Financial planning involves a big picture examination of one’s entire financial picture to devise strategies to achieve long and short term financial goals1. Unfortunately, financial planning is often simply viewed as a synonym for investments, but it is so much more. Its cross-disciplinary approach involves considering investing, taxes, retirement issues, estate issues and insurance issues among others2.
Over the years, the Family Wealth Decisions Group has observed many financial decisions which could have turned out better…and probably should have turned out better. We are limiting this discussion to only five in areas we consider to be foundational.
Mistake #1: Not knowing what life costs.
The most concerning and possibly most common financial mistake we see is an insufficient understanding about what life really costs on a monthly or yearly basis. Sometimes, there is even insufficient knowledge about how much income there is. Without a good understanding of the cost of maintaining the current lifestyle and the income resources available to support it, how can you know if the current lifestyle is prudent, affordable or sustainable? Without knowledge of cash in-flows and out-flows, how can a budget be created?
A corollary to understanding cash-flow is the ability to use that information to create a budget. Budgets can help keep you on track to avoid unintended overspending and to effectively allocate your resources to fund progress toward your goals.
The numbers are astonishing as reported from a Debt.com 2024 survey11. It appears that 50% or more Americans live from paycheck to paycheck. The vast majority of those surveyed stated that they do budget and that budgeting has helped them to avoid or eliminate debt. Those that don’t budget complain it is too time consuming and some don’t want to look at it because it makes them feel bad.
When my children received an unsatisfactory test result in school, merely telling them to study harder was not sufficient. Teaching them how to study properly defined specifically what we meant by studying harder. With respect to a stressed cash-flow, merely suggesting spending less and making a budget may not be sufficient advice by itself. An understanding of how income resources may be allocated to expenses to maintain lifestyle is needed to determine where cuts can be made.
Lifestyle cost includes more than just credit card purchases. It includes things such as mortgage or rent payments, utility costs, “one-time” expenses (such as auto repairs or purchase, home repair or improvement), cash withdrawals which are spent on untracked items, gifts to family members and expenses paid for by others. Expenses paid for by others may include things like the value of the company car available for personal use or other business perks that you might want to continue at your own cost after employment ends. Consultation with an experienced advisor can help devise a process to calculate what it actually costs to maintain your current lifestyle and ultimately to create a budget.
Mistake #2: Not creating and maintaining an emergency reserve.
Another frequent and significant planning error involves the failure to establish a sufficient emergency reserve bank account to act as a kind of buffer against unexpected expenses. For those in stressed cash-flow situations living paycheck to paycheck, a buffer can mean the difference between paying basic monthly bills in a timely manner or going into debt for basic living expenses in the event of an unforeseen large expense.
The numbers again are astonishing. As of May 2024, 59% of Americans are uncomfortable with their level of emergency savings, yet 27% of all US adults have no emergency savings. As of December 2023, a majority of Americans would not pay a $1,000 bill from savings, with borrowing being the most common option.Interestingly, the younger generations (Gen Z and Millennials) are comfortable with a smaller reserve covering three months or less while the older generations (Gen X and Baby Boomers) are more comfortable covering six months or more4.
The right amount of an emergency reserve account is highly individual. A “rule of thumb” might be the reserve should be big enough to replace three to six months of living expenses. This rule assumes a job with a steady predictable income. However, if your income is variable such as a small business owner’s might be, or if you are a seasonal employee or member of the gig economy, a larger emergency fund might be more appropriate3. Of course, if you still need to address the issues associated with Mistake #1 above, you may not know what your monthly expenses are to properly calculate a reserve amount.
Since the primary purpose of this fund is to be available in the event of an emergency, an insured savings account at a local brick and mortar bank branch would seem to meet the need for quick access to cash. CDs may not be the most appropriate receptacle for an emergency reserve if they impair access to funds or cause a loss to retrieve them. Access, not return, is the important characteristic of an emergency reserve.
Mistake #3: Not accounting for inflation and taxes.
Inflation is the rate of increase in the cost of goods and services over a given period of time5. Based on history, prices generally increase over time. The CPI (Consumer Price Index) is a general annual expression of inflation in the prices consumers pay for a given basket of goods and services5. Describing the causes of inflation may be somewhat complicated. However, the impact of inflation is pretty simple – life becomes more expensive and the purchasing power of each dollar of future income declines over time.
Financial planning often takes a long-term view in fashioning strategies to achieve objectives. In doing so, projections about income, expenses and investment returns may be referred to. Yogi Berra said that “it’s difficult to make projections, especially about the future”6. More importantly, the impact of inflation over the long-term is difficult for many of us to account for in our “back of the envelope” cyphering. Some “cyphering” shortcuts may be helpful such as the rules of 72, 115 and 144. When each of these numbers is divided by an assumed inflation rate, the result may be an estimate of the number years it would take for a value to be halved, reduced to a third or to a quarter, respectively7.
Income taxes may also result in some lost purchasing power. We know that generally we need to pay tax on our taxable income regardless of whether the income is from employment or investments. However, often income taxes seem to be under-considered and sometimes ignored when engaging in short-cut assessments of our financial condition.
For example, if you retire with a large tax-deferred retirement account, required minimum distribution rules may result in annual taxable distributions with income tax reducing the amount of that distribution available to spend8. If nearly all of your assets are in tax-deferred retirement accounts when you retire, the tax bite might be high as not only will there be required minimum distributions, but additional taxable distributions may also be needed to completely fund lifestyle. This is an area where an experienced financial advisor can assist with employing strategies to reduce the impact of income tax in retirement.
Mistake #4: Not devoting sufficient resources to savings and protection.
We all have a finite amount of income and asset resources. Planning is largely about how we allocate those resources to achieve our financial goals. Allocation of these resources is often determined by how we prioritize each of those goals. All of our financial goals and desires are competing for financial shelf space but in the end, we may run out of shelf space as some of our desires may be beyond our financial means.
Commonly expressed savings goals may include funding a purchase such as a car or a house as well as the longer-term goal of funding retirement9. These goals may require a disciplined savings plan as part of the budget for months, years or decades. Therefore, some of our income and asset resources need to be allocated to these goals. After all, a goal without a plan is just a dream or a wish10.
Allocating resources to short, medium and long term goals are budgeting priority challenges. However, often not considered is the need to allocate some resources to protect your family’s ability to maintain a life and achieve some of your family goals in the face of unanticipated adverse events. Such events may include the death or disability of a breadwinner or being named as a defendant in a negligence lawsuit. Insurance costs money. What’s the potential cost of not insuring against catastrophic events?
Therefore, if 100% of your income and asset resources are allocated to current lifestyle expenses, there may be no resources left to fund retirement or shorter term anticipatable large purchases. There may be no resources available to fund life, disability, long-term care and adequate liability insurance which exist to protect your family’s ability to reach some of their goals. Bottom line: some portion of your resources should be carved out for savings and protection.
Mistake #5:Not planning with the big picture in mind.
Lack of planning coordination is an error we see with nearly every type of financial decision-making and planning. Often decisions about tax strategies, retirement strategies, estate strategies, insurance policies and investing are made in individual silos – in isolation of other financial decisions. These financial decisions may be made with different advisors at different points in time for different purposes. A lack of coordination among these decisions may obscure the big picture and create planning gaps through which wealth may be lost or which may cause goals not to be fully met.
Have you tracked your spending so you know what life costs and where your money goes? Have you created a budget that allocates your resources to address your current and long-term goals? Have you adequately factored in inflation and income taxes and their impact on the purchasing power of your savings over time? Have you carved out some resources to fund savings and protection? Have you coordinated your life insurance and retirement account beneficiary designations with those in your will or trust documents? Do you need any creditor protection for those who might inherit from you in the event of their poor financial, business or marital decisions? Does your big picture asset flow meet with your satisfaction?
* * * * *
We consider the five mistakes addressed above to be foundational in dealing with financial planning. However, we have seen many others – some big and some small. Why do these mistakes occur? Sometimes decisions may be made emotionally, compulsively or rashly. Sometimes decisions may be made in the absence of good information or based on misinformation. Sometimes decisions may be made carelessly without consideration of the potential consequences in the mistaken belief that the decisions are not important.
Good planning decisions should be made not only considering their immediate consequences, but also those that may derive from them. Effective financial planning decisions are not made in a vacuum, isolated from all other planning decisions, but rather should be made in coordination with them. This is where an experienced credentialed advisor can be of assistance and value.
Whether you need to create a financial plan now, update an existing plan or merely review your planning, a conversation with an experienced advisor can be beneficial. Often mistakes, once discovered, can be reversed, repaired or overcome. Sometimes they cannot be corrected or ameliorated. This is why we offer a complimentary consultation to discuss the financial decisions you may need to make. Contact us to arrange your consultation.
1. https://www.cfp.net/why-cfp-certification/career-guide/what-is-financial-planning
2. https://smartasset.com/financial-advisor/financial-planning-explained
3. https://www.nerdwallet.com/article/banking/emergency-fund-why-it-matters
4. https://www.bankrate.com/banking/savings/emergency-savings-report/#sudden-bill
5. https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Inflation
6. https://www.ling.upenn.edu/~beatrice/humor/yogi-berra.html
7. https://groww.in/blog/7-thumb-rules-for-investing
9. https://credit.org/blogs/blog-posts/financial-goals-examples-and-tips
10. https://www.deangraziosi.com/goals-without-plans/
11. https://www.debt.com/research/best-way-to-budget
CRN-7489690-010225