An Engineering Approach to Money

It never ceases to amaze me that no matter how much people make they seem to have no trouble spending it as fast as they make it. I have worked with people who make $20,000 a year, and those making $200,000 a year, and the people who make the most seem to be no better at saving than those who make the least. I think it is just written into our psyche that our wants are only limited by our ability to pay. Unless you limit yourself artificially your stuff will expand to consume your earnings.

One of the best lessons I ever learned was to pay myself first. This neatly gets around this tendancy by taking your savings out of your paycheck before you start spending each month. This is the exact opposite of what most people try to do, which is to save whatever they have left at the end of the month, and surprise, most months there is nothing left, so nothing gets saved. Uncle Sam figured this out a long time ago, that is why your income tax comes out of your paycheck before you ever see it. No matter what you make, your take home pay is less, because Uncle Sam always gets his cut first.

What you need to do is something similar. Call up your bank and set it up so that $100 is transferred out of your checking account into a savings account every month right after payday, or $50 twice a month of you are paid twice a month. Never take money out of that savings account to pay everyday expenses, this will for the beginning of your cash cushion. At the end of a year you will have $1200 you didn’t have the year before and most likely you’ll never even miss that extra money, because in essence you never had it to begin with. Once you are comfortable with your new spending say after 3 months you could consider increasing this amount an additional $50. Then keep upping your savings until you reach the highes savings level you can deal with. If you can get yourself up to $200, $300 or more a month you’ll be really starting to make progress toward paying down your debt and achieving your savings goals.

But don’t wait, start saving today. You’ll never reach your goals by sitting on your butt. You must set your priorities, take action, and start moving things is a direction of your choosing. Even a little movement in the right direction will eventually get you to your destination, it might take a long time, but if you don’t move it will never happen. If you pay yourself first, then every month you know you will move a little bit closer to your goals.

When I was a kid, the family down the street had 3 kids, and those kids used to just destroy their toys. By March they would not have any of their Christmas presents left. You’d go to their house and they’d have the toys they just got for their birthday but literally nothing else. I remember saying to my mom, I have toys that I got so long ago I can’t remember when it was, how come Steve’s toys always break so fast? “Because he doesn’t take care of his things, honey”, she replied.

I have always been able to make my stuff last well beyond what most people can. I try very hard to be careful with my stuff, and make it last. I think this trait is one that you have to have if you’re going to save your way to wealth. You have to make every penny count and one of the best ways to do that is to make every item that comes into your house serve as long as you possibly can.

The battery on my electric razor appears to be going, I’ve had it for 11 years. My car is just comming into the middle of it’s life, it’s almost 10 years old. We just bought a new barbeque grill today, the old one lasted 8 years. I’ve been in the same house now for 9 years, and my stereo speakers are 18 years old.

Replacing these things are expenses that we never had to pay. Each dollar saved in this manner is another dollar that is in our portfolio compounding and growing our assets. So my advice to you all is take care of you stuff, make it last, and your dollars can be off earning more dollars instead of buying more stuff.

If you do not have a cash cushion then you are at serious financial risk. A cash cushion is a block of savings that is used to cover an unexpected turn of events. In a sense it is your “oh crap” money. It’s money that you hope you never have to spend, but can get you out of an unexpected problem. Some examples of unexpected problems are:

1. Car Accident
2. House Fire
3. Loss of a Job
4. Family Member getting hospitalized

These are big expensive events that do not happen often, but when they do you’re going to be way stressed out and not having to worry about where you are going to get the money to pay for the crisis will give you one less thing to worry about. It is your own personal social safety net. You don’t have to got begging for a loan, or visit your local pawn shop to figure out how to meet the costs of these events, you just dig into the cash cushion you have created for these events. As soon as you spend a dime out of the cushion you must immediately start building it up again so that it is there should lightning strike twice.

I recommend that your cushion be enough to cover 3-6 months spending, if you are not sure of your spending keep 3-6 months of your after tax take home pay. Once you have this cushion in place you can use it as a form of self insurance. A great way to save money is to increase the deductible on your insurance to as high as you can. I have $1,000 on my cars, and $5,000 on my house. This saves me about $400/year and I have yet to make a claim on either in the last 20 years so that’s a savings of $8,000 during that period. So your cash cushion can not only give you peace of mind, earn you interest, but also will save you money. What’s not to love about that?

Plan of Action

If you don’t have a cash cushion, start building one today by saving as much as you can, even $100 a month will get you there eventually, once you have $1000 in your account go to your auto and home owners insurance policies and increase your deductible to $1000 and plow the savings into your cash cushion. For now just keep it in your regular savings account. Eventually you’ll want to move it somewhere that while still has a small risk to principle earns you a better rate of return. I’m always a fan of making every dollar work as hard as possible.

My personal cash cushion is 6 months expenses, how much is yours?

When I talk about money, and my goals, becoming wealthy is right up there. But what is wealthy? Is it having a million dollars? It it having a billion dollars? How will we know when we have acheived it? Let’s think about this some.

It certainly used to be that you had arrived when you could lay claim to the title millionaire, that was enough money so that you could live the rest of your life in style and not worry about running out. When a nice house cost $20,000, a million was a lot of money. But with more and more homes selling for a million dollars, I don’t think having a million dollars in the bank automatically puts you in the wealthy club anymore.

A billion dollars certainly puts you in an elite class. I can’t imagine how I’d ever go through a billion dollars. Heck at a 4% rate of return that billion dollars throws off 40 million dollars a year. Even in Uncle Sam takes half I couldn’t spend money that fast. On the other hand, I can’t see how I’ll ever be worth a billion dollars unless I live to be about 500 years old, which seems unlikely somehow. So while a billion dollars is certainly wealthy, I don’t think you have to get close to that to be wealthy.

I don’t think that being wealthy is a specific number. Robert Kiyosaki had one of the best definitions for wealth that I have seen, he says that you are wealthy when your passive income covers your expenses. For those of you unfamiliar with these terms your expenses are all your money out, everything you currently spend money on. Your passive income is the income your assets produce for you. Of course, most assets do not produce a steady revenue stream, but will vary depending on market conditions. When you can reliably count on the passive income from your assets to produce enough money each month to cover all your expenses you no longer need to work to support yourself. When you have acheived such a state at a level of spending that you are comfortable with, then in my book, you are wealthy.

To me this is the reason to manage your money well, because being wealthy depends not only on your income, but also on your spending. My goal is to become wealthy enough to do what I want with my time, and let my assets produce enough income to support me and my family. I’m getting closer every day, in good years my passive income now exceeds my spending, but in bad years it’s not even close. After 19 years of work I’m on the right side of the power curve headed down hill and hope to acheive that goal in the next 5-10 years. My hope is that by reading this blog you too will become inspired to start yourself on the road to joining the ranks of the wealthy.

Most people don’t have any idea that their life could be so much easier, they have found a way to survive with their current level of spending and earnings and that’s good enough. They don’t know how money works, so they simply have money in from their job and money out from their spending and hope like heck that the money in will continue to flow and support the money out. These people have no idea that it could be any other way. Let me give you a mental picture of what I call the power curve.

Think of the power curve like a hill, most people live on the upslope, some live on the crest, and a few have made the journey all the way to the downslope on the other side. Of course you don’t just stand on this hill, you are pushing a big rock. It’s much harder work to do that on the uphill slope, than on the crest or the downhill side.

• The upslope represents debtors. Those people with little or no savings but with credit card, auto, and mortgage debt. Trying to save is hard because a chunk of their earnings go to pay the interest on stuff they bought last year or earlier. The bigger their debt the steeper the hill. If the debt gets too big the rock is going to crush them no matter what they do.
• The crest is those people who have paid off their debt. They no longer have to pay interest on past debts, they can live slightly below their means and still save money. It’s much easier for them to save as they have little or no interest payments.
• The downhill slope is those people who not only have little or no debt, but also have an investment portfolio or other passive income generated by their assets. Eventually their passive income will grow to the point where the rock will roll itself downhill and they can stop working and still maintain their standard of living.

Where are you on the power curve? If you are not somewhere on the downhill slope then you have work to do, the work will not be easy, you have to move your rock uphill. But trust me this first step in the hardest and once you reach the crest and dig yourself out of debt things get much easier because now you are on the good side of the power curve and don’t have to push your rock up hill.

I started pushing my rock about 18 years ago, and within a decade I was rolling down the good side of the hill, it takes a while to dig out of college debt. My passive income is growing every year and I continue to move down the good side of the power curve. Don’t wait for someday, get your financial house in order and start moving toward the crest of that hill, you will be glad you did.