Inspired by: I cant save money
tl;dr: This could be the most important model you ever build.
When I started IBD in Toronto, I had a mortgage but no house. My MBA student loan was pretty bad (Canadian schools, while they don't enjoy the prestige of our US counterparts, can nonetheless be equally expensive). The worst and probably most embarrassing part is, despite being a low cost of living location (globally speaking) and relatively high comp (all-in pay for Analysts and Associates is comparable to places like NYC), I was somehow not saving any money. I would need to blow off steam, usually aggressive drinks with the guys (lots of bottles, although not so much models. I know... no game). I think the point is if you are willing to spend money, there is always someone willing to take it.
I had a short but rough unemployment patch before starting my MBA and the idea of living with no income and eating into my savings was still too fresh in my mind. Yet, because of the stresses of banking, I couldn't help but want to blow off steam. Aggressively. One night after waking up to a bill of several k's, I decided that this was a bad strategy. Being a finance nerd, I figured the solution was to build my own personal financial model. I realized afterwards that some of my colleagues had them as well.
In the hopes of helping other monkeys avoid some of the stupid mistakes I have made, I would like to present the high level steps for how I build a personal financial model and how it helped me get a handle on my spending. To be clear, the model didn't change my day-to-day spending (I didn't stop going out for lunch, drinks or buying my friends and family gifts etc.), but it just made it clear where all my money was going so I felt more comfortable with my habits.
It's actually gotten to the point where I was speaking to a financial advisor recently and they said I might be saving too aggressively (sure, he was trying to sell me his investment products, but I'll take the compliment).
Easiest step. How much do you make on your regular pay check? The only trick is that taxes change throughout the year as you pay off your Social Security (Canadians: Social Insurance) over the year, but otherwise this part should be pretty predictable.
The trickiest part is bonus, but I think most people will tell you to "bank your bonus" so I didn't even model it in my first few years. And what ever I got made sure I hit my $18k 401k max (or RRSP for Canadians) first and the rest was to pay down student debt / save.
2. Budgeted Expenses
This is the trickiest part. It's often hard to estimate your expenses. I had two categories: run-rate (monthly) budget (rent, dinners, lunches, coffees, occasional drinks, transportation etc.) and discrete seasonal (planned holidays, birthdays, gifts, charitable donations etc.).
I created what I thought was a typical budget. And then to back check, I downloaded the last three months worth of credit card statements, categorized all the expenses and compared my budget to my actual spending. I was actually pretty close, but had to make some adjustments (ate out a little more than I expected and the meals after tax and tip were a little higher than I originally thought).
Also, once you get to this step, you can start to calculate how much you should be saving on a regular basis. After this step, I set up an automated transfer from my checking to savings (or initially, student debt pay down). I also calculated my own min-cash balance as I wanted to pay down my debt as fast as possible.
3. "Unique One-Time Adjustments"
This is the most important part. Tracking unbudgeted overspend. Once you have parts 1 and 2, you need a place to track your actual spending against your anticipated spending. Any large deltas have to be captured and a comment put in place. This won't immediately change your spending habits, but as you see it over time, you become more aware of where you are wasting money.
If I overspent, I knew I wouldn't be able to make my automated saving target and would either have to cancel it, or temporarily transfer money from my savings to checking. That forced me to acknowledge that I had mis-calculated: something I did not enjoy on a very visceral level. Missing targets then became very obvious.
4. Retirement - LTIP
Make a LTIP for yourself. I found that this helped. Because what's the point of making a short term goal if there isn't a long term objective? This is highly illustrative math for myself, but I like to think that with reasonable assumptions, I'm doing ok in the long run also. Getting a financial advisor at this point also helps (and I can keep them honest because I can back check their work against my personal model).
I built my personal financial model several years ago now. I paid off all my student debt within two years (not hard to do in IBD if you aren't stupid about spending) and have saved a decent amount of money. I deliberately dragged paying my student debt towards the end. I deliberately kept a small balance to encourage myself to stay hungry and as a reminder of leaner times. Also, it was cheap capital. I also have several years of records and can tell you exactly how much I've spent over the years. I haven't enjoyed life any less, but I feel much more comfortable about my spending habits.
How about you? Do you have a personal financial model? Do you keep pretty close to it? Any other suggestions or tips for fellow monkeys? As always, SB's for helpful insight.
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