Are you getting to that point in your career where you're finally making real money? If so, it is a reason to celebrate! Whether from getting the job you went to school all those years for, working in a higher-paying position, or getting a significant annual bonus, having more income is an incredible feeling. And now you may be asking yourself, "What do I do with this extra money?"
Besides more income, what you've accomplished is finally putting yourself firmly on the next stage of your financial journey that could result in long-term wealth. Retiring early, taking a sabbatical, feeling secure in starting a family, accomplishing goals like buying a house, starting your own business, and going back to school for a graduate degree are now within reach. But how you handle the next stage of your increased income makes a big difference in how soon you achieve your pursuits.
It can be a lot to take in, but you can take some easy steps to keep more of the income you're earning, relieve your debt burden, and establish new assets so they may begin growing your wealth.
Know Your Self
Knowing your goals and values allows you to make the correct financial choices for your situation and makes it easier to say no to things that distract from your primary objectives. Take the time and reflect on what makes you tick. What are your three most important values? What habits do you have which may derail your plan? Anticipating what is essential to you helps you navigate changes in your life and enables you to draft a cash flow plan you are more likely to execute.
Maximize Your Employee Benefits
Your employee benefits are valuable if you use them thoughtfully. Your benefits may include more than employer-paid health insurance, paid time off, and a retirement plan. Your benefits may also include pre-tax contributions to flexible spending accounts for dependent care, a health saving account, employer-subsidized commuter expenses, health and wellness perks, student loan aid, and education assistance. Time spent reviewing your employee handbook and signing up for benefits can keep more money in your pocket and better manage your taxable income.
The most valuable benefit is typically an employer-sponsored retirement plan, such as a 401(k), 403(b), SEP IRA, or SIMPLE IRA. Contributions to traditional retirement plans provide tax benefits. Contributing the optimal amount to your retirement plan can have significant long-term benefits. Savers typically should contribute as much as possible to receive any employer match. Not taking advantage of this benefit is like leaving money on the table. Instead of getting a raise, it's like volunteering to take a pay cut. After receiving the employer match, you should consider providing additional savings to help you attain your retirement goal. A general rule of thumb is that 10-20% of your salary should be earmarked for your retirement savings.
You Need a Cash Flow Plan
The ability to make purchases and know you can cover them at the end of the month is a great feeling. But without proactive planning, such spending can quickly get out of control and undermine your long-term goals. If you're spending everything you earn and your checking account's balance is not growing – guess what? You're still living paycheck to paycheck; it's just that your income went up.
With increasing income often comes "lifestyle inflation." The temptation to increase your expenses along with a rising income is understandable. You should reward yourself, but excess spending can leave you in the same place. It can create a situation where you are not growing your wealth and working closer to attaining your pursuits.
You can avoid getting stuck by having a cash flow plan. Your cash flow is simply the money coming in and going out each month. But don't confuse your cash flow plan with your budget. Budgets are about controlling spending. Cash flow planning links your income to your goals. This process illuminates where you need to make changes. These changes can include limiting spending but may also minimize debt costs or increase investment risk. Cash flow planning helps with comprehensive planning across your entire financial picture.
Map out Your Net Income
Determine your after-tax income, and list your monthly net income across all sources, including salary and bonus, side gigs, etc.
Pay Yourself First
List out your savings. This list will typically include savings for:
Emergency fund
Major purchase (such as a home or car)
Retirement
Identify Your Expenses
Your expenses usually break down as follows:
Debt including credit cards, leases, student loans, and personal notes
Other taxes except for salary taxes, which already accounted for in your net income
Essential monthly expenses include rent, food, gas, cable, phone, etc.
Discretionary expenses such as dinners, trips, entertainment
Insurance costs such as homeowners, renters, health, umbrella liability, auto, disability
Get Your Net Cash Flow
Next, you take your income less your savings less your expenses, which tells you your net cash flow. Knowing this number helps you make proactive decisions about your finances. If you have a surplus, you can begin to negotiate with yourself if you want to save more or spend more. If you have a deficit, you will have to think through your priorities and either earn more, save or spend less.
By knowing where you're at, you can begin planning for what else is possible. This means identifying your other short-term and long-term goals not already accounted for in your cash flow projections. Maybe you begin to think you can save more for:
A vacation trip
A new car or other big purchase
Buying a home
Buying into a practice or starting a business
Creating a timeline for when you want to accomplish your goals and then tying it to your cash flow planning can help you identify areas where you want to make changes to hit your goals. It also enables you to understand if your goals are realistic.
More Cash Flow Than Goals?
I also often tell people that if they find they have excess cash flow and not an additional reason to preserve it, it never hurts to save. Setting aside money creates flexibility so that even if your goals change, you have cash available to make a shift and work toward your new pursuit. Having money buys you options. And options can be precious.
Monitor Your Cash Flow
Your goals will develop, and life will change, so it's essential to review and evaluate your cash flow plan to ensure it aligns with your changing situation.
Creating a Reserve Fund
Also known as an emergency fund, your cash reserve should consist of 3-6 months of your essential living expenses (or more if you have variable income). Having a cash reserve is a necessary piece of your financial foundation. It could help you avoid high-interest credit card debt if an unexpected expense arises. Typically it is best to keep your emergency fund in a high-yield savings account to earn slightly higher interest than it would at a traditional bank.
Getting Out from Under Debt
Debt can get expensive. And the fewer obligation you have, the higher your credit rating will be. This matters when you want to move forward with goals like buying a house, but even lease rates on cars or credit cards are sensitive to your credit rating.
How can you go about minimizing debt?
The refinancing decision is first up. If your credit score is good and your debt-to-income ratio is below 50%, you may want to explore options, such as a lower interest rate or a shorter loan term. If you are eligible for the federal student loan repayment program, you typically shouldn't refinance. If you refinance out of the federal student loan, this will result in a loss of many benefits.
Set up auto-pay. You'll often get a slight discount for using autopay, but mostly you don't ever want to miss a payment, and autopay avoids that.
Increase your payments. Paying extra money each month to your original payment plan can help you pay down debt faster. You'll need to contact your servicer to ensure they put extra money toward your balance and not your next monthly payment.
If you have credit card debt, you'll want to pay that off as quickly as possible, so prioritize that in your cash flow planning.
Enjoy Your Money
What's the point of a financial plan if you never get to enjoy your money? Building a solid foundation around the basics and creating good habits is essential, but making flexibility and fun part of your plan is necessary. This portion of your money should be for things that bring you joy, whether travel, nice dinners, shopping, etc. Your overall situation will determine how much you can spend in this area, but don't forget to build it into your cash flow plan.
The Takeaway
Financial planning aims to help you enjoy your money today and ensure you are setting yourself up for success in the future. You can begin deploying tactics and strategies to align your money with your defined goals by thinking through your financial goals and values. Money is nothing more than a tool to get you where you want to go.
At Pursuit Planning and Investments, LLC, I help you think through your options and ultimately help you make the best decisions for yourself, your family, and your money. Feel free to place a commitment-free 30-minute meeting on my calendar. In that meeting, we can discuss your cash flow plan and how to begin best optimizing your financial plan.
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