There is a psychology to finances and handling money. Some people are extreme hoarders of cash. Other individuals spend every dime they are able to posses. And then there are folks that see money as a tool to be used as an extension of themselves. All of us fall into one of those categories to a certain extent, whether we realize it or not. The key point here is that our mentality towards money sets the stage for our financial life.
When discussing money and managing it, it is best to first establish a common basis of understanding the primary uses for money. Money is used for three primary purposes. The first purpose is for transactional uses. This means money is used as a medium of exchange. For example, you give someone $100 and they in turn give you two pairs of jeans. In that scenario $100 was exchanged for two pairs of jeans. The next primary purpose is for precautionary uses. This is typically what is referred to as a “rainy day” fund or “emergency savings.” This would be money specifically designated for unexpected expenses such as car repairs, replacing a garage door, or a medical bill. The third primary purpose is for speculative uses. This is the money you designate for acquiring appreciating assets to grow wealth (stocks, bonds, art, etc.). Dollars for speculative uses should be amounts you can stand to lose if the investment doesn’t yield desirable results.
The primary purposes or key uses of money mentioned above is how individuals organized their financial lives and begin to establish financial independence. To be fair, compartmentalizing various uses of the money you obtain is easy to understand but difficult to perform on a consistent basis. The good news is that it doesn’t take completely changing who you are to have success at getting organized and disciplined around specific uses of cash available to you. In the paragraphs below, I will reference good habits to think about and maybe develop as uses of money to start pursuing financial independence.
The first habit is to set financial goals and adjust them as you meet your desired progress. That means establish a budget! A budget is not a bad thing and it doesn’t mean to deprive yourself. A well done and reasonable budget allows for a spending plan that helps you achieve your goals over time. So being motivated by instant gratification is not the goal here. The purpose of a budget is to keep you honest about what should be your areas of financial focus.
The next habit to focus on is to be frugal. That doesn’t mean be cheap! This simply means to make the best use of every dollar available (buy items on sale, don’t fall victim to retail therapy, etc.). American society has influenced the people to feel good about buying expensive things and thinking that is the end game. As a consumer your end game should be maximizing how you utilize every dollar. Take a step back from the marketing ploys and truly assess if what you are looking to buy will either help your financial goals or the goals of someone else if you make that purchase. It’s a tough question to answer but one you need to ask if you want to be serious about establishing and protecting your financial independence.
The next habit to improve upon is paying off debt and learning to use debt strategically. Consumer debt is currently at trillions of dollars in the American economy and constantly growing! In the spirit of increasing your free cash flow (the amount of money you have left over after meeting your financial obligations), eliminating debt is a path to your financial freedom. You can pay off a smaller bill then use that previous payment amount and apply it to what you are already paying on larger bills to get the remaining bills paid off. That is a process that is called “snowballing.” The key there is to no longer pay off a debt item and then turn right around and create a new debt item you now have to pay off. When you pay off a bill collector treat yourself like a bill collector and use what you were paying out and start paying yourself!
Once you’ve mastered your budget and have more cash to work with, the next habit to consider is learning to buy appreciating assets more than you indulge in buying assets that depreciate over time. Buying land or stocks is a better use of cash than buying very expensive clothes and cars. Tangible things may seem nice sitting in your closet or garage but it doesn’t really provide peace of mind when you are lacking in terms of available cash for necessities and emergencies due to financially over-extending yourself. There is nothing wrong with having nice things. But we shouldn’t mortgage our financial future to do so. Lastly, if you are looking for a generic proposal of how to breakdown an allocation of your income, here is an approach to provoke thought:
Allocate no more than 50% of your income on your needs (housing, food, transportation, utilities, etc.)
Allocate around 20% for various savings initiatives (emergency funds, retirement savings, health savings, etc.)
Allocate around 15% on charitable givings (tithes, charitable causes)
Allocate around 15% on your wants (as in things completely not vital to your livelihood or service to others).
The proposed percentages referenced above may sound unreasonable or impossible to achieve but I encourage you to see this as just something to get you going in the right direction. It is up to you to determine the right percentages and categories that work best for you. I will note that those who manage money well and have achieved financial stability are disciplined, self-motivated, make appropriate sacrifices, and have a money mentality that respects money. Just know that starting with small amounts is fine just be sure to start! Remember, each dollar you have is an employee of you! Those employees (dollars) should be working for you in the best way possible! I hope you find this content helpful. As I always say: “In all that you do, seek to BeUpwright.”
– LW
