Master Your Cash Flow With This One Visual
We all know the saying “A picture is worth a thousand words”.
If you would create a picture of your annual cash flow, what thousand words would it illustrate? What story would it tell? And most importantly, is it the story that you want to be told?
We all have core values. Principles that we live by. I think that’s a big reason why people are hesitant to talk about money. It has a way of exposing whether you’re living out your principles on an everyday basis. It can bring out feelings of embarrassment or shame. We attach our self-worth to our net worth.
But let me be clear: This is not about money.
Do you want to support non-profit charities, but find that your purple line is only a small sliver? Do you want to be a world traveler, but your debts are dominating your outflow?
This exercise is meant to get you thinking about your full financial picture, using the fictional couple Sonya & James. As you’ll see, there is a lot more to it than just what hits your checking account.
Income
The first step is to understand your expected annual income. For tech professionals, this is usually pretty straight-forward since most are salaried W2 employees. Start with your gross salary (not take-home). You know, the one in your offer letter or compensation statement. If you’re not sure what your annual gross salary is:
Grab your paystub
Find your “Gross Pay” number for that pay period
Multiply that by the number of pay periods you have. Hint: if you get paid every two weeks, that’s 26 pay periods.
For contractors, it gets a little fuzzier. Employment is more fluid, contracts can be cut short. On the other hand, some jobs may require working overtime… but hey, at least you’ll get paid for that! In any case, you can still take your gross hourly rate and multiply it out by the number of hours you expect to work. 2,000 hours is the average working year, accounting for taking two weeks of vacation.
Don’t forget about any bonuses or stock compensation
I know many people who somewhat purposefully don’t plan for bonuses so that when it arrives, then it feels like extra money that has no strings or job attached to it. You know, fun money!
You know who doesn’t ignore it? The IRS.
And it can have a huge impact on your tax burden and make you afraid to file your taxes. So while it spoils the surprise, plan for that bonus income.
With stock compensation, there are different flavors of stock compensation that tech employers award their employees. The most common would be Restricted Stock Units (RSUs), and can also include Incentive Stock Options (ISOs), Non-Qualified Stock Options (NQSOs, or non-quals for the cool kids), and Stock Appreciation Rights (SARs).
Without going into the gory details of each, it suffices to say that planning for stock compensation is vitally important. The tax implications are potentially huge, as are the upside benefits.
Other Income
Do you have rental income? Side hustle? Do you have investments in a taxable brokerage account that kick out dividends? Make sure that’s added in, too.
Charity
Charitable giving represents something that runs deep in defining what you stand for.
In Christianity, tithing is the act of giving 10% of your income and is often referred to as “first fruits”. In other words, it comes out off the top.
For those reasons, Charity deserves the top spot.
Efficient charitable giving strategies can save thousands in taxes and also mean more money going to your charity. A few of my favorites are:
“Stacking” multiple years + leveraging a donor-advised fund to increase itemized deductions
Donating appreciated stock to avoid capital gains and increase the level of donation.
Qualified charitable distributions to count towards your Required Minimum Distribution but not your taxable income
Taxes
I’m convinced that this is one of THE MOST IMPORTANT areas to focus on for effective financial planning. Lowering taxes is a concrete, quantifiable value. Paying less money in taxes means deploying more money towards what you really care about.
How much you pay in taxes is directly driven by the rest of this visual. Income, stock compensation, charity, and tax-advantaged saving all determine your resulting taxable income.
The IRS Tax Withholding Estimator is a great starting point to get an estimate of your annual tax obligation, as well as if you are withholding enough from your paycheck.
When making decisions on where you save your money such as Roth vs. Traditional 401k contributions, the key is to try to lower your lifetime taxes. This is what separates a financial planner from an accountant when it comes to tax planning (generally speaking… don’t come at me, CPAs). In addition to living in the past and present year, we look years and decades into the future. That may mean that you purposefully realize more income, contribute or convert money to Roth accounts, and actually RAISE your current year’s taxes.
Savings
Declaring What Is Important
Travel the world or buy a vacation cabin? Save for college or increase your retirement income?
Most everyone does not have enough income to fully fund everything that you could possibly want. If you do, congratulations! Let me redirect you to the Charity section…
The Savings section is where you answer these questions of priority. These conversations between partners are so meaningful, yet rarely happen. It can bring a couple together to a shared understanding and shared direction.
System Over Discipline
When I show a client their cash flow visual, they’re often taken back by how much they actually pay in taxes.
“What’s this FICA tax?!”
The answer is that it is money withheld from your paycheck by your employer to pay for the Social Security & Medicare programs. It’s common to see clients paying in excess of $20K toward it. BUT since you never see that money, you don’t feel the pain of paying it.
Apply that same principle to paying yourself first. Set up a system that moves your money into savings goals quickly enough that you aren’t tempted to spend it. The Money Guy Show refers to this tactic as forced scarcity.
Saving into a 401(k) and HSA is already set up this way since that is also done by your employer. But it’s up to you to execute your savings plan for college, IRAs, and other goals.
Mortgage (or Rent)
This portion is generally fixed. For homeowners, it includes principal, interest, and property taxes. For renters, it’s… well… rent.
The only thing to address here is whether the ratio of this expense is in line with your income or if it’s squeezing out too many other items (and you’re “house poor”).
Or if you are in the market to buy a new home, it can help gauge how much house you can afford (again, so you don’t become “house poor”).
Living Expenses
Here is where it gets down to human behavior. Gulp!
This encompasses all of your day-to-day items: Bills, subscriptions, groceries, restaurants, kids’ activities, gifts, fun money, and more kids’ activities.
Should You Follow a Budget?
Maybe… Probably… Sometimes absolutely.
It definitely aligns with the idea of living with intention. It’s assigning purpose to your money. We’ve been doing it on a larger scale this whole time.
A common misconception is that it’s very restrictive. But it can actually be a liberating experience. You can spend on that coffee without guilt because you have already allotted money to it.
You Need A Budget, or YNAB, is a platform that does very well with all things budget-related. Rather than me trying to parrot what they teach, go check them out. WARNING: You may find yourself joining the YNAB cult. It’s very active on both Reddit and Facebook Groups.
Reverse Budgeting
On the other hand, if you’re checking all of your savings boxes, maybe you don’t need to keep track of every last transaction. This is the idea behind Reverse Budgeting.
Creating this type of visualization at the beginning of your year tees up your Reverse Budget. Here, all you need to make sure is that your overall spending is not exceeding the amount that is in this one Living Expenses section.
Insurance
First, let’s define the primary role of insurance: Insurance is in place to protect you from catastrophic financial loss. Period.
Keeping that in mind, what types of insurance are truly necessary? That depends on what constitutes catastrophic loss in your world. Well, and sometimes it’s required.
Unfortunately, the insurance industry has caused insurance products to be over-sold due to the high commission reward (I’m looking at you, Variable Universal Life guy). That has left a bad taste in the mouths of many consumers. It doesn’t help that they often have “Financial Advisor” on their business card.
Nevertheless, risk management is a very important piece in the financial planning puzzle. Get properly insured.
Debt
It may show on the bottom in the visualization, but it is on the top of our minds.
Personal finance is so much more than a math problem, and that’s especially true when it comes to debt.
I won’t go into all of the nitty-gritty details around debt here. I did that in a podcast episode, hosted by fellow fee-only CERTIFIED FINANCIAL PLANNER™ Kyle Hill of Hill-Top Financial Planning.
Once you can get rid of all of your debt, you can begin to make incredible strides toward your other financial goals. With this level of intentionality and visualization, another side effect may be that you will never want to be in debt again. And that’s a good thing!
Cash Flow Planning In A Changing Environment
We now have a neat and tidy plan laid out in front of us, and all we have to do is execute… right? Right?!!
Sure, some of these numbers are more static and probably won’t move much. But it goes without saying that life is unpredictable (points to “all of 2020”).
Does that mean that you shouldn’t worry about understanding your current picture and where your dollars are going? Just go with the cash flow? See what I did there…
It’s a fine balance between rigidity & apathy. We live in the grey.
If you treat your plan and budget like an infallible document, then you are setting yourself up for failure & frustration. And possibly a fight with your partner.
If you never engage with your finances and assign jobs to your dollars, then it will slip through your fingers and you will be left wondering where all of your money (and more importantly, your time) went.
“Plans are worthless, but planning is everything” -Dwight D. Eisenhower
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