If you’re finally ready to get serious about saving money, then here’s how I do it without tracking any individual expenses, disrupting my business cash flow, or making any personal sacrifices.
Before I dig too deeply into the technical details, let me tell you a story.
When I was 18, everything was new and exciting. I was incredibly naive about money (weren’t we all?). I went from being debt-free to over $50,000 in the hole in about 12 months. Discover and Chase were handing out credit cards like penny-candy, and I had a major sweet tooth.
Between those, and a very nice car, I was in up to my eyeballs. And, since I had a well-paying job, I thought I was doing just fine.
Then came the dot-com crash. I lost that job and, with it, the ability to pay for my lifestyle. I did (eventually) learn something from that whole ordeal, however.
You see, at the time, I lived in the Finger Lakes region of New York. The winters there were brutal — so brutal that, in the middle of February, the simple act of breathing forms tiny ice crystals in the back of your throat and in your nose.
Your gas and electric supplier almost always offers you budgeted heating in the winter, because the heating bill can be astronomical, especially if you live in a drafty old victorian home or farmhouse (both of which are very common there).
The first winter out on my own, I noticed something: not being on the budget made it incredibly difficult to pay for my heating. But, being on the budget made expensive months seem not quite so expensive.
I started to wonder why other companies didn’t offer this as an option. Then, it dawned on me — maybe they didn’t have to.
I could use the same idea to build out my own budget, take back control of my finances, and even out what was then a highly variable, and very unreliable, income. When I started a career in financial services, I learned that this is exactly how life insurance companies establish reserves, and make good on claims.
In the insurance business, it’s called “level premium funding.”
The insurer sets the insurance premium at a level that’s more than enough to cover the basic cost of insurance. Then, it invests the excess amount. As you get older, the cost of insurance rises, but your premium doesn’t.
The reason is because the insurer uses its excess cash reserves to control those rising costs.
This same principle, applied to more basic money management problems, completely eliminates the need for traditional budgeting and expense tracking.
In simple terms, you average the total of all your income and expenses.
Then, every month, set aside enough income to equal the average of your expenses. In some months, your expenses will be lower than the average. In other months, it’ll be higher than the average.
But, every month, you set aside the same amount of money — enough to hit the average.
And, that’s it.
Today, I don’t do any form of traditional budgeting, and I’ve come to realize that it doesn’t matter. Doing things the conventional way violates a basic rule of economics. As Emily Oster, an associate professor of economics at the University of Chicago Booth School, points out in her controversial Slate article: money is fungible.
You don’t really need to manage a budget for “utilities” and a budget for “office expenses.” All you need to do is manage the total.
The cash reserve you create in “strong” months protects you during lean times. If you’ve done a good job creating your reserves, you’ll never be in any real financial trouble. In fact, you can use this to start an “automatic” savings plan that’s practically immune to variations in income.
From there, you establish certain minimum thresholds for capital reserves, and debt-to-income, to create a “moat of safety” for yourself and your employees.
Here’s where things get interesting.
How To Save Money, and Control Your Cash Flow, Without Sacrificing Liquidity
A certain percentage of the cash reserve you’ve created is invested, accelerating the reserve amount and creating a highly liquid savings without you ever having to actively pursue a special budgeting or savings strategy.
When I did this, it made paying down debts much easier because my own efforts were augmented by interest from various financial institutions. Over time, I developed a method for borrowing from savings and calculating opportunity cost as an interest rate, similar to how banks charge interest on loans.
I used a cycle of borrowing money from (and against) savings and repaying with interest to consolidate debt, redirect interest I was paying to lenders back to myself, and ratchet my savings up to over 50% of my income.
I also used a few other tricks to save money on common business expenses, and then went ahead and put together an extensive guide so other business owners could do the same.
What’s Holding You Back?
A general rule in accounting and finance is that you need to track each and every expense, and that this will allow you to properly save and spend. We hear this from financial experts, radio, and T.V. personalities, and from our friends. In business, it’s a “truism” that just won’t die.
I want to tell you that this “truism” is just not true.
You have to admit, a financial planner telling you that budgeting is a waste of your time is a bit heretical, isn’t it?
Call me a heretic.
It takes guts to throw away an entire budgeting and accounting system — especially if you think it’s working well for you. But, if you could get something much better in return, would you want to at least check it out?