Many people struggle with cash management, from tracking income & expenses to knowing which goals or debts to prioritize. People with steady, secure employment have it a bit easier than seasonal, cyclical, or self-employed earners – since income is easier to predict with a steady job – but no career or income level is immune from confusion about cash flow.
One analogy that provides a simple, easy to understand approach is to imagine a town next to a river that is under your care. When the river is flowing, fresh water is plentiful. Water is abundant during the rainy season and slow during the dry season. As the town planner, it is your responsibility to make sure that excess water is stored to be used when needed.
Income is the river and checking, savings, and investment accounts are the reservoirs. They allow excess income to be stored for later use.
The first reservoir is a checking account used for the most immediate expenses, like next month's housing, utilities, groceries, debt payments – and some fun stuff every now and then. While a checking account can theoretically hold an unlimited amount of income, treating it as having a cap is useful.
Identifying a target maximum balance provides a quick and dirty way to know when and how much money can be moved from a checking account into a savings account. It also helps control spending by limiting the amount available to be spent, which results in an intuitive frugality as the balance decreases. I personally favor two months' worth of expenses – or one month with a 100% margin of error – as a target checking account balance. Any income in excess of that target balance can flow to the next reservoir to be used later.
The second reservoir is a savings account. Extra money not needed for the next couple of months can be stored in an interest-bearing, FDIC-insured savings or money market account. The interest earned in a savings account is not spectacular, but the purpose of this "reservoir" is not to maximize returns. It exists to re-supply your "town" when income is slow and the checking account balance starts to dwindle. This money can also be treated as an Emergency Fund – cash set aside specifically for unexpected events – with three to six months' worth of expenses as a good target.
In addition to covering emergency expenses or adding to your checking account when income is slow, a large Emergency Fund can also allow bolder choices regarding job selection and new opportunities. A person sitting on enough money to cover expenses for the next six months might be better able to walk away from a bad employer or seize a time-sensitive opportunity. (JL Collins calls this "F-you Money" in his excellent book "The Simple Path to Wealth".)
Once both the checking and savings accounts are sufficiently full, excess income can flow through to other goal reservoirs like a home downpayment, vehicle purchase, or long-term investments in retirement, education, or brokerage accounts. A good rule of thumb is that any money needed in the next 3-5 years – such as a downpayment – should held in cash and not invested in volatile assets (like stocks) or illiquid assets (like property). Cash is great for near-term expenses since it retains its value, while stocks and property are well-suited for long-term goals due to the historical tendency to appreciate and generate income over years and decades.
Please reach out to discuss this concept or your own money management habits.
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial futures. As both advisor and accountability partner, we help identify current strengths and weaknesses, clarify and refine your long-term goals, and prioritize understandable, manageable, and repeatable actions to bring long-term financial well-being. Reach out today to take the first step.
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