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What is Cash Flow?

Cash flow is arguably the most valuable money management tool. It is used in concert with net wealth and balance sheets to develop a successful money management planning strategy.  Budgeting, systematic savings, debt payments are all part of our cash flow.

Cash flow is a comparison of money in versus money out.  If net worth is to grow, money in must be higher than money out.  Though simple in principle, this is seems to be difficult in practice.  For example, the concept of “burn more calories than you take in” is simple concept as well, though as a society we seem to have just as much trouble with it. [Read more…] about What is Cash Flow?

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What is Liquidity?

Liquidity is the ability to quickly convert assets into cash without negatively affecting their value. Your need for liquidity in an investment depends on the purpose and time frame for the investment.  If the investment is part of an emergency fund or for something you plan on buying in the next month, the investment should have high liquidity.  If the investment is part of your retirement and you’re 30 years old, your investment should be low in liquidity in order to realize a higher return. [Read more…] about What is Liquidity?

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How Do You Make Financial Decisions? Make ‘Em Better

Decision is a critical aspect of personal finance. Our past, present and future are a result of decisions we’ve made and will make. We’ve all been taught to learn from our mistakes. However, if we have an incorrect or incomplete understanding of what has transpired we may incorrectly label a solid decision as a mistake. Conversely, we may incorrectly label a mistake that happened to have a positive outcome as a quality decision.  This error in understanding tends to tarnish judgment

1. Decision Quality is not Determined by Outcome

Good decisions sometimes have poor outcomes and poor decisions sometimes have good outcomes. An example: If you liquidate your child’s college fund, go to Vegas for a weekend, and put it all down in one arbitrary hand, is that a good decision?  What if you double your money, was it a good decision then?  A bad decision is a bad decision, regardless of its result. Chance or luck is not an aspect of decision-making.  I love being lucky just as much as the next guy, but I don’t bet on it.  The quality of a decision is not a product of its outcome.

2. Decisions are only as Good as the Information and Assumptions they’re Based on

Garbage in, garbage out. This applies to any decision or process, but it is particularly obvious in financial planning. If you base any part of your financial plan on incorrect information or faulty assumptions, the product will be substandard. You can have the best financial planner in the world working for you, but if the data you provide is garbage, the result of the process will be garbage.  Ensure that the information used is both correct and complete.

3. Take Context and Purpose into Consideration

Different investments are designed with different goals in mind. Long term investments (i.e. the stock market) will sometimes have poor short-term performance. Short term investments (i.e. Treasury Bills, Savings Accounts, etc.) will often have poor long-term performance (in terms of rate of return). Overlooking such considerations can lead to developing an invalid understanding.  Be sure to evaluate results in the proper context.

4. The Human Factor

We have a natural tendency to underestimate the odds of future problems and overestimate the value of current pleasures. Imagine being 70…imagine your lifestyle, where you’ll live, who you’ll live with and how you’ll spend your time. Will your current choices give you the life you want? Is ‘that’ item really worth financing for an exorbitant interest rate? Is it worth increasing your debt? How much will you end up paying in interest when all is said and done? Are you doing it for yourself or to impress others? If the money were invested instead, how much would it be worth in 20 years?

It’s not just about retirement. If you’re young, will your current financial decisions give you the lifestyle you want for you and your family when you have kids or will you be broke, living paycheck to paycheck and financing everything? Something to think about…

Take the above into consideration when evaluating past financial decisions.  At the same time, do not skew the facts in order to justify a poor decision. Doing so will reduce the quality of future decisions, it won’t change the past. What’s true is true.

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What is the Time Value of Money?

Money now is worth more than money later due to growth potential and the erosive effects of inflation.  This is one of the most important concepts in personal finance.  This concept is what makes 0% financing so attractive.  Assuming no payments are missed and the loan is paid in full during the 0% period, inflation essentially pays a portion of your bill.  Not a bad deal.  Remember that if payments are missed or other conditions go unsatisfied, the interest rate often balloons to a ridiculously high interest rate.  Be smart with your money; don’t be lured into “deals” with circumstances you’re not sure you can satisfy. If you miss a step, any step along the way, you’ll pay dearly.  Nothing is free, everything is conditional.

Inflation eats away at buying power:  $100 is worth more now than $100 a year from now.  Inflation (averaging 3% per year) eats away at the buying power of money.  Assuming a 3% inflation rate, $100 today will only purchase $97.09 (100/1.03) worth of goods a year from now.

Retaining buying power: You can retain buying power by making your money work for you.  You may deposit into savings, money market or other accounts to gain interest.  Leaving excess funds (i.e. more than you need for bills and a respectable cushion) in checking accounts is typically a bad idea because checking accounts generally have some of the lowest rates. You may also invest your funds in stocks or mutual funds, accepting a higher risk to potentially earn higher returns.  These strategies will allow you to somewhat counter or even beat losses of buying power to inflation.