From both myself, Lauritz von Hörsten and Phillip Swart, at Koru Business Consulting a very warm welcome to our second Blog entry. We aim to share information and articles that will assist you in your daily financial planning but also provide insight into the economic conditions locally and internationally. From time to time we will post changes to important legislation influencing the general public and our clients in general and we hope that these bits of information assist you in making informative decisions.
This piece was written by Laig and Laicy (http://www.laigandlacy.com) called "You have a budget but do you have a plan". This piece sets out a 9 step plan which could not be more applicable under the current economic downturn we face locally. We would like to thank both bloggers for sharing this piece with us and look forward to watching their blog grow along with their own personal financial journey.
You may have a budget but do you have a plan?
Having a budget is without a doubt the first and probably the most important step one should take if you are serious about taking control of your finances. If done correctly a budget allows you to allocate your income effectively and to have greater insight into where your money is going each month. But a budget is only a tool to help you achieve your overall financial plan. In your financial journey you have to know where you are going and a budget will not help you with that.
One of the major influences on our journey to financial independence is a guy called Dave Ramsey. On his website he lists seven steps which focus on taking an individual out of debt and stress and into a life of saving and financial freedom. For Lacy and I we found that this approach was both easy to understand and implement. However we felt that whilst it gave us a fantastic framework to structure our financial plan we thought that we would tweak it a bit to suit our journey. We therefore arrived at our own version titled “9 Steps to Financial Freedom” and it looks like this:
As you might have guessed the coloured blocks on the right side of the image indicate whether we have achieved our goal (green), are almost there (yellow) or still have some way to go (red). As we move through the year we update this document accordingly either by changing the colours, changing targets or perhaps adding an additional step which we feel might assist us on our financial journey. We believe that by following our plan we will reach our goal of financial freedom. What is important to note is that this plan needs to be followed sequentially as much as possible. Start at Step 1 and move through the list.
Can you see the difference between a budget and a plan? A budget focuses on the finer detail of your income and expenses whilst a plan sets out your journey. Put differently, a budget is like a compass showing you where to go and your financial plan is like a map showing you your route and destination. Let’s look at each step in a little more detail:
Step 1: Start an Emergency Fund
All of us at some point during the month encounter an expense for which we did not budget for. Maybe it was for repairs done to a car, for a child’s school outing or for whatever. The fact remains that you need to pay for this expense but with what money? If you don’t have any savings then you might be forced to take money out which was earmarked for another expense, ie. Food, cellphone, etc. The problem with this is that later in the month you will need this money but unfortunately you spent it already. In the absence of savings most people resort to credit cards or loans to finance this shortfall. This, if not repaid quickly, will lead to further money shortages and troubles in the near future.
However, having an emergency fund will allow you to fund small extra expenses without having to go into debt or cash out an investment earlier. There is no set amount that your emergency fund should be initially but it must be able to cushion you against the one or two expenses that life might throw at you during a month. Ideally, if you use this emergency fund then you should change your budget in the next month in such a way that you are able to restore it.
Step 2: Pay Off All Debt
This has been our biggest issue to date. Over the past couple years we racked up an awful amount of debt which we are still busy paying off. Debt is one of those things that is so easy to get into, feels great at the time as you are able to spend on whatever you want, but the hangover is horrendous. Paying off debt is doubly difficult because not only do you have to reduce your expenditure in order to fund this repayment but you also need to readjust your mindset and spending behaviour so that you don’t go into debt again. However, since we started treating debt as an emergency (Thank you, Mr Money Mustache), we have literally seen our net worth increase far faster than it was before we started paying off debt. I will write further on this topic in a future post but for now all your efforts should be placed on eliminating debt as fast as possible.
Step 3: 6 Months Expenses Saved
After you have an emergency fund and eliminated all debt your efforts should be focused on adding to that emergency fund. Your targeted amount should be between 3-6 months of your expenses. The reason why this step is important is because life is unpredictable. If you rely on a salary from an employer or a certain income from your business what would you do if all of a sudden this was withheld from you? You still need to put food on the table, pay for water and electricity, cellphone bills, etc. You definitely do not want to cash out investments early or go into debt in order to fund your monthly expenses. Having an account with a balance of between three to six months worth of expenses will afford you the time needed to find a replacement income or another job without stressing about where your next meal is going to come from.
Step 4: Invest 15% of Gross Salary into Retirement
How much should I save towards my retirement? This is a very common question and most people will tell you to save as much as you can. Personally I believe that there is no correct answer but for readers of this blog you would know that we advocate saving 25 times your annual expenses and then only withdrawing 4% of that final lump sum each year. We therefore focus on controlling expenses as much as possible whilst increasing our savings rate each year relative to our annual income. A general rule of thumb calculation advises you to save at least 15% of your income towards your retirement. However, if you are able to save more then this will assist you in retiring earlier.
Step 5: Reach Our Lump Sum Target
We track our net worth every month via 22Seven. We know that we need to reach 25 times our annual expenses before we can think about retiring. After the above Steps have been reached all focus should be put on savings towards this number. The more we save (and the less we spend) the earlier we can retire financially free.
Step 6: University Funding for Children
We don’t have any kids yet but one thing Lacy and I are both determined to do is provide a quality level of education for our child. Ideally when our child is born (or sooner) we will begin investing in an account which will assist with funding this tuition. Through the effect of compound interest over approximately 18 years this should be able to assist quite substantially with the cost of the child’s education.
Step 7: Pay Off Home Early
Again, this is an area which we haven’t ventured into yet. Currently we rent our apartment but we would like to own our home one day in the future. Time will tell whether we make this investment or not.
Step 8: Build Wealth and Give Back
Assuming we are able to successfully navigate through all the previous steps our next focus will be to engage in more philanthropic adventures. Personally I am very passionate about the Cape Town Central City Improvement District program (CCID) and want to increase my efforts in assisting this organization more. For those living or working in Cape Town, the CCID are the awesome ladies and gents wearing lumo green uniforms who keep our city clean and safe at all times of the day and night. Other areas which we hope to become more involved in is providing clean water to more people, plant more trees and to focus on sustainability in general.
Step 9: Live Off The Grid
We hope to one day be able to derive our household power needs from solar energy, reduce our dependency on fossil fuels and, hopefully, be able to desalinize enough water for our own daily consumption. The technology to achieve all of the above is available today but it is out of our league at the moment.
And there you have it, our financial plan. These are the major money-related goals that Lacy and I have set for ourselves. This blog is meant to document our journey through this plan. We budget every month in such a way that we can slowly but surely move through each step. Some months are better than others but we find that having a plan does tend to subconsciously direct and change our behaviour. This plan is not going to be achieved quickly, in fact, this is going to take us at least 13 years. But we are finding that through the day-to-day budgeting and activities our overall financial plan is slowly starting to come together.