"If you don't know where you spend money, you won't know where you can save,” says Claire Mackay, an adviser at Quantum Financial.
And why is this so important?
You might think that being wealthy, or at least comfortably off, depends on what you earn, but in fact, argues this financial adviser, there is more to it. Being wealthy depends on how much you spend.
"My wealthiest clients know exactly where all their money goes," says Mackay. She adds that invariably clients can find ways to reduce their spending if they need to, even if it is changing to a cheaper mobile phone plan or reviewing their electricity, gas or insurance arrangements.
There are two things you need to understand about your finances. The first is the so-called balance sheet, which shows what investments you own and how much debt, or borrowings, you have.
The investments might be an investment property, shares, money in a bank account or superannuation savings. The debt you owe might be a mortgage, debt on your credit cards or car or personal loans.
The balance sheet part is important when it comes to retirement because you will need to rely on these investments to support you when you are no longer earning a salary.
The other area of your finances that you should be on top of is the day-to-day stuff, that is, your monthly or annual income and your expenses.
When you think of your salary, don't think about it in gross terms, but the amount you receive after tax and super contributions have been deducted – your net salary. This is the amount that you actually have to spend.
When calculating your expenses, you should include everything from groceries and your daily coffee bill to your expenditure on rates, entertainment, clothing, car insurance and your telecommunications.
My wealthiest clients know exactly where all their money goes.
You need to be careful to capture everything, warns Mackay.
Longer term, the idea is to arrange your income and expenses in such a way to allow you to shift the money you receive via your salary to the investments that appear on the household balance sheet – although in the shorter term the money may be shifted to separate holiday or school-fee accounts.
Once you are retired, you will not want to have much debt hanging around, so the idea is to gradually pay down borrowings.
The bottom line is you need to understand your financial position – what is going on in terms of your assets and borrowings, and income and expenses — even if you are simply overseeing it rather than involved in the day-to-day operations. Ultimately you need to know if you are converting income into assets.
‘It’s not at all hard’
Eighty-four-year-old Peggy Runting was a feminist before young ladies from the suburbs had heard the term.
At 18, she knew she was clever (she had attended a selective high school) and she knew she had to be independent (her father had just been killed at work on the Melbourne wharves). She also knew she was highly capable.
"When I went through the hairdressing academy a fellow gave some talks each month on being successful. 'You can do it,' he'd say. It was the best thing I had in my life, those talks. I was confident. I could do anything."
And Peggy pretty much did. She opened her first hairdressing salon at 18, supporting her sisters and mother, who had been pregnant when she was widowed.
She went on to open two other salons — remarkable for their Parisian-inspired decor and indoor gardens — and set her mother up in a milk bar, where they also all lived.
And she took care of the household budget.
"I had a chequebook, we lived near the shops and we had a regime," Peggy says.
"You know how much you can afford. I was making money. I used to go and bank it every couple of days and I knew how much was coming in."
And that is the key to budgeting, she says.
"With your budget you know what you can do. It's not hard at all."
Peggy's salons did well: "You've got to have a laugh. Half of business is having a bit of personality."
But she was ready to give it up when she decided to marry George, a 40-year-old war veteran, when she was 34.
"I wouldn't marry him until he agreed to go overseas for three months on our honeymoon."
Building houses, having two children, taking holidays in her beloved caravan and working part-time in a nursery ensued. Now home for Peggy and George is in a retirement village.
"I lived," says Peggy.
Case study by Natasha Hughes