Every business owner knows about the importance of managing their cashflow. Get it wrong, and even the most promising business can suddenly go to the wall. But proper cashflow management is something that all of us, not just businesspeople, need to learn. And, as financial planner JONATHAN GIBSON explains, it means viewing your income and expenditure from a whole-of-life rather than a day-to-day perspective.
“Money is like soap. The more you handle it the less you will have.”
— Professor Eugene Fama, Nobel Laureate
The reason why cashflow is so important is because cash is king. It’s a phrase that often gets used in business, but it’s no different when it comes to your personal financial life. It’s important to be wise with the income you have, and in order to do that you first need to define where your income is going and is expected to go.
Budgeting is the cornerstone of being able to manage your money well and wisely. Budgeting doesn’t need to be complicated and it doesn’t have anything to do with how much money you have. A budget is simply a plan and it’s only once you do this that you will be able to control your money and identify ways of being more efficient with your spending.
We would be wise to categorise our current and planned expenditure as well as our financial goals and milestones into three main categories: living (survival), lifestyle and aspirational.
Living or survival money is typically non-negotiable and is what’s necessary to live. For most people this probably includes most household expenditure, commuting costs, vehicle expenses and essential clothing. However, it could also include childcare costs and medical expenses such as dentists, opticians and prescriptions. The question to ask yourself is, “Do I need this to live?”
Lifestyle money is typically discretionary, personal and leisure-related expenditure. Personal expenditure could include items such as clothing, wine, grooming, music streaming subscriptions, buying books, public transport and buying a coffee on the way to work. Lei- sure-related expenditure includes sport and hobbies, holidays and travel, entertainment and socialising, and eating out. The point is we don’t need these in our lives to live. I know this is hard to accept, and believe me, I can’t imagine life without a family holiday to the Lake District or Italy for instance; or a life without good food, good wine and good company. However, my ability to live does not depend on these.
Aspirational money is what I regard as luxuries, the ability to pay for independent schooling, to start a business, take time out to travel the world, write a book, learn a different language or skill such as cooking or flying, own a holiday home or classic car.
From a wealth planning perspective, we need to define the cost of your desired lifestyle — the life that’s important to you. The cost of your desired lifestyle represents your lifetime expenditure, financial goals and milestones, all categorised as either living, lifestyle or aspirational. Knowing the cost of your desired lifestyle is vital in knowing if you have surplus income and how much is needed to live, as well as to live the life that’s so important to you.
What I have noticed is that, although aspects of many of my clients’ lifestyles are aspirational and include things like independent schooling, they are also content with spending less in other areas — they don’t necessarily live in large homes and their personal and leisure-related expenditure is relatively modest. They’re not necessarily extravagant in how they spend their money.
Ultimately, the headline principle here is that you should be spending less than you earn, making sure you’re living within your means and also giving careful consideration to your financial future, or in other words, the cost of your desired lifestyle, the life that’s important to you.
Budget to avoid debt
This is a crucial point to make, because if you budget and manage cashflow properly it will help you avoid debt throughout your life. Research has found that people say if they earned 20% more than they currently do, they’d be fine in a financial sense. Everyone thinks that they just need 20% more, regardless of how much they actually earn — an example of Parkinson’s Law, which says that the more you have, the more you use. The thing with money is that you’ll always find a way to spend it — the more you handle it, the less you have; and please know this, as a borrower you are a servant to the lender.
What you need to remember is that excessive debt won’t help your financial situation and in fact will choke your financial future. Therefore, budgeting properly and managing your cashflow throughout your lifetime will help you to avoid falling into too much debt.
A fresh approach to cashflow
I’m very conscious that the term “cashflow” sounds dull and can have a very narrow definition for some people. For example, banks talk about balancing what you have coming in each month with what you have going out. However, that’s a very simplistic view and one that isn’t forward thinking or looking. Looking at your cashflow on purely a month-by-month basis isn’t enough. Your income will change throughout your life, as will your expenses, and you need to plan for that.
Cashflow is about financial forecasting and looking to the future, rather than basing your budget on your past. Cashflow planning looks at your unique financial circumstances, desired lifestyle and financial goals and aspirations.
Taking a lifetime view
When I talk about cashflow planning as a wise financial strategy, I’m talking about financial forecasting and helping you work towards living a fulfilled, purposeful and contented life. I’m not only looking at the cost of your lifestyle today, but trying to anticipate the cost of your lifestyle tomorrow.
Remember the timeline I mentioned in Part 1? Your timeline is an essential element of cashflow planning and financial forecasting because it’s helping you to prepare for your life’s transitions. This involves thinking about the different stages of your financial life — the savings years, spending years and later life years. It’s about considering milestones, such as your children leaving home to go to university, or life’s transitions, such as selling your business or leaving paid employment.
What I want to do is forecast how much income and expenditure you’ll have tomorrow, as well as looking at what you have today. Therefore, cashflow planning and financial forecasting needs to be meaningful and will require us to make three important, reasoned and reasonable assumptions with regards to your financial future: inflation, interest on savings and return on investments.
What I want to encourage you to do is avoid living a consumptive lifestyle during your saving years. You need to make sure you’re planning ahead to achieve and maintain the life that’s important to you, as opposed to feeling compelled to spend, spend, spend and living beyond your means. The concept of “keeping up with the Joneses” can come into play here and it can certainly be a risk. Sticking to a planned budget requires discipline and self-control; however, your motivation to do so will increase once your wealth plan, which incorporates your lifetime goals, has been created.
I’m asking you to take a lifetime view of your cashflow. You need to know how much income and spending there is from a whole-of-life perspective, not just today.
When you take this whole-of-life approach to your cashflow, it changes the dynamic completely and puts you in a much stronger position. It gives you the clarity to visualise what your financial future could look like; leads to greater contentment so you are less anxious about tomorrow; and provides the certainty to know you can secure all that you value. This planning and forecasting will often reveal to clients that they also have more than enough to provide for who’s important to them, as well as the causes and communities they care about.
How much do you need in retirement?
One thing I see repeatedly is people who are worried that they won’t have enough to fund their retirement. This fear of not having enough is incredibly common. However, in reality, what often happens when people properly assess their spending, plan their budget and adopt a whole-of-life approach to their lifetime cashflow, is that they realise they have more than they’re ever going to need.
When people discover they have a surplus, it can help them live a more fulfilled life, whereby they might feel comfortable booking one more holiday a year, or helping their grandchildren onto the property ladder, for instance.
I recently had a meeting with a couple who have modest but not significant wealth. They’re close to their state retirement age and had been telling me about the last cruise they went on, and the one they planned to go on to Iceland later in the year. I asked them if there was anything they weren’t doing because they felt they just didn’t have the money.
They told me that in the following year they’d probably like to spend a bit more money on a cruise and go to Lake Garda for two weeks rather than one. When I asked why they didn’t spend more money on their cruises, they couldn’t say. During that meeting, I was able to show them that they could have an additional £8,000 a year to live off, tax free, just by withdrawing more from their investment portfolio each year. I told them, “You’re not going to run out of money. Go and have that cruise and holiday in Lake Garda.” That’s just one example, and in the vast majority of cases, I find that my clients want to use what’s surplus to help support their families, whether that’s their children or grandchildren.
This comes back to the idea of stewardship. If you have more money than you’re going to need, how can you invest that surplus if not for your future, then for your children’s financial future?
JONATHAN GIBSON is the founder and managing director of Wells Gibson, an evidence-based financial planning firm in Dundee.
This article is an extract from Jonathan’s new book Purposeful Wealth, in which he sets out his principles for living a fulfilled and purposeful life and shares the key financial planning strategies you need to focus on to achieve it. It is re-published here with Jonathan’s kind permission.
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