I’m not much of a re-reader of books, but one book I’ve read several times over the years is Thinking in Systems: A Primer by Donella Meadows.
The idea behind the book is a simple one. It proposes that there is value in looking at the problems of the world, from the scale of our own lives to global challenges, in terms of systems rather than separate facts. A system is simply a collection of things that produce a pattern of behavior over time, usually achieving something.
It can be really useful to look at personal finance through that lens, so let’s get started.
Start with the basics.
In our lives, we have certain “pools” of money from which money flows in and money flows out at different rates. We have pocket money, checking accounts, savings accounts and investment accounts — we’ll stick with mostly those three kinds of accounts.
Money flows into those accounts from a variety of places, too. For many of us, the main flow of money coming in is from our jobs, which puts money in our checking account. If we save for the future, money probably flows from our checking account to our savings account. If we’re investing for retirement or for other purposes, money flows from our checking account to our investing account, or perhaps even from our job directly to our investing account (in the case of a 401(k), for example).
I often like to draw things out when I’m visualizing things in this way, so the way I’ll usually do that is to draw a big box to represent a pool, an arrow to represent the flow of something into or out of a pool, and a cloud to represent something outside the scope of what I’m drawing, and I label each of those things as I go.
So, I might draw a cloud and write “MY JOB” inside of it, then draw a box over to the right that says “CHECKING ACCOUNT” inside of it, then draw an arrow from “MY JOB” to “CHECKING ACCOUNT” and write “PAYCHECK” above that arrow. Make sense? It’s a way to visualize this.
You can keep adding details to that picture. You might add another box that says “SAVINGS ACCOUNT” and have an arrow from checking to savings that says “EMERGENCY FUND SAVINGS.” You might have a box that says “RETIREMENT INVESTMENTS” with an arrow from your job to that retirement box that says “401(k) CONTRIBUTIONS” and an arrow from your checking account that says “ROTH IRA CONTRIBUTIONS.” You might even have an arrow from “RETIREMENT INVESTMENTS” looping back to itself that says “DIVIDENDS REINVESTED,” because dividends earned by your retirement account usually just fold back on themselves.
Of course, there’s a lot of money flowing out of the system as well, mostly out of the checking account. These could be represented by arrows going away from the “CHECKING ACCOUNT” box and into various clouds labeled with things like “BILLS” and “GROCERIES” — all of the things you spend money on, split up in ways that make sense to you.
Here’s a simple example of what I’m talking about that I sketched out quickly on a sheet of scratch paper. It shows money coming in, money going out to various places, and a few pools of money that I have.
I strongly encourage you to make a sketch like this for our own finances, adding details as they make sense to you. It can be as detailed as you’d like — in fact, it can be very useful to simply add every element of your financial picture that concerns you and think about how they connect to other things.
Money flows through the system.
The thing you’ll notice about such a diagram is that the arrows represent the flow of money through your life.
It comes in from sources external to your life — your workplace, the Social Security Administration, the Treasury Department, the companies that issue dividends, perhaps a business you partially own.
It moves to pools within your life that you own — your checking account, usually. Sometimes, it will move around among multiple pools in your life – money might go from checking to retirement, for example.
Then, a lot of it flows out of your life, going to all of the different businesses and organizations that you pay for services. A little goes to the energy company. A little goes to the grocery store. A little goes to your favorite restaurant. A little goes to a charity.
You might recognize that some arrows are bigger than others. If you want, you can represent that in the drawing by making a particular arrow nice and thick, or even drawing it with a large-tipped marker. That way, specific arrows that suck a lot of money out of your accounts show up more clearly.
Do your pools fill up?
Something you’ll quickly notice is that, if the money flowing in is greater than the money flowing out for a period of time, money will start to collect in the pools in your life.
If you make more money than you’re spending or transferring to other accounts, your checking account will gradually accumulate money. If you put money into retirement without withdrawing for many years, your retirement account will gradually accumulate money.
I really like to use a water analogy here. If you spend money as fast as it comes in, your financial life is much like a river. It flows in, it flows out. You never accumulate much.
On the other hand, if you slow down the rate at which money flows out of your life, it’s like building a dam in the river. The water will start to build up above that dam, much like how money will start to collect in your accounts.
What if you figure out how to increase the rate at which money flows into your life? That scenario looks more like a flood, and depending on how you respond to that flood, it either might start pooling up (meaning you start saving or investing that money) or it might simply widen the river and keep flowing out of your life (meaning you start spending more on non-essentials).
My number one rule of personal finance is to “spend less than you earn.” It’s actually several pieces of advice wrapped into one phrase, because not only does it give you the secret to accumulating money, it points to two ways to accumulate money faster than you are right now – spend less or earn more. Spending less means that you’re trimming down the arrows leading out of your pools, while earning more means you’re widening or increasing the number of arrows leading into your pools.
If you want your pools to fill up — in other words, have more money in the bank and achieve financial success, you either need to widen the arrows coming in (or increase their number) or narrow the arrows going out (or decrease their number).
Why are you doing this?
This is a great point to step back and ask ourselves about the purpose of the system. What is the purpose of this system that you’re looking at?
Obviously, a big part of the purpose is to sustain your ordinary life activities. You have a handful of bills you need to pay, things to ensure that you have food on the table, a roof over your head, clothes on your back and more. Those are arrows going out. You need enough arrows going in to make sure that those arrows going out are covered.
The question is what else do you want to do?
If you want to live a more materially luxurious life right away, you’re going to add arrows going out of the system until it matches or even exceeds the arrows coming in. Beyond that, you probably want to add more arrows coming in or widen your arrows coming in — meaning promotions at work, a new career initiative or starting your own business — so that you can add more arrows going out for luxury goods and experiences.
If you want a simple, stable life with less stress, you’ll want to decrease the size and number of arrows going out, replacing them with arrows between your various pools. You decrease the number of arrows going out by canceling services and paying off debts. You reduce the size of arrows going out by cutting back on various types of luxury spending. The arrows between pools mean that you’re moving money from checking to investments.
If you’re saving for a goal, you’re likely following a mix of these plans. You want to reduce the size and number of arrows going out, increase the size and number of arrows coming in, and then add some arrows (or increase the size of them) between the various pools in your life.
Again, I find it really useful to sketch what I want the system to ideally look like when I’ve achieved what I want to be doing. I just draw a picture of what my financial system looks like when I’ve achieved my goal (or am getting very close to it).
For example, my goal is to retire as early as possible. In that situation, my financial system looks something like this:
What’s changed here?
First, there is no arrow coming in from a cloud called “JOB.” That’s because I’m no longer working for a wage.
Instead, now there are arrows coming into my checking account from my retirement accounts, labeled “DISTRIBUTIONS.” That’s the money I’m withdrawing from my retirement accounts when I retire.
There’s also a reduction in outward arrows. In my first picture, I had a cloud representing “DEBTS.” In my ideal situation (and, luckily, my current situation), I don’t have any debts, so there’s no arrow going out to that cloud.
Here’s the reason for doing this: when you draw a picture of the system you have now and then the system you ideally want that represents your goal, the differences between the two are a checklist of the things you need to do to get there.
So, for me to get to where I want to go, I need to have my retirement account pools big enough so that the arrows that would come in from them would cover all of the arrows going out, ideally forever. That way, I can get rid of the arrow coming in from “JOB,” which is really the big goal here.
Basically, a systems-based view of your finances gives you a nice visual way to look at your financial situation right now and compare it to where you want it to be. That comparison tells you what needs to change.
Often, those changes boil down to changing the arrows around. How do you eliminate some arrows? How do you add others? How do you change the “size” of them?
Here’s how to reduce the number of arrows going out of your pools.
This approach aims to increase the amount of money staying in your pools by simply eliminating bills entirely. That money that stays with you can then be used for other purposes.
Pay off your debts. This is an obvious way to eliminate a bill. Once you’ve paid off a debt in full, that arrow going out of your system goes away.
Eliminate an expense permanently. You can do this by canceling a gym membership or a subscription service. Again, that particular arrow going out of your system goes away once you cancel that service.
Consolidate some bills. In general, consolidating your bills reduces the amount of money you’re paying in total for those services. You replace a few arrows going out with one bigger arrow, but that bigger arrow is smaller than the combined smaller ones. You might look into packaging together various insurance plans you have under one insurer, for example. This will eliminate some insurance bill arrows and replace them with one bigger insurance arrow. You might do the same with debts if you can find a more friendly interest rate.
Here’s how to make arrows going out smaller.
Another effective way to keep more money in your pools is to simply make arrows smaller. In other words, you find ways to reduce particular expenses in your life.
This is where frugality is useful. Frugality is all about the art of making arrows smaller in a way that balances the good you get out of those expenses with what you’re spending. Your aim is to reduce the size of those arrows without significantly reducing the benefit you get from those arrows.
Here are some of my favorite ways of doing this.
Buy store brand food staples and household items. Buying store brand garbage bags and toilet paper and flour is less expensive than the name brand versions of those items and almost always do the job just as well. You get virtually all of the value from those expenses while spending much less. The arrow just gets a little thinner.
Make your home more energy-efficient. This is all about thinning the arrow that goes out to your energy company without changing the way you live. You can do this by replacing light bulbs with more energy-efficient ones, buying EnergyStar appliances when replacing them, using fans more efficiently instead of using air conditioning or furnaces, and so on.
Do more things for yourself. Instead of getting take out, make something at home. Instead of making convenience food, make something from scratch. Instead of paying for an oil change, do it yourself. Instead of calling a plumber, try fixing your own toilet issue first.
Here’s how to make the arrows coming in bigger.
This usually involves improving your current career path or small business trajectory. The catch with this approach is that when you make that arrow coming in bigger, it usually comes with non-financial costs — more stress, more time working, and so on. Often, that stress happens before the arrow gets bigger.
Get a raise or a promotion. This usually involves convincing your supervisor or other decision-makers within your current business that you’re doing a good enough job to warrant more pay (to keep you as an asset and/or to keep you away from competitors). If you’re promoted, this often involves more responsibility, too. Much of the work needed to earn a raise or promotion happens before you actually get those things, so it’s effort put in for the long term benefit.
Switch jobs within your career path. You may also simply switch to another job within the same career path, one that pays more for the same work or offers some advancement for you. Again, you probably need a solid resume or connections to make this work, which are things you build up before you make this kind of move.
Start a new career. This might involve a lot of night classes or other efforts in your free time, meaning you’re probably just treading water in your current career for a while, or it might mean walking away from your current career entirely to get a fresh education.
Double down on building your business for the long term. If you’re an entrepreneur, look for ways to increase your business income for the long term by investing in things that will produce long term results. This varies widely from business type to business type, but you’ll want to aim for things that will make your arrow thicker for the long term, not just a short term boost. Of course, these types of investments usually don’t produce additional income in the short term.
Here’s how to increase the number of arrows coming in.
Another approach is to add more incoming arrows to your system. There are a few ways of doing this.
Get another job. This is the easiest way to do it, particularly when you’re wanting immediate results. Getting another job means sacrificing a chunk of your free time to get a paycheck in pretty quick order.
Create something that will produce a long tail of income. You might create a website with ads, make a high-quality YouTube tutorial video, write a book or an ebook, or create something else that people will either buy (or enjoy for free with ads) with little additional effort from you. Those things will produce revenue for you for a long time without a lot of additional work, but you’ll invest a lot of work upfront for minimal return.
Invest. Many types of investments become their own arrow producing money for your system. Money in a savings account becomes a small interest arrow. Stocks produce dividends. Investment properties produce rent.
Changing the arrows around to achieve your goals is the real puzzle of personal finance.
A systems-based approach to personal finance makes it easy to visualize your financial system as it is now and where you want it to be. The challenge, then, becomes figuring out what needs to be done to make that change happen.
Do you add more arrows? Do you remove arrows? Do you make some outgoing arrows smaller? Do you try to make some incoming arrows thicker?
Those questions aren’t purely financial questions. To really answer them effectively, you need to examine other areas of concern in your life. What things do you most enjoy? What things do you most value? What things do you spend money on that you don’t really get much value out of? What things do you spend time and energy on that you don’t get much value out of?
As you start to answer those questions and apply them to your life, you’ll find that they change the picture of your financial system. Your pools grow. Arrows change and disappear and appear.
Gradually, your picture starts to look less and less like what you started with and more and more like the goal you have for yourself.
For some, this type of visual approach to personal finance makes something that feels like boring numbers on a spreadsheet come to life in terms of something meaningful. Consider this type of systems-based approach to be another tool in your financial toolbox, particularly if you think visually rather than numerically.