What do we know about cash flow? It’s good. Okay. My work is complete.
Not quite. What else do we know? It’s important to look at it once in a while so you can see if you are – no, tell me it’s not so – spending more than you are making. You’re not? Phew! Okay, we dodged a bullet on that one. So if you are not spending more than you are making, you must be spending less than you are making. I’m liking the sound of this already.
You earn $5,000 a month but only spend $4,000. That’s called a surplus or excess reserves. Or where I come from, that’s just called good. And here’s the beauty that most people haven’t quite really thought about: what can you do with this extra money? There are just three things.
That’s right! Bellagio, Venetian, or the Wynn! Vegas, baby. Vegas! Okay, no. That’s not good financial advice, but you could spend it. That’s the first thing you can do with extra money.
What’s the second? Well, if I were a good financial advisor, I might suggest you save it. You could put the money in your bank account. You could invest the money in a Vanguard mutual fund. You could buy a tax-free municipal bond.
Okay, so with extra money, you could spend it or save it. But there’s one more option you have. Can you guess? You can pay off debt. Absolutely. Instead of spending it or saving it, you pay down credit card debt, your mortgage, student loans, car loan, whatever.
Extra cash is powerful. And the other cool thing is how your cash flow is connected to, and affects, your net worth. They are bound together. What happens to one affects the other. Or as Dr. Phil would say, they are in a co-dependent relationship. How’s that working for ya?
Spend it (no change).
Save it (cash comes in, or goes to investments, net worth up).
Pay it down (cash reduces liability, net worth up).
To track your cash flow, it’s easiest to use an online program, such as Mint.com, or software, such as Quicken. These programs make it easy to see what you’re bringing in and what’s going out. Aim to review your cash flow each month.
Turn your finances into a game. Your goal should be to increase your net worth. By reviewing your cash flow, you can make better decisions. If you notice you are spending what you’re making, or worse, spending more than you are making, you can see your net worth start to go down. But, hopefully, this awareness will then cause you to make different decisions. Spend a little less so you have that extra cash at the end of each month. That extra cash is powerful. It can be used to buy more investments or pay down debt. Either way, your net worth goes up.
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.