Part 1: Cash-Flow/Budget/Debt Planning
Austin Colby, CFP®, MBA
Cash-flow planning—many people get uncomfortable the moment this topic arises. It is very likely the most personal part of personal finance; it is also very likely the most important part of your long-term financial plan.
We talk often about how having a grasp of your month-to-month spending plan is paramount to your retirement planning success. What we mean is this: a key component to creating a rock-solid financial legacy is understanding how much wealth is needed month-to-month to provide the lifestyle you want when you are no longer earning income.
A survey performed in 2019 by Intuit Mint, a popular personal finance budget tool provider, showed that 65% of Americans do not know how much they spend in an average month. Oddly enough, over 30% of those surveyed indicated they wished they spent less each month…which of course is difficult for a person to do if they have no idea from where they are starting.
With so few public-facing opportunities to learn basic budgeting/spending, it is no wonder so many Americans can struggle in this area. Very few schools teach any type of personal finance, and any classes that are available do little to teach how money is earned (work), what you should do before you earn those dollars (budget/plan), and the most effective ways to allocate those dollars once you have earned them (give, save, spend).
As a painful exercise to remind myself of this fact, I pulled the last 95 years of federal government budgets (public information available for anyone who is a glutton for financial punishment), and found that the average federal “budget” actually listed spending that was 27.63% higher than available dollars for that year.
For perspective, that would be akin to an American tax-paying household earning $100,000 but spending $127,630…every single year. That is a good formula for bankruptcy.
The most common question we hear from client families when discussing the area of cash-flow planning is the same question proffered in two different manners:
- How much money should I be saving each month?
- How much money can I spend each month?
The answer to the first query depends on what you want the answer to the second to be—and the answer to the second is determined by how you answered the first.
For families who are in accumulation mode (actively adding to their portfolio for future spending), every dollar that is saved is one additional dollar that isn’t spent, which equals fewer dollars you will need to have saved in order to comfortably retire.
A quick example below.
- Family A earns: $100,000
- Family A invests for the future: $10,000
- Family A spends the rest: $90,000
- Family A invests for 30 years: $1,123,000 future spending (hypothetical)
- Family A can now spend in retirement: $6,000/month (assuming 30 years of retirement)
- Family B earns: $100,000
- Family B invests for the future: $12,000
- Family B spends the rest: $88,000
- Family B invests for 30 years: $1,347,000 future spending (hypothetical)
- Family B can now spend in retirement: $7,230/month (assuming 30 years of retirement)
The 2% reduction in spending during the earning years actually led to a 20% increase in investing, and a 20%+ increase in the future safe monthly spend amount.
Cash-flow planning tips:
- Plan your spending before you earn the money.
- Automate the most important parts of your personal plan (giving, saving, investing, debt pay-down).
- Do your best to track your baseline monthly spending.
- Increase the good habits automatically (up your investing percentage by 1% every few months, increase your monthly mortgage payment by $100 every few months, etc.).
The point of budgeting or creating a spending plan is not to cut spending, though that could very possibly be a result, but rather to give you a clear understanding of what your current lifestyle is and thus what you are working to recreate in the future.