Your best next step

Quite regularly I get a tingly feeling that I want to be physically healthier – fitter, stronger, thinner and more flexible. 

Most of the time, I do nothing. Why?

One reason is that I quickly become overwhelmed by the options. Changing will be hard and I want to be effective and efficient, and among all the options I don’t know where is best to start for me. So, I lose momentum and keep doing what I’ve always done.

It’s similar with our ambitions to be healthier financially. Changing our behaviours will be hard, so where’s the best place to start?

A map

I define being financially healthy as the confidence you can afford a life you love, today and tomorrow.

To help you navigate the thousands of financial options let’s start with a map of the territory, which I call the 3Cs of Money Mastery.

3Cs of Money Mastery. Venn diagram with Cash Flow in top-left, Capital in top-right and Contingencies in bottom circle. The intersection of Cash Flow and Capital has the word Save in it.

Cash Flow is King! The biggest determinant of having money for what matters most to you in life is how you actively earn, spend and save your money.   

The Capital you have saved by spending wisely is a primary source of your financial security and independence. This element captures all the strategies related to investing wisely.

 The third and most overlooked element is that of your Contingencies, which will help fund your desired life choices if misfortune strikes. This element captures all the strategies to wisely protect your lifestyle and your capital.

The journey

The journey to financial health and independence is like the journey to physical independence.

We don’t sprint out of our mother’s womb. In fact, we’requite immobile, living meal to meal. We first need to learn foundational gross motor skills like rolling and sitting. Then we add fine motor skills and coordination as we learn to feed ourselves, crawl, walk and eventually run.

In managing money, we start living pay to pay until we learn cash flow management skills, which are the foundation of our financial health.  As our savings and competency grow we can add wealth creation skills.

This journey to financial independence is captured in my Six Stages of Wealth Creation model below.

Six stages of wealth creation model

Where to start

Two concepts that have really helped me in my parenting are to reframe my expectations based on behaviours that are developmentally appropriate, and to remember that it is a journey where each stage builds on previous ones.

To be most effective with your efforts to improve your financial health start with the actions that are developmentally appropriate for you. Ignore what everyone else is doing.

Use the Outlook column in the Six Stages to identify your stage in the journey based on your current financial behaviours.

Your outlook may be year-to-year if you consistently save each pay but by the end of each year those savings are used.

Someone with an outlook of up to 5 years has savings that grow each year, but when it comes to predictable expenses such as a car upgrade or renewing their kitchen and bathroom they still need to borrow.

If you assessed yourself in the bottom three stages, you are not alone. A raft of research has shown that most (yes, at least half) of adult Australians spend all they earn and have minimal savings.

However, whilst you may not be alone, I believe you don’t yet have optimal financial health and independence until you are confidently on track to retire by age 67 with your desired lifestyle. (I chose age 67 because that is the current eligibility age for the government age pension.)

Your primary developmental target needs to be knowing you are on track for stage 4. By laterally interpreting the research I estimate less than 20% of adult Australians currently achieve stage 4 and higher. I  am on a mission to improve that number.

What to do now

Once you’ve identified your stage use the right-hand column to identify where to focus your efforts right now.

Those in stage 1 need to focus on the fundamentals of cashflow control, incorporating budgeting. A cash flow coach, who is much like a financial personal trainer, is an excellent professional partner to support you in learning and embedding healthy spending behaviours.

In stage 2 you build on your cash flow control fundamentals to begin consistently saving for those infrequent but predictable expenses and life experiences that matter to you.

As you begin consistently saving for expenses that are further into the future you progress into stage 3.

It is then that broadening your focus to the second C of Money Mastery, wisely investing your capital, will provide good reward for your effort. Stage 3 is the time to evaluate your entire financial situation and implement a comprehensive plan that coordinates all financial elements, including ensuring your existing investments are working hard for you.

What not to do

Despite the popularity of borrowing to invest (gearing), especially into residential property, I believe it is not developmentally appropriate to use wealth acceleration strategies until you’ve nailed stage 4 and only if you want to target early retirement (stage 5).

And I believe it’s unnecessary to chase higher potential returns in more complex non-mainstream investments unless you want to target stage 6.

Whilst stages 5 and 6 are alluring, first do your financial apprenticeship. Without first developing fundamental competence in cash flow management and investing you will often be taking more risk than you can handle. Typically, you won’t realise until it’s too late and you’re sliding/crashing back down the stages.

Another common mistake is to pursue investing when you’re in stages 1 and 2, in the hope that passive income will help you get out of debt. An investment will not solve a spending problem.

Set your target

Everyone’s definition of a life they love is different. Different experiences with different costs.

To support you in making smart yet tough financial decisions it’s very helpful to define an inspiring vision of a life you love.  Then make it tangible and actionable by estimating the cost of those experiences.

It’s okay if you’re not yet sure how to define that life, and certainly it’s not a pre-requisite to taking action right now. In the six stages table I’ve suggested some targets for your net wealth that you can adopt until you refine a personal target.

The target of $640,000 for stage 4 is from the ASFA Retirement Standard for couples at April 2018, and assumes current age pension eligibility rules. It’s such an important target that if you are in stage 3 I recommend you engage a certified financial planner professional to help you calculate the right number for you.

An aside about contingencies

The above Six Stages of Wealth Creation model focuses on cash flow and capital strategies.

But misfortune can strike at any time, therefore it’s important to concurrently consider your contingency plans, such as growing your liquid savings and acquiring income protection insurance. Both of these actions are available to you, even if you’re living pay-to-pay and a financial planner will show you how.