5 STEPS TO FINANCIAL CONTROL
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Being ‘good with finances’ can be achieved by anyone if they take the right steps. So often with managing money we focus on the things that are a bit more fun. Perhaps the shiny new investment or how to save for the next holiday. There is however an under-appreciated area which is ‘financial control’ and here are the 5 tips to achieving it:
1) Know your cash flow
So this rule is as relevant for a millionaire to someone on minimum wage. Now I fully appreciate review your spending is probably the most boring thing imaginable but this is the starting point. Rule 1 - spend less than you earn. And if you can’t do this then you DON’T have control of your finances.
It’s not just about making sure more is coming in than going out. It’s about making sure you understand the levels of expenditure. If you know relatively intuitively the difference between your:
Core spending - what you need to spend. Think bills, mortgage etc.
Discretionary Spending - what you often spend in addition. Think going out for drinks and perhaps a holiday a year. Important but not essential.
Lifestyle Spending - this is the extra holiday you took or perhaps the last new item you bought you didn’t need to. Aspiration but not part of normal spending.
Once you have these figures you can see this as ‘taps’ you can turn down or perhaps turn off. I also want to show you this:
This is the importance of your savings rate in early retirement. At the start of your journey to perhaps being in the position one day when you can actually live off your investments. Your savings rate is far more important than your investment return. So you ability to manage your finances is crucial. Have a look at this example and you can see how much over time the savings rate dictates the process and eventually the investment return does.
2) Define your goals and priorities
This is less specific this step but it’s undeniably important. You need to decide what you’re saving or investing for. This can be just to get control of your finances at the start but you have to look at your own situation and understand what is the most important to you. The next 3 steps are arguably equally important but the order that you put them in will depend somewhat on your personal circumstances.
There’s a big difference between the information to do something and the application and you should see a methodical approach to goals and priorities as helping yourself to understand what is important to you. With any savings it will take a degree of self-discipline and commitment so if you make it clear you intention at the start, you have a much better chance of sticking to it.
In my video on ‘essential tips to save money fast’ - I recommended the ‘know why, then remind’ technique towards savings and with your financial plan this is just as important. In fact, a job of a good financial planner is to make sure when working with someone that we understand what drives them and make sure any planning fully aligns to that. These techniques you can use on an individual basis as well.
3) Build and emergency fund
What you are looking for here is a practical amount to cover emergencies but also a ‘sleep at night’ factor. The general guide would be 3-6 months expenditure but the truth is that this will very much depend on your own circumstances. For example, someone who has a very steady job in a profession which always needs people may differ in emergency fund compared so someone with a less secure job, or perhaps have a position where you in a life transition where you may need capital then it’s better that emergency fund is larger.
4) Protect against disaster
What would happen if you were unable to work over the medium to long term? How long would your finances hold up? How would you family cope?
Also, one thing i will say is sometimes people can say. ‘Well my family will look after me.’ Just be wary of that. Of course they would if they needed to but how would you feel if they were running out of money as they had to pay for your inability to work. Would that be something you’d be comfortable with?
Having control of a position is minimising the downside so you can work the upside. There is a great statement which is - ‘don’t insure what you can easily replace.’ So can you replace your ability to work? Probably not. You can outsource the risk and often at reasonable cost. Trust me, it is well worth doing and for me personally, it’s a key part of my overall financial stability.
So income protection is a regulated product and if you do get it you want to make sure you align it to any cover you have with your employer if that is in place. No point for paying for something you don’t need. I’d always suggesting getting advice specific to you.
5) Pay down high interest debt
So you may have noticed i didn’t say all debt. So I’m not saying mortgage (apart from perhaps in specific circumstances) and not saying student loan. I’m talking specifically about what would be considered ‘bad debt.’ This is high interest debt. The simple reason for this is maths. In the 3 Golden Rules of Personal Finance I gave a conservative estimate of future expected returns from shares taken from Vanguard of around 5.5%. The average credit card interest rate is over 20%. It’s simple maths, you will be way way behind if you are paying out that much in interest there’s no point investing in something that could be volatile when you will likely make a saving on your overall position by just paying out the debt.
Very simply - £100 and you’re paying 20% interest. Your down £20 in dead money. if you invest £100 even 10% - You’ve grown your assets here in by £10 but you are still down overall as your investment growth is less than your debt.
So as you can see you need to take a step back and think about your overall net worth and what would be the best for your overall position.Now steps 3, 4 and 5 could arguably be interchangeable depending on your circumstances, debt levels etc.
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