Finding Cash to Stash
"How a person spends money is arguably far more important to amassing wealth than how one invests it."
One of the most vital keys to building wealth is effective cash management. At first blush, this might sound pedestrian, but it is an undeniable fact that how well your clients manage their cash will affect most facets of their overall financial situation - emergency reserves, debt levels, affording adequate insurance protection, accumulating long-term wealth and simply enjoying life in a fast-paced era.
Living Within One's Means
One could argue that how a person spends money is far more important than how he or she invests it. It is much easier to reach retirement goals by deciding how to live than how to invest. Thomas Stanley and William Danko's best-selling book, The Millionaire Next Door, is an excellent treatise on this subject. Successful wealth managers realize that personal financial planning consists of three general activities: 1) controlling day-to-day financial affairs to enable them to do the things that bring satisfaction and enjoyment: 2) choosing and following a course toward long-term financial goals such as buying a house, sending kids to college, or retiring comfortably; and, 3) building a financial safety net to prevent financial disasters caused by catastrophic illness or other personal tragedies.
The majority of people seeking the counsel of a financial adviser have not saved as much as they would have wished. Their reason is not that they did not intend to save, but they did not have a system. Lacking a system makes it very easy to be distracted by the many opportunities to spend earnings.
A cash-management system will function best if it reflects goals, whether long-term or short-term. Has your client committed to financial goals, including amounts required and target dates, to writing? Are savings and investment included as a priority in their budget? For most people, achieving goals involves reducing expenses as much as possible to reallocate dollars toward goals.
A budget is a written plan for utilizing available financial resources to achieve financial goals within a given time frame. Instead of thinking of a budget as financial handcuffs, encourage your clients to think of it as a means to achieve financial success. It ultimately serves as a yardstick against which to measure actual results. Budgeting reveals inefficient or ineffective utilization of resources. Budgeting makes family members aware of the need to conserve resources and helps to allocate roles in achieving overall financial objectives to various individuals. Budgeting allows the recognition and anticipation of problems before they occur.
As you work with clients to review their personal financial statements and budget, two glaring symptoms of poor cash management are excessive debt and minimal cash reserves. Consider the following sobering statistics from American Consumer Credit Counseling, Inc.:
In essence, credit is the privilege of spending money you don't have. Despite a strong stock market and negligible unemployment, bankruptcies are at an all- time high.
Use of debt may be either an important tool for you to obtain what you want or a drain on your resources. In general, debt is best used for large purchases, such as a mortgage for home ownership. However, entering into debt requires payment of interest and periodic repayment of principal that limits funds for other consumption and savings. Therefore, consumer debt (credit cards, car loans) should be avoided as much as possible. Although some situations will require the use of consumer credit for the individual to obtain a needed item or service, consumer credit generally should be used for convenience only.
In the February, 2001 issue of Research magazine, Paul K. Fain, III, CFP sets forth the importance of keeping a positive cash flow in family finances. The article is intended for planners and investment managers, but anyone can learn from it.