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MONEY CONVERSATIONS are part of my daily life. I’ve written a personal finance blog for five years and recorded a related podcast for three years. I work full-time for a fiduciary financial planning firm. All of these activities expose me to folks seeking to improve their financial literacy.
I love talking money. But the more “money talks” I have, the more I see that people overlook the most fundamental principle of personal finance. What principle? No, it isn’t about investing, which gets endless attention.
These are good questions. If you don’t know the answers, you should—eventually. Taxes are the next most popular topic. Most people hate taxes and want to minimize them.
I get it. Taxes are a vital component of financial planning. But taxes, investing and most other “catchy” financial topics put the cart before the horse.
Financial newbies are bombarded with a plethora of catchy online financial content. Understandably, they get the false impression that these catchy topics are what they should focus on. Don’t believe me? Just ask a GameStop investor.
So, what’s the mysterious fundamental principle they should focus on instead? It’s cash flow. Yes, it’s a boring topic. But cash flow is the foundation of everything else in our financial lives. All those catchy topics—investing, tax planning, all of it—come after you understand your cash flow.
What do I mean by cash flow? It’s simply your income minus your expenses. When experts evangelize that you should “spend less than you earn” and “pay yourself first,” they’re preaching the gospel of positive cash flow. When they suggest you budget and track your expenses, they’re asking you to measure cash flow.
A negative cash flow has an inevitable—and painful—floor. You’ll run out of money. You’ll go into debt. Or go bankrupt. However you define it, you’ll achieve financial failure. None of us wants that.
Charles Dickens made this point in his novel David Copperfield, where the character Wilkins Micawber states: “Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
Your index fund portfolio is funded by positive cash flow. Ditto for your two-week trip around the Caribbean. Those fun topics follow from healthy cash flow.
How do we measure cash flow? Up until last year, I used the app YNAB. I still think YNAB is the best budgeting app out there, and I’d recommend it before any others. But when we married, my wife and I wanted to combine finances. We settled on a simple Google Sheets spreadsheet. We update the sheet every month with our current account figures. That allows me to do month-to-month comparisons and measure our monthly cash flow.
Without this kind of measurement, I’d be lost—like the couple I spoke with last year. They knew their income, which was $10,000 a month. They assumed their expenses were roughly $7,000 a month. Result: They had monthly positive cash flow of $3,000, right?
My prior career was in aerospace engineering, so I like to check my math. I asked this couple, “If we look back at your bank and investment accounts over the past year, can we see roughly $36,000 in contributions? That would be $3,000 a month for 12 months. If we see those contributions, we’ll know that your cash flow measurement is accurate.”
Can you guess where this is going? The money wasn’t there. None of it. Their accounts showed no measurable growth over the past year.
You might be wondering, “How can that possibly be? How can someone be missing $36,000 a year?” It’s always the same culprit. Always. They assumed they knew their expenses, but they were wrong. Garbage in, garbage out.
A poor understanding of your spending is nearly impossible to overcome. One of my blog’s readers confessed to me that his annual income had been roughly $400,000 for 10-plus years, but he had barely saved beyond his 401(k). How can someone with $4 million in income over a decade not have an after-tax penny to show for it? There are only two options: He either misunderstood his income or misunderstood his spending.
We rarely have a poor understanding of our income. Income comprises one or two transactions per month. It’s easy to track. Do you know anyone who has no idea what his or her salary is?
But spending involves dozens of transactions per month. Measuring that spending is tedious and easy to mess up. It frequently forces us to face painful conclusions like, “The Peloton has spider webs on it. We haven’t used it in three months, but we’re still paying for it.”
It’s not fun to face that music. But you can’t manage what you don’t measure. You need to understand your spending to know your cash flow.
It strikes me that I might be preaching to the choir. “Jesse, this is HumbleDollar. We’ve been around the block. We know our cash flow.” But I also know many HumbleDollar readers serve as financial guides to others.
Our friends, family and colleagues know we’re “money people.” We get peppered with questions about target-date funds, Barron’s cover stories and the latest yawping from Jim Cramer (no relation, I repeat, no relation). So maybe, just maybe, the next time your cousin asks you about GameStop, tell him: “Not to dodge your question, but let’s not put the cart before the horse.”
Jesse Cramer is the pen and voice behind The Best Interest, a blog and podcast. After a decade in aerospace engineering, Jesse switched careers and now works with clients at a fiduciary wealth management firm in Rochester, New York. Jesse enjoys reading, racket sports, and fostering dogs with his wife.
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Every time I hear about budgets, and paying attention to every transaction I giggle. IMO, it boils down to many small decisions we have made over the years and common sense.
* The profession we selected. hint: STEM
* How did we handle money? Frugally
* Big items. We bought a house less than 50% of what the agent told us we could.
Vehicles = mostly Hondas + Toyotas.
*We accumulated a large portfolio and only started investing in our mid-late 30s after immigrating here with nothing and retired after 23 years.
It wasn’t how much money we made, it was all about living below our means while our coworkers spent a lot more. We hardly ever got bonuses, never got profit sharing, or stock options.
*Never in my life, have I used a spreadsheet, excel or any other software.
* Savings = started with 401K. For every raise, use half for expenses and increase saving by the other half. We never touched the 401K.
*We paid our credit cards and all bills on time. All were setup and forgotten. I hardly do anything manually.
*We use simple 2% Penfed cash back credit cards for everything from $1 to whatever, it also has zero fees around the world. We use Penfed 5% cash back for anywhere gas in the US. Schwab Global ATM has zero fees around the world too.
*For big items we take the cheap low interest, think 0-1.99%. I made a lot more in the market. That sounds dangerous for many, but not if you know and understand money.
*Investing: I never practiced buckets or income. It was always investing at 99+% in the best risk/reward funds and staying in the best categories. Later I added timing. I know, it doesn’t work, but it did for me.
*We make long-term goals and reach all/most of them.
*Our motto in the last several decades has been, if we take care of our savings first and pay for all our bills on time, then we don’t care about budgets and each transaction. Of course, we looked at our accounts to see if we could afford it.
Jesse, very much enjoyed your article. Generally, folks spend too much time trying to get the investing part exactly right and not enough time monitoring their spending habits. A good balance of both will go a long way…
Thanks Andy! I’m glad you enjoyed it.
I have always gone the pay yourself first route. Once a month I add up my income and transfer 6% to a brokerage account. That and the 401k have funded our retirement with no budgeting needed.
This works well for a lot of people. It’s a great tactic. Pay yourself first, spend second.
Jesse, you mentioned using Google spreadsheets at one time to track expenses. Do you have an opinion or feedback on a program offered by Tiller that uses Google spreadsheets to track expenses? My interest is solely on tracking expenses, not budgeting or net worth.
Hey hey. I’m not familiar with Tiller, actually.
Once I figured out just how much carrying a couple hundred dollars on a credit card was costing me, I went to pay yourself first budgeting. Retirement account first, saving for mid-term goals second, saving for known expenses that don’t happen monthly third, bills fourth, then I can spend what’s left. If I have more than a thousand dollars in checking the day before my first paycheck of the month, I sweep the extra into my Roth IRA. I only have a vague idea what I spend on groceries and gasoline in a month, but I know exactly what’s going to retirement.
Good article and I totally agree with your point about managing for income after 7 years in retirement. I use a very simple system, I just add up my assets once/week, check the totals, and very closely track any changes. This system addresses several concerns:
Bill
Hey Bill. Exactly! Yes, same here but on a monthly basis. Your Point #2 is an easy, effective way to monitor cash flow.
Excellent advice, Jesse. The budget style my wife and I use is really just making sure the important stuff is taken care of first, then tracking our spending to make sure we know we’re staying within limits we’ve agreed on. I’m more naturally frugal than she is, so having a system keeps us on the same page. Got to keep track of the “portable property,” as Micawber might say.
Thanks Edmund!
Ed, how do you not stay within your limits if you don’t spend more than net income?
Good point. The “important stuff” are things like regular monthly bills, planned savings, planned giving and the like. The difference between the sum of those items and our income is where we have to have our consult. I don’t see the need to spend it just because it’s there, and just because we haven’t agreed ahead of time on every possible budget iota. I like a little bit of ready cash “just in case,” and I like to see it grow. I like to see what’s going out. All that being said, my wife is wonderfully frugal, and we haven’t had a negative talk about money in many, many years.
I think it’s great if you can teach your grandkids the basics when they are young such as
Once they were old enough to make some $$, we helped them open a Roth account and invest. Several of them have automated a monthly contribution into their Roth account. The most fun is when they see their money start working for them.
Thank you for your article. I mworked in the investment business for 42 years and the hardest discussions I ever had were not about investment performance, but about spending. Too many clients had little understanding of what they were spending and instead, blamed poor investment performance for their loss of capital. And, as you note, if you managed to get someone to make an effort to identify their spending, it was more often a work of fiction than an actual account of where their money was being spent. MAny of the people I worked with preferred to spend time identifying what assets a client had and what their investment goals were. That’s all good, but what they spent is equally important.
Thanks for reading it, UofDuck.
For those who use Bank of America, they now have a great budgeting and spending feature which is only available on their web client (no mobile). I don’t use the budgeting part but the monthly spending by account is sometimes handy. I’d hope most bigger banks have this now.
I’ve never been much for budgeting. I put all my savings, investments, and retirement funds on automatic and, as long as they were growing, didn’t worry much about sending. By the time I retired (at 51), I was saving over 30% of my income.
After retirement, I did set a target amount for total spending but didn’t itemize it. I entered all my expenses into Quicken and found that they came to considerably less than my target. I eventually stopped paying much attention to expenses as long as they were less than my income.
I’m still trying to decide how much of my assets I can prudently donate to my favorite non-profits during my lifetime. Like Jesse Cramer, I live in the Rochester NY area, and I notice that he’s on the board of one of those organizations that I donate to.
Hi Gary – thanks for writing in. And thank you very much for donating to Lollypop Farm. We couldn’t do our animal welfare work without donors like you!
One thing I’m proud of (or ashamed of) is the notebook I have from since 1993 detailing all my spending. (“Cash” counts as an expenditure with no further detail on what it’s for.) I started this because I moved into an apartment after college that might not have been affordable. I had a roommate bail on me and was a bit desperate. I keep a running total on the side of whether I’m positive or negative. I wanted to see whether I’d need to cut back on stuff. Over the years, I’ve reset that running total to $0 a number of times. The running total really makes no sense at all, but I still keep it, as well as detailing each of my expenditures, 30+ years later. I’m on my second notebook. There are all kinds of softwares I could use, I’m sure, but I stick with my spiral notebook.
Your article makes me think of the folks who have a big house but can’t go to dinner with you because their expenses for the house eat up their cash.
Not being judgemental (yes, I am). Maybe they don’t enjoy going out.
Many years ago, while looking for our first house, a wise person told us, “Don’t get married to your house.” (ie. Don’t overspend).
This article is spot on. Knowing your real +/- cash situation is a must. However, I want to quibble about the nomenclature. Many finance writers treat income and cash flow as synonyms. They know they are not but they think they need to simplify to help people understand. Which definition of income is equal to cash flow? Probably none are. When someone says they made $400,000, did they actually have $400,000 going into their bank account? You can’t spend what goes into your FSA or your 401K, and all the other deductions on your paycheck. Your W2 doesn’t show your incoming cash. If you reinvest dividends they aren’t cash either. So, somehow we have to help people understand what amount of the funds that flow through their lives they actually control, and then how are they spending those dollars.
“The Peloton has spider webs”—you’re funny AND you quoted Dickens. I’m totally checking out your blog and podcast!
I love my Peloton, though. It’s never had time to grow any spider webs!
Thanks Dr. Lefty! I do my best to keep it fun and light. And helpful!
For me, the first step in retirement planning was to know my current spending. In 1998 I began entering all incoming payments and outgoing expenses, big and small, in Quicken, intending to do this for one year. It was so easy and so worthwhile that I still do it to this day.
Then I made a Lotus 1-2-3 spreadsheet, with columns of years and rows of income and expenses. I projected ahead 20 years with an inflation of 3% per year. As I learned more and began to invest, I added more rows, projecting withdrawals from my 401(k) and investments. After doing this for a decade, I was able to retire with confidence.
On the first day of every month, I run a Quicken report showing income and expenses for the previous month, so I know how I’m doing.
That first sentence – I couldn’t agree more. Knowledge of spending is fundamental to a retirement plan.
Always good to read your content, Jesse! For some reason my wife and I never needed to budget. I always earned more than we wanted to spend and consequently we saved and invested much more than we needed to retire early. But I think that puts us into a minority group.
Steve! Good to see you here. Hope all is well. Sounds like you’re frugal by nature – a super power!
Thanks, Jesse, for getting to the core of being able to save and invest.
Despite having a passion for spreadsheets, the most effective cash flow tool for me has long been the back of an (used) envelope. Expenses are grouped into broad categories and always generously rounded up. I typically
don’t revisit my budget “sheets” except to check if an unanticipated expense exceeds the “miscellaneous” category.
Now in retirement and with more time on my hands, I print a month-by-month bill paying planner. It includes columns for billing entities, payment method, and typical due dates. I record each payment date and amount as bills are paid. This helps me identify missing or late bills and remember to make payments. Could this be better automated with Quicken and e-bills? Certainly. But I suspect my paper and pencil methods will outlast those more modern ones when my memory declines.
You’re welcome, Jo Bo, thank you for reading.
All true Jesse. I know guys that are like walking encyclopedias when it comes to sports section statistics, but ask them about their cash flow…..
I fully agree about what you say regarding cash flow and knowing about spending, but for the life of me I do not and never understood the need for budgets, spreadsheets and the like to learn what you are spending.
Your example of the $36,000 is easy to solve, you save the $3,000 a month first, then spend. As far as that big once in a while spending goes, accumulating it through the ongoing cash flow and then spending it seems simple – to me at least.
We are in Florida for a month, I don’t worry about what we are spending becasue all we need was accumulated in a separate savings account over the past year. If it wasn’t we wouldn’t be here.
Living within one’s means includes saving, thus saving first drives the means and there is no need for a budget. Of course, this assumes a person has the determination to not spend more than they have available each month.
So you budgeted by having a separate account.
Hey R Quinn, thanks for the thoughtful feedback. I think we agree.
Does someone need to know they spend $800 on groceries, and $100 on clothes? Not really.
Should they know they spend $4900 a month, and earn $6000 a month? Yes.
The level of detail depends on the person. But base level cashflow knowledge is fundamentally important, in my opinion.
I don’t need no stinking budget either Richard, but not having one is the reason why a lot of people spend their lives living under water.
You are too funny, Dan.
I never made any complicated mathematical calculations or performed any wizardry with spreadsheets.
I always knew what I had to work with and conscientiously adhered to practicality and common sense.
Having a budget would have made me feel poorer than I was.
I am happy, however, for those who maintain a budget to assist them in reaching their goals.
I’m guessing it is not the lack of a budget, but lack of financial discipline that gets people in trouble. As I have said too many times on HD, save first, never pay credit card interest and then spend whatever you like. We did it all our lives and still do it in retirement.
It doesn’t take long after retiring to know your ongoing spending each month and you should know cash flow regardless of the source. If I were living on investments I would set up a regular monthly drawdown that sustained me and then fit spending into that flow. Actually I would set up an immediate annuity to cover such expenses and build up savings to cover large discretionary spending and emergency spending.
“… it is not the lack of a budget, but lack of financial discipline that gets people in trouble.”
Amen
It’s not that hard to determine how much you’re spending. I have one checking account, and all my budgeted spending income goes into it. Every month, I can add up what came out of the account, and add the Medicare premium deducted from my SS check. That must be my spending. I don’t care what I spent it on, I just look at the total – is it under budget or over budget? Only if you are over budget do you need to investigate where the money is going.
We follow a similar tracking procedure, except we do it once a year. If the checking account balance at year’s end is above what it was in last year’s tally, cash flow is positive–and the surplus is moved to investments (we don’t draw anything from our investments except our RMD, which is tracked separately–most of the RMD goes back into investments, taxes on the RMD, QCDs or Roth transfers). The first 12 years or so of our retirement (before claiming Social Security) we had negative cash flow and we did use Quicken to track everything. After cash flow went positive, we stopped tracking and just enjoyed ourselves. If the yearly balance check ever goes negative, we will have to get back in the weeds I guess, but I’m not going to make work for myself until then.
You just described my budget method as well.
Many years ago working in business, us managers were measured individually on cash flow as much as we were measured on profit margin, revenue growth etc so I learnt the value of this. Doing your own spread sheet with your income and expenditure items (we automate most of the main items) including the exact date the money leaves your account gives you an excellent handle on your finance and over years that counts.
So right. The first time my now wife and I lived together – summer 1985 – neither of us had anything. Poor, poor, poor. That summer I was studying and had only part-time teaching gigs. Every single night, we quite literally emptied our pockets of all bills and change and budgeted exactly what we would spend it on the next day. Many years and some extremely big salaries later, we no longer empty our pockets nightly. But we still have a weekly ritual — every Saturday without fail – of truing up everything we have and everything we’ve spent. Is it necessary? No. we spend so much less than any safe withdrawal rate that it isn’t a problem. But it is a ritual that is meaningful to us and that keeps us from getting financially sloppy, and it is one that I’m sure we will keep as long as we can still see the computer screen.
An example of Poor, Poor, Poor: After my wife and I were first married in the summer of ‘83 I attended graduate school. I had managed to save 5K working as Physical Therapist for two years. I was paid a small stipend as an Athletic Trainer, and my wife was working minimum wage as a floral designer as she was unable to get a job in her profession. My wife reminds me that we would take out only $5 at a time from this new device called an ATM. Our only splurge was weekly Friday nights all you could eat Spaghetti dinners with free bread at the local family Italian restaurant. We used to hoard extra bread before we left one because it was free, and two because it was delicious.
We were also married in June of ‘83 and poor, poor, poor. I remember one Saturday night we went to a double feature at the $1 drive-in movie (so $2 for both of us). We stopped at the 39-cent hamburger stand (that’s what it was actually called) and got burgers, fries, and Cokes for dinner. We air-popped popcorn at home for the movies. Total for the Saturday night date was well under $5. We still talk fondly about that night.
Ah, air-popped popcorn, something I definitely don’t miss!