Method Money Management

Friend 1: Todd, we just got $2,400 in stimulus money! What should we do with it?

Todd: Where are you in your financial plan?

Friend 2: Todd, my mom passed away and left us $50,000… What should we do with this money?

Todd: Where are you in your financial plan?

Friend 3. Todd, I just got a $10,000 bonus at work! What should I do with it?

Todd: Where are you in your financial plan?

Notice a theme? I do. Often the look I get in return looks something like this:

Getting a big check out of the blue is fun and it feels great! Turning around and using it to pay off a Capital One Visa card really sucks. Depending on where you are in your plan, however, that is the 100% right call with your windfall. When you receive a significant amount of unexpected money it begs the question – where can this money be most effective? The answer depends on where you are in your financial plan.

Don’t have a plan? Read on…

First off, before we go further, I readily admit these steps below are adapted from Dave Ramsey’s “Baby Steps“. I have tweaked them a bit and offer some “parallels” as well. In some instances I am more conservative and in some I am more aggressive than Dave’s advice. This plan will work and it is the plan that has led to my financial success today.

Method Money Management

I call this plan “Method Money Management”. It is a systematic approach toward building wealth and achieving financial freedom.

Step 1

Your first step is to get some money in the bank. This will be your “Emergency Fund” and you should start with at least 1 month of expenses. We’ll re-visit this fund in Step 3, but for now save up 1 month of expenses. Get it in a savings account separate from your main checking account.

Parallel to this, start working on your monthly budget. Get a written budget and concentrate on efficiency. If you have a lot of debt you will need to concentrate on frugality & austerity as well. Tell your money where it’s going before you even bring it home.

Step 2

Concentrate here on cleaning things up and getting out of debt. Line up your debts from the smallest to largest balance (excluding your home). Focus on that smallest balance and when you have it cleaned up go to the next. Keep hammering them out with all the money left in excess of your monthly “baseline” budget. Be intense, take an extra job, curtail spending.

Parallel to this the only investing I would recommend is the minimum amount you need in your 401k to get your employer match (usually 6%). I just hate to lose that “free money” match. Aside from that, or if you are self-employed, focus 100% of your take-home pay on your budget and debt repayment.

Step 3

As you enter Step 3 you’re out of debt, except for your home. Congratulations! Let’s re-visit that emergency fund and top it up. Get at least 6 months of expenses in there. I am very conservative here and keep 1 year in reserve. This is not money we’re using to build wealth, this is money we can rely on if more bad bat is served at the Wuhan Street Fair.

Parallel to this, start looking at your mortgage. Can you re-finance to a lower rate? If you have an adjustable rate, a 30-year, or some alternative financing, what does a 15 year fixed look like? Your house payments should not exceed 25% of your take-home pay. Grab that low rate 15-year fixed if at all possible.

Step 4

Here you should be very solid and consistent in your monthly budgeting. You should have all debts paid except your home. You should also have at least 6 months cash in reserve. Now let’s focus on retirement savings. You want to save at least 20% of your income toward retirement. This can be in your 401k, Roth IRAs, Traditional IRAs, SEPs, 403b, or a combination. Work with a tax-planner to see what may benefit you most and then go from there. Crank up your retirement savings rate to 20%.

Parallel to this, make sure you are investing in solid, low-cost investments. You should be looking at Target-Date Funds or Robo-Funds if you want a set it and forget it type scenario. Otherwise low cost index funds are your best bet to begin with. Do the necessary research to know and understand what you are investing in and how it works. Stay diversified. Don’t fall for “hot tips” or get rich quick schemes.

Step 5

In Step 5 you are rolling! You’re debt free except your house, and now your long-term investing for retirement is in place. Here, look to another big ticket item – college tuition. Consider an EDU IRA or 529 Plan. The earlier you start the less you need to invest on a monthly basis. There are plenty of online calculators to help you determine future costs and how that calculates to monthly investing today. Steer clear of the student loan epidemic.

Parallel to this, don’t let lifestyle creep thwart your efforts. You’re probably making good money at this point and have some wiggle room in your budget. The temptation will be to upgrade your lifestyle as you increase your pay scale. Don’t slide backwards by giving way to lifestyle creep. Stay the course!

Step 6

Let’s do it and pay off that house! With everything else covered and your total plan in place, get 100% debt free. When you get there, take that former house payment on your budget line and commit it back into your plan. Do you want to go up to 25-30% of income toward retirement? That could lead to you hitting a condo in Sandestin by age 50 or 55… Maybe you want to keep retirement at 20% and start saving for another property right away, like a lake house or a mountain cabin.

Or, you can do like I did, and use this opportunity to scale back and slow down a bit. I chose a career change to lower health insurance & health care costs. As a bonus I picked up benefits like sick pay, paid vacation time, a 401k match, and an ESPP – for the first time in 25 years! I was less stressed, worked fewer hours, and enjoyed the change of pace. My income decreased a bit but with a very low overhead we actually increased our savings rates across the board.

Step 7

As you save, invest, and accumulate wealth, establish your near, mid, and long term goals, needs, and plans. Money to be used within the next 5 years should be saved in cash – a Money Market or possibly a CD. Money targeted for 5 years and beyond can be invested in the stock market with a broadly diversified strategy. Other investments may include rental property (pay cash for it), investing in a business (your’s or another), a charitable trust, or having some fun with it by way of a boat, motorcycle, or classic car…

It’s Easy

Now it’s easy. You’ve fully embraced Method Money Management. If you get those Trump Bucks, that Mnuchin Money, or those Pelosi Pennies in the mail you’ll know exactly what to do with them. If you get a cash bonus at work or if your deceased relative leaves you a 6-figure check, you will be able to easily determine where the money needs to go.

It’s like a flowchart – when you get that unexpected money, simply ask:

Are you in debt and barely making ends meet? Start at Step 1 and drill into your budget. That cash you’ve received can go into building up that initial emergency fund. Then…

Step 2 – this cash can lead to you wiping out a credit card balance you’ve been working on. Pay that sucka off, or as many debts as the windfall will allow. Still have money left over?

Continue with any money left to Step 3, putting this cash into the emergency fund to build up that 6-12 months of expenses. Boring I know, put it puts you on a path to success. Still have money left over?

If you still have money left from your windfall take a look at Step 4. You’re monthly retirement savings should be 20% of your income going forward. If you’re there, go on to Step 5.

If you’re in Step 5 the remaining cash can be used to make a big push into those college savings accounts. If you’re on track there and you’d rather let those ride on monthly investment deposits, you can skip to Step 6. Otherwise, maybe college is now funded with your windfall? It’s an option, or…

In Step 6, knock out that mortgage or take a big chunk out of it. You will never regret it! Still have money left over?

You’re to Step 7! If you’re 100% debt free your unexpected windfall can really go anywhere. Perhaps it goes to another family in need or to your charitable giving. Alternatively it can be invested toward near, mid, or long term goals that have been clearly identified.

Conclusion

Failure to prepare is preparing to fail. Stay prepared so you don’t have to get prepared. Manage your money needs, don’t let your money needs manage you. I could go on and on… But I hope this helps.

As always feedback, thoughts, and ideas are always welcomed. Cheers, and thanks for reading!

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