Budget. If there is a another word in the financial advisor’s lexicon that generates such a strong reaction among clients, I’m not aware of it. For some clients, budgeting is something they’ve always done automatically, while for others it is the financial equivalent of a root canal. Frank and Jackie fell squarely in the latter category. He was a media exec and she was a surgeon, and in spite of their 60 hour a week jobs and two kids at home, they’d still found the time to stay on top of their finances and the cash flow to save a good percentage of their incomes. When it came time in our initial Discovery meeting to discuss their financial concerns, Frank didn’t miss a beat.
“We’ll do what we need to do to meet our financial goals but,” he said looking at me squarely, “we really don’t want to have to live with a budget.”
Their sentiments are understandable. As financial advisors, we work with a number of couples who work long hours and earn solid incomes and when they do have some free time, they’d like to enjoy it. The prospect of living in what they perceive to be the financial straight jacket of a budget isn’t something they want to do and fortunately, in some instances a detailed budget isn’t necessary. Here is what we look for in determining whether a detailed budget is necessary:
A Viable Financial Plan is in Place
In the case of Frank and Jackie, they were saving a good bit of their income and we had put together a plan that showed based on their savings and other factors, they had a high probability of being able to fund retirement and college for their kids. Since the plan showed the amount they were saving was sufficient, there was no need to wring additional savings out of their cash flow and thus no need for a detailed budget.
Overall spending amount is known and predictable
Frank and Jackie didn’t know exactly how much they spent on particular items like eating out or expenses related to the kids, but they did know roughly how much they spent each month. Further, although there were some fluctuations in their spending, overall the amount was predictable. These factors are key because it allowed them to confirm they could continue to save at the amounts assumed in the plan and because we were able to use current spending to predict how much they would need in retirement.
If both of the above criteria aren’t met, we generally recommend trying to follow a detailed budget for at least some period of time. The first step in doing so is gathering the data and there are a number of products that can help with that. Mint.com is a popular tool that can connect to thousands of financial institutions and credit card issuers and help track spending in real time. Yodlee is a similar software package that’s often available through financial institutions and financial advisors like ourselves, and some of our clients prefer Quicken. Lastly, a low tech solution is a simply to carry a notepad to record all spending. Regardless of which option you choose, spend a few months gathering data to determine how much you spend.
If your current level of spending is such that you can hit the savings targets established in your plan, then a detailed budget probably isn’t necessary. If you do need to pare back, start by determining what within your budget is discretionary and determine whether or not you can cut back enough on those expenses to meet your savings goals. One good way to implement the budget is via the envelope system, which I will discuss in a later post. If cuts in discretionary expenses aren’t sufficient to meet your savings goals, then your best bet is to retool your plan to include more realistic savings projections.