As part of my daily responsibilities financial planners will come to me to discuss a particular case; sometimes these cases are mind boggling estate planning cases ($20million, $30million, $50million+) and sometimes they are just your run of the mill new family starting out.
When the case has to do with estate planning the planner and I are coming up with strategies and techniques that can be used in that particular client’s situation, however, when it is your new family situation I am really just there to input data and build spreadsheets.
It was during one of the latter new family conversations that provided the muse for this post. The Facts as presented to me:
- Married Couple
- 1 New Born
- Husband Makes $100Kish
- Wife Makes $100Kish
- Spend $80Kish after taxes (includes housing)
- Save about $6K/yr in qualified Accounts
- Save about $5k/yr in Non-Qualified Liquid Accounts
What is wrong with this Picture?
Why Don’t People Know What They Spend?
As soon as the facts were presented I knew there was a problem. Simply put this couple has NO CLUE what they are spending per year and guess $80K because it didn’t make them feel like they were spendthrifts. Alternatively, they have no clue what they are saving per year and $5K/yr in non-qualified money and $6k/yr in qualified money “sounded” right.
Very simplified Cash Flow Review
- - $6K Qualified Investments
- = $194K Taxable Income
- - $48,500 Taxes (I used 25% effective tax rate: Understand the difference between effective and marginal tax rate)
- =$145,500 After Tax Money Left over
- -$5k savings
- -$80,000 What they think they are spending
We have $60,500 unaccounted for! That is over $5,000 a month in non-accounted for money.
When this happens (and you’d be surprised how often it happens) there are three possibilities:
- The Financial Planner didn’t ask the right questions
- The Client didn’t understand the questions
- The Client is absolutely clueless as to what they spend
- The Client is absolutely clueless as to what they are saving
It is shocking how often it is option 3. So often that I have written about cash flow before:
- Personal Finances are the same whether you make $46k or $460K
- Do You know How Much Money You Spend a Year?
Given their assets and their age I am going to guess it is somewhere between options 3 and 4. They are probably spending more than they think but saving more than they think as well.