The more conversations I have (both via The Best Interest and my full-time job), the more I see people overlooking and underestimating the most foundational principle of personal finance.
What is this simple fundamental? I’ll get to it in 30 seconds.
Instead of focusing on this fundamental, though, investing usually gets the glory.
- “Should I invest in stocks? Which companies? What’s going to happen in 2024?”
- “How much should I put in my 401(k)? What about my Roth?”
- “Are 529 accounts worthwhile? What about HSA accounts?”
These are all good questions that someone should eventually understand. I get it. Investing is cool!
If not investing, then taxes are the next most popular topic.
- “We earned way more income this year than we expected…any tricks to reduce my tax bill?”
- “I’m retiring soon and worried about RMDs…how do I go about tax planning?”
Again, I get it. Who wants to overpay taxes? It’s another great topic. But both investing and taxes put the cart before the horse.
Because the financial fundamental that most people overlook is monthly cash flow. Your cash flow is the foundation of everything else in your economic life. All the other important stuff (investing, tax planning, all of it) comes after understanding your monthly cash flow.
What is “Monthly Cash Flow?”
What, precisely, do I mean by “monthly cash flow?” Quite simply, it’s your Income minus your Expenses. Yes – it’s that simple. Income minus expenses. Simple, but not easy.
When experts evangelize “spend less than you earn” or “pay yourself first,” they preach the gospel of positive monthly cash flow. When they suggest you budget and track your expenses, they ask you to measure your monthly cash flow.
After all, where are your investment dollars coming from? You’re not pulling them from thin air. They can only come from having a positive monthly cash flow. Investing follows positive cash flow.
A negative monthly cash flow has an inevitable – and painful – floor. You’ll run out of money. You’ll go into debt. Or go bankrupt. However you define it, you’ll achieve financial failure. None of us want that. Charles Dickens had a point in his novel David Copperfield, where the character Wilkins Micawber stated:
“Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.”
Measuring Monthly Cash Flow
How do you measure monthly cash flow? I have two suggestions:
- Up until ~June this year, I used the app YNAB religiously. I’ll explain why I stopped below. But I still think YNAB is the best budgeting/tracking app out there, and I’d recommend it before any others. YNAB is detailed, granular, and a perfect tool for measuring monthly cash flow.
- But now that I’m married, my wife and I wanted to combine finances – including finding a budgeting/tracking method that works for both of us. We settled on a simple Google Sheets spreadsheet. We update the sheet every month with our current account figures. That allows me to do a month-to-month comparison and measure monthly cash flow.
If you’re not doing something like this, I’m concerned for you. Why? Because I’ve seen firsthand where someone:
- Knew their income. It’s easy to measure, after all. Their family took home $10,000 per month.
- And they assumed they knew their expenses. Roughly $7,000 per month.
- Hooray! Positive cash flow of $3,000 per month…right?!
So, I asked this person:
Great. If we look back on your bank accounts (and investing accounts) from a year ago, can we see the (roughly) $36,000 in growth? …a $3,000 monthly surplus times 12 months = $36,000. We should be able to see that money and check that your cash flow measurement is accurate.
Can you guess where this is going? The money wasn’t there. There was no measurable growth over the past year whatsoever. I see this same story play out over, and over, and over…
You’re probably asking yourself: How can that be?! How can someone be “missing” $36,000 per year?
It’s always the same culprit. Always. They assumed they knew their expenses at $7,000 per month. They were wrong. It’s that simple.
They either measured poorly, or didn’t measure at all, or created a budget before spending and then never tracked their real spending after the fact.
Perhaps they accounted for typical monthly expenses but forgot to include big, one-time expenses. Your $10,000 family vacation is very real, even if it’s not a monthly expense. Pro tip: take those big one-time expenses and divide them by 12. You now have a monthly expense to add to the ledger.
A poor understanding of your expenses (your spending!) is both common and near-impossible to overcome. You have to earn a ridiculous amount of money to no longer care about your spending. One reader confessed to me that his annual income has been ~$400,000 for 10+ years, but he has barely saved beyond his 401(k).
How?! Spending.
It’s very rarely a poor understanding of your income. Income is usually one or two paychecks a month. Very easy.
Spending involves dozens (maybe hundreds?) of transactions per month. Measuring spending is tedious. And it might force you to face painful conclusions, like, “I haven’t been on the Pelaton in 8 months, but I’m still paying for it…”
Nevertheless, you can’t manage what you don’t measure. You need to understand your spending to know your monthly cashflow.
Brick By Brick…
Personal finance can be thought of like a building. It takes planning, “materials,” and plenty of time to build.
Your monthly cash flow is the foundation upon which all growth occurs. If you know it, you’re rock solid. If not, you’re building on quicksand.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
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