I know I focus on Corporate Finance, but a surprising number of people have asked if they can use what I teach to improve their personal finances. Without a doubt, the concepts applied to business can be extended to individuals, as well as non-profit organisations.
In this article, I draw upon standard Corporate Governance principles to create an objective framework for personal spending. In the principles below, I focus on optimising financial decisions, maintaining financial discipline, enhancing transparency of your decisions, and monitoring performance.
Key Corporate Governance Principles
(If you want to cut straight to the three steps, just skip this section. Academics like to explain the theory underlying their recommendations, so please indulge me!).
The principles I draw upon are the following:
- There should be an effective framework for financial decision-making;
- Resources are employed to maximize the wealth of all shareholders (i.e. you);
- Stakeholder (i.e. your partner/family) interests should be reflected in all decisions;
- All decisions are completely transparent;
- Managers (i.e. you) are held accountable for their decisions.
You’ll be surprised at how easy it is to adapt these to the personal level.
In the following 3 steps, I propose a structure for personal financial decision-making that replicates the business decision framework seen in modern corporations.
I have steadily iterated and improved on these 3 steps since 2012 (four years ago) and can attest to their effectiveness. If you think you can improve on these further, please let me know.
The Three Steps
Step 1: 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’s impossible to keep to very strict spending limits. In the corporate world, businesses keep a cash float to deal with unexpected liquidity shocks and building up a cash reserve is essential.
Calculate Recurring Spend, Savings, Discretionary Spend and Emergency Fund for Month:
- At your monthly spending review, subtract all fixed recurring expenditure (such as mortgage, rent, car loan, etc) from your total income.
- Of the remaining funds, choose how much you want to save over the coming month and transfer that amount into a separate savings account.
- What you now have left is for unexpected and discretionary spending. Aim to spend only 80% so that 20% of your remaining money is left for emergencies.
- You’re now at the end of the month and hopefully there has been no emergency. Whatever you have left, put into an emergency fund to deal with any one-off spending shocks (replacement central heating, car repairs, etc.) that may occur in the future.
Your take home pay is £2,000 and your fixed recurring spend is £1,400 (this is your mortgage, telephone, rates, grocery budget, etc.). You have £600 left for savings, discretionary and unexpected spend. You plan to save £200, leaving you £400 for discretionary/unexpected spending. Target 80% of this amount (£320) is for discretionary spending. The residual amount (£80) should be kept aside for emergencies.
Tip: Calculate your total annual vacation costs (flights + hotels + taxis + spending money), divide by 12, and include this amount in your fixed recurring spend so you have enough when holiday time comes around.
Step 2: Each month identify one of your repeating expenditures and 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 categories and cut a permanent 5% from the recurring monthly spend. This may entail renegotiating terms with your suppliers, switching suppliers, or cutting down/back on usage.
Recommended accounts to target:
- 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
- Food Carry Outs
Step 3: Carry out a Monthly Spending Review
Reviewing and monitoring your monthly spend is one of the most important tasks one can do. At your monthly spending review, objectively assess spending performance over the previous month against each spend category (i.e. mortgage, groceries, eating out, etc.). Identify spending requirements for the coming month (including one-off expenditures) and target one spend category for a 5% efficiency. Always look to create efficiencies where you can.
Checklist for Monthly Spending Review:
Important: Only choose from one of the questions listed below each month. Cycle through the questions so you revisit each area every six months.
- 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?
Example Monthly Spending Review
Let’s finish off with a detailed example. You have £2,000 net monthly income and have worked out your recurring monthly costs are £1,400. You plan to save £200 this month, leaving you £400 for discretionary spend/emergencies.
Let’s choose the first option from our monthly checklist (remember to do a different item each month).
Did you spend money on goods/services you didn’t really require?
Using your spreadsheet, itemise everything you bought/spent over the previous month and allocate to a spend category (e.g. groceries, mortgage, mobile phone, media and TV). Tally these up and calculate the cumulative amount you spent for each category. Look at each transaction and ask yourself if it was urgent AND necessary. If it was both, then fine. However, if this wasn’t the case, then it was discretionary spend and could have been postponed or avoided completely.
Make a commitment to reduce, avoid or postpone spending in one category over the next month.
Next we pick an account to target 5% spending efficiencies. The first one I would choose is groceries as it is easiest to change and control. Assume your average total monthly groceries spend is £800. Since 5% of £800 is £40, you should look to reduce your grocery spending to £760 over the next month. This is equivalent to cutting back by £10 a week, which is definitely achievable.
After carrying out the Monthly Spending Review, you would have committed to the following:
- Reduce/Avoid/Postpone spending in one of your key spending categories as identified in the review;
- Aim for 5% reduction in grocery spend.
Try it out yourself
By going through these simple steps each month and consistently applying financial discipline, your money situation will definitely improve over time. It doesn’t take long at all to do the Monthly Spending Review and you will certainly see improvements in your personal finances within months.
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