This is a guest post by Robert, who lives in Calgary and worked as a financial adviser before retiring at age 35. He is married, has three kids and has returned to school with the goal of eventually living and working overseas.
Financial planning deals with decisions that relate to present and future stages of life. In order to put it in context, some theorists look at the life cycle as a context for making decisions and developing rules of thumb. For example, an investment choice that can be related to the life cycle is the rule of thumb of investing 100% – your age (eg. 100% – 60 = 40%) of your portfolio in bonds. (Disclaimer: this rule isn’t appropriate for everyone.)
There are also shorter cycles that occur. For most of us, our day-to-day life is built around cycles of a day, a week, a month and a year. As anyone who has worked toward a multi-year goal can attest, breaking it down into chunks that fit the shorter cycles makes it more manageable. As an example, I have a goal of being able to cycle 40 kms in 1:15 by September 2013. I don’t refer to my year-long plan to reach my cycling goal. Instead, I have a weekly workout schedule and a monthly workout plan. As I achieve my weekly and monthly targets, I know I’m on track to reach my goal for next year.
The same is true in financial planning. Because most people get paid twice a month (or every two weeks), it makes sense to match mortgage payments and saving to the same cycle. For example, if a person were paid twice a month (on the 15th and last day), it would make sense to have a mortgage payment automatically withdrawn on the following day and to have savings automatically withdrawn at the same time. This would mean more frequent mortgage payments (for many people), but it would smooth out the amount available for spending. Increasing mortgage payment frequency to every two weeks (26 times per year) makes the most sense if that matches the frequency of a person’s paycheque.
Saving regularly avoids the pitfall of having no money left at the end of the month to save. It also allows a person to spend everything that’s left, because the savings were already made. That’s what it means to “pay yourself first.” Saving a little bit of money, more frequently, is far easier than trying to accumulate money in a spending account and saving it once a year.
It may be possible to fit other spending to monthly or twice-monthly cycles. For example, I can have my property tax charged monthly instead of yearly. I make insurance payments monthly. I have tried to coordinate these additional payments so some are at the beginning of the month and others at the middle. This way, my spending is relatively consistent, much like my saving. The result is that any irregular spending or one-time purchases must be planned and undertaken consciously, not impulsively.
How do you control your cash flows? Does your debt repayment, spending and saving fit the same cycle as your earning?