Perhaps the single most important factor in reducing financial stress is managing cash flow.
In their book The Millionaire Next Door, Dr. Thomas Stanley and William Danko explained this financial principal as “I make plenty of money but there is too much month!” This is a common refrain for many people. This is especially true in California where the cost of housing is quite high, in relation to income.
People are obligated to pay many predictable expenses each month. These include items such as: food, shelter, transportation, clothing, and entertainment. In addition to the fixed monthly payments, there are variable expenses. A few examples would be: a vacation, an annual property tax bill, an unexpected home or car repair, holiday or back to school shopping. These expenses often require a sizeable outlay that can’t be easily handled within the confines of a person’s monthly paycheck.
Ideally, surprise expense would be paid out of a cash reserves. Unfortunately, for many, these expenses end up on a credit card with a potential steep interest charge to boot.
One suggestion we make, when working with people who have this problem, is to consider creating a sinking fund to take care of the surprise expenses. We call this fund, a savings to spend account.
When clients create a monthly budget they list their expenses in two columns. In the first column are expenses that people are obligated to pay each month. The other column is used to list non regular annual expenses. The non-regular annual expenses are totaled and divided by twelve. Each month, money is set aside in a savings account, to fund these expenses. For example when it comes time to take a vacation, the money is available
There are additional benefits to this strategy. For example, it can relieve money stress, for couples. This time of year can be a challenge for households with multiple children. The month of August is typically time for back to school shopping. Multiple trips to a variety of stores to get the kids prepared. The expenses when totaled often are sizeable. This can lead to some uncomfortable conversations between spouses.
By creating a savings to spend account couples can agree about their short-term spending priorities. They fund these in an account and when the expenses arise, they pose no problem.
Further, by estimating taxes, monthly expenses, savings to spend and actual savings people begin to get a good handle on the total expenses in the budget. This framework helps people understand whether they are living within their means. Remember: there is always something you can spend money on! We want to be in control of our financial life and have our money work for us, instead of the other way around.
In my own experience, this approach to cash flow management allowed my wife and I to develop budget harmony. The two of us against the world! Together we could accomplish our financial goals without animosity.
When laying out a budget people should build some real savings as well (not designed to spend). People should start by creating an emergency reserve of three to six months’ worth living expenses. Once that is complete they should fund retirement programs, particularly those with a matching contribution from their employer. As they become more successful they can build intermediate savings in the form of a brokerage account.
Managing cash flow truly is the key to gaining financial security. If you would like a copy of the expense worksheet we use to help people prepare a budget with the two columns of expenses, email me at