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|How To Avoid a Financial Crisis
© 2006, Don Mize
As this article is the fourth in a series, you may want to review the first three. In
"How to Get Ahead Financially" we discussed a Net Income Budget, a plan to
effectively use the cash you handle each month. In "Why Budgets Fail" we dealt
with the emotional pitfall that wrecks most budgets. In "Checking the Compass"
we summarized how to review a budget and make adjustments.
In this article we deal with periodic bills, i.e., bills that come due other than once a
month. For example, an auto insurance bill may arrive every three months.
Insurance on your home and property taxes often come due once a year. Most of
us have experienced the frustration of being without money for a periodic bill.
Create a Hold Account
Periodic bills must be included in the monthly budget. If every three months you
owe $300 for auto insurance, $100 in your monthly budget accumulates the $300
needed. If each year you owe $1200 for insurance on your house, $100 in the
monthly budget accumulates the $1200 needed. However, money left in the regular
checking account evaporates.
By transferring money for the periodic bill to a Hold Account each month, you keep
it safe. A Hold Account means that you open a second checking account into
which you transfer your periodic bill money. To use the above examples, every
month you would transfer $200 to your Hold Account ($100 for auto insurance and
$100 for insurance on your home). Most families must transfer several hundred
dollars each month to the Hold Account to cover periodic bills.
If you use a Hold Account, your regular account balance indicates your actual
financial situation rather than allowing you to assume you have money left. Money
left in the regular account tends to disappear while lulling us into a false sense of
security. If you use a Hold Account, you simply write the $300 auto insurance
check from that account each time the bill appears. You have safely nurtured the
Avoid Unnecessary Debt
As mentioned in previous articles, you must allow yourself several months to create
a workable budget. No one remembers every expense in a first draft.
Nevertheless, gradually including everything in the monthly budget is essential. A
monthly budget is something you can deal with effectively: errors and
misjudgments you find each month can be corrected. If you cannot pay your
monthly bills, you accumulate growing debt. Money will not magically appear to
for property taxes, auto insurance, or a new roof. Facing reality each month
allows time for adjustments. You must either find a way to increase your income
or find a way to cut expenses.
Of course, you can borrow the money for a new roof, for your property taxes, or
for your auto insurance, but you will be paying to use money (paying interest in
addition to paying back the amount borrowed). Borrowing money for regular
expenses (operating expenses) is only postponing the inevitable and adding debt to
the existing problem. Now you have a debt payment (an additional bill) in your
monthly budget without correcting the underlying problem: you are spending more
than you are taking in. By including periodic bills in your monthly budget and
transferring the money to your Hold Account, you will have the money needed.
Manage Irregular Income
If your income is irregular, you must plan a basic budget and a challenge budget.
In your basic budget, include essential living expenses (including periodic bills), but
in your challenge budget include additional items (new cabinets for the kitchen).
Many people do not have a regular income each month (i.e., a salary check that is
the same each month). Plan your basic budget around your lower regular income.
For example, during hay season you may earn extra income by mowing. Plan your
basic budget around your regular income. Then, when the extra income is actually
in hand, wisely choose which items in your challenge budget to buy. You still pay
your monthly bills from your regular account as always. If you put the extra
income (hay mowing money) in your regular account when you deposit it, you
write your challenge budget checks (new cabinets for the kitchen) out of the
regular account also.
Remember, you first take care of regular expenses (including transferring the
periodic bill money to your Hold Account) and then purchase the challenge budget
items. Do not forget that extra income means extra taxes, so transfer your
additional tax estimate to your Hold Account. By using this approach, you always
know where you are financially. Thus you can pay your essential expenses and
can choose wisely how to spend the extra income.
Assume Emergencies Happen
Remember also that every family needs an emergency account. The amount should
equal living expenses for three months. In other words, take your basic budget and
multiply by three. If your regular monthly expenses call for $3000, multiply by 3 to
realize that you need $9000 in savings. Your savings should make it possible for
you to live three months without working.
Therefore, in hay season if you have extra income, you may choose to transfer
some to savings. Also, you can include an amount for savings in the regular budget
each month. Thus, in addition to your regular account and your Hold Account, you
need a separate savings account that you only touch during emergencies. Rather
than making your life more complicated, each account is like putting the money in a
separate pocket, keeping it safe.
Emergencies happen. If you know you can live three months without working,
you reduce stress. In addition, you avoid bad decisions caused by financial
pressure. A drought may mean decreased extra income from mowing this year. A
layoff may leave you with a house payment in addition to needing money for a job
search. Such instances illustrate why a cash reserve is good business.
Stick With Your Plan
So, with a Net Income Budget, an allowance for recreation, a regular checkup to
see how you are doing, and a way to handle periodic expenses, you can enjoy life
and avoid needless worry. No matter how much our income, we can always find a
way to spend it. Wisely using the cash that comes into your possession will
remove worry, ensure bills are paid on time, and avoid unnecessary debt. With this
plan, you can successfully mange your cash.