Skill in money management matters. Common money management misconceptions lead many to financial despair. This is in the face of what should be an opportunity to build wealth and secure a comfortable financial future. This is especially so during distressing economic times when the focus is on the high costs of living. We are constantly barraged with messages about high (and increasing) mortgage interest rates, inflation and the threat of recession. Consideration of what leads to that feeling of being worse off, including after having an increase in earnings, is warranted.
Except for the very wealthy, there are a few habits that should be practiced, regardless of the general economic climate. It has long been the case that without a plan, we tend to spend more when we earn more. We need to avoid the temptation of trying to ‘keep up with the Joneses’. The trap is not just in the spending of more, but also in spending on more expensive items. Money management matters.
How does money mismanagement perpetuate?
External factor impacts
Firstly, a lack of understanding of external impacts such as taxation and other income-level based costs have on cashflow. An increase in salary might look impressive when you move from a level of say $70,000 to a promoted position paying $100,000. Your first impression is that you have an additional $30,000 to spend (or otherwise utilise)! However, from that increase you will need to allow for taxation (you are now in a higher tax bracket). And if you have a HECS/ HELP debt, the rate at which that will have to be repaid increases. You may also have other commitments that will increase on the basis of the level of your earnings. The overall effect is that the apparent increase of $30,000 may actually be less than $25,000. Recognise that!
Lifestyle choices
The temptation arises to live a lifestyle commensurate with the financial status you have attained to earn the extra income. The occasion giving rise to the increased income also extends the network in which you operate. Consider your wardrobe, the standard of meals, the social events you attend, and even the car you drive. The initial phases of this new lifestyle can be very expensive and can lead to poor money management outcomes.
Financial illiteracy
Finally, financial illiteracy makes it difficult for the emerging wealthy to realise their potential. The lack of awareness of the benefits of advice and planning at this stage can be a setback. We anticipate that future generations will learn new skills, as we all adjust to an ever-increasingly cashless way of living. However, some wealth management skills are timeless and stand us in good stead to make good use of the opportunities we encounter. Absent astute financial literacy, the ever-present risk is to spend more than what the new-found increased earning actually yields.
Effective money management matters is an antidote to these shortcomings.
What are some of the traps that result in money mismanagement?
The barriers to improving your financial position in a situation where you are earning more, are as follows:
- Failure to plan
- Getting priorities wrong
- Failure to attain financial literacy
- Indiscriminate discretionary spending
Failure to Plan
There is an old adage that ‘failure to plan is a plan to fail’. Whilst that may not be a universal truth, it is regrettably a frequent experience.
The process of planning requires us to formulate some strategies to deal with anticipated events, utilising resources and skills that we have or are able to acquire. It requires us to consider our current position/ status; our knowledge, training and experience. We need to set goals for what we would like to achieve – and a reasonable timeframe for their accomplishment. Planning requires us to devise strategies by which to achieve those goals within that timeframe. Sound management of the process requires setting some milestones by which to measure progress. And we need to regularly review that progress.
That process may appear to be a complex approach to some of the challenges we are here discussing. Whilst it may be ‘an overkill’ in many cases, it will help us consolidate the money management skills we need.
Wrong Priorities
In the absence of a considered, informed plan, money management can be addressed like some of the information-gap misconceptions. When news is released that leaves unanswered questions, we try to fill the gaps based on our prejudices or experiences. And all too often, jump to inappropriate conclusions. The excess money that we have been fortunate to acquire or earn, can soon find a home in the pockets of others if we fail to consider –
- Why we are undertaking a particular purchase or expenditure;
- What is to be achieved by it – and what are its implications for the future; and
- How those funds might best serve us for a sustainable financial future.
Some questions that might highlight this erroneous prioritisation, include –
- Does my new income status really require that luxury car that I have always desired?
- Isn’t the home that I currently live in adequate for my present and, at least, near-term needs?
- Is my wardrobe so out of line with my new status that it needs a complete revamp (or could some selected items – garments or accessories – be adequate for a time)?
- Do I need to spend money on restaurant meals and/ or alcohol and entertainment so frequently, merely because ‘I can’ or because ‘I think it’s expected of someone in my position’?
Dealing with all of these matters in a considered way will ensure that money management matters are handled to your long-term financial advantage.
Financial literacy
In Australia, financial literacy is something that we leave to the individual to develop. Unless choosing a career in financial services (such as accounting, banking, financial planning) we tend to ignore this shortcoming. The definition of what constitutes financial literacy can be complex and not always agreed. Here, we use the term to mean ‘to have an understanding of the role of money in the economy and in our lives; and how to effectively utilise the various financial wealth management resources at our disposal’. A reliable guide to your financial literacy competence is the confidence and comfort you have in managing your wealth.
There are many resources available to us to gain and enhance our financial literacy. In the meantime we do well to engage appropriate professionals who will guide us with of the financial strategies. And they will introduce us to products that will help us achieve our goals. They will also explain the benefits – and any potential pitfalls – in using them. The ‘sleep at night’ test is often cited as a good measure of your comfort with how your financial plan is serving your needs.
Discretionary spending
There are essential expenditures, and there is discretionary spending: the first might be considered as that spent on items essential to our health, safety and well-being; whilst the latter is what we spend on ‘treating ourselves’.
If you head off to the shops with a list of the items you need to cater for the week’s meals and can return home with just those items, you have managed the essentials well; but if you get home and find a packet of biscuits, a chocolate, or other extras that you have been lured into because they appealed to you as you strolled past them (or that they were well merchandised by those canny retailers), you have probably fallen prey to indiscriminate discretionary spending – spending because you could, not because you needed the item. One of the problems with discretionary spending is that, left uncontrolled – even unrecognized – habits can form that will impact the sustainability of your financial resources.
How can we avoid these traps and exercise money management wisdom?
There are a number of ways available to us to avoid the issues that lead to unwise money management practices.
Primarily, from a financial wealth management perspective, we need to understand what financial resources we require to satisfy our own needs and the needs of those dependent on us. This can be a very tricky exercise, because whilst not everything can be quantified in financial terms, ultimately the provision of some needs will incur a financial cost – or at least impact our ability to generate income. There are some interesting discussions taking place in financial circles these days, regarding what constitutes ‘wealth’ – and it is being recognised that the value of an investment portfolio, or the balance in a person’s bank account(s), is only a part of their wealth.
In this article, we refer to the financial impacts of meeting the needs to which we have committed but also reference some examples of how the non-financial matters affect our money management decisions and outcomes. So now, to avoiding those traps:
Be aware of your commitments, current and emerging:
These commitments include time, and resources (physical, financial and knowledge). They are personal to you, and to those dependent on you – and acknowledge that the more dependents you have, the more complex these commitments become to manage. They are also likely to be enduring, so ensure that you limit your commitments to what you can service satisfactorily for a sustained period. There may come a time also when some rationalisation will be called for: be ready to deal with the consequences of those.
Inform yourself as to choices and options:
This will help you make palatable choices when commitments are likely to need to be culled. Perhaps some options exist for melding some of those commitments so as to reduce the time and other costs that lie ahead. At this stage, you should be able to start preparing a timeline calendar and a financial budget to bring the consequences of various commitments into sharp focus. (Experience tells us that budgeting is far from an exact science: it is another tool that often needs monitoring and refining over time – particularly when dealing with the cashflow aspects of it – and updating it for changes due to price rises, added expenses due to your plan, and ‘unforeseen life events’, etc.)
We have published articles on Budget preparation: a couple that will be of interest to those following this topic are: ‘Preparing a family budget’; and ‘Preparing for retirement’.
Understand your aversion to risk-taking:
Investor risk profiling is an evolving practice, but in many respects your willingness to take on various types of risk (physical, emotional, financial and the like) feed into the evaluation of your investor risk profile when determining your wealth/ money management strategy. Whilst you may be able to locate tools to help you with the process, we strongly recommend that you seek the advice of a financial services adviser in this regard – they will be able to help you interpret what the profile that you assess as, means in investment terms.
Set SMART goals:
As we have written in a number of articles1 (including in our monthly eNews), SMART goals meet particular criteria that fit well into the whole strategy of avoiding money management mistakes (through misconception). As you will read in those articles, SMART goals are –
- Specific: goals should not be general in nature. Rather than saying you would ‘like to be wealthier’, express this as a known amount, such as that you would ‘like to have $60,000 as a deposit for a home’.
- Measurable: knowing the amount you currently have accumulated, and your anticipated level of earnings, the rate to accumulate the $60,000 can be determined – and measured over time.
- Achievable/ Attainable: you will know from your work on the abovementioned budget just how much you should be able to set aside for this goal (or indeed, for your menu of goals); and the likelihood of it being achieved in an acceptable timeframe.
- Realistic/ Reasonable: there is no point having a champagne goal on a beer budget as they say (unless of course, such a goal inspires you to strive more purposefully to achieve more).
- Time limited: unless you are specific about what success looks like by setting its timeframe, you risk becoming despondent and giving up – and as we have seen happen, being time-specific may also drive you to higher performance.
Develop strategy:
This is the aspect of the planning process that should keep you focused when distractions arise during progress of implementation of your plans. Strategy tells what you will do to achieve your goals, and how you will implement the plan: you will already be aware of the why you are in this process, as it will have been the motivation to make the start on the process.
Monitor progress and review strategy:
This is an important part of the planning process as it allows you to fine tune the plans as circumstances evolve. Sometimes the evolution is because of the success of the planning and its implementation, other times external factors could be at play – but one to keep an eye on, is how to manage the future as realisation of goals is achieved. Because life is ever-evolving, circumstances regularly changing and expectations changing as previous goals are achieved, we need to prepare to add further goals or, on revision of the strategy, to change direction to account for new demands previously unidentified.
Advice on avoiding money management mistakes
Money management wisdom really does matter!
Being aware of the need to be financially literate, that indiscriminate discretionary spending is a serious impediment to sound money (financial) management, that there are steps to be taken to avoid the traps of money management misconceptions – and advice readily available, you are now armed to avoid them.
The Continuum Financial Planners Pty Ltd team is available to assist you with your wealth management strategy and planning: call us on 07-34213456, or use our Book A Meeting link to arrange an appointment at your convenience.
(First published in October 2023, this article is revised/ refreshed occasionally, most recently in July 2024)
