How you regulate your cash flow can make the difference between financial success and financial failure. Thanks to software developer Don Blanton, we have the Personal Economic Flow Model to give us a visual picture of how your money flows.
If you are able to visualize your money from perhaps a different perspective than you have ever seen before, it may help you to increase the overall efficiency of how you manage your cash flow.
To begin, you have a lifetime wealth and income potential. Everyone does. It’s the total amount of money that will pass through your hands during your working years. It is a large but finite amount. The primary source of capital is probably the earnings from your occupation.
You may also have other sources – an inheritance, for example. We usually receive our money from our employer on a weekly or monthly basis. For some, the amount fluctuates from pay period to pay period. For others, it is a fixed amount.
Now imagine that money in a large tank that is
being fed by your paychecks week in and week out.
At the bottom of the tank is outflow pipe. Fortunately, for you, there is a regulator valve that you can control. You can choose to divert some of your lifetime capital into savings and investments.
Imagine two tanks above that valve, one marked “Savings” and one marked “Investments.” Money that flows directly into your lifestyle is lost and gone forever, with the possible exception of principal payment on your mortgage. We will consider that an investment. But the rest of what flows out of the lifestyle pipe is spent and just evaporates.
Blanton says that you can ignore the regulator valve if you choose to, and risk ending up with nothing when you reach retirement.
Or you can adjust the valve, redirecting a calculated amount of money into your retirement savings and investment program so that you will live more comfortably in retirement.
How much should you save and invest?
This is an important question. Before you can answer it, though, you need to answer to the following questions posed by Blanton:
- What return would I have to earn on my savings and investments for my current plan to work?
- What is the minimum amount of money I need to be putting away each year to enjoy my present lifestyle during retirement?
- How long would I have to work before I can retire and enjoy my present standard of living until my life expectancy?
- What is the most I will be able to spend in retirement and have my money last to my life expectancy?
That little Lifestyle Regulator Valve that you control determines how much income you allocate to your lifestyle and how much you wish to pump into your savings and investment tanks. I use the word “pump” because it doesn’t happen naturally. It requires effort to save and invest.
The tanks into which you divert these are long-term accounts. These two tanks will provide you with the money you need to live on when the inflow of your weekly or monthly paychecks stop. You may also use these tanks to help you finance major capital purchases, such as cars, education, and weddings during your accumulation years.
Imagine that these two tanks into which you divert savings and investments are marked “Safe” and “Risk.” Every dollar deposited into the savings tank is safe, meaning there is no potential for loss unless you move it.
The investment tank is marked “’Risk” because it potentially offers a higher return, but comes with a degree of risk. Money levels in this tank can fluctuate up and down over time. There is also no top on this tank.
It would be prudent to pay attention to how much
you put into each tank, as you get older.
When you first start out, perhaps the lion’s share of what you set aside should first be in the savings tank until you build up an emergency fund. Then, during your peak earning years, divert more money into the investment, or Risk tank.
As you grow older, divert more and more into the Safe tank. A good rule of thumb would be to have enough money in your savings tank to cover any major purchase. A major purchase is anything you wish to buy that you can’t pay for in full from your monthly cash flow.
Is it possible to withdraw money from these long-term accounts during your accumulation years?
Of course! Emergencies may arise that will require you to have to unexpectedly withdraw money. However, failure to put it back could possibly be a costly decision down the road.
Also, during retirement, it is essential to keep an eye on the lifestyle regulator. You don’t want to run out of money. You may even wish to pass some of what you have accumulated on to your heirs.
Look at all of the things in the category of “lifestyle” that can drain your resources:
- Sales taxes
- Education costs
- Medical insurance
- Property taxes
- Auto insurance
- Home owners insurance
- Life insurance
- Cable TV
- Giving… and the list goes on.
The Lifestyle Regulator Valve is the most important piece of equipment in this money plumbing system. The more you pay attention to it during the period of time when money is flowing into your Lifetime Capital Potential tank, the better off you will be during your retirement years.