I have written before about the odd, often ironic, way American's treat money. For a capitalist country whose culture revolves around money, we are just plain terrible at managing it. Even people with successful family businesses often dont know much about money or how to talk about it with their family.
Most Americans have little or no training in managing money and they take money very personally as a measure of self-worth. Taken together these two facts are the one-two punch of financial problems. Most American's try to use a cashflow management system ("If I have cash in the back, I must have money.") but thanks to credit cards, their spending is completely out of control and they really have no idea how much money they have or where they spend it.
It also surprises me how many people think "business" money is somehow different from "household" money. Your household IS a business. You have income; you have expenses; you have to balance the books to stay out of bankruptcy. Everyone should think of their household as a business so that they can make money less personal and be more productive talking about it. Thinking of a household as a business is also a good way to involve more members of the household in financial dialog and decisions.
the three steps
There are three basic activities for managing money in a household or business. Each activity creates a foundation for the next one and they work in order. Some people have skills in one area but you need to address all three to be successful.
- Accounting -- The techniques and record-keeping that tell you where the money goes
- Spending -- Deciding what to buy or (even more important) not buy every month
- Investing -- How to make money with your past savings
The first activity, accounting, is pretty much solved with software like Quicken. By recording your purchases and bank records in Quicken and using the business reports (income/expense, balance sheet, cashflow) one can easily keep track of where their money goes. Even though I am regularly frustrated by Quicken and its quirks, one just cannot manage a household-business without it.
The second activity, spending control, is a set of values and behaviors that lead to decisions. Controlling one's spending is almost completely absent in many if not most households because people dont have any data with which to make decisions. Without data, all you have are emotions and its not possible to make good decisions purely by emotion. Without data you will always give in and overspend which is why so many people have credit card problems. There are so many individual purchase decisions in a given month, one can never know what they truly can afford without accounting data.
Spending control involves daily discussion of priorities and goals with your family partners, including the difference between needs and wants. It involves looking at your accounting reports to see what resources you have and where you spend money today and comparing that with your financial goals for the years ahead. Most of all, it involves the willpower to say no even when every part of you wants to say yes. Spending control is the hardest part of managing money because our culture is all about spending and the peer pressure is enormous. But fact is that you will never have any savings until you learn to control your spending.
The third activity, investing, is about knowledge. If you do the first two steps, you will have free cash flow, ie savings, every month with which to invest. Knowing what to invest in and different types of investments (stocks, bonds, ETF, mutual funds, options) is a matter of training and education. The same is true for understanding different investment vehicles like IRA's, 401Ks, 529s and the like. Even if you have limited investment knowledge but you master the first two steps, you will be better off than millions of your fellow Americans.
closing
The bad news is that managing money is a lot like losing weight - you have to learn to honestly and regularly use a scale, learn when to say no, and you need both willpower and patience to stick with it over a lifetime.
The good news is that all three steps are doable by just about anyone. Taking charge of your finances, while difficult at times, is also quite empowering and it is never too late to start.
