When I begin to work with financial planning clients, one of the first things I do is take a look at their cash flow. Cash flow is made up of money coming into your accounts (in other words, your income) each month and money going out (which is made up of your expenses).
If you have more money coming in than goes out the door, you have a positive cash flow. But if more money leaves than comes in, you’ll find yourself in the red.
Even if you don’t overspend each month, your cash flow might not be optimal or even healthy. You don’t have to spend more than you earn to end up feeling like your finances are disorganized, out of your control, and overwhelming.
Sound familiar? The good news is that by developing a sound system for better managing the monthly flow of money in and out of your accounts, you can take back control, get organized — and most importantly, start making better financial choices around your spending and savings habits.
The Importance of a Strong Cash Flow Management System
Just in case you’re not convinced of the power of a well-managed cash flow, consider this: In 2017 alone, consumers spent $34.3 billion in overdraft fees. That’s billions of dollars lost for no good reason at all, and something that’s completely avoidable through better managing the cash you have on hand.
What makes that figure worse is that it doesn’t even include the amount of interest people lost from simply having too much cash sitting in checking accounts (when it could have been allocated to high-yield savings vehicles or put to harder work in investment portfolios).
Betterment CEO Jon Stein recently took to this podcast to highlight the problem of how most people struggle with cash management — and mentioned it’s an area he sees as ripe for innovation because the problem is so widespread.
The bottom line is that most of us spend too much time inefficiently managing our cash flow, and one of the results is we end up wasting way too much money.
One potential solution? A working cash flow management system that allows you to prioritize every dollar you earn.
To help you get started, here are a few principles to keep in mind, some ideas for setting up a basic management framework, and a bit of advice for staying on the right track.
The Basic Framework for Better Cash Flow Management
Most people struggle to manage their spending. It’s easy to let this get out of control and spend more than you intended. It’s even easier to slip up if you have no ideal spending goals at all.
One hack to take back control of your cash flow is to organize transactions into three major spending categories. We often refer to these categories as “buckets.” Here are the three to start with:
Bucket 1: Fixed Spending
This includes past commitments that you need to pay back monthly, like your mortgage (or rent), car payments, credit card debt and other bills that recur on a regular basis that you know you have to pay. You can include any fixed household costs in this bucket, too, such as you cable and cellphone bills.
Bucket 2: Variable Spending
This bucket is for present, day-to-day expenses like groceries, coffee, drinks and gas. These tend to be a bit harder to monitor because there's so much variation in the amounts you spend each month.
To help you better manage this bucket, set a level for your variable spending. If you don’t put limits on this bucket, it tends to get out of control very easily — and that translates into eroding the cash available to use for saving or investing for the future.
We tend to spend whatever we have available, thanks in part to Parkinson’s Law. You might have heard of this before, with an expression like “work fills the time you give it.” What that means is if you allocate eight hours to a project, you’ll get it done in eight hours … and if you give that same project 16 hours, it will take you 16 hours instead, simply because the time was there.
The same thing happens with our money. If you see that you have $1,000 to spend on your variable budget categories each month, you will easily find a way to spend that whole $1,000. If, however, you put a limit of $500 on your variable spending, you’ll find that you will likely still get by just fine.
You need to have a level that you aim for each month. Each time you spend over that level, you need to stop and recognize that this money comes at a cost: You’re taking it from another part of your life (like your ability to reach important goals) and if you continue this over time, you’ll end up eroding your net worth.
You either take from an existing asset (like a savings account) or you increase your liabilities (by charging additional spends to a credit card). Capping this bucket with a hard limit that you are not allowed to exceed can help avoid those problems and give you more control over your cash flow.
Bucket 3: Future Spending
This bucket holds the funds you want to use in the future. It can be money that protects you from unexpected financial challenges, allows you to fund retirement or lets you save up for a shorter-term goal, like a home-improvement project or family trip.
Planning Is Easy, But It’s the Implementation That Proves Challenging
Knowing how to allocate your money isn’t the same as actually going through the process and taking the actions required to organize your cash into these buckets.
These will help you see the big picture and might help you understand how your finances fit into the buckets mentioned above. The bad news is that while these tools allow you to better understand your past spending habits, they don’t do anything to change them.
That requires a bit more proactivity on your part. Try changing things up and making this management more manual for a period of time. Keep an old-school, pen-and-paper budget for a month. Write down every transaction by hand. Hang on to all your receipts and review them at the end of the month.
This might sound tedious, but it can also help you develop new habits as you increase your awareness around your cash flow and spending.
Keep Your Good Management System Going
In order to give yourself the best chance to maintain a successful cash flow management system, you can put a few controls in place to help keep variable spending in line:
Spend only what you have: All variable spending should be done from a debit card. I know people love points, but if you’re struggling to manage your money you should ditch your credit card.
If the money is not in the account, don’t spend it. Make the decision of whether you should or can buy something much easier by allowing your checking account to be your barometer. If the money is in the account, you can. If the money is not in the account, you don’t.
Simplify: Speaking of accounts, reduce how many you have. Fewer bank accounts and credit cards to keep up with will remove some of the complexity and confusion, and help streamline your management system.
Automate as much as you can: Instead of trying to plan out expenses a month in advance like you do with your fixed spending, automatically fund your debit card via a transfer on a weekly basis.
That allows you to know that every Monday morning, for example, you will have funds in the account for the week (and once you spend that money in that week, no more!). It’s much easier to plan for a week of eating and going out than it is to plan for an entire month.
Taking these actions and learning these systems might be tough at first, but stick with it. You will have weeks where you overspend, but it’s important not to beat yourself up over that or just throw up your hands and say “I can’t do this” and quit trying.
Building better habits — and working toward financial success — is a long-term game. It’s a marathon, not a sprint. After all, as Robert Collier said, “Success is the sum of small efforts — repeated day in and day out.”
Remember that effective cash management is crucial to financial well-being and the accumulation of wealth, so put in the effort to get a system in place that lends itself to the good habits you want to have.
Paul Sydlansky, founder of Lake Road Advisors LLC, has worked in the financial services industry for over 20 years. Prior to founding Lake Road Advisors, Paul worked as relationship manager for a Registered Investment Adviser. Previously, Paul worked at Morgan Stanley in New York City for 13 years. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN). In 2018 he was named to Investopedia's Top 100 Financial Advisors list.
How to Buy Stocks
Not everyone knows how to buy stocks, even as investing in the stock market becomes more and more popular. This four-step plan can help.
By Will Ashworth Published
One Key Rule for Understanding 2023 RMDs
RMDs Required minimum distribution (RMD) rules can be confusing, but there is a guideline that can help.
By Kelley R. Taylor Published
Five Simple Year-End Tax Tips to Set Up a Successful 2024
If you wait until the new year, you may miss out on some valuable tax planning strategies. Here’s what you need to know before closing out 2023.
By Julie Virta, CFP®, CFA, CTFA Published
Six Estate Planning Tips for Younger Generations
Millennials and Gen Zers are taking their estate planning seriously. These tips can help make the process seem less daunting.
By David Weinstock, CFP®, AEP®, CPA Published
Year-End Tax Planning for a Financially Healthier Retirement
Getting your tax ducks in a row for the end of the year can decrease your tax liability and make the most of your income, now and in retirement.
By Ryan Marston, Investment Adviser Representative Published
Where to Start Financially After a Life-Changing Diagnosis
Dealing with an illness, yours or your child’s or that of another loved one, is hard enough without adding financial duress. Here are some considerations and suggestions for covering expenses.
By Stephen B. Dunbar III, JD, CLU Published
Six Ways to Prepare for Widowhood and Protect the Surviving Spouse
No one wants to have to plan for losing their spouse, but having plans in place and knowing what to do when the time comes can alleviate at least some of the stress.
By Tyler Hill, Investment Adviser Representative Published
Creating a Blended Family? Three Key Steps to Consider
Blended families can make your finances and estate extra complicated, but you can head off some of those issues with careful planning.
By Adam Frank Published
Do You Need Disability Insurance?
If you work for a living, the answer is yes, so don’t overlook protecting your biggest asset. Open enrollment season is the perfect time to assess your options.
By Frank J. Legan Published
Retirement Planning in a Time of Inflation and High Interest Rates
Today’s challenges make retirement planning even more complicated than usual, but it’s not all doom and gloom.
By Ken Moraif, MBA, CFP®, CRPC® Published