A great quote I came across recently was “The loftier the building, the deeper must the foundation be laid.” Just like building a house, when it comes to financial planning the key is getting a solid foundation in place. Without it, the lightest breeze has the potential to knock your plan down.
When we talk about a foundation for financial planning a good place to start is your cash flow. Economics talks about the allocation of finite resources; we all have a finite amount of resources to play with, some greater than others, but ultimately it’s not endless. Financial planning is about using your cash flow in the best way possible.
I’m always hesitant to use the word “budget”, because it can feel a bit tedious or negative. Instead, when it comes to allocating your cash flow I like to talk to my clients about viewing your cash flow as three buckets.
Bucket one: Fixed costs
Everyone will be able to identify with this bucket. Pay check to pay check there is always an amount that needs to be put aside to pay for those fixed costs. These are the things that we can’t stop (at least very easily); for example, mortgage repayments, rent, utility bills, groceries etc. Therefore we know no matter what happens we have to put aside an amount to account for this.
Bucket two: Discretionary spending (quality of life now)
This is the bucket that we all seem to do really well at. The problem is we often overdo it. Discretionary spending includes the things we spend money on to give us enjoyment (quality of life) now. This might be eating out, going to the movies, new clothes etc.
For the people that would put themselves into the “living from pay check to pay check” category it’s often because after they have put money away for bucket one they then spend anything left over on bucket two. This is why the third bucket is so important.
Bucket three: The goals bucket
I find the third bucket is the one that is often forgotten about completely. Most people have some sort of vague goal in mind, maybe its “I’d love to go on an overseas holiday this year” or “I really want to buy my first home”. For a goal to be achievable though it needs to be SMART (specific, measurable, agreed upon, realistic and time bound). Once you understand the cost and the timeframe, you can work backwards to understand how much needs to be allocated each pay to achieve it.
The balancing act
Now comes the challenge. For the majority of us, once we add up how much we need to allocate to each bucket we find there is a shortfall (if there isn’t that’s fantastic!). When you have a shortfall we then need to have a trade-off discussion; i.e. what are we willing to give up? We know that Bucket One can’t be changed, so the trade-off has to be either giving up some of Bucket Two or Bucket Three. This in essence is what financial planning is, balancing living for now and living for the future.
It is important at this point to prioritise your goals and understand what you are willing to forego. The greater the importance of your goal the easier it will be to give up things you are spending now.
If we think back to the quote “The loftier the building, the deeper must the foundation be laid”, in this case our goals are what we are building towards. So take some time to understand what these goals are and then start building your foundation and seeing your building grow from pay check to pay check.
If you feel you need help identifying your goals or help with building your foundation this is where a financial planner can help. Feel free to get in touch with us today.
Casey Shaw is an authorised representative and credit representative of AMP Financial Planning.
Blueprint Planning Pty Ltd (ABN 78 097 264 554), trading as Blueprint Wealth, is an authorised representative and credit representative of AMP Financial Planning, Australian Financial Services Licensee and Australian Credit Licensee.
This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider you financial situation and needs before making any decisions based on this information.