There are four aspects of personal finance that we deal with every month, unlike taxes and insurance which are typically annual affairs.
Income
Debt
Expense
Asset
Thus the I, D, E, A is what one deals with every month – month after month in that same order.
Typically a household finance (or monthly cash flow) goes like this:
Income (I) -> Pay Debt (D) -> Pay Bills (E) -> If left over, invest in assets (A)
The problem is that the IDEA is wrong. It will never make one financially independent as the Asset part is only an afterthought, and mostly never happens.
This requires a correction in perspective and is much touted by financial advisors as Pay Yourself First, where A should come before D and E.
So the IDEAL sequence is I,A,D,E,L.
Income (I) -> Pay for Assets (A) -> Pay Debt (D) -> Pay Bills (E) -> If Left over (L), have fun.
The last part if consistently found to generate surplus, can also be adjusted for subsequent months to increase the “Pay for Assets (A)”.
How does one do this course correction? Here is one simple technique.
You know how much Income comes in.
Decide a percentage (start a bit aggressive, like 20%) to set aside for A.
But do not invest yet, just set it aside to another savings account.
Pay your debts (D).
Pay your bills and monthly expenses (E).
If shortfall, pull a bit from the A saved aside.
If not, good news. Invest the 20% into assets (A) and enjoy any surplus (L).
This habit if done over 3-6 months, will build the automatic flow of savings and investment.
The sequence described above has the following automatic advantages.
It starts with an aggressive savings goal of 20%.
As one sees the expenses budget drying up towards end of the month, it encourages one to cut unnecessary spending.
The savings is still saved aside till the end of the month, so can be pulled in if needed.
Pulling in the savings every month however has a mental resistance, hence should be difficult to do month after month.
To make it more difficult, put the A into another bank so that the transfer will take some time and effort to execute.
As one adjusts to a comfortable level of savings (A) percentage, it brings in awareness of how the budget and cash flow works.
The IDEA is not so bad after all, you just need to fit it in the right sequence to work.
A company which is listed in the stock market has to publish 3 essential financial statements.
The balance sheet
The profit and loss statement
The cash flow statement
Briefly, the balance sheet shows the health of the company at the reported time, profit and loss statement shows how much profit the company is making after all expenses and taxes, and the cash flow shows how the company is generating the cash from its operations as well as investments.
Free Cash Flow (FCF) is an important metric that is used by investors to evaluate the real worth of a company.
In personal finance, while balance sheet (Your net worth) and profit and loss (how much you are making and spending) are important, managing the cash flow is key to achieve your financial goals.
In this blog, we will talk about how to manage your cash flow – no matter whether you earn a lot or earn an average paycheck.
Most people do not manage their cash flow, forget about doing a budget or any other conscious form of tracking.
At the end of the month or year, we wonder where all the money earned went.
Conventional ways of managing cash flow
There are several techniques Personal Finance experts have championed time and again.
Do a budget, track every dollar.
Create an envelop for groceries, utilities, fun etc.
Use separate accounts.
New automated solutions like Stash, Digit etc.
All of these are good methods, but the problem is sticking to the discipline of maintaining it day after day, month after month.
Isn’t that boring and worrying at the same time? Few issues with these approaches are:
Writing down expenses every day
Stuffing that envelop and counting the money every time before spending
Keeping track of multiple accounts
Not knowing how much the AI driven savings app is going to deduct next month
So is there a simpler and better way?
Just like most posts in this blog, I seek simplicity and automation.
The simpler way of managing your cash flow
There are 4 goals to managing the cash flow every month.
Invest for the future
Save for the short term
Pay your bills
Spend the rest
In fact, any wind-fall is also a one time cash flow, and can be fit into the same framework. Lets say you got a bonus of $1000, for example, the Govt is sending a check to all Americans. And if you want to keep it simple, allocate 25% to all the 4 goals.
Invest $250 in your long term (retirement, child education) plans. The market is down and you can invest $250 in a mutual fund or an ETF.
Save $250 for any short term goals that you have. It could be added to your monthly savings goals, towards anything like vacation, buying that new phone, or simply emergency fund.
If you have consumer debt, why not allocate some to pay it off? Use $250 to pay off the highest interest or smallest balance credit card.
Now you have $250 to splurge on. Buy that favorite book, order the special meal or decorate your home.
But how do we automate and manage the cash flow every month?
Invest – Direct deposit investments. In fact most employers have systems to auto-deposit 401-k investments or direct deposit to your chosen brokerage firm.
Save – Auto transfer to a savings account from your checking account.
Pay Bills – Setup auto-pay with your credit card or debit card. Set the bill payments mostly towards beginning of the month.
Spend – Use your debit card to spend – it will tell you when the money runs out.
Once setup, the only stress you have is the last bullet, where you have to make your spending within the limits, or rather the residue after all obligations are set aside or paid off.
How it can snowball into Financial Freedom
As you get consistent with stashing money away for investing and savings, those may generate additional cash flow or assets which will come back to bolster the spending budget.
Thus cash flow is a virtuous cycle once set up the correct way. Lets take some initials and approach this from a math perspective.
J – Job Income
R – Retirement
I – Investment
S – Savings
B – Bills
E – Expense
P – Portfolio Income
J + P = R + I + S + B + E
Ican produce Pin terms of interest, dividend or rental income.
In the wealth accumulation years, the goal should be to increase J, so that Ican be increased, which when invested can increase P. Pis added to J and a part reinvested, saved or used.
As you reinvest P, it will generate more P till at a point, J becomes less and less important.
This cash flow situation is called Financial Freedom.
Conclusion
We just presented a simple and fully automated cash flow management system for personal finances. It does not take much discipline and will power to stick to it, once correctly setup.
The title is taken from a famous book as below. Even though it is meant to be a management philosophy, it applies to the subject of personal finance as well.
Financial Planning does not work?
There is a proverb in the military – Plans are good till the first bullet is fired.
Some of us who are obsessed about managing or advising on personal finance can go really overboard with planning. Have you heard about those retirement numbers, college planning or even financial freedom number?
While long term planning is good, problem with personal finance is that it is a not a standalone aspect of your life. It impacts and gets impacted by life events – birth/death/marriage/divorce in the family, choice of career or college, changing goals and circumstances and finally your own priorities may change.
How my circumstances kept throwing my plan astray
Lets take an example in my case, as I transitioned from India to US.
Till 2005, I did not know a zilch about managing finances. In fact I was pretty bad at it, just enjoying my life and like many, used to blow up my entire paycheck in frivolous expenses, needless shopping and eating out. So in a nutshell there was no plan.
Then in 2005, I decided I can at least start investing some money out of my paycheck. Good plan but was it anything long term? No it was too flaky as I jumped from one hot fund (mutual fund) to another. This was the time when the Mutual Fund and Private Insurance industry was taking off in India in a big way. I also lost money investing in an insurance plan (actually a bad plan) that was masquerading as investment.
Eventually as I got better with finances, I actually created a long term plan complete with everything – retirement fund, children’s education fund, vacation fund and corresponding projections several years into the future. I built separate portfolios for each, and tracked them to utmost precision even calculating year after year growth.
However God had other plans for the family. In a series of unfavorable health and personal issues, we decided to move out of India at least for a few years and relocated to US.
This obviously altered my earlier plans completely, since my place of work and source of income changed. The retirement numbers started to look different, the college education fund seemed minuscule when compared to US college costs and all the plans are to be redone again.
Well what do I plan for now? I don’t even know whether I am going to move back to India again in few years or not.
In a global economy mobility is a part of life and no one stays in the same place or country throughout their working life. Moreover as you move, international taxation is another beast which can alter your long term investments (like tax sheltered) into immediately taxable entities.
Plan to adapt, not adapt to a rigid plan
So finally you have to take into account an ever changing plan, moving from Plan A to Plan B and keep adjusting according to your circumstances.
When I read about estimating expenses at retirement, I wonder how can someone calculate that? Following factors and more can make it completely non-deterministic.
Where will I retire? Different cities and countries have vastly different living and medical costs.
Will it be only me and my wife? What if the children stay with us?
What do I want to do in retirement? Will I work or travel more?
What health condition will I be in?
What other obligations (including social and family) will I have then?
So projecting your expenses at retirement based on today’s lifestyle is like predicting the weather 20 years from now, based on 20 years of past data.
Same goes for College funding. Even if you are saving in 529 or other accounts, do you have a goal or a number in mind? How do you arrive at a number for college costs, when the costs are going up every year? Isn’t that also as variable as retirement? The following factors come to my mind immediately.
Do you know what career will your 5 year old choose when he/she turns 16-18?
Do you know which college will she go to? Ivy Leagues, State or Community colleges? Are the costs not vastly different?
Are you even going to stay in the same state or country when the time comes for college?
In today’s volatile world, planning too far away (more than 3-5 years) is futile.
Planning based on solid principles, not circumstances
The best way to plan your finances is to look at your current goals, aspirations and develop good money habits.
Below steps will help you be in control and act nimbly to adapt to changing situations.
Live below your means – no matter which country or which circumstance you are in, you can always strive for this and become better. Living below your means is common sense, yet so uncommon.
Budget – Goal based budgeting – This is very important as it ensures you have control over the cash inflows and outflows. Again something which does not change with your place of work or future plans.
Invest with simplicity – Find investments that are easy to understand. Index funds, mutual funds, Real estate, CDs and savings accounts.
Keep some portion of portfolio liquid – Sometimes this can be called an Emergency Fund or Contingency Fund. No matter what you call it, it is useful. When I moved from India, I kept a portion of my India portfolio into Fixed Deposits (similar to CDs here in US) and then built up an emergency fund in US too. This gives me option in both places if I decide to just leave work for some time or get laid off.
Remain consumer debt free – This is also related to freedom. Except for one mortgage in US, I am completely debt-free otherwise or rather bad-debt-free. Being debt free coupled with a portion of portfolio in cash, gives you plentiful of options to enjoy life at your own terms.
Keep investing for long term – Unless your investments are in countries with troublesome political climate, long term investments (a part of the portfolio) can be left to grow with time. Long term investments work on the principle – its not market timing, but time in the market that will reward your investments.
To plan and execute above steps in the most efficient way, read the following posts.
Money decisions should not dictate all your life’s decisions. Money is only a tool to live a good life.
Let your financial plan adapt to your own goals and aspirations, rather than rigidly follow personal finance gurus and templates.
If someone screams in YouTube to pay off mortgage, it does not mean you have to follow as your plans may be completely different. Similarly you may not fall for all those high reward promising credit cards if you are not going to use those benefits.
A chess player does not know what the board will look like after the next few moves.
Safety in financial world is an oft-repeated word, and is mentioned in contrast to risk and growth.
We talk a lot about risk-return trade-off, safety of invested principal in long term and short term investments.
There is another way of looking at Financial Safety. The SAFE plan described below is a way of setting up financial life that is SAFE by design, not in the traditional sense of Safety vs. Risk but automatic habits that ensure you don’t stray from common sense.
Common Sense and Simplicity in Financial Plan is hard to achieve. True it is counter intuitive, but most people land into financial trouble due to complicated behavior – be it spending recklessly, chasing high unrealistic returns or simply throwing caution to the wind.
The SAFE Plan
Let me first present the 7 steps to SAFE plan.
Invest in pre-tax accounts like 401k and HSA.
Set up a direct deposit of the remaining taxable income to a checking account.
Set up credit card payment to be auto paid from the checking account on the 30th of every month.
Set up an auto-invest plan where 10-20% of the taxable income is diverted to a brokerage account or another IRA account (like Roth IRA).
Spend your monthly expenses on the credit card. Keep an eye on the credit card balance with the money left over in the checking account.
Save the left over surplus, if any.
Continue and repeat next month …
Simplicity
The above steps are nothing new. They have been suggested by numerous financial coaches and gurus. However the importance of the SAFE plan is how the steps are stitched together and flows through a seamless automation.
Since we have established the Simplicity of the SAFE plan, lets look at the Automation part and how to set this up.
Automation
You just need to figure out the % you want to put in 401k or HSA, and inform your payroll department. This can be decided based on the following factors.
Your cash flow needs after this deduction.
How much to invest to capture any employer provided matching contribution.
Max limits of the 401k or HSA.
Direct deposit of the taxable amount to checking account.
This is handled by your payroll department automatically.
Setup credit card auto-pay from your bank account for the 30th of every month.
This one if not done, can prove to be dangerous as missed payments are very costly.
The trigger will also help you pay-off something even if you have amassed a debt.
You can configure to pay off the entire balance, minimum payment or a fixed amount.
Setup auto invest for 10-20% of the taxable income. The exact % can vary as it will depend on your household expenses.
Even if your budget does not allow this today, find at least a small amount ($50-$100) to divert automatically to an investment account.
This will build the habit and set you up for regular investment.
The amount can be increased over time as the budget frees up extra cash.
Live within your means. This is again a cliche, but very difficult to be consistent month after month. You can manage it with some automation and discipline though.
setup a notification when your credit card balance crosses 90% of your projected expense for the month (or simply the money left in the checking account).
Put a Level 5 tornado/hurricane warning when it is crossing over the money left over in your checking account.
Typically the projected expenses can be simply set to the money left over in your checking account. You cannot spend more than that without incurring consumer debt or dipping into other savings/investments.
Save the surplus – If you have surplus at the end of the month (that is, Credit card balance < Money in checking account) you can save it for future goals, short term and mid term.
I wish banks provided this facility, but it can be set up to transfer a fixed amount once you have an idea of your monthly expenses.
Some apps like Acorns or Digit automate this although in more complicated way.
Do not leave the money in the checking account otherwise next month it will create an illusion that you can spend more.
Let the automation run month after month.
Flexibility
Once setup correctly, the basic version of the SAFE plan is low maintenance and enables an almost debt free living.
Of course, we have not taken into account mortgage payments, prior debt pay down, saving for education – but these can also be fit into the plan. In the step where you are investing 10-20%, you will break that into smaller chunks of various debt pay down and remaining amount can be invested for various goals.
Thus the plan is also extremely flexible to adapt to individual situations.
Efficiency
The last part of the SAFE plan is that it is efficient in managing money.
The following good principles are built-in into the plan.
Pay Yourself First – Pre and Post Tax investments are deducted in the beginning.
Low maintenance – no coupon cutting, daily budgeting etc.
Keeps you debt free – just keep tab that your credit card balance is below money left over in checking account.
Encourages more savings at the end of the month – creates a healthy race to increase it, by reducing your spending.
The efficiency is evident if you do this for even one year. You will see the difference in your credit score, savings balance, net worth and above all, peace of mind.
Conclusion
This plan has been working for me for a long time. The simplicity and automation helped me manage it seamlessly without getting distracted from my main job – which is not finance.
And the in-built savings and investment discipline in the plan has helped me invest and accumulate cash for emergencies, short term purchases or just a cash cushion.
Here is my version of the 7 steps of the SAFE plan (the % are approximate and rounded)
Invest some in the Roth-401k and H.S.A.
Direct deposit first paycheck. (50% of monthly)
Use the credit card from same account. Set up auto-pay on 30th of every month.
Investments/Pay downs
10% to mortgage account
10% to savings for property taxes, insurance and maintenance
20% invest in mutual funds via brokerage account
10% to a 529 Plan
Next paycheck direct deposit on 15th of month. (50% balance monthly paycheck)
Living expenses capped to 40-45% of monthly total.
Pay off credit card balance within this limit – I make sure it is $0 as it enters following month.
Sometimes it is hard to stick to the limit, then I have the cash cushion (from previous months’ savings, step 6) to dip into.
5-10% savings for vacation/travel, fun, cash – diverted to a high-yield online savings account.
We all know the importance of metrics and data driven decisions. Specially in today’s world, everything is driven by data, big data or small.
Why should personal finance be left behind? Just saving and investing money does not mean much if we are not able to quantify our financial situation and be able to improve it year over year. So lets look at some of the metrics that we can develop or borrow from other financial scenarios.
There are many financial terms and metrics for evaluating company fundamentals and corporate performance. We can take a small subset of that and use them to measure the health of our finances.
These ratios and metrics really give you a picture as to where you stand, what will happen in a worst case scenario (lets say the stock market goes down) or you lose your job.
It is like your annual health checkup, you may feel alright but you don’t know fully what your body is going through internally.
Without much more introduction, let me explain the 5 key metrics I use to keep track of my finances. They have told me stories that I did not know without calculating them.
Net worth
This is the most obvious and most popular one. There are different viewpoints regarding this, some people say its only a vanity number yet others think it summarizes your financial position.
In short, Net worth is all assets you have minus all liabilities you have to service.
So if you have $1000 of assets but owe someone $200, then your net worth is $800.
What to include in the assets is also controversial. Some people include their home value, while others will say home is really not an asset.
My view is if you are not going to stay in the home throughout your entire life, then you can count its present value (or at least purchase value) as the asset price. The liability section will account for the mortgage balance you have.
This Net worth number may sound like a vanity or it can give you a milestone to reach. For example, for many people reaching the first million in Net worth is a big deal.
A positive net worth signifies healthy finances, on the other hand a negative net worth means trouble as the person is over-leveraged.
OK so you have a positive net worth and want to celebrate. Not so soon.
In reality, majority of your asset may be made up of not-so-liquid instruments like house, cars, jewelry etc. Moreover your liabilities may be mostly short term debt like credit cards. Lets take some numbers.
You live in a $300,000 house, and has only $1000 cash. You have a mortgage of $250,000 and $25,000 credit card debt. What is your net worth?
So you have a positive net worth, mainly due to the Home Equity trapped in your house.
However the cash you have is not enough to pay your credit card bills or possibly even the monthly minimum amount (after other expenses). This can cause trouble or through interest charges can slowly eat away the net worth and push it towards negative.
Hence it is important to have a cash cushion to cover your short term obligations. And short term obligations may not mean only credit card debt, they could be impending quarterly taxes, property taxes, insurance premiums and any other short term debt. Typically all payments to be made quarterly or annually within the next one year can be added up as short term obligations.
The Quick Ratio is then calculated by:
Quick ratio = (Cash and cash equivalents) / (total short term obligations)
With a Quick ratio of above 1, you know your finances are well equipped to cover upcoming obligations.
Personal Finance Equity is really the Net worth that we calculated first.
Lets say in the positive net worth, you have a mortgage in terms of a long term liability.
But think of a dire situation, when you are asked to pay off the debt at a very short notice. Such emergencies can be losing a job and not able to pay the monthly payment. The lender may demand a complete pay-off or a short sale of the home.
For example repeating the earlier example in section Quick Ratio:
Here the debt of $275000 cannot be covered with the Net worth.
But lets say you also have $350,000 of investments in long term accounts like retirement portfolios. Now your net worth is $376,000 which if worst comes to worst, can be used to pay off all your debts and save you from foreclosure or bankruptcy.
This can be measured by yet another useful ratio.
Debt/Equity ratio gives how much of your net worth is leveraged. In the above example with $350,000 of investments,
D/E ratio = ($250,000 + $25,000) / $376,000 = 0.73
D/E ratio below 1.0 is safer as you know you can be debt-free if you want, though you need not liquidate your investments immediately if they are earning more than the interest on your debts and you have a good Quick Ratio above 1.0 to cover your immediate payments and obligations.
Since we are already talking about dooms day, it cannot be complete without the concept of emergency funds. Almost every personal finance book or article starts with this concept. But there is a large deviation in the range of the amount to be saved for emergency fund, some say 3-6 months, 1 year or even just a set amount.
Lets approach this as a scientific ratio like we have done so far.
We will calculate how many months you can survive covering your true expenses if you lose your income.
Emergency coverage = (Emergency fund value) / (monthly living expenses + monthly payments)
Note that monthly payments may not mean only mortgage or car payments, it should also account for monthly share of any annual obligations like taxes, insurance etc. Typically it should not affect your lifestyle (barring non-essential and lavish expenses) if you have to spend out of your emergency fund these many months.
The Emergency Coverage directly tells you how many months can be covered by the reserve fund. It is an individual choice to select the number, but typically 6 months is a good norm.
So far all the ratios indicate the current state or health of your finances. None of them talks about or helps grow the Net worth.
The savings ratio is pretty simple and easy to guess from its name. How much are you saving from your take home pay? It could mean saving for long term investments like retirement funds, children education fund or general investing.
However it should exclude savings done towards goals which are ultimately expenses in the short term – vacation, down payment of a car or house, or for meeting upcoming obligations.
The real savings should contribute to growing your Net worth on a year on year basis for a long term.
Savings ratio = (money saved away per month for retirement and investments + principal part of mortgage payment) / (take home income per month)
If the numerator includes amounts which are deducted pre-take-home like 401k, then it may make sense to consider a gross income as the denominator.
The Savings Ratio indicates growing net worth, and can be turned into a goal – for example I will achieve a 20% savings ratio this year.
These five ratios can be used to monitor personal finance health, and growth of net worth in the long run.
Also the simplicity of these ratios make the math very easy, you can also set these up in Excel and just update the variables on a monthly or yearly basis.
Finally these ratios with the recommended values give you the peace of mind. The following set of recommendations are a good thumb rule.
After months of dillydallying, I bought a second car. I also have a list of home improvements that I want to see get done. With the holiday season approaching, the vacation dreams are taking shape too.
However all these cost money, some little some a lot. And didn’t we say, we want to save more, invest more so that our retirement corpus grows with time? The $20000 spent on a car (decent, used or new), if invested instead can go a long way in boosting retirement savings over 15-20 years.
But life also gets in the way. We do have emergency fund for the unforeseen, worst case expenses. So are we going to just live frugally and save the rest?
After all, desires and dreams also make your life worth living. You have to find a balance on how to live a fruitful life and yet not damage your personal finances. However, it is very important to avoid consumer debt in all cases, and be ready to save and pay cash for these desires and wants.
I did exactly that. I had neat sum saved up in a savings account, and was procrastinating how to invest it. I also knew at the back of my mind that the family may need another car. Finally I gave in to the need and bought the car.
Thinking through this phase, I realized there are few expenses which are better made when the need arises. So I compiled a list of 10 such expenses, which are intangible investments in a way. These apply to my situation, yours may be different and so make your own wish-need list.
Insurance
We think bad things cannot happen to us or our family. However life is uncertain. I experienced this last December, when a very close family member in India met with an accident and passed away suddenly. He left behind a wife and a school going child, and being the only bread earner in the family, the whole situation was very shocking and sad.
Life insurance, health insurance and disability insurance are things no one should ignore. The exact amount of the need should be assessed and insurance purchased as soon as possible.
I have also seen in India, people do not want to buy pure term insurance in which you do not get back anything if you survive till maturity. That’s precisely the meaning of insurance, to transfer the risk of a life/event to the company. Many unscrupulous agents push cash-value, investment plans at a higher cost and lower insurance just to lure the people who wants to get back a return.
Keep the investment for the low cost mutual funds and ETFs, and buy insurance for what it is. And there is no better alternative to a cheap and effective term plan.
Peace of mind is worth paying for.
Car
A good car is a must for our commute, weekend trips and running errands. As I researched my way through used cars in various forums like Carmax, craiglist and dealers, one common theme came up.
You can get cheap deals (Dave Ramsey’s proverbial $1000 car) but they may cause you more headache down the line. If you are anyway buying it, you better buy it to use for a number of years. I don’t plan to trade in my car in just 2 years, just to upgrade to a bigger and newer model.
It is always better to wait a few more months, save up more through a budget and then pay cash for a decent car (2-4 years old) with low mileage. These are the cars I bought in last two years.
2017 – Toyota Corolla from a private party – 2015 model, < 20k miles for $11,000 cash.
2018- Toyota Camry from a dealer – Certified Pre-owned 2017 model, < $25k miles for $18,000. I traded in the Corolla, as I wanted to pay cash and did not want to hold two cars. So I just had to pay the difference in cash.
2019 – Honda Accord from the same dealer – 2017 model, < $20k miles for $17,600 paid in cash.
So with the Camry and Accord, my needs are met for the next few years. Me and my wife do not have to timeshare our work anymore, it was only possible earlier as I was working from home. I think it is money well spent, and with no debt (a.k.a car payments).
Debt-free mobility is another name for Freedom.
Vacation
If done correctly, and afforded with cash, this is one of the events I look forward to every year. And who doesn’t?
While in India, we used to go to the beach town of Goa every year, after the Dec 25 – Jan 1 rush is over. It gave us access to the same festive ambiance (since the beach shacks are still celebrating with their longer stay clients) at a much lower cost. The airfare and the hotel prices start dropping after Jan 1.
Now from US, one of the vacations I save for throughout the year, is visiting India in the summer. It is very relaxing to be able to meet family and friends and also keep my children bonded to their roots.
Whatever you do, make sure you enjoy it. A vacation bought with debt only brings back stress and payments, and hence make sure you save up for this event throughout the year. It’s an investment for your well being, and like any regular investment this should be planned and saved in small increments.
After all, stuff do not make you happy, experiences do.
Home improvements
This can be small to big ticket items. You can fix or enhance small things like paint a wall or room, or bigger improvements like a kitchen or bathroom remodel.
While it can be very costly to do the high end remodel, this is a project that can pay off in the long run. Some well designed improvements like in the kitchen, bathrooms, an extra room increases the home value, while others may just increase your happiness and convenience to the family.
We had this problem where we did not have an extra space in the house, for my children to practice their dance lessons. We had to move the couch or dining table every day and it was becoming quite inconvenient. The natural reaction was we need a bigger house.
But then we realized we use our garage for only storing junk, and may be the car in the night. Throughout the day, it is an unused space that can be used. Cooling (AC) the garage effectively is a problem, but the kids are not going to practice for more than 30-40 mins anyway. So I spent about $2000 to have a shiny epoxy floor and some lighting installed. In that $2000, we now have a beautiful hobby space, and my wife improved it further at very low cost (just interior decoration and a bigger fan) to shift her music studio there.
At night, we still park the Camry inside. Its all about space management with an investment of $2000.
Home is where the heart is. Do not neglect it or underestimate it’s intangible value.
Netflix
After the above expensive proposals, here is sweating the small stuff. However its not small, as cable expenses can add up to hundreds of dollars for some people.
While in India, I realized that I do not need the 100+ channels that the local cable or some of the high end services were advertising and everyone buying them.
Except for certain sporting events, I just ended up surfing and jumping from one channel to another killing time and really not watching anything to the full. I guess choice spoils you and your time.
So then I discovered Netflix (it was still new in India few years back) and subscribed to it. I knew if I needed entertainment, I can just start a movie and sit through it better than listening to a news anchor shouting at the top of his voice, throwing his political opinion.
Netflix has remained with me since then and the only TV subscription I have in the US. The $9/month is a good investment and much more value for money than any other TV subscription. With free YouTube complimenting the rest, I don’t need to spend any more on passive entertainment.
You will be more entertained when you channelize your focus to one medium.
Books and Courses
From my childhood, my introvert nature has one true friend – Books. I love reading and it has increased over the years to varied topics like technology, business and personal finance.
A part of my budget is spent on kindle books and paperbacks. This is also the reason why I do not need anything beyond Netflix, as my free time is well spent reading otherwise.
When I came to US, I discovered the local library which opened up a further avenue for my reading at $0 cost. The public libraries are an excellent initiative and maintained by the city here. Sadly they are long lost in most Indian cities, only some schools still have them.
To grow myself intellectually and improve my skills, Coursera has also been a huge help. Nowadays they run many good courses with a $49/mo plan, where you can take the course at your own pace (faster the better as you pay every month) and it gives you a certification. I am presently doing this amazing course on personal finance.
Its certainly a wise investment and a satisfying experience to learn continuously out of work and school.
Education is much more affordable and accessible now than ever before. Use it and grow your skills and knowledge.
Eating out
The finance gurus will scream – Live within your means, should not eat out, drop that latte and save the $3.50 everyday. But what is the problem if you have budgeted for it, to eating out with family twice a month? Or a set amount like a $100, which can amount to 2-3 dine outs for the family depending on what kind of food and restaurant you eat at.
It is a way to unwind once a week or two, and treats your taste buds to different cuisine. Socializing with friends and family also makes you happy and you get back to work on a Monday fresher and looking forward to another week.
Of course, daily and random eating out can have adverse effects on health and finances, hence like everything else, it also has to be budgeted and planned for.
Dine out not for the food, but for the experience.
Productivity stuff
I have talked about automation in personal finance and other areas of life in an earlier post.
Some of these websites and tools charge a monthly/annual fee, while some others may be fees for investment or specific service.
These fees, if reasonable, can be well paid to get the convenience of automation and services that will improve your productivity. Some of the online services and apps that I use are:
Rentometer and Dealcheck – Real estate information in USA. They help in evaluating rental properties. However, subscribe to the paid version only if you are seriously going to invest in rental property. I used them for a year but then dropped my plans as I am not investing in this hot real estate market. The reason I mentioned them here is the service is very good and constantly improving. I even wrote to the CEO of Dealcheck and gave him a suggestion of a new feature. I was happy to see that they rolled out the feature in next few months.
You Need a Budget (Y.N.A.B) – I use this for my daily and long term budgeting. The features are worth paying the $84/year and helps me to keep a holistic view of my cash flows.
I am sure you will find your own useful apps and after the trial period, if it seems useful in the long run, do not hesitate to sign up for the paid version.
Only thing to keep in mind is that we sometimes turn on the subscription and then forget to use it till the next year, when the credit card on file is charged automatically.
One way I manage it is – I download the app on my phone, and keep it all in one folder called “Productivity” or “Personal finance”. I visit this folder daily at least for the apps that I need to use. It gives me an instant look at the others in the folder which are lying unused. Once I figure out I am not going to use it in the near future, I cancel the subscription. This is how I discovered that I was not using Rentometer and Dealcheck after a few months. Most of these subscriptions let you finish the tenure that you already paid for, so you can keep using it and ramp down your usage.
Paying to get back your time and establish a system is worth its penny.
Offline Automation
What is the offline automation? Just like online apps and automated services, there are some things in life that are unavoidable but you don’t want to spend your valuable time on them. For example, Amazon has made it so easy to get things delivered that running errands have cut down by a lot for most people.
For me, tasks like mowing the lawn or fixing the plumbing (when it develops a problem) are simply not expertise I want to build or spend time on. Hence I outsource this to contacts and experts who know their job, and in turn I don’t mind paying them regularly for their services. I also subscribed for a Home Warranty who dispatches service professionals when I have a problem with my household appliances.
It can get costly though if you want to use this blindly. You have to develop a good idea of the cost of each service through collecting quotes or researching on the Internet.
But at the end, I think its money well spent if it saves me the headache and time to try to do everything myself. And indirectly, I get to help the local businesses run.
Expertise is available and widely distributed, make use of it judiciously.
Giving
Last but not the least, Giving is never regretted. In fact, what you give gets back to you in multiples of the original amount.
This is God’s way of paying interest to the good people.
I am not an expert on charity, and as long as you can find a legitimate and genuine organization which helps the needy, this is an activity worth spending money on and automating the giving every month.
Even if its just $20-$50, automate it so that there is no hesitation left. Sometimes we know we should, but we keep postponing it till we think we have enough surplus to give.
It is difficult to get over the inertia, so just like “Pay yourself first”, pay your rent on the Earth and help the not-so-fortunate brothers and sisters.
Giving is a way to abundance, even if it sounds counter intuitive.
Conclusion
In personal finance, the gurus and pundits constantly talk about saving, investing and minimalism. However life is not about accumulating wealth alone – money is a way to gain freedom and is only a means and not an end.
The real freedom is when you are happy doing the things you love, and some of them do cost money, defying all financial logic and the only return is happiness.
Fin Tech – Financial Technology is everywhere now. From Internet only banks to robo-advisors to automated loan processing to auto-invest, auto-save, the automatic word has prevailed the personal finance world.
Gone are the days when people queued up in banks to deposit or withdraw money, fill up paper forms to open an investment account and wait for hot tips to buy that fateful stock.
With the financial world so much dominated by technology, there are some tools and techniques we should employ to make our personal finance more automated and efficient, thus leaving us more time to pursue real passions.
Here are a few areas of personal finance where I think we cannot avoid the best of automation.
Banking
This is a no-brainer, however people still flock to big mortar banks like Chase, Bank of America or Wells Fargo. If you read the reviews of these banks, there are endless complaints about non-explained fees, bad customer service and old style bureaucracy.
On the other hand, I bank with a Credit Union which does not even have branches in my state of residence, and another online savings bank which is linked to the checking account in the Credit Union.
In last two years in US (and same in India), I did not feel the need for a local branch. True, once or twice when I needed to withdraw cash more than the permitted limits in authorized ATMs, I could just go to one of their affiliate Credit Union branches in my city.
Thus moving your banking to completely Internet based and using mobile apps, you are in better control of your money than dealing with the brick-and-mortar banks.
All the internet banks provide goal based savings accounts, the one I use definitely has that feature. It makes it extremely easy to setup savings goals (5 minutes) and let it go automatic every month.
If you still don’t want to do the planning, budgeting etc. for saving money, check out Acorns or Digit, these are two advanced FinTech companies who help you save in the background.
Acorns helps you accumulate the spare change from your everyday purchases and siphons it away to an investment account.
Digit is a bit more sophisticated in that it analyzes your spending pattern from a linked checking account, and saves off what it can. Of course you can set it up in a way you like, but they also guarantee not to cause overdraft.
Before you try out these apps and link your account, please read through reviews and understand their fees. The fees has to be justified compared to the value it will add to managing your finances.
For example, I signed up for Digit but later decided to pull back, as I already know and have set up automated transfers for my savings goals.
There are other similar apps and the following link may help.
Like Acorns is a micro-investing app which pulls money out of your account and forces you to invest, there are robo-advisors for bigger and planned investment.
Wealthfront and Betterment are two companies that are revolutionizing the space of robo-advisors and has features like tax loss harvesting in your investments.
This can be a completely hands-off approach to investing and let the expert designed algorithms decide your asset allocation and investment product mix.
Here is a good discussion, again from nerdwallet.com.
Moreover, the brokerage companies like Schwab also has robo-advisor options.
Tracking
What gets tracked, grows. I don’t know who said that, but tracking your Net worth and investments is important.
While you can keep the overall numbers in your head if you check your accounts regularly, there is nothing better than having an algorithm do the data crunching and show your portfolio with all kinds of analysis and charts. It is even better if it can project future growth of Net worth with reasonable assumptions.
This can be done by plain old Excel sheets and I do the same before I could trust the online sites with a consolidated view of my personal finance.
While this is very convenient and tempting to look at all the analysis available, do this if you are comfortable linking all your accounts to one of these services. Below is a detailed review of Personal Capital, but do your own diligence and research.
This one is my favorite and real innovations are sweeping this field.
While real estate is the most lucrative (and hyped) investment of all, it comes with high degree of everything – risk, reward, hard work, expertise and complexity.
Traditionally real estate portfolio is built by acquiring houses and buildings with part cash and part leverage, and then managing the day to day affairs of keeping a tenant, fixing issues, chasing rent cheques, vetting and evicting tenants etc. You need a lot of knowledge, time, experience and most important of all, a team of real estate agents, lawyers, tax professional, property managers to run a successful business.
Simple investors who have a different passion than real estate (or loves their own job), do not have so much time and risk appetite to run a full fledged business of rentals.
This is where sites like Fundrise, Roofstock, Rich Uncles come in play. They are making it easier for small investors (even non-accredited) to get a flavor of real estate in their portfolios without the heavy lifting of managing rentals and tenants.
However real estate is an ill-liquid investment and may take 7-10 years to get back the principal. Proceed with caution and read the prospectus, investment style and restrictions carefully before diving in.
I have personally invested with Fundrise but less than 10% of my overall portfolio.
The main risk is once invested, you lose control of the principal as you cannot sell on your own. However the convenience outweighs the risks, if you know what you are doing. With Fundrise for example, your portfolio is invested all across the United States in commercial buildings. It is simply not possible to build such a portfolio directly, unless you want to be a full fledged real estate professional.
Similarly Roofstock enables you to actually own a rental property in different states of US but once invested, you own and manage it with the help of certified property managers.
Tread with caution, surely real estate crowdfunding is going to take off, unless it runs into a major scam or something.
Conclusions
With so much automation in the personal finance industry, it is difficult to stay away and not take advantage of these tools. At the same time, it is scary to lose control of your money and investments.
Many people are still skeptical of online finance and not without reason, given the recent data breaches at Equifax and CapitalOne. Another reason for skepticism is due to the perceived loss of control. For example, lot of investors still prefer to hold physical real estate than trust online real estate crowdfunding. It reminds me of the obsession in Asian countries (especially India) of holding physical gold (bars or jewelry), till paper gold ETF came along and created lot more gold investors.
On the contrary, we leave so much control of our lives to experts. When we fly, we leave it to the pilots and the airplane auto-pilot system. When we are sick, we let the doctors take over. When we are educating our child, we send them to good schools.
So why should it be different for personal finance, if FinTech frees you from unnecessary headache and lets you concentrate on your real passions?
Let the experts and machines do the job (for a fee of course) but you have to do your research so as not to run into dubious sites and services.
The new mantra of personal finance – Learn, Automate, Delegate, Track.
Disclaimer – I am not promoting any of the services mentioned in this post nor my opinion should matter in your choice. Do your own due diligence, as I have done in selecting my own set of services according to my needs and risk tolerance.
There are many articles on how to be frugal, how to save more, earn more and invest for high returns.
All this is good advice, and the Internet is full of such articles, blogs, videos, courses.
However the key to saving money and investing for growth is action and the discipline to implement the good practices.
If you go through most of the articles, some common themes emerge such as:
Pay yourself first
Do a proper budget or at least allocate money to your various expenses
Big tax refunds are not cause to celebrate
Get out of debt
Regularly invest a little
Use Robo advisors
and so on…
Yet lot of people (some say 78% of Americans) live paycheck to paycheck, and will not be able to cough up $400 cash in times of emergency.
With so much of good advice and technology out there, why then we still have the problem with more than 50% of the population? What is different with the 10-20% who manage to create and keep wealth?
I think the answer lies in being organized, intentional and disciplined. As Dave Ramsey said “Personal Finance is more behavior than numbers”.
It requires a system to be organized and manage your money. Once the system is in place and you get into the habit of it, you will automatically resist impulsive behavior.
In this post, I will highlight some of the systems that I follow to organize this area of my life. And remember, the more organized and intentional you are on personal finance, it impacts rest of the areas of your life as well. Cliche, right? Yes but difficult to implement.
There are 5 parts to the system:
Automate
Cap
Archive
Remind
Learn
Just for fun, lets rearrange and call this the CARLA system (Cap, Automate, Remind, Learn and Archive). Really the order does not matter.
1. Automate
Automation is the heart of any system. And with most of the financial products employing high end technology, there is no reason to avoid automation.
A simple automation makes the “Pay yourself first” a breeze like operation.
For example, in my case, the first bi-monthly paycheck (pre and post tax) simply goes to my mortgage and investments (retirement, 529 plan, HSA, investments). I just cannot see it in my checking account by the 2nd or 5th of the month.
How do I run my expenses and pay my bills then? Another automation.
All my bill payments are set on the one and only credit card that I use. It is completely automated so I don’t need to remind myself to pay electricity, water or phone bills. The same credit card is used for first half of the month to buy essentials.
By the same system, the second bi-monthly paycheck pays off the credit card bill in full.
A portion of that also goes into savings for short term goals (provided the credit card was not overused – we will talk about caps in next section).
Advantages:
Naturally implements the Pay Yourself First.
Automated bill payments, so no chance of forgetting and running into credit problems.
Earn points on the credit card, as all expenses are charged to the one.
The credit card is automatically paid off within the month.
Risks:
Need to control expenses as the credit card balance should not overshoot the projected amount.
Unexpected debits to the checking account (checks issued, or charged by institutions) may cause overdraft scenarios if not careful or kept track of such expected transactions.
The Starter Kit explains how to setup a system from scratch.
2. Cap
One of the toughest part of personal finance behavior is to cap your spending. No amount of technology or automation can address this adequately. There are budget apps, reminder apps, envelope system but at the end of the day, if you are armed with a credit card, there is no stopping you.
There are two ways to address this:
If you are using a credit card, then absolutely you will need a budgeting and expense tracking app. I use YNAB (You Need a Budget) but I have heard people liking Mint or Personal Capital. In these apps, you can set limits for spending under each category like Food, Transportation, Utilities and Fun. Here is a referral link to YNAB.
However a more effective way and not to run into debt, you can automate to transfer the estimated monthly expenses to another checking account, and use the ATM/debit card of that account. As soon as you see the account is drying up, you know you have to rein in your spending. As you do this more, you will slowly understand the pattern and be able to make or adjust estimates.
Advantages:
Having a cap of expenses is non-negotiable in the pursuit of good personal finance habits.
You know exactly where each dollar is going and how to optimize or reduce the outflow.
Risks:
The first approach definitely has the risk of running into credit card debt, and not able to pay in full.
The second approach is safer but if you are not keeping track, can hit you with overdraft fees or embarrassing card decline at the checkout counter.
A good archiving system is also key to good personal finance habits. Not only habit, but it keeps you stress-free. Remember the scrambling during tax filing season, looking for bank statements, dividend results, interest certificate etc.
Moreover we have multiple sources of information, statements coming through email, snail mail, website downloads, or even previously archived repositories.
A simple system I follow consists of a uniform folder structure across multiple sources of information.
There are 4 aspects of personal finance that you need to keep track of.
Taxation – Everything related to your taxes year wise. Returns, documents sent to CPA, CPA communication, IRS communication and so on. For each year, I have the following folders.
Year
Source documents – Everything I sent to the CPA
Processing – All drafts and iterations I had with the CPA
Final – Final copies of the filed return and acknowledgements etc.
IRS – In case there are any direct interactions with IRS after filing (notices, response, tax due, tax paid etc.).
Bills and Receipts – Miscellaneous bills and receipts if they do not fall into above categories.
With the above organization, you can simply create the archival system in all your information sources.
Gmail – create these as labels or email folders.
Evernote – you can create notebooks and store documents as notes under each notebook.
Google Drive – create folders. You can save attachments from gmail directly to these Drive folders.
Laptop local drive – Sometimes it is best to store in the local drive than cloud. That is, if you are uncomfortable storing documents containing sensitive information (SSN, date of birth) into the cloud. Be sure to periodically back this up into external hard drives.
Physical documents – Paper statements can be either scanned and stored in above places, or simply dropped into file cabinet drawers, with appropriate labels. The labels should follow the same categorization.
Once you have the uniform structure across all these platforms, storage and finding information is easy.
Advantages:
Easy to file and find.
Following same structure in all systems that you use.
Risks:
None at all.
4. Remind
So you have automated, capped and archived personal finance. But what about still those actions to be taken, follow-ups to be done and making sure time sensitive things do not fall through the cracks?
I don’t want to describe personal productivity or time management here, but an essential part of managing personal finance is timing. There are taxes to be paid quarterly, investments to be made, or simply a phone call to be made.
Choose whatever system works for you as reminders, be it an app on your phone, or calendar on the laptop.
For me, plain gmail works as it has a snooze facility, by which I can redirect any email to come back to my Inbox at the time I need to take action. In my opinion, it is an important tool in time management as now I can remember to take action at the right time. It just pops in my Inbox on that Sunday prior to the week I need to take action on that.
Another good platform for keeping track of your laundry list is Trello. I use it quite extensively and the concept of board and cards, helps keep things visually clear.
Advantages:
Even if you automate everything, there will be things for which action needed to be taken timely.
Remain stress free and auto-magically respond or follow-up with people at the right time. Sometimes this surprises people as they may have promised to do something (or get back to you) and you follow up on the agreed date.
Risks:
Unless you stick to one system (Trello or Gmail), you run the risk of multiple apps keeping track of your to-do lists and confuse you enough not to take action or update new items.
You may run the risk of irritating some people who do not like to be followed up, especially if they wanted to forget what they promised.
5. Learn
I cannot emphasize this enough and with the plethora of information on the Internet, whatever I say will sound like cliche.
However as with any field, it is important to keep yourself up-to-date with advances in personal finance topics.
One of the simplest ways is to dedicate a couple of hours every week, to read about different topics, blogs and videos of personal finance. You can subscribe to magazines like Money or Kiplinger. Or simply come back to this blog as I normally post every week.
Advantages:
Learning is always good, and opens up new opportunities for you.
You build your own system and strategy as you read and learn techniques others have used.
Risks:
Don’t get obsessed by personal finance reading, as it can get repetitive very easily. You may end up wasting lot of time reading the same message in different ways.
You may take wrong action or jump into investments without fully understanding the consequences, or simply following some author’s thumb rule from a book.
These are the Five essential elements of a good system that can be setup with minimal infrastructure. It worked for me and I hope you find it useful.
My CARLA system (Cap, Automate, Remind, Learn and Archive) – a system to automate, manage and grow personal finance.
If you are just starting off with organizing your personal finance, or restarting from scratch, here is a step by step way to get started.
Most of the times, we get started haphazardly, the first account in the local bank or the ad-hoc insurance policy or even the next stock tip forces us to open a brokerage account.
However there is a need to get started in a more planned way.
When I moved to the US couple of years back, the below is how I setup my money system. I had a similar one running in India for a long time and it has given me very good results.
Here is the starter kit that you need to get organized and get started.
Since it is built in a systematic manner, it will help you automatically organize and keep your finances in order.
A checking account
This is the first step as you need a place to deposit your income, be it direct deposit from your employer or you get checks at the end of the month.
Get a simple checking account at a Credit Union which provides you with a basic ATM and Debit card. Try to find a credit union or bank which has very low fees. Obviously they will have some like overdraft fees that we will anyway avoid, but others like ATM access are something unavoidable, so shop around a little.
This is where all your income will come in and get deposited.
A credit card
We are going to be responsible spenders, right? If not, do not get this and use your debit card from your checking account.
The key to being a responsible spender is to make a budget, stick to it and pay off the credit card bill in full every month. Lets just assume you agree to all of this.
There are many credit cards in the market with various features like cash back, travel rewards etc.
As a starter kit, you will just get one from the same bank or credit union where you hold your checking account. The reason is ease of payments and setting up automatic transfers from your checking account to pay it off at end of month.
The bonus will be of course if the card also has generous cash back benefits or other similar perks. But get a free one and not one with annual fee loaded just for extra perks.
The credit card will be your main expense vehicle. It gives you automatic fraud protection, insurance and easier account tracking.
Budgeting
If you do not do any further, you have setup the very basic system. You earn money which get deposited into the checking account, you spend with your credit card (on a budget!!) and your checking account pays it off every month.
But this sounds like living paycheck to paycheck or Living on the Edge, right?
We are going to do better – save and invest.
First what we need is a planner. As the above system of checking account and credit card gets working in a flow, you will start getting an idea of how much you are spending every month.
For the next 2-3 months, track your spending to categorize your money into only 4 parts.
Food and Dining
Utilities and Transportation
Clothing and miscellaneous
Surplus
You will automatically get motivated to squeeze the first 3 categories and increase your surplus every month.
The above technique will help you generate surplus for both savings and investment, make it your goal to only increase it and not fall back to paycheck to paycheck cycle.
Savings Account
There are unexpected events or expenses that will always come up. You need to be prepared for it and the only way is to build up a cash cushion.
This is similar to Dave Ramsey’s first 3 baby steps, where you start with saving $1000, then get out of debt (hopefully you have none if you started with this) and finally build a cushion of 3-6 months of expenses.
I use an online savings account like CapitalOne 360, Ally Bank or Synchrony. There are many others, and online banks provide little more interest on your deposits than brick-and-mortar banks, or the one where you have your checking account.
Setup an automatic transfer of your Surplus from your checking account to this Savings account. Set this up for beginning of the month, so that your budget works with just the right amount needed (to pay off the credit card at end of month).
Investment Account
Get to this step only when you have a running budget, able to generate surplus consistently and stacked up 3-6 months of expenses in your savings account.
From here on, you become a pro in personal finance as you are about to invest and grow your net worth.
There are two main investment accounts, a retirement account and brokerage account.
Contact your employer for a 401k (Pretax or Roth) account and contribute to it, if there is a match. If this exhausts your projected surplus, no worries you have got started.
If there is still surplus, good news. Open a brokerage account in one of Schwab, Vanguard or Fidelity. Preferably open a Roth IRA account if your income is within eligible limits.
The above is a simple 5-step process to take you from a personal finance newbie to a disciplined investor and saver. Taking action in a systematic way is the key to financial bliss.
