CHAPTER 3

The Gift of Discipline

HOUSEHOLD CASH FLOW

Pretend for a moment that your personal life is actually a business. The board of directors is getting together to review your stewardship of the company’s finances. Would they be pleased with your performance as the company’s chief financial officer? For many of us, if we conducted our occupational endeavors the way we manage our household finances, we’d be fired!

Personal Financial Statements

I encourage you to manage your household finances as though you are a business, and that management centers around three financial statements that are just as effective when used to manage You, Inc. as they are in Fortune 500 companies.

The three Personal Financial Statements are:

An easy way to remember these is to view them as representing the past, present, and future. Your cash flow statement represents your financial past; the balance sheet, your financial present; and the budget, your financial future. Many confuse these three statements or assume that the single statement they use is sufficient. But without all three statements working in conjunction, the value of any one of them is reduced to almost nothing.

Recently, I learned about the results of a 20-year exhaustive psychological study conducted at Stanford University. This psychological test was done on a number of preschool children who were then followed for decades to determine how they succeeded in their lives. The Marshmallow Test may be one of the most accurate and precise indicators of future accomplishment. It is simple but poignant and goes to the heart of all success principles.

In the Marshmallow Test, a preschool child is taken into a room with a small table and one chair. The child is seated in the chair, and one marshmallow is placed on the table before the child. The child is then instructed by an adult that he or she will be left alone for just 15 minutes. During that time, the child can eat the one marshmallow or wait until the adult returns, at which time the child will be given two marshmallows. This seems ridiculously simple, as do most great tests and lessons in life.

Those children who ate the marshmallow immediately were found more likely to have career, substance abuse, relationship, and financial problems than their contemporaries who saw the wisdom in waiting a few moments and delaying their gratification in order to receive two marshmallows. This principle of self-discipline and delayed gratification, when learned as a small child and carried out through adulthood, results in better academic careers, better athletic and social experiences, and successful employment and business endeavors. It’s not a matter of one marshmallow or two. It’s a matter of learning to sacrifice now for something better later.1

Once you begin to understand success principles and compounding returns, you will understand how expensive the single marshmallow is now, and you’ll also understand that when you delay gratification by not eating the marshmallow instantly, your reward can be much more than two. Success doesn’t add. It multiplies geometrically. As you go through your Personal Financial Statements, be willing to pay the price for that future reward.

The Personal Cash Flow Statement is an accounting of your past expenditures. Most people who say they budget are actually only tracking their cash flow after they’ve already spent the money. It is true, however, that you can’t prepare a reasonable budget without knowing—and understanding—your cash flow. This task is made much easier with the advent of online banking and online aggregation tools which we’ll discuss later in the chapter. Now you can effectively view and manage your cash flow without even lifting a pencil.

My good friend (Scott, we’ll call him) is, by any standards, wealthy. His net worth is in the multi-millions. In early 2008, he decided to do a complete analysis of his cash flow. What he learned so shocked him that he now tracks his monthly cash flow with religious fervor. He realized that in the calendar year of 2007, he spent over $12,000 at Starbucks alone! You’re probably thinking, “I know Starbucks is a little pricey, but it’s impossible to spend $12,000 at a coffee store in one year!” Here’s how it happened:

Scott lives in an affluent neighborhood in one of the most expensive cities in the world, where there is a Starbucks less than a block from his residence. In the morning, afternoon, and evening, Scott would treat himself and his wife to a Ventimochalattesoychaifrappuccino (or something like that) at the bargain price of $5.50 per. That means he spent $33 every day. Anyone who appreciates Starbucks knows that an addiction of that nature can simply not be broken once it is well established, so after 365 days of that, Scott spent $12,045 in 2007!

If Scott was willing to break with his addiction and put the $12,045 into an investment account that earned seven percent per year, in 30 years, his account would be worth $1,137,780! Yeah, tracking your cash flow is important, and it is possible to spend a million dollars at Starbucks!

The Personal Balance Sheet is a snapshot of your assets and liabilities at a particular moment in time. What do you own and what do you owe? Many of my college students at Towson University will be graduating with a negative net worth. Armed with their accounting and finance degrees, they’ll hopefully get good jobs to start creating consistent cash flow, but they’re starting in the red thanks to college and auto loans. In our next chapter, we’ll discuss debt in detail, but the completion of your own balance sheet will give you an aggregated view of your financial realm.

The objective for your balance sheet is relatively simple; you want to make your net worth a positive number, and then you want to see it rise each year. The mechanism for doing so is your Personal Budget.

Most people mistake tracking their spending after-the-fact (the cash flow statement) for the Personal Financial Statement that represents the future (the budget). It’s nearly impossible to create a budget without first having completed the exercise of creating a cash flow statement. With that in hand, you’re ready to create your budget, the projection of what your spending should be in the future. For most of us, our income and expenses run on one of a few variants of a monthly cycle; therefore your budget should also be computed on a monthly basis, although it is also helpful to view it on a quarterly, semiannual, and annual basis to fully appreciate how much your personal vices and creature comforts cost you.

Unplanned vacation spending and gifts are the most notable culprits that derail millions of nonbudgeters every year. Each of these irregular expenses should be broken down into a monthly amount that will enter a budget category to be there waiting for you when you need it.

The key to wise and low-stress management of your personal finances is margin. You’ve doubtless heard that you’re supposed to keep a specific amount of cash as an emergency reserve on your balance sheet. This is true, but in the real world, most people making up to $200,000 per year live paycheck-to-paycheck. The first step to having adequate emergency reserves is getting one month ahead of your bills. A cash flow innovator, Jesse Mecham, developed software designed to help people do just that. I spoke with Jesse, the architect of YNAB.com (You Need A Budget), and discussed the origins of his product.

Best Budgeting Tools

The inception of Mecham’s widely used budgeting software was brought about by necessity. He and his bride-to-be were examining how their finances would be joined. Jesse, an accountant by trade, recognized the importance of analyzing and planning their cash flow together to stay on top of things financially. The first of YNAB’s four rules, the foundation of his product, is “Stop living paycheck-to-paycheck.” Jesse told me, “When living on the financial edge, you don’t have the option to plan wisely.” If your monthly income immediately exits your checking account to pay for due bills, you know this all too well. By getting only one month ahead, your income this month is set aside to pay next month’s bills. This increases the ease of bill paying, reduces the stress of imminent collectors, and gets you off to a running start on that emergency reserve, which we’ll discuss in greater detail in the next chapter.

In addition to being imperative in your balance sheet, margin is also a key component in your successful budget. That means that any line items or categories whose monthly allotment can be variable should be estimated in the upper portion of that range. If every category is pegged to a hopeful number that can often not be achieved, the process of budgeting will become a fearful one and will eventually be abandoned as a failed attempt.

Why do the majority of income-earning Americans not budget? “It’s too difficult,” is a comment that I’ve heard. Tedious it may be, but difficult, it most certainly is not! Consider this recent interaction that I had with my then three-year-old son: Connor, our second son, emulates his father’s character and personality traits, for better and worse. Even at his young age, his aversion to succumbing to authoritative direction is unmatched—that is, since I was his age. One night, Connor decided that the tedium of brushing his teeth before bedtime was simply more than he was willing to accept, and he demanded an indefinite waiver. A battle of wills ensued.

He screamed and wriggled every little muscle in his body as I brushed his teeth—by force. After three nights of this, I decided to take a new tact. I said, more than partially exasperated, “Connor! You don’t have to brush your teeth if you don’t want to. But, if you don’t, your teeth will start to rot, causing a lot of pain, and then they will fall out!” He said, “Get out of my way; I need to brush my teeth!” Now, when in the swirl of activity surrounding bedtime, if I forget to remind Connor of his duty, he will remind me that, “Dad, I need to brush my teeth so they don’t fall out!”

Most of us don’t budget because we say it’s too much work. It is work, but then like many other little annoyances in life, they become part of our regimen and no longer bother us. Do you despise brushing your teeth in the morning and at night? No, you just do it. These daily disciplines stop grating on our nerves and become natural and neutral, if not even a source of peace as we relish, if only for a moment, checking off one of the day’s to-dos.

Once you’ve developed your mechanism for the management of your personal financial statements, it will take little more time than brushing your teeth, but far less time than a daily physical workout, another incredibly gratifying discipline. Like all the other disciplines, you don’t have to manage your personal financial statements if you don’t want to . . . but if you don’t, one day, you’re likely to discover that you’ve fallen into fiscal ruin!

Aaron Patzer, the creator of the personal finance web site, Mint (www.mint.com) has made this task a great deal easier for us. Mint aggregates all of your financial instruments and accounts. After the initial work of inputting your online usernames and passwords for your bank and investment accounts as well as your mortgages and credit cards, as often as you open the Mint page, you’ll see precisely what your balances are in each—on one single page. Your personal balance sheet is updated to the minute right before your very eyes. In addition, you can create a rough budget and also track your expenses, so the site also helps you in your cash flow and budget management. The best news is that Mint brings this all to your computer, laptop, and even your iPhone or Android for the low, low price of nothing—nada!

In our discussion, Aaron acknowledged that Mint certainly does have an economic bias, and that is that they accept advertising revenue and even spotlight certain products and services from which they receive compensation, but I can attest to their relatively benign presence on the site. Frankly, I’d rather pay nothing for Mint and look past advertising that I don’t need. Remember, it’s not that economic bias is always wrong. It just requires recognition so that we’re more informed consumers.

I was introduced to Jesse of YNAB and Aaron of Mint as I surveyed all of the budgeting and cash flow tools available on the market. I believe that these are two that rise to the top. As I mentioned, Mint is the best aggregator of personal financial information on the market and has received notoriety from other third-party resources like Kiplinger’s Personal Finance and Money magazine. The cost to utilize the service is zero dollars.

YNAB, in my estimation, is the best product for the serious budgeter. It trains and refines you and your process. The cost, as of my recent discussion with Jesse, is $59.95, and I have found it worth every penny. And, while we’re talking economic bias, I think it’s only fair that I mention that I did not accept anything from either of these young entrepreneurs, and they did not seek me out. I put them up against the biggest names in the business, conspicuously missing from our “Best Of,” and found them to be superior in just about every way, and also better values.

Financial Crises

Many, if not most, Americans saw their personal net worth decline year-over-year in 2008. Most houses lost 5 to 30 percent and that is the largest item on most Personal Balance Sheets. The next largest item, your 401k(s) and/or IRA(s), also likely backtracked in 2008. The broader U.S. market indices lost around 40 percent, and with most investors following the preferred investment “logic” of the largest financial institutions, they felt the full brunt of the downturn’s wrath.

These losses and their corresponding financial, emotional, and relational pain was the impetus for this book and will be discussed in much greater detail in the chapters on investing, but the origin of much of our economic calamity is found in these three Personal Financial Statements. Banks whose policies invited homeowners to take on more housing debt than is reasonable deserve significant blame and should be made accountable, but we are the chief financial officers of our Personal Balance Sheets, not the loan officer at the bank or mortgage company. It was common practice for banks to offer mortgages and home equity loans and lines up to, and in some cases even over, 100 percent of the value of the property. What did banks or homeowners think would happen when the inevitable year or years came where their homes lost value?

Shame on them and shame on us, but why would any of that matter so much if people just kept making their mortgage payments? The answer is that it wouldn’t have, and it doesn’t matter to those whose ability to make their mortgage payments is not hampered. But for those who utilized adjustable rate mortgages, HELOCs that were tied to a variable rate, or those whose compensation diminished or expired as a result of the recession, they began having trouble making their payments or chose to give up hoping for some sort of personal bailout. This, too, is a Personal Financial Statement problem, because so many people consume most or all of their disposable cash flow, have little to no buffer or emergency savings on their balance sheet, and outspend their budget on a monthly basis, backfilling it with whatever equity was left in the home—until the unsustainable double-digit growth on homes reversed.

Let’s learn from this mess. Let’s seek and find the peace that accompanies wise financial stewardship and explore the problem at the core of Americans’ financial troubles in our next chapter, “The Gift of Enough.”

1. You can find an interesting and entertaining report from CBS News at this link: http://www.cbsnews.com/video/watch/?id=6419395n