Lifestyle Design

Measuring The Health of Your Spending

/ Patrick Facey / Leave a comment

The old saying, “what matters is what’s measured”, is certainly a truism in personal finance. In order to improve on your circumstances, you have to objectively analyze what is going on so that the problems areas can be identified. The most common use-case for this rationale is a budget. I have mixed feelings on when and why a budget should be used. On the one hand, everyone needs to itemize all expenses at least once to fully see where exactly money goes. That can be a very sobering experience. On the other hand, it can be a bit tedious and unnecessary to concern yourself with where every dollar is going. Spending freely on reasonable purchases is a liberating feeling that should be enjoyed if you are still saving and progressing towards your goals. However, if you are a chronic over spender, this may not be the best mindset to embrace.

A more straightforward and quick way to examine your financial health is to use financial ratios. Ratios are an effective method in comparing your financial habits against a pre-determined benchmark in order to target any potentially category of your finances that may contain an overextension of money. There are numerous different ratios out there, but here I have chosen to highlight those that cover some of the most important areas of your finances.

Savings Ratio= Savings/Net income; .20 minimum

If you care about improving your personal financial situation, your savings rate is the most important ratio nail down. No matter what type of financial goal you have, you will have to be able to save money in order to reach it. Therefore you simply must know the amount of income that is left over after paying taxes and living expenses.  Saving 5-10% of net income is certainly better than nothing, and can be a good start, however we should all really be striving to hit at least a 20% savings rate. Contributing at least 5% into the TSP is mandatory, so working towards stashing away an additional 15% should be a primary goal, bringing your total AFTER tax saving ratio to 20%.

Housing Expense Ratio= Housing Expenses/Net income; .30 maximum

Housing is the number one largest expense for most. Whether renting or paying a mortgage, the cost of a place to live is the usually the most expensive line item in all of our budgets. The good news is that because this expense is disproportionately large to the rest of our budget, it also provides the biggest opportunity to free up cash. The housing expenses ratio takes the monthly total of all housing related expenses and divides it by monthly net income. Housing expenses not only include the amount of rent or mortgage, but also utilities, property taxes and home insurance, as these are all part of the living situation. We should aim to spend no more than 30% of net income on a place to live, which would equal a ratio of .30 here.

Liquidity Ratio= Liquid Assets/Monthly Expenses; 3-6 minimum

You simply can’t get ahead when minor setbacks easily knock you down. That’s why establishing an emergency fund is one of the first orders of business in building financial stability.  Having a readily accessible stash of cash is necessary for dealing with the inevitable ebbs and flows of life. The liquidity ratio serves to show how long your current lifestyle could be sustained solely off of your liquid savings (meaning investments do not count). The resulting number from the ratio is in months, so 3-6 is a solid target to shoot for. In the event of something like a job loss or any unexpected expense, this provides an adequate financial cushion to help absorb the impact, without having to immediately scramble over the bills.

 

Credit Utilization Ratio= Credit Amount Currently In Use/Total Credit Amount; .30 Maximum

Good credit can be a useful financial tool to have. It helps you obtain the best financing arrangements when needed, and provides an additional source of funds to be used strategically. This matters most on large purchases, like a house or a car. Credit utilization is simply the amount of credit that you are currently using out of the total amount of credit that you’ve been given. Scoring agencies like FICO typically consider you responsible in this category if you are using less than 30% of the total credit that you’ve been extended, so your score will reflect positively in that range. The lesson in responsible credit utilization applies to all areas of personal finance. Buying a fraction of what you can actually afford is typically a smart move. The smaller the loan, the less the interest that will paid over its life. Applying this approach to the largest purchases, such as houses, cars and education, can yield nice savings over the years.

 

Vehicle Expense Ratio= Vehicle Expenses (purchase price of car + .6 *( annual miles))/Net Income; .20 Maximum

After housing, vehicle costs are next on the list of the three largest recurring expenses for individuals. Minimizing how much you spend on a car and how much it is driven is crucial to your finances. The vehicle expense ratio accounts for exactly these two costs: how much is spent on the purchase of a vehicle, as well as the average cost per mile driven. The cost per mile is derived from an average provided by AAA that takes into account depreciation, insurance, gas and maintenance. Ideally, we would want this ratio number between .15 and .20. To achieve this, you will likely need to adhere to the cardinal financial rules of vehicle ownership. To sum up these rules: spend no more than 1/8th of your net income on vehicles and live within a 10 mile roundtrip commute of work. As long as you aren’t racking up hundreds of miles on weekends, these two points will drive your vehicle expenses way down.

Financial ratios exist to serve as a reasonable guideline in evaluating the condition of our financial standing. They should not be treated as steadfast rules, but should certainly be given reasonable consideration. If you find yourself outside of any of the recommended ranges, simply consider bringing some attention to that area of your finances. Spending more in a certain area of life that brings more value to you is perfectly fine. Just understand that it may be taking away from other financial opportunities, such as retirement. Being genuinely content with those types of tradeoffs is a big part of feeling successful with managing your money.

Fundamental Stages of Building Wealth

/ Patrick Facey / Leave a comment

Unlike making the Forbes rich list, building a comfortable level of wealth into one’s life can be accomplished in a fairly systematic manner. The attainment of financial stability is a precursor to financial security, which can then pave the way for the common end goal for most, complete financial independence–meaning that all of your income is being derived from investments or other sources that don’t require your active effort. This is what ultimately needs to be accomplished for retirement. By progressively achieving certain financial milestones, the foundation can be laid for a secure financial future.

  1. Avoid Bad Debt: From day one, avoiding any and all debt should be a priority. For most, debt won’t be entirely avoidable in the early stages of life. If and when debts have been incurred, extinguishing them needs to become an urgent priority. You simply cannot afford the headwinds of paying interest to others while trying to secure your own financial footing. One important distinction to be made is between good and bad debt. Consumer debt (credit cards/ auto loan) is the clear bad, and should be avoided at all costs. Investment debt (school loans/mortgages) can be considered good debt. I emphasize “can” because it completely depends on the terms upon which this debt was obtained. Egregious amounts and/or unfavorable terms can easily sour these “investment” loans. If any bad debt has managed to nestle itself into your financial house, it’s imperative to banish it ASAP. Getting your future self ahead financially is unnecessarily difficult when you’re still stuck paying for the consumption of your past.
  2. Acquire Knowledge/Skills/Experience: In our early, lower earning years, we might not be saving much and perhaps even going into debt to stay afloat and progress forward. Since younger people simply haven’t had the time to build the skills and experience, it’s common to earn less the younger you are in life or a career. Skills, knowledge and experience are the three things that really fuel our earning potential going forward through life. The downsides of making a low income or even going into debt are lessened IF they are being leveraged into a much more valuable long term outcome. The best part about not having had the time to gain experience is that you likely have a lot of time to gain experience. It’s not so much where you are, but where you are going that ultimately matters.
  3. Develop a Savings Habit: Developing the habit of spending less than you earn is the fuel that pushes you forward on your wealth building journey. Just as eating fewer calories than you burn each day snowballs over time into a healthy body weight, spending a little less than you earn eventually builds into a meaningful sum. It doesn’t matter if you’re only saving 5% of your paycheck at first, saving anything will get you into the positive habit that pays off handsomely over time. The more you save, the harder you push on the accelerator towards financial independence. Once you have saved 3-6 months of your living expenses, you will feel more financial secure knowing that life’s inevitable curve balls will no longer immediately derail you. This relieves a great deal of stress and opens up mental capacity for the next stages, thinking about investments and creating your vision. It’s also important to acknowledge and deal with the forces that will work against our saving efforts as we grow and progress through life. Typically, the more we earn, the more we are tempted to spend. Developing the discipline to safeguard you from this destructive lifestyle inflation is an invaluable trait to possess while building wealth through life.
  4. Think About Investments: The word “investment” should be used loosely here. Investments can be thought of as anything that requires an outlay of resources to produce a more valuable outcome than would have otherwise been attained. Often times, we’re quick to associate the thought of investments with the stock market or real estate. Those assets certainly have their place in a portfolio, but they should by no means be the default for your investment dollars. Some investments that might have a much greater return are: a professional education, a family vacation, time off work, a backyard remodel, a home gym, a side business, or debt repayment. Once a decent emergency fund has been established and the savings habit is firmly in place, it’s time to start thinking about investing. As the CEO of your life, it’s your job to determine where money should be allocated in order to derive the maximum benefit to your personal situation.
  5. Create a Vision: Money is a means to an end–its only value lies in its ability to purchase the outcomes in life that you desire. Once you have enough savings in the bank, and you are making investments to improve the quality of your life, the bigger picture should be more seriously considered. This doesn’t mean that you should expect to have your whole life mapped out. Life is fluid and unpredictable, and the dots rarely connect going forward. Creating a vision is simply thinking about the possible additions (or subtractions) to your life that would collectively create your most ideal state of living. When you begin to realize your desired life through a conscious effort with money, you will begin to experience true wealth.

Progressing through each of these stages of building wealth will put you on a solid track to becoming financially secure, while also setting up the lifestyle that you desire. The best part is the positive compounding effects that these create in your life. The longer the time frame that you can persist in their application, the more powerful the wealth generation in your life will become.

 

 

 

Make More Money by Increasing Your Value

/ Patrick Facey / Leave a comment

When it comes to building wealth, a lot of focus is placed on the saving and investing side of the equation. Seeing as how investing is arguably the most attractive aspect of personal finance, it makes sense. However, this results in a disproportionate amount of attention being directed towards the accumulation rather than generation of money. At the end of the day, the money available to be saved and subsequently invested depends on two factors: the amount of money coming in and the amount of money going out. It all begins at the top, with how much is coming in. So naturally, increasing that amount will have a trickledown effect on the rest of our finances.

Most people would like to earn more money. It’s an understandable desire, as more money generally equates to more options in life. In an employment scenario such as a federal career, this is generally accomplished by increasing value which leads to promotions over time. Value, in the context of the workplace, is an overarching concept that is comprised of many facets. We can, and should continually strive to increase our value by working on its driving factors.

  • Increase Knowledge: There may be no cliché more universally true than “Knowledge is power”. Knowledge is what ultimately shapes our ability to problem solve, critically think and work effectively. It also broadens our perspectives and shapes our worldview—two things that help us find meaning and happiness, in and outside of work. Through formal study and self-study, we can effectively build the knowledge base that will propel us forward in our careers. In many career fields, college degrees are now simply the cost of admission. Seeking out professional certifications and designations in your career field not only gives you the few extra letters after your name, but should also provide the specialized knowledge that is required to become an outlier in your field. If it doesn’t, you shouldn’t be investing time and money into it. For most of us, it’s difficult to find the time and mental energy for self-study on top of the life’s other demands. It is crucial, nevertheless. One efficient way to implement this into a busy life is through the use of audiobooks. Audiobooks are particularly useful for commutes and can provide a lot of value.  
  • Manage Time: Time management is the crux of accomplishing anything in a day, week, month, year and ultimately, a lifetime. Effectively managing time isn’t so much about planning every minute of life as it is about understanding how your tasks adhere to your personal energy cycles. Everyone functions optimally at different times of the day, and even at different times of the year. It’s useful to learn your energy, and schedule your tasks (and relaxation) accordingly. It’s impossible to operate at max capacity all day every day. Productivity will plateau, and burnout will quickly ensue. It actually may lead to less effectiveness over time. On that note, constantly switching attention between tasks and checking your phone all day is also ineffective. Focus is everything, and it’s becoming increasingly difficult to harness in this age of endless distraction. The practice of focusing on one thing at a time will certainly give you an edge in getting things done. Planning what and when we are going to work on something is key to dialing in and making meaningful accomplishments.   
  • Practice Entrepreneurship: You don’t have to start a business to practice entrepreneurship. And we should all be practicing entrepreneurship on some level. Employees may operate in a completely different work and incentive structure than entrepreneurs, but they can benefit greatly by applying some of the more entrepreneurial practices. Employees are like entrepreneurs, just on a less consequential playing field. An employee has certain tasks and functional areas that they are responsible for executing, a kind of mini business that they are in charge of. If they fail to do so effectively, they risk losing promotion opportunities, a demotion or maybe even losing their job. The natural progression through the ranks of a system, such as a federal career field, is to gradually become responsible for greater tasks and larger functional areas. Typically, the more breadth or depth of responsibility equates to a higher position. Learning to view your current tasks and responsibilities as your own “business” that you are in charge of running successfully helps in producing great work. Business owners also usually look to expand their operation over time. An employee may do so by exposing themselves to new learning opportunities after mastering their current responsibilities.
  • Take Initiative: The stagnation of most careers comes down to one central theme—complacency. Matter of fact, most issues in life arise out of complacency. Be it a career, relationship, health or what have you, when we stop putting the effort forward is when things begin to decline. If we are to make progress and feel fulfilled, we have to continuously fight mediocrity. It’s not enough to do the bare minimum, we need to always push ourselves into new limits in order to grow. Simply put: if you’re not growing, you’re decaying. More often than not, others don’t have the time or inclination to hold our hands and guide us towards progression that we desire. They’re busy with their own life. It’s up to the individual to take initiative and actively pursue the path forward.  
  • Gain Experience: Learning plays an important role in bettering our abilities, but it has its limits. Eventually, we must be able to apply the knowledge in practice for it to be of any use. Gaining real life experience is ultimately what matters most in any field. Reading every book on building a house won’t make you a better house builder than the guy who has successfully built 100 houses. Putting ourselves out there to experience trial and error in real time exposes us to the best learning opportunities. It equips us with the necessary practical experience to become a master of the craft.  
  • Update Resume: Resumes are an often overlooked and undervalued aspect of our financial lives. Being able to market yourself in a clear and concise manner is what ties opportunities together. Nothing is more concise than the resume. Everything that you know, have done and are capable of doing has to be effectively synthesized into a couple of pages. Unless the hiring manager knows you personally, this is often the ticket towards receiving any kind of consideration for a position. It’s likely what will land you the interview, only at which point you can (and should) elaborate more effectively on your abilities.

Money is the byproduct of value. In federal employment you will receive small “step” increases based on time, but it’s not reasonable to expect substantial increases in pay just because you’ve been doing something for a long period of time. If we desire to meaningfully increase our income, it is only logical to increase the value that we provide. The more value that we can create for others, the more we will be compensated. Increasing your value can be accomplished by building knowledge and sharpening skills, but also through managing time and organization. Taking the initiative to gain experience and pursue opportunity is the driving force behind achieving a satisfying position–in both a career and life.  

The Only Relevance of a Budget

/ Patrick Facey / 1 Comment

We hear it time and time again–if you want to get ahead on your finances, you need a budget, and you need to stick to it. While modern technology has made it much easier to plan and track spending, worrying about our budget every month can start to feel like the dollars run our lives. Knowing where our money is going is important. It’s simply impossible to know if we’re making progress towards our goals without that knowledge. However, it’s not so much the amount being spent that matters, but whether or not the spending is bringing value to our lives.

Track Spending
There are a number of apps these days that can seamlessly accomplish this task. You simply link your bank and/or credit card accounts, and the software collects the information for you. Or, simply busting out the old Excel spreadsheet and manually entering what we’re spending money on each month works as well. Regardless of the method, this is a task that anyone seeking control of their finances should engage in. Knowing where your money is going is the first step towards taking the reins of your financial future. Not only does it give you a bird’s eye view of how cash is flowing in and out of your life, it provides insight on how much of your paycheck is reasonably available after expenses to fund any goals.

Then, Evaluate Spending
The most useful part of tracking spending, is having the ability to then analyze it. This is where having a “budget” really makes a difference. When we look at spending under the microscope, we get to determine if we like what we see. More often than not, we’ll find at least one area of spending in the beginning that gives us a little shock. Eating out and entertainment are common culprits. But maybe it’s something more rudimentary, like the cost of car ownership. It’s easy to forget that commuting to work comes not only with the cost of gas, but also car payments, insurance, maintenance and depreciation–not to mention the time it involves. However, maybe you enjoy the alone time on the commute, enjoy driving, or like using the time to listen to audiobooks. I personally enjoy nice beers more than some might consider economically justified. But I also feel that consuming them brings me a level of enjoyment that exceeds what saving the money instead would provide. Whatever the case may be, it’s important to ask yourself if each purchase brings an equal value to your life. This is the surefire way to use a budget to begin weeding out the expenses in your life that don’t bring enjoyment, and instead diverting those funds toward building the life you desire.   

The true value of having a budget is not in controlling how much you spend, but in how you spend.

Having a budget to simply constrain yourself, in turn feeling guilty about spending, undermines its purpose: becoming empowered by having control over your money. If spending extra–reasonably and within your income of course–on the lifestyle you genuinely want  boosts your quality of life, it may simply be worth it. The maximum enjoyment of life isn’t promised to those squirreling away every last dollar. At the end of the day, money exists to be spent. It’s up to each of us to figure out how it is best spent.