Overview:

There’s an old saying about the 2 ways to become rich:

–          Be born rich or

–          Marry rich

Purpose:

However, in actuality, there are countless other ways to get rich: winning the lottery, driving yourself to a high-income job (i.e. investment banker), finding gold, starting your own business and controlling your spending. All of these ways except the last one is based upon your cash in rather than your cash out.

The purpose of this article is to give the basic building blocks around controlling your cash out. A great study on why controlling your cash out (aka spending) can lead you to be the next millionaire is a book called “The Millionaire Next Door” by Thomas Stanley.  The book discusses that one of the quickest ways to becoming rich is by controlling your spending. The first thing you need to do to control your cash out is to build a budget.

Analysis:

Before we can even build a budget, we need to define some key terms around budgeting.

First let’s look at the Maslow’s Hierarchy of Needs[1], which are broken into 3 categories with 5 different types of needs:

–          Basic Needs:

§  Physiological (food, water, warmth, rest)

§  Safety (security, safety)

–          Psychological Needs:

§  Belongingness and Love (intimate relationships, friends)

§  Estate (prestige, feeling of accomplishment)

–          Self-fulfillment Needs:

§  Self Actualization (achieving one’s full potential)

Some other terms we need to define to help us build our budget:

–          Needs – What we need to survive. These are the basic needs of food and housing.

–          Self-fulfillment – These are not needs, but things that would be nice to have but can also drive future growth.  For example, I want to get my MBA. This has a cost to me now, that I try to justify that the degree will drive my future income potential.

–          Wants – These are not needs, but things that would be nice to have. These wants try to fulfill our psychological and self-fulfillment needs and generally drive no future growth. This is where the balance is most needed. Compared to my MBA example, I also wanted a car with leather seats. This might lead to nothing but some small short-term satisfaction in my psychological needs but won’t lead to future growth and I doubt it will stay with me as a lasting memory.

–          Lasting Memory – There are many articles on how experiences, not things will lead to happiness. [2] Thus, I define these items as non-tangible experiences that drive your fulfillment of your psychological needs.

–          Status Items – These are items where we want to be something we’re not. This often comes in the form of clothing, purses, cars, or food.

–          Veblen Good – Items which the demand increases as price increases, your classic Luxury good. These are even higher than just status items and they definitely do not hit any of our needs only wants that drive no future growth.

–          Auto Saving – Deductions out of your cash account into a saving vehicle.

–          Timing of Payments – I have a separate article on cash vs check vs debit cards vs credit cards, but this relates to when payments are taken from your net worth.

Action Plans:

Now that we’ve defined many items within a budget, here are some action steps you might take to start controlling your outflow of cash:

–          Read the next article on building budget examples;

–          Read books on cutting costs, like the Millionaire Next Door by Thomas Stanley;

–          Set up Mint (or any spending app) to start to understand where your spending is going;

–          Set up an auto saving plans (401k, IRA, investments);

–          Set aside time every week for your budget review (I try and do mine every Friday night when we don’t have plans. Usually while watching a movie with my wife, so I can ask her questions and have controlled spending discussions); and

–          Review other articles on budget building on Finance First.