Welcome back. In the last episode we explored common investment mistakes people make. It’s not really essential that you listen to Part 1 before giving this one a listen, but if you haven’t listened to that one yet, perhaps make that the next episode you grab.
Today we’re going to explore common cash flow mistakes that I see people make.
I mentioned in the first episode that when I was first planning this post, I jotted down 12 ideas – financial mistakes I’d seen regularly over my 18 years as a financial planner. Last episode we covered the three that I grouped together as investment related – procrastination, being too conservative, and trying to be a share trader. In this episode I’m going to start with three more, that all have cash flow as a common theme.
Hopefully you’ve listened to a few Financial Autonomy episodes by now, and if so you’ll know that a common pre-cursor to making progress on your Financial Autonomy goal is having a good handle on your household’s cash flow. How much comes in, and how much goes back out. In the Toolkit for the episode I’ll make sure that our Budget Tool is included. I know the “B” word strikes fear into many, which is why I typically focus on cash flow instead.
The thing is, getting on top of your Cash Flow is much easier now than it used to be. That’s courtesy of internet banking.
Our Budget Planner template has Expenditure first and income second, but if you want to get some quick progress, fill in the income figures as they’re the easiest to get. You want the after tax number here – how much actually goes into your bank.
Now go back to the top and work through your expenses, referring to your bank statements in your internet banking to get the numbers. Focus on the bills first because they are easily identifiable. For things like your phone bill, they’re pretty stable month to month, so you should be able to just check a couple of months’ worth and then get a good estimate of what they will cost you over the year.
Bills like Electricity and Gas can vary quite a bit between summer and winter, so you might need to go back and get the whole years figures for these ones.
Once you’ve filled in the clearly defined expenses, then go back and perhaps focus in on 2 months’ worth of figures and tally up what you spend on food, clothes, and the like. Things that you will always spend money on, but for which it varies a bit, and drips out over the course of a month.
I would print out the 2 months worth of bank statements and tick items off as I allocate them to a group such as food. Perhaps you could use a few different coloured highlighters – one for food, one for entertainment, etc. The end game is that once you’ve completed this exercise, everything you’ve spent money on in the past 2 months has been put into a category in your budget.
So now you total up your expenses, compare that to your income, and hopefully you like the answer. If the answer is that you should be saving $x per year, reflect on whether that has been your actual experience over the past year. If not, why not?
One key element of the exercise, probably the most important, is for you to see what you spend your money on, and whether that’s really bringing you the greatest happiness. Is the way you are currently running your finances bringing you closer to your Financial Autonomy goal? In know that money and finances can be a point of stress in some relationships too. Perhaps going through this exercise together might help you both have a deeper conversation about where you are currently going, and whether that is taking you to the destination you both want to arrive at.
So not having an understanding of your cash flow is common financial mistake number 1 this episode. Very much related to this, common mistake number 2 is spending more than you earn.
You don’t need the mental powers of Einstein to figure out that this can’t work, yet it is an easy trap to fall into. The most common ways I see this unfold is through credit cards, and the generosity of well-meaning but ill guided parents.
Credit cards, and I guess general consumer debt like interest free periods on white-goods, is the most common way of spending more than you earn. If this is you, you’ll know it. So do the budget exercise mentioned earlier, understand why your expenses exceed your income, and devise a plan to do something about it. Perhaps you can come up with a way to increase income. Most likely there will need to be some strategy to reduce expenditure. As with the investment problem identified in part one of the post, the key is don’t procrastinate. Identify the problem and take steps to resolve. You may not come up with the perfect solution straight away, but make a start in changing things, and refine as you learn more.
The less well recognised way that people fall into the habit of spending more that they earn is through the generosity of well-meaning parents. I’ve had retired clients over the years whose retirement savings have been drained by adult children constantly putting their hand out for financial help, or just where the parents say “oh well, poor Tina’s doing it a bit tough so we paid her credit card off for her”. These parents are well meaning, they love their kids. But by “helping” in this way, their children, who are adults, never get on top of things financially. They never get to the point of standing on their own two feet.
I’ve dealt with one family where mum and dad provided the daughter with quite a bit of financial help in her 20’s, enabling her to drive a Mercedes and live a really high material standard of life. She met a lovely guy and they got married. Her expectations of what life should be like were really high though, and as a couple, that lifestyle just couldn’t be maintained. The husband felt like a failure because he couldn’t support his wife in the lifestyle she had become accustomed, and ultimately they separated. It was sad story because they are both lovely young people, but her parents, with the best intentions in the world, effectively sabotaged that marriage by not making their daughter at an early age understand the fundamental need to live within your means and spend less than you earn. Unrealistic expectation were baked in at an early age.
In contrast to this, I saw an article recently that criticised the celebrity chef Gordon Ramsay for flying in first class, whilst his kids flew in economy. Now I have no idea if this story is true, or, if it is, what the back story was. But if his thinking was that he doesn’t want them to have an expectation that every time you fly in an aircraft, it will be in the first class section, then I think he’s doing his kids an enormous favour. If his kids enjoy success later in life and can buy their own ticket in first class, then good luck to them, they will have earnt it. But if dad just shells out and they think nothing of it, then surely, roll forward 5 or 10 years and you’ve got a train wreck of a life waiting to unfold.
Continuing on with the cash flow type common financial mistakes that people make, feeling the need to keep up with the Jones is my third offering for you. Back in Episode 7 – How to retire early, I touched on the interesting findings from the authors of The Millionaire Next Door. You’ll recall the two authors studied households whose net-worth (ie. assets minus debts) exceeded one million US dollars. One really interesting finding was that millionaire households were disproportionately clustered in blue collar and middle class suburbs, and not in the higher income, white collar, more affluent suburbs that you would assume. Digging into why this was the case, the authors found that the higher income earners devoted more of their income to luxury items and status symbols, often funded with debt. These people tended to neglect savings and investment.
This finding delivers the double whammy of linking the problem and the consequence. Feeling the need to keep up in a material sense with friends, neighbours, or whoever, results in you being less wealthy. And in the context of what we’re trying to achieve – your Financial Autonomy, your financial independence, gaining choices in life – less wealth directly pushes against you achieving your goals.
Let’s finish off today’s episode with another financial mistake that I commonly see, and that is often really quite sad. That is the scenario where one member of a couple handles all the finances, and the other is totally ignorant of all things money in the household. I say it’s really sad, because I’ve seen this scenario unfold in a number of ways.
One is where the person who controls the finances dies, and the surviving partner is completely ill-equipped to manage their affairs. Sometime they don’t even know what assets the couple owns.
A variation on this is where a relationship ends in divorce. The person who took no interest in the finances (or perhaps wasn’t given an opportunity to be involved) is now rudderless. I can think of one instance where, post-divorce, the wife, who had previously just left everything to the husband, was utterly shocked when she did learn of the state of their finances and how money was being spent.
On the flip side, I’ve had clients in total despair, because they are trying to manage the household finances, but their partner just whips out the credit card at a moment’s notice and buys something that they simply can’t afford. Sometimes the person in despair feels like a failure because they can’t support the lifestyle that their partner seems to feel is the norm.
So if you’re in a relationship, I really encourage you to ensure that both of you have a working understanding of your finances. Sure, one of you might do more of the tracking – you’ve got to play to your strengths. But you need to be able to discuss things as a couple. Finances are a potential point of stress in any relationship. Openness is the best medicine.
Well, I think that’s enough for this episode. That’s 4 more of my original 12 common financial mistakes that I see people make. I’ve got 5 left, so look out for part 3 in a fortnights time.
A reminder too, don’t forget to download the free toolkit for this episode – I’m keen to help you take action on the ideas that I share, and the toolkit is a really critical piece in delivering on that. There’s no “fluff” here at Financial Autonomy.
I’ve put together something of a bumper toolkit, covering all 3 parts of this series on common financial mistakes. I have the 12 most common financial mistakes listed so you tick them off as you’re confident you’ve worked through or around those. I’ve also included the Budget tool to help you get your cash flow under control, a piece on risk vs. reward, useful books, personal insurance options so you can cut through the jargon in this area, and a piece on SMART Goals.
So hopefully tonnes of usefulness in there, so be sure to visit the financialautonomy.com.au website and grab your copy.