Tuesday, April 12, 2016

Controlling Your Finances

There are plenty of systems and ideas floating around about how to perform budgeting.  The envelope methodThe 60% solution.  There are several variants to the same idea, such as the 50-30-20 budget.  Some companies use a zero based budget.  There are plenty of ideas around that part of life.  However, I see a lot less emphasis on how to manage the money and expenses you have.  For me, it took a while to develop a scheme for handling my day to day management.  Dave Ramsey's baby steps comes closer to a suitable scheme. However, even his steps are a bit abstract.  So here is my attempt to describe how to organize your finances.

Control the Money

Off, Button, Press, Icon, Symbol, Power
Don't give your billers all the power.  Keep the off button.
There are lots of places that offer automatic withdrawal from accounts.  These sorts of automated systems are useful, however, I suggest that it is better to have a push system rather than a pull system.  By this I mean, it is better to send money to pay the bill rather than have the biller pull money from your account. I have several reasons why I prefer this system.  First of all, they might pull out the wrong amount of money and leave you in a bind.  I have seen this happen personally, and most billers will not pay your banking fees if they cause you to overdraw your account.  Secondly, if there is a mistake in your bill, you are more likely to notice if you have to enter in the amount.  Thirdly, you are more likely to have a deep understanding of your "budget" when you hand pay your bills every month.  Finally, you can ultimately turn off these payments.  I have heard of stories where people have tried to turn off services but continued to be billed for multiple months after canceling their service.  Having the ability to push the off button gives you the power, rather than the biller.

This is not to ignore the convenience of modern times.  Most banks allow you to send money to a payee via their web interface.  That way no checks or stamps are required.  For bills which have a static cost, you can even have the bank auto pay that amount.

Controlling your money is not just keeping people from billing you automatically.  Controlling your money is also making sure you understand what you are controlling.  You should also try to disentangle yourself from long term debt.  While I do cover debt in other posts, let me give a brief set of suggestions.  Find some way to get into the habit of paying off your debt early.  If that means starting with the smallest bill and work on paying it off, do that.  If that means having an automatic payment to your mortgage, do that.

Background, British, Budget, Business
Keeping some cash around for emergency is important.
Another piece to this puzzle is creating an emergency fund.  I suggest a bare minimum of 1000 dollars per 2 members of your family.  This means if you have two adults and two children, you should keep 2000 dollars.  Why the extra money?  Since you have a larger family, the chances of something going wrong increase, and the day to day expenses are higher, making an emergency that much more stressful.  Having a little extra cushion will help prevent that stress.

On the other hand, I do suggest you limit the amount of spare cash you hold.  Ultimately, it's better to invest that money into retirement accounts than have 50,000 sitting in the bank.  Even better if you can put it into a IRA or 401k account where it goes untaxed or sheltered from future tax.

Control the Data

Your money leaves a trail that you can follow to gain insight.  In general, I use my bank's export features to gain understanding of my accounts.  My bank allows exporting from multiple years back.  Some banks might limit such an export to the last 90 days.  I usually export my data once a month, but excluding the current week, because some payments are 'processing' and may end up different, which affects the data.  I also do this for my credit cards.  Using a tool, such as Money Pig,  you can get trending data, and gain understanding of what my finances look like.  I also look at the past month and try to add notes about why a particular month was 'different from average'.  I also keep an eye on trends like if my expenses are going up.

I should note that I specifically pull my credit card data so that I can track and categorize it as well.  While I may pay my credit card using a single check from my bank, that makes it hard to categorize the actual expenses.  In order to know how you are spending your money, you need to break that down.  That also means that if you have large cash you withdrawal, these will not be well documented.  This means that you will have to hand track this data or estimate it in your head.

Control the Debt

Refugees, Economic Migrants
Your accounts balances can either go up, go down or remain the same.
There are no other possibilities.
There are only three states possible in regards to income/expenses.  You can make more than you spend, you can make less than you spend or you can keep both equal.  Keeping both equal is very difficult, although possible.  So in the majority of cases you are either saving money or you are spending money.  If you are in retirement with a sizable nest egg, it is okay to spend more than you make, because hopefully on average your investments will make up for the lack of incoming cash.  If you are 20 and going to college, it maybe acceptable to spend more money than you save in order to get an education.  However, at some point you have to pay that debt off, and the sooner, the better.

In my opinion, there are only a few cases where debt makes sense.  If it is short term and can be paid off the month you are in debt, it maybe easier to track than cash.  Another good reason to do so in the short term is when ordering online.  If your credit card is stolen, most credit cards cover all losses, where as a debit card can get you into trouble.  If it is a long term investment, such as a car to get to work, a home (if it makes financial sense).  There is a debate raging on if betting on your future earnings justifies going into debt.  It certainly is a long term investment, but it is also a risk.  Like starting up a business, you need to be aware of the risks and then make a personal judgment on how comfortable you are with those risks.  Finally, in some emergency cases, such as when you are going through a divorce and may not have access to your emergency fund.

Don't forget, no matter how good a deal you are getting, you have to factor in financing costs and emotional costs in the months and years to come from the debt.

Control Yourself

Ultimately, things like budgets are only useful if you have a habit of following through.  No matter what methods are provided, you must learn to control yourself.  In some cases, the way people treat money is not unlike that of any other addiction.  In fact, in some cases, it is clinically considered to be an addiction.  Learning to live with in your means can be difficult.  Even if not an addiction, breaking habits is long and hard work.  Replacing habits is often easier.  So instead of buying expensive things, try to buy cheaper items.  Another strategy is keep a list of things you want to buy and limit yourself to only buying 1 per week or month (depending on circumstances).  Happiness research suggests that satisfaction last longer when you treat yourself with an experience rather than purchasing a thing.  So if you feel the need to treat yourself, choose experiences.  Keep in mind an experience need not be a expensive plane trip to some fancy beach.  It might be eating out at a nice restaurant with friends or family, enjoying a park or many other small, cheaper experiences.

Experiment and discover what works for you.

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.