A lot of people think that lawyers make a lot of money. People automatically think highly of you: “Oh, you’re a lawyer, you must be rich or at least you’re getting there.” However, there is nothing farther from the truth. Of course, there are those blessed few who have made it to the big leagues and are now founding or senior partners of large and prestigious law firms. Surely, without possessing other sets of skills, in-depth knowledge of the law alone will not and cannot guarantee financial freedom and prosperity.
Lawyers usually earn in one of three ways: a) as a purely compensation income earner, i.e. as an employee; b) as a fee-based self-employed professional; or c) a combination of the first two. The problem is, especially for self-employed lawyers, as well as other similarly situated professionals, our income is wholly dependent on how much man-hours we put into working. In other words, no work, no pay! Those who use the time-billing method know this particularly well. As such, most lawyers end up working all their lives because no matter how old we get, for as long as we’re alive, our cost of living just keeps on going up to no end! Sometimes, we even proudly use it as a battle cry, “Lawyers never retire!” Verily, the stereotypical image of the “Abogado de campanilla” comes to mind: An old thin man with unkempt gray or balding hair wearing a faded barong carrying his briefcase to court. Indeed, it is such a sad and sorry sight to behold. I know because I’ve seen them. And could you imagine what would happen to them if they become too old to work or permanently incapacitated?
Generally, lawyers, except for those who are at the same time finance professionals such as CPAs, CFAs, RFPs, RFCs, CFCs, CWMs, etc., abhor numbers. To be sure, one of the significant reasons why people take up law, among other things, is because they did poorly in math and science during their elementary and high school days. Wait, I might just be describing myself here! Nevertheless, studying law and passing the dreaded bar exams do not require one to be adept in numbers. There are no complicated formulas or computations save for the determination of an employee’s minimum wage, a stockholder’s shares of stocks, or the occasional computation of taxable income; although the last one is pretty much done by accountants. The point is, lawyers, nay; most people in fact, just tune out when numbers are involved. As behaviorist Daniel Kahneman said in his landmark book, Thinking, Fast and Slow, our brains usually take the shortcut or the easier route when we are faced with numerical problems, which he refers to as the “System One” mode of thinking.
No wonder, it is because of this numerical aversion that lawyers avoid thinking about personal finance. To make things worse, society’s high regard for lawyers along with the dignity of the profession leave lawyers with no other choice but to do their very best to project success and honorability in how they dress, walk and talk. These kinds of expectations, not to mention the challenges of life itself, put a strain on a lawyer’s finances, especially if that lawyer already has a family of his own.
Having said this, learning about personal financial planning is indispensable for a person who wants to achieve financial freedom and prosperity, regardless of occupation. But the big question in most people’s minds is, “Where do I begin?” And a very good question it is indeed because personal financial planning is a process. Being a process, you should not jump from one step to another without completing the previous step. At Personal Finance Advisers Philippines (PFA), we have what registered financial planner and seasoned investment adviser Efren Cruz, calls the CD-RW approach to personal finance. CD-RW stands for the phases of or major steps in the financial planning process, which are: Cash, Debt, Risk and Wealth. Not undertaking any one of the four areas of financial management will lead to instability in one’s personal finance. Other registered financial planners divide the steps into five or twelve as do Randell Tiongson and Alvin Tabaňag, respectively. For simplicity and ease, however, we shall summarize the process to the four steps. A person hoping to get out of debt should not be investing before he reduces his debts to manageable levels. In fact, he shouldn’t be investing at all if he hasn’t yet protected his downside risks through insurance. Let me briefly discuss each phase:
“Cash” pertains to improving one’s cashflow. There are many ways to do this such as getting a promotion, getting more clients, starting a business, or selling some stuff that you do not need anymore. In fact, Robert Kiyosaki refers to this as Financial Intelligence No. 1. Short-term and current savings also fall under this phase. In fact, these two steps under this phase may and should be done simultaneously if you can. In fact, being successful in this area alone would definitely have a strong and lasting impact in your financial well-being.
“Debt” pertains to getting out of debt. Albeit, it is not always necessary to totally eliminate all debts because there are certain debts that are truly indispensable or even good such as debts incurred for business capitalization purposes. What is more important is that debts are reduced to manageable levels.
“Risk” pertains to protecting yourself and your family from life’s unexpected risks such as loss of job, total and permanent disability, and even death. The steps comprising this phase are setting up one’s emergency fund and insurance planning—both life and non-life. Although not usually done, I would also include here adequate asset protection planning.
“Wealth” pertains to the accumulation thereof through long-term saving and investing. In other words, it is how to make your money work for you and not just you working for money. This is the phase where if successful, can spell the difference between being rich, just right, or poor. The primary reason we should be investing is because we will not always have the ability to generate income. Investing can be in the form of real estate, business, commodities, or the most popular class, paper assets such as stocks, bonds, money market instruments and pooled funds. Of course, we cannot bring our wealth with us when we pass on from this life, hence, included in this phase is estate planning or how to legally pass on your property and money to your loved ones when that time comes.
For now, we will focus on the first phase, which is the foundation of the financial planning process, and that is cashflow management. Contrary to popular belief, cashflow management is not only about being frugal when it comes to one’s expenses but about being wise. In behavioral economics, it is said that finance is only 10% skill and 90% behavior. This means that while we may possess all the necessary technical skills, all of that will be for naught if we cannot control ourselves and exercise prudence when it comes to spending our hard-earned money.
For effective cashflow management, categorize your expenses into “needs” and “wants,” the latter also being referred to as “discretionary expenses.” One of the biggest mistakes people make is rushing into financial decisions without considering what’s really important for them. As many people get caught up in the responsibilities of their daily lives, they often do not have time for reflection. The easiest way to identify wants is to actually start with needs. Needs can be further broken down into two broad categories: absolute or bare necessities and near necessities. Absolute necessities are those that are important for our basic survival, things like food, shelter and clothing. On the other hand, near necessities include things like reliable transportation, insurance coverage, utilities, telecommunications, and personal care expenses. While these last items are not necessary for survival, they are fairly important for us to function as responsible and effective members of society. Now that we know what needs are, it would be easy to define our wants. Now, everything else that do not fall into the category of needs are therefore classified as wants and could be cut out if necessary. To be more specific, wants are items that are only nice to have. They are not things that you need to survive. Although sometimes, needs turn into wants when you take your needs beyond the basics, i.e. if you buy a home that is much larger or a car that costs more than you can afford. Carefully go through your expenses and determine which are truly needs, and which are actually wants the order them. After determining your needs and wants, create a plan for living within your means. This is important to finding success in your personal finance.
To reach a certain place, the first thing you must know is where you are right now. You simply cannot plot your course without knowing your starting point. In order to know where you are financially, you have to determine your net worth. Your net worth is an important barometer of your financial health. It indicates your capacity to accomplish major financial goals to be discussed later. Just as all government officials are mandated to submit their Statement of Assets, Liabilities and Net Worth (SALN), everyone would do well to follow suit as this is an excellent tool for financial planning. To compute your net worth, you just have to follow this simple formula: Assets – Liabilities = Net Worth. Your assets consist of everything you own, both real and personal properties including cash in bank and cash on hand; while your liabilities consist of everything you owe such as debts and taxes. For financial planning purposes however, it is generally recommended that you exclude your family home when figuring out your financial assets. Include your home only if you expect to someday sell it or otherwise have it leased out to generate passive income.
Once you have determined where you are, the next preparatory step is to know where you want to go. In short, determine your goals. Your goals will vary depending on the life stage you are in; whether you are a student, single professional, married, married with children, empty nester, or retired. Accordingly, your financial goals may be one or more of the following: income continuation, starting a business, children’s education fund, health fund, buying a house or a car, getting married, a family vacation, retirement fund or estate creation and preservation. It is important to determine your goals as each of these goals will have a corresponding cost that you will need to prepare for. Not knowing where you are or where you are going will only lead you nowhere fast! It would just be like driving around aimlessly with no purpose in mind except to waste precious fuel. Failure to plan is a plan to fail.
Once you have plotted your course, it is now time to gather your resources for the journey, and this is where saving money comes into play. Most people however, if not everyone, try to save only what is left, if any, of their salary or income after paying all the bills and cost of living expenses, sometimes even including their leisure expenses. And this is exactly why they fail. Instead of using the formula Income – Expenses = Savings, we should change our mindset to Income – Savings = Expenses. Better yet, I’ll let you in on the secret formula to prosperity: Income – Tithes – Savings = Expenses. Specifically, the apportionment should be as follows: 100% (Income) – 10% (Tithes) – 20% (Savings) = 70% (Living Expenses). Now why do I include the tithe? It is because I believe that because God is the one who gives us the ability to produce wealth (Deuteronomy 8:18), then giving back the tithe is one of the best ways we can honor Him with our wealth. To be sure, God told the prophet Malachi to instruct His people to “Bring the full tithe into the storehouse, that there may be food in my house. And thereby put me to the test, says the LORD of hosts, if I will not open the flood windows of heaven for you and pour down for you a blessing until there is no more need” (3:10, ESV). In fact, this is the only exception to God’s law against putting Him to the test (Luke 4:12). This principle of saving is referred to a “Paying God and yourself first.” Nonetheless, if saving 20% is really difficult for you right now, you can start small with just 10% and increase it later on when your cashflow improves.
Saving is an essential part of the process because the funds accumulated as a result of which is where you will source the money needed for your emergency fund, paying off your loans, insurance premiums, and investments, in that particular order if not simultaneously. Without improving your cashflow and saving money, any financial planning activity shall be futile for lack of the ability to execute the same. The strategy to saving effectively is quite simple and is no secret at all: “Spend less than you earn,” or to put it in another way, “Live below your means.” It never fails. One can choose to be a saver or a big spender. The big spender follows the incorrect formula for saving. I know, it’s so much easier said than done; but with God’s grace, it is truly possible!
Some people tend to blame their financial shortcomings on not earning more income. Such people believe that if only they earned more, their financial—and personal—problems would melt away. The thing is, as Robert Kiyosaki puts it, “It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.” In short, it is all about increasing our financial I.Q. Remember, you cannot grow what you do not have. Regardless of your income or how you earn your income, you can make your money stretch further if you practice good financial habits and avoid mistakes. Effective and efficient cashflow management is essential to building wealth. In fact, the lower your income, the more important it is that you make the most of your income and savings because you don’t have the luxury of falling back on your next fat paycheck to bail you out. As aptly posited by Alvin Tabaňag, “A healthy amount of savings is the foundation on which you will build your personal wealth. Without any savings it is impossible for you to achieve financial security.”
There is so much more to learn about personal financial planning that this article can cover. Unfortunately, personal finance, for all its importance and practicality, is not generally taught in our schools. Yes, we have economics in high school and college, but the theories taught therein are usually either archaic or inapplicable in real life due to its extreme technicality. So, invest in yourself first. Read books, blogs and attend seminars of reputable finance professionals such as those mentioned above. The journey of a thousand miles begins with a single step. May the grace of our Lord be with you!