In our consultation, I refer to the Five-Step Cash Flow Priority Model. It was designed as a very conservative common sense formula to manage cash flow priorities. It is a simple but very effective model to achieve financial freedom.
Financial Freedom comes from either good planning, plus conscientious saving and investing OR you win the lottery. It is not haphazard and it does require discipline. Our formula is not new and not revolutionary but it works for our clients.
Step One: CASH (Create a Cushion)
Create a cash cushion. This means money on-hand and readily accessible for life’s little un-budgeted emergencies. We aren’t talking huge money here. For a family of four, earning $80,000 per year, $10,000 to $15,000 should cover it. If you are self-employed or on commissions the number should be higher to account for an irregular monthly income. The purpose is to allow you to handle emergencies with cash and not fall into the habit of always using credit for these unforeseen circumstances. The rule of thumb is 3 months income in your cash cushion.
Note: The biggest point I want to get across is that personal finance is almost totally about habits and not about numbers and rates. If a person has good financial habits and they consistently exercise those habits over a long period of time, things will most likely work out for them when it comes to finances. When you consider that approximately half of all marriages end in divorce and most indicate money as a key factor in their divorce, we can easily see how this kind of advice can impact us.
Step Two: DEBT MANAGEMENT (Get Debt Free)
The idea here is to eliminate all non-preferred debt. This would be all debt that isn’t a mortgage. This would mean all credit cards, zero-percent auto loans, student loans, etc.
The top two reasons to eliminate these types of debts are to free up your monthly cash flow, and form the habit of saving money and earning interest instead of paying interest. The key to financial independence is for you to have control of where your money goes and then to conserve (save) and not consume that money.
Step Three: BUILD LIQUIDITY
One Years Salary Saved: We’re talking big bucks here. This isn’t retirement savings, but true liquidity. This is money that you can access for two primary categories of reasons: good and bad. An example of a “good” reason would be to take advantage of business or investment opportunities. Most of the time, when someone is presented with an opportunity, there’s an up-front capital/cash requirement. If you have the money, you at least have the option of taking advantage of the opportunity. An example of a “bad” reason would be a major interruption of income. This would include health issues, job layoffs or any economic factor that’s outside of your control. Currently, the number one cause of home foreclosure is disability.
You will see that if you had no debt outside of you home mortgage, and one year’s salary saved in a liquid, safe, diversified place, you’d have gone a long way toward reducing or eliminating the financial stress in their life. You would also have choices that most will never have. You will be able to make decisions, both major and minor, without having finance as their number one consideration. Where could you work or live if money wasn’t a factor? What would you do with your time? How would your relationship with your spouse change?
Step Four: MORTGAGE PLANNING (Pay Off Your House)
Here’s where it really begins to get fun. Most people dream of some day having their home paid off. For many, this is a far away dream and it seems that more and more people are starting to doubt if they’ll ever have a mortgage burning party. Most homeowners would define “having their home paid off” as not having a mortgage. That, of course, is one way to look at it – but wouldn’t it also be true that if they had a $400,000 mortgage and also had $400,000 readily available, they would, from a balance sheet perspective, have their home paid off?
In looking at the Five-Step Cash Flow Priority Model, we said that our monthly cash flow should first go to developing a cushion, then to paying off all non-preferred debt, then to liquidity/savings, and finally to paying off the house. If you haven’t completed steps one through three, does it make sense for you to make a down payment when buying a home? Does it make sense for you to get a loan that requires principle payments? When refinancing, does it make sense for you to leave equity in the property if you have other debts or lack liquidity?
Note: It may be the goal to is to buy the home for the tax deduction and the home appreciation and that may be more important but to ask yourself the question is to prioritize your actions.
Step Five: FINANCIAL FREEDOM (The Road Home)
This is where your basic financial living conditions are met and you are striving to put yourself in a place where you can live the life you want from your investment portfolio. This could be the longest to achieve and the hardest goal to keep focused on because it takes so long. Setting this up involves, either doing it yourself or involving a financial planner to guide you toward your goal. I suggest for a couple of reasons that you use a financial planner; 1) they have the training to know about how money works and can offer multiple solutions to meet your goals from their experience, and 2) a financial planner is not emotional about the investments as you might have a tendency to be. Financial freedom comes from making a plan and working the plan in a diversified and balanced long term portfolio.
As I stated before, this is not rocket science. If one sits down and looks at the plan and thinks it through, rarely will someone find that it doesn’t make perfect sense? Our entire emphasis is on conserving (saving) assets rather than consuming assets.
I saw this originally from Jim McQuaid, a mortgage professional in Virginia. It is simple and complete – follow this plan and you will achieve financial success.
If you have any questions about divorce planning in California, sent me an email at david@YourDivorcePlanner.com or call me at 925-484-4030 ext. 26
DW
