Friday, January 31, 2014

Remove the Debate from Personal Finances

This is part 1 of 14 of my series on the 14 ways I am changing my life in 2014.

As promised last week, I am going to jump into the details of all 14 of ways I am changing my financial life in 2014, one way at a time.

#1 on that list: Clarify priorities to render financial decision-making automatic, not a daily debate.

Financial Priorities
Financial priorities and the decision-making process are complicated with human emotion, ego, obsessions, and sometimes even addictions. After all, Dave Ramsey has an entire radio show dedicated to helping callers (and listeners, indirectly) prioritize what they should do with their money. Should the caller pay off a student loan or save for a down payment on a new home? Each caller describes a unique situation, but Dave has his set of 7 baby steps, or financial priorities, to clarify how each dollar should be spent.

My Priority List
So, here are my priorities, a little different than Dave's and anyone else's list that I've seen. They are in order of importance. I make sure that each one is managed/handled/resolved/funded/ each month before I allow any other money to go toward the next one.
  1. 10% of all income to Tithing, at least another 5% to charitable causes.
  2. Pay for all monthly living expenses while working to optimize the all expenses, meaning I try to focus as much of my spending as possible into things my family values (defining and living by family values is an entirely separate post for another day). This includes a small "slush" fund, or fun money, for each spouse to spend with zero accountability to the other.
  3. Set aside money for expenses that hit my checking account less frequently than monthly, like annual life insurance premiums, vacations, Christmas, etc. Then I am ready to pay for them when they do come knocking.
  4. Make sure I have enough money for all of next month's financial obligations, learning to live on last month's income.
  5. Put all excess funds towards paying off all debts except the mortgage on my residence.
  6. Put in minimum required to receive maximum match from employer's 401(k).
  7. 6 months of living expenses in an emergency fund, including 1 month already reserved for next month's expenses as mentioned in #4 and food and other commodities storage. 
  8. Fund Roth IRAs and retirement to a specified amount each year.
  9. Save up to $200/month saved for kids missions (Why no college savings in a later post)
  10. Set aside money for anticipated, larger-item purchases, like a car.
  11. Put any excess funds toward paying off the mortgage. I still have a ways to go on this one, so I am not executing on any priorities beyond this point.
  12. Boost amount saved for kids missions.
  13. If kids missions are funded, consider saving for kids' college and other one-time expenses, like weddings. If my wife and I think we might want to try and serve a mission before we can pull money out of retirement penalty free, then we might also save that under this same premise.
  14. Not sure what to do beyond this point. It is several years away. I have lots of ideas, and I'm sure we'll be ready to make some new decisions by this point, anyway.
The Monthly Process
Now, here is my monthly process that I have started to follow like clock-work, the "automatic" decision-making process. I sit down with my wife on about the 2nd of every month. We start by reviewing how we did on each of our priorities during the prior month and make sure our daily spending decisions are supporting, but circumventing, the already-decided-upon priorities. We also discuss variances from our plan and make adjustments to our future assumptions. Next we plan for the current month by going down our list of priorities:

1. 10% of all income to Tithing, at least another 5% to charitable causes - Since our income can vary from month-to-month, I make an estimate of what it will be, then we pay our tithing and other donations at the beginning of the month. Then I true-up our actual earnings with my estimate at the end of each month to make sure I didn't underpay. If I did, then I add it to the payment I make at the beginning of the next month. I have a simple spreadsheet I use to keep track of this, and I update it every month.

2. Continuously work to drive monthly living expenses down while directing as much of that spending as possible into things my family values - I'll be honest. There is some negotiation that happens each month in this area. But it is a good, healthy discussion. I don't like to call it cutting expenses. I prefer to call it OPTIMIZING expenses, meaning we focus on the best use of our resources to optimize the outcomes we desire. More on this in a later post.

3. Set aside a monthly amount for each less-frequent-than-monthly expense. This move solved so many of the budgeting issues I had in the past, primarily because it will be really hard for anything to "bust" our budget now. We make sure we don't have any surprises for which we know we can plan, like Christmas, annual life insurance premiums, vacation, etc. More on this in a future post.

4. No debt except mortgage. Next I use any extra funds to pay off any debts except the mortgage on my home. In January I resolved my final non-mortgage debt, a loan I took from my 401(k) plan.

5. Put in minimum required to receive maximum match from employer's 401(k). Once steps 1-4 are handled, I need to start paying myself. If I defer 5% of my paycheck into the 401(k) plan, my employer matches 80% of it into the plan, or a 4% raise. That is 4% I never would have received, or an immediate 80% return on my investment. It would be foolish not to take advantage of this great benefit. 4% is the maximum amount of my paycheck my employer will match, so I defer 5% automatically out of each check. I will talk more about how I invest my 401(k) money and other retirement savings in a future post.

6. 6 months of living expenses in an emergency fund. This is the sanity money, and it is no small amount. With a wife and seven kids life is not cheap! This money allows me to have security when I want to take risks and enjoy a sound night's sleep knowing we have a runway of cash that is easily accessible if needed. I just accept the low interest rate from my online bank's savings account in exchange for preservation of capital (FDIC insured) and accessibility. If I ever have to draw this balance down, I will not move beyond this priority until it is fully-funded again.

7. Fund Roth IRAs and retirement to a specified amount each year. I have a specific amount I am trying to set-aside every year, but only after the first 6 priorities are in shape each month.

8. $200/month saved for kids' missions. This is a small amount that I hope to increase dramatically after the house is paid off, and I only do it if the earlier priorities are dialed in.  

9. Pay off mortgage. This is the "beast" priority. I have a ways to go, but a clear plan. Every free dollar I have every month is going toward this priority. I will not see priorities 10 and beyond for a while. But occasionally I think about what life might be like without a mortgage payment. All of that cash, plus the extra we've been using to get it paid off, can now be applied to even greater causes. That's what keeps me motivated.

Conclusion
The financial priorities represent decisions we have and will continue to make. If we ever question how we will spend money in the future, we can just refer to our map of priorities and it will be out guide. Although these may need to be adjusted from time to time, having financial priorities allows us to avoid the need to re-make decisions and have a clear path on what we do with every dollar each month.