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.
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
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.
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.
The most important characteristic of my money management technique is flexibility. It is designed to deal with a wide range of possibilities including
- My freelance work dries up completely
- 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
- Me picking up more freelance clients or ramping up another income stream
- 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 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.
- 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.
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.
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]