Mastering Everyday Money - Day 2
#003: Money Trim
MASTERING EVERYDAY MONEY
A step-by-step guide to managing your money.
The steps to take to bring your spending plan into balance.
A positive balance doesn’t just happen. It takes a concerted effort to get there.
General Principles for Balancing
I developed my own short hand for keeping my spending plan in balance:
Reduce, Replace, Remove
I work through these sequentially, starting with the category with the highest value and running through each line item in that category.
From Figure 1, Household would be the category with the highest value.
For each line item under Household I will questions whether it is possible to Reduce, Replace or Remove.
When to Reduce:
When you can find cheaper options to something you currently pay for or scale back on the frequency of it.
A classic example of this is utility bills. You could find changing providers gives you a more competitive pricing. You could also decide to reduce your consumption to lower your bill (which isn’t always possible).
When to Replace:
Here it is important to focus on what you get out of something and then think of ways to achieve the same outcome for les or free.
I like to use gym membership as an example. Say you’re a stay-at-home mother and going to the gym is one of the few adult times you get during the week. You might think of replacing this with a walking group with other mothers. You get your ‘adult-time’ but for free.
When to Remove:
When you come across any item you don’t use or see value in, it should be taken off your spending plan.
Look for dated subscription plans.
Standing orders/recurring payments you forgot to cancel.
Something you pay for but hardly use.
Trimming your Spending Plan
Continuing from the steps in Day-1
Step 4: Trim you Plan
Trimming is an interactive, collaborative (if being done as a family) process. It is not intended to be done in one sitting. Go through each line item, starting with the category with the highest value and sequentially decide on whether to reduce, replace or remove.
Below are some question prompts to help:
Can I find a cheaper alternative to this item? REPLACE
Do I have two or more items doing the same thing? REMOVE (duplicates)
Can I get the same service for less? REDUCE
Can I achieve the same outcome for free? REMOVE
Step 5: Recalculate your Balance
This is a repeat of Step 3. Work through the steps in described in the previous post and to see which of the 3 outcomes you sit in.
This is the point at which we have to be realistic and consider whether it is realistic for you to trim back any further.
Recall that your balance given by:
Net Income (amount coming in) - Total Expenditure (what you have going out)
To tip the balance to a positive number you have 2 leverage point:
Leverage Point 1: Reduce expenses, income stays the same
This has been our focus to this point and will be for the rest of this series. If we imagine that your income remains the same, then reducing your expenses (by trimming) is one way to tip your balance to a positive number.
Leverage Point 2: Increase income, expenses stay the same
If you have exhausted trimming your expenses and still find you have a negative balance, then the focus should shift to finding ways of increasing your income. In the coming months I will run a series on increasing employability and navigating the job market. Make sure you are subscribed to be notified when they go live.
The reason I prefer to start with Leverage Point 1, is because I am thinking about what we have the greater control over and what can give us a sense of quick win. I also think is it good practice to periodically review your spending plan as a way to guard against lifestyle inflation1.
Getting Back to Zero
What about zero based ‘budgeting’?
If you’ve followed Dave Ramsey, then you know of “zero-based budgeting” which is an accounting concept use for Balanced Sheets.
When we discuss balance above, I am illustrating that the ideal is to have your income greater than your expenses and that to reach that point, you can use one of the 2 leverage points above2.
Zero based budgeting is not a contradiction to that.
Your spending plan is the big-picture view on the overall health of your finances i.e. do you have money left over after all your expenses are covered?
Your budget (discussed in later posts) it what you do on a month-to-month basis to make your plan reflect your reality - because life happens. After years of doing this, I know with certainty that anything prescriptive will eventually fail. Having flexibility built in makes all the difference.
How do I get back to zero?
Note, the illustration is not a reflection of income vs. expenses but rather where your balance sits. The goal is to get back to zero. The 4 scenarios below explain how.
Scenario 1: Balance is zero, with savings.
If you calculate your balance and end up with zero, then my immediate question will be whether you have anything accounted for in the Savings & Investment category. If the answer is yes because you are already setting money aside for short, medium and ling term goals then there is nothing further to discuss.
Scenario 2: Balance is zero, no savings.
If you calculate your balance and end up with zero, and there is nothing apportioned to savings then it’s back to: Leverage Point 1, until exhausted and a shift in focus to 2.
Scenario 3: Balance is greater than zero
Any balance greater than zero can be redirected to Debt (to pay it off sooner) or Savings & Investment. It’s worth cautioning again about lifestyle creep
Scenario 4: Balance is less than zero
This is approached the same as scenario 2, but has more urgency. If you find yourself here, then I would suggest you a more radical approach to the 3Rs as an initial step and incremental ways to supplement your income3.
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Mastering Everyday Money-Day 3
How to use budgeting to add flexibility to your spending plan
This is our tendency to increase our spend to either match increasing income or sometimes and increase sense/need for status.
It is possible to do both.
If time allows.