As I scanned the headlines this January, I couldn’t help but chuckle to myself at the stories that alternately encouraged resolutions around financial planning and weight loss.
“Shed 100 pounds!” “Save $1 Million Dollars!”
Everywhere I turned, promises of a “New Year, New You” abounded.
But who among us is truly excited about either of these propositions, other than the salesmen who stand to benefit from our overly ambitious commitments? After all, why should January be different than any other month of the year when it comes to improving our lives? If you’ve ever made a commitment to losing weight or improving your financial picture, you know that it’s a year-round commitment, and it makes no difference what day you start — the important thing is that you begin in earnest.
5 Parts to the Cash Flow Conversation
Unfortunately, most people who dive into improving their financial affairs do so from the wrong direction. They think that the most important thing is that they have a budget and a plan, and while, yes, planning is important, a lack of understanding of their cash flow (the flow of money coming in and money going out) is actually the biggest thing that trips people up. In our practice, we have an exercise called the “Cash Flow Conversation,” that takes just 15 minutes every year, and requires just five things. They are:
1. Year-end pay stubs or tax returns.
2. Details on any change to bank balances or credit card balances.
3. Details on one-time, non-recurring expenses that may occur this year (or early in retirement if you’re planning your retirement needs.)
4. Mortgage statement, if you have one.
5. For folks headed into retirement, a list of all your income sources that will be available to you, including assets in your 401(k), Social Security & pension.
These five data points are all you need to gain an understanding of your cash flow.
Next, you’ll want to make sure you deduct expenses that will go away after you quit work, such as recurring 401(k) contributions, social security taxes, disability insurance, and so forth. Also calculate and deduct the amount you paid in taxes on the income you earned to pay those expenses. Finally, deduct the principal and interest on your mortgage. That payment represents money you're using to support an asset that should be (hopefully) growing at a rate faster than your cost to carry it.
Once you make those deductions, the amount that's left over represents your consumption or "lifestyle number."
For those approaching retirement, compare your "lifestyle number" to your income sources in retirement. If you have a gap, you'll know that you need to increase your savings. If retirement is farther away, your "lifestyle number" can help you build an annual budget.
Understanding Cash Flow
Having a simple understanding of the cash flow you have to work with can prevent hours of financial stress and anguish, and taking steps now to understand your cash picture better might be the best financial resolution you can make. — in January, February, or any other time of year.
If you are looking to improve your finances and would like some guidance, we're here to help!