Spending Strategy vs. Budgeting

01:08 Who is Wade Reed, and why are his insights important?

Patrick Donohoe: So it’s probably 2009, 2010. And I distinctly remember the office space because it was the first office that we moved into as an organization after some pretty significant chaos. And in walks this guy. At the time he was working for New York Life as a financial advisor, fast forward almost 15 years and here’s Wade Reed. Together, we’re doing a few episodes about the Perpetual Wealth Strategy, specifically focusing this episode on cash flow.

Wade is an incredible Wealth Strategist here at Paradigm Life. He’s been here for almost two years, actually, three and a half. Wow. Well, it’s kind of like COVID and COVID messes with time. Why don’t you take a moment and talk about what you’ve been up to? What happened after we met in 2009, 2010? And, your story?

Wade Reed: Sure thing. Thanks, Pat. Thanks for letting me join you for this little conversation about cash flow. I would push this back just a little bit further to 2005 because that’s when I had this epiphany that my career path was not physical therapy, it was personal finance. It just rocked my world because I had this little whisper come to me that year. I was in my undergraduate days. I was recently married and I thought, I just need to take a personal finance class with my wife. We both agreed to take this elective course and I was like, wow, why are so many people clueless about money and why am I not as clueless?

It wasn’t to say I was an expert at that point, but I wasn’t as clueless as other people. I thought this is actually a really interesting space. I want to be here. Fast forward to 2009, I’m working in life insurance, had been working in banking, and was seeking mentorship. I was also seeking the right methodologies for financial success through reading books about cash flow, living a life of passion, and finding the right career path.

I knew I needed to be here. I knew that there was a big problem in the world around money and how emotionally taxing it was for those preparing for retirement, as well as those who were younger trying to just make ends meet. I wanted to be an asset in that space to help people overcome a lot of the stresses that show up when you’re dealing with life and money.

I knew first-hand how taxing it can be. I was in college, had two children, and married for about five years. Around 2009, 2010, we met when we were on parallel paths doing very similar things with very similar philosophies, but kind of lost track of each other for a while after.

I’d been subtly checking in on your organization over the years to see where you were at, if you were still doing the same types of things. I always knew that if I changed my path a little bit from the path I was currently on at that point in time, coaching small business owners, that I would likely make a shift and join forces because we were so aligned from the very beginning, we saw things similarly.

We’ve experienced similar gaps, right? It’s the gap between why people struggle and why they don’t have to struggle. There are strategies out there, there are systems out there, there are solutions out there. But you just see in the financial services world, there’s typically this myopic focus on one area or another. And typically it’s the area of investment.

The question is usually, how can I position my assets and accounts to get the highest return? There’s just so much more to a healthy financial life. And so, yeah, looking at how the Perpetual Wealth Strategy has evolved over the years, our philosophies have aligned and you bring, I would say, a more holistic approach to wealth building because obviously at Paradigm Life, our focus is a financial product. It’s a core financial product. That plays so many different roles in finance. We’re obviously experiencing where people are making mistakes and hurting themselves financially and figuring out ways to provide solutions, whether it’s in the form of an education, product, service, or other tools of technology.

Patrick Donohoe: But, you worked for a number of years with our friend Gary Gunderson at the Wealth Factory and experienced the nature of holistic financial strategy and wealth strategy. So what you bring to the table isn’t just stuff that you regurgitate from a book, it’s literal experiences with clients and the challenges that they face outside of the specific financial product world.

Wade Reed: Yeah, absolutely. To give proper context to that, over nine years from 2010 to 2019, I had a chance to work with over 700 clients. Most financial advisors work with 700 to 1000 over 30 to 40 years. I did that over nine. We worked very comprehensively with this client base who were almost exclusively business owners.

Part of the reason for that particular group was because the nature of their problems were the same and yet a little more advanced. There was a need for more complex planning at times because of the holistic nature of a business owner. You’ve got your business revenues intermixed with your personal revenues. You don’t have a personal financial life without a business life.

We had to get the business figured out. The entity structure, tax structure, asset protection had all got to be right. You’ve got to have estate planning in place and sometimes there’s more sophisticated planning there that is necessary for some versus others. I developed this really broad spectrum of knowledge and often more depth in that area than many other advisors could get because of just the sheer number of people I got to work with. It’s pretty rare in the financial services industry to have people hire you, pay you a fee, and take you through a process, as opposed to just selling you something.

That experience gave me the perspective of the critical nature of cash flow and having liquidity sources, because as you mentioned earlier, financial crises are generally, and almost exclusively, about cash flow. They are a function of illiquid assets, money stuck in businesses, money stuck in qualified plans that we’re so fearful of getting out when these crises happen that we end up in debts, which is a negative cash flow.

08:23 What is cash flow?

Patrick Donohoe: So, cash flow. Let’s start with an introduction. What is cash flow? And, how do you define it?

Wade Reed: Cash flow represents the money coming into your personal life, which is then allocated based on your priorities and values. This covers everything from paying your mortgage or rent and utilities to creating memories and experiences for yourself and, if you have one, your family.

08:52 What is healthy cash flow?

Patrick Donohoe: Healthy cash flow is one that is net positive. In the financial space, there’s often confusion between net and gross. Net is what remains after deducting expenses. So, a net positive cash flow indicates a profit, meaning you have more left over at the end of a given period (like a month or week) than what you began with.

To maintain a healthy cash flow, you must consistently have more left over. There are many parallels in life to what constitutes health. For instance, with our physical bodies, if we consume more calories than we burn, it leads to health issues. Over time, our body deteriorates, leading to diseases like diabetes, heart disease, high blood pressure, and cholesterol. Most of these conditions aren’t due to genetics but result from daily habits. Engaging in a few good disciplines daily can lead to accumulated health, just as bad habits can lead to accumulated disease.

To illustrate, I recall a story from a trainer I hired about 8 to 9 years ago. On my first visit, he shared a tale of a man who wanted to become a world-class rower in just six months, aiming for Olympic gold. The trainer explained that such physical prowess is accumulated over years, even decades, and can’t be achieved in such a short span. Similarly, financial health is accumulated over time.

Patrick Donohoe: Consider another analogy: an ecosystem, be it a forest or a rainforest. If the energy produced is less than the energy consumed, the ecosystem will perish. But if there’s a surplus, it thrives. The same principle applies to cash flow. Without a healthy cash flow, which is foundational, a series of negative consequences will follow, impacting wealth building and how one handles unexpected life events. When faced with such events and an unhealthy cash flow, the decisions made might not be favorable.

Most people understand the basic principle: spending more than you earn is detrimental. Yet, statistics show that the majority live paycheck to paycheck. Even though it’s widely recognized that to be financially healthy, one must produce more than they consume, just as in an ecosystem or with personal health, many still struggle to maintain this balance in their finances.

11:37 Why are budgets difficult to maintain?

Patrick Donohoe: Let’s dive into the typical approach to managing finances: budgeting. Why doesn’t budgeting always work?

Wade Reed: While it does prove effective for some, the mindset we have about budgeting often hinders its success. Many perceive budgeting as restrictive, which can be off-putting.

From personal experience, I recall the challenges of accurately predicting my income, which was often uncertain. While I could anticipate certain fixed expenses like rent and insurance, variable expenses were harder to pin down. It’s these unpredictable, emotionally-charged expenses that can derail a budget. For instance, an unplanned fun activity or outing with friends might not have been accounted for in the budget. If funds weren’t set aside for such spontaneous events, it can lead to feelings of guilt. Questions arise like, “Am I jeopardizing my financial future by indulging in this activity?”

There’s a fundamental misunderstanding about the human need for emotional spending. We crave variety and spontaneity in our lives. If our budget doesn’t accommodate this need, it can feel restrictive and lead to a sense of loss, especially when missing out on opportunities to spend time with loved ones.

Budgeting, at its core, revolves around the idea of restriction. This isn’t to label it as good or bad, but merely to highlight its nature. People inherently dislike constraints. They yearn for freedom, flexibility, and control over their decisions.

13:38 What is the difference between budgeting and spending strategy?

Patrick Donohoe: Right. So that’s budgeting. Now, looking at how we frame, I’d say, healthy cash flow. We look at spending strategy versus budgeting. How would you differentiate the two?

Wade Reed: I’d just look at the context. A budget feels restrictive, but a spending strategy sounds and feels proactive. It’s a choice. I’m choosing this particular way of doing things, designed deliberately with some flexibility and buffer space for dealing with uncertainties, spontaneous opportunities, or emergencies. I’ve noticed there’s a function around saving and setting money aside for the future that’s often built into a spending strategy. But it’s often not effective because of the order of how we do things. Have you noticed that too?

Patrick Donohoe: I have. Budgeting, at least how I was conditioned, means you save what’s left over. You pay all the bills, handle variable expenses, fixed expenses, and save what’s left over. But as society evolves, there’s always more to spend money on.

Wade Reed: There’s an infinite amount of stuff to spend money on. It’s an insatiable appetite to consume.

Patrick Donohoe: So, we get a spending strategy. How we frame it is by shifting that order, like you mentioned. There’s a lot of evidence supporting this shift, like the book “Profit First” and Barbara Corcoran’s approach. The order of setting aside money for saving and investment first, then spending the rest, is crucial. We’re biologically designed to consume. This consumption drive is rooted in our primitive instincts. We get a dopamine rush from spending, but it’s not always healthy. We need to shift this dopamine hit from spending to saving and investing.

Wade Reed: When we shift the order of things, it makes a difference. I advise my clients to save everything first into a separate account. This way, they see the value of their earnings and can prioritize their spending. It’s like having cash in the pocket; you can only spend what’s in there, unless there’s an unexpected event or opportunity. Evaluating unplanned expenses or opportunities according to our values and priorities is essential. Many clients want to give generously, but it’s often the last thing they do. However, if it’s part of your spending plan, it just happens.

Patrick Donohoe: For Paradigm Life clients, we have tools like “WealthView360” and “Hierarchy Of Wealth” available on our portal, that help you get a pulse on where you are in your financial life. If you find yourself asking “why don’t I have any money left at the end of the month?” then login and evaluate your cash flow and financial health with these free tools.

I have a personal story about my wife, Cynthia. She grew up in a really rough area in Sonora, Mexico. When money was available, it was spent immediately due to uncertainty about the future. When we incorporated a cash flow system, it changed our spending habits. All income goes into a central account, and then we have separate spending accounts. This system helps control our spending. It’s essential to understand our biological tendencies. We’re designed to consume, but we also don’t like feeling restricted, like with budgeting. A strategic spending plan is the ideal solution.

Wade Reed: I’ll give you a quick case in point. One of my clients several years ago was in the dental business. We evaluated his financial circumstances and found that he had a business producing $1.5 million a year in revenue, netting him about $300,000 to $500,000 a year. Yet, he had $1.3 million sitting in a 401k. I asked him, “Why do you have $1.5 million in debt?” He couldn’t provide a clear answer. He mentioned his mortgage, business loan, vehicles, and other obligations. I questioned his approach, asking why he was accumulating this debt.

He seemed unsure. I then pointed out, “Have you noticed that your balance in your 401k is very similar to what you have in loans?” He hadn’t realized it. I suggested that perhaps he had shifted his liquidity away as a business owner. While he was setting money aside for his future, which was commendable, the method he was using created a scarcity mindset. This mindset led to behaviors where his loans were never fully paid off. And even if they were, they wouldn’t remain that way for long because his behavior was to spend.

I proposed a different approach. “Let’s try this method we’ve been discussing. Set up a separate account and funnel all your income through that first.” Within a couple of months, he came back to me, excitedly saying, “Wait, I’ve got $75,000 sitting here. I’ve never had this much liquid cash available to me.” He was experiencing the dopamine hit not from spending, but from saving. This liquid cash gave him peace of mind, knowing that if an unexpected event occurred, he didn’t have to pull money out of his 401k or take on new debt. He simply had the money ready.

It’s fascinating. He had a significant amount in his retirement accounts, but it was this relatively smaller liquid amount that brought him so much excitement. If these numbers sound large, don’t be daunted. It’s the behavior around money that matters most, regardless of the amount. Whether you’re making $150,000 a year and netting $30,000 to $50,000, the principle remains the same. Our ideal strategy suggests living off about 80% of your income. Achieving this might require strategy, working with a wealth strategist, or conversations with your spouse or partner. But it’s certainly possible.

24:19 How much of your income should you be saving, spending, and reserving?

Patrick Donohoe: One of our ideal targets, or strategies, is to aim for about 20%, meaning living off about 80% of your income. This approach is very healthy. Naturally, reaching this target might require some strategy. It could involve working closely with your wealth strategists or having in-depth conversations with your spouse or partner. But ultimately, achieving this is possible.

Okay, let’s discuss the importance of reserves. Saving a certain percentage of your income is a good start, but it’s not the end-all. Reserves are crucial. Wade mentioned unexpected and variable expenses. Sometimes these are minor, like spending a bit more on a vacation or an anniversary dinner. But there are also significant unexpected costs: a medical emergency, a car accident, or unforeseen expenses related to kids. I genuinely believe that these significant expenses are probably inevitable for most people. That’s why having between 3 to 6 months of liquidity is so vital. It acts as a buffer for the valleys of cash flow.

Wade Reed: Absolutely, and I’ve often been curious: why the range? Why not just three months or just six? And in some scenarios, might someone need up to 12 months?

It’s about assessing risk and being prepared. If you’re a single income household, six months seems right. If that sole income were to stop, you might need up to six months to find a replacement. But if there are two income earners and only one loses their job, three months might be enough. For business owners, especially those with new or seasonal businesses, I’d lean towards 12 months. Would you agree?

Patrick Donohoe: I do. There are general guidelines, but it’s also about the specifics of each situation. A new or seasonal business might need more cushioning. But if you have a business with consistent accounts receivables, you might need less. More is always better, especially until you’ve solidified your cash flow system and spending strategy. Excess cash does have an opportunity cost, but it’s about balancing that with security. Having cash in a bank or a money market account is ideal for those initial 3 to 6 months. But then, as we discuss in the Hierarchy Of Wealth, there’s the tier one capital. We often recommend cash value as a very liquid position. It offers good returns, often superior to bank returns, and comes with tax efficiency. That’s why working with your Wealth Strategist first, and then evaluating it every so often can be beneficial.

Wade Reed: Right, it’s not just about stashing money under the mattress. We’re talking about optimization. Some of it is kept close in a bank account, but we also look at more efficient places to store money that still offer safety, like cash value life insurance or certain brokerage accounts. The goal is liquidity, safety, and control. If we can add growth and tax advantages on top of that, it’s a win-win. But there’s more to it than just the numbers. The peace of mind these strategies provide has its own value. It’s not just about the earnings inside the account. It’s about how that peace of mind can make you more effective in your various roles, whether as a parent, employee, or employer.

The opportunity cost, which is easily quantifiable in bank accounts, becomes less tangible but no less real when you consider these broader benefits. The value of cash isn’t just in its immediate spending power. It’s in the choices and capabilities it affords us in life. I’m willing to bet everything I have that if you maintain cash and liquidity, you’re far more equipped and likely to seize opportunities than if you’re constantly restricted and drowning in debt.

29:04 How can the Perpetual Wealth Strategy improve the quality of your life?

Patrick Donohoe: As we wrap up this first episode on Cash Flow, I’d emphasize that the Perpetual Wealth Strategy is about achieving the highest quality of life. Life isn’t about tomorrow; it’s about the present. Everyone seeks a high quality of life, which isn’t quantifiable, it’s something you feel and experience. I’ve seen in my life and in the lives of many clients how financial stress can impact this quality. It affects relationships with family, business associates, clients, and employers. Achieving a high quality of life requires strategy, especially since life is dynamic and always changing. Cash flow is crucial. Without a proper cash flow system or spending strategy, people often resort to credit cards. When those max out, it can lead to bankruptcy. Life will always have its ups and downs, but a good cash flow strategy can help buffer those challenges.

Wade Reed: I think with cash flow comes a healthy respect of self. Recognizing that the money we have is a result of the problems we’ve solved for others, and that it represents our value, is essential. Managing our cash flow is a reflection of our self-worth and appreciation. It’s a testament to the value we bring to the world.

Patrick Donohoe: I’ll add to that. When you have healthy cash flow and achieve a higher quality of life, the feeling it gives you accelerates your understanding of your value. When you show up to work with confidence, less stress, and a high quality of life, you produce more. This can lead to new opportunities, whether with your current employer or elsewhere. Our society today is proof of the limitless potential we have. People are making millions on platforms like YouTube doing the most random things. Mindset is everything. Healthy cash flow fosters a positive mindset, enabling you to capitalize on opportunities that might already be around you.

Wade Reed: Or, give up what takes away your life’s energy. If you’re stuck in a job you despise because of minimal cash flow or debt, shifting to a positive cash flow mindset can give you the freedom to leave and confidently pursue other avenues.

32:36 Free cash flow evaluation tools exclusive to clients of Paradigm Life

Patrick Donohoe: All right, everyone, thank you for tuning into this episode on Cash Flow. I’d like to remind our Paradigm Life clients that we now offer self-evaluation tools. Head over to your portal account to explore Wealth View 360. It’s a digital dashboard that provides an overview of your entire financial life on a single page. Additionally, we’ve been promoting the Hierarchy Of Wealth for several years, and we’ve now digitized it. This tool helps you organize your assets and identify opportunities for maximum growth with minimal risk.

If you’re not yet a client, you can get personalized guidance on your cash flow by clicking “request a free consultation” above this transcript. We’re excited to have you join us for the next episode.

Wade Reed: Thanks, Pat.

Patrick Donohoe: Thank you, Wade.