Hello, GreenMoney Journal readers!
Let’s take a break from talking about investments. Yeah, yeah. This is a journal about Sustainable Investing, but what is it you’re really after? What’s the reason you’re investing in the first place? Have you thought about where you’d like to end up? How will you know that you accomplished what you’ve set out to accomplish if you haven’t defined your goal? Investments are an important tool but they become more powerful when you view them as a part of your larger financial life strategy.
What I’m talking about is the process of Financial Life Planning and that’s what I do. I help people use money as a tool to accomplish their goals and live their ideal life. It’s what I call becoming a Financial Badass and it all starts with just six basic steps.
These six steps give you a framework to define your values and goals, and then uses those as a basis for your financial decisions. These steps provide a process that you can follow without fail, and help you provide the WHY behind your financial decisions. The WHY is your motivation and knowing that is empowering. Becoming a financial badass is a process of enlightenment and it’s a process where a little knowledge can go a LONG way.
Step #1 – Define Your Vision, Values, and Goals
What do you want to accomplish with your time on this earth? Going through this process may be the start of something bigger. It will take you down the path of breaking down your life and defining what you need to do to get you where you want to go.
All you need to do is take the time to be present for yourself and answer these questions:
• What would you like to accomplish in life over the next three years? 10-15 years? Beyond that? Think about this from a personal, professional, and financial perspective.
• What does money mean to you? What do you want it to help you accomplish?
• If you have an unlimited source of money and the rest of your life to spend it, what would you do with your time?
• If you have unlimited money and 5-10 years left of life, what would you do with your time?
• If you only have 24 hours left to live, what would you do with the time you have left?
These questions are here to help you realize what’s important to you and reestablish your values.
Have you come to any realizations once you answered them? Is there some part of your current daily/weekly/monthly life doing what you would do if you only had 24 hours left to live? If not, should you take a step back to reevaluate?
Step #2 – Are You a Saver or a Spender?
It’s no secret but savers are going to have a gigantic leg up throughout life. They have the funds set aside to execute on opportunities as they present themselves. Or, have reserves available if they happen to lose their source of income. If that happens, the savers won’t need to rely on debt to support their lifestyle until they find another job.
Don’t worry! If you’re a spender, all hope is not lost! As long as you realize you are a “spender”, you can take the steps ahead of time to ‘trick’ yourself. To do this, you need to automate a percentage of your paycheck into savings and investments and “theoretically” forget about it. Then you have the other percentage of your paycheck to live your life in whatever way you choose. Just remember to pay yourself first! The percentage you set aside is there for Future You!
Saving vs. Spending is about behavior. Many believe that if they were earning more money their financial fears and problems would disappear. The problem is that most money problems aren’t financial in nature, they are behavioral. That’s why living paycheck to paycheck is a systemic issue and so difficult a habit to break.
Getting financially ahead is less about what your income is and more about how much of your income you aren’t spending. If you spend less than you make for long enough, you’ll achieve financial independence. This is the essence of being a saver versus a spender, so let’s learn how to become a saver.
Step #3 – The Details
So where do you stand right now? Most of us aren’t starting from Zero. Some of us may be starting this process with debt and some of us may be starting out with assets. Either way, we need to find out where you are now to see what you need to do to get you where you want to be. This statement of your personal financial position is called your Net Worth. What we are going to build to calculate this is called a Balance Sheet:
1. Grab statements for all of your accounts (including debt) and values for hard assets (house, car, possessions)
2. Draw a T-chart on a sheet of paper:
• Label the left side Assets and list out the value of all your accounts and assets
• Label the right side Liabilities and list out all of your debts
3. Math time!
• Add up both columns at the bottom of your sheet of paper
• Assets – Liabilities = Net Worth
Now that you know where you are, what can we do to grow your net worth?
Step #4 – Your Budget
What’s a budget? A budget is a tool you can use to tell your money where you want it to go instead of leaving yourself wondering where it went at the end of every month.
The first part of the budgeting process is about awareness. It’s about figuring out what you’re currently doing with your income. The next step is taking that awareness and making changes with that new knowledge. Setting spending goals for each category will start to free up income. Should you spend less so that you can save and invest more? Can you actually afford to increase your lifestyle? Let’s find out:
1. Grab a pen and paper or open a spreadsheet.
2. Answer the following questions:
• What is your net monthly income?
• What fixed expenses do you have every month? (For example – rent/mortgage, utilities, cell phone, groceries, car payment, insurance, etc.)
• What discretionary expenses do you have every month?
3. Subtract your expenses from your income. (Income-expenses=???)
4. Is this number Positive? Negative? How do you feel now that you see where your money is going?
To get a more accurate picture of your expenses it may help to look at the actual data:
• Gather 3 months of statements with your transactional data such as from your checking and/or credit card.
• Go through your statements and categorize your purchases and expenses on a separate sheet of paper or spreadsheet.
- Add up the totals in each category for each month
- Divide those totals by 3
- This is your average monthly spending for each category and is a good starting place for a future monthly budget
- Review each category
- Does your spending line up with your goals and values?
- Are there any categories you can reduce or eliminate?
- Take some time and set spending limits for each category
See if you can stick to these for the next few months.
- Note if you are overspending in any one category, is an adjustment necessary?
Now that you are aware of where your money is going, are there any changes you feel you should make? Are you happy about what you found going through this exercise? What percentage of your income are you saving? What percentage are you spending?
As an aside, I’ve had many people tell me that they are good with money because they pay off their credit cards in full every month. I think that’s a great thing to do, but you need to make sure that the things you are spending your money on are aligned with what you really need in the first place.
Step #5 – Emergency Fund/Cash Reserves. The what, why, and how
So what do you do if you lose your job, have an unexpected medical situation, or you have a friend or family member that needs a boost? Financial life planning is also about preparing yourself for the unexpected.There are two ways to look at this.
1. You want reserves set aside in case something happens in your life. You will be able to take cash out to pay for an emergency instead of taking on debt. Set aside $1,000 in a savings account (and forget it’s there!)
2. The next iteration of an emergency fund is to prepare yourself for what could happen if you lost your income. How long could you float yourself before finding another job? Or if you’re looking to start a business, how much time do you want to give yourself before you can pay yourself an income? This is as simple as taking a look at your monthly expenses from Step #4 (budgeting) and multiplying it by how many months you’d like as a cushion. For example, if your monthly budget was $2,500 and you want 12 months of expenses set aside, you’d need $30,000 set aside. Keep this in a safe, liquid vehicle, so it’s there if you ever need it.
Alright, that makes sense… What do we do if we have a lot of debt? Funny you should ask…
Step #6 – Paying Off Debts
Debt sucks. Straight up.
It’s an expense that you incurred in the past that you told your future self you’d deal with as you earn more income. Trouble is, you probably didn’t realize how suffocating that concept was until you got into it.
Fear not! You can get rid of it. Now that you know where your money is going from doing your budget in step #4, you have an idea of how much extra income you can put toward saving, investing, and paying off debts. Has this article inspired you to get your s4!t together and become super intense about paying off all your debts? Great! Get after it! Similar to the spending vs. saving debate, this can often be more emotional than financial and that’s ok.
For those that want a strategy surrounding your debt payoff, there are two strategies that work well.
The Debt Snowball:
Organize your debts by their balances, smallest to largest.
Find the minimum payments for all your debts. Determine the maximum amount of money you want to set aside for debt payments. Distribute that money toward the minimum balances, take the leftover excess and add it to the smallest balance, and so on. As the smaller debts are paid off, roll those additional payments to the next smallest balance. The debt snowball is effective because it’s emotionally satisfying to see the number of your debts disappear.
The second method is the Debt Avalanche.
For this method, organize your debts by highest interest rate to lowest interest rate. From there, follow the same process as the debt snowball. As balances get paid off, roll those payments into the debt with the next highest interest rate. This is the quicker way to get rid of your debts but may not be as emotionally satisfying. If you have high interest rate debts that have high balances they will take longer to pay off.
Either method you choose is a fantastic way to get rid of your debts. It’s far better than the alternative, letting them continue to accumulate and ignoring the effects.
Calculators here: http://www.calcxml.com/calculators/restructuring-debt?skn=38#calcoutput or here: www.whatsthecost.com/snowball.aspx
Putting it All Together
Work through these steps one-by-one, remember this is a process and in life things are constantly changing. These processes work whether you’re in debt or you already have a few million dollars of savings and investments under your belt. The contents of this article and the understanding of them will give you a HUGE leg up when it comes to your personal finances. Mastering them and using them to move forward in life is what being a Financial Badass is all about! Get to it!
Article by Gabriel Anderson, a Certified Financial Planner (CFP) and founder of Crafted Wealth Management (www.CraftedWealthManagement.com), a Venice, CA based virtual Wealth Management firm. Gabe takes his clients through a values based approach to help them use their money as a tool to accomplish their goals and live their ideal life. You can follow him on Twitter @GabrielCFP