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Mine Your Cash Flow to Build Your Wealth

Albert Zdenek

Executive Vice President

Feb 28, 2021

Summary

Beyond the income that we earn, many of us increase our wealth by finding and saving cash. It’s not the most glamorous method, but it works. So where can you find the money to save and invest? The secret to building wealth is finding, increasing, and saving your cash flow. By tracking your spending and making intentional choices about where you spend your money, you can find savings in your daily life. Here are some ways to get started.

Find more cash flow by mining your spending

You are listening to a friend brag about the latest hot stock tip. You think to yourself, ”If only I could spend the time finding these gems, I would have a lot more money in my portfolio.“ Most people tend to equate their wealth with the investment returns and balances in their retirement or investment accounts, but very few people make their living buying and selling securities. The overwhelming majority of us increase our wealth by finding and saving cash. So, why not concentrate your efforts on finding additional cash flow from everyday activities and increasing your savings?

Tell me if you can relate to this: You get your paycheck and at the end of the month, you find that you have nothing left after paying your bills. This has gone on for as long as you can remember. In my CPA tax preparation days, when reviewing a client’s yearly income, I would often see a look of amazement come to their faces. Shocked, they would say, “I made that much? Where did it all go?”

Over the course of my career, I have seen that whether someone earns an eight-figure income or a five-figure income, the song is the same: “I can’t find the money to save.” Granted, perhaps it is harder to save if you earn a five-figure income. But the real issue is that people at all income levels have the same reasons for why they can’t manage their cash flow. However, in my experience, if you really want to save, there is a way to find additional cash flow from everyday actions, even if it is just small amounts per week.

The secret to building wealth: Finding, increasing, and saving cash flow

Now you know the secret! As a wealth advisor, I am a fanatic when it comes to helping people find and manage their cash flow. Why? Because the more ways you can uncover and save your money, the sooner you’ll reach your financial goals.

We all know it be can tough to make ends meet, let alone save. There were many years when I earned a lot less or I had to borrow to live. I recall one particular summer when my family was trying to plan a vacation. I was broke, so my kids came up with a plan: We’ll start collecting our spare change into a jar and use that money to take a vacation. After a couple months, we had saved enough to afford two nights at a cheap hotel by the shore. It was one of the most memorable vacations we ever took.

Even during tough times, you can find a way to save. If times are too tough (like now with the pandemic taking a toll), you might have to suspend saving for a while. But it’s important to get back on track when times pass.

Two basic but powerful financial principles you need to know

The power of compounding. To understand the importance of finding, increasing, and saving cash flow, we need to review two important financial principles. The first one is compounding. You may have heard this described as “money growing money” but most people don’t understand the power of compounding.

“Warren Buffet’s $300,000 Haircut” illustrates the power of compounded earnings over time. Buffet is known for his thrifty lifestyle, considering his wealth. When he was a young man, he calculated that if he continued to spend the amount he did on a haircut, it would cost $300,000 during his lifetime (Hence, the hypothetical question of “Would I spend $300,000 on a haircut?”). He realized that if he spent half the amount for a haircut, he could save $150,000 just from this simple action. He then started to apply this lesson to his spending and investing.

A haircut is a great example because it’s something that seems completely ordinary. How much do you spend on cable TV monthly? Many people spend $100 easily. Over a year, that amounts to $1,200. Over 10 years, it turns into $12,000 (assuming no inflation but we all know that cable prices only go up). Over 30 years, this amounts to $36,000 (30 times $1,200). If you do nothing with this savings, at the end of 30 years, you’ll have…$36,000. But if you decide to invest the money over 30 years instead, depending on the rate of return, it could grow to more than $100,000 very easily. The difference between $36,000 sitting doing nothing and investing is due to the power of compounding. This is a simplified explanation, but you get the idea. Saving and investing and allowing your money to grow is compounding doing the heavy work of building a lot of wealth for you.

If you’re in your 50s or 60s and think, it’s too late for you to save; think again! You could live for another 30-40 years. Making prudent cash flow decisions, even at age 50 or 60, or in later years, can have a profound effect on your wealth and your lifestyle.

By the way, this is also a perfect time to remind you that you should enjoy your life. You can buy the latte, if that’s important to you. We’re not looking to cut and slash; don’t remove all the joy. So, if you find savings, maybe you might spend part of it and save part of it. Spending time and working at saving can be difficult. Reward yourself too.

Make income taxes work for you. The second financial principle you need to understand is the impact of taxes on your earnings and cash flow. Let’s say you’re going out to dinner or enjoying a night on the town. You can easily spend $200, $300 or more. It might be even more if you live in an expensive city. To spend $300 on a night out, you have to earn more than the $300 you are spending that night. Why? Because you pay taxes on earnings. Depending on your level of income, it is not difficult to reach the top tax rates and pay 40% of your income between state and federal tax rates. That means to spend $300, you have to earn $500 [40% of your tax rate times $500 of your earnings equals $200 and $500 less $200 equals $300]. Get it? Your tax rate may be less or more, but you have to earn more than $300 if you want to have money left over to save.

Here are some ways to make taxes work for you to find cash flow:

  • Save as much as you are allowed in your company 401(k). If your employer matches your contributions, don’t leave free money on the table! This can translate into thousands of dollars and help you save tax dollars of 40% or more (depending on your tax rate) on your contributions.
  • Once you fill up your 401(k) or other defined contribution plan, contribute to an individual retirement account (IRA). There are different options with IRAs so talk to your advisor about which makes sense for your financial goals. Bottom line, saving your money now gives compounding time to work its magic to grow your wealth.
  • Other tax actions include meeting with your CPA or tax advisor at the start of each year to review your tax situation. Let them know your goal of wanting to save tax dollars. While some limits may apply, your charitable contributions and employee business expenses may help save a lot of tax dollars.

Do you know where your money goes?

We now know that if we save and invest money, compounding will speed up our wealth building. We also know that income taxes can be a headwind to growing wealth. So how can we find ways to increase cash flow?

The first step is to find out how much cash is coming in and going out on a monthly basis. Believe it or not, most people don’t do this, but it’s not difficult to figure out. First, add up all your paychecks for the month. Next, find your beginning cash balance at the start of each month and add in your net earnings to the beginning cash balance amount. At the end of the month, look at your cash balance. Is your ending balance higher or lower than your beginning balance? If your ending monthly balance is higher, that means you spent less than you earned. If your ending monthly balance is lower, you spent more than you brought in.

Now, I’ll throw in a word here that some people don’t like: budget. You can be as detailed (or not) as you want when it comes to budgeting, but once you know when your money is going, you can predict and target your spending. List out all your spending by categories (i.e., groceries, entertainment, gym membership, etc.) for the month. There are many tools you can use to track your spending.

My experience is that people who start doing this find surprises. I’m still being charged for that magazine subscription? Look at your spending with an eye toward, “Do I really need that?” The whole point is to know what and how much you are spending. Maybe you’re okay with it or maybe there’s a chance to save. Remember, per Buffet’s rule above, saving $100 per month can mean saving over $100,000!

If you have a spouse or significant other, I encourage you to track your spending and budget together. Keep in mind that this is not a time for shaming or blaming; we’re not looking to find fault but understand where the money goes. What do you spend money on that’s important for you? How about your partner?  Use this time to support each other and compromise. Building wealth as a couple is a team sport!

Other places to find your cash flow savings

Once you start tracking your spending, you may find more ways to save. Here are some ideas to get you started:

  • Review your mortgage/home equity payments. If you have not refinanced in over two years, you are probably paying too much. Saving 1% on a $300,000 mortgage amounts to $3,000 per year ($250 per month).
  • Have credit card balances? They usually come with high finance charges.
    • Consider taking out a home equity loan to pay them off. It will likely cost less in interest and you might be able to pay less principal per month. Tom, a client of mine, recently saved over $350 ($4,200 per year) per month doing this.
    • Whether you have a home equity loan or not, you can call up the card companies and negotiate a lower interest rate or monthly payment (this can be especially helpful during poor economic times). If they can’t accommodate you, switch to another company that offers a better rate/payback terms.
  • How much are you spending on your phone, internet, and cable bills? There are many alternatives today to these services. Do you still need to have a landline or can you use your cell phone? Use Netflix or another provider and drop those expensive extra channels on cable. At the very least, call them and threaten to leave unless they charge you less. Yes, this works too!
  • Scan your monthly credit card statements and look for possible ways you can save. Are you still subscribing to magazines or other services that you’ve forgotten about or no longer use? A lot of people are cooking more at home with the pandemic so this may curb your fondness for eating out and help save you money. Also, when making big purchases , try to pause and think about the purchase.
  • Seek out price reductions and discounts. With any renovation or repair, ask for a discount from the contractor. A client just got $4,000 knocked off a renovation, 10% of the cost, just by asking. The worst they can do is say no. Negotiating when buying a car is common knowledge, but you can also apply this approach when making other purchases. Just make it a habit to ask for a discount anytime you are purchasing something. Then save the savings!

Your job can help you find and increase your cash flow

A fertile source of finding cash flow is assessing your current employment situation. You know you deserve more, but have you asked for it? Emily was having trouble reaching her savings goals and while she liked her job, she knew she was worth more. During our conversation, I encouraged Emily to talk to her boss about her compensation. But before that, she needed to do some research. She contacted a recruiting firm to see what she was worth in the market as a data point. She quickly got an offer from the recruiter where she would earn $24,000 more per year.

If Emily earned $24,000 more per year and saved this money over 35 years, she would have $700,000. Applying the powers of compounding, if we assume an investment return of 6%, that $700,000 would be almost $1.4 million! Not bad for taking some time to find more cash flow. Emily went to her boss armed with this knowledge and got the $24,000 match. So, she got to stay at the job she liked and earned more!

Sometimes you can do what Emily did and not get the same outcome. You might have to change jobs to get a pay upgrade. Or maybe you want to start a business if you think you can earn more pursuing this path. These are all tough choices, but not living the life you want now and reaching your financial goals is tough also.

Life is especially challenging right now. Learning about your spending and finding ways to make your cash flow work can help you achieve your financial goals and can feel in control of your life. Engage your advisor in this discussion; having a partner keep you on track and motivate you can help you stay the course.

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