Financial Physics – Part II

Never pay fixed bills with variable money

In the second law of financial physics, we move our discussion to the importance of understanding cash flow. In my years of advising clients, I have noticed one main difference between those that find perpetual peace and those who don’t. It all lies in how they pay their bills. As we stated in our first law of financial physics, the perpetual income stream is the holy grail of financial independence. In Part II, we are going to discuss the relationship between the perpetual income stream and our expenses. Get Part II right, and you are well on your way to financial peace.

Each year we should spend money on what makes us happy. We will call this our lifestyle number – the amount of annual after-tax, cash flow each year it requires to keep doing the things you like. If you have to worry about getting a bonus, cashing in stock options or hoping the market goes up to cover the lifestyle number, you have a mismatch. And this mismatch in a best case scenario leads to severe heartburn. Worst case – financial suicide.

Variable money is unpredictable and unreliable. The danger comes when one begins to rely on variable money to pay the bills. It is easy to do. I know several corporate executives who relied on their bonuses to support their lifestyle. After all, they had a decade of experience getting the bonus. Along comes 2007 and the beginning of a 5 year hiatus from bonuses began. Paying your bills with variable money is an accident waiting to happen. I have seen far too many people that skirted financial catastrophe because they had to depend on their variable money for survival. When the variable money stopped, so did their ability to stay financially solvent.

The second law of financial physics asks you to pay your bills with fixed money. Fixed cash flow includes base salary, bonds, dividends, rental income, etc. The income is not a surprise. The event that causes the income to stop is a surprise. Set your lifestyle up to pay your bills with fixed money and you are on your way to your Point of Independence. In Part III, we move to your personal profitability.