The Thing We Never Talk About

Timothy Iseler: Hi everyone.

Welcome to The Thing We Never Talk About.

My name is Tim Iseler.

I'm a certified financial planner and I
run my own independent financial advisory

business helping musicians, artists,
and other people with weird jobs make

smarter decisions with their money.

You can learn more at iselerfinancial.com.

And if you have a question about money or
personal finance, please send it my way

by visiting iselerfinancial.com/podcast

and I will answer it in a future episode.

And if you enjoy this podcast, you can
sign up for my Keep It Easy Newsletter.

I write about exactly this kind of
stuff, and I share it there most weeks.

You can subscribe at
iselerfinancial.com/newsletter.

I work with a lot of people who are
self-employed in one way or another,

whether that's freelancing, operating
a one person business, or running

a small business with employees.

And one of the biggest challenges
that self-employed people face is

not knowing how much money they make.

That can make planning for
the future more difficult.

A lot of financial planning tasks and
tools start with how much money you make.

Certain budgeting techniques, for
example, look at how much you make and

then assign a purpose to every dollar.

You can't do that sort of thing
if you don't know how much

you're gonna earn this month.

Retirement projections incorporate how
much you make into the calculations,

so if your income goes up and down,
those projections are less accurate.

And debt repayment plans often rely on
the ability to overpay your monthly debt

obligations, which is just not always
possible with an irregular income.

Because of that, lots of
people stall out there.

They say, since I don't know how much
I'm gonna make this month or this

year, I can't do any of that stuff.

I say not so fast.

Even though self-employed people
don't have the luxury of a predictable

paycheck, there's no reason they can't
take control of their financial lives.

You just have to come at it in a
different, sometimes unconventional way.

While you might not know how much
you earn every month, you could

still get a pretty good idea of how
much you need to spend every month.

And that is important information.

Here's a really simple way to understand
how much you spend that doesn't take a

lot of time or rely on a budget: gather
six months worth of statements from

your bank accounts, add up all of the
money going out, and then divide by six.

Voila.

You now have the average for how much you
spent each month over the last six months.

It's not a super detailed or sophisticated
approach, but it gives you a decent

estimate in probably 30 minutes or less.

And today we're gonna take your average
monthly spending and use it with a

mental framework that is helpful for
understanding how to manage your cash

flow with an up and down income, as well
as knowing when to save money in your

savings account and when to invest it.

I call it the reservoir
system for cash management.

It's a simple idea, a simple framework,
but I think it really helps people who are

perhaps a little intimidated by budgets
and numbers understand how much they

should keep in different accounts, when
they should save, when they should invest,

and how all of those relate to cash flow.

So here's the setup: imagine that
you are the manager of a small town.

This town is situated next to a river
that flows down from clean, natural

springs high up in the mountains,
and your town relies on this water.

In the rainy season, there's enough water
for everyone and everything works great.

But then the river dries up sometimes.

Your town still needs that
water, so what do you do?

In this metaphor, the river
represents your income.

When you've just landed a big gig or
client or finished a big job and your

flush with cash, everything feels easy.

You're going out to eat, treating
people to dinner and drinks,

and heck, why not buy yourself
something fun while you're at it?

You've earned it, right?

But then your income slows down and
you need to tighten the metaphorical

belt, and you start to worry about
when that next check is coming in.

This up and down, boom or bust
cycle is just plain stressful.

You'd need a better plan
for how to deal with that.

Back to the metaphor: as the town
manager, you need to keep enough

water available at all times to
cover your town's immediate needs.

In order to do that, you need
to know how much water your

community uses on average, right?

You can't keep the right amount on hand
if you don't know how much you need.

This is the same as knowing
how much you spend on average.

And here's where the reservoirs come in.

Your first reservoir is
focused on immediate needs.

On any given day of the month,
you need to make sure you have

enough water to handle demand.

And since demand can fluctuate,
you'd ideally like to have a little

bit more than just the average
amount so there's some wiggle room.

Now, if your water levels start to drop
below that target amount, that means

you might be at risk of running out.

We don't want this to happen.

This is the job of your checking.

It's there to pay your immediate expenses,
and it's a good idea to have a little

bit extra in case things go wrong.

I think aiming for about one and a
half to two times more money than

you spend in an average month in your
checking account is a good target.

It's enough to cover this
month with some surprises.

And if you notice the number in your
checking account starting to drop below

what you spend in an average month,
you know that you've been spending

a little bit more than expected
and you need to cut back, right?

It's a simple way to understand if you've
been spending the right amount or too

much just by checking on one number.

So your checking account
is your first reservoir.

You need it for solving
immediate problems.

But you also need to plan
for extended dry seasons.

So as the town manager, you divert
some water from the river into another

larger reservoir to get you through
the longer periods of instability.

This is your savings account.

You should keep enough money in
an interest bearing, FDIC insured

savings account for at least three
to six months worth of expenses.

The more you hold in this account,
the more stability you will

have in your up and down income.

Now, I'm gonna stretch the
metaphor a bit, but stick with me.

Because you are so clever, you built
that second reservoir, the one

for the next three to six months,
next to a natural spring that

trickles into your water supply.

That spring isn't enough to support
your town on its own, but over

time it adds to your reservoir with
no additional work on your part.

What a bon chance for you!

This is akin to the interest you
earn in your savings account.

It's not enough to get rich,
but it helps your money grow

over time with no extra effort.

When your first reservoir starts to feel
a little dry, you can pull water from that

second reservoir to keep your town going.

In other words, it's totally okay to pull
money from your savings account when you

need it to cover short-term expenses.

That's what it's there for.

The only thing to be cautious about
though, is making sure that you refill

your savings account afterwards.

If you end up draining your savings
account, then you have no safety net when

there's an extended period of low income.

So that should be a very big priority.

Now, let's say that, as a forward
thinking town manager, you anticipate

a day when your town will grow and its
needs will exceed the current levels.

So you wanna get ahead of that
problem and start storing up resources

now that you will need later.

It is time to build your third
reservoir, which is investing.

Like the second reservoir, your
savings account, this new one is

located near several natural springs.

But these springs don't just add a trickle
to your water supply; they can add an

average of 10% more water each year.

So if you divert some of the river's
water to this reservoir each year,

it can grow at a pace that will
exceed your growing town's needs.

In fact, given enough time, this
third reservoir could support

your entire town without taking
any new water from the river.

Not that you have to do that, but
it sure would be nice, wouldn't it?

This is exactly how investing works.

You take a portion of today's money,
use it to buy investments that line up

with your goals and timeline, and, with
enough time and patience, your investments

can begin to replace your income.

But please note that having enough cash
on hand for your immediate needs takes

priority over adding to your investments.

Your biggest investing superpower.

Is to let your investments grow
for a really long time, and that

doesn't happen if you need to sell
them because you ran out of cash.

So even though I want everyone to invest
for more and better options in the

future, I want you to prioritize short
term security and stability first by

keeping enough money in your checking
and savings accounts at all times.

Okay, back to this Town Manager framework
for a little recap: you take today's

resources, your income, and you first make
sure that your checking account has enough

money in it to cover at least the next
month, but preferably the next month and

a half or two months worth of expenses.

Remember, you want a little buffer
in there for unexpected things.

Think of this as your first reservoir.

Once you have enough in your checking
account, there is no added utility

to keeping extra money there.

It's time to move that extra
money to a savings account

where it can earn some interest.

This is your second reservoir.

Everyone should aim for a minimum
of three months worth of expenses

in a savings account, but people
with up and down incomes should

aim for at least six months worth.

If you're extra cautious, you
can aim for 12 or even 24 months.

But at a certain point, there isn't a
lot of extra benefit in continuing to

add money to a savings account, and
this is because interest, even for the

highest earning accounts, never really
outpaces inflation by all that much.

Often the interest a bank pays you
is actually less than inflation.

So even though bank accounts are very
safe in the short term, you need something

else that will grow at a fast enough
pace to replace your income over time.

So once you've reached your target for
your savings account, it's time to move

excess money into investment accounts.

This is your third reservoir.

Keep in mind that there are different
places you can invest your money for the

future, and all of them are important.

Retirement accounts, like IRAs,
offer you tax benefits when

you invest for your future.

That's a good thing.

But the downside is that you will
be penalized and possibly owe taxes

if you take money out too early.

In practical terms, that means that
you can't really use your retirement

accounts to augment your cash
accounts when they start to run low.

But non-retirement investing accounts,
which might be called individual

or taxable or just plain brokerage
accounts, fill a different space.

You don't get any tax breaks when you
invest in these types of accounts, but

the upside is that you can turn those
investments into cash on short notice.

There may be tax consequences when
you do so, but there are no penalties.

So it's always preferable to take
money from your non-retirement

accounts if you need extra cash and
let those retirement accounts continue

uninterrupted for a long time.

Also, since the tax code is basically
written to benefit rich people, who

happen to own the majority of all public
and private investments, the taxes

involved with non-retirement investing
accounts are never higher and often

lower than your ordinary income tax rate.

If you've owned an investment for
less than one year, any dividends

or capital gains are taxed the
same as your regular income.

Never more, there's no penalty involved.

But if you've owned an investment
for more than a year, dividends

and gains are always taxed lower
than your ordinary income tax rate.

In fact, capital gains taxes max
out at 20% even for people in

the highest income tax bracket.

Most people will never pay
more than 15% on capital gains.

So even though taxable investment
accounts don't have the same advantages

as retirement accounts, they're
still really useful when it comes

to being able to access that money.

And the taxes you do incur
are typically the same or less

then your ordinary income.

Using both retirement and non-retirement
investing accounts is a good thing.

So that's the reservoir
system for cash management.

Like I said, it's a simple idea, but
I think it can help you understand

when you should save, when you
should invest, and how both of

those relate to your cash flow.

Aim to keep at least enough money in a
checking account for the one and a half

or two months, move excess money into a
savings account until you have at least

three to six months worth of expenses,
and then put any additional money to work

for you by investing in both retirement
and non-retirement investment accounts.

I hope that helps.

Let me know if you have any questions,
i'm always happy to talk about this stuff.

That's it for today.

Next week I'll be
talking with Emily Flake.

Emily is a cartoonist, and you can find
her work in publications like The New

Yorker, for example, but she's also a
writer, a comic, a teacher, and much more.

I met Emily years ago back when
we both lived in Chicago, and

this is probably the first time
we've spoken in at least 20 years.

It was a great conversation and
definitely recommended for anyone

with a multifaceted freelance income.

All right.

I'll see you back here next week.

The Thing We Never Talk
About is for educational and

entertainment purposes only.

It's not legal, investment or tax advice.

People on the show, including myself,
may have interests for or against

any investments discussed, so do
yourself a favor and don't ever make

any investment decisions based on
what you hear on this or any podcast.

If you like what you hear, please
like and subscribe to this show

wherever you get your podcasts.

If you have a money or finance
question you would like answered

in a future episode, please visit
iselerfinancial.com/podcast.

And you can get my insights on money and
more delivered directly to your inbox by

subscribing to my Keep It Easy newsletter
at iselerfinancial.com/newsletter.

Thank you so much for listening.

I appreciate you.