Managing your cash flow is at the heart of all personal finance. Whether investing for the future, applying for a mortgage, planning for retirement, or paying down debt, you have to know your numbers.
We talked on a recent podcast about how some things cost more now than they did a year ago. And while inflation is all the rage lately, it is something that always persists. The price of goods and services is always in motion. How much you make on a year-to-year, or even month-to-month basis is also always in motion.
One of the ways you can control for inflation, is to pay attention to your expenses. And see what is costing more in black and white. And make adjustments accordingly. You need to check in on this stuff, it is very important!
How much money actually came in? How much money actually went out? Do this on a month to month basis. Once you have a good grasp on those numbers, here are 3 other questions to answer to better assess your cash flow situation.
How to Manage Your Personal Cash Flow
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.
A savings rate between 10-25% is a good place to aim.
Besides the net number each month (the difference between what came in and what went out), the savings line item is the next most important number.
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? Be as specific as possible.
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. Put that in a savings account. Savings for retirement should be in a tax-advantaged account first, and then 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.
The reason we treat savings as an expense is because paying yourself first is crucial. It frees you up. Once it’s done, spend what you want, where you want, within your means of course.
Cash flow management isn’t always about pinching pennies. It’s about prioritizing your life and saving money accordingly.
How Many “One-Time” Expenses Did I 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 might 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 11 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 easy 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. Especially coming off a year like 2020. 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 on what your income will look like next year. Are some months tighter than others?
One thing to keep an eye on here is lifestyle creep. This happens when your cost of living (expenses) increase with your income. 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.
If you wait until 2022 to get a reading on how your 2021 went, you may carry forward some of those missed opportunitties, or bad habits, into next year.
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.
These are practical topics you can focus on right now. If you want help going through this cash flow process we’d be more than happy to help you get things started in the right direction for 2022.