Have you tried to fix your finances only to give up when trying to build a budget? My hunch is that you’re not alone. Budgeting can be overwhelming and often unpleasant. And while websites like Mint.com (which I use) make it easier to track expenses, reliving one’s past purchases can evoke feelings of shame and regret.
“Budgeting can be a depressing exercise,” says my boss and CAMG founder John Girouard. “You go through your last twelve months of expenses. You see how much money you spent and how little you have left. It demotivates people.”
If you’re barely scraping by, then line-by-line budgeting could be important. Every dollar counts in those circumstances. But once someone reaches a certain lifestyle and comfort level, I’m not so sure budgeting provides the same benefits. For example, if you earned $5,000 in net income last month, spent $2,000 on fixed expenses, and saved $0, does it matter where the other $3,000 went?
I’d argue that it doesn’t. At the end of the day, you consumed every dollar you made. And though it might be helpful to have a big-picture sense of your spending habits, I worry that going line by line is more likely to turn you off than change your behavior.
A Different Way To Start A Financial Plan
For financial planners, the tedium of budgeting poses a different challenge. How can we explore a client’s finances without making the process feel like a tooth extraction?
At CAMG, we’ve replaced the budget conversation with something we believe is more effective: a Cash Flow Conversation. Our goal is to show our clients how much their lifestyles cost as painlessly as we can.
Rather than spending valuable time examining individual purchases, we build a broader picture of clients’ inflows and outflows. That gives us an effective, judgment-free place from which to dive deeper into their financial plans.
How Does It Work?
The underlying theory behind our Cash Flow Conversation is that income ends up in one of four places:
- It gets withheld for taxes, insurance, benefits, or retirement account contributions
- It flows into home mortgages, rent payments, and bank accounts
- It gets consumed for big-ticket, one-time expenses
- It gets consumed for everyday living
We can see the breakdown of where a client’s cash…ahem…flows…by looking at just a handful of documents:
A recent mortgage statement (or a monthly rent amount)
A mortgage statement shows us how much cash a client is using to build wealth in a home. We view mortgage principal as a form of savings and mortgage interest as a cost to carry the asset (the home). If the client rents, we ask for the monthly rent amount and we show how much wealth could be built by owning a home with an equivalent payment.
A recent paystub, and a W-2 or tax return from the previous year
These items show us a client’s gross income. They also show us how much came out of a client’s paycheck for Social Security and Medicare (a cost that goes away in retirement), how much was saved in a retirement account, and how much went to insurance and other benefits.
A snapshot of bank account balances from the beginning and end of the last 12 months
Did a client’s bank balance go up in the last year? Everything else being equal, that’s a sign of savings. Did the balance go down? That’s a sign of overspending.
A snapshot of credit card balances from the beginning and end of the last 12 months, but only if the client carries a balance
Similar to bank accounts, we’re interested to see how a client's credit card balances changed. If someone’s balance went up, that’s a sign of overspending. If the balance went down, that’s a sign of savings.
A list of one-time expenses that are outside the norm of usual spending
Say a client’s bank account balance dropped by $20,000 last year. But the client spent $20,000 on a new roof. That purchase isn’t going to be repeated annually, so it shouldn’t be considered as part of the client’s normal “lifestyle.” Once the client stops working, big-ticket purchases are more likely to be covered by retirement savings than from monthly income sources.
The Result is Your Lifestyle
After we’ve stripped away paycheck deductions, savings, mortgages, one-time expenses, and taxes, we’re left with the amount of money our clients use to live their lives. We call this the “Lifestyle Number,” and we assume every single dollar gets spent. I like to say that our clients’ Lifestyle Number represents their “walking around money”: the amount of money they use for on food, clothing, entertainment, travel, and everything else.
By running through the Cash Flow Conversation with clients, we show them how much money they’re consuming each year, how much money they’re using to build wealth, and how much income they’ll need to draw from their nest eggs once they stop working. The process takes about an hour and is entirely judgment-free. We don’t care how clients spend their money. We just care that they gain an accurate idea of how much cash they need to support their lifestyles.
Once we're finished with the Cash Flow Conversation, we’re ready to dive into deeper financial planning issues. No line-by-line examination required.
Interested In A Cash Flow Conversation?
If you’d like to run through a Cash Flow Conversation with us, we have a team of financial planners who would love to help. Alternately, if you’re a planner who’d like to incorporate this tool in your planning process, we’d love to talk with you. Click on the button below and we’ll get in touch!