The theme of the list? These changes are simple, easy to execute, and most importantly, they actually work! Without further ado:
1. START OR REPLENISH AN EMERGENCY ACCOUNT
Maybe you’ve already done this. If so, great, you’re on your way. But the biggest risk I see to cash flows and household budgeting is the absence of an emergency account. If you only have your checking and investment accounts, it’s only a matter of time before something will pop up. Here’s how it plays out: something crazy happens, and you will not have the cash in your checking account to cover it. You will be forced to liquidate your investments. Investing by definition implies a long time-frame. If you are selling things with no notice, that means you didn’t plan for it, and couldn’t possibly have aligned your investments accordingly.
Emergency accounts should sum to at least 6 months of your monthly expenses when one spouse is the main earner. If both spouses work, more like 3 months can work.
2. HAVE A ‘ONE-TIME’ EXPENSE ACCOUNT IN YOUR BUDGET
This is the second derivative of the emergency account. Emergency accounts should be for real emergencies, things that are unpredictable, scary, and can devastate a family’s finances. Think job loss, health loss, death of a family member, etc.
The ‘one-time’ account involves somewhat predictable expenses, but they don’t happen every month. A few great examples: car repairs or insurance premiums. You’re going to use a chunk of money for that nearly every year, but I find people don’t think about these items until the bill arrives. And just like an emergency situation, you won’t have the cash sitting around the checking account to handle it.
Properly planning a ‘one-time’ account basically means sitting down and figuring the one-time line items in your life. Start with insurance premiums, but think about gifts, travel, car service, etc. You’ll quickly come up with a list and tentative amounts, and the total can then be broken down into 12 monthly chunks. That’s how much you need to save monthly to fill the ‘one-time’ account. When your paycheck comes, your one-time account should receive a piece of it.
This is a very basic, simple investing rule. The average investor has a bunch of investments, usually mutual funds, usually in their 401k. But what doesn’t happen enough is to rebalance them amongst each other. The simplest explanation of rebalancing: Sell your winners, buy your losers.
People tend to avoid this step because of pure emotion; Why would I want to sell my winners!?!? But time and time again, history tells us that things that go up don’t go up forever (see: real estate, 2007) and tend to revert to the mean. Yet it’s so hard to sell them! This is the biggest step for an amateur investor: overcoming your emotion and making a commitment to a systemic method to what you buy and sell.
4. GET CHEAPER
The ultimate KISS rule. Look at everything in your life. Can you enjoy that same thing, but do it cheaper? Your investments matter here too; can you get a similar return through a cheaper device?
Also in this category? Insurance premiums, cell phone contracts, cable/internet bills, etc. Sometimes just asking for cheaper will get you cheaper. If you don’t ask and investigate, I promise they won’t offer!
5. TAKE THE 1% CHALLENGE
I started this challenge years ago when I would speak to employees about their 401k plan. I’ve never found a simpler way to increase your savings over time, and anecdotally I can tell you it works. Many people have contacted me later and said they succeeded using this simple challenge.
How’s it work? Look at your savings rate for last year. For most people this is their 401k rate, but can apply to all savings. Now figure out your savings as a percentage of your pay. Increase it by 1%. Now go live.
What you’ll notice immediately? Your life is the same. You aren’t changing lifestyles, you aren’t skipping meals. But you’re saving more. Do this for a quarter, and reassess. Ask yourself honestly, has my life changed? Am I not having fun because of this saving plan? I promise, the answer will be no. If you can do it for a quarter, then try to increase it again for another quarter. Maybe you’ll feel it, maybe you won’t, but imagine the difference to your bottom line by the end of the year!
That’s it! 5 Simple Ways. If you can execute these, you’re on your way to a tremendous amount of financial freedom.
Happy New Year!!!