Couple discussing home economics

Managing Your Money Effectively Pt.1

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As I have mentioned in my previous post, you need to divide your money on a monthly basis to manage your money effectively.

The Play Account

Let’s start with the fun. All work and no play makes Billy a boring boy! You work all of your life to generate an income—what’s the point if you can’t enjoy that income? Many people have the opposite problem; they spend too much of what they earn and they never accumulate anything. So it is important you find a happy balance. The play account allows you to facilitate this in an automated way. Each month you pay a set percentage into your ‘Play’ account. This money you have to spend on fun stuff and treats. That could be clothes, eating out, a nice watch—whatever flicks your switch. If you do not enjoy the money you earn, your subconscious will not compel you to earn more, and you will be less successful. I would suggest 5% of your monthly income should go into your play account.

Post retirement, this principle still holds true. Enjoy your hardearned savings by spending it on things you enjoy. The ‘Play’ account will force you to continue doing that, while keeping you from going over the top.

Long-Term Growth Fund

We all have bigger capital expenses that we need to save for in the future. Pre-retirement this might be your children’s education, setting up your own business, or phasing in your retirement. So it makes sense to have some long-term savings that you can access before retirement, should you need to. If not, this can be included in your Financial Freedom Number.

By having this capital working hard for you over the long term, it is not sitting idle; however, if you do need money for a larger expense, you have the capital to do so.

Savings For Specifics

You may also already know what you want to spend on with your money. Much better than to borrow at this point is to already have saved for these specific situations. Again, by automating savings shortly after your salary or income drops into your account, you ensure it happens every month. You can then plan the spending in these areas much more effectively, because you will know when you have reached the amount required.

Necessities Account

What is left over needs to be enough to cover all the essentials, like the mortgage, food bills and utilities. Keeping all of these coming out of your income, and away from ‘Play’ and ‘Savings’ accounts, allows you to budget and monitor much more effectively. For me it makes sense to have my income coming into this ‘Necessities Account’, with set Standing Orders established to divert the ‘Savings’, ‘Play’, ‘Gift’, etc. funds into their respective places.

Give Account

It is important that you find a way to give to charities and causes that are important to you. The power on the subconscious of knowing that you have enough money to be able to support a good cause will truly benefit you. Not only will you feel good about this generosity, but in the long run it will also come back to you ten times over. As long as you section out what you intend to give, it doesn’t really matter whether you put this amount into a savings account to distribute at the right opportunities, or you set up Direct Debits to a few of your chosen charities.

Financial Freedom Fund

If you want to stop work in the future, you need to ensure you have built up enough money to live off. The Financial Freedom Fund will help you achieve this goal. When you accumulate enough money to live off for the rest of your life, you are ‘financially free’. Once this capital is built to the right level, you will have the income you need for the rest of your life. How much you save into here will depend on your situation. Ideally, you want an accurate calculation done

through what’s called a ‘Lifetime Cash Flow Forecast’, but we have also looked at the formula of half your age as a percentage of your earnings, too, as an easier way to get you started. Most sensible people will use a pension for their ‘Financial Freedom Fund’, because of the tax breaks already discussed, but you could use NISAs, property, or other investments if you wish.

The important thing about the ‘Financial Freedom Fund’ is that you put in money, invest it over a time frame in preparation for your retirement, and you do not dip into it. You need to leave the capital to grow; otherwise, it will never reach your ‘Financial Freedom Figure’.

Calculating Your Financial Freedom Figure

The ‘Financial Freedom Figure’ is the amount of money you need to

reach to be able to meet your expenses for the rest of your life. Again,

this is better calculated by an accurate Cash Flow Forecast, but here’s

an easy formula to generate a target for Financial Freedom Figure:

Expenditure – (Passive income like rent × 25)

This is not very precise, but it works on the premise that you can get income from your capital of 4% plus inflation from your invested capital. A more precise version of this formula would reflect your tolerance to risk.

A second important target is your ‘Financial Security Number’. This works on the same principle, but instead of being based on your desired expenditure, it is based on your absolute requirements—for example, your bills, your food and your mortgage, if you still have one. This capitalised figure will be lower, indicating the income you need to secure the bare essentials.


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