How would you react if you are told that you will go on a tight health plan that builds in one hour of tough physical exercise every day and cuts out most of the things you love to eat and drink? You may do it if you were facing a health crisis and this was the doctor’s order. You may begin doing it if motivated enough. But most people won’t stick to it unless, literally, their life depends on it. Managing money is very similar—you plan to do it, but sometime in the future and when they do begin, they begin with many large goals that mean fairly drastic changes in their current way of living. But this soon fizzles out, leaving them with not more money but a mild sense of guilt. Just the way it takes a health crisis like a heart attack or diabetes to shock a person into initiating and staying with a diet and physical activity plan, it takes a life crisis, like a job loss, the death of the main breadwinner or a large loss in business to get a family to begin and stay with financial fitness.
It takes a crisis for us to get serious. But is there anyway we can begin on the road of better financial health without hanging over the cliff? I find that a baby steps method has a much higher chance of success than a let’s-do-everything approach. We tend to get intimidated when we take decisions that force us to commit money to risk, and if that money is in a risk-bearing product that is long term, the decision gets so much tougher. What seems to work with most people are baby steps that do not involve taking investing decisions at the beginning of the financial fitness programme. Let’s leave investing for the last part of this process that may come even a year later. Remember that it is a marathon of 30-40 years that you are starting to run and not a 100-metre dash.
The first baby step would be to get your cash flows in order. Why do we want to do this first? Because it does not involve buying a new product where advice may be conflicted and because a clean cash flow system helps you set the stage for more complicated steps (still baby ones) further ahead. I like to use three bank accounts to do this. One account is the “money-in” or inflow (or salary) account—all money inflows drop into this account. Salary, bonus, rent, interest, profits, fees—whatever it is that you derive your income from collects into this account. If it is a double income household, keep the salary accounts separate into His and Hers. Make it a joint account, of course, but only one person operates the salary account. Now from this account, at the beginning of the month, transfer money to the account we’ll call the “spend-it” account. A couple can both make transfers so that the living costs are shared (always a good idea to do this or women end up spending on the house and men build assets—becomes a problem if the marriage breaks). Everybody has a rough idea how much they spend each month. Take that amount, add another 10% for extras for the first few months and begin crediting the spend-it account at the top of the month. Whatever is left in the money-in account, transfer to the third account that I call the “invest-it” account. This is the money that is freed up for turning savings into investments. At this stage, even if it sits in a money-losing 4% savings deposit for six months, it is worth doing, just so that you get a sense of how much saving is freed up for investing each month without a problem.
So by the 10th of the month, your money-in account should show zero (salary accounts are usually zero balance accounts, so that should not be a problem). If you already have investments or premiums that are in place, choose the invest-it account from which to make those payments. Use only the money in the spend-it account to pay bills, withdraw cash and pay credit card bills. In six months you should have a very good idea of what you are spending each month and what you are able to save without too much effort as balances begin to build up in the invest-it account. The household that has multiple access points to the bank accounts (husband, wife, parents, children) must all buy into and work with these mental buckets or this small baby step will not work. Most people, at the end of six months, feel much stronger financially that they did at the beginning of the period and all that you did was streamline your bank accounts! The next baby step would be around getting your insurance plans in place, but let’s do that after sometime. Meanwhile, get your cash flows in order.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at firstname.lastname@example.org