This step is what I usually call “resource allocation.” Some people might prefer to speak of asset allocation or income allocation. What is resource allocation? It is simply a method or “allocation system” that enables you to control money (and potentially other assets or resources) by assigning each dollar to a specific use.
Why Resource Allocation is So Important
This article is a bit longer than usual, but it may be the most important one you will ever read about money. Please take time to read it carefully. Much of it may be new to your thinking about money but it is extremely important.
Resource allocation, or if you prefer income allocation or asset allocation, in this discussion is not about real estate investments, insurance, or stock market wizardry. It is not about banking, accounting or taxes.
An effective resource allocation system is about a simple, almost mechanical method for controlling the use of your money.
An effective resource allocation system is about a simple, almost mechanical method for controlling the use of your money, and in more advanced ways we will not discuss here, it can help you manage other assets or resources.
If you have found a method of your own, great. But the fact is that the vast majority of people today do not know how to manage their money in a way that keeps them in control of their spending and investments. As a result, whenever they have an increase in income or pay off a major obligation the newly available money just evaporates into the mass of spending opportunities that surround us all.
The previous three steps in this series have all been in preparation for this one. This is the central key to the whole process of getting control over your money even though most people are unaware of it and even some people who learn about it scoff or at least fail to recognize its value.
Until you learn how to control money with resource allocation (whether you call it that or not), you simply cannot ever be successful with money.
Until you learn how to control money with resource allocation (whether you call it that or not), you simply can never be successful with money. The reason you cannot succeed If you do not learn how to do this somehow is that without it you can never really learn how to control money.
Understanding Resource Allocation
Before explaining the details, it is helpful to understand the framework of the process, what it is intended to do and what it doesn’t do. Just keep these thoughts in mind when we go to the next part of the discussion which explains the mechanics of an allocation system.
Different Methods for Different Folks
The specifics of the method I am going to suggest are certainly not the only way to do it. You may prefer a somewhat different approach. The exact method you use to control money doesn’t matter as long as an effective allocation system is put into place.
A few people can manage their affairs like a business accountant. I’m not one of them. The method I will describe is simple enough that once it is set up, just about anyone should be able to maintain it effectively.
If you prefer another way, OK, but pay attention to the comments I make with each part of this description of resource allocation so you will be aware of the essential elements of any approach that works.
The sole purpose of a resource allocation system is to guarantee that you will spend the amount you choose to spend where you want to spend it.
Allocation Systems Control How to Use Funds
Keep in mind that this is a method of money control. It will not tell you how much to spend on anything in particular. The sole purpose of a resource allocation system is to guarantee that you will spend the amount you choose to spend where you want to spend it. If you don’t like how much you are spending in some area you can change it at will.
Designating individual expenditures in the way we will discuss will not change the total amount you are spending or investing either. That only happens when you manage to do so by increasing (hopefully not decreasing) your income somehow.
Think about it. All of your money is going somewhere every month right now. Once again, a resource allocation system will only help you make sure your money goes where you want and and in the precise amount you choose. It does not tell you how much to spend; you decide that for yourself.
Resource Allocation and Your Spending Plan
Also, think about the relationship between this step and your spending plan (or budget, if you will). The spending plan lets you see how you are using your money now and enables you to assign that amount to each account.
Your allocation system simply provides the mechanics needed to see that your money is distributed as your spending plan directs. First you choose how you want to spend your money, then you use your system to make it happen.
Multiple Accounts Make It All Work
The secret is to set up several accounts, whatever is needed in each individual case. Each account will control money for a certain group of expenditures.
Don’t get hung up on the idea of accounts. They don’t have to be complex. For example, each person needs personal spending money. You could easily “allocate” the needed funds by giving a set amount of cash to each individual in your family at the first of each week or month to be kept in a wallet and spent at will over the allotted time.
There is nothing complex about setting up such an account.
- You decide how much spending money goes into that account each week or month.
- You put the designated amount into the account (or wallet in this case) as scheduled.
- You use that and only that money for spending for the assigned purpose during that period.
It's that simple!
Many people have learned how to control money by using the simplest method of all—the old time envelope system. They use several envelopes, each marked for a specific use and distribute all their money in cash into them on pay day. For most of us a cash system may not seem practical, but it is used by many and it works.
My recommendation is to use one account, say a checking account, for all of your fixed expenses. This can include your mortgage, car payments, insurance, even retirement funds.
Should any extra money come in not required to exactly meet these needs it should be placed in a reserve savings account.
Other expenses can be included here that appear to vary from month to month, but are still predictable by adding payments together for the year and dividing by twelve for a monthly rate. You see here how the spending plan will already have this amount determined for you.
At the first of the month, or for each month if on a different date, you will deposit exactly the total amount required to meet all the required expenditures assigned to this account for one month. The same will be true for every account you establish.
Should any extra money come in not required to exactly meet these needs it should be placed in a reserve savings account. Leave it there until a purposeful decision is made about its use.
You may need more than one “account” for variable expense areas. This is the most important part of this plan because it is in these flexible areas that your money just disappears without a trace.
Practical Resource Allocation
A look at the suggested personal spending account is a good way to get an idea of what we are talking about. Say a husband and wife each get $100.00 in cash at the first of each month for their personal spending. Each family will identify how much money to include and what must be covered by these accounts.
With your resource allocation system in place the money you put into each account is the same amount you found in your spending plan development that you customarily spend. Consequently it is not difficult to adjust to your new allocation system. Using the system does not reduce the amounts available from what you spent before.
The difference, while seemingly trivial, is immensely important. Why? Because over a short time a mental mindset takes over.
We adjust to having and spending a certain amount of money for a given expense when we maintain a consistent amount to work with. We learn to cut back in one place so we will be able to spend more in another.
We adjust to having and spending a certain amount of money for a given expense when we maintain a consistent amount to work with.
When eating out, in order to eat a more expensive meal one day we will eat a less expensive one than usual another. But always, at the end of the month we come out even in each account. Or perhaps in some cases we even save a little over.
It is essential to incorporate every penny of income into your allocation system. Using resource allocation to get all flexible areas under control is the top priority. This is where spending gets out of hand.
Food and household items is a major area that is flexible, too. It will require its own account, probably a checking account. Because your allocation system lets you see from the beginning how much money is available, you easily learn to spend just that amount and no more each month.
To reinforce our point: remember that the most important thing is to keep working until all expenditures are covered, and at the beginning with the amounts you are now spending. This will not take as many accounts as you might think because in fact, most of your expenditures will be fixed and can be paid through one account.
The Fantastic Benefits of Allocation
The most obvious result of using this system for allocating your money is that no expenditures will expand without your permission. You won’t just haphazardly start spending more on some recreational activity, for example, without having to think about the costs and then finding and allocating the money to do so.
Anyone following this system will automatically learn to live within their income.
An extremely important benefit of asset allocation is that anyone following this system will automatically learn to live within their income.
Once this is achieved everything else becomes possible. Without this essential element nothing else is possible.
Almost as important is another benefit of having an allocation system that becomes clear at this point. Whenever you get an increase in salary or whenever you pay off a debt, the resulting funds will be available for you to designate purposefully to specific uses.
Without an allocation system like this, whenever more money becomes available it will simply dissipate into a thousand small places that don’t even register in our minds as any gain at all. With the system in place you will achieve total control of your money.
Control Your Money for a Better Future
Have you always wanted to take that special vacation or open your Roth IRA. Soon you will find yourself being able to do many of these things you never could manage before because there was just no money.
Nothing is more important to our financial success than learning how to get into control of our money. And nothing is more important to getting in control of our money than learning how to allocate our resources to our purposefully chosen uses.
That being true, there is no more important money action to take now than to get started putting into practice a resource allocation system, an individually designed asset or income allocation system. And honestly, once you know how to control money, it is relatively easy.