Achieving financial independence
Published in Femail.com.au, December 2010
By Dale Gillham and Janine Cox
Many people have asked me to show them how they can create wealth. In most cases they expect that I will give them the 'holy grail' of investing, the one thing that will make them millions. Instead, I ask them a simple question - ‘do you have a budget? You know, the vehicle that many suggest to get you out of debt, well it can also help you to become financially independent.’ The sad news is that only around 10 per cent of people actually have a budget, so why is this?
If you are like most people, you probably think a budget will restrict your spending, hamper your lifestyle and generally make you miserable. However, none of this is true - a budget is simply a plan to succeed and will make a massive difference to your financial future.
Unfortunately for many, a budget usually creates a considerable amount of angst, as many fail to put aside the necessary time to create one, preferring instead to do what is urgent rather than what is really important. The sad thing is that without a budget, how do you know how much you are actually spending or, more importantly for your financial future, how much you can save?
There is an old saying that you can’t buy new clothes until you clean out your wardrobe, which means you need to create space in your life so you can get more of what you want. A budget allows you create this space (cash flow) in your financial life by getting rid of bad habits and creating news ones that get you to your goals.
Sadly, it is usually not until people receive their group certificate at the end of the financial year that you hear the outcry - ‘I got paid that much, what did I do with it all?’ Only when spending habits are quantified do we know how much we can save and I have never met anyone that could not save at least 10 per cent of their income after completing a budget. Most people could save 20 to 30 per cent of their income and still maintain a good lifestyle.
It is important to think about the consequences of not doing a budget, after all only 10 per cent of people budget and only around 10 per cent of people retire financially independent. Ask yourself who is most important in your life?
Do you like to pay your bills and then wait to find out what is left over? If you do then it is likely you will always spend everything you earn. Rule number one is to pay yourself first, this means putting money aside for your investments so that you can have the future you want. After all who are you working for?
Budgeting is like your roadmap to financial independence - it provides you with a plan of attack that allows you to create your preferred reality. The bottom line is a budget will allow you to allocate your income appropriately so that you stop leaking cash. Once you see the power of what it can do you will never want to give up that control over your finances again.
Creating a budget
So let’s get started…Firstly, write down your sources of income, like wages/salary, dividends from shares, distributions from other investments, bank interest from savings and income from rental properties.
Now make a list of all foreseeable expenses for the next twelve months by breaking them up into three groups; Essential, Necessary and Lifestyle. Decide on the importance of certain expenses. The Essential list should include all of the things like rent/interest on your home loan, household expenses like electricity, gas, water, phone, maintaining/running a car, healthcare, food etc…
Remember to include all the variable expenses, like entertainment/social activities, birthday presents/gifts, stationary, other clothes, personal care items, holidays etc... Also remember to include an allowance for an unexpected emergency, called a Contingency. That way you don’t need to take money from your planned savings if something unexpected were to arise.
Sources of this information come from:
- rent/home loan statements
- bills
- credit card statements
- bank statements
- receipts or any other proof of spending
Once you have worked out your income and expenses you now need to determine how much you will save. The minimum you would expect to be able to save is at least 10 per cent of your total income. Let’s say your total gross income from all sources is $45,000, which means you could save at least $4,500 per annum.
If you want to pay yourself more then reduce some of your expenses, and you guessed it, the first area to look at is Lifestyle and then Necessary expenses. You may also be able to pay less for some of the Essential expenses if you shop around.
Bringing it all together
You now need to record the information; if you are a wiz at spreadsheets you can spend the time creating your budget planner yourself. Create a table with the categories down the left and weeks/months of the year along the top. You will need at least five categories; Income, Essential Expenses, Necessary Expenses, Lifestyle Expenses and Savings.
Alternatively, get access to a free budget planner. You can find one on the government website www.moneyhelp.org.au, or you might like to consider something like the ‘5 Minute Manager’. Both come with instructions. If you decide to search for a free online budget planner, be very wary of ones that want you to enter all of your personal information on line.
Once you free up cash for savings, you then have the opportunity to significantly accelerate your wealth by investing in the share market. Did you know that if you invested your savings in the Top 20 shares on the Australian market over a ten-year period you would see a return including dividends, and before tax, of around 12 to15 percent per annum. Compared to bank interest, investing in the share market has the potential to get you where you want to go much faster.
Further to this, if you include the effects of allowing your returns to compound and let your nest egg grow you may be surprised at how quickly you can build wealth. Albert Einstein referred to compounding as the most powerful force in the universe for good reason, and anyone can use it.
