Episode 30: The Wealth On Any Income Book – Section 3: How to Handle Emergencies – Transcript
Hi Folks, Welcome to the Wealth On Any Income podcast. This is where we talk about money tips, techniques, attitudes, information and provide inspiration. I’m your host, Rennie Gabriel.
In the previous episodes I spoke about your five year financial goal; the difference between good debt and bad debt; how good debt can support you to create wealth. We discussed how to complete a Balance Sheet and determine your net worth so you know how close you are to Complete Financial Choice™.
With the Income and Expense form, when you focus on expenses first you’re rewarded with more income. We discussed how to measure the level of pleasure based on where you spend your money. We covered what to do if your expenses are more than your income. And in the last episode we covered the most powerful way to start building wealth and Complete Financial Choice™.
Today, I will continue reading the third section of the Wealth On Any Income book. This section is where I cover the tools, tips and techniques that will lead to you having Complete Financial Choice™ in your life. Today I’ll explain how to handle emergency spending without creating a financial disaster.
It will be around 20 minutes today.
As I read, I could stumble over some words. I am not a professional voice over actor so please forgive me if that happens.
From the previous section you learned the importance of paying yourself first. Now, where do you put the money? I have two approaches. A simple savings allocation I will explain shortly, and a more sophisticated approach I will explain afterwards. You can set aside 40–60% of the money you pay yourself first into long-term savings or investments. Later on I’ll provide suggestions on where to put that money. This allocation I’m referring to often creates confusion, so I’m going to provide shocking simplicity.
In order to create financial freedom, and pay off past debts, and be prepared for future expenses, you must not only spend less than you earn today, you must set a portion aside for tomorrow. Working with thousands of people I’ve discovered the following: About 10–15% of what people earn needs to be set aside today to be spent later. When you add up non-monthly expenses like car repairs, registration, vacations, gifts, clothing, and so on, the average is 10-15% of current earnings. If this is not set aside, then it won’t be available later, and this is how credit card debts are built up and continue.
In addition, 10% needs to be set aside for your financial independence. This means, on average, 20-25% of what you earn today must be set aside for the future. 10-15% will be spent later, and 10% will be kept for the rest of your life.
Consider a circle you cut in half. This represents a simplified allocation of 20% that needs to be set aside each time you receive money. Half goes to long-term savings and investments and the other half will be spent later. I’ve found this to be a typical allocation based on the 10 - 15% from the previous paragraph for the sporadic expenses. If all you can start with is to set aside 10% of your income in total, then 5% would go to keep forever and 5% would go to spend later. While yours could be slightly different, like 40/60, I want you to keep it simple, and any allocation is better than none at all.
When you go to the bank and ask what types of accounts they have, they’ll generally tell you they have two primary types of accounts: checking and saving. For most people this is not true.
For most people the banks have checking and spend later accounts. Most people who open up savings accounts only save up money until they have enough to buy something. I don’t consider that a savings account, I say that’s a spending account. I’ll explain shortly that you will open an account like this, but it won’t be to save up to spend later.
When I say savings, I mean save for the rest of your life, not save for a new car or vacation. I mean to save to create financial freedom and Complete Financial Choice™. The money for a vacation or car goes into a spending account, which the bank calls a savings account.
What are some of the ways you could be paying yourself first and putting it away for long-term use? You could put it into a mutual fund by dollar-cost-averaging, a life insurance policy (whole life, universal or variable life), payroll deduction into a credit union or 401(k) plan, or automatic withdrawals for the down payment on your first or second piece of real estate. 50% of the money when you pay yourself first will never leave your hands again, unless it’s going into an investment that will be part of creating your Complete Financial Choice™. I’ll go into more detail in Step 12.
1. A simplified savings approach
50% of the money goes into what the bank calls a savings account. You know this is a spending account. Half of this money can be for an opportunity or emergency and the other half can be for emotional spending. This is where the money comes from that gets spent on things you’re rarely prepared for, like the car breaking down, or the water heater which needs to be replaced, or the semi-annual insurance premium or property tax bill, or the unexpected medical expense.
Half of the money in this planned spending account is for emotional purchases. With half of the money here you can now buy something and not feel guilty about it because you hadn’t planned on making the purchase. It could be for a weekend trip you need, just to get away. It could be to purchase a gift for someone, or even yourself. The money was there waiting, you just didn’t know what it was for when you put it away. Take out the money and buy what you want, and don’t feel guilty. Isn’t that a great way to buy something? This is the practice which will allow you to get away from using credit cards for something fun and unexpected. You now have cash to use.
Again, the 50/50 or 40/60 split is a useful rule of thumb for the amount to go into the future spending account. If you requested all the forms I talk about in this audio version of the book, you will have received a Cash Flow Form. If you have not yet requested the free forms, you can get them by sending an email to Rennie@WealthOnAnyIncome.com and put All Forms in the subject line.
On the Cash Flow Form you’ll notice small stars (*) next to some items such as auto repairs, auto registration, clothing, vacations and others. This represents items most people don’t spend money on each month, but will spend money on during the course of a year.
As an example, you might not be purchasing clothing each month, but you might go out and only purchase clothing twice per year. If you spend $600 each time you go, that would $1,200 for the year. If you divide that by 12 months, then it would be the same as if you spent $100 per month. This $100 per month needs to be accounted for or set aside somehow. This is what the planned spending account is for.
If you add up all of the starred items from the Cash Flow Form it will generally be about 10% of your take-home pay or after tax income. As discussed earlier, that’s the rule of thumb. For the expenses that come up sporadically during the year, you need to set aside about 10% of your take-home pay each month to be prepared for them. Check your situation, it might be 15%, or it may need to be 20%. Otherwise, when these expenses show up, you have no money to draw from, and you have to use a credit card. Again, this is the practice that will allow you to get away from using credit cards in an emergency because you will have cash to use.
2. A more sophisticated plan for periodic or sporadic expenses.
If you want to get more sophisticated, listen to the next example. It explains how to plan for annual, semi-annual, periodic or even sporadic expenses. This is for your “spend later” account that you know you’ll spend for expenses that don’t show up monthly. The strategy is to cover the expenses you know you’ll have during the year, but you may not know when some of them may happen, like when the car will break down.
Start by looking over all of the starred expense categories for items that do not occur each month, but can be broken down into a monthly amount such as property taxes, annual insurance premiums, auto maintenance, vacation, a major purchase, or school tuition. Now divide the annual amount by 12.
Property taxes, annual $1200 ÷ 12 = $100.00
Life Insurance, semi-annual 1800 ÷ 6 = 300.00
Auto Maintenance, last year 1020 ÷ 12 = 85.00
Vacation, last year 3000 ÷ 12 = 250.00
Next car down pmt in 2 yrs. 5040 ÷ 24 = 210.00
School tuition, due in 7 months 1995 ÷ 7 = 285.00
TOTAL TO SAVE EACH MONTH = $1230.00
Each month, you will write a check for $1230 and deposit it in the planned spending account. When the insurance bill arrives two months after you start this program, there will be over $2,400 available to pay the premium. The premium is only $1800. When each expense comes due, all of the money will be available because it is very unlikely everything will come due all at once. When you’re ready to buy the new car, you will have saved up the down payment. Whether or not you can sell the old car won’t matter.
There are other expenses you know will show up: A life insurance bill you know will arrive in July; property taxes in December or April; tuition bills and things of that nature. What I’m suggesting is you divide the expense by the number of months before it comes due, and set aside that amount of money each month.
Whether you elect to use the simple approach or the sophisticated approach, this is a crucial exercise. With the Cash Flow Form (Tool #3) and using Step 11, you can calculate if you’re actually bringing in the level of income you need for all of the expenses you have, not just the ones that show up each month. This is where most people go wrong and end up having to use credit cards. Things come up that they weren’t prepared for, but could have been.
By seeing if you have the money to set aside for the items that don’t show up each month, you know if, and by how much, you are living beyond your income.
A lady who came to my workshop was complaining about refinancing her house one year earlier to pay off credit cards. Not only were the balances back, but she was about to be 30 days late on her payments. She was hoping the new refinancing would close before she hurt her credit. When we met individually, she discovered for the first time that when we added in the items that don’t show up each month like car repairs, registration fees, and fire insurance, she was spending $425 per month more than she earned.
This was an intelligent woman. She was a competent 45-year-old legal secretary in a prestigious law firm, earning over $50,000 a year in 1994. I’ve even had these experiences with financial planners who were earning $200,000 to $500,000 per year. These concepts and tools apply to every income level.
This method which I call the sophisticated approach happens to be the one my ex-mother-in-law uses. She’s actually setting aside the money to replace her roof when it wears out in 15 years. Believe me, it can be done for anything. She started this habit when she was 15 years old with her baby-sitting money. Her dad was a CPA and taught her this method. You and I may not have been as lucky with parent selection.
Personally, I use the simplified approach to set aside 20% of my income. Each time I deposit money at the bank I transfer 20% into savings. It didn’t matter if I was standing in front of the ATM machine or the teller. I received checks for consultations, speaking engagements, book and cassette tape sales, and coaching fees. It didn’t matter where the money came from, how large or how small the check, 20% was set aside in savings.
My ex-mother-in-law’s method is a little too much work for me, but it may not be for you. You may be adept at computer programs like Microsoft Money or Quick Books. Both my ex-wife and her mother have shown me how to use Quickbooks, but I can’t be bothered. I have my assistant do all of the data entry into Quick Books. I guess in the finance area I’m just a paper and pencil kind of guy.
The Story of Two Attorneys
The following story began in 1991. It’s about two attorneys, a husband and wife. At the time the wife came to me she was not practicing law. Her husband asked her to sign a loan to borrow against the equity in their home to pay income taxes that were due. He earned a good living at the time, about $180,000 a year, and was short $12,000 to pay income taxes on April 15. I knew his wife to be a rather quiet type, but in a loud and angry tone she said, “Rennie, I’m sick and tired of this.” I was shocked. I asked why she was so upset about this equity loan and she screamed, “It’s the third year in a row!” Now I understood her upset. It was the third year in a row of borrowing against the equity in their home to send down the income tax rat hole. (A rat hole refers to a hole in the ground where rats live. If you drop something down in that hole, it’s too disgusting to reach in there and retrieve it.)
In the United States we have great opportunities, choices and freedoms that very few countries in the world can match. Our system may not be perfect, but as far as I’m concerned, it’s the best there is. To maintain this system, we have an obligation to pay income taxes (among other taxes). If you’re not earning any money, you don’t pay taxes. If you are earning money you get the privilege to pay taxes that support the country that offers us the freedom to choose to do what we want. These taxes come out of our earnings or profits in business. If we have to pay taxes it means we have made money or profits. It’s a fair exchange; taxes for freedom. However, borrowing against a home three years in a row, reducing equity and net worth to pay income taxes is not on my list of suggestions.
When I met with them the first time we filled out the balance sheet and cash flow forms, just like those in the Appendix of the book. Again, you can request all of the forms by sending an email to Rennie@WealthOnAnyIncome.com and put All Forms in the subject line.
We did a lot of guesswork in filling them out. He said he would go to the ATM machine and pull out a couple of hundred dollars, and a few days later it was gone and he didn’t know where it went. He said they liked to eat out a lot. Do you think $600 per month is a lot to spend eating out? Most of the people in my workshops thought so. And remember, this was $600 a month in 1991.
Anyway, I asked him to use an earlier version of my Spending Plan Register. I didn’t have it organized as I do now. I suggested he write down all the money he spent—cash, credit cards or checks—in the Spending Plan Register. Or, for checks he wrote, he could use the information from his checkbook register.
Before he even started, he complained it seemed too time consuming. I showed him it would take 5–10 seconds. He asked, “What about 25 cents I might spend in a parking meter?” I said, “Write it down under transportation expense.” He asked, “How long do I have to do this?” I told him, “Just six weeks until we get back together.” He agreed to use the register.
Six weeks later, we got together and reviewed the data. We looked at what a typical month might look like based on the six weeks he tracked his spending. We had to adjust most of the items either up or down. One of the figures always stands out in my memory. When it came to Meals Out, it wasn’t $600 per month. It was more than he thought. Are you guessing $800 or $1,000 a month instead of $600?
It was actually $1600 a month he was spending eating out. He was off by $1,000 per month in one account! When you figure he was short $12,000 to pay his taxes, and he was off $1,000 per month on his meals, you realize he ate practically everything he needed for his taxes. The first year after he used the Spending Plan Register, he saved $12,000 and got current with his income taxes. Not a bad return for a $14 financial tool. What do you think?
In addition, when we got together he had $190,000 of short term debt: credit cards, business and personal loans. This did not include his home mortgage. Four years later he was still current on his taxes. He reduced his short term debt by $70,000, leased a new Lexus, and took the whole family on a trip to England, paid in full. Remember I said he was earning $180,000 per year when we first met? Do you want to know what he was earning four years later that produced those dramatic results? It was the same $180,000 a year. He didn’t earn a dime more in annual income in four years. The point to this story is this: It’s not so important how much money you earn; it’s what you do with it that makes the difference!
Six years after our initial meeting, two more things developed. One, all the short term debt and credit card balances were paid off in full. Two, their family income jumped substantially. What I discovered is that when people handle expenses more responsibly (me included) they seem to generate more income easily and effortlessly.
I have two theories as to how this happens, and you can choose the one that is most comfortable for your belief structure.
The first theory: When we have shown we can handle money more responsibly the universe aligns with who we’ve become and money shows up. We generate money more easily and effortlessly. We see opportunities we would have missed in the past.
The second theory: By taking responsible actions, like paying ourselves first, paying bills on time, or living on less than we earn, we create a psychological shift. We now view ourselves differently. We’re proud of who we are. We now make even better choices and decisions. Others recognize this shift in our self image also. We now see opportunities we would have missed before and generate more income easily and effortlessly.
These results have been demonstrated in my life and the lives of my clients over and over again. I don’t care which theory you want to adopt, just be sure you adopt one of them. The results prove the actions work. You don’t need to understand how electricity works to turn on a switch and have a light come on. You only need to take the action of turning on the switch. You don’t need to know why or how paying yourself first will create more money, or how spending less that you earn will create more money. Just do it and you will have the rewards.
Here’s your opportunity to grow: This week open up your two accounts; one for the money that will create your Complete Financial Choice™ and the other to handle the sporadic, periodic or emergency expenses.
As a reminder, if you want all of the forms that were described in the previous episodes please send an email to Rennie@WealthOnAnyIncome.com and put ALL FORMS in the subject line.
In the next episode we’ll cover the financial terms you need to understand to create a prosperous financial future.
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Until next week, be prosperous. Bye, bye for now.
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