First, let me say, I never cared much for the word budget.
It sounds a bit restrictive and a little like being on a diet.
What if I told you, you didn’t really need a budget?
Now, before you get all excited, a budget.... actually, lets start using “expense plan” instead. An expense plan may be a necessary tool in getting one’s finances in order.
If you find that each month you have a shortfall, i.e. more money going out than coming in, this definitely needs attention and an expense plan is critical.
I’ll let you in on a little secret, only a small percentage of the US population doesn’t need an expense plan.
These are people that earn not only way more than they spend, but also follow my rules for a successful financial life.
So, what are these rules and am I doing everything I can to help ensure I’m in that small percentages of folks that doesn’t need an expense plan?
You may be thinking, “Rick is talking about the ultra-wealthy that has millions or billions of dollars”.
While you may think the more money one makes ensures a lifetime of financial freedom, you may be mistaken.
Let’s look at two couples.
Carl is married to Mona, and has two kids, Noah age 4 and Leo age 5. Carl has an annual gross income of $800,000.
Sounds like a lot of money (It is!) but let’s take a look at some of their monthly expenses.
1. Mortgage - $14,000
2. Dining out - $4,500
3. Nanny - $2,800
4. Personal trainers - $1,100
5. Groceries - $2,500
6. Vacations – $5,800
7. Car lease payments - $1,850
I could keep going but you get the idea and remember, these are monthly costs. Many times, the more one earns, the higher the lifestyle.
Over the last 30 years, I have seen countless people increase their lifestyle as their income has gone up.
I’m not saying this is wrong, I’m saying one should follow my rules for a successful financial life.
So, what are these rules?
Well, Carl and Mona really don’t have any. Since he earns a lot, they are able to live a pretty good lifestyle. Traveling many times each year, driving expensive cars, and eating out several times a week.
Despite their high income, they really don’t know if and when they will be able to retire or if they can pay for college for their two girls.
You might be thinking, “If they earn 800k a year, they must be okay and can surely retire any time they want as well as pay for any college their kids want to go to”.
Here is something I learned long ago. One of the most important factors in how well someone will do financially is based not on how much they earn but what their expenses are.
After taxes and their expensive lifestyle, Carl & Mona are actually not prepared for retirement, educating their kids or other important goals.
Other than contributing to Carl’s 401k, they don’t have much in the way of savings.
They have also not prepared for life’s uncertainties or curveballs.
Ideally, one should start with a Comprehensive Financial Plan. Think of this as a blueprint for building your financial dream home.
If building a house, you'd think about how many rooms, how many baths, what type of counters are in your kitchen?
You wouldn’t just hop down to the lumber yard and buy a bunch of wood and start hammering away.
You need to understand what the cost would be to build your dream house.
The same applies to building your financial life.
We start with an inventory of what you own, what you owe, how much you earn, and a list of your short-, mid-, and long-term goals.
Your financial plan dictates how much needs to be invested or saved each month to meet those goals. Mona & Carl have not thought about that and that is understandable. When one earns that much, it isn’t top of mind.
Mona and Carl, despite their high income, might indeed need an expense plan. Reason being is, they have no idea if their long term goals will be met and waiting until retirement is a bit late in the game to figure it out.
Let’s look at another couple. Here we have Mia and Ben.
They both work, however, their gross income is closer to $260,000.
Mia and Ben sat down with a Certified Financial Planner practitioner and discussed what their goals and concerns are.
Their goals look something like this:
1. Both retire by age 64
2. Fund college for Molly age 4 and Emma age 7
3. Buy a vacation home when they retire.
4. Take annual vacations in retirement.
Of course, I would need more specifics on what retirement looks like for them, what a vacation looks like, what schools they think the kids might go to etc.
Then, in their action plan, it may say,
1. Based on your goals, each max out your 401k’s until the year you retire
2. Each contribute $541 a month into a Roth IRA*
3. Put money away each month in an FDIC account until you reach 12 months of expenses. This will be your emergency fund
4. Save $600 a month for Molly’s education*
5. Save $800 a month for Emma’s education*
6. Each purchase an additional $1,000,000 term life policy to protect your daughters and each other if you we no longer here*
So, does Mia and Ben need an expense plan?
If they have enough income to fund their various goals each month, does it really matter if they goes to Starbucks once in awhile or out to eat on Saturday night?
Not really. Their financial plan helps dictate what they need to save each month to not only meet their various goals, but it also incorporates “guardrails” that keep them on the road when things get slippery.
As long as they are following the plan, they should be okay.
Now, there could be times when things require them to make a change and be more mindful of spending. Cars need repairs or replacing. Roofs leak. These are examples of expenses that should be incorporated into your plan.
Let’s say one lost their job for example. These are times when you must take a closer look at spending.
Oh, and one more thing. Just because one has a particular goal, it doesn’t mean it could come to fruition. In Mia and Ben’s case, they have a goal of a vacation home. Goals many times need to be prioritized. Trade offs might need to be made such as working a bit longer or spending less in retirement or even going to a less expensive college.
Only until you walk through a comprehensive financial plan will you get a better understanding of what is possible.
If you feel you would sleep better knowing how your overall finances look, feel free to reach out to me for a complimentary chat.
Click on my calendar link HERE
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In good health.
All the best.
Rick Fingerman, CFP®, CDFA®, CCPS®
*Names have been changed. This blog is meant as a general example and is not specific legal, tax, investment, or insurance advice. Always seek proper counsel from a licensed professional. Investments carry risk of loss.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, health, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.