Setting a financial foundation
The place to start every journey to financial independence
As I said in my welcome post, I’m going to try to skip the basic stuff in this blog. There’s no way I am going to be able to cover “setting up an emergency fund” any better than Dave Ramsey, or all of the hacks that emulate him. But… this first topic is something that would genuinely be useful for anyone. It’s certainly essential if you plan on saving and investing in any serious amount.
You have to know where you are to get directions
My day-to-day financial life used to be really confusing. Every month, my paycheck went into my checking account, bills went out, checks went out, and I spent whatever was left. My “budget”, was basically just a spreadsheet with my income, followed by a list of bills. Every time there was a big bill about to be paid, I had to check to make sure I had the money in my checking account.
As you can imagine, I overdrafted frequently, with the requisite fees and inconveniences. But in the long run, the more damaging affect was my inability to plan, or understand where my finances would be in the future. I was so busy monitoring my money, I couldn’t ever make a plan for saving and investing.
I came to two important realizations:
- I had to separate my variable daily activities (“spending money”) from my fixed bills and savings
- I had to start keeping track of not just how much money I had now, but how much I would have in the future, at any point in time
The “operating account”
The reason I had to separate my spending money from my bills and savings was pretty straightforward: my non-bill related spending is erratic. Why would I want all of my random purchases going on in the same account where I have my fixed monthly bills coming out of? The net result was my complete inability to predict or understand how much money I had, or would have, at any time. See the diagram below for a basic overview.
Figure 1: Financial chaos
It was actually really easy to separate my spending and bills. Instead of commingling everything in the same account, I created a new account that was solely for my bills which I call my “operating account” (because it sounds fancy). Then, I set up an automatic transfer from my operating account to my checking account every week, with a fixed amount of money for spending. This also has the convenient side effect of limiting my spending to only the money I have.
Now, as you can see in Figure 2, everything that touches my operating account is predictable, allowing me a stable platform to plan my investments and savings plan from.
Figure 2: Financial Peace
The best part of this system is the ability to understand how much money you have now, and how much money you will have in the future. Those of you with halfway decent parents will remember sitting down with your first checkbook, and having your legal guardian show you how to write down your expenses and balance your checkbook. For me, that shit went straight out the window the moment I had to write “$2.19 - Chewing Gum”; what a pointless exercise.
But, as you can see from Figure 2, if every variable expense is now isolated to a checking account, the Operating Account only has fixed monthly costs going out every month. With fixed amounts going in, and fixed amounts going out, it’s possible to create a spreadsheet that will accurately track the balance of the account at present, and going forward indefinitely. Mine looks a little like this.
If you’re looking at this and thinking “This is basically just a way to balance my checkbook” you are absolutely correct. However, it’s been adapted to modern technology and the reality of $0.20 debit card purchases (dealt with via separate accounts).
This is still a relatively “dumb” spreadsheet, since you need to manually add each day there will be an expense. However, I have at least built some smarts into the numbers once you move past the dates, with a vlookup that references the amount of each expense as you go down. In other words, once you have the dates and the names of each expense filled out, you should be good to go. I would also advise using a tool like Personal Capital to keep track of your expenses and balance in real time.
This is all basic stuff, but it’s essential. As you can see in the spreadsheet, knowing where you will be in the future is invaluable to understanding how much you can save, and ultimately how quickly you will be able to reach your financial goals. I’ve been using this system for four years now and it’s been one of the keys to the money I have saved and invested in that time.
What would you do differently?