Our money: The Tank and the Taps

TapsMy version of living a life of freedom and autonomy revolves around having and applying two complementary sets of skills: entrepreneurship and personal finance.

I believe very strongly that being good at both of these things is the key to quickly achieving the type of life balance you would like. Mastering either of these disciplines in isolation definitely has the potential to improve your life vastly (and eventually give you the freedom you desire) but putting them together is like pouring lighter fuel on a fire.

My aim with this article is to show you how these two skills interact in my life, i.e. how our personal finances are configured to allow me to take calculated entrepreneurial risks without worrying too much about what will happen if I get things wrong.

Let’s begin.

As I’m interested in personal finance and entrepreneurship, I meet a lot of people in both camps. I’ve found that people who are enthusiastic about both areas are very rare.

The big savers

By personal finance, I’m not really talking about the people who are good at transferring their massive credit card balances from one provider to another to benefit from 0% deals. I’m interested in people who really understand the power of living below their means and accumulating assets instead of consuming all of their income.

I count a few quite frugal people amongst my friends. They are generally professionals with comfortable incomes. They don’t spend every penny of their salaries, they save diligently and are likely to retire very comfortably. However, they are not inclined to step outside their respective comfort zones and try to start anything for themselves. On paper, they’re quite free already as they have plenty of financial resources which could be reconfigured to allow them to live more flexible lives. However, they’re stuck in the very common

I need a job – there is no other way

mentality.

There’s nothing wrong with that (if it makes them happy) but it’s absolutely not true that they couldn’t have a similar lifestyle to mine if they so desired.

The risk takers

A lot of my other friends are of the entrepreneurial bent. They create products and start businesses. They’re good at sales and are generally really confident in their own ability to bring home the bacon.

But they save absolutely nothing. If a bet goes against them at some point, they may well be forced to use their sales skills to get a 9-to-5 job. It’s unlikely, but in reality, it’s not even a possibility they’ve considered.

They do this shit to make a lot of money and they like to spend it! I suspect they think something along the lines of

Andy is this weird, stereotypical Yorkshireman who’s a bit careful with his money even though we know he’s not poor.

My goal

Personally, my views on money and business have been formed over many years of thinking about and working with those subject areas.

I’ve worked in a couple of banks, started businesses and built up savings. I’ve also learned a lot about economics and personal development. I did all of these things (I thought) because I was just fascinated by the subject of money and the process of getting it.

But as I got older, I began to realise that the core value that has been driving my fascination with money for 15+ years can be boiled down to a single statement:

I want to be able to do what I want most of the time

At the end of the day, my material wants are quite simple. The thing I’ve always wanted to buy for myself is my own freedom.

By nature, I’m quite productive so the freedom I’ve always wanted hasn’t necessarily been freedom from having to work completely. Instead, the freedom to say ‘yes’ to the good things and ‘no’ to the bad things is what I desire.

Get as rich as you like

We live quite frugally. It’s easy to be free when your wants are few and you have high earning power.

However, I’m not going to say that if you want out of the 9-5 then you need to ‘live like a monk’ forever. If you really like the things that money can buy (and none of my persuasion can convince you otherwise), then I definitely think that making a lot of money in the future should be part of your plan.

I believe you need to build some really strong foundations first though. It’s a lot easier to ramp up your income to £100k per year and keep your autonomy when you’re financially stable already than if you really depend upon the next salary payment that’s coming your way.

Barring any sudden windfalls, the only way to build those foundations is the tried and tested, boring way – spending far less than you earn, at least for a while until you’re ready for the next step.

The majority of the modest financial foundation upon which my wife and I have built our reasonably low-stress life was accumulated over an 18 month period of being very frugal whilst earning a moderately high amount.

The rest of this article will explain the system I’ve designed in order to use our financial bedrock to give us the life we want.

Design considerations

The most important characteristic of my money management technique is flexibility. It is designed to deal with a wide range of possibilities including

  • One of us becomes ill/injured and can’t work
  • My wife can no longer cope with being a part-time working mum and I have to take responsibility for generating all of our income
  • Somebody involved in one of our working relationships upsets one of us enough that it’s necessary to tell them politely that we won’t be continuing the association any longer

The thing I know we’ll need in any of those situations is time. Thinking of our financial life like a ship, if I want to change its direction by moving the sails, it will take time for us to be on the new course. The course change might entail

  • My wife finding a different job
  • Us being able to wait it out until some bad circumstance has passed

Whatever the reason, having the ability to tolerate fluctuations in income is what will allow me to keep that promise to myself: I generally won’t be forced into doing something that I don’t want to do like getting a job.

Beyond trying to maintain that level of optionality, anything else goes according to how we feel at the time.

If we just want to earn enough to keep us ticking over and spend time on hobbies, that’s OK.

If we want to go completely mental and invest (or, perish the thought, spend) an extra £50k this year, that’s possible too with appropriately-directed effort.

To give an example of a future plan for me to ramp up the income production efforts, I know that at some point (probably when the kids are older), there are places we’d like to see and the trips will cost a lot of money. I will have to produce more income to accommodate this desire.

That brings us back to the headline of the article. The Tank and the Taps is the mental model I’ve constructed to help me think about money (specifically cash) management

The tank

The analogy is pretty straightforward. I think of cash as water, and our reserves as a tank. Here’s a picture representing how I see our cash stash, income and expenditure.

TheTank

  • The money we spend is represented by the tap at the bottom of the tank
  • The money we earn is represented by the various differently-sized taps feeding the tank from the top
  • The little overflow tap at the side of the tank is used to bleed away excess water (cash) to be put to better use (our investment portfolio) if the tank gets too full

In my situation, the spending tap runs at a reasonably steady rate which I’ve been measuring for years. The feeder (income) taps all run at different rates.

Some of them are unreliable (e.g. project-based freelance income, coaching clients). Some of them are tiny little trickles (odd IT support jobs). At least one has a moderately-high flow rate and, so far, has been pretty consistent (my wife’s part-time job). I’m adding new streams all the time which might have still different characteristics.

Let’s think about what happens when one or more of the feeder taps is turned off.

Well, assuming I’ve picked the appropriate capacity and limits for the tank, the spending tap will continue to run for quite a long time with no problems, even if all the feeder taps were stopped completely.

It doesn’t matter which tap(s) are replenishing the tank, just that, in the long run, the income taps put more into the tank than the expenses tap allows out.

The situation is actually complicated a little bit by the fact that the excess money we divert into investments must be enough to make us completely financially independent before we’re too old to produce any income by working. I’ll go in to more detail about this in a later post but, suffice it to say, we’re currently comfortably ahead of schedule and are likely to be able to stop working completely (if we so choose) by the time we’re in our late 50s.

The levels and the signals

The current ‘set point’ at which I try to maintain our cash holdings is equal to the last full year’s expenditure. This is a moving average and so fluctuates slowly with our spending trends but it doesn’t change too much.

When I do a monthly financial review, if our cash holdings are higher than the set point, I sweep (pour? OK, the analogy’s getting a bit ropey!) the excess into the investment portfolio (this happens pretty much every month). If the holdings are lower than the set point, this acts as a signal to me to start taking action to increase our income.

The ‘oh shit’ signal corresponds to the lower level on the diagram. This is currently set to half of the last year’s expenditure. If the cash stash gets down to this point, I will be doing two things:

  • Working very hard to generate some income
  • Selling off investments to bring the tank back up to its desired level

In reality, getting to the ‘oh shit’ level would signify that something had gone wrong quite a while ago anyway. Just seeing the cash stash drop slightly below its desired level has always been enough to get me on the phone looking for business.

The cost

If you’ve arrived here from a personal finance (or particularly an early financial independence) site/blog, you will have noticed that we’re massively conservative with how much cash we hold. You have likely made the very valid observation that, even though on average, the interest on our cash (spread around to get the best deals) has probably just about maintained its purchasing power, we’re still leaving a lot of potential (real) investment returns on the table.

This is very true. I’m well aware that the £30k+ that we hold in cash could easily be producing a real return of £1200+ every year, if only I invested it. However, I am happy with this choice. It’s not even a question of ‘being able to sleep at night’. I’m quite calm and very confident in my ability to get hold of some money in an emergency. But it’s really important that, as far as possible, things are always on our terms.

The outcome that we’re hedging against by holding so much cash is not so much being unable to get hold of some if we needed to, but rather being forced to compromise our lifestyle and values.

To keep our optionality, we have to keep a large amount of money in a non-volatile form. The opportunity cost of doing this is equal to the amount of investment returns we are forgoing. This is a cost we’re willing to bear in order to get the desired benefit of (almost) always being able to choose and never being forced sellers.

Stay tuned

I hope this brief introduction to our financial setup has been informative and useful.

I intentionally constrained the article to only really discuss the cash management part of our financial strategy. To give the whole picture, I’d like to write a couple of further articles in the future detailing things like how I track expenditure, what asset allocation strategy we use for the money that we do invest and how we think about things like insurance.

If you’d like to have a one-to-one chat about setting up your personal finances for a life of freedom and autonomy, please get in touch.

In the meantime, I’d love to hear from you. What would be most valuable for you? Is there anything in particular relating to personal finance you’d like me to zoom in on? Just leave a comment!


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[Image “Cartoon Character Hamster Exercise” courtesy of saphatthachat at FreeDigitalPhotos.net]

8 thoughts on “Our money: The Tank and the Taps

  1. nice post & also a nice blog…. good to see a new “entrant” into the UK FI blogosphere. I don’t write a FI blog myself, as my hobbies & community work already keep me plenty busy…. but am a keen reader of them & you may see my comments pop up from time to time. i found you via mr Firestarter last night 🙂

    Though less entrepreneurial, Mrs LCIL & myself are actually quite similar to you 2 in some ways…. we both downshifted out of our FT positions around 6 years ago: principally this was to spend quality time with our young children though we have outgrown that mindset now as we are enjoying the huge freedoms only working 3 to 3 1/2 days a week brings. We got to this point by saving fairly hard in our late 20’s & early 30’s & so had plenty of “FU” money, growing our assets & have always maintained a reasonably frugal lifestyle relative to earnings: mortgage was always being over-paid, extension (needed for kids!) built with cash not extra mortgage for example.

    Even though we now earn less than we did when we were FT, we still maintain a 40-ish% savings rate so we know our future FIRE options can be triggered whenever we like in our 50’s really. My wife loves her job… & mine is mostly more fun than not, so there is no huge sense of urgency to FIRE as we could quite easily maintain our lifestyle on Mrs LCIL just working a couple of days a week & me earning a little bit doing anything really.

    once our children are old enough to not need us around, we are thinking we will travel internationally & do volunteer work some of the time where needed, my wife probably picking up paid medical work in her field from time to time.

    keep up the posts!!!

    1. Hey LCIL.

      Thanks for the kind words. I’ve had an itch to write for ages but only decided to turn the site into a blog a couple of months ago (I’ve been coaching and doing meetups etc around the topic of living without a job since I went freelance). I hope I can add some fresh perspective to the UK PF/FI discussion.

      The main thing I want to contribute is getting people to think outside the box when it comes to how they provide value to others rather than assuming their job title as the only method for making money. I’m not a big-time entrepreneur at all (far from it), I just favour using a bit of creativity when it comes to earning a living.

      It sounds like we have quite a bit in common. We’ve also got young kids and my wife’s medical-ish (a vet). We’re currently not saving a lot as the other half’s still on maternity leave after the latest addition, but under normal circumstances, we’re in th 25-30% range. Funny really – compared to the FI crowd, I feel like we almost spend everything we earn. But tell a stranger on the street that you drop £1k+ into your investment portfolio every month and you sound like Scrooge McDuck!

      I’m all for the complete FI thing but the trade-offs involved in killing myself for 7-10 years don’t compute for me. I’m with your wife. If I work, I’m paid well for it and I love it 75% of the time. We’ll still retire earlier than most and engineering in some 6 month breaks for extended periods of travel when the kids are older won’t be difficult.

      I will definitely be keeping up with the posts (I’m going for every Friday).

      Thanks again for taking the time to leave a thoughtful comment.

  2. Very much how I’ve started to think about our income and expenses over the last few years as well.

    Looking forward to your thoughts on insurance. I never thought I’d say that sentence but I really am! 🙂

  3. Have now read all your blog postings and have to say what a fantastic resource this will be to those of us based in the UK. Found you totally by accident despite following many of the blogs you mention based in the US.

    My philosophy and current lifestyle kinda mirrors your own at the moment, I have my Fuck You money which I have to say makes a world of difference to pretty much every area of my life knowing it’s sitting there and giving me the flexibility to live life on my own terms.

    Currently I freelance around 2.5 days a week perhaps more at times if something comes up that interests me but again it’s a choice rather than driven by a need. work doesn’t feel like work tbh and the rest of my time is my own to spend with my family, hone new skills or whatever takes my fancy. For me the freedom element is worth more than anything else money could buy.

    Will be interesting to read more about your investment strategy as this is an area I’m constantly working on will be good to hear from a U.K point of view.

    1. Thanks Philip. It’s good to hear from somebody with a similar approach.

      As you can probably tell, freedom is also the most important thing money can buy for me. A lot of people miss this point. They tend to focus on the ‘going without a holiday’ or ‘going without a brand new car’ aspects of my life whilst completely missing the fact that they have to go without the freedom to do what they want for 5 out of every 7 days.

      I have to agree with you that the psychological benefits of having a decent bit of cash in the bank are massive. I honestly don’t know how people who have the choice (i.e. those who are not living on the breadline) would willingly put themselves in the position of needing to be paid at the end of every month in order to not run out of money.

      I’ve got a 90% complete post about my investment philosophy so watch this space!

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