The principle of spending less than you earn resonates with many people. The challenge usually is applying it to personal finances. People cite varied challenges such as lack of a clarity in developing a financial plan, lack of confidence, high amounts of debt, low incomes, peer pressure and lack of patience.
Borrowing from the example of successful organizations, they all have strategic plans that guide their overall and specific activities. These organizations further develop financial plans detailing projections of sources and uses of money to enable them achieve their purpose for existence. Majority of these organizations engage professionals to help them develop these plans, benefiting from their expertise and objectivity. If for whatever reason you struggle developing your financial plan, please seek help from a Financial Planner preferably one who is not selling you anything. To apply financial management principles successfully, you need clarity on where you are going and how to get there. Clarity on what action to take this year, month and week to achieve the vision will direct your efforts and provide motivation.
First step is to establish your current position. Are you spending less than you earn, all that you earn or more than you earn? If you are not applying the principle, you will need to either grow your income or manage your expenses. However, an increase in income will not help much if you do not prudently manage your expenses.
Next step is to analyze your incomes and expenses by tracking them for a period of one month. If you thrive on detail, record all your expenses without exception. If you do not enjoy details, track and record your income, giving, savings, debt repayment and taxes. The balance of your income is what finances your lifestyle. Identify where you can make adjustments to free some cash. Current circumstances resulting from the pandemic can help you see how your lifestyle can be in lean times and help you in establishing an appropriate lifestyle.
To illustrate how to create a surplus, let me share some few adjustments I made resulting to huge savings:
- Buying in bulk and where possible from wholesale shops
- Making scheduled visits to the supermarket and shopping with a list
- Dinning in
- Making payments on time, avoiding penalties
- Avoiding being wasteful – just buying what I need (this includes clothes shopping: identifying what I need, saving up and shopping once or few times in a year)
- Saving up and buying cash
It is important to note that as your income grows you will enjoy your finances more and plan for fun activities such as dining out.
Finally, save the surplus. Do not fall into the trap of making a saving and failing to save. Once you create a surplus, put it in an appropriate savings product such as a money market account then subsequently in a specific investment to cover a specific goal. Wise management of savings and investments is crucial to ensure you meet your needs when they do arise.
For some, the challenge is how much to save.
The answer to this question depends on a variety of factors and your specific circumstances such as:
- Life stage: A single person in their late 20’s, a married person in their late 40’s supporting two generation and a 65 year old retiree who has met most of their long term goals will need to save different amounts from their income.
- Personal goals. Goals differ in terms of numbers and financial value
- Investment opportunities: Invest your savings so they can grow over time, reducing the actual amount you need to save from your income to meet a financial need.
- Income level. Savings should be proportionate to one’s income allowing you to meet other needs.
As a guide, I apply the ‘Joseph Principle’, which implies living on 80% of income and saving the remaining 20%. My first 10% goes into short-term investments to cover emergencies and short-term needs such as school fees and irregular expenses while the remaining 10% goes into long-term investments to cover long-term goals such as retirement, children’s higher education costs, owning a home and starting a business.
The bible story of Joseph in Genesis chapters 37, 39 to 47 illustrates this principle and gives practical ideas on how to implement it.
- Genesis 47:23-24 (ESV) Then Joseph said to the people, “Behold, I have this day bought you and your land for Pharaoh. Now here is seed for you, and you shall sow the land. And at the harvests you shall give a fifth to Pharaoh, and four fifths shall be your own, as seed for the field and as food for yourselves and your households, and as food for your little ones.”
- Proverbs 2:6 (CEV) All wisdom comes from the Lord, and so do common sense and understanding.
In our next issue, we will address the second principle of creating a margin or liquidity.