I thought it would be good to kick off my blog series with an
important section from my book, Following Your Money, on personal flow of funds. This fundamental personal finance concept was the inspiration for naming my website. Clearly in order to follow your money you must understand the concept of cash inflows and outflows, and most importantly how decisions regarding those flows will impact your ability to fund life events and goals.
As shown in the exhibit, funds flow into and out of 2 boxes where you have either an inflow or an outflow:
- Income received from sources such as employment or bank interest
- Bills paid (not based on borrowed money) such as a utility bill
Additionally, there are 2 boxes that have both inflows and outflows.
- Money saved or invested, such as savings taken from your paycheck (outflow) and deposited into retirement account that will one day be an inflow; and
- Money borrowed, such as a loan received to buy a house (inflow) that needs to be repaid (outflow)
The flow into and out of these boxes is directed by your life goals and plans. As an example, if your goal is to buy a house you would:
- Convert income into savings for a down payment (boxes 1 >> 3)
- Borrow money from bank to pay for balance of house purchase price (your mortgage), then pay it back monthly with income (1 >> 4)
- Pay for the added expenses of owning a home, such as utilities, maintenance, etc. (1 >> 2)
The other important concept captured in this exhibit is net wealth, referred to as Pride Money in my book. Pride Money is the difference between what you own and what you owe, and is the most important measure of financial decision-making skill. Simply put, if you have a lot in the savings/investments box (#3) and very little in the borrowings/financing box (#4), then you have positive net wealth and should be proud of what you have achieved financially.