The first three parts of this blog looked at what Sarah wanted her money to do, her priorities (the heart bit) and some of the reality of finance (head). In this 4th part, we’ll look at the “hands” of the process, taking the information about the person, their dreams and their realities, and putting those into concrete plans for their finances. In the final part, we’ll look at how to deal with problems in implementing the plans, and how to keep implementation flexible.

Practical plans and goals

For the immediate future, Sarah’s personal finances needed to cover her key categories. That means money:

• to live on,

• pay for relevant professional development,

• a (smaller than she’d have liked) amount for “fun, and

• emergency funds.

It would be possible to have a bigger social/fun/discretionary spending fund -but that would take away from the building of an emergency fund, that was the other priority.

Emergency funds?

Talking emergency funds, there’s a lot of myth around what that means.

A common idea, promoted in a lot of financial “advice” articles is to have “three months money”.  It’s not a bad idea, per se, but why three months? Why not a month (if you budget monthly) or a year (if you’re cautious?)  The reason it’s three is because somebody said it once. I suspect it was like “you should spend three months’ salary on an engagement ring.” That’s taken as “the rule” by a lot of people. It’s become a standard “truth”.

It was actually a De Beers (the diamond firm) promotion. They wanted to sell more and bigger diamonds, so they came up with the quote “diamonds are forever” (prior to that a diamond wasn’t the most common engagement ring stone) and said that any swain worth his salt should spend three months’ salary. And now it’s like a law, you buy a diamond, and you pay about three months’ salary. With the implication that if not, you’re a cheapskate!

The three month “emergency fund” standard might not have simply mimicked that, but it certainly didn’t come with any more thought as to what is sensible or desirable (depending on the people involved) than the engagement ring “should cost” idea.

Necessary <> Optional expenses

Knowing, or in Sarah’s case, averaging her expected income every month we sorted out a ‘career’ budget to cover the business, and professional development costs. We budgeted for the necessary expenses (stuff like rent, car expenses, food etc.). We put in a bit (less than she would have liked) for optional expenses – buying her favourite shampoo, for example.

That’s a very personal thing – and one reason why the “three months” idea and the idea of “essential” and “luxury” expenses frustrates me. Everybody is different. Bar food, shelter, basic clothing, health and perhaps company, everything is optional. My “luxury” might be something you wouldn’t touch with a bargepole. And vice versa. I class things as necessary (to avoid death, ill health, bankruptcy, divorce etc.) and optional expenses (everything else).  There are things you have to have, but, for example, entertainment streaming subscriptions and the older equivalents such as blue-ray or DVD, tumble dryers and smart speakers were unavailable to our grandparents. Even vacuum cleaners were “new technology” 100 years ago (let alone cordless, super suction, pet hair proof systems). We might think “it’s necessary” but it isn’t, even if it’s advertised extensively and all your friends have one. It’s optional and it’s up to the individual how high up the priority list the item comes. There are always more things that you’d like than there’s money to pay for them. Sarah, like everybody, had to decide what to give up and what, after necessities, was a priority.

Sarah could cover the essentials, including what she personally regarded as essential, like her shampoo, the only one that allowed her to feel really good about her hair. For somebody else, that would be optional, but for her it was necessary for mental health. She economised on the stuff she wasn’t so bothered about (trading down to “own brand” stuff, for example instead of named items where she couldn’t tell the difference).

Proportioning surplus for emergency and fun

This gave her a small surplus. If she could bring in some other money – doing some things part time, selling things she no longer wanted, great.

• That surplus went part towards “fun”. That might be meals, clothes to feel good (as distinct from business or necessary stuff), socialising. She had a budget for it, calculated monthly. If she blew it all in a week, she knew she’d have to pull her horns in for the next three weeks.

• The rest of the surplus went into the emergency fund. The target for the fund was six months normal (as calculated for now) income.

There were a couple of reasons it was six months.

One was the unreliability of her income. If she got a couple of good months, she might build up a smaller amount quite quickly and think she’d got money to spend. Then, in the event of a downturn and/or a financial blow, that money would be needed. In that situation it pays to be cautious, and that fitted with Sarah’s cautious, slightly nervy, approach – a bigger intended buffer gave her more security. That would mean she would be less likely to worry that she was making a mistake, being naïve or overconfident and therefore make it easier for her to use her head with decisions rather than potentially being panicked if there was a problem.

The other was that an emergency fund wasn’t simply for business emergencies or problems like car breakdowns. Her biggest asset was herself, her earnings potential and her current income, contacts, skills, contracts. If she was ill or injured, she might be entirely unable to work. Contracts would lapse, contacts would go cold and her income could reduce to zero. She insured her car.

Why not insure her own income?

Giving expert advice with my financial hat on

As a financial advisor, I’d get asked about whether people without a partner, children or other dependents or a house needed life insurance. As soon as they had any of the four, the answer was yes, and they need a will too. When they’re single, a will is still a good plan, but who is life cover going to help? Most single people are independent. If they don’t have dependents (no children, no parental care responsibilities) and if they’ve got a house, it’s no good to them if they are dead. But while they’re alive, they want to live, to have an income, to be able to support dependents if they get some and to pay a mortgage if they have or get a house. Insuring against long term sickness or illness usually makes sense, while life cover doesn’t always.

Income protection is more expensive than life cover, and more complicated. Therefore, it doesn’t get sold so much and isn’t so well known. It also gets confused with accident insurance, which is an annual plan (like motor or home insurance). Accident insurance pays out lump sums on death and injury or sickness (hence the jargon term, “death and spare parts”). If there’s a claim, premiums can go up the next year or be refused. Income protection, if premiums are paid, is not cancellable or alterable by the insurer. Hence an alternative name, Permanent Health Insurance.

Income protection is also expensive because lots of things that won’t kill you, stop you working. A bad back, an injury to your dominant hand (depending on the job), potentially minor issues of depression or anxiety. The medical underwriting is more extensive and the cover more expensive. It’s written with a “deferred period”, the time you must be unable to work before the benefit gets paid. For employed people, it’s written for the period during which their salary would be paid in full (It might taper off if, for example, the contract said three months at full pay, three months at half pay).

For the self-employed it’s more difficult to calculate, so ideally you have to start it as soon as possible. That is usually very expensive. The other issue with self-employed is that the underwriters want to know that you do actually earn the money – it’s not like you have pay slips or similar. Generally, they want three years’ accounts. The underwriters don’t want to be promising to pay you, say, £20,000 a year until you reach retirement age if you can feign illness and you only earned £15,000 a year in a good year. As many self-employed people found trying to get furlough in the UK during Covid, if you can show that you’re receiving a regular income, you can potentially get cover. If you’re only working on projections and theory, you might not (NHS knowledge base).

What’s possible for Sarah to consider in her current situation?

Income protection is important to Sarah because:

• She wants an independent life, with meaning.

• She doesn’t want a relatively minor injury to take that away, so insuring against it is sensible.

On the other hand, the premiums can be pretty high. And she needs evidence of income, so she might only be able to insure for a proportion of what her real income is likely to be, until she’s built up more evidence of a steady level of income. A six-month deferral period is probably a good compromise, but it depends on the rates (and availability of cover). It worked in this case, but it might have been necessary to keep it in mind and build the emergency fund up quicker, and/or to build up to twelve months emergency fund, so the deferred period could be twelve months (which makes it cheaper). For Sarah, the sensible compromise was to get cover for six months, review the level as she built the business, and also build up the emergency fund to give her six months cushion.

On the subject of insurance, another issue for coaches and most independent consultants is Professional Liability and/or Indemnity. Basically, it covers against things going wrong and getting sued by a dissatisfied client. Some regulatory bodies insist that members have it. Some don’t. Similarly, some clients (typically larger organisations) might insist that all coaches working with them have indemnity insurance. In Sarah’s case, the regulatory requirement was largely irrelevant. Part of her sense of self is that she’s a people person, and her values dictated that she do her best to protect clients, irrespective of costs. This had the advantage of automatically meeting the indemnity requirements of many potential clients, and several regulatory authorities but irrespective of this, Sarah wanted to feel that nobody else would suffer financially if she made an error and that was the motivation for this being included in her “necessary” expenses, rather than it being an optional “nice to have”.

What would you do?

For coaches, or other new professionals, who are starting out in their own business/career, and have been following this blog series so far, how well are you managing your budget for your personal finances for your business and personal (necessary and optional expenses) expenditures, savings, and insurance policies?

Whether you’re new to the profession, or well-established, when you’ve got this far with finance, what goes into the implementation of your plans?

• Which categories do you put your budget into that motivates you to keep at it?

• How do you put it into practice?

• What’s worked?

• What do you do when you blow the budget a bit, feel shame, go for retail therapy to cheer yourself up and completely blow the budget?

The last point s is what I’ll cover in my final piece of this series.

References:
NHS Knowledge Base -  https://faq.nhsbsa.nhs.uk/knowledgebase/article/KA-02233/en-us

Kim is a former financial advisor and an Associate of the Chartered Insurance Institute (hence the interest in costs, ROI etc.) and now a Chartered Psychologist, coach and tutor/assessor in neuroscience.  He’s written two books on the psychology of personal finance and can be contacted on kim@stephenson-consulting.co.uk or via the website, www.tamingthepound.com. 

* I’m qualified in finance and worked as a financial advisor for 14 years, have taught personal finance and am a qualified and experienced psychologist and coach.  I do know a bit about both people and money. From that (unique) viewpoint, those ideas are wrong.  They assume people are simple, while money is complex and money is more important than people.  Neither assumption is even partially true.