A great article from my colleague Dwayne Burnell, owner of FinancialBallGame.com and author of my two favorite books A Path To Financial Peace of Mind and Financial Independence in the 21st Century.
It is so true for all of us that our money comes to us but 90% of it leaves our hands. Where does it go and what can we do to hold onto more of it.
Dwayne explains below just how that happens and what you can do to change things.
Managing the Flow of Your Money
Your Financial Life Cycle
Any number of metaphors can describe how money comes into your world and leaves it. More important than the metaphor is the reality that the key to financial control and independence is in how you manage the flow of your money.
Money entering your personal financial world could come from your job, social security, your pension, savings, an inheritance, investments, or other sources (trusts, annuities, etc). Most people want to grow their wealth, and they focus on the “incoming” or inflow side of the financial life cycle as they look at the rate of return on their investments.
What people often neglect is the other side of this cycle: the outflow of money. It is such a simple and unglamorous point. But after all that effort to make money and search out investment products that promise a great rate of return, most of us pay little attention to the ways our hard-earned money flows away from us.
If you’re like most people, you are often keenly aware of the cost of living needs and choices. But these expenses are not what we’re talking about here. We are referring to the less obvious leaks in our financial system –— the ways that money quietly flows out of our financial world with little or no thought, or even direct action on our part.
You cannot control the erosive impact of inflation on your purchasing power. However, you do have far more control than you realize over many of the leaks in your financial system.
Let’s examine five ways that money needlessly seeps out of your financial system.
1. Taxes
Taxes of all shapes and size are a reality of life. We have taxes on our income, capital gains, property, purchases (sales tax), and on our cell phone, cable, and internet services, to name a few.
Paying some of these taxes may be inevitable and even necessary. In the case of income tax, we want to meet our civic responsibility and pay our fair share but not more. How we structure and time the income coming into our life will determine how much income tax we pay now and in retirement.
Take investment income, for example. If we neglect to consider the amount of money we pay in taxes on that income, we are making a financial mistake. With a little strategic planning, we may reduce our tax burden and subsequently the money that flows away from us by paying too much in taxes.
2. Capital loss
If we can prevent the loss of our original principal (or capital) in the first place, then we are not continually coming from behind to try and catch up. We start on a firmer financial footing when we are growing money not subject to lose.
The effect of just one period of a capital loss at any point over the investment period exerts a long-lasting impact on your wealth.
3. Payment of loan interest to others
When you ask for a loan and borrow money, whether it is from a financial institution or a credit card, you are not in control of the interest rate and repayment terms. The bank makes a loan offer and you either accept their terms and conditions or not. If you don’t accept their terms, you don’t get the loan.
Many of us pay loan interest on our cars, homes, and other purchases. We pay high-interest rates on many of our credit cards. Credit card interest can be particularly tricky. Miss one payment and the interest rate on your balance can change from your current rate to one as high as 29.99%. It can take years to pay off credit card debt when you are paying 29.99% interest.
Payment of interest can be a significant drain on your household income. Often, we feel trapped because we need access to credit, but the cost of this credit can be debilitating. A key way to manage your household economy is to remove the burden of high-interest rate payments and the structured schedule under which you repay your loan.
4. Fees and miscellaneous service charges to others
Many of us pay a large amount of money to others to manage our money. We pay ATM fees, debit card fees, account maintenance, and other transaction fees to financial institutions; we pay transfer fees, paper fees, service charges, and commissions on our mutual funds.
If we reduce the fees, service charges, and interest we pay to others, we don’t need to earn as much on our money because we are not losing so much. In fact, Don Blanton (MoneyTrax, Inc.) sums it up when he says, “There is more opportunity in preventing losses than in chasing gains” 1
5. Lost opportunity cost
The money that flows away from us due to taxes, capital loss, and loan interest, fees, and service charges, does not come back to us. As a consequence, we lose the opportunity to save this money and use it for the rest of our lives. We also lose the chance to have this money work for us, whether it is in a savings or investment vehicle.
You may also hear the conventional “wisdom” that you can afford to take more investment and money risks when you are young. The rationale goes that if you risk and lose money, it is okay because you have time to recover. However, losing dollars at a young age means you lose the earning power of this money for the rest of your life.
Why should you take a loss at any age?
Remember…
You can’t control the global economy. You can’t control our national or regional economy. You don’t even have control over your local economy. The only situation over which you have control is your household economy.
You can manage your household economy by controlling how your money moves—both incoming and outgoing. By aggressively managing your tax liability, minimizing the impact of capital loss, and reducing fees and loan interest you pay to others, you take an important step forward toward financial independence and the successful growth of your own wealth.
[1] Don Blanton, 2011. MoneyTrax, Inc., Circle of Wealth®.
As always please leave comments below and feel free to contact me with questions.
Mary Jo