The seven rules of cash flow(Read article summary)
Software program "You Need a Budget 4" suggests four rules of cash flow. It's a great start, but here are three more rules of cash flow.
Courtesy of You Need a Budget
A few days ago, I downloaded and triedÂ You Need a Budget 4, a software package that helps people develop a working budget and get better control over their money. I wonâ€™t get into a long review of it â€“ my belief with tools like these is that theyâ€™ll work great for people who want it to work and wonâ€™t work at all if youâ€™re not committed to the personal changes â€“ but I did want to talk about some of the ideas behind it. (If you do want a full review, hereâ€™s aÂ great review from Wealth Pilgrim.)
As it clearly says in the documentation and is implied throughout the software, You Need a Budget is based on the so-calledÂ Four Rules of Cash Flow, which are as follows:
Rule 1: Give every dollar a job.
Rule 2: Save for a rainy day.
Rule 3: Roll with the punches.
Rule 4: Learn to live on last monthâ€™s income.
Letâ€™s walk through each of these a bit.
Rule 1: Give Every Dollar a JobÂ simply means that youâ€™re deciding in advance where each and every dollar you bring in is going to be spent. You donâ€™t spend a dime without planning for it first.
Rule 2: Save for a Rainy DayÂ means that you need to build up an emergency fund because there are going to be times where life whacks you hard and you need to be able to prepare for that.
Rule 3: Roll with the PunchesÂ means that sometimes youâ€™re going to make a mistake and that your budget needs to account for that. Often, this means rolling any overages into next monthâ€™s budget by reducing that category.
Rule 4: Live on Last Monthâ€™s PaycheckÂ means that youâ€™re in a position where you donâ€™t need to touch your paycheck when it arrives â€“ or even for quite a while â€“ giving you plenty of time to plan for how to use that money.
Straightforward ideas, right? They make a lot of sense and, if you follow them carefully, theyâ€™ll push you in a good financial direction over time.
However,Â I view these four maxims as just a starting point.Â They give you a good idea of how to start spending less and put yourself in a situation where a disaster wonâ€™t sink you, but they donâ€™t give you any further encouragement as to how to turn your financial life around.
So, letâ€™s say youâ€™ve achieved those four maxims. Youâ€™re keeping track of every dollar, you have a decent emergency fund (say, a monthâ€™s worth of living expenses), and youâ€™re no longer in a situation where youâ€™re burning through your paycheck the second it arrives. What now?
Iâ€™d suggest a few more steps after the four rules of cash flow.
Step 1: Repay Your Debts Sensibly
I usually suggest that people who are in a position where they have a grip on those four rules move on toÂ creating a debt repayment plan, but the principle behind this is really simple:Â debt is bad, because every dollar of interest you pay is a dollar youâ€™re not keeping for yourself.
The simplest first step you can take is to pledge to make a double payment each month on whatever debt you have that has the highest interest rate. Letâ€™s say that debt is $50 per month, so youâ€™re paying $100 a month. When that debt is paid off, take theÂ entireÂ double payment â€“ $100 here â€“ and apply that as an extra payment to your current debt with the highest interest rate. So, if your next highest interest debt is $80 per month, youâ€™re now going to pay $100 extra, making it $180 per month.
Your debts will go away, slowly at first, but then faster and faster and faster until suddenly youâ€™re free of debt and you have aÂ hugeÂ amount of money available to you each paycheck.
Step 2: Look Down the Road
At some point, youâ€™re going to retire. If you have kids, at some point theyâ€™re probably going to go to college or a trade school. In both cases, youâ€™re going to get hit with a gigantic expense.
You can start preparing for this now, and every little bit of preparation helps. If your work offers a 401(k) plan, sign up for it and contribute whatever seems reasonable each month. You donâ€™t need to break yourself to do it, just look for a comfortable amount. Remember that with 401(k) contributions, if you contribute 4%, your paycheck will go down less than 4% (closer to 3%, actually), so the impact wonâ€™t be as big as you think. Every little bit for retirement helps.
The same thing is true for college savings. Itâ€™s easy to open up a 529 plan (basically, a special savings account for your childâ€™s college education where you donâ€™t have to pay any taxes on the money you earn if they use it all for college) and have money taken out of your checking account on a regular basis.
Look down the road and start saving a little bit now. Every dime you save right now has many, many years to grow before your goal arrives. If you put it off, you give your money less time to grow.
Step 3: Re-evaluate Your Goals
If youâ€™ve got your debts under control or, even better, eliminated entirelyÂ andÂ you have a retirement plan underway, itâ€™s time to ask yourself some deep questions.
What do you want from your life? Are you happy with your career? Are you happy with your current job? Are you happy with where you live?
Debt freedom and a bit of financial security open up aÂ lotÂ of doors that werenâ€™t open before. Start thinking about these questions as you begin to reach that stage so that youâ€™ll have some answers when you get there and can establish strong personal goals.
The four rules of cash flow are aÂ greatÂ way to get started, but theyâ€™re just the first big steps in a journey that will take you almost anywhere you want to go. All you need is patience and determination.