“What Most People Need To Know, But Don’t, About Their Household Cash Flow”
Similarly to the way the healthiest of most businesses are run, the income and expense picture of every household needs to be tracked, monitored and averaged. The truth is, few individuals appreciate the importance of having an accurate and categorized picture of their outgoing cash flow. It would be an understatement to say this is the single most important piece of data concerning their entire financial well-being.
The reason is simple: tracking and averaging your monthly expenses will yield the cost of your standard of living. This number is the very beginning of the planning process. These lifestyle costs will be the driving factor in all of your financial decisions. It’s funny, but in the three decades that I have been in the financial planning business, I’ve read many books and articles about how to set up investment portfolios, decide on appropriate life insurance and how to use tax-favored retirement plans. Yet none address the most basic piece of information: your current cost of living.
When it comes to investment portfolios I’ve heard things like “percentage-wise you should have your age in bonds, this way as you get older your portfolio gradually becomes more conservative”. That’s just plain silly. Or, you can make certain rate of return assumptions if you have X% in stocks and Y% in bonds”. That’s putting the proverbial cart before the horse.
The real way to make these decisions is to first have an accurate number for your average monthly expenses over a trailing 12 month period. That number will be adjusted for inflation over the number of years you are investing for. That gives you your goal! So if it’s retirement that you are planning for take your current number and adjust it for inflation until the age you would like to retire. After you’ve factored other retirement income sources such as Social Security or any pension income, you're left with the amount to be withdrawn from your retirement savings.
Now that you have the goal, look at the value of your portfolio now and determine how much you could be adding from now until then. At this point, you can figure out what rate of return you’ll need to get to your goal. Then, and only then, you can determine what mix of investments is likely to get you there. Conservative portfolios can expect a lower rate of return (and lower volatility) and aggressive portfolios can expect a somewhat higher rate of return (and higher volatility)
Contrary to conventional wisdom, younger people, who can sock away a lot each year, can be conservative in their approach and older people, who did not, will need to be more aggressively invested.
When it comes to determining the proper amount of life or disability insurance knowing the ongoing cost of your standard of living dictates how much coverage you should have.
Why this aspect of financial planning is not nearly emphasized as much as it should be is beyond me.
Scott J. Menta, CFP, CLU, ChFC
Scott Menta has helped many people make decisions through a structured planning process that focuses on meeting long-term goals. As a CERTIFIED FINANCIAL PLANNER™ professional at Barnum Financial Group, Scott has published numerous articles offering insights and guidance to individuals looking to create and manage their wealth. He can be reached at smenta@barnumfg.com or 1-877-GO-SCOTT.
This article was prepared by Scott Menta and is not intended as legal, tax, accounting or financial advice. Scott Menta is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484 The opinions provided above are not necessarily those of MML Investors Services, LLC or its affiliates.