Budgeting - The Foundation of Financial Success

The very foundation of every good financial plan is a cash flow plan, or budget. Budgets are actually fairly simple to create, but require that the budgeter is honest with themselves. Aye, there's the rub. As it turns out, most people would much rather not investigate the truths in their spending habits, as it is in those truths that their personal demons lie...

Some don't want to admit they spend that much money on "entertainment", others spend too much on shoes or other clothing items, some aren't interested in facing the fact that the interest costs on their short term debt are higher than what they allot themselves for food.

Yes, these are unfortunate issues. In fact, the lack of will to look plainly at their spending habits is the number one reason most people spend their entire lives playing catch up, rather than enjoying the fruits of their labours.

See now why it's useful to have a coach? Often I have spent time going over the budget specifics with clients of mine in order to assist them in getting smart with their cash flow. I once saved a family $1700 per month in unnecessary cash flow expenditures just by rearranging their debt. That's big money. Imagine what benefits you might find just by spending the time to investigate where all the money goes.....

How many of those monthly transactions that occur automatically out of your bank account are necessary? How many of those transactions can you even say for certain that you know what they are? Don't you think that it might be important to know where your money goes?

Now, why again can't you save an additional $50 or $100 per month?

So, the question becomes, what's the process? Well, the first thing to do is to begin documenting every transaction that you make. One of the often discovered side benefits of this particular activity is that, when you're actually forced to write down your purchases ALL THE TIME, it can sometimes change your decisions and curb some of those unnecessary impulse purchases.

Then, you need to start posting those purchases to individual expense categories, such as rent/mortgage, utilities, groceries, fast food and snacks, liquor, cigarettes, gasoline, bus passes, vehicular maintenance, car lease or purchase payment, subscriptions, insurance, savings, etc. You get the drift.

At the end of a couple of months, you'll see some clear patterns emerging in terms of each expenditure category. Here is where you need to actually spend some time thinking about what's really important. Ask yourself the following questions: Is this item important enough to my future goals to require this percentage of my income? Is this item more important than that item?

You need to start to prioritize. Again, this is where it can be useful to have a coach to whom you make yourself accountable. The simple fact is, most people will not go all the way through this process, as they're simply too weak to be honest with themselves.

How about you?

Once you've been through the thought process and considered your spending habits and patterns, once you've spent the time prioritizing the categories, you can begin to allocate your future funds to the individual categories. This, my friend, is your cash flow plan.

The next step is to stick to the budget. Again, useful to have a coach here to keep you honest. Nonetheless, however, there's simply no chance that you're going to be successful unless you monitor your expenditures, and stick to the amounts you've budgeted. This goes back to building good habits.

If you are able to create an honest budget predicated on genuine numbers and thoughtful consideration of your life goals, and then have the discipline to stick to that budget, you are on your way to executing your very own financial plan, and will very likely find considerably more financial success than most others out there. You can do it if you really want it.

But it does help to have a coach.

I'd be really interested to see comments below from readers who have spent the time to do a proper budget, and how that has been valuable to them. Thanks for your time and feedback!

Habits

Hi folks,

There are various different "levels" at which an advisor can assist the client. These can range all the way from the very basic "coaching" to help you develop habits, to the very involved process of estate planning.

In my experience thus far, most people who haven't before worked with an advisor are in the riskiest place of all, the "I don't have an emergency fund" place. Usually, when I encounter this circumstance, the first thing we'll do is get started on some type of a regular savings plan. Many advisors will, at this time, suggest that the client begin an RRSP and suggest using some specific mutual funds. This is where I differ.

The problem with the "I don't have an emergency fund" place is that the risk of needing to dip into that RRSP fund is huge. All it takes is a broken vehicle, a leaky roof, or a dead furnace to erase all that hard work. People will either dive deep into short term debt solutions such as credit cards or lines of credit, or redeem RRSP funds, often incurring sales fees and usually causing some serious tax inefficiency, not to mention the forever lost RRSP contribution room.

So, the risks are pretty high, as most people will at some point in their life encounter the broken vehicle or dead furnace problem.

As a risk management guy, I'm always looking at ways to reduce risk. The best solution I have seen for the beginning saver is to start by building good habits.

Good habits to build:

• save some of every single paycheque
• budget your cashflow and monitor your expenditures
• limit the amount of impulse purchases to a fixed dollar amount per week or month
• never ever touch saved money without due consideration as to the consequences of that action

That last point is essential, and here's why. I've worked with a number of younger families (30-45 years of age) who have made a HABIT of redeeming their RRSP funds or other long term savings to offset shortfalls in cashflow, to pay off credit cards, or to pay for trips or other big ticket items. The problem with this behaviour is that, psychologically, the individual has now crossed the "Do Not Touch This Money" line. That may sound like it's no big deal, but people tend to repeat the behaviour. This is what takes most people off track from reaching their financial goals, and what usually leaves them mired in the short term debt cycle.

So, learning good money habits is essential. In order to do this, the advisor must act as a coach, encouraging the client to save in low risk, low volatility, liquid vehicles such as high yield savings accounts or money market funds so as to build up an emergency reserve as a cushion. Then, only after the client has been able to develop saving as a habit, should we look at putting some of it away for longer term goals.

Have you ever redeemed money from your RRSP? When was the last time your credit card had a zero balance? Perhaps finding a good coach would be helpful.