Our worries regarding the finance circles around looking for the optimum return on investment. However, there’s much more to financial fitness than just investments. We do not need a single shot solution. Rather, we need a system.
We feel guilty about the mess in our money lives. We feel worried about saving enough for our kids, for our ageing parents and ourselves.
Several techniques are available around us to track our expenses and stay financially disciplined but are we able to stick to it? Can we write down each rupee spent (as petty as money spent on milk, bread, petrol, coffee, lunch) each day and not get bored after some time and junk the whole exercise?
Bucket Technique
We therefore suggest an easy cash flow system and the science behind it. The goal is to separate out money according to its function so that the brain is better able to map it.
Create three buckets for the three functions of money:
- Income
- Spending
- Saving
How do you do it?
If you can separate your money in these three buckets, you will be better financially controlled than the boring budgeting exercise of writing down each expense every day. Now, separating your money into these three accounts is harder than you think and thus, you must have three separate bank accounts acting as the three buckets. Name the three accounts – ‘Income Account’, ‘Spend-it Account’ and ‘Invest-it Account’. Remember, naming is very important.
As soon as your salary hits your account, move your expected monthly expenses to Spend-it Account, leave 10% of your salary in Income Account as it is (for first few months) and whatever is left, move it to your Invest-it Account. For this system, you need net banking in place. In case you do not have the same activated, spend some time to get this activated as it will always save your time and effort everywhere.
Buckets in detail
- Income Account – This account is where all your income gets in. Whether it is just salary or salary plus rent, interest, cash gift from elders, etc. As soon as you have your income credited, you move whatever you think will be your monthly expenditure to Spend-it Account and rest of the money to Invest-it Account. Now, initially for three months, you will leave 10% of your income here just in case your Spend-it Account falls short and your calculation has gone wrong, you can simply add it to your Spend-it Account from here. So, it is a kind of three months practice for you to arrive at an exact percentage of salary you need in your Spend-it Account. You would ask that you can do this by transferring money from Invest-it Account to Spend-it Account – NO! Moving money from Invest it to Spend it is not allowed at any condition.
- Spend-it Account – This account will take care of all your expenses, utilities, fuel, pocket money, commitments, bill payments, rent, EMI, whatever. Every outflow which is not an investment has to go from this account. Set calendar alert if you have a premium payment any particular month for medical, house, car or insurance and move that much more money to take care of this additional expense.
- Invest-it Account – Putting money here does not necessarily mean you have to put the entire money you have here in markets. We have to plan for fifty years ahead and it is okay to keep the cash lying idle to grab any opportunity you encounter. And again, no money goes to Spend-it account from here at any condition – that’s the rule.
How do you evaluate yourself?
In three months, you will know what is going on in your money life. If your Invest-it Account is empty, you are spending too much. In worst case scenario, you should move at least 20% of your income to Invest-it account irrespective of your EMIs, credit card bills, spending, commitments, whatsoever.
Two things will happen once you start doing this:
- Once you start realizing how much money you are moving to spend-it account, you cannot hide from yourself anymore.
- As you start building up your Invest-it Account, you will realize your saving capacity.
Putting a label on money prevents people from using it for other purpose – this is called mental accounting and separate our money into different accounts according to our intent and stops us from using it for different purpose.
When you try to apply this principle of mental accounting unconsciously – you fail miserably; but If you use this mental accounting in the cash flow system we discussed above – we actually use the principle to work for us. When we label the money as Invest-it, we refrain from spending it for our current needs and trick our brain to do the right needful thing.
Budgets are boring – instead of tracking small expenses, have these thumb rules in place. If you are consistently going over the set limits, you need to stop and relook at where your money is going.
Go for a balanced, rather than a hard spending diet. Hard diets fail!
Probably you may not need this if you are towards the end of your wealth creation cycle, but this is something you can definitely share with your child so that they start early and reach as far as you have.
Next week we shall cover how much you need for emergencies and how to create and maintain that emergency fund.
Stay tuned!