Financial Wizardry: Guide to Managing Your Money
Usually, it's me who gets pissed off when hearing yet another story from someone who always spends 100% of his income, no matter how much he earns, and then asks to lend a little bit till the next month's payday.
Safe freelance setup
I think I've already mentioned in one of my previous posts that I've spent some significant time, reinventing a wheel inventing a kind of safe freelance setup.
I've described how I tried things like having several projects at a time (two and even three) to avoid sitting on a bench, and why it didn't work.
Afterall, my solution was to pay attention to my personal finance and construct safety on that ground.
Disclaimer
I've got a superpower. Even when I did literally zero personal finance mananagement I was doing it fine. When I was getting regular monthly salary I was not tracking expenses or doing some wise tricks with my personal finance at all, but it always turned into at least 1 month salary backup for a rainy day. So on a payday I was always having 2 salaries in cash. I have no idea how it works, a kind of gut feeling of expenses. 🤷♂️
Useless Advice 1 - Write it down
The very first thing suggested when approaching personal finance is to start keeping track of all your expenses. Frankly, all my attempts to do it ended on the very next day I started.
It's just too boring to write down every purchase even if it is a mobile app with a cool UX. Every time I installed an app, I wrote down a couple of purchases and never opened it again.
Some personal-finance mobile apps learned how to parse bank-related SMS and categorize all purchases automatically. And now, every second banking app categorizes all expenses automatically.
The huge delusion is to believe that writing down everything and classify the expenses will fix your personal finance and make you rich.
You will probably notice that you've spent to much money on something. (Don't you know you bought a yacht last month?). Perhaps you will decide to cut down some categories in of favor others.
But that won't change anything globally. Like giving up smoking doesn't make you a millionaire by itself by saving on cigarettes.
Useless Advice 2 - Give every dollar a b job
The next commonly adviced step is to give every dollar a job. In other words, that's all about budgeting.
Advice #1 will let you have all your expenses divided into categories. Knowing your income amount, you assign every incoming dollar to some future expense. Important thing is not to forget to leave something for a rainy day.
Ok, at least it looks more like a practical "how to".
Most people are unlikely to have a chance to even approach Advice #2, because they will stuck at Advice #1 by just not tracking their expenses. Advice #2 assumes spending a lot of time architecting your budget.
Not just making it up with a calculator, but also predicting your future expenses based on... oouuhhh historical data?! WAT?! How much data is needed to predict it accurately? Big Data? Machine Learning? Data Science? Who is it designed for?!
Who the hell on this planet can predict accurately his expenses along with his income for at least 1 year ahead? Elon Musk?
Ok, if you can, ping me in comments, I would like to get acquanted with you.
Once I was reading an article about a family of 2 that utilises "give every dollar a job" recipe and is very successful and pretty satisfied with it. In the end they've mentioned that if they both loose their jobs, they will have 1 month of money buffer to find new jobs.
It's a total CRAP. Guys, if you are having something similar, your personal finance is fragile like glass. 1 Month is nothing. Half a year is at least something to deal with.
Advice #1 and Advice #2 are not just useless because they are hardly achievable and overcomplicated, and require a lot of time...
They are useless mainly because they zoom you in, they are burying you in financial micromanagement while managing your personal finance efficiently requires you to zoom out.
Frame your income
I don't remember where I've heard it, but I liked that approach.
The idea is not to start with writing down the expenses but to enter from the backdoor: income.
The approach is to frame income into
- Inevitable costs
- Recreation expenses
- Savings
The proportion is to be tuned, but in my opinion, your personal finance may be considered to be more or less healthy if you can keep the proportion close to 50% / 30% / 20% (Inevitable costs / Recreation expenses / Savings).
Before you even start
Consumer credits and loans
That's the first thing you are to get rid of. Get rid and forget about it.
Mortgage
When talking about mortgage and comparing it to rent it's reasonable to take on the account such parameters, like interest rate, location and it's price growth opportunities, inflation, rent prices, etc. That's exactly what is not done when usually comparing rent vs. mortgage. That's why let's not kill it and just consider as inevitable costs if you have it.
Debit cards
Debits cards are your friends. Especially with cashback and interest rate on leftovers. That's what helps your cash survive inflation while you sleep.
My secret sauce
I've deprecated framing between inevitable costs and recreation.
First of all because Savings is the most essential. Secondly because I'm lazy. Furthermore, my expenses are unpredictable and volatile just like their structure and the rate of inevitability.
In my case, Inevitable costs balance with Recreation expenses automatically. Just because they are Inevitable.
So the whole thing is cut down to a single parameter: % of income that goes to Savings.
No matter how much you earn. Saving 5-10% of income whould be unnoticable for the whole budget, but it will play a huge role in future.
Share experience
I don't remember the exact numbers, but it was somewhere around 10-20% when I've started freelancing and payed more attention to finance. As for now, I'll just say that I've managed to grow savings % parameter significantly during the last years and now they are close to best F.I.R.E. practices.
In my opinion, the most optimal strategy is to increase savings parameter gradually untill you face a slight feeling of lack of money. Then try to increase income in absolute values.
Flexibility of expenses
That may be the reason why cutting down expenses artifically (by increasing savings paramater) works.
I've found out on practice, that if my average normal monthly spends is 1X, it can easily grow up to 2X-3X if I don't limit my spends anyhow.
On the other hand, in case of crisis conditions, I can cut my expenses down to 0,5X rather easily almost without severe drop of quality of life: Just go out once a month, have a meal at home, work at home, buy nothing extra and that's it.
When I see 5X monthly spends in my spreadsheet, I'm starting to drop tears.
Now, by tuning savings parameter, I'm expecting to get somewhere near 1,25X-1,5X because 3X is really too much.
1X amount is reasonable for evaluation of expected spends. For example, 1X multiplied by 6 is something that can be enough for half a year.
Clash of Caches of Ca$h
Framing wisely
I devide all income into Cash Levels allowing it to go from one level to another like fluid in communicating vessels.
Level 0 - undistributed income
While on the way home with your salary in pocket.
Level 1 - Spendable
Accessible like cash in your pocket. As for me, I mainly use debit cards for it but also store something in cash. Level1 is all funds left after applying Savings rules to income.
All amounts that appear to be on Level1 can be already considered as spent. So there is no sense to evaluate or classify carefully what's going on here. Amount is also rather low - usually somewhere about 1-2 months of usual 1X expenses. Better if 2X-3X expenses. That's what is considered "cash".
As for me I cover all my expenses with Level1:
daily expenses/vacations/gadgets/not matter and never let my hands into Level2.
Level 2 - Crisis Backup
Non spendable under ordinary circumstances. If Savings % parameter is chosen optimally, Level2 is kept untouched while Level1 is always enough to cover expenses.
It should absorb all freelance uncertainty in case of suddenly finished projects, time on bench, while looking for new projects, etc.
Waiting for a super-cool well-funded freelance project in the worst times. Suddenly happened relocation expenses in case of a cool job opportunity in the other side of globe.
I believe that 6-12 months backup is really enough for covering almost all possible cases.
18 months backup can also include legendary armor kit for implementing a couple of side projects and then looking for a relocation package to Antarctica on a position of a senior penguin developer.
Level2 must be still accessible but it doesn't need to be as liquid as pocket money. Bank account with some tiny interest rate and without any time limitations on withdrawals is pretty suitable.
Cash Level Management
From the very first zero level, income is distributed according to the Savings % rule. Part of it is going to Level2, the rest is to Level1. If Level2 plan is fulfilled, all savings are going to Level3
As I've mentioned, in my opinion, the best strategy is to choose some basic Savings % parameter to start with and then try to increase it gradually. It can be considered to be choosen optimally if expenses are covered tightly and Level1 amount does not grow too much. When Level2 is fullfilled all the savings are targeted to Level3. Simple and effective.
Level 3 - Early retirement package
When Level2 plan is fulfilled you don't need to collect any more.
That's the place where long term planning strategy is in the game. Liquidity may be low, because the timespan is at least more than 3 years. As for me, I'm trying to think as wide as possible, applying 10 years planning interval for the Level3 when considering liquidity, profit opprortunities, etc.
In fact, Level3 is even more complicated than just investments and profits. It's also about your whole life planning in a broad sense, like choosing a place to live, where to grow up or not to grow up kids, etc.
So it all turns into stochastic N-dimensional differential non-linear equation with very unstable numerical solution.
But if to it cut down to just investments it's also an interesting thing to research and think about.
In fact, there is not so many available options for an ordinary FIRE-guy:
- Long term deposits
- Real estate
- Financial markets
Obviously, deposits are the most simple and accessible with the lowest interest rates. Real estate may seem the most obvious and the best solution with high entry level due to the capital required.
Anyway, I have strong concerns about long term opportunities for real estate.
Financial markets seem much more complicated then they are.
In my opinion they are more decieving then compicated. Decieving thanks to skammers and bullshit around them. Decieving about expected returns wrapped into all kinds of cognitive biases.
But what is true about financial markets is that they may offer additional returns for additional risks, comparing to deposits.
I think that theme deserves a separate and a very long article and I'll write it one day.
Our goal is FIRE
FIRE aka. Financial Independence and Early Retirement.
According to the best FIRE practices we need to save 25 annual expenses to FIRE successfully. Somebody has calculated that this amount, invested in stocks + bonds index funds, will be enough for living assuming, that only 4% of such portfolio will be spent every year after the retirement.
That's rather large amount and I think that the majority of FIRE-inspired youngsters won't achieve it at least by the age of early 40s.
And even if they do, there are still many possibilities of sudden fail, like global financial crisis that may suddenly wipe a significant part of the portfolio.
Anyway, that doesn't mean that this is a bad idea. Managing personal finance wisely is GREAT idea and FIRE can be considered as nice goal or an ideal case.
No doubt that it's still pretty good to be at least 50% financially independent while going on with your favorite daily job on part-time basis, for example. Any better than 100% dependent.
Scaling your Personal Finance
Family scale
It's pretty simple to scale the approach to a family. The only thing to be added is one more parameter that will separate shared family income from personal incomes of each member.
Probably some people would prefer to have zero-personal and entire-family. But in my opinion it's more antifragile to separate these two things in some proportion. The next step is to apply the whole approach to personal income and familiy income separately. Eazy breezy.
Company scale
Can it all be scaled up to a company size? I think not. That's why it's personal.
Company is completely different first of all because ownership and operational roles are separated.
It's wise to keep the whole company finance separated from your own.
Personal finance strategy is applicable to the dividents you get from the ownership of the company. Personal finance strategy is applicable to the salary and bonuses you personally get for your role.
Instead of conclusion
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