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8 Questions for the Constantly Broke

May 7, 2010

Posted by Roshawn Watson under Uncategorized

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By: Roshawn Watson

Recently, Yahoo Finance republished an article from US News entitled the “8 Questions for the Constantly Broke.” I enjoyed reading it. I wanted to highlight the major points from the article, provide some rationale and context for the advice given, provide some helpful and relevant rules of thumb for some of the various topics discussed, and share some personal anecdotes.

Where Is My Money Going?

Your answer to this question is so critical. The most important phrase in the world of money is cash flow management. Cash flow management is the skill that allows you to identify deficits, to do economic forecasting, to meet goals (i.e. paying off debt or having enough funds for investments), and stop financial hemorrhages, etc.

Do you make too much to be this broke? Cash flow management can tell you why. Without proper cash flow management, you not only risk making little to no progress in your finances but in some extreme cases, you may be a bankruptcy waiting to happen. I firmly believe that my financial life and the lives of nearly everyone I know would be a wreck if they neglected managing their cash flow for too long. The reason is most of us simply cannot afford NOT to pay attention. Even if you think you can, you should heed the tacit warning in last year’s post Rich But Financially Inept. In it, I discussed the various ways athletes and other professionals have personally generated hundreds of millions and still file bankruptcy. Two of those reasons are: lacking financial adaptation and poor spending habits. The kicker is how do you know if you need to adapt or if you have poor spending habits if you aren’t tracking your finances. You can use tools such as http://www.mint.com/ and http://www.wesabe.com/ or Excel to track your income and expenses, or have someone else do it (i.e. hire a bookkeeper). Without knowing what your income statement looks like, you won’t see your financial past or your financial future. Using income statements to assist your cash flow management will allow you to plan your expenses (monthly and yearly), identify your Latte Factor (items that you spend money on daily that ultimately have huge financial implications), and your weaknesses, which were all listed as potential reasons for you being broke in the original article.

Are You Saving Too Much?

This is a hard one to write about because saving is supposed to be good. Up until 2008, we had a savings rate that hovered around 0 to negative. For example in 2007, it was -1.22%. I always joke that only an economist can calculate a negative savings rate. However, the problem is the yield from savings tends to be much than eliminating debt and investing. What sense does it make to have $10,000 in credit card debt at 15% APR and $50,000 in a savings account generating a dismal 1.10%. Pay off the bill. I agree with the statement in the article: “if you’re going into debt to fund your lifestyle and you’ve already cut back wherever possible, then it’s time to look at how much money you’re (saving).” I personally stopped saving and investing until I became debt-free excluding the house. It’s one of the ways I could eliminate those debts more quickly.

Is Your Relationship Hurting Your Finances?

This is an interesting one because relationships often get missed in many personal finance discussions, and yet they have so much bearing on our financial successes and failures. Consider the following two statements very carefully.

The number one reason for divorce in North America is money problems.

95% of millionaires are married and 70% have spouses that are more frugal than the highest income earner of that household. (Millionaire Next Door)

It is extremely difficult, and sometimes impossible, to make progress if your significant other is not on board with the plan. If you are married, you are not a joint venture and should strongly consider managing your finances together. It not only enhances communication about finances but also allows you to share the financial burden of the household. There is clearly a strong association with financial agreement and becoming a millionaire, so don’t neglect this important principle.

Watch Those Big Ticket Items

I am so old school conservative when it comes to big purchases and for good reason. Big ticket items are a quick way to become poor or at least an under accumulator of wealth. Dave Ramsey offers sage advice regarding major purchases that I agree with: your monthly mortgage should not exceed 25% of your take home (net) income, you shouldn’t finance a car ever, you cannot afford to purchase a new car unless you are already a millionaire, and your wedding shouldn’t exceed 50% of the annual income of the people who are paying for the wedding. Probably the hardest rules of thumbs are not buying a new car and the reducing the costs of the wedding. Most of us are car people, but as the original article suggests, cars are being made now better than ever, so the risk of buying a bad used car is lower than ever. Buying a gently used car instead of a new car can literally save you tens of thousands of dollars. Additionally, most new cars depreciate 45% in the first 3 years, and most people simply cannot afford to lose that much of their net worth. Containing wedding costs is even more challenging because it is such an emotional purchase, so we often rationalize expenses that we simply cannot afford. However, beginning a marriage saddled with debt provides a challenge for the newlyweds: the stress of money problems. Remember, the number one reason for divorce in North America is money problems. Of course, I am not saying it cannot be done (it certainly can and has), but I can personally vouch for the fact that it is great to begin your marriage without money stresses. Other big ticket items to monitor are debt and groceries (note that the cost of groceries tend to add up and are a major expense).

Are You Wasting Too Much Money Carrying Debt

Some of you have called me out on this before, but I never tried to hide my bias: I hate debt. However, let me attempt to make a logical argument for why you shouldn’t be carrying consumer debt. The second biggest constraint to the cash flow of most people is debt. Consider that the typical car payment in North America is $480 monthly (Edmund.com), the second car payment averages $200 monthly, the average student loan payment is $250 monthly, and a typical credit card payment is around $200 monthly, and then there are other miscellaneous debts (i.e. furniture, stereos, personal loans etc.) of around $120 monthly. You can easily see how debt costs the typical American family in excess of $1000 monthly. If this were invested for 25 years instead and received a conservative 10% return, you would have $1.3 million. It is no wonder that 75% of the 400 richest Americans (Forbes 400) say “the best way to build wealth is to become and stay debt-free.” Simply put, paying off your consumer debts gives you a guaranteed return on investment (ROI) and liberates your most powerful wealth-building tool: your income.

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Image credit: Matthiaorfield

5 Responses to 8 Questions for the Constantly Broke

Joe PlemonMay 7, 2010 at 10:49 am

Shawn,I like these kinds of lists…makes the reader think about which ones apply. The "saving too much" caught my eye until I read your explanation, which I FULLY agree with!
Shawn WatsonMay 7, 2010 at 11:06 am

@JoeThanks so much for the comment. I try not to overuse lists, but every now and a list just works for the topic. I was surprised that the US News article listed saving too much too, but it is certainly appropriate depending on other financial priorties.Best regards,Shawn
AnjaMay 8, 2010 at 8:47 am

Where is my money going is a critical question?
Shawn WatsonMay 9, 2010 at 6:17 am

Yes Anja, the most important word in the world of money is cash flow management.
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