Take a closer look

Is it time to give your financial profile a new look? If you’re concerned that you’ll have to give up on some of your financial goals because they’ll cost more than you can afford, think again. You may have to make certain changes in the way you spend money now. You may have to postpone some of your less time-sensitive objectives to meet those that are more time-specific. You may even decide to sacrifice something you’d been excited about to achieve an objective that seems more urgent. But before you can make any of those decisions, you do have to know where you stand now, and what change you may have to make in the way you spend money.

In the black or in the red?

If you’re serious about meeting your goals, the place to begin is by looking at your cash flow. Cash flow is the relationship between the money you have coming in and the money you’re spending, on a weekly, monthly, or annual basis. The bottom line is that if you’re paying all the bills that are due and regularly have money left in your account, your cash flow is positive.

If you’re always short of cash, if you skip payments even occasionally, or you have to borrow regularly from savings to meet your obligations, your cash flow is negative. Persistent negative cash flow has two inevitable consequences: You fall into debt, and you don’t make progress toward meeting your financial goals.

The good news, though, is that there are solutions to negative cash flow. You can increase your income or reduce your expenses — or both. The first may sound better, but the second is actually easier and is probably more important to long-term success.

Putting savings to use

When you’ve got your cash flow in the black, you’ll probably want to think about creating an emergency fund. That’s savings you can use while you’re between jobs or to see you through an illness, the aftermath of an accident, having to replace the roof, or buy a new car unexpectedly.

Advisers typically suggest you keep at least three to six months of living expenses in your emergency fund and that you choose fairly liquid investments. Liquidity, in this sense, means that you can withdraw cash easily or sell investments without having to worry about losing money. That’s why money market mutual funds or short-term bond funds are considered more liquid than stocks.

The more money you keep in your emergency fund, the more types of investments you may want to make. The cost of even a serious emergency tends to be spread out over several months or longer, giving certificates of deposit (CDs) and US Treasury bills — which generally pay higher interest rates than savings accounts — time to mature before you need the cash.

Within the limits

Though everyone allocates her income a little differently, depending on what she earns and what her priorities are, some basic expenses are unavoidable.

You need a place to live, food to eat, clothes, transportation, and money for medical expenses. You need insurance. You have to pay taxes on your income, on your real estate if you own your home, and, in most states, on some or all of the purchases you make.

So how do you spend less? Again, individual choices will differ. But if you’re serious about living within your means, you have to look seriously at every category. Assume, for the sake of argument, that your housing and healthcare are fixed costs. Where else can you trim — and by how much?

Could you reduce your food and transportation costs by 15%? Could you do the same with the money you spend for clothes? Could you still have a good time if you cut your entertainment budget by 15% or more? If a 15% cut seems unrealistic, try 10% to start.

Then figure out what difference those savings are making in your bank balance each month.

Number Games

It’s probably easiest to evaluate your cash flow on a month-to-month basis since so many bills are due every 30 days or so. You can also get a good sense of how holidays and vacations affect your spending. But be sure to account for payments you make quarterly or less often — such as insurance premiums or taxes that aren’t withheld — by dividing the total due by 12.

Then, again, figure out what difference those savings are making in your bank balance each month.

Looking to the future

Once your emergency fund is set, it’s time to invest, a critical step on the path toward realizing your financial goals. Just as you allocate a percentage of your cash flow to pay the mortgage or your life insurance, you can allocate a percentage of your income to one or more investment accounts.

Here are some techniques for boosting the amount you’re investing:

Don’t buy the next thing you plan to put on your credit card. Put what it would have cost in an investment account.

Pay off the balance on your credit cards and start investing an amount equal to your average monthly payment.

Have a percentage of your salary deposited directly into a tax-deferred or tax-exempt investment account each pay period.

Invest some — or all — of any extra money you earn or receive as gifts or bonuses.

Avoid having too much withheld for taxes and invest the difference between your old and new withholding each pay period.

Reinvest all the dividends and interest you earn, preferably automatically, so you’re not tempted to spend it.

Sign up for a retirement savings plan that’s offered through your job as soon as you are eligible.

Copyright image

This information is provided with the understanding that the authors and publishers are not engaged in rendering financial, accounting or legal advice, and they assume no legal responsibility for the completeness or accuracy of the contents. Some charts and graphs have been edited for illustrative purposes. The text is based on information available at time of publication. Readers should consult a financial professional about their own situation before acting on any information.