Planning and goal setting are critical to your success if you
want to become wealthy. The two key traits of people who do not
become wealthy are, firstly, they tend to spend all of the money
they have and, secondly, they do not know what they spend their
money on. The lack of goals is the main culprit. Ric Edelman,
author of The Truth About Money and Ordinary People,
Extraordinary Wealth, calls this “spending unconsciously”. He
says the reason why people spend without giving it much thought
is they have no goals. Without goals, we live unconsciously from
moment to moment, we never plan for the future, we spend all of
our money, and as a result, we are unlikely to ever become
wealthy.

* Ordinary People, Extraordinary Wealth, by Ric Edelman *

“Unconscious spending” is more prevalent in our society than we
realize. I would estimate approximately 80% to 90% of the
population do it. With the exception of one or two people, the
vast majority of my clients had no idea what they spent their
money on until I asked them to prepare a list of their total
expenditure and outgoings before our first session. In fact,
many were too frightened to do the initial exercise and waited
until they arrived at my office, so I could help them through
the ordeal. Money matters simply scare people. They are
terrified to know how out of control their finances are. Yet,
this is precisely what needs to be done before we can start
working on a solution.

Whilst it is important to become relaxed and carefree with our
financial matters, this does not mean careless. We become
carefree with money when we know that it is not a scarce
resource, we work on increasing our income, we invest a little
time on a regular basis to plan and review our finances, and we
systemically set aside part of our earnings regularly to build
our savings and investments for the future. We are careless with
money when we don’t keep track of what we are spending and
squander money on things that are wasteful, extravagant and not
needed.

I often compare money to water, another important commodity in
our lives. Both are essential and critical to our survival;
however, we rarely worry about water in the same way we do about
money. We systematically set aside water when it rains in dams
and reservoirs to provide us with water ‘on tap’ when we need
it. We are careful not to waste water; however, at the same time
we can relax and not have to worry about it on a day-to-day
basis. When we apply the same reasoning to managing money we are
well on the way to becoming wealthy.

The first step is to put aside a little time to set goals and do
some planning. Planning does not have to be an arduous affair.
It takes approximately one to two hours up front to prepare your
plan and, thereafter, an hour a month to review or revise it.

The first part of your plan is to set some goals. For example,
accumulating $500,000 in income-producing assets in 15 years is
not a difficult goal to achieve. If you save $170 a week into
investments returning an average of 15% per annum for 15 years,
you will have your half a million dollars. Goals will help you
focus on the future and increase your willpower to prevent over
spending. The more concrete you make your goals, the more
committed you will be to achieving them. Set time frames and
break them down into manageable steps, as in the example above,
to make your goals more realistic and attainable.

Along the way, however, we also need to manage our day-to-day
spending to ensure that we set aside the required savings to
achieve our goals. In designing the Money Program, I used a
simple, effective formula that everyone can apply to easily
manage their finances. I call this the 40%-30%-20%-10% rule.
This formula is used to measure your expenditure and cash
outflows. You divide your expenditure into four categories and
calculate the total of each category as a percentage of your net
(after tax) income. The four categories are Fixed Costs,
Variable Costs, Discretionary Costs and Savings.

Fixed Costs are your essential costs that are known and have to
be paid on a regular basis. For example, mortgage or rental
payments, personal loans and credit card repayments, insurance,
council rates, and school fees. These costs are usually
determined by your lifestyle choices, the size and cost of your
house, cars and major possessions, and therefore difficult to
change without making major adjustments to the way you live.

However, because fixed costs are comprised of debt and committed
payments, they are critical in determining your ability to
create wealth, as well as your capacity to lead a stable
financial lifestyle. If your fixed costs are too high, you will
probably be living from payday to payday worrying about the next
large bill that arrives. If your fixed costs take up too much of
your weekly pay packet, there will be less to spend on other
essential costs, and often little for luxuries – unless you go
further into debt.

Variable Costs include our essential living expenses, which can
vary from week to week, yet you have some control over what you
spend. These will include food, clothing, groceries, mobile
phone expenses, medical and motor vehicle running costs, such as
petrol and repairs.

The previous two categories relate to essential costs that we
cannot live without. Some are controllable (variable costs) and
some are set (fixed costs). Discretionary costs are expenses
that are non-essential and highly variable. These costs are very
much in your control and where most choice is possible about how
much is saved each month. For example, entertainment,
dining-out, presents, holidays and all luxury items that we love
but can live without. I affectionately call this part of our
budget, our ‘play money’. The problem with most budgets is they
often exclude this significant element and this is why most
people fail. We all need a little play money and a few luxuries
in life.

Whilst working with this formula with my clients, I found that
people who live within their means tend to spend their money
roughly within the 40%-30%-20% rule. That is, their fixed costs
are roughly 40%, their variable costs 30% and discretionary 20%
of their net income. The more I worked with this formula the
more I realized it was an excellent way to achieve two things.
First, it provides you with a simple effective method for
planning and allocating your finances, and secondly, it is the
perfect method for getting you out of debt and into wealth.

The most critical category is fixed costs. The fixed costs of
people who are living comfortably within their means are
generally around 40% of their income. People with fixed costs
above this percentage, tend to lead lifestyles that cost them
more than they can afford. The size and quality of their homes,
cars, furniture and other items that they have borrowed for,
have forced them into excessive debt. Because fixed costs are
comprised of debt and committed payments, they are crucial in
determining your ability to create wealth. If you want to be
wealthy, you have to be committed to dropping these costs below
40%.

When clients first come to me, their fixed costs are often 50%,
60% or even 70% of their net income. The aim is to reduce that
percentage to 40% or less, over time. Creating wealth is about
building strong financial foundations that cannot be shattered
regardless of what we may be faced with in the future.
Regrettable, strong foundations take a little time to build.

People in severe financial hardship usually have fixed costs
that are greater than 65% or 70% of their net income. This is
usually due to excessive debt or insufficient income. People who
are in financial crisis, where they tend to live from payday to
payday and seem to be going from one financial problem to the
next, tend to have fixed costs between 45% to 60% of their
income. If their fixed costs are approximately 40% of their
income, they are living comfortably within their means, and if
their fixed costs are below 40%, they usually have excess money
that could easily be channeled into additional savings and
investments. So the key to good financial management is managing
and controlling your fixed costs.

Remember, it is all done by measuring your fixed costs: if your
fixed costs are 40%, you are living within your means, if your
fixed costs are above 40% you will be putting yourself under
financial strain, and if they are below 40% you will be in a
surplus position. Therefore, if you want to accelerate your
wealth, keep your fixed costs well below the 40% mark and invest
the surplus.

If excessive debt is keeping your fixed costs high, formulate a
debt free plan and do not go deeper into debt. Learn to live
with cash. It is far more finite and when the cash runs out, you
know you definitely cannot afford to buy those extra purchases.
If low income is your problem, consider all alternatives to
increasing your income. These may include: part-time work,
turning hobbies or crafts into cash or investing in additional
training to further your career prospects.

Also, to decrease your fixed costs you may have to make some
difficult decisions about the way you live. Is the house you are
living in far too costly for you? Are you running two cars when
one could suffice? Can you down size anything now, which is
costing you far too much money? Are you trying to live well
above your present means buying clothing, accessories or
electronic gadgets that you cannot afford? Are you a
shopoholic, and can never resist a bargain – regardless of
whether you need it or not? Are your credit cards always to the
maximum limit and you cannot afford to pay the balance? These
are often difficult choices to make, but well worth it in the
long run.

Remind yourself that you can have the bigger house, cars, toys,
etc. – later, when you can better afford them. If you get a
bigger mortgage to upgrade your house or borrow for a better
car, you will increase your fixed costs. By keeping your fixed
costs as low as possible, you will accelerate your progress to
becoming wealthy. Your plan should always aim at decreasing your
fixed costs below 40% by either increasing your income or
decreasing your debt, or both. Once you have achieved this, use
the extra money to add to your savings and investments. This is
the guaranteed way to accelerate your path to wealth.

About the author:

Author: Leslie Koch

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