Cash Flow Steps

Recently I had the opportunity to sit in on a 401(k) enrollment meeting which Crystal was conducting for one of our clients. The questions we heard were the motivation for this column. The overarching question we heard from employees and participants was “Our household has cash flow left over each month, or discretionary cash flow. What do we do with it?” We recommend the following.

STEP 1

Set up a savings account and put $1000 in it. For most of us, this account needs to be at a bank or financial institution separate from where we keep our primary household checking account. Why? To make this $1000 in savings more difficult to access. The goal is to keep at least $1000 in this account rather than sweeping it into your checking account because you found something you want to buy. An online search may yield an institution willing to pay you 4% to 5% interest on this balance. Automate this. Make the transfer automatic so you don’t have to think about it. And let’s refer to these dollars as a General Reserve.

STEP 2

Pay off any credit card balances, starting with the card with the highest interest rate. Be very diligent and focused in this endeavor. Apply all discretionary cash flow to the first card and make minimum payments on all other cards. Once the first card is paid off, apply all these discretionary dollars to the second card and pay it off. Repeat until all credit cards are paid off. If you must carry a credit card, carry only one. And get rid of department store cards. Just say no. If you do use a credit card, pay the balance in full monthly. Once credit cards are paid off?

STEP 3

Start adding money to the savings account from STEP 1. Add all the discretionary dollars plus all the credit card payment dollars to this account, until you have three to six months of household operating expenses in this savings account. So, if your household operating expenses are $5000 monthly, keep $20,000 to $25,000 in this savings account. If they are $30,000, keep $100,000+ in general reserves. In today’s interest rate environment, you should be able to earn 4% to 5% interest on that account. Automate this.

STEP 4

Now apply all discretionary cash flow including what may have been credit card payments to paying off your autos. Once your autos are paid for, continue to set aside what was your car payment so you can pay cash or have a large down payment for your next auto.

STEP 5

Those funds set aside for your next auto? Let’s refer to these funds as an Allocated Reserve. Allocated reserves are those dollars designed to be used for purchases in the next two to five years, which purchase prices would exceed your monthly cash flow. Typical items are capital assets, such as autos and homes. What’s required here? Giving thought to your plans over the next several years, assigning dollar amounts to those goals and targets.

For those of you who own businesses, these dollars can buy other businesses, commercial buildings, or plant and equipment. We suggest a savings account separate from that used for general savings. And again, these dollars are invested in a money market or high yield savings account earning 4% to 5% interest. These dollars don’t need to be invested in the stock and bond markets.

STEP 6

Once allocated reserves are in place, we can start investing for the long term. This is where investing in the stock market comes into play. Only after general reserves and allocated reserves are funded do we need to consider investing in the stock market. And the purpose of investing in stocks is to build long-term wealth and to create assets which will support us when we no longer care to show up at a job, or as we prepare to release the reins of business. In this case, open an account or accounts with one of the large discount brokerage firms, and begin setting funds aside. And again, automate the process.

When it comes to investing in the stock market, a phrase from physical training “time under tension”, comes to mind. Time under tension is the amount of time a particular muscle or muscle group stays under stress. And in PT, the longer the time under tension, and the more consistently such muscle groups are exposed to time under tension, the greater the growth and development of that muscle group.

How does this apply to the stock market? The greater the length of time that money is exposed to the stock market, and the more consistently funds are added to the market, the greater the growth and development. The tension in investing in the stock market comes from two sources. First is the volatility inherent in investing in stocks. The second is the behavior of the investor. Investor behavior is driven by how each investor manages external input and their thoughts and perceptions. The more the individual gives way to either fear, greed, or mental dissonance often tied to external input from those who promote fear or greed, the more likely they are to choose to release that tension by going to cash. While this does release the short-term tension, it destroys long-term growth and development.

BUT WHAT ABOUT?

So where does my employer’s retirement plan fit in? After STEP 1. Once you have $1000 in savings, participate in your employer plan enough to pick up the employer match. Once you have no debt other than a mortgage, split discretionary cash flow between pre-tax and post-tax investments until your pre-tax contributions hit the maximum allowed.

HOWEVER

We are specifically NOT recommending fiscal austerity or a vow of current poverty simply to amass wealth. In developing a workable spending plan for your household, allow for expenses which feed your soul, add joy to your life, and maintain and enhance relationships and your general well-being. Lunch or dinner with friends? Travel? Pocket cash for a personal splurge? Books and the beach? You know what feeds your soul and enhances relationships. Make those a part of a meaningful spending plan.

FINALLY

Enjoy the process of following these steps. And enjoy your life along the way. Choose to reject being overwhelmed by any of this. And if you’d like to talk through it with us, reach out.