AS we live our lives as best we can, our individual journeys — over the miles and through the years — undulate through good times and bad. Each person's terrain is different. But through it all, our intermediate and, later, ultimate economic states are determined by how wisely or unwisely we carry out these five activities:
1. Generating active income by working;
2. Determining our desired lifestyle and paying for it;
3. Accruing debts along the way and paying them down;
4. Building adequate cash cushions and reserves for life's endless stream of challenges and outright emergencies; and
5. Saving and investing to accumulate future wealth.
For some people, these five core economic activities are kept front and centre. They focus on them every day. For most others, though, awareness of those critical money-related activities is low — until a crisis, big or small, blindsides them.
The good news is that IF we let a catalysing crisis awaken us to the importance of living proactively instead of reactively, we can readily reassess our priorities to live better and more mindfully.
Consider how we generally think about assets and liabilities: All of us know assets are things we own, and liabilities are debts we owe.
That bit's simple. Here, though, are where things get tricky:
When it comes to liabilities, we should control our unlimited appetites to borrow less than we can, and, at the right point in our adult lives, decide to stop taking on fresh loans and then switch mental gears to ferociously focus on accelerating our personal debt repayments to clear all liabilities as quickly as possible. I have clients of my holistic financial planning practice who have primarily hired me for this purpose.
However, many more of my financial planning clients are less focused on the liabilities side of their respective net worth statements, and more interested in optimising their mix of assets. While our assets comprise all the stuff we own, they actually fall into two categories:
1. Depreciating assets or negative cash flowing assets; and
2. Appreciating assets or positive cash flowing assets.
SETTING GOALS
Over time, as we age from year to year, we should set two linked goals, namely, to reduce our ratio of category 1 assets (Cat1A) to our total assets, and increase the ratio of our category 2 assets (Cat2A) to our total assets.
If we refer to our total assets as TA, it's easy for us to understand that: TA = Cat1A + Cat2A
Translation: Our total assets (TA) obviously equal all our category 1 assets (Cat1A) plus all our category 2 assets (Cat2A) because any stuff we own must fall into one of those two mutually exclusive groups.
But why should we — as we age — aim to decrease our Cat1A/TA and increase our Cat2A/TA respective ratios?
Well, category 1 assets make us poorer over time because they either depreciate, like our cars and computers, or they suck up cash like the home we live in. But be careful not to oversimplify things by saying Cat1A items are 'bad'. They aren't. We need stuff like cars, watches, tablets, computers, stereo systems, furniture, books and, most obviously, our homes, plus lots of other things, to live well.
But if, as we age and move closer to the end of our working careers, we don't also increase our store of category 2 assets that appreciate or that cause cash to flow passively into our lives — which means those Cat2A items work for us — then our financial futures will not be bright.
This is why it is vital for all of us to manage our personal cash flow patterns responsibly by spending less than we earn, and saving and investing the difference. Responsible cash flow patterns are established through written budgets. So, establish a written down budget for yourself.
SAVINGS AND INVESTMENTS
You'll never get through a single month precisely matching the dictates of your written budget, though. Don't let that demoralise you. Your budget is a dynamic document you should craft and recraft (meaning redraft) intermittently. Done correctly, it can help you generate healthy sums of monthly cash flow surpluses.
You should then — carefully and wisely — channel those surpluses into savings and investments or in other words toward Cat2A items. As you do so, month after month, year after year, and decade after decade, one day you'll look up from your grindstone or workspace and realise you're in terrific financial shape.
I urge you to set course for that bright future. And, in case, you feel you've let things slide too long, also focus on your health and fitness to improve your odds of working productively (and profitably) long beyond your expected retirement age. Doing so will give you an extended runway to get the right things done.
If all we've discussed seems overwhelming, then focus on this one dictum: Buy assets that generate for you and your family an integrated stream of passive income of interest, dividends, cash distributions and rental.
Simple? Perhaps not. But crucial, and thus worth doing.
© 2024 Rajen Devadason
Rajen Devadason, CFP, is a securities commission-licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).