There is a business maxim that says to measure what you manage.
The reason being that you don’t know if you are successful in your management unless you have something to measure against. You need to set the bar as to what is acceptable and what is not.
Money is the same way. If you spend, save, and invest without a plan you review, and hope that it turns out ok, you will fail.
But you want to weigh that against “analysis by paralysis”. You don’t want so many metrics to review that you lack focus – you will spread yourself so thin that none of the items will get your full attention and all will suffer. The “Jack of All Trades, Master of None” syndrome.
So you list out all the things you can manage and prioritize the top three and focus on those three. It’s works at work and it will work in your home.
A great starting point is to focus on spending, saving and debt. Once you get one of these under control move on to the next one, such as investing.
It works best if you have a system in place that is simple, repeatable and eliminates mistakes.
Note: If you missed the first three lessons, they are here
The main goal in this category is to spend less than you make. Think of yourself like a business. If you spend more than you make and keep doing that, eventually your business will go bankrupt and have to shut down.
Run your finances the same way.
The problem here is that people make this too complicated. That is probably the fault of us accountants. We love details and tracking things down to the penny and making sure all the dollars are in balance and reconciled.
This is too much for most people. They work out a budget, follow it for a month or two and something comes up that requires they juggle the budget and everything is out of whack, or they run out of time to manage it and they get into a hole where they can never catch up, or the budget is too complicated and they don’t understand it, don’t like it and they don’t get good results from it.
The solution is to keep it simple. Divide every pay check up into a handful of large broad categories like living expenses, savings and paying down debt. With just a few big categories to manage it becomes much easier to review if you or on track or not.
For example, if your paycheck arrives and it is for $2,000 (net), have 10% go into savings ($200) and another $200 go to an account to pay down your debt. That will leave you with $1,600 to pay for living expenses until your next check.
If you find that $1,600 doesn’t provide you with enough money to live off of, you need to look at your spending. What went wrong? Don’t analyze every cent. Look at the big ticket items. Are you spending too much on those items; house, cars, food? You only have two choices; cut back on those big items or make more money.
Here you will only look at your main assets like house, cars, cash, bank accounts, retirement accounts. Ignore things like furniture, lawn equipment, unless it is very valuable like jewelry, art, collectible music equipment etc.
Look up the values once a month, or for things like your cars, look up the values once a quarter or once per year.
Keep track of the totals on a spreadsheet and compare to last month and last year (Ex May 2014 to May 2013). Are the totals going up? Are some totals going up and others decreasing? Did that new car you wanted so badly drop in value after you bought it? How about the value of your wife’s three year old Honda Accord, did it maintain its value? Food for thought, right?
SAVINGS DEEP DIVE
At least once per month look at your savings. Are you funding your emergency fund, retirement account and large future expense accounts according to your goals? Why not? Do you have automatic deposits setup to fund your savings so you don’t have to even think about it? If not, do it this week – put it on your to do list.
How many months of expenses do you have saved in your emergency fund? Three, six, twelve? If you have reached twelve then stop and save that money elsewhere?
Review your large future expenses. When are they due? If you were supposed to save $500 per month for your real estate taxes and they are due in four months, do you have eight months saved (8 x $500 = $4000)? If not, how are you going to get caught up in the next four months? Work out a plan today.
Are there any large expenses that you’re no longer excited about? Are you no longer that interested in going to Africa after hearing reports of violence on tourists? Thinking of going to Costa Rica instead and the price is $7,000 less? Consider moving that extra money to another account to save for something else, or leave it there and take two or three vacations instead. What other items did you want to save for originally but didn’t make the cut? Can you afford one or two of them now that the Africa trip is off?
Take a look at your total debts owed for the month and compare to last year and last month. Did the total go down? How much? Doesn’t it feel great to see that number go down? Does it motivate you to cut expenses somewhere else to pay down debt faster?
Did you pay off the lowest debt during the month? If so, move on to the next lowest one and increase the minimum or required payment by the amount you were paying on the debt that was just paid off.
Could you reduce debt further by downsizing your house, selling one of the cars and taking the train to work or buying a cheaper car?
Can you stop going out to dinner for a month and use that money to pay down your student loan?
Have you looked at mortgage rates and would it make sense to refinance for a cheaper rate or shorter time frame? If so, start looking for a bank to refinance with or call your current lender and ask about refinancing.
Now look at your net worth by subtracting your debts from your assets. How does it look? Did it go up this month? How much?
Can you see the double-bubble effect you get when you pay down debt and save money? You’re increasing your assets and decreasing your debts, which really makes your net worth grow. The smaller your debt, the more money you can put into savings.
In conclusion, you can’t manage what you don’t measure. The good news is this doesn’t have to take a lot of time. Do your detailed financial review for an hour once a month to track how you’re doing and where you need to improve. Add it to your to do list to focus on the areas for improvement. Steady, consistent improvements over time will make a huge difference in your financial picture getting you closer to your freedom.
Next lesson I will suggest how to allocate your paycheck.