| Savings to Invest |
1. Step 1: Beginning with Your Balance Sheet
Quick, without cheating, what's the current balance in your 401(k) or other work retirement account? How much money is currently in your checking account? What did you spend on food last week?
Stumped? We'll assume so by that blank stare. We keep hearing about people who are unwilling -- or too terrified -- to look at their financial statements. If it's any comfort, you have a lot of company. Some of the nation's top brass haven't a clue about the inflows and outflows of the companies they're paid handsomely to manage.
Don't let executive-level laziness be the standard for your personal money management. Simply put, it's poor financial management. Look no farther than Warren Buffett for a model of a competent, hands-on CEO. Here's a guy who can practically recite his company's annual report -- and five years' worth of his personal checkbook entries -- verbatim. And we're only partly kidding. In a recent interview, Buffett recalled puzzling over a $4 income item on his latest tax return. A $4 item! By a guy worth $35 billion!
Step one in cleaning up your financial act begins with the balance sheet-- the snapshot of what you own, and what you owe. It'll take just 15-20 minutes to perform this self audit. Use your computer, checkbook, abacus, and all those under-used fingers and toes to add up your major assets and liabilities. Simply write down the balances of the following items:
Now see if you can answer these questions:
If you can't determine what direction your money is going (up, down, or haywire), use your simple money rundown as a starting point for your personal audit, and repeat next month when you have a baseline for comparison.
Guess what? Now you have a snapshot of your personal balance sheet! You have an idea of your net worth, and a baseline from which to determine whether you're increasing the value of your empire over the years. This single piece of information puts you ahead of the majority of Americans, and maybe even countless CEOs.
2. Step 2: Stalk Your Inner Spendthift
As investors, we demand a prudent use of resources, a tight rein on spending, and a track record of steady growth from top executives. It makes sense to expect such discretion from the stewards of our investments and, indirectly, our economy.
Shouldn't we expect the same thing from ourselves?
The formula for enhancing your net worth is simple: Spend less and save more. To cover the spending side of the equation, take a look at your cash flow. In other words, ask yourself "Where does all my money go?"
There are many ways to track the flow of your dough, such as reviewing your bank statements from the last three to six months and calculating how much you spent on various categories, like food, shelter, insurance, and -- perhaps the most telling of all -- "Junk I bought but never used."
We know that exercise will prove informative, but we also know it takes a chunk of time. So, try this: Just for a day, record every transaction. Carry a piece of paper in your pocket and make a note of every time a greenback or a credit card leaves your wallet. At the end of the day, project the annual cost of each expenditure by multiplying it by 365.
For example, let's say you go out for lunch, which costs you $7. If you did that every day of the year, you would be spending $2,555 annually. Keep in mind that this is after-tax money, so if you're in the 27% tax bracket, you'd have to earn more than $3,500 to have $2,555 to spend. If you earn $40,000 a year, this means that almost 9% of your income went to lunch.
We recognize that analyzing just one day's worth of purchases provides limited information. (After all, if during the day you pay a plumber $100, that doesn't mean you'll send $36,500 down the drain each year.) If you have the inclination, keep an eye on a week's worth of spending, then multiply by 52 -- or even a month's. But we think that even a day's worth of money monitoring will be enlightening.
3. Step 3: Set Clear Goals
If you've been playing along at home, you've already got a snapshot of your current balance sheet. And you took one day (at least) to track every dollar that left your hands (right?), to get an inkling of your annualized spending.
At this point in your journey of financial self-discovery, it's time to powwow with your troops. Take 15 minutes to hold a strategic planning session with your board of directors (or sole dictator, if you're single). Write down your short-, mid-, and long-term company goals. If you don't already have a cash cushion for emergencies, that's a good short-term place to start. What big expenditures do you plan to make in the next 5 to 10 years? (A new roof? College for the kids? New Humvee?) Now think even farther out. Retirement sounds like an OK long-term goal, right? What else gets you excited about saving and investing?
Next, take a moment to think about how closely your everyday spending reflects the goals you set for You, Inc. The best CEOs run their companies with laser-sharp focus, making sure every dollar they spend and save is aligned with their company mission. They aren't easily distracted and don't fritter millions away on ventures that don't add to their ultimate vision. So ask yourself: Are you funding the things that are most important to you?
Remember that $7 lunch you bought yesterday? When you annualize that expenditure, it comes out to around $2,500. What percentage of your annual income is that? Was the hour of satisfaction (and extra jiggle in your thigh) worth it?
No expenditure is too trivial to throw off your plan; every dollar counts. Can you afford to set aside just 10 bucks a week? Over the course of 15 years, you could pile up more than $11,600 in savings (assuming a 6% annual rate of return). By contrast, spending $10 a week on a credit card charging 18% interest will leave you owing $40,000.
Your assignment: Take 10 minutes to make a list of short-, medium- and long-term goals, and see how your spending (at least during the day you tracked it) stacks up against it.
The next step in your self-audit is easy. Yup, you read that right. You're going to put your savings plan in motion
4. Step 4: Save on Autopilot
You're closer than ever to getting a handle on your personal financial statements. Like the head honchos of corporate America, you've subjected your finances to some serious scrutiny. Let's review:
First you reviewed your balance sheet
Then you spent a day (or more, if you're an over-achiever) tracking your spending,
With that spending list, in hand, you questioned whether your cash flow was consistent with your goals.
These exercises reveal what you've done with your money in the past.
Now it's time to look to the future -- what you can do now to improve your situation and attain your goals years down the road.
Here's a simple solution: Make savings mindless. That's right; take the guesswork and busy work out of budgeting by putting your savings plan on autopilot.
If you're contributing to your retirement plan at work via withdrawals from your paycheck, congratulations -- you already have an automatic savings plan! You are regularly socking away money for an important goal. Since the money is transferred to your plan automatically, you don't have to worry about forgetting or accidentally spending your retirement plan contribution. It's such a no-brainer, and it makes great financial sense.
But such a smart plan is not limited to saving for retirement. Many banks, brokerages, dividend reinvestment plans, and mutual fund companies will automatically transfer money from your checking account to the investment of your choice. Will you need the down payment for a house in three years? Have $100 to $500 sent to a money market account every month. Want to send your kids to college? Sign up for a 529 plan and make hassle-free contributions over the years. Don't have a particular goal in mind, but you want to increase your net worth? Figure out how much you can save, and have it automatically invested. Over the years, it'll really pay off.
Now it's time to make your savings really pay off. Let's plug up the cash flow leaks that can threaten your financial empire.
5. Step 5: Make Cuts that Count
The biggest eye opener for most people performing a self-audit is that they're not saving as much money as they'd like. Welcome to the world of living below your means (or "LBYM," as those in the know refer to it).
Lucky for you, living below your means is as easy as pie! Just spend less money that you bring in. Then pass that savings along to a good investment.
Simple? Sure. Easy? Maybe not. But it's certainly worth the effort. As we pointed out earlier in our auditing series, every dollar can make a difference. Just 10 bucks a week piles up more than $11,600 in savings (assuming a 6% annual rate of return) in 15 years.
Living below one's means is a practice employed by some of the best CEOs. On a bigger scale, those who keep a lid on their company's costs and make smart decisions about directing their savings are rewarded. Take Winnebago Industries (NYSE: WGO). The cost-conscious company has zero debt and $115 million in cash on hand, helping it become the top seller of motor homes for the first time in two decades, according to Business 2.0.
The turnaround is in large part due to the penny-pinching guidance of CEO Bruce Hertzke. Hertzke's LBYM ways extend to his personal finances, too. "The guy pulled down more than $650,000 in salary and bonuses last year, but expects his 50 cents back from the three bucks he tosses on the bar for his $2.50 Canadian Club and 7-Up," Business 2.0 reports.
As the CEO of your financial empire, apply the same cost-consciousness to your own finances. There's no better place for guidance than the community of Fools who live under the LBYM moniker. Here are some resources that will help you find ways to plug up any cash flow leaks:
By doing a little due diligence, chances are you'll never be blindsided by accounting calamities like the execs at WorldCom. If you've followed along in this series, you've raised the bar on your personal money management. Best yet, you're almost done with our little financial odyssey. All you have to do now is certify your results.
^ back to top ^