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Is there a way to boost your financial success?
In the last post, we discussed the importance of growing your income to your financial success. Although it’s unlikely to grow your income indefinitely, the take home message was that your income reflects the value you bring to the marketplace. If you keep increasing your market value, the chances of improving your income are significantly enhanced.
The next step to your success is what you do with the money once you have it. Managing your income and expenses is a critical part of your success.
Pay yourself first
Well technically, the government gets paid first if you are an employee. But once the money lands in your account, what you do with it is vitally important.
Habits were discussed in an earlier post and this is an instance when the right money habits can make or break you.
What are your habits?
The chart below depicts a range of scenarios that have you ahead of the game, level with the game or behind the game.
The vertical axis displays increasing income, the horizontal axis, increasing expenses.
The breakeven line is when your income and expenses are equal.
If your income is greater than your expenses you will have positive cashflow. That is, at the end of the year, you will have more money in your bank account than you did at the start of the year (the green and blue dots).
If your income is equal to your expenses, you will be cashflow neutral (the breakeven line). Your bank account will be the same from start to the end of the year. (The orange and yellow dots)
If your income is less than your expenses, you will have negative cashflow (the pink dot). Meaning your bank account will be lower at the end of the year, or you will be in debt. This debt usually ends up on a credit card.
By the way, the colours mean nothing. I just picked some colours.
I will be repeating exactly the same chart as we progress through this post so you don’t have to continually scroll up and down as I highlight different points.
Don’t be the pink dot!
This is a bad place to be.
If this is a result of a few crappy things happening in the one year, that can be tolerated. A water heater may need replacing, your fridge breaks down, your car needs costly repairs. It can happen. And all at once too! But you want to get back above the breakeven line as fast as possible.
But if you are here because of poor money habits, you are heading for a lifetime of money misery. Money stress will consume your life.
You need to sit down and critically look at how you spend your money.
All successful businesses know where their money goes. All successful people know where their money goes. Whether you use an app or a spreadsheet to track your expenses – just do it. You need to. This takes discipline.
Once you know where your money goes, only then can you make changes to improve your situation.
Ask yourself tough questions.
Is it gambling, holidays, expensive toys, eating out frequently or just mindless purchases?
Are you living a lifestyle you just can’t afford? This will be hard to own up to. Do you live in a suburb you can’t afford? Drive a car you can’t afford?
You need to know. And be 100% honest with yourself.
Next – you have choices to make. Hard choices.
What expenses will you stop?
What expensive toys that may have a loan need to go?
Do you really need all that “stuff”?
Should I move to a more affordable suburb?
If you are the pink dot, this is a pivotal moment in your life. You are at the fork in the road. One path leads you further down a dark hole, the other, into the light.
Money stress is one of the major miseries in life.
Bad habits may have got you here. The right habits will lead you out.
You need:
- A burning desire to be in a better financial position.
- A solid game plan.
- Discipline and persistence to see it through.
The orange and yellow dots can breathe
If you breakeven each year, you can breathe, but it only takes a little bad luck to send you backwards. You may be living pay day to pay day. Nothing left at the end of the pay cycle.
If you’re young and have no responsibilities, this is OK. For a short time.
But this is when habits become entrenched. You get stuck in a way of living that is hard to change.
Remember this unsexy term – delayed gratification.
Your ability to work towards a goal that is off in the distant future is a key indicator of success. Most people live in the now. Most people are NOT successful. Don’t be most people.
Also remember the power of compound interest. The earlier you start to save and invest, the more time your investment has to grow.
But first you have to save.
What’s the difference between the orange and yellow dot?
This is a common trap people find themselves in. Your income increases, but so does your expenses.
As a reward for a pay increase you may decide to buy a better house in a nicer suburb. Buy a better car. Or take a bigger holiday every year.
Guess what? You are still just at breakeven.
What’s even worse is that if you lose your job or income takes a hit for whatever reason, you have a mountain of debt that needs to be serviced – now you’re the pink dot!
Expensive suburbs are full of people just hanging on. It’s like a house of cards. An ill wind blows, and it all comes crashing down.
Let’s move from the orange to the blue dot
What we are doing here is maintaining the same income level but reducing expenses.
Now you have positive cashflow. Now you can pay yourself first. This means savings. This means capacity to invest. This means one more step closer to your financial goals.
Will there be some pain in this process? Quite possibly.
Will there be some grumbles from within yourself and others around you? A good chance of that.
Will your life change? Most probably.
Are you better for it? Absolutely.
When? Not so much tomorrow, but in years from now you most definitely will be. Think delayed gratification.
$10,000 saved each year earning 8% is nearly $460,000 after 20 years. That could be $460,000 you would never have if you never saved and invested. In twenty years’ time, your life could be drastically different.
I am happy to forgo little things now for the big reward later. This should be your new mantra. Say it over and over until it changes your brain.
What to focus on?
Many people (subconsciously) plan their money by thinking about expenses.
Your money plan should start with income. Then save and invest. Then expenses.
You know your income (and should be working on ways to enhance it).
What’s a good target to save?
A common figure is 20% of your after-tax income (it can be more, some go as high as 70%!). I assume you can work that out.
Jim Rohn (a popular motivational/success speaker), would say save 30% of your income. It should be broken down as follows:
- 10% to charity. Start a giving habit early and with small amounts. It will be entrenched as the amounts get bigger.
- 10% to active capital. In other words, some sort of money-making venture. Perhaps a side hustle. The aim here is to make a profit.
- 10% to passive investments (one where someone else does the work). A managed fund, exchange traded fund or some other quality investment (no speculation).
Remember, big goals require big action.
Your accounts can be automated (speak with your bank) so your income can be allocated to a savings account without you having to do anything. Every pay cycle, boom, 20% goes straight there. You don’t have to think about it and potentially not do it.
The rest is for your essential expenses and discretionary expenses. You could even set an account for savings towards a holiday.
Savings buffer for a rainy day
This is an essential part of your success plan.
In a separate savings account you should store 6 months expenses.
When it rains, I mean lose your job, get sick or have big and important unexpected expenses, you have these funds to get you through. Your safety net.
This should be done before you start investing.
If you ever need to dip into this account (not for holidays or Christmas presents, etc), your aim is to top it back up as soon as possible. Then leave it untouched until the next rainy day. Which I hope never comes. A security blanket.
The move from blue to green
The ultimate in discipline.
An increase in income while maintaining the same level of expenses.
Imagine a person so focused on their goal that there is no temptation to go for the shiny new object (car, house, Rolex). Delayed gratification to the max.
This is absolute mastery of yourself and of your money.
You are making money.
Your money is making money.
Your financial goals are getting closer by the day.
Now is a good time to mention the difference between frugal living and being cheap.
To constantly achieve positive cashflow requires being frugal. Achieving a savings target of 30% definitely does. Some people who follow the F.I.R.E movement (Financial Independence Retire Early), aim for a 70% savings target.
Frugal living means being very intentional with your money. You spend on things that matter and cut back on unnecessary spending. This might mean no Foxtel, but you donate to charity. No big holiday but are generous with friends and family. Eating at home instead of always eating out.
Over time, the little things add up to big amounts. For example, spending $20 per day on lunch at work. There are roughly 250 workdays each year. That’s $5,000 per year. A $4 coffee. That’s $1,000. You can start to see how seeming little habits can make a big amount. When it happens each day you don’t notice. Then you start to wonder where your income goes!
Being frugal is very different to being cheap. Nobody likes these people. If their share of the bill is $24, they give you a $20 note and ignore the rest. They will never bring a bottle of wine to dinner but will happily drink yours. You know these people.
Don’t be one of them.
The winner is the green dot
You want to be in the position of the green dot.
This is a conscious decision to live in the world of the green dot.
You need to continually invest in yourself to build your income. Tuck away a percentage of your income each pay cycle for investing. Then control your spending.
You need to first live WITHIN your means. Then when your means expand, ensure your expenses don’t expand with it.
The concept is simple but the discipline behind it is not easy.
Delaying good times now for a greater future is not easy. But so worth it.
A quote from Warren Buffett (on his Instagram):
The Wrap
Treat yourself like a business.
A business is always trying to grow its income.
It always tracks and manages its expenses.
Live within your means.
The name of the game is to make money.
This is not for everyone. If it was, everyone would be generating positive cashflow and setting themselves up for a fantastic second half of their life.
What if you live for the now? As I said, this is not for everyone. It might look exciting when you’re 25. But when you’re 45, all you will have is your memories, I hope they are great ones. Because you might not have anything else!
If you are successful at this, you may need to be controlled now, but once you build a sufficient asset base, the income from it could sustain your living expenses for the rest of your life. Do you want to work today? Nah, I’ll go back to bed, to the beach, for a run, play with the kids. Close your eyes and imagine the freedom.
You can retire at 35, 40 or 45. It just depends on how well you have implemented your action plan and how early you started.
Be the green dot.
I always say that what I teach can apply to other areas of your life. For example, if you want to lose weight. Be the green dot. Burn more energy than you put into the system. Create successful health habits and if necessary, change the way you live your life.
Up next …..
Are all assets good and all liabilities bad?
Take action in your life.
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