All personal finance revolves around being able to manage your cash flow. You have to make more than you spend. Then you have to figure out the “right” things to do with that surplus. The “right” thing for you might be different than the “right” thing for someone else. That’s why they call it personal finance after all.
The last couple of years have been a whirlwind for a lot of folks from a financial point of view. The COVID pandemic changed the nature of work for just about everyone. The Federal Reserve and government responded with monetary and fiscal policy changes that largely impacted the economy and stock market. And now here in 2022, inflation (things costing more) has been the big narrative. It never seems to end, does it?
You need to find a way to balance it all while still working toward your goals.
The best way to know if you have made progress toward your goals, is to take stock, ask questions, do some self-analyzing and see in black and white… what came in and what went out?
3 Questions for Better Cash Flow Management
Did I Save Appropriately?
What was your savings rate?
Take your after-tax income (the amount of money that hits your bank account), and divide it by the amount you saved each month. That is your savings rate.
Example: You get two paychecks a month, each for $3,000. That’s $6,000 in after-tax income. Annualize that ($6,000 x 12 months) = $72,000. Over the last twelve months you’ve saved $8,000. That is a saving rate of 11% (8/72).
A savings rate between 10-25% is a good place to aim.
In order to determine if you saved appropriately, you have to know what you are saving for in the first place. Are you saving for retirement? Are you saving for college? Are you saving to buy a house? Are you saving to build your emergency fund? Or, are you saving for all of these at the same time?
The answers to these questions will also help you determine where to save. Savings that will be need in the next 1-3 years should not be put at risk or locked up in retirement accounts. If you are unsure about when, or what, you will need the money for, flexibility and liquidity are important to maintain. Savings for retirement should be in a tax-advantaged account first, and a regular brokerage account once the contribution limits are met.
While yes, you should save as much as you can for retirement, you also need to pay your bills and live your life. Saving for retirement before getting your cash flow straightened out is like putting the cart before the horse. You can do both at the same time. But don’t stretch yourself too thin. We hate seeing folks raid their investment accounts early (and pay a penalty to do so). It’s really all about finding the right balance for your current situation.
How Many “One-Time” Expenses Did You Have?
Life happens. There will be expenses that pop up out of nowhere. Whether it’s car repairs, a new dishwasher, or god forbid, unexpected medical expenses, these irregular things may happen more regularly than you think.
It’s easy to rationalize “one-time expenses” in the moment because you usually don’t have a choice. But look back over the course of the last 12 months, how many “one-time expenses” did you have? How many months out of the year did something unexpected come up? And how much did each expenditure cost?
While you may not be able to build in a concrete number for one time expenses, you may find it beneficial to build in some wiggle room into your cash flow plans. Have an easily accessible “emergency fund” that’s not at risk. 3-6 months of expenses is the minimum. And when an emergency, or one time expense comes up, pull from this account. And then replenish it.
Will My Income Look Similar Next Year?
Knowing what your income will look like next year allows you to plan in advance. Now, we know that nothing in life is guaranteed. We also know that incomes largely vary depending on commissions, bonuses and time of year.
With that being said, if you are not planning on changing jobs next year, your income for this past year (and years prior) is as good a gauge as any.
One thing to keep an eye on here is lifestyle creep. This happens when your cost of living (expenses) increases just because your income increases. Just because you make more doesn’t mean you have to spend more. In fact, it shouldn’t mean that. Getting a raise and not spending it is one of the best ways to get ahead financially.
With inflation increasing the cost of goods across the board, your everyday expenses likely will be higher than last year. This is unavoidable. Lifestyle creep is more about discretionary spending on things that are not necessary. Pay attention to those items closely.
It sounds too simple, so a lot of people brush off the importance of cash flow management. But how are you going to get to where you’re going if you don’t know where you’ve been? In our professional opinion, “best guesses”, “approximations” and “well I think it costs…”, don’t work out so well. The squishier the numbers, the squishier the plans. And the squishier the plan, the less likely your plans become reality.
So pay attention to where your money is going and answer these 3 questions to have a better grasp on your cash flow.