Surely the wealthy don’t need to budget …
It is true that some high income earners have no idea how much they spend, simply too busy making money to take the time to work out how they are spending it. And there are some people who consider you are not really wealthy if you ever have to ask how much anything costs. Budgeting is so demeaning.
However, it is no coincidence that all major businesses budget and account for their cash inflows and outflows. It is unlikely any lender or potential shareholder would provide them with funds if they didn’t. They would be viewed as financially irresponsible.
If you’re serious about personal wealth management, we believe that household cash flow budgets are a necessity, not a nice to have or something only the less well off need to worry about.
A personal cash flow budget requires you to estimate:
- The timing and amount of your expected cash inflows (e.g. earnings from employment, interest, dividends); and
- The timing and amount of your expected cash outflows (e.g. family expenditure, tax payments)
for an appropriate planning period. We consider that an appropriate period for most of our clients is to their age 100.
These estimates, together with their regular review, are critical to building a realistic financial plan and accumulation of wealth by design, rather than by accident.
You’re financially blind without a personal cash flow budget …
Some people are very diligent in recording their annual cash inflows and outflows, using software like Quicken or Microsoft Money to reconcile their bank statements and, perhaps, provide information for preparation of annual tax returns.
But many don’t go the next step, to ask what are my expected cash inflows and outflows for the next year. And then spend the time to compare actual with estimates, to understand whether they are saving more or less than they expected.
Even fewer prepare these budgets over extended periods. The purpose of such long term (or lifelong) cash flow budgets is to help assess whether, if you keep doing what you are doing now, you will be able to accumulate sufficient wealth to retire when you plan and continue to live in the manner you have (or want to) become accustomed.
Without them, your chances of achieving your long term financial objectives are pretty remote. But if you are going to the trouble of doing lifelong cash flow budgeting, it is important that it is done properly. Otherwise, it is a case of garbage in, garbage out. A real life situation will illustrate.
A number of years ago, we assisted a client who was three years away from his planned retirement. He was a partner with a major accounting firm, good with numbers, who was comfortable that he was well placed, financially, for retirement. But, fortunately for him, he sought a second opinion.
When questioned in our introductory meeting how much he was currently spending and how much he expected to spend in retirement, he replied confidently about $150,000 p.a. and $100,000 p.a. respectively. By the time we had completed a thorough budgeting exercise with him, the figures were revised to more like $200,000 p.a. and $150,000 p.a.
Among other things, his initial estimates had failed to take account of “capital maintenance”. In particular, the ongoing upkeep of his Sydney residence and a family beach house, and the regular replacement of two motor vehicles.
Our rough rule of thumb, discussed in “How far to financial freedom”, indicates that additional wealth of about $1.25 million is required to support another $50,000 p.a. of planned expenditure! The comfortable retirement expectation needed some significant revision.
The story had a happy ending. With some adjustments to his existing financial position, and a decision to take on some part time work beyond his retirement from the accounting firm, the client’s revised expenditure expectations were able to be met. But all this would not have been necessary had he prepared more comprehensive and regularly updated budgets for ten years, rather than three years, prior to retirement.
Lifelong personal budgets are the foundation …
Well formulated lifelong cashflow budgets are the foundation on which any smart wealth management plan should be built. If you do not have at least reasonable estimates of what you expect to come in and go out over extended periods of time, we think it severely jeopardises your ability to build a coherent investment strategy consistent with both your attitude to risk and your lifestyle objectives.
And given a world of great financial uncertainty and our emphasis on focusing on the things you can control, we believe that failure to give sufficient focus to two financial variables over which you have a fair amount of influence (i.e. your personal income and, particularly, your personal expenditure) really biases the odds against achieving the financial future you want.