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.
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.
I had been thinking of upgrading to a bigger house for some time now. This is a difficult decision when you struggle to justify more debt, more wants and lifestyle creeps.
There are various factors to consider in deciding whether you buy that next dream house or say goodbye to your wants for a duration, till you are better prepared.
There are two aspects to this –
a numerical analysis
a behavioral analysis
Numerical Analysis
What can you afford?
It is definitely not what the lender tells you in a pre-qualification or pre-approval letter.
You have to see the following numerical aspects in your finances.
Do you have cash for down payment? Usually 10-20% of the purchase price is a good thumb rule. 20% is better to avoid Private Mortgage Insurance, which will increase the monthly payment otherwise.
Add the mortgage payment to other costs like Property Taxes and Insurance.
Are there any up-front rehab costs? Can you get those repaired by the seller?
After adding up all costs, adjust your monthly budget to see where you will stand once you buy this house.
See the impact to your net worth and asset allocation once you spend the cash for down payment. Although it moves from cash to Home Equity, it can skew a previously well thought out asset allocation across stocks, bonds, real estate and cash.
There are two main items where you have to shop around and get the best deals out there.
Purchase price. Since here we are dealing with numbers, the only thing that matters is whether you are paying too much.
List price offer or a multiple offer situation can quickly escalate the price and throw all deals out of the window.
Assess what all rehab needs to be done. It is better to get a contractor estimate during the inspection period, so that you can back out if found expensive.
Try to buy 10-20% below the price after subtracting any projected rehab expense.
Interest rates – This will depend on your credit score and the interest rates available in the market.
Getting estimates from various lenders will help compare the best rates.
Take into account closing costs and points as these can be significant and varies quite a lot across lenders.
What are the future costs?
A house purchase does not end with the closing. In fact, in terms of expenses it has just started.
Many people take on big house purchases only to realize later that the recurring costs or the holding costs of the property are too high and severely constraint their finances.
Holding costs
After you have accounted for the P.I.T.I (Principal, Interest, Taxes and Insurance), you need to make sure you still have enough slack in your budget to save for unforeseen expenses.
You need to have a cash cushion (preferably separate from your 3-6 months worth of emergency fund) for this property. The HVAC can go bust, the roof may get damaged in the next storm or there could be a disastrous water damage.
You also need to consider increase in Property Taxes and Insurance year after year.
To correctly account for the holding costs, you need to budget an amount every month and sock it away in the Home Maintenance Fund.
Future sale or rent value
No one stays in the house forever. You will also move at some point.
It is important to decide how you project the use of this house once you move out. Do you plan to convert it to a rental or sell it?
Decide on a tentative time frame when you may move out. Based on this and the neighborhood real estate projections, find out what the future sale value or rent will be.
Will the rent cover all the P.I.T.I expenses per month? Add a few more expenses like reserves for maintenance, capital expenditures (big expenses like roof), property manager (whether you use or not, just budget for it). To effectively analyze this, learn about Cap rates, Gross rent value etc.
If you plan to sell it, will the appreciation rate be enough to justify your costs, with a sale commission of 6% and all the money you will spend on Property Taxes, Insurance and upkeep of the house over the years.
After you can define a good deal by satisfying most (if not all) of the above parameters, it is time to take stock of some behavior patterns.
Behavioral Analysis
Do you really need to upgrade? What are you going to sacrifice?
Often it is our wants that itch us constantly to make that lifestyle upgrade. Whether it is keeping up with the Joneses or simply growing out of your current residence, it is a natural behavior trait for most people.
Answering the following questions may steer you to a better decision.
What is the motivation? A better neighborhood, schools or simply more space?
What exactly is the motivation? Is it due to moving to a better neighborhood, or moving to a better school zone? Or is it that the family grew and everyone needs more space?
This should be evaluated purely on basis of needs. For example, for more space can you rearrange or sell off unnecessary furniture and create more space in the process?
How will you clean and maintain the bigger house?
While buying a bigger house sounds exciting, think about maintenance. A bigger house brings in more maintenance headache. And we are not talking about money expenses here (we did that in the numbers section), but the overall energy you will need to keep it clean, mow the lawn and maintain the appliances, carpet etc.
Do you like more debt or want to manage debt?
For most people, buying a house with cash is not an option. So invariably you will take up a larger mortgage, whether you have one currently or not. Overall your debt increases. This has to be justified by the future stability of your job or the state of the industry or business you are dependent on. Or simply the peace of mind and how much debt will still keep you comfortable.
Is this going to be your long term buy?
If you buy a house (not an investor deal) and turn around to sell it, you will lose a bunch of money. Even after few years, it is difficult to break even. So if you are not staying in the house for longer, it will be another expensive switch few years down the line.
Thus it is better to justify all the needs and factors and make sure it will be a long term buy.
Can you rent first and then check out similar homes in the area?
Often the reason could be to just move to a better neighborhood for schools, or get more space. However instead of finalizing a buy, you can always rent a house in the desired area and then check out better deals as they hit the market.
This has the disadvantage of spending some money on rent, but in this section we are analyzing non-numerical aspects. Renting for a year or two will give better idea of the neighborhood, bigger house etc. and better justify the buy decision for a longer term.
Conclusion
All the above factors may seem daunting and may not be possible to satisfy to make a rational decision.
Some of the factors like rent to value ratio can be area specific. If your area is very expensive, then some of the numerical analysis will not give favorable results.
Hence it is important to consider other factors and take an overall informed decision.
This will also prevent the almost inevitable buyer remorse which is very common as you inch towards the closing date.
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.
