You’ll be surprised at just how few individuals approach their personal finances in a robust and objective manner. It is definitely the case that many people review their spending on a regular basis. However, very few analyse their spending behaviour and/or periodically monitor it.
In this article, I draw from standard corporate governance principles, which are embedded in all successful businesses and apply them to the personal finance space.
The key principles of Corporate Governance are as follows:
- There should be an effective framework for business decision-making;
- Resources are employed to maximize the wealth of all shareholders;
- Stakeholder interests should be reflected in all decisions;
- All decisions are completely transparent;
- Managers are held accountable for their decisions.
Can the principles of good corporate governance help individuals with their own personal finances? You’ll be interested to know how easy it is to adapt these to the personal level.
In the following 4 steps, I propose a structure for personal decision-making that replicates the business decision framework seen in modern corporations. I am sure that if the steps are followed each month, readers will soon see identifiable improvements in their own financial situation.
Step 1: Create an Effective Framework for Decision-Making
No matter what your personal circumstances (single, married, divorced, single parent, etc), you should have explicit constraints on what you can spend your money on and how much. Having these boundaries in place will reduce the likelihood of impulse spending.
An effective personal finance framework (that draws on the principles of good corporate governance) requires the following:
- All financial transactions (buying goods, borrowing, opening a credit card, etc.) should enhance your utility (i.e. quality of life);
- You must only spend within your means;
- Your financial decisions are legal;
- If you share your finances with someone else, (i.e. a partner), there is a clear articulation of how spending decisions are made.
- Ensure you keep records of your monthly income and all your spending.
- Sit down once a month (with your partner if you have one) and objectively analyse the major financial decisions of the previous thirty days and any issues that are likely to come up over the coming four weeks. This is called your monthly spending review.
Checklist for monthly review:
- Did you spend money on goods/services you didn’t really require?
- Did you throw out food? What did you buy too much of? What is your monthly/weekly/daily food bill?
- Is your mortgage/rent too high? Can you get a better rate elsewhere?
- Are you paying too much for electricity and gas? Can you get a better deal elsewhere?
- What is the total cost of your car (monthly car payment + monthly fuel cost + monthly road tax cost + monthly car insurance + monthly maintenance/servicing)? For some of these, find the annual spend and divide by twelve to get the monthly amount. Is it substantially cheaper to take public transport/hire taxis?
- Is your spending balanced across all areas of your life?
Step 2: Create a savings plan and spending targets for the next month
In personal finance, strict budgets don’t work. Unanticipated events regularly destroy the best plans and it is impossible to fully keep to strict spending limits. In the corporate world, businesses keep a cash float to deal with any one-off unexpected spending, but in the personal finance world these unanticipated spending demands are much more common.
- At your monthly spending review, choose how much you want to save over the coming month and transfer that amount into a separate account.
- Of the remaining money left, subtract your fixed recurring expenditure (such as mortgage, rent, car loan, etc).
- Of the remaining amount, this is what is left for the unexpected and discretionary spending. Aim to spend only 80% of this amount over the coming month.
- At the end of the month, you should have 20% of your discretionary funds minus any unanticipated spend during the period. This should be diverted to a different emergency savings fund to deal with any one-off spending shocks (replacement central heating, car repairs, etc.).
Step 3: Identify one of your repeating expenditures and attempt to shave 5% off the spend
Companies continually seek efficiencies and the same should be done with personal finances. In any one month, choose one of your spending accounts and look to cut a permanent 5% from the recurring monthly spend. This may entail renegotiating terms, switching suppliers, or cutting down on usage.
Recommended accounts to target are:
- Car Loan
- Insurance (home, car, buildings, life, mobile phone, travel, or dental)
- Utility Bills (electricity, gas, water)
- Phone (home, mobile)
- Credit Card Interest
- Car Fuel
- Satellite or Cable Subscriptions
- Home (Furnishing, maintenance, garden)
- Internet spending
- Carry Outs
Step 4: The Monthly Spending Review
At your monthly spending review meeting, objectively assess your spending performance over the previous month. Identify spending requirements (including one off expenditures) and set targets for your spending in the coming period.
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