This is the second in a three-part series.
During part one of this series, I explored the necessary steps to create financial sanity in your life. To reiterate the foundational issues, let me first go back to the basics. In order to create financial “sanity” it is first important to define what, in this sense, sanity is. I proffer the following definition:
Financial Sanity is attained when one is living within one’s financial means and according to a well-conceived, written, and tested plan of action. It must also consider and prepare for the impact of reasonable possibilities that might alter the success of the plan.
In applying this definition, you can discern that several very important steps are involved in attaining financial sanity. You must have:
1. A clear understanding of your situation.
2. Goals that are synergistic to your values.
3. Examined the specific possibilities that pose a threat to your success.
4. A written game-plan.
In Part 1, I outlined the steps necessary to understand your Net Worth and how to create a statement. In today’s column, the focus will be on your spending plan — a.k.a. your budget, or Dynamic Spending Plan.
Traditionally, a cash flow statement or budget begins with the top line of Income or Inflows of Capital and then proceeds to list your spending.
I propose another way of approaching a budget that is geared more towards building your Net Worth. Remember, your Net Worth can be grown by: 1) The increase in your assets (cash, investments, retirement, etc.) or, 2) Decreasing your debt.
In the spending plan I propose, we want to begin with Income or Inflows (funds that will flow into your accounts to be allocated elsewhere). The funds could consist of money you earn from a job, Social Security, pension payouts, or inheritances received.
The next step is to consider to what degree you wish to increase your net worth throughout a determined set period.
By subtracting that number from your inflows, you now know how much you have left to spend.
Dollars that go towards reducing debt or increasing your assets are included in this number. If it’s your mortgage or other interest-bearing loan, use only principle (not the total payment which includes interest).
Allow me to plot it out for you in a proforma.
Inflows (Salary (net of taxes), revenue, or anything that comes in the door) $___________
Increase to Net Worth ($__________)
Difference = $Cost of living
The increase in Net Worth must be part of your thinking of your overall game plan.
Ask yourself: Where am I going and why is it vital that I get there?
This question draws directly to number 2 above, which requires you to think through your goals and values. But I will talk more about that in the next installment.
Let’s continue on the Spending Plan.
The increase in Net Worth includes funds that you contribute into retirement accounts, savings, other investments, or paying down the balances of your debts. That number needs to be REAL. It is vitally important. In other words, it cannot be a “wish.”
So here you are with your Cost of Living: $__________________
Next, you should list your fixed costs:
- Rent/Mortgage Interest/Real Estate Taxes
- Interest on other debt
- Child Care
- Insurance premiums
The next set of numbers are those which can be controlled in part:
- Personal Care
The last set of numbers are discretionary or those which are completely controllable:
This should deplete the cost of living to zero. If there is still a positive balance, it means you can save more and increase your net worth even further. But if the number is negative, meaning you’ve spent more than the allowable Cost of Living, you need re-think your living habits and start to make decisions that allow you to live within your means.
I didn’t say this was going to be easy, but if your goal is to create financial sanity, it’s important.
In the next part of this series, I will talk about creating goals that align with your values and the threats that impact your success.
While life presents challenges, it’s too easy to throw up your hands and not try.
I know you can do it… so chip away at the Spending Plan and we’ll continue next time. Good luck.