Financial Crisis is characterised by a problematic financial position. All you seem to be doing is going from one financial problem to the next. Finances are tough. You are barely surviving from payday to payday. There is a strong sense of scarcity; there never seems to be enough and there doesn't seem to be any way out.
When my clients are in this this stage, it is often all doom and gloom. It is extremely difficult to motivate them at first because this is when their fears and doubts will rise to the surface. Any cut backs that are asked of them appear as huge sacrifices and many resist. The remedial action for this stage is to break old patterns and, unfortunately, this is the hardest to do. Crisis Management is the most difficult stage but the effort that you exert now is more than worth it.
The strategies for managing this stage and moving forward are:
- Establish a debt-free plan
- Working with the 40%-30%-20%-10% Formula
- Start saving
- Manage your credit cards
ESTABLISH A DEBT-FREE PLAN
There is one main reason why people get themselves into financial difficulties. They simply spend more than they earn. Therefore, the financial equation is: I - E = W .
If E is greater than I, the result will be negative W, or debt! The real solution is either to increase I, income, or decrease E, expenditure. Unfortunately, our fears or impatience can prevent us from doing either. So, the only other option is to increase our debt. If you want to be wealthy and have financial freedom, you must stop the downward spiralling pattern. Stop using credit cards (if that is the main culprit), do not get into any more debt and develop a debt-free plan to pay off all credit cards and additional loans that keep you from living within your means .
WORKING WITH THE 40%-30%-20%-10% FORMULA
I have found that the 40%-30%-20%-10% formula I teach in 'The Money Program' is the key to getting us out of debt and into wealth. When clients first come to me, their fixed costs are often 50%, 60%, 70% or even more of their net income. This is expected. The trick is to aim to reduce that percentage to 40% or less, over time. And I stress 'over time'. Do not expect to be living within the 40%-30%-20%-10% rule until you reach the middle stages of the program. The 40%-30%-20%-10% formula is used as a gauge to determine what stage you are in.
If your fixed costs are more than 60%, then you are cutting it too fine. Life will be too stressful and, therefore, more difficult to manage. It is still possible to enjoy yourself, even in financial hardship, if you learn how to manage your finances. This, of course, takes some immediate, remedial action. First, you need to re-negotiate wherever possible with your creditors to reduce your monthly payments. Speak to your creditors; keep in contact with them. Keep them up-to-date on how you are endeavouring to meet your financial obligations. This has never failed. It is only when they do not hear from you, that they are forced to take serious action. Do not, under any circumstances, pledge money or monthly payments more than you can afford. If you make an agreement and then fail to meet it, you will create distrust between you and the creditor. Now is the time to build bonds of trust.
Secondly, in order to reduce your fixed costs down to 50% or 60%, you may have to make some difficult decisions about the way you live. Is the house you are living in far too costly for you? Are you running two cars, when one could suffice? Can you downsize anything now, which is costing you far too much money, which you really do not need? At this point, I would like to emphasise the word 'need'. Make sure that you do not make any rash decisions without thinking them through. Sometimes, the costs of selling a house and downgrading to a smaller one may increase your cash outflows, which you may not be able to afford at the time. Brainstorm all ideas with other members of your family, make sure they are reasonable and the items you are selling, are things you do not need. These are often difficult choices to make, but well worth it in the long run. Remind yourself that you can have the bigger house, the better car/s, etc - later, when you can better afford them.
In all of these stages, there is a tendency to do just the opposite of what is required. However, that is usually what got us into trouble in the first place. There is often a resistance to saving, particularly in the earlier stages, because it feels like we have less money if we have to put aside an extra 10%. Saving 10% of your income is probably the foremost thing to do at this stage. Eventually as your wealth factor increases so will the dollar value of your 10% increase and, as you reduce your fixed costs, you will probably be saving 15%, 20% or even 30% of your income to reinvest into assets that will eventually make you financially free. So, the discipline starts now. I tell my clients with children that the most important thing you can teach your children about money is to save 10%. If you start them young and teach them, in the same way as you would teach them to brush their teeth everyday, to save 10% of everything they earn, they will be millionaires by the time they are 30 or 40 years old. It is as simple as that. Start them saving as soon as they start receiving pocket money.
Other wealth strategies may advocate paying off all your debts first and then start savings after. I disagree. These systems also usually put you on a very stringent budget. To me, this is like going on a strict diet. It is too harsh for most people in the long-term and they, more often than not, fail.I prefer to start everyone off with saving 10%. It gets them into a good habit right from the start. They also have some discretionary money to play with, which takes away the feeling of complete denial. We then work to play with the other percentages until we get the right mix. But saving 10% is a must.
Always, and I mean always, the client gets a major sense of accomplishment watching that initial savings grow. For many, it is the first time in their lives that they feel they are being constructive where money is concerned. It provides a strong feeling of security because when there is money in the bank you never feel poor. You may still have debt but as long as you have a debt-free plan in place, you can finally relax and know that the future is being taken care of.
So, I stress once again - always, always start by saving 10%. One of my closest friends, who like many others, struggled with the concept of saving 10%. Finally, one day as I was reinforcing the reasons why we should save, she had a breakthrough. "Wow", she said, "You mean the savings are the most important thing". "Yes", I replied. "Well then," she continued, "I'm going to turn the whole formula around with the 10% savings at the top, then comes the 20% for my play money, 30% for the household essentials and 40% for the fixed costs. The 10% will always come out first". And so it should.
MANAGING YOUR CREDIT CARDS
Managing your credit cards is of critical importance at this stage. Together with learning to save, managing credit cards are the two most essential strategies to 'kick start' your wealth generation. Unfortunately, for most, these two areas require the most effort in the beginning. However, the effort that you generate now is worth the million dollars in the bank, later . There are two ways to manage credit cards:
1) Tightly budget the expenses that you use the credit cards for, or
2) Stop using credit all together.
The choice is yours. Cash is more finite. I found it was far easier to budget my money in the earlier stages when I was using just cash.I bought a large wallet with different compartments. I would leave my 40% in the cheque account to pay for the fixed costs.
I withdrew the remainder of each salary in cash. 30% would go into the variable costs compartment of my wallet, 20% would go into the discretionary spending compartment and 10% into the savings compartment. The latter would be deposited into a separate savings account. If I were saving up for a special item, I would simply move a little each week into a fourth compartment, from my discretionary or variable costs allowance, and waited until it accrued to the full value of the purchase The problem with using credit cards is the infinite feeling they give us. There is no limit to what we can buy, or so we think. Unless we add up every receipt and keep a constant tally, it can easily get out of control. That $15.00 here, the $25.00 there, all adds up. And soon we are up to our limit. Credit cards make it too easy to fall into bad habits that ultimately lead to wastage and extravagance. Yes, I can have that new dress. No cash? Never mind, just put it on credit. Won't think about it now. It will all work out, later. However, later will come, and so will your credit card statement!
The real problem with using credit cards, and other means of debt for that matter, is it gives us the feeling of being in a higher stage than where we really are, which is breaking the fundamental rule of the Money Program. In order to successfully navigate our way through the stages of wealth creation, we always need to know where we are and the appropriate strategy to apply for that level.
If we act, which in money terms often means spend, at a level above where we are, we will fall down to the level where we need more practice. That is why money management is so stressful to most people. They keep bouncing back and forth between affluence, scarcity, affluence, scarcity, and so forth. Credit cards are invariably the main culprit. Stop using credit cards and learn how to manage the scarcity first, then affluence will follow naturally.
Ann Marosy is an accountant, consultant, and motivational speaker. She was formally the Financial Controller of an Aust subsidiary of the Fortune 500 Company, Jardine Matheson; Finalist of SA Executive Woman of the Year and is the author of 'The Money Program: How to Manage the 6 Stages of Wealth' and 'Money Rules: The 7 Simple Rules of Money Management'.
Visit her website at http://www.moneta.com.au.