Working On Me

I recently blogged about the eigth ways of getting rich. The last two of those ways are a little different from the others. They are magnifiers.

When you invest money you have earned you make it work for you. Quite independent of your efforts to earn money, it beavers away making you more. It is as though suddenly you have acquired staff.

And when you control how much of your money you spend and channel additional money instead into investment, there's a further boost to your efforts, another staff member stepping up and making you richer.

There is often a belief that being careful about spending is a bad thing; we think of the miser, Scrooge, and the unpopular colleague who never buys a drink when it's his turn. But these are extreme cases and controlling spending and being fundamentally ungenerous are two very differenet things.

Spending is identified by the experts as the top factor in determining your lasting wealth. It seems that you annual income does little to influence your long term wealth, but how you spend your income, whatever its size, is a good predictor of wealth.

I have a relative who illustrates this perfectly. She arrrived in the UK in the mid 1960s with her new husband. Between them, they owned £5. Although well-educated by the standards of the country of their birth, they could only find menial work in the UK, never earning as much as the equivalent of minimum wage. My relative, now widowed and a pensioner, owns property and other investments worth well over a million.

It strikes me that there are only eight ways to get rich. Any one or more of these has the capacity to make you wealthy:

1. Inherit from or marry a rich person
2. Steal, commit fraud or some other crime
3. Gamble
4. Entertain or exploit some other personal skill or talent
5. Own a business or represent other talented people
6. Buy and sell goods or services at a profit
7. Invest
8. Limit your spending

The more of these you do, the better your chance of establishing wealth. Very few of them are free from moral issues, but that's something you'll have to work through for yourself.

Most of us don't think twice about buying magazines or sweets on a whim when we're out and about or travelling to and from work. There is money in our pockets or purses and we simply spend it. Each of these little purchases seems insignificant, but the cost mounts up over time. If you buy a £3 magazine even once a week and a 50p chocolate bar twice a week that's over £250 in the space of a year, more than £20 a month that you hardly notice spending.

Over the space of a month, keep a record of your incidental spending, and consider the impact over a year. Decide how much you want to limit yourself to for this kind of spending, and set a monthly or weekly budget for this purpose. Place the cash in an envelope or coin bag and spend only from this bag. When it's gone, it's gone.

Impulse spending can ruin the most careful budget; impulse eating means more diets fail than succeed. A self talk technique can help curb these impulses. Impulses are hard to resist because acting on them provides immediate gratification, although it is often short-lived. You can resist an impulse by asking yourself how you will feel an hour from now (or a day) were you to give in and yield to the impulse. In all likelihood, you'll feel no better than you do now. Reinforce this by immediately focusing on what you hope to achieve by controlling your eating or spending and ask yourself how you'll feel when you achieve your goals through not yielding to impulses.

The biggest problem careful budgeters have to battle is the 'buy it now' habit. If we want it, and if can buy it, we generally do. The trick to taming your impulse purchasing habit is to fool it. Carry a notebook whenever you're out of the house. If you see something you're tempted to buy, write it down in your notebook and set a date on whioch you will buy iy. Try to put a date that's a month or more away.

When the date comes around, if you still want it just as much as you did, buy it. Alternatively, you might decide to just set a new date, further in the future. If you no longer want it, just cross it out.

I have found that more often than not, the urge to own an item disappears between seeing the item and the date I set to buy it, saving me a fortune.

Debt is what helps most people buy their home, but debt also keeps many tens of thousands of people from enjoying the benefits of financial security. Debt helps you afford the comfortable car you deserve, rather than the slightly less comfortable car you could afford with cash only. But debt in the way of credit card bills consigns a growing number of people to an endless cycle of running to stand still. Debt is what makes the economy boom in good times, but debt is what makes the bad times longer and more painful. Debt buys us things we could never normally afford, and yet it makes us pay for them many times over.

Here’s a familiar scenario. You have a credit card, probably more than one. There’s maybe £5,000 outstanding at the moment. On payday, you’ll repay about £500 of that debt and feel good, but you’ll find yourself putting purchases on the cards again as next payday approaches and the money runs out. Lo and behold, when the statements arrive, you’re right back where you started the month. Even if you manage to spend less on the cards than you paid off, the monthly interest on the outstanding balance makes sure you don’t really put a dent in the amount owed.

If you don’t recognise that picture, I’m genuinely pleased for you. But please believe me when I say that it represents a way of life for a large proportion of people, particularly the supposedly “affluent” or “high income” ones. And it’s a very difficult rut to get out of. You make a repayment, which reduces your available income, which forces you to borrow, so you make another repayment … and here we go again.

But there is a way out of the cycle. It is perfectly possible to wipe out that debt, establish savings and regain financial security. Although it may take a little while, it can start tomorrow. And because it will happen in a planned and consistent way, you can start feeling better from day one, secure in the knowledge that the problem is solved. Do I have your interest? OK, here we go…

STEP 1: Calculate your monthly spending. Add up everything you spend each month. Include all your bills and direct debits, plus one twelfth of annual costs like car tax and holidays. Do include discretionary spending on leisure as well. However, don’t include your repayments on this debt you are seeking to clear.

STEP 2: Calculate your net disposable income (NDI). This is the difference between your net monthly income and the figure you derived from Step 1. If you have a negative NDI, then go back to Step 1 and try to eliminate some of the discretionary spending, such as eating out or some (but not all) of your leisure activities.

STEP 3: Apply an 80/20 split to your NDI. 80% of it you should allocate to debt repayment and 20% to savings. If you can, set up standing orders to your credit card or loan account and to a savings account.

Before we go to Step 4, let’s see an example. You have £4,000 of debt and a net disposable income of £200 per month. So each month, £160 goes to debt repayment and £40 to savings.

After one month, here is the position:

After two months, things look like this:

After six and twelve months, you can see the effect.

To keep the arithmetic simple, I've ignored credit card interest, which will diminish in effect as you operate this plan, but will in reality add two or three months to the process.

Something interesting happens after 20 months in this example:

Savings have now reached the level of the remaining debt. Are you tempted just to clear it? Of course you are, but here is where Step 4 comes in.

STEP 4: Continue with the plan. Zero debt may look attractive, but zero savings is how you got into this debt in the first place. As well as repaying the debt, this plan seeks to regain you some financial security, so keep going.

Finally (in this case after 25 months), the job is done:

You now have zero debt, plus £1,000 in savings. You also have a standing order to save £40 a month, which can obviously continue. Furthermore, the £160 a month you were using in repaying the debt is now freed. Some of this you’ll want to spend and enjoy, but why not use part of it to increase your savings, perhaps in a longer-term plan?

Last week I wrote about putting yourself at the front of the money line. Before even a year of applying this technique has passed, you will have accumulated a whole extra month’s earnings. Keep it up, and compound interest will mean before long you will have a year’s earnings on deposit, then ten years’ earnings. And if you can manage after a while to put away 12% or 15% through better financial discipline, then you will get there even faster.

Another boost comes when you get a pay rise and decide that half of it will go straight to your savings. After a few rises, you might find that 25% of your earnings go straight into your special account. A few simple sums will show you what a huge impact this can have on your future financial security.

Most people receive their income these days on a monthly basis, but it seems that as soon as the money arrives, everyone is lining up to take a chunk of it. At the front of the queue is the cost of your housing – the mortgage repayment or the rent. Then there are the utility bills, groceries and the general living expenses, and people tend to think of what is left at the end as ‘their’ money. In other words, you stand at the back of the money line and have to be grateful for whatever is left, if anything.

But the money was earned by you, was paid to you. Why should you have the last call on it? What I'm suggesting is that you move yourself to the front of the money line. The first call on your money is the 10% of your income you set aside for yourself. Everything else has to take its turn, because that 10% is yours. Set up an automatic transfer with your bank so that this money is transferred to an interest-bearing account as soon as your monthly earnings arrive at the bank. Then, everyone else can have their chunk afterwards.

Of course, you still need to live within your means, so effectively you are now surviving on only 90% of your income. But you should be able to do it quite easily. In the past, you have been content to just wait your turn and take what is left. If there is an expense that you have to think about, then too often you will have decided there is enough money and just incurred it,. The result has been that you have probably never been able to accumulate significant savings. But by putting yourself first in the money line, you limit your ability to spend on unnecessary (or even frivolous) immediate wants.