you would like your lifestyle to look like in 10 (or 20) years.
Your road map – what you need to do to get to your destination.
Your cash flow – what resources you have to work with.

And we have the 5 Steps of effective personal financial management:

  1.  Organize your debts according to the interest rate and develop a plan to pay them off over time.
  2. Record and track your income & expenses (cash flow) month by month and sort the expenses into their respective categories.
  3. Review your cash flow monthly to identify the elasticity, priorities and patterns of your income & expenses. Take control over how, when and why you spend.
  4. Decide on your destination. Take a piece of paper and describe your preferred lifestyle in 10 years (or 20 years if you are under 30).
  5. Create your financial road map. Using 4 columns decide: what you need to do to get from where you are today to where you want to be in 10 (or 20) years, how much it’s going to cost to do that, when you need/want to do it, and what your monthly savings needs to be to achieve it in the time frame you have chosen.

Unfortunately, as simple as effective personal financial management is, it isn’t easy. It will require discipline and accountability. But every day you keep at it will take you that much closer to the lifestyle that you would like to have.

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