Spending & Saving

So what is your cash flow made up of? 

Income: This one should be pretty straight forward. Where do you make your money? 

• Salary/bonus from your job as an employee 
• Income from a business you have ownership in 
• Real estate income (i.e. from a rental property) 

Think of money that actually hits your bank account. Do not include things like growth in an investment account or appreciation of a property you own.

Fixed Expenses: What expenses do you have to pay every single month?

• Income taxes
• Property taxes 
• Utilities 
• Cable/internet/cell phone
• Insurance premiums (medical, dental, vision, life, disability, auto, homeowners, etc.) 
• Child care
• Organization dues 

Liabilities: What debts do you have outstanding? While fixed expenses could theoretically go on forever, liabilities have a specific term and interest rate associated with them. 

• Mortgage
• Student loan
• Home equity loan or line of credit 
• Personal loan
• Credit card loan 

Variable Expenses: What expenses do you typically incur but vary in amount and frequency from month to month? 

• Groceries 
• Dining/eating out 
• Uber/Lyft
• Concerts/events
• Gifts 
• Auto gas 
• Personal care
• Car repairs 
• Home repairs 

The first step in cash flow optimization is getting a grasp on where you stand today. When you lay out all of the above categories, ask yourself a few questions.

1. What is the total dollar amount in each category? 
2. What percentage of gross income do your expense categories and liabilities consist of? I dive into the 50/20/30 savings principle in a previous blog post  “Savings Strategies for Six Figure Earners”. 
3. Is there a “spread” between how much you make and how much you spend? If so, how big is that spread? 
4. If something doesn’t seem right, make sure you account for money you may already be saving (i.e. into a retirement account). If it still seems off, it is likely a discrepancy in your  variable expenses.  

Once you’ve taken a look at your current situation, you are going to want to take steps to widening the spread between your income and expenses. Here are a few ways to do that. 

1. Increase your income: For most people, this means earning AND asking for a raise. Be sure that you are being compensated fairly. We recently had a client get an offer for a 10% raise, counter it by asking for 25%, and settle on a 23% raise!  
2. Eliminate or refinance bad debt: We will refer to bad debt as any debt with an interest rate > 8% or so. Pay off low balance bad debt and look into refinancing high balance bad debt. Two categories that often contain “bad debt”, are credit cards and student loans. I talk about the trade off of savings vs investing and some other cash flow strategies in this NerdWallet article. 
3. Track variable expenses: This is not the most sustainable activity in the long term, but can be a game changer in the short term. For 2 or 3 months, keep track of ALL variable expenses. Set a time every week or every other week to evaluate your spending. Is it what you thought? Are you able to easily reduce certain areas?

Now that you have created and maintained a “cash flow spread”, it’s time to level up. 

1. Increase savings over time: If you have been saving 20% of your income every month, set a goal to increase that rate over time. Can you get it to 25%? 30%? 40%? It is always going to be a balance between saving for your future and enjoying your money now. What trade off are you comfortable with? 
2. Combat lifestyle inflation: This is going to help with the first recommendation. As you make more and more money over time, do your best to keep expenses low (and increase the “spread”). Do you need a bigger house? Nicer car?  Expensive clothing? Maybe you do. Just make sure you are aligning your spending with things you actually enjoy.

Cash flow is the oxygen to your financial life. Without it, everything else falls apart. Take the first steps to cash flow optimization.

1. Identify the cash flow “spread”: Where is your money coming from and going to?
2. Widen the spread: Look for opportunities to bring in more income and reduce expenses and liabilities.
3. Level up: Do not get complacent with your wealth building. Keep increasing your savings and do you best to combat lifestyle inflation.

Congratulations! You are finally making a great income and your career is on an upward trajectory. Living paycheck to paycheck is suddenly a thing of the past. While making money has been great, you can’t seem to figure out where it all goes every month. You’re not alone! 

I want to share with you some practical strategies for saving money as a six figure earner. In this blog, we will go over 5 specific tips for using your income to build adequate savings for your short, intermediate, and long term goals (even if you have not defined them yet). 

The first thing you want to do is decide how much you would like to save every month. The key here is to lead with savings, not expenses. We want to set a savings goal and spend what is left over (not the opposite). 

Setting a goal for how much you want to save is not an exact science. You may not even know exactly what you are saving for. Even if you are unsure of how much you want to save, getting started is still a good idea. The fact is, you do have future financial goals, even if you can’t define them yet. 

If you don’t really know how much to save, I recommend starting with the 50/20/30 rule: 

1. 50% of Income = Fixed Expenses (Examples: income taxes, property taxes, housing costs, utilities, cable/internet, liabilities, insurance, child care)
2. 20% of Income = Savings (Examples: 401k, pension, IRA, brokerage account, 529 plan, traditional savings account) 
3. 30% of Income = Variable Expenses (anything else) 

These guidelines are somewhat arbitrary but as we already discussed, you may not have defined goals just yet. This framework will certainly get you heading in the right direction. 

Let’s assume you were able to implement the above strategy and are saving 20% of your income. The question now becomes, where should that money go? 

1. Start with an Online Savings Account:
   • Another rule of thumb is to have 3-6 months of fixed expenses in a dedicated savings account. This money has the sole purpose of preventing against unforeseen expenses. Things like home repairs, car repairs, and medical bills are a few examples. 
   • There are 2 reasons I recommend using an online savings account. 
     • Higher interest rates: Most traditional banks offer interest rates that are far below that of an online savings account. Check out this article from Nerd Wallet on a few of the online savings accounts available to you today. 
     • Mental Accounting: You do not want it to be overly convenient to access your savings. If your savings account is at a separate location from your everyday checking account, you are less likely to dip into it. You will start to view this account as an investment, rather than readily available cash. 
2. Think about Reducing Your Tax Bill:
   • After you build up adequate cash savings, you are probably thinking about your intermediate to longer term goals. A great place to go if you haven’t defined your goals yet are tax advantaged retirement plans:
     • Pre-Tax Retirement Plans: Examples of these would be a Traditional 401k or Traditional IRA. Your money goes in before any taxes are deducted, it grows tax free, and is taxed upon withdrawal at a later date (typically retirement).
     • Post-Tax Retirement Plans: Examples of these would be a Roth 401k or Roth IRA. Your money goes in after taxes are deducted, it grows tax free, and is tax free upon withdrawal at a later date (typically retirement).
   • If you decide you are saving for retirement, these are excellent options. The tax advantages of these accounts will typically outweigh the benefits of investing in a taxable brokerage account (i.e. an individual account you would open at one of the larger firms like Fidelity or Schwab). 
3. Consider Other Options: 
   • While you are likely going to start with cash savings and retirement plans, it is important to at least be aware of what else is out there
     • FSA & HSA: Flexible Savings Accounts and Health Savings Accounts are designed to allow you to pay for medical and healthcare costs with pre-tax dollars. Here is another nerd wallet article describing the difference between the two
     • Taxable Brokerage Account: The primary benefit of these accounts as compared to a retirement account is liquidity. You can access the money whenever you want without a penalty. The investment options are similar to that of an IRA but you have to be wary of capital gains taxes and taxes on dividends and interest. 
     • Employee Stock Purchase Plans (ESPP): These plans allow you to purchase your company’s stock at a market discount. An example would be a CVS employee getting a discount on CVS stock. While discounts are great, you need to be careful of putting too much of your money into one stock. With that said, if you are able to buy company stock at a large discount and sell it relatively quickly, that may be a great deal for you. 

You are now saving 20% of your income and have various buckets in which to put your money. The next step is to optimize your savings. 

1. Take Advantage of the Employer Match: This one is simple. If your employer matches contributions to your company retirement plan, take advantage of it. An example would be that your employer matches every dollar you contribute up to 5% of your salary (i.e. You put in $500 a month and your employer puts in $500 a month). 
2. Diversify Investments: You have probably heard this before, but what does it mean? Simply put, don’t put all your eggs in one basket. For company plans, target date retirement funds work pretty well. You simply select a retirement date and there is a fund associated with it. The further you push that date (i.e. 2045, 2050, 2055, etc.) the more aggressive the investment allocation will be. More aggressive meaning more stocks than bonds. This is an oversimplification, but you get the idea. 
3. Minimize Expense Ratios: These are the internal expenses within a given investment. The investment options within a plan can vary, so don’t assume your company has low cost options. As another rule of thumb, try to use funds that have expense ratios less than 0.50%.  We can’t control a lot when it comes to investing, but we can control expenses. 
4. Don’t Get Stuck on 20%: Saving as much as 30% or 40% of your income is a great idea. It is also important to balance saving for the future and enjoying your life today. If you feel like you are living a fulfilling life and can afford to save more, go for it! 
5. Diversify your Buckets: Everyone is always wondering which investment account is better. Traditional? Roth? Taxable? HSA/FSA? The answer is that they all have their unique benefits and downfalls. Often times it is best to do a little bit of everything. Your tax situation will change. Government laws will change. Your goals will change. Having money spread across different buckets can provide you with some great flexibility down the road. 

This step is crucial. We need to find ways to take our emotions out of our investment decisions. Automation is the key. 

1. Auto Transfer Checking to Savings: Set up an automatic transfer from your checking account to your online savings account at the beginning of every month. We want this money to transfer over before any expenses hit your account. Don’t trust yourself to do this manually. You will come up with a million reasons why not to transfer this month. Or even more simply, you could just forget. 
2. Auto Deduct Money from your Paycheck: If you are contributing to a company retirement plan, set it on autopilot. Select the percentage of income you want to come out every check and let it go to work. Once you set your asset allocation, you can auto invest your contributions to the same target every time. 
3. IRA’s & Brokerage Accounts: If you are saving in these buckets outside your employer plan, set up another auto transfer. Be aware of contribution and income limits on Traditional and Roth IRA’s. They are much lower and more restrictive than company retirement plans. There is no limit on contributions to taxable brokerage accounts. 

Do your absolute best to avoid irrational decisions during difficult markets. As someone who is not all that close to retirement, a market downturn can be advantageous if you are constantly investing during that time. Think about how you would feel if everything went on sale at your favorite store. Isn’t it logical to want to buy at that time? 

No strategy is final. You are going to want to periodically review your situation and adjust as things change.

1. Did you recently get married? How does your spouse impact your current financial situation? 
2. Did you recently have a child? Maybe starting a 529 Plan makes sense.
3. Did you get a raise but your expenses stayed the same? Consider bumping up your savings rate.
4. Do you have new goals that are closer than retirement (i.e. buying a home)? You may want to start saving more into cash or short term investments. 
5. Have you maxed out your contributions to your company retirement plan? Where does the next dollar go?

In summary, what can you do right now to improve your savings situation? 

1. Find your savings rate. Decide what percent of your salary you are able to save today. 
2. Pick your saving buckets. Allocate your savings into cash, tax advantage retirement plans, taxable investments, and any other bucket. Try not to go crazy over which bucket. Just get started. 
3. Optimize your situation. Take advantage of employer matching, minimize expenses, diversify your investments, and increase your savings percentage. 
4. Automate. Put your monthly savings on autopilot. 
5. Revisit your strategy. Ask yourself what has changed and how that should impact your savings.