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Money Management Matters

Common money management misconceptions lead many to financial despair even in the face of what should be an opportunity to build wealth and secure a comfortable, stable financial future: skill in money management matters. Especially during times when the focus is on costs of living, high (and increasing) mortgage interest rates, inflation and the threat of recession being spoken about in the popular media, some 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 rules that should be observed, and habits practiced, regardless of the general economic climate: it has long been the case that without a plan, a strategy, it can be the experience that the more we earn, the more we spend. Apart from the folly of what used to be called ‘keeping 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?

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 – it looks like you have an additional $30,000 to spend (or otherwise utilise)! However, out of that increase (the $30,000) you will need to allow for taxation (the increase will put you in a higher tax bracket); if you have a HECS/ HELP debt, there will be an increase in the rate at which that will have to be repaid; and you may have other commitments that will increase on the basis of the level of your earnings – with the effect that the apparent increase of $30,000 may actually be less than $25,000. Recognise that!
Secondly, the temptation to live a particular lifestyle commensurate with, or demonstrative of, 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 – and that is often accompanied by an expectation that your lifestyle will change. Items such as clothing, the standard of meals – and regularity of taking them in a restaurant, the social events you attend, and even the car you drive all come into play, and under scrutiny. The initial phases of this new lifestyle can be very expensive and if not well-managed, can lead to poor money management in the future.

Finally, financial illiteracy, including the lack of awareness of the benefits of advice and planning, makes it difficult for the emerging wealthy to realise their potential. Whilst future generations will learn new skills, as we all adjust to an ever-increasingly cashless way of living, some of the skills and practices of wealth management are timeless and stand us in good stead to make good use of the opportunities we earn or are given. Absent these skills and astute financial literacy, the ever-present risk is to spend all, and often 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?

In short, the traps and barriers to actually 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

You may be familiar with the adage that ‘failure to plan is a plan to fail’ and 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 and/ or are able to – and as is relevant in this discussion – about to, acquire. It requires us to consider our current position/ status; our knowledge, training and experience; to set some goals for what we would like to achieve – and a timeframe that is reasonable for their accomplishment; to devise strategies by which to achieve those goals within that timeframe; set some milestones by which to recognise progress; and regularly review our progress.

Whilst that may appear to be a complex approach to some of the challenges we face and would be ‘an overkill’ in many cases, the principles of planning applied appropriately, will help us restore the money management skills we need to improve our financial prowess.

Wrong Priorities

In the absence of a considered, informed plan, money management can be addressed like some of the information-gap misconceptions that we experience when news is released that leaves unanswered questions to ponder: we often hasten to fill in the gaps based on our prejudices, experiences or beliefs – and all too often, jump to inappropriate conclusions. With new-found financial prosperity, the excess money that we have been fortunate to acquire or earn, soon finds 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

Unfortunately, in this country, financial literacy is something that we leave to the individual to develop, unless of course they choose a career in financial services (such as accounting, auditing, banking, financial planning, insurance and related services). Whilst the definition of what constitutes financial literacy can be complex and not always agreed, we use the term in this article 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 pretty good guide to your level of financial literacy is the level of confidence and comfort you have in managing your wealth.
There are many resources available to us to gain and enhance our financial literacy, but in the meantime we do well to engage appropriate professionals through whom we can gain some understanding of the financial strategies and products that will help us achieve our goals and be able to 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 website Contact Us form.

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