Becoming financially well-organised
Being organised implies ‘an element of thinking ahead, of prudence, of not always acting on impulse’*.
Alternatively, we can ‘live passionately, devoted to impulse, feeling, intensity, beauty
and delight free from the prison of everyday pre-occupations’*.
* Bertrand Russell, A History of Western Philosophy
Living at either extreme is dangerous. Realistically, finding a balance
between passion and prudence leads to a healthier, more fulfilled life
Financial organisation is an important route to achieving this balance
as well as the balance between the present and the future, the short term and long view,
impulse and forethought, living in the moment and taking responsibility for the longer term.
Start by watching my introductory video below (click on the bar under the video to read the full text).
Then spend some time on self reflection and further reading.
Let it go
Hello, its Jeremy here and its a privilege to be introducing this month’s topic which is about becoming financially well organised.
I know already I am talking to two constituencies on this subject. Some of you will be saying to yourself, financial organisation just what I want, lets get stuck in.
Some of you on the other hand may be somewhat less enthusiastic, concerned about the time it will take, the restrictions it will impose and the freedoms it will curtail.
Prudence and forethought
In my humble opinion this is something we need to address from the outset. Being organised implies an element of thinking ahead, of prudence, of not always acting on impulse.
In philosophical terms, this matters. Bertrand Russell points out in his History of Western Philosophy that the civilised man is distinguished from the savage mainly by prudence, or, to use a slightly wider term, forethought.
Russell describes the civilised individual as one who is willing to endure present pains for the sake of future pleasures and increasingly sacrifices his present for the future. Psychologists call this deferred gratification and see its acknowledgement as a defining step in the journey from infancy to maturity.
However, prudence and forethought can be taken too far and Russell cites miserliness as an example of prudence overreached. And indeed for many of us a more Bacchic way of life, one devoted to impulse, feeling, intensity, beauty and delight free from the prison of everyday pre-occupations, will be preferable.
So here we reach the philosophical heart of the matter. Both prudence and impulse in excess can be destabilising, even dangerous. A highly organised life will probably be unadventurous and unexciting. It will be a life in which we are confined in our box, protected by our own rules, unable to innovate, change or appreciate life’s wonders.
Conversely a life lived purely for passion is likely to be centred in the present, in our selves, and will be so impulsive we will be unable to consider or plan for the future. And when the future comes, and we are unprepared for it, we will find ourselves in deep waters.
Balancing prudence and passion
Russell concludes his analysis by saying that prudence versus passion is a conflict that runs throughout history. It is not a conflict in which we ought to side wholly with either party.
And so the start point for financial organisation is to decide where on the spectrum between prudence and passion you want to be, and to appreciate the implications of your position.
From my point of view, as a coach and financial planner, I try to aim for some sort of balance, a position that allows us to live passionately and impulsively today whilst being sufficiently well enough organised to prepare for the future and the shocks and upsets that will come our way.
Financial organisation defined
This allows me to define financial organisation. Financial organisation is having the right money in the right place at the right time to live wholehearted, fulfilled and passionate lives today without compromising our long term wealth, health and happiness.
One thing you need to realise from the outset is that this is not about financial products; rather its about building a framework on which to hang appropriate financial products, much as the steel and concrete of a skyscraper is what keeps it standing. The outer cladding can be adapted to suit ones taste.
And to be fair, it is a tall order and one that evidently concerned many of my clients when they first met me. Here are a few of their quotes from those initial meetings:
- We work hard and never seem to have anything to show for it
- We are asset rich and have no cash for daily living
- We are terrified of making a wrong decision
- We have no savings, reserves or pensions; we are one pay check away from disaster
- We lack financial discipline and literacy
In these quotes we see a lack of financial organisation and the conflict and imbalance between prudence and passion.
The benefits of financial organisation
So, what do we gain from being financially well organised? Well, here are some thoughts:
- Financial organisation is one of the best ways to balance the present and the future, passion and prudence, the short term and the long term, impulse and forethought, living in the moment because we don’t know whats going to happen to us tomorrow, and taking responsibility for the longer term because many tomorrows probably remain for usIt enables us to achieve our short and long term goals, passions and lifestyle
- It involves setting boundaries, such as in spending; within these boundaries we can live our lives of freedom, passion
- It will deliver long term security
- It ensures we are well positioned to deal with shocks and upsetsIt provides peace of mind
- It brings a sense of reality to our lives and money
- It provides a practical framework for running day to day household finances
So how do you become financially well organised.
How to become financially well organised
First, your financial organisation needs to be expenditure led, not income lead. Rather than looking at your income and saying I’ll spend what I have got, or a bit more, or a bit less, start with deciding what you want to spend, based on the lifestyle you want to lead, then working out how to achieve the income you need to support that expenditure
Next, start to save right from day one. Savings combined with compound returns and asset allocation are your drivers to financial freedom. If you have difficulty with this, reverse the psychology by looking at the amount you save as the income that, in the words of George Clayson (see below), author of The Richest Man in Babylon, is yours to keep and not to give to people who supply you with the goods and services you require for your lifestyle. Alternatively, call savings the purchase of shares in your spending plans, which makes it seem a little more exciting
Build up reserves for contingencies and to smooth out erratic cash flow. Reserves are also armour for your personal integrity as its easier to walk away from a situation where your integrity is under pressure if you know you have reserves of cash and savings to cover your expenditure for the next six months.
I learnt this lesson the hard way when I joined a company whose culture and practices I hated. However, I remained trapped in the business for far to long as I was reliant on the income, something that made me feel ill.
Match assets and liabilities. So, if you have to make a mortgage interest payment next week, have cash in the bank to make the payment. However, if you have to repay the mortgage capital in twenty five years time then you can hold assets in higher risk, longer term investments.
Keep debt levels realistic and in check and once again match to assets. So if you need to borrow money to buy a car, use a borrowing package that ensures the amount of borrowing matches the declining value of the car. In other words, don’t buy a car on a credit card which is expensive and should be repaid quickly. And don’t take out a twenty year second mortgage to buy a car which will be valueless in just five years.
Record, document and analyse your finances. Know how much you are spending and on what, check your net worth at least annually and compare it to previous years. Calculate your personal key financial ratios and ask yourself if you are comfortable with the results.
Life is risky and you should insure against some of those risks. However, it may be more efficient and cheaper to self-insure some of those risks, for instance by building savings against a temporary and unexpected drop in income.
We’ll come back to many of these principles again and look at them in more detail and you will find more to help you on the rest of this page.
Let me wind up by reminding you that becoming financially well organised does require work and time. Look on this as an investment, because the return will be a more fulfilled life and your world kept in balance.
That’s it, and thank you
The Richest Man in Babylon
George Clason (1926)
I class this as required reading in the field of financial organisation.
Clason tells stories about money using fictional figures from ancient Mesopotamia. His thesis is simply that the route to wealth is through saving. However, he turns the normal mantras around to describe savings as the piece of our income that is our own to keep, the rest being forfeit to others so we can live.
Clason sets out seven ‘cures’ for a lean purse and tells other parables that illustrate how to be wise with money.
Favourite quote: ‘A part of all you earn is yours to keep.’
Recording, documenting and analysing your money
Here are some ideas on how to do this
Your financial balance sheet
Draw up and review your financial balance sheet at least annually. It’ll save time in the long run to set up spreadsheet although a paper version is perfectly satisfactory.
There should be four sections:
- Liquid assets, mainly current and savings accounts, that can be realised into hard cash in your hand in less than a week
- Readily realisable assets such as investments, bonds, stocks and shares and investment properties that may take a week or more to liquidate (and certainly less than a month). Whilst many investments are, in theory, easy to liquidate at a moment’s notice, remember they could, without warning, suffer from significant falls to below their purchase value or be subject to significant taxation on liquidation. Some investments are liable to have restrictions imposed on their liquidation by their managers
- Used and illiquid assets such as your principle private residence, investment properties, smaller company and crowdfunding investments, pension funds, vehicles and other ‘stuff’.
- Liabilities, which may be short, medium or long term.
Add up the first three to give your total worth. Subtract liabilities to get you net worth.
Your income and expenditure
In the same way as your balance sheet, build a statement of your income and expenditure.
For income, always use grows (pre-tax) income. Taxation becomes a (controllable) expenditure.
The difference between income and expenditure is your cash flow, which may be negative or positive.
A useful cross-check is to compare the two statements. If your cash flow appears positive whilst your balance sheet is weak you may well be underestimating your expenditure (and vice versa).
Expenditure is the most difficult part of this project, partly because its time consuming, partly because we don’t usually keep good records and also because it holds up a mirror to our lives which can be quite dispiriting. To help you with expenditure here is a list of expenditure categories you should probably build in to your statement. Note the order and draw your conclusions!
- Annual savings (view as the purchase of investments)
- Debt repayment (capital and interest)
- Donations to charities (and other causes that are important)
- Travel and personal development (the two are not dissimilar, especially travel with a purpose)
- Sport, leisure and hobbies (have some fun)
- Daily living (mainly food and drink)
- Family and friends (including hospitality, dining out and gifts
- Annual house costs (how much does it cost to heat, light, maintain and secure your house?)
- Household expenses (cleaning, repairs, renewals, etc)
- Health and personal care (prescriptions, opticians, dentists, hairdressers, therapists etc)
- Childrens’ expenses (you may want to give this a higher priority, especially for younger kids)
- Personal expenses (miscellaneous bits and pieces)
- Professional fees
- Investment property costs (if applicable)
Your key financial ratios
You have collected a considerable amount of data about your finances. However, raw data does not tell us much. There is value in analysing the data and developing key personal financial ratios.
Here are a few. Whilst we don’t make recommendations as to the optimal ratio, you can look at your situation and decide, from your own attitude to life and risk, if each ratio is too high or low, and decide what action to take.
|Liquidity||Cash to monthly expenditure, measured in months||________ months||________ months|
|Savings ratio||Percentage of household income saved||________ %||________ %|
|Savings to income||Savings as a proportion of income (should increase throughout your working life)||________ x||________ x|
|Debt to income||Size of your debt relative to your income (should fall throughout your working life)||________ x||________ x|
|Debt to total assets||Liabilities relative to total assets||________ x||________ x|
|Debt to liquid assets||Liabilities relative to liquid assets||________ x||________ x|
|Debt servicing costs||Debt servicing costs relative to net income||________ x||________ x|
|Debt servicing reserve||Debt servicing costs covered by liquid assets, measured in months||________ months||________ months|