Planning and goal setting are critical to your success if you
want to become wealthy. The two key traits of people who do not
become wealthy are, firstly, they tend to spend all of the money
they have and, secondly, they do not know what they spend their
money on. The lack of goals is the main culprit. Ric Edelman,
author of The Truth About Money and Ordinary People,
Extraordinary Wealth, calls this “spending
unconsciously”. He says the reason why people spend
without giving it much thought is they have no goals. Without
goals, we live unconsciously from moment to moment, we never
plan for the future, we spend all of our money, and as a result,
we are unlikely to ever become wealthy. “Unconscious
spending” is more prevalent in our society than we
realise. I would estimate approximately 80% to 90% of the
population do it. With the exception of one or two people, the
vast majority of my clients had no idea what they spent their
money on until I asked them to prepare a list of their total
expenditure and outgoings before our first session. In fact,
many were too frightened to do the initial exercise and waited
until they arrived at my office, so I could help them through
the ordeal. Money matters simply scare people. They are
terrified to know how out of control their finances are. Yet,
this is precisely what needs to be done before we can start
working on a solution.
Whilst it is important to become relaxed and carefree with our
financial matters, this does not mean careless. We become
carefree with money when we know that it is not a scarce
resource, we work on increasing our income, we invest a little
time on a regular basis to plan and review our finances, and we
systemically set aside part of our earnings regularly to build
our savings and investments for the future. We are careless with
money when we don’t keep track of what we are spending and
squander money on things that are wasteful, extravagant and not
needed. I often compare money to water, another important
commodity in our lives. Both are essential and critical to our
survival, however, we rarely worry about water in the same way
we do about money. We systematically set aside water when it
rains in dams and reservoirs to provide us with water ‘on
tap’ when we need it. We are careful not to waste water,
however, at the same time we can relax and not have to worry
about it on a day to day basis. When we apply the same reasoning
to managing money we are well on the way to becoming wealthy.
After we resolve our beliefs about money and realise that
becoming wealthy is within our possibilities, the next step is
to put aside a little time to set goals and do some planning.
Planning does not have to be an arduous affair. It takes
approximately one to two hours upfront to prepare your plan and,
thereafter, an hour a month to review or revise it.
The first part of your plan is to set some goals. For example,
accumulating $500,000 in income-producing assets in 15 years is
not a difficult goal to achieve. If you save $170 a week into
investments returning an average of 15% per annum for 15 years,
you will have your half a million dollars. Goals will help you
focus on the future and increase your willpower to prevent
overspending. The more concrete you make your goals, the more
committed you will be to achieving them. Set timeframes and
break them down into manageable steps, as in the example above,
to make your goals more realistic and attainable.
Along the way, however, we also need to manage our day-to-day
spending to ensure that we set aside the required savings to
achieve our goals. In designing the Money Program, I used a
simple, effective formula that everyone can apply to easily
manage their finances. I call this the 40%-30%-20%-10% rule.
This formula is used to measure your expenditure and cash
outflows. You divide your expenditure into four categories and
calculate the total of each category as a percentage of your net
(after tax) income. The four categories are Fixed Costs,
Variable Costs, Discretionary Costs and Savings.
Fixed Costs are your essential costs that are known and have to
be paid on a regular basis. For example, mortgage or rental
payments, personal loans and credit card repayments, insurance,
council rates, and school fees. These costs are usually
determined by your lifestyle choices, the size and cost of your
house, cars and major possessions, and therefore difficult to
change without making major adjustments to the way you live.
However, because fixed costs are comprised of debt and committed
payments, they are critical in determining your ability to
create wealth, as well as your capacity to lead a stable
financial lifestyle. If your fixed costs are too high, you will
probably be living from payday to payday worrying about the next
large bill that arrives. If your fixed costs take up too much of
your weekly pay packet, there will be less to spend on other
essential costs, and often little for luxuries – unless
you go further into debt.
Variable Costs include our essential living expenses, which can
vary from week to week, yet you have some control over what you
spend. These will include food, clothing, groceries, mobile
phone expenses, medical and motor vehicle running costs, such as
petrol and repairs. The previous two categories relate to
essential costs that we cannot live without. Some are
controllable (variable costs) and some are set (fixed costs).
Discretionary costs are expenses that are non-essential and
highly variable. These costs are very much in your control and
where most choice is possible about how much is saved each
month. For example, entertainment, dining-out, presents,
holidays and all luxury items that we love but can live without.
I affectionately call this part of our budget, our ‘play
money’. The problem with most budgets is they often
exclude this significant element and this is why most people
fail. We all need a little play money and a few luxuries in life.
Whilst working with this formula with my clients, I found that
people who live within their means tend to spend their money
roughly within the 40%-30%-20% rule. That is, their fixed costs
are roughly 40%, their variable costs 30% and discretionary 20%
of their net income. The more I worked with this formula the
more I realised it was an excellent way to achieve two things.
First, it provides you with a simple effective method for
planning and allocating your finances, and secondly, it is the
perfect method for getting you out of debt and into wealth. The
most critical category is fixed costs. The fixed costs of people
who are living comfortably within their means are generally
around 40% of their income. People with fixed costs above this
percentage, tend to lead lifestyles that cost them more than
they can afford. The size and quality of their homes, cars,
furniture and other items that they have borrowed for, have
forced them into excessive debt. Because fixed costs are
comprised of debt and committed payments, they are crucial in
determining your ability to create wealth. If you want to be
wealthy, you have to be committed to dropping these costs below
40%.
When clients first come to me, their fixed costs are often 50%,
60% or even 70% of their net income. The aim is to reduce that
percentage to 40% or less, over time. Creating wealth is about
building strong financial foundations that cannot be shattered
regardless of what we may be faced with in the future.
Regrettable, strong foundations take a little time to build.
People in severe financial hardship usually have fixed costs
that are greater than 65% or 70% of their net income. This is
usually due to excessive debt or insufficient income. People who
are in financial crisis, where they tend to live from payday to
payday and seem to be going from one financial problem to the
next, tend to have fixed costs between 45% to 60% of their
income. If their fixed costs are approximately 40% of their
income, they are living comfortably within their means, and if
their fixed costs are below 40%, they usually have excess money
that could easily be channelled into additional savings and
investments. So the key to good financial management is managing
and controlling your fixed costs. Remember, it is all done by
measuring your fixed costs: if your fixed costs are 40%, you are
living within your means, if your fixed costs are above 40% you
will be putting yourself under financial strain, and if they are
below 40% you will be in a surplus position. Therefore, if you
want to accelerate your wealth, keep your fixed costs well below
the 40% mark and invest the surplus.
If excessive debt is keeping your fixed costs high, formulate a
debt free plan and do not go deeper into debt. Learn to live
with cash. It is far more finite and when the cash runs out, you
know you definitely cannot afford to buy those extra purchases.
If low income is your problem, consider all alternatives to
increasing your income. These may include: part-time work,
turning hobbies or crafts into cash or investing in additional
training to further your career prospects.
Also, to decrease your fixed costs you may have to make some
difficult decisions about the way you live. Is the house you are
living in far too costly for you? Are you running two cars when
one could suffice? Can you downsize anything now, which is
costing you far too much money? Are you trying to live well
above your present means buying clothing, accessories or
electronic gadgets that you cannot afford? Are you a
shop-oholic, and can never resist a bargain – regardless
of whether you need it or not? Are your credit cards always to
the maximum limit and you cannot afford to pay the balance?
These are often difficult choices to make, but well worth it in
the long run. Remind yourself that you can have the bigger
house, cars, toys, etc – later, when you can better afford
them. If you get a bigger mortgage to upgrade your house or
borrow for a better car, you will increase your fixed costs. By
keeping your fixed costs as low as possible, you will accelerate
your progress to becoming wealthy. Your plan should always aim
at decreasing your fixed costs below 40% by either increasing
your income or decreasing your debt, or both. Once you have
achieved this, use the extra money to add to your savings and
investments. This is the guaranteed way to accelerate your path
to wealth. Copyright © Ann Marosy, 2002
The 40%-30%-20%-10% formula is featured in The Money Program:
Managing the 6 Stages of Wealth. Visit: www.moneta.com.au
About the author:
Ann Marosy has a Bachelor of Business from RMIT and developed a
successful career in company accounting. Ann taught accounting
at university; established her own recruitment agency and was a
finalist in the SA Executive Woman of the Year 1991 award. In
recent years, Ann has provided consultation to private clients
on money management practices. Using her financial background
and personal experiences, Ann designed the Money Program to
assist her clients to understand and manage money.
|
|
