What's the best ratio?...
Spoke to a client of mine today. We've done one session prior to this with a number of the standard action items from session 1 (get proper insurance, consolidate accounts, pay credit cards, etc.). In addition to mildly poking him for not sending me his list of action items (I require this of all clients because I find it builds dedication), I was asked to answer a question I've actually never been asked before.
The client asked me, "What's the optimal ratio of income left after expenses?" At first I wasn't sure what he meant, but as I broke it down he was really asking me "How much is enough to have left over after I pay all my bills?"
Now, those of us who are readers of pfblog no doubt will scoff at this question on first blush - surely we want to get AS MUCH AS POSSIBLE left after paying our bills - that's the whole point right? But, as I pondered this, I was left not with "what an idiot", but more with an interesting puzzle.
I decided to answer like this - I said, "We don't really talk about it that way, but I get where you are coming from. Basically the idea is to limit your expenses in such a way and magnitude that you are still reasonably comfortable, you are meeting your required obligations, you are doing the right things*, and you aren't spending all your money."
* By "right things" I mean, get the proper insurance, save at least 10% (min) to 15% (better) of your gross income, and pay down debt without canibalizing your emergency fund (6 months of cash).
It just struck me that, here we have a guy who really really wants to do this right, but doesn't have the basic vocabulary to wrap around even the most primitive of budgeting, let alone planning. I was reminded of why I call myself a Personal Financial "Coach" and not a Personal Financial "Planner". It's my job to educate my clients to do the right things while also living a comfortable lifestyle within their means and paying down debt.
Sure, my work is cut out for me, but at the same time it's very much worth it. I'm also left thinking "Why don't they teach this in school?". But, that's a topic for another rant/day. Keep reading and be well.
Paul J. Lim noted in the New York Times, as quoted in The Week, "Youth is wasted on the Generation Y investor." Of course, that's on average and talking about 401(k) contributions, but the numbers are startling. Read
After a long thread of very interesting comments from some readers, I've been giving more and more thought to the task of completely converting my personal cashflow model to a more traditional set of personal financial statements. Read
Those of you with a number of mutual funds know the overwhelming amount of paper mail you get from these companies. Most of the time there is no way to keep up with it. That said, I always read the publications from Selected Funds. The ... Read
The last few weeks have been spent closing the books on my personal accounts as well as my 4 business ventures. End of the year is always a fun time! However, I'm back and have been working on my yearly retirement portfolio rebalancing and reallocation ... Read
I think if a person or household net 25%, they're doing ok. To me, this 25% would break down as 10% tax-advantaged retirement savings, 10% taxable savings, and 5% short-term savings (ie. car and house downpayments). While 25% sounds like a lot, my wife and I nearly made it this year; a year in which she was a student with immaterial part-time income. It can be done.
That's interesting, because I always consider savings (of all types) to be part of the expense column. Basically, I think of money in and money out. They are equal, like on the income statement. It's just that the client chooses where that money goes. In terms of savings percentage 25% is very good. I imagine the "CPA" has something to do with that. ;-)
Do you count the 10% tax-advantaged before or after tax? (10% of gross I'm guessing)
Coach, I'm confused my your statement that you view savings as part of an 'expense column'??
I don't think it's wise to confuse cash flow with income/expenses. Cash flow is certainly a consideration, but I always recommend that folks focus on the net-worth impact of their behavior and actions.
This may help... http://republicanuu.blogspot.com/2006/01/danger-of-cash-flow-thinking.html
Early - Thanks. It's interesting, because I'm realizing what works for me (and always has) doesn't really make sense to a lot of people. What basically happened is that over many years (before I even starting working on my CFP classes) I designed a system of money handling for myself that had no basis in accounting at all (because I didn't know it).
I ended up with a system where I have everything managed by cashflow and absolutely no notion of net worth. What I came to see was that this works great for someone with savings discipline like me, but doesn't work as well without that. So, I'm in the process of redesigning my own handling so as to get more in line with convention. All the principles are the same, but the way I think about it differs from most everyone else.
I still think the cashflow model is useful, but I'm realizing that for people who aren't as emersed in their finances as I am, it's not as illustrative. Despite that it works for me, I'm wrestling with the conversion because I do understand exactly your point.
That said, I'm also making inroads in turning clients' thinking a bit toward my model, while being careful to ease into the conversion as well.
Early - also, I realize my use of "expense column" is not the right wording. It's my "cash outflow" column really. Like I said, Money In/Money Out is how my model works. It's clunky in real accounting terms because I invented it without accounting knowledge. It was only later that I learned "the right way".
Coach - while I agree that 'cash is king', and a positive cashflow is crucial to being financially viable, I really can't comprehend how exactly your model works. Cash in I understand, but cash out can be very different based on where it's going (consumer durables, consumer consumables, financial investments, etc.) To me, the only thing that matters is net worth, and the period-to-period change in that net worth.
The way I started to think about money was entirely based on cashflow after taxes. I just looked at all income as my cash in, didn't matter the source. So, conversely I looked at all money "out" and I measured the sum of outbound money as 100%. Every outbound "expense" I categorized into one of about 12 categories which includes Groceries, Home, Education, Savings (Short Term), Savings (Long Term), Transporation, Entertainment, Debt, Rent, etc.
So, my goal at first was to simply track what I was doing. Based mainly on "feel" over a few years I tuned the category percentages such that I thought I was savings enough and keeping all non-savings categories under control. However, there are some catches in that since I'm working from post-tax cash only, I have no register of 401(k) savings as a % of Net Income. I also have a mainly hindsight vied of what I did before for budgeting, rather than a planning tool (working on this now).
Like I said, I conceptualized all of this before knowing anything about how one would calculate Net Worth (which should be done) and basic personal accounting (financial statements). I still think it's a useful way of thinking, but I'm realizing that it's a poor way of illustrating.
Thus, I'm trying to reconcile the two.
