Perhaps the most important advice in financial planning is to “spend less than you make.”
These simple words of financial planning wisdom apply to everyone. Whether you are an individual starting your first job or are a wealthy family with multiple homes, spending more than you receive in income is not sustainable over the long-term.
It’s important to have an understanding of your income and expenses, as this information will allow you to live within your means and ensure you are on a path toward building wealth (not eroding it).
WHAT NEEDS TO BE DONE
To understand your cash flow situation, you will need to summarize your income and expenses. You can build a picture of your cash flow by summarizing bank account withdrawals and credit card statements, although this can prove to be a very tedious and time-consuming process.
Fortunately there are numerous apps on the marketplace that can help you to automate this process. Not only will they track cash flow, but they will assist you with the budgeting process as well.
If you prefer to gather this information yourself, you should have a good start on some income and expense data if you compiled a balance sheet, which is the first step in getting organized financially.
NEXT STEPS ONCE YOU HAVE THE DATA
You should divide your expenses between discretionary and non-discretionary spending. This will allow you to understand which expenses can be reduced, if needed, to match your level of income and accumulate savings.
Developing and monitoring a plan for how much to spend is called budgeting. During your wage-earning years, your budgeting plan needs to ensure that you are not just spending your income, but that you are also saving money. Aim to set aside between 10-20% of pre-tax earnings toward retirement savings. Also, build non-retirement savings into your plan to meet other goals and objectives (EX: saving for a down payment on a home).
The equation of cash flow for retirees is different. While they may have some income (social security, pension, etc.) it is typically not enough to meet all their spending. Retirement savings are used to bridge this gap. The key is to make sure that the projected withdrawal rate from your savings is low enough for your savings to last throughout retirement.
Most financial professionals agree that a withdrawal rate of 4-5% or lower is generally sustainable. The theory for this is based on the historical expectation that a balanced and diversified portfolio of investments can earn approximately 4-5% per year on average without taking on undue risk.
If you are spending more than your portfolio earns (on average) you will find that your portfolio will diminish over time and you will be at risk of running out of retirement savings. Working with an independent advisor to prepare for retirement is advised. Clearstead has expertise in retirement cash flow planning.
CONSIDERATIONS FOR WEALTHY FAMILIES
Similar to a retiree, wealthy families can rely on accumulated savings or wealth to support their lifestyle. But being wealthy does not exempt you from cash flow planning.
Just because you have enough money to purchase an additional home or a boat does not mean it is a good idea. These types of purchases reduce your liquid savings and create additional, ongoing expenses to maintain the asset. Careful cash flow analysis is required before proceeding on large purchases.
Other common missteps for wealthy families include spending too much on vacations, being too generous with family or charitable gifts, and not understanding the income tax impact of marketable investments and business interests. It all comes back to taking the time to understand cash flow and ensuring you “spend less than you make.”
CLEARSTEAD CAN HELP
Clearstead is ready to help you with your cash flow planning needs. Our projections are tailored to each client’s specific situation. We also project cash flow over longer periods of time (20-30 years) to identify and illustrate cash flow needs during several different points of your life.
We also project your net worth so that you can envision what kind of estate you might leave your family, as well as identify potential estate tax issues in time to avoid them.
Our comprehensive approach to wealth management ensures we use our cash flow analysis to inform your investment strategy and vice versa. In addition to long-term cash flow modeling we also provide supplemental services such as financial reporting and bill pay solutions to help you monitor and simplify your cash flow situation.
Our ClearSight process is a good sample of how we integrate all aspects of your financial picture to tailor recommendations and solutions to your specific needs.
Once you’ve gotten a handle on you or your family’s balance sheet and cash flow, you can continue to “clean up” your finances and lay out an organized estate and financial plan. We will cover this topic in our next post.
Information provided is general in nature, is provided for informational purposes, and should not be construed as investment, tax or legal advice. These materials do not constitute an offer or recommendation to buy or sell securities. The information provided is from public sources and data available at the time the information was written. Any information provided is subject to change at any time. Clearstead disclaims any liability for any direct or incidental loss incurred by applying any of the information provided. You should consult with a professional before making any investment, tax or legal decisions.
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