Monthly Archives: March 2017

Method to Prepare an Expense Budget and Why

All of us look to the future and hope for the best, but not everyone makes the effort to collect the data needed to answer the question: “Will I have enough?” Indeed, most people just roll the dice and trust that an optimistic attitude will be sufficient. Yet the reality in most cases is that the future may not be the most comfortable of times.

A proper budget and financial plan requires input on four key categories: what you earn, what you spend, what you own and what you owe. The information needed for three of the four categories is relatively easy to find. It’s the spending that’s trickier, sometimes a lot trickier.

The hitch with spending is that it needs to be viewed from four different perspectives. What most of us focus on is current spending. But then we get into the retirement years and the what-ifs. The time of retirement is generally predictable. What is not predictable is the early demise of a spouse (often the key wage-earner) and the impact on expenses before and during the retirement years.

So a sensible expense budget encompasses the outgoing cash flows as they are today, as we expect they will be during retirement, and how they would be adjusted if only one spouse makes it into the late 80s or 90s. Although there’s no guarantee, a sharper focus on these alternatives will increase the likelihood of a good night’s sleep.

The key items in an expense budget include the following, which are largely fixed for extended periods:

  • Monthly mortgage or rent payment for residence
  • Food and household incidentals
  • Utilities (gas, electric, water)
  • Telephone and internet
  • Property taxes
  • Life insurance premiums
  • Health insurance premiums
  • Homeowner’s insurance premiums

Then there are fixed items for shorter periods, such as:

  • Alimony, child support
  • Auto loan payments
  • Other loan payments

Next, the unpredictable expenses:

  • Healthcare expenses
  • Legal costs

And finally, discretionary items that may be reduced as needed:

  • Clothing and personal items
  • Property maintenance and upkeep
  • Domestic help
  • Babysitting, child care
  • Entertainment and vacations
  • Books, papers, subscriptions
  • Home furnishings
  • Gifts, birthdays
  • Credit card payments
  • Charitable contributions

These are just the “normal” kinds of expenses one would need to include. In addition, there are huge variables such as funding for children’s education and outlays for major purchases such as those for a larger or second home.

Education expenses will be among the biggest nuts to crack. A child born today will probably cost $750,000 for four years of tuition and related college expenses. That’s a daunting prospect that will require either hefty savings from day one, the good fortune of a scholarship or a combination of the two.

The what-if scenarios must be addressed as well. Downsizing is often worth considering as a means to reduce expenses. And, of course, several of the fixed items will drop simply because there would be only one person involved.

Once this is done, the process of looking ahead requires an extrapolation of where things are today and the understanding that this is a dynamic process with periodic adjustments to stay on course. It can be a challenging task for individuals and is perhaps best handled with the assistance of a qualified financial professional.

Here When to Talk to Your Kids about Finances

When should you start talking about financial matters with your kids? I suggest as soon as possible. My father worked in the investment field his whole career and I grew up hearing stories about how putting a little away each year can add up to a lot in 30+ years. I remember being a freshman in high school and my dad telling me if I put $2,000 in my IRA for 20 years, when I was ready to retire I’d have a million dollars. Now that got the attention of a 15-year-old. Don’t worry if you or a family member aren’t in the financial industry, there are a lot of resources to help educate your kids about money.

There are plenty of books, websites and YouTube videos that not only educate, but can confuse and overwhelm. Therefore, I suggest keeping the message simple: “save a little every month until you retire.” The amount will change as income increases but the premise of paying yourself before you pay others is the message you want your kids to understand. My father gave me a book that I have given many of my clients who have given it to their children, called The Richest Man in Babylon, by George S. Clason. The book is about a man in ancient Babylon who put one coin for every 10 coins he earned into his pouch and later he was able to use those saved coins to earn more coins for himself. His simple act of saving and investing is how he became the richest man in Babylon.

The goal of the conversation is to get kids excited about saving by showing what they can accomplish with baby steps. As their savings grow, the next conversation is about where to put the savings and how much to save.

Applying to College

Eighteen-year-olds should not be expected to make a decision about whether or not to attend a university without understanding or at least having a conversation with their parents about the cost and how their schooling is going to be paid for. At that age, if their options are properly explained they will understand enough to have an opinion on their selection. If the choice is $100,000+ in college loans for a private university or $40,000 in loans from a state school, the child who will be responsible for the loans certainly needs to be involved in that decision. Treat them like the adults you want them to be.

Family Finances

I have seen clients take very different approaches to talking with their kids about finances, but I believe it is prudent to educate them about your goals and financial philosophy. Kids don’t need to know their parents exact net worth at age 21 but as their parents enter their 70s I think they should. For estate planning, legacy and philanthropic planning, it is important to understand what a total estate looks like. Waiting until an illness or advanced age occurs can cost a family financially by not having enough time to initiate a plan, and your goals might not be achieved.

Before You Get Ill

Too often advisors are contacted by the children or grandchildren of someone becoming ill later in life. Suddenly they are in charge of their financial affairs. Between the illness and the newly appointed responsibilities for their financial wellbeing, it can be overwhelming, but having a proper estate plan, healthcare directives, and well-organized financial assets will make the responsibility less of a burden. We help our clients remove some of those stresses by keeping their financial affairs organized, and during the legacy planning we’ll create a wealth transfer plan (WTP). The WTP is incorporated within a comprehensive estate plan and helps the beneficiaries understand what is important to you and why. This makes the management of your assets easier for them and hopefully keeps everything more in line with your goals.

A WTP is comprised of three parts:

  1. A wish list, containing your personal goals, values and desires that you would like to be carried out for/ by your future generations.
  2. An implementation outline listing the steps that are necessary to satisfy the wish list.
  3. A personal letter written in your own words to your future generations in which you express your goals, rationale and desires regarding your intentions. This is not a legal document, just an opportunity for you to speak from your heart about what you want and why you have made the decisions you have.

Ask for Help

Many people don’t feel comfortable trying to explain their financial state to family members, sometimes because they fear they don’t fully understand it themselves. But these concepts and conversations don’t have be covered by a family member. I have been asked to help friends and clients have these conversations with both their kids and their parents. If you don’t feel comfortable having these types of conversations, consider asking a friend who is financially savvy, your advisor, CPA or attorney to help. Starting the conversations early using examples like savings and college will hopefully make you feel more comfortable with future financial conversations. Either way, I do recommend that you bring in a trusted advisor when you start your legacy planning.

Tips How Much Cash Should I Keep in the Bank

Everybody has an opinion on how much money you should tuck away in your bank account. The truth is, it depends on your financial situation.

What you need to keep in the bank is the money for your regular bills, your discretionary spending and the portion of your savings that constitutes your emergency fund.

Everything starts with your budget. If you don’t budget correctly, you may not have anything to keep in your bank account.

Don’t have a budget? Now’s the time to build one. Here are some thoughts on how to do it.

The 50/30/20 Rule

First let’s look at the ever-popular 50/30/20 rule. Instead of trying to follow a complicated, crazy-number-of-lines budget, you can think of your money as sitting in three buckets.

Costs that Don’t Change (Fixed): 50%

It would be nice if you didn’t have monthly bills, but the electricity bill cometh, just like the water, Internet, car and mortgage (or rent) bills. Assuming you’ve evaluated how these costs fit into your budget and decided they are musts, there’s not much you can do other than pay them.

Fixed costs should eat up around 50% of your monthly budget.

Discretionary Money: 30%

This is the bucket where anything (within reason) goes. It’s your money to use on wants instead of needs.

Interestingly, most planners include food in this bucket because there’s so much choice in how you handle this expense: You could eat at a restaurant or eat at home; you could buy generic or name brand, or you could purchase a cheap can of soup or a bunch of organic ingredients and make your own.

This bucket also includes a movie, buying a new tablet or contributing to charity. You decide.

The general rule is 30% of your income, but many financial gurus will argue that 30% is much too high.

Financial Goals: 20%

If you’re not aggressively saving for the future – maybe funding an IRA, a 529 plan if you have kids, and, of course, contributing to a 401(k) or other retirement plan, if possible – you’re setting yourself up for hard times ahead. This is where the final 20% of your monthly income should go.

If you don’t have an emergency fund (see below), most of this 20% should go first to creating one.

Another Budget Strategy

Financial guru Dave Ramsey has a different take on how you should carve up your cash. His recommended allocations look something like this (expressed as a percentage of your take-home pay):

Charitable Giving: 10-15%

Food: 5% – 15%

Saving: 10% –15%

Clothing: 2% – 7%

Housing: 25% – 35%

Transportation: 10% – 15%

Utilities: 5% – 10%

Medical/Health: 5% – 10%

About That Emergency Fund

Beyond your monthly living expenses and discretionary money, the major portion of the cash reserves in your bank account should consist of your emergency fund. The money for that fund should come from the portion of your budget devoted to savings – whether it’s from the 20% of 50/30/20 or from Ramsey’s 10% to 15%.

How much do you need? Everybody has a different opinion. Most financial experts end up suggesting you need a cash stash equal to six months of expenses: If you need $5,000 to survive every month, save $30,000.

Personal finance guru Suze Orman advises an eight-month emergency fund because that’s about how long it takes the average person to find a job. Other experts say three months, while some say none at all if you have little debt, already have a lot of money saved in liquid investments, and have quality insurance.

Should that fund really be in the bank? Some of those same experts will advise you to keep your five-figure emergency fund in an investment account with relatively safe allocations to earn more than the paltry interest you will receive in a savings account.

The main issue is that the money be instantly accessible if you need it. (On the other side, remember that money in a bank account is FDIC insured.) For more advice, see Building an Emergency Fund.

If you don’t have an emergency fund, you should probably create one before putting your financial goals/savings money toward retirement or other goals. Aim for building the fund to three months of expenses, then splitting your savings between a savings account and investments until you have six to eight months worth tucked away.

After that, your savings should go into retirement and other goals – invested in something that earns more than a bank account.

Finance : How Long Must Take to Save for a Down Payment

The more money you can put down on a purchase, the less your loan will cost. That’s because you will pay less in interest. This is true of any loan, regardless of how large a sum you are borrowing. For this reason, it’s important to save as much as you possibly can before making that big purchase. The question is: How much should you save? That – and your resources, of course – will determine how long it will take to reach your goal.

Differing Views on Loans and Down Payments

Many personal finance gurus believe that taking out a loan for any reason is not a good idea because the amount of money you’ll pay over the life of the loan makes the asset you purchased way over priced. Let’s say you buy a $200,000 home with a 4% interest rate; on a 30-year loan, you would pay more than $140,000 in interest. That’s a lot of money thrown away.

But it’s not that easy, right? For most of us, if we didn’t take out a mortgage, we would never purchase a home.

Others argue that the responsible use of credit is healthy. Whatever your opinion, even the experts agree that the more money you can put down, the more cost effective the loan. And that means you have to save as much as possible.

Take home mortgages. Although you can put down as little as 3.5% with an FHA loan or 5% with some other loans, you will probably pay a higher interest rate because the lender sees you as a higher risk borrower. That means the cost of the loan is unnecessarily higher.

Any home mortgage that doesn’t reach the 20% loan-to-value level will have private mortgage insurance added to the monthly payment. That means that you will pay between .5% and 1% of the loan amount annually for this insurance. For this reason alone, it’s best to put at least 20% down for a mortgage.

The same principle is true for car loans. You don’t have to worry about PMI on an auto loan, but cars depreciate fast. If the loan stretches out too many years, you risk finding yourself owing more money on the loan than the car is worth.Car gap insurance can help against that risk, but you’re better off not putting yourself in that situation in the first place. That is why experts recommend at least a 20% down payment on any auto loan. If you can’t afford that large a down payment on the car you want, consider looking for a cheaper model to keep the cost of the loan within your price range.

How to Save

A 20% down payment on a car loan or home mortgage is a large amount of cash, and for many households it isn’t practical. Still, you should attempt to reach these levels.

In the case of a car, the down payment doesn’t necessarily have to be in cash. Dealers will often lower the price of a new car if you trade in your old automobile as part of the deal. Or you could sell your car privately to raise money. The same is true for a mortgage. Selling your current home at a profit becomes the money you use for your down payment. Don’t take the first offer you receive if it’s below market value. Better to wait a little longer and get a fair sale price so your down payment is larger.

If you’ve barely saved anything, the hard truth might be that you need to slow down and be patient before making that big purchase. Create a budget for yourself that allows you to save as much as you can each month.Also look through your home and see what you can sell to raise money. You may have more value than you think tied up in your belongings.

You also might consider taking a part-time job or doing freelance work to earn extra money to put aside for your purchase. To motivate yourself, spend some time calculating how much you could save over a year if you worked a second job.