A common theme throughout popular finance literature is the idea that the rich see money differently than average people. You may have heard buzz phrases like “pay yourself first,” or “don’t work for your money, let your money work for you.” These concepts sound great in books, but putting them to practical use can be a challenge.
My finances used to be a mess. I was drowning in a sea of debt, late fees, overdraft fees, and collection notices. I was always a few dollars away from a total financial meltdown. Even though I had read dozens of books on personal finance and understood the basic concepts of wealth, I obviously didn’t know how to put this information to work. Something was going to have to change or I was going to struggle forever.
When I finally had the “a-ha” moment that turned my financial life around, it wasn’t by learning another wealth strategy. I realized that even though I was creating a very sophisticated budget every month on a detailed spreadsheet, by the end of the month, I was right back where I started.
The thing that I finally figured out was that wealth has more to do with psychology than with math. As smart as I thought I was with the numbers, it never came out as I planned. I was able to put a stop to the madness by setting up a system that carried out my intentions for me so that I couldn’t mess it up. I found that changing my perception of money attracted more of it into my life.
Where Does the Money Go?
Have you ever realized that no matter how much money you have in your pocket, it always seems to disappear? Is there a place in the sky where all of our misplaced money goes to congregate and have cocktails? Most people spend money almost unconsciously until it’s gone. This phenomenon is why most people never really get ahead even as they make more and more money.
Creative people are especially vulnerable, mainly because we have great visionary skills to see what we want for ourselves and our money; but these skills usually come at the expense of the logical management skills that are necessary to carry out our plan. To make things worse, creative people tend to rely more heavily on their emotions, and therefore are more susceptible to impulse buying and frivolous spending.
This type of behavior is how Las Vegas makes its money. Most people think that the house always wins because the odds are stacked against the players. While this is true, it’s only part of the story. The rest of the story has to do with psychology.
During the course of an evening of gambling, the average person’s winnings and losses oscillate back and forth to some degree. Vegas wins because they know when a person will walk away. Think about it: is a person more likely to walk away when they are up $500 and “feeling lucky” or when they are completely out of money and have nothing left to gamble? Very few have the discipline to walk away when they are up.
The Economics of Bartending
Ironically, most people’s financial situation doesn’t change much between large and small paychecks. I learned this from years of bartending, an industry where the income is highly volatile. To make things worse, I worked in a restaurant on a lake that was very sensitive to the seasons. We joked that it was solar powered.
In the summers, when the place was packed, my pockets would be fat with wads of money. In the winter, when it was deserted, there were nights that I didn’t even make enough to pay for my ½ price employee dinner. Ironically, my standard of living never really changed much; I was always on my last dollar. How could this be?
It turns out that when I was making a lot of money, I was spending it as fast as I could make it. Feeling like I had money, I was more likely to go out for dinner or buy toys, but at the end of the week, I didn’t have anything to show for it.
When I wasn’t making much, I still somehow came up with enough to pay my rent and bills. I was still able to eat, put gas in my car, and I even went out from time to time. It didn’t seem possible, but it always worked out.
This taught me that how much money I was making wasn’t the problem. The problem was that I didn’t have a system in place to organize it before I spent it.
My last few years bartending I took a chance and transferred to a new restaurant next door that had great potential, but was still very slow even in the summer. My thinking was that I would get in while it was slow and ride the wave up until I was making the big bucks.
Unfortunately, the wave never happened. The restaurant continued to struggle as if it were winter all year round. The amazing part was that since I had this new system working for me, I was able to work my way out of $20,000 in debt even though I was making less money.
My Old Way of Thinking
I was struggling because of how I saw money. I realized that I was mentally and physically lumping it together into one category: just plain money. There was no difference to me between the money I had in my checking account, hidden under my bed, given to me as a gift, or in my savings account; it was all just money. While this doesn’t seem like an entirely illogical way to think, I’ll show you why it’s dangerous.
With this mentality, when someone asked me to go do something with them that cost money, this is how my decision process would go:
“Do I have enough money?
Let’s see, I’m out of money in my checking account…
I don’t have any under my bed…
I might have a bit left in my savings account…
Yeah, I’ll just transfer some over to my checking account and pay it back later.
Cool… so, where are we going again?”
In my mind, if there was any money anywhere, it was available for the taking. This became an even bigger problem when I started to apply this way of thinking to my credit card balances. Since I didn’t give myself any barriers to accessing my money, it was as if gravity was pulling it down like sand into a hole.
A New Way to See Money
My first clue that it was my mentality that was holding me back was when I asked a friend who was well off if they wanted to do something that cost money. “I don’t have any money,” he told me.
“What are you talking about?” I said. “You have all kinds of money. What about the $300 you made last night?”
“That money is for rent. If I make a little extra money tomorrow we can hang out.”
I couldn’t believe my ears. Rent wasn’t due for two weeks. Besides, this guy was trying to tell me that he didn’t have any money and everyone knew that he was doing just fine. Why couldn’t he just spend that money now and use the money he made the next day for rent?
Compartmentalize Your Money
What my friend understood (and I didn’t) was that all money is not created equal. He gave every dollar a purpose from the minute he made it. I learned that if I was going to learn to keep more of my money, I would have to learn to compartmentalize it.
When each dollar has a purpose in its own compartment or category, it is free to pursue its intended goal. A good example is the difference between principal and interest in an investment. A person who doesn’t compartmentalize blends the two into one category: just plain money. Using this mentality, they might dip into the principal and diminish its power.
A savvy person knows that the principle is never to be touched. They might move the principle from one investment to another, but it will always remain invested. The interest, on the other hand, might be harvested as passive income, or reinvested. Principle and interests are two different types of money with different assigned values and barriers to access.
A Support System
Just seeing it this way is not enough. To really implement this type of mentality it is important to set up a system that makes it as easy as possible to know the barriers between the compartments. I suggest that the best way to do this is to open up five separate bank accounts, one for each major compartment. When I worked for tips, I had five separate envelopes that I put my money in so that there was no confusion as to where it belonged before it made it to the bank.
Here are the five categories that I suggest in order of importance.
1. Long Term Wealth
2. Minimum Spending Cash
3. Regular Monthly Expenses
4. Irregular Expenses
5. Fun Fund
It is possible to have many more compartments for your money, but I find that five is enough without getting too confusing (and driving your banker crazy). Money should flow into these compartments in this order as it is received. The absolute best way to accomplish this (if your company allows this), is to automatically split your check into these different accounts when it is deposited directly on payday.
1. Long Term Wealth Account
(Principle Debt Reduction, Retirement Savings, Passive Income) – Money Market Account
The first 10 – 30% of every check should end up in this account. This is what is known as “paying yourself first.” Some people think that “paying yourself first” means taking yourself out to dinner, but it really means putting aside money that you will invest and grow for the rest of your life.
Even if you think that you don’t have enough money for this type of account, DO IT ANYWAY! Most people won’t even notice taking home 10 – 30% less money, just like I didn’t notice the winters at in my bar jobs. Start by paying yourself first, and then adapt the rest of your budget.
A good type of account for this compartment is a money market account. These types of accounts generate a decent interest rate and have restrictions on how many checks you can write. Restrictions are a good thing for your most sacred compartment.
The most important thing about this account is that you never touch it. You are allowed to move it from investment to investment, but the principle that you put into this account should never be cashed for the rest of your life.
Principle Debt Reduction
The first job of your wealth account is to pay off any debt that you might have. Use your two or three checks a month to make principle payments on credit card or any other debt you have until it is paid off.
After your debt is paid, set up a retirement savings account like an IRA and that draws monthly funds from your wealth account.
The money that is left over in your wealth account should accumulate until it is big enough to make an investment that will product passive income. If you can save $10,000, you can easily find a piece of investment property that will produce some passive income for you. If $10,000 sounds like a lot of money, read this article on five ways to create passive income with little or no money.
2. Minimum Spending Cash
(Groceries, Gas, Dining, Entertainment, Coffee, etc) – Checking or Savings with ATM Card
Figure out the minimum amount of spending money you need each month and put it into your spending account. For example, I have found that I can usually live on about $200 a week or $800 a month, but I add another $200 as a buffer for a total of $1000.
Try to err on the high side because you don’t want to have to dip into another compartment. As you get more financial breathing room you can increase this to a more comfortable level.
Withdraw your weekly spending limit in cash one day a week and put it in your wallet. I generally take my cash out on Sunday or Monday to start my week. Cash is important because people tend to spend 10-20% less money when they use cash. It is also important to have a constant visual gauge of how much money you have left.
The first two things I buy with my weekly cash on Monday is groceries and gas. These are the least discretionary of all of the cash expenses, so I like to get them out of the way to make sure I have enough money.
The rest of the week, when faced with a spending decision, the answer will be in my wallet. Do I have enough to make it the rest of the week or not? This makes it easy to know if I can afford that cup of coffee or lunch out with a friend.
Resist all temptation to dip into next week’s stash! You should have added a buffer, but try to save up your buffers for several months and treat yourself on the overflow.
3. Regular Monthly Expenses
(Rent or Mortgage, Electric, Gas, Phone, Cable, Internet, Insurance, Credit Card Interest Payments, Car Payment, etc.) – Checking With Bill Pay
Add up your monthly bills plus at least a $100 buffer and put it into a checking account. The absolute best way to make this account a no-brainer is to get a checking account with bill-pay. Set up all of your bills on bill pay and you will hardly have to pay attention to this account.
4. Irregular Expenses
(Car Maintenance, Medical Expenses, Gifts, Necessary Travel, Emergencies, Taxes, etc.) – Money Market Account
Irregular expenses are the number one category that people forget. This is also known as the “Murphy’s Law” category because it seems to always kick in at the worst possible moment. Compartmentalizing this one category alone is enough to save you a lifetime of money trouble.
Add up all of the possible irregular expenses you can think of over the course of a year and divide it by twelve. Add a healthy buffer and put this money in a money market fund each month.
Use your limited checks to take care of these expenses as they arise. Hopefully you won’t use it all over the course of the year and you can put the excess in your fun fund!
5. Fun Fund (Vacations, TV’s, New Cars, Boats, Jewelry, Shopping Spree, etc.) -Money Market Account
The last compartment on the list is the fun fund. Only put money in this fund if there is some left over at the end of the month. This is the account that will take the place of your credit card for luxury expenses. Wait until you have enough money in this account to make a purchase and avoid using credit at all costs.
Most people make the mistake of combining their wealth account with their fun account (if they have any savings at all). By mingling their most sacred money (wealth account) with their least sacred money (fun fund), it “dumbs down” their sacred money. By withdrawing money every time they make a major purchase, the wealth money never gets a chance to gain traction and benefit from exponential growth.
Possible Other Accounts
I recommend keeping the number of accounts that you have as manageable as possible, but some cases require other separate accounts.
If you are an entrepreneur running a small business, it is an absolute must that you have a separate account for your business. Mingling personal money with business is the easiest way to put yourself out of business.
I recommend setting up a separate bank account for each individual investment property that you own. This makes it easy at tax time and gives you an easy gauge as to how much cashflow the property is generating.
Sometimes it is wise to set up a separate account for special purchases like holiday expenses or a wedding. If you are saving for something that is important to you, put a barrier between it and your other money by opening a separate account.
I hope this information has been helpful to you. I am still on my path to riches like most people, but I am light years ahead of where I used to be. I am finally free to work for myself and pursue my creative passions. The mission of geniustypes.com is to help people to free their inner genius and create their own life by sharing this type of information.