Sunday, November 8, 2015

Personal Finances: Organizing your Financial Life

Personal finances are one of the more difficult things to manage in adult life.  As children, most of us may have had allowances, but we didn’t think in financial terms.  We had toys, not assets.  We saw what we had as just an allowance, spending money, not an income stream.  We put money in our piggie banks, we did not deposit funds.  We bought our toys on impulse, or if our parents did some teaching, we might have had to save up for a toy.  We did not have multiple debt obligations competing for our funds along with social obligations and yes, still, toys we want to buy, even as adults.  At best, perhaps we learned a little of this playing games like Monopoly or possibly discussing it with our relatives and close friends.  All of that is not the same as living it day to day with all of life’s other complexities going on.

My goal today is to describe how you can organize your finances so that they are trackable and traceable.  While I will talk about tools, all of this can be done by hand or using one of a multitude of tools to solve the problem.

There are multiple different ways to slice the problem, but let me give you a few suggestions:

  1. Updating the Plan:
    A plan is just a map for a possible future.  The future is often different from your plan.  You must keep an eye on changes and adapt to them.  Gas may go up in price and that 100 dollars of savings per month may no longer be feasible.  You might get a bonus which allows you to pay your car off early and now you have a car payment's worth of money you no longer have to dedicate to car payments.  No matter what happens, you need to keep your plan up to date. 
  2. Gather Data: This can be what you know off hand, but I suggest you try to gather records from the bank.  Even if all you do is write down the balance at the end of the month for several months in a row, that will at least show you a trend line.
  3. Create High Level Goals and a Plan: The goal portion of this is what you want to achieve.  Do you want to have enough money for retirement?  Do you want to pay off your home mortgage as fast as you can?  You make a plan to help you reach your goals in a sustainable way.  The plan can be a budget, saving to get your first car or this can be about retiring with a certain amount of money in the bank.  The plan needs to reflect the realities discovered in the data gathering phase.  That is to say it needs to be achievable and realistic.
    1. NOTE: If you have a significant other, it is important that you talk about your goals.   Even if you choose to keep your finances separate, talking about goals and plans will give each other a sense of how you are doing.
  4. Working Towards Achieving Your Plan: Put effort into making your plan work.  Use automation such as moving money from checking to savings.  I suggest you pay your savings account first, or else you will be tempted to withdrawal from it.  If it is a 401 K, have your employer take it out of your account for you automatically.  If it is paying off your mortgage early, then have your bank automatically send additional payments.  
    1. NOTE: In my personal experience, it is better to have your bank control the automatic payments than to have the mortgage company take the money out of your account.  Banks often are more interested in making their system's customer friendly and allowing you to modify the rules, while mortgage companies have less motivation to provide top tier service.  So I suggest you run all auto pays through your bank rather than your mortgage lender, if you are allowed to. 
In the past, when people exclusively wrote checks, they would often keep track of the balance of their account in a little page in the back of the checkbook.  This was call the checkbook register and this was a way of keeping your checkbook balanced.  In today's complex world, few people still keep with this tradition, but there is some evidence that keeping records by hand helps your memory which in turn may help you realize your goals.

A frequent tool to organizing personal finances is a budget.  I think budgets are useful tools, however, never mistake the map for the road.  Budgets provide you guidance on how your income and spending should appear in a given month, but they are just there to attempt to describe an average month.  So rather than treating a budget as something you must follow exactly, I suggest you use a budget to give you map of how you can achieve your plan.

Some people find budgets less useful and would rather look towards trend lines.  That is to say, they would rather take previous income/expenses and average them out and see what the world would look like if those held constant for a certain amount of time.  These trend lines give you a glimpse into the future. In this trend line, you can see that the person's income is going up.

A example Money Pig graph.  This trend is up and to the right, exactly what you want to see.
The line is a trend showing an estimate of what the account total might look like in half a year.


Of course they don't take into account the pay raise or job loss you may experience in the future, but they do give you a degree of confidence that if you don't experience a change in your lifestyle, what life in the near future will look like.

The last method is to play it by ear.  That is to say, some people find that having an occasional formal check is all that is needed.  For the rest of the time, they just  use some built in measures to keep track of their funds.  One method may have an automatic withdrawal to a different account to buy that new car.  Another method may have keep their balance at some 'even number', such as 1000 dollars and if it goes over 2000 dollars they might reassess their finances.  These sorts of methods can be useful, but be aware that they also leave you vulnerable to surprises.  You might forget that you have to get an expensive car repair or other unexpected expenses.  These sorts of methods, without periodic inspections of a check list, can fall prey to such events.

All of these methods have different pros and cons.  You must figure out what does and doesn't work in your life.  You might notice that I wrote these methods in order from the most formal to the least formal.  I suggest you start with the most formal methods and as you get more proficient, you can then slowly move towards the less formal methods.  If you have life changing events, I again suggest going back the formal methods since that will help you learn what a normal set of income and expenses look like.  No matter which method you like, Money Pig can help you get there.


Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investing advice and/or professional financial advice. Always consult with a licensed financial professional.

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