Financial organization is 80% of being good with money. It is also the one topic that comes with the most psychological baggage and fills many people with dread. Today is the day we tackle financial organization head on, step by step. When thinking about financial organization I want us to think of designing a simpler financial life for ourselves. Good design has practical problem solving at its core. It is about being intentional in our financial life.
First things first. To know where we are, how we got here and where we are going, we first need to gather all our financial documentation whether that be in the dreaded financial folder, online or a combination of both. We break down financial organization into three areas, financial administration, what we earn and spend and what we own and owe. Building on last week’s episode each area has more in depth steps in order of priority. We start with financial administration, followed by what we earn and spend, and finally what we own and owe:
Step 1 - List and consolidate all financial accounts, policies and documentation in one place such as a spreadsheet, an A4 pad or digitally. Types of financial accounts are a current, deposit, savings, credit card, investment, loans, pension and so on. Among the first financial documents we want are our latest payslips & our employment detail summary (the replacement for what was our P60’s) for the previous calendar year. We can access our employment detail summary through Revenue’s My Account service. Our payslips will provide us with details related to our employment such as, payroll date, PPS number, PRSI class, our pay, hours worked, employee/employer pension contributions, health insurance premium, tax (PAYE, PRSI & USC), professional subscriptions, business expenses, protection benefits, bonuses and so on. Our employment detail summary will provide our total annual income related to our employment in that calendar year. Our income earned from working our day jobs is referred to as active income. It is income that stops if we decide not to go to work. Examples include, salaries, bonuses, tips and so on. We should also include any passive income we receive. Passive income is money generated from investments or past work that keeps generating income. It is income that is received regardless of the day job. Examples include, rental property income, dividend income, royalties, monetizing content and so on. A large part of being a financial planner is to assist client’s transition from active income to passive income by building wealth and achieving financial independence for their desired lifestyle. I will do an episode on active & passive income in Series 2.
Step 2 – Review our list of financial accounts. Reduce duplication and overlap by switching or closing bank accounts that are surplus to requirements. We can collect more financial accounts than is necessary over time and it only adds to the complexity when trying to determine our past spending. Calculating our total lifestyle spending will be easier to track, the less accounts we have while keeping cash spending to a minimum. Less is more, clear out the clutter. The goal is to streamline and automate our money online. Centralize our spending and saving in as few accounts as possible. It is likely we are paying bank fees and stamp duty on each account. When reviewing our accounts we should ask ourselves the following questions:
What do we use it for? Income, spending, saving or debt?
Do we have multiple A/c’s for the same categories, if so why?
Which account has the most favorable terms?
Can accounts for the same category be switched into one account and surplus accounts be closed?
Direct debits and standing orders can be transferred as part of the switching process.
For each individual there should be no need for more than two or three bank accounts for spending and saving and preferably with the same bank. A current a/c, a savings a/c and if you really need it, a third savings account. In my day to day I have seen some clients with anything from a half dozen to two dozen bank accounts. It is increasingly difficult to track and manage our money the more accounts we have. What I am saying might challenge how we compartmentalize our spending and saving in certain accounts. My only aim is to simplify our financial accounts for an easier life. Minimalism for our money so to speak. Couples who aren’t married typically have a shared account for bills or they identify who pays for what and then nets that spending off against each other, transferring the difference. Married couples accounts can add another layer of complexity. The structure of financial accounts between those who are married can vary substantially and really the best structure is the one that suits your relationship best. Once married, legally what’s yours is theirs and what’s theirs is yours. A financial union is a lot like when you first start living together for the first time. There will be a bedding in period where you suss out each other’s nuances. There are a myriad of account scenarios. What I will do is outline the Pros and Cons of joint accounts.
The pros are:
1. Convenience – Centralized account for all income, spending and saving
2. Estate Planning – In the event one of the joint account holders closes their eyes for good, the remaining joint account holder maintains access to the account without the need to go through probate, typically 4 to 6 months assuming there is a Will in place. This joint account advantage can often be overlooked by those with single name accounts and can compound the loss of a loved one if unable to access funds freely for a significant period.
3. Transparency and Trust – Less likely to encounter financial surprises. Two eyes are better than one. This has a downside when purchasing a gift for our significant other as it will appear on the bank statement. Paying cash or having a separate discretionary spending account can solve this.
The cons are:
1. A sense of losing our own financial individuality or freedom – Not maintaining the same level of financial freedom or autonomy a single account provides might be a sticking point. This has a flip side for a one income couple or family when the person not earning does not have a joint account and thus no direct access to income.
2. Unequal financial circumstances – It is rare that a couple’s finances are exactly the same. So, when two become one it is important to set ground rules relating to our historical finances across income, spending, debt, savings and existing assets pre financial union.
3. Relationship breakdown/ending – It happens all the time and for various reasons. Emotions can be running high and therefore managing a joint account can become precarious and messy. What people do or don’t do with money can often be one of the biggest contributing factors in relationship breakdowns.
There are those who are happy with entirely separate accounts, those who only hold joint accounts and those with a hybrid of both. A best of both scenario can be using a joint account to receive all income and from which to pay all related joint spending, saving and debt while also transferring left over funds to two individual accounts for personal spending and saving goals. This hybrid strategy of one joint account for income, and two individual accounts for spending or saving is convenient, futureproof, and transparent. Whether there is one or two earners it all comes back to trust and our relationship with money. Sitting down, discussing the pros and cons, any pain points, concerns or worries. Entering into a financial union with our eyes wide open. It is really what works best for you as a couple but be honest and open about it. There is usually a lead person when it comes to money in a relationship, however it is important you are both on the same page. We all come to the money table with different experiences and so be patient and keep communication lines open. Teamwork makes the dream work. Two heads are better than one, once you are on the same page.
Step 3 - Categorize our financial list into income, spending, saving and debt. Anything that doesn’t fit into income, spending or debt goes into savings. Then categorize further, by labelling our spending with basic, leisure & luxury. Basic spending is food, clothes, housing & transportation, in that order. They are essentials for living. Leisure spending is sports, hobbies, holidays, entertainment, eating out, cash withdrawals and so on. Leisure spending is defined as a quality of experience or spending money in our free time. Luxury spending is jewelry, yachts, a second home, high end clothes, sportscars, and so on. Luxury spending is defined as something that brings pleasure or happiness, an indulgence. Everyone’s interpretation of Basic, Leisure and Luxury spending will be different relative to their earning power. These exercises will make us more conscious of where our money is being spent and how much. Completing a spending planner or budget will reveal whether you are spending more than you earn, spending what you earn or spending less than you earn. Our spending almost always rises to meet our income in what is known as lifestyle creep. More money, more spending. Correcting lifestyle creep and continuing to be disciplined will contribute to our financial success.
Step 4 – Sign up to e-statements, e-billing, use direct debits and standing orders to pay our bills. Minimize the possibility of missing payments & late fees by setting up direct debits and standing orders. If things change you can always cancel them. If possible, you can coordinate payment of bills to a couple days after you get paid.
Step 5 – Scan and save down on our computer, memory stick or cloud storage any historical documentation we feel we would like to maintain a record of. There is no unilateral rule of thumb when it comes to maintaining records of our financial documents. Businesses are to keep all financial records for 6 years for tax purposes. When it comes to personal financial documentation there are few scenarios where we will be unable to get our hands on a physical or electronic copy of a document if so required. This being said it is always best to air on the side of caution and keep a physical document & electronic copy in our records for reference. Once the pertinent pieces of information are included on our spreadsheet list, we can file that document away.
A large part of how financially organized we are will stem from how organized we are when spending money in our lives generally. An example of this is grocery shopping. Shopping once a week with a written list. A shopping list is visualizing the to do list. In order for this to happen we need to map out what food we will be having for the week, breakfast, lunch & dinner not forgetting some snacks. Maybe we want to hit some nutritional goals, so we need to identify what recipes capture these ingredients. Maybe we want to do all this with a certain amount of money and so on. Being organized in our lives will be reflected in our spending.
What we earn and spend:
Step 1 – Using our latest payslip, record our after-tax income onto our spreadsheet. That is the income we receive into our bank accounts from work. It is important to record our income in the format we get paid, that is, weekly, biweekly, monthly and so on.
Step 2 – Using our bank accounts start adding up our weekly, monthly, quarterly, half yearly, yearly and multiyear spending. So, for example if you are paid weekly, add up what we typically spend in one week. A prime example of a weekly expense is groceries. Then we move on to what we would spend in a month. Examples of monthly spending are rent or mortgage, utilities such as electricity, heat, internet, tv, bins, mobile phone, gym, subscriptions such as Netflix, Spotify, debt repayments, childcare and so on. If working weekly, we want to carve out a portion of each weekly paycheck to pay for our monthly spending. We do this by dividing our monthly spending by 4.35. This is because there is only one month, February, that is 28 days or four weeks long, 7 days times 4 weeks equals 28 days. So, the remaining 11 months of the year fluctuate from having 1 to 3 more days per month. Four weeks times twelve months is 48 weeks which leaves us a full 4 weeks shy of our 52-week year. Getting back to carving out a portion of our weekly income to pay for monthly spending. Dividing our monthly spending by 4.35 will give us the figure we set aside from our weekly paycheck for monthly spending. If paid monthly, we do the opposite and multiply weekly spending by 4.35. It is our less frequent spending that usually catches most of us out. That is, spending that is not weekly or monthly. Examples of less frequent spending are christenings, communions, confirmations, engagements, hens, stags, weddings, anniversaries, birthdays, Christmas, Easter, Halloween, New Years, Valentine’s Day, funerals, holidays or weekends away, car replacement, phone replacement, furniture, electronics, appliances, insurances such as (Car, home, pet, travel, health, life, phone), taxes, clothes, annual subscriptions or memberships, healthcare, beauty/grooming, school fees and so on. We want to get to a point where our calendar’s and bank account are working in unison, ahead of time.
The goal is to calculate how much of our weekly or monthly paycheck is to be used for our less frequent spending. This is achieved by dividing our less frequent spending by the number of paychecks between now and when that future expense comes due. Carving out a portion of our weekly, biweekly or monthly paychecks so that less frequent future spending is covered. An example of this would be a car. Say we have had our current car for 5 years and plan on having it another 5 years. We plan to spend €10,000 on our next car in 5 years’ time. If we are paid monthly, we divide €10,000 by 60 ( which is 12 months times 5 years) which equals €167 per month. So, €167 from our monthly paycheck needs to be allocated to our future car fund. We then apply this method to all of our less frequent future spending that we know will come due and set it aside in a dedicated account. This is what budgeting is all about. It is about being proactive, making money more manageable and realizing how much of our income is already committed to yearly, and multiyear spending not just daily, weekly and monthly spending. We want to synchronize our weekly, bi-weekly or monthly paychecks with our total future lifestyle spending. We will be doing extremely well to factor in 80% of our less frequent future spending. It is inevitable we will overlook or forget to include some things, but it is a process of refinement as we move forward. If we are really forward focus, we can add an extra 20% to our total less frequent spending to prepare us for the things we have overlooked and life’s inevitable surprises. This process is more of an art than an exact science as the goal posts are constantly moving. The further back we review our bank statements the more comprehensive our spending accuracy will become. Some banks have the facility to download transaction history in spreadsheet format online. If we use cash review our receipts, if we don’t have our receipts, start a spending diary or switch to using our bank card full time. There will be a point in time where we draw a line in the sand and use it as a marker of where we are currently.
Step 3 - If we spend more than we earn or what we earn, we will need to cut spending or increase income. Start by reducing or cutting spending across luxury, leisure and then basic, in that order. Look for deals and discounts. Shop around when it comes to all our bills and debt repayments. Are we getting the best bang for our buck? It has never been easier to compare offerings online. Avoid what appears to be a good deal in the short term but is a worse deal comparatively overall. Changing supermarket or buying store branded products can have an immediate impact on our pocket. When deciding between two of the same product or service value should play a primary role in our decision making. There are so many tv shows that help us live better while making our money go further. What planet are you on? And Eat Well for Less come to mind. Small savings across many expenses over a long period of time can have a significant impact. A spending diary and or the envelope system can work well here. A spending diary documents our daily, weekly and monthly spending. It forces us to engage with our spending on a conscious level. The envelope system is where we withdraw cash from the ATM and place the allocated cash for each spending category into an envelope to cover our spending for that month. This has many benefits. It visualizes our spending target, keeps us honest and forces us to manage our money in a very tangible way. By placing a limit on ourselves it forces us to evaluate our money decisions differently. It may start us down a path of becoming more creative with how we spend our money. Knowing the true cost of our lifestyle is critical to getting to grips with our savings rate.
Step 4 – If we spend less than we earn, how long will it take us to a) build a €1,000 starter emergency fund, b) pay off all debt except the mortgage, c) build a fully funded emergency fund of 3-6 months of expenses, d) save for a deposit on a home (if applicable), e) pay ourselves first, secure our financial independence, f) save for children’s education (if applicable), g) pay off the mortgage early. A key tenet in personal finance is spending less than you earn and therefore having the capacity to increase debt repayments &/or save. That is our ability to save a percentage of our income consistently over time. When it comes to building an emergency fund the higher our savings rate, the quicker we will reach our emergency fund goal. Example, we have €200 savings surplus available with each paycheck. It will take us five months to reach our starter emergency fund goal of €1,000. Using the €200 we then attack all non-mortgage debt. Episode 5 will cover debt in detail. We then build a 3-6-month emergency fund with our €200 savings plus redirected funds previously used for non-mortgage debt repayments which are now paid off. How quickly we accumulate the 3-6 months emergency fund will depend on our, savings rate, monthly expenses and job security. Reaching a €1,000 emergency fund, paying off all non-mortgage debt and saving a 3-6-month emergency fund will be the hardest steps by far. Depending on our circumstances the financial pain can be relentless, and some will contemplate giving up. Don’t give up and believe in the process. What doesn’t kill you makes you stronger. When saving for a deposit on a home, start with our income multiplier to determine the maximum we can borrow. The difference between what we can borrow, and the price of the home will be the deposit while abiding by Central Bank of Ireland’s minimum deposit requirement. Again, our savings rate will determine how quickly we reach our home deposit goal along with government supports and the bank of mum and dad. Mortgages will be covered in more detail in episode 9. Pay ourselves first, not last. Tax is likely to be our biggest lifetime expense. The Irish government has incentivized us to save for our future selves by applying income tax relief when we pay ourselves first. This is applied when contributing to our pensions. Saving for our future selves will be covered in Episode 7. When saving for our children’s education we start at the end and work back. Divide the total cost of education by the number of paychecks between now and when the children will attend school or college. Paying off the mortgage will be one of our greatest financial achievements. Owning our home out right with no further repayments to come out of our paychecks will allow us increased financial security.
What we own and owe:
Step – 1 List things you own on one side and what you owe on the other. This will indicate our net worth. Simple as that. Examples of what we own are our property, vehicles, land, pension, cash, investments, savings and so on. Examples of what we owe, are mortgages, car loans, personal loans, and so on. Our net worth is a snapshot of where we are at financially. Reducing what we owe and increasing what we own will improve our net worth position.
In summary, keep our financial life simple, so it’s easy to track and manage. Our savings rate is critical to our future financial success. Focus on building our net worth by reducing what we owe and increasing what we own.
This week’s book recommendations are The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organizing by Marie Kondo. While not money related there are many parallels this book advocates that can be applied to managing money in our lives. And You Need A Budget: The Proven System for Breaking the Paycheck-to-Paycheck Cycle, Getting Out of Debt and Living the Life You Want by Jesse Mecham. As the name suggests this book is a deep dive on budgeting 101. And finally, The Automatic Millionaire: A Powerful One-Step Plan to Live and Finish Rich by David Bach. The best way to financial success is removing the decision making from the equation. Consistent and systematic automation of our money minimizes the will power required to make the right decisions. This book piggy backs off of the previous book recommendation Nudge.
This week’s movie recommendations are Trading Places. Eddie
Murphy plays a con artist who trades places with a snobbish investor, all
orchestrated by two millionaires to determine the winner of a bet. And
sticking with Eddie Murphy and the 1980’s, Coming to America. A film about a
Prince who travels to Queens a New York borough in search of his queen. Both
are hilarious and at times provide an insight into how people value money.
Link to Spotify podcast episode: https://open.spotify.com/episode/5l6RCUWzfrxnz6kr4Vy9zf?si=55dae7e2c2d24f72
Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s1-e4-financial-organisation/id1539630506?i=1000500971092
For personal financial planning advice email email@example.com or call (01) 539 2670.