The biggest hurdle I see in the financial planning data gathering process is typically cash flow. People can tell me exactly how much they make. However, it's usually a mystery when I ask clients where their money goes each month.
Financial planners need to assess the ability of a client to meet retirement goals in a Financial Plan. Cash flow is a core component of any plan, so understanding how much money is being spent (and on what) should be a priority.
In this post, I discuss why you should track your money as well as a simple process you don't need to spend more than 10 minutes a month on.
There's an old saying in scientific circles; you can't understand what you don't measure. Without measurement, you don't have data. Without data, you don't have information. Without information, you're guessing at outcomes.
We all know that assumptions can lead to faulty conclusions. Take budgeting for example. It's easy to say "I think I spend $7,000/month". Without context, that number might not mean much on its own. For example, does $7,000/month represent your basics like food, gas, new clothes, and Netflix? Or, does it also include expenses like a mortgage, insurance, and taxes?
Let's say we simply inject a general expense of $7,000/month into our financial plan because that's what it "feels" like is going out the door each month. The financial plan says we're on track to meet our goals based on all our future sources of retirement income. We continue to make our 401(k) contributions and think everything will be fine.
Imagine basing your entire retirement plan on $7,000/month in expenses, inflated over several decades, only to wind up short because you underestimated your true expenses. The biggest fear most retirees have is running out of money. Not having a solid handle on expenses increases the likelihood you'll overspend in early retirement and then run out of money prematurely. No one wants to be 85 and stressed out about how they're going to pay their bills.
Failing to properly assess cash flow by overestimating expenses can also produce negative planning outcomes. Let's say you base your savings habits on that same $7,000/month in expenses, but your actual expenses are only $5,500/month. When expenses are overestimated, it places a higher savings burden on the plan.
We all want to enjoy life, which means spending money on things we enjoy and experiences to cherish. If our plan recommends a higher savings rate than necessary, then we're robbed of cash flow we could otherwise enjoy now.
GET COMFORTABLE WITH SOFTWARE
You may have heard of online budgeting software. The way these programs work is they track income and expenses to understand exactly what's coming in versus what's flowing out. In addition to websites to check your numbers, they all have apps for your mobile devices if that's more convenient.
No matter which software you choose, you'll need to electronically link spending and savings accounts. If you're new to this concept, don't be afraid. They use the same security protocols your bank does when you log in online. All the software is doing is aggregating transactions from multiple accounts to a single report.
The benefit of linking spending and saving accounts is that it saves a massive amount of time. The only other way to understand cash flow is to review each of your separate spending & saving account statements each month and then manually import transactions into a homemade spreadsheet. This is overly time-consuming plus there's the added element of human error.
These are some of the popular cash flow solutions to check out:
Mevelopes (great for the digitally anxious)
Mint (best free software to track spending)
Quicken (perfect for those like bells and whistles)
You Need A Budget (nice for those new to cash flow/budgeting)
Moneydance (great for budgeting and investment reporting)
It's typical to have a few credit cards, a debit card or two, a mortgage, maybe a car & student loan, multiple bank accounts, and a handful of investment accounts. All of the software is amazing in that they capture transactions in and out of all our accounts simultaneously. What would take a few hours every month takes zero time with technology.
However, not one piece of software properly categorizes each transaction 100% of the time. For example, the software might not be able to differentiate between the gas, food, or tv you bought at Costco. Each of those purchases should fall into different spending categories.
It can also be confusing when a credit card lists each purchase as a separate line item within the software, but then you also see another expense paying off the credit card at the end of the billing cycle. A third line item represents "income" to the credit card when you pay it off, reducing the balance. Without familiarity or a bit of massaging, the expense reporting can feel cluttered.
You'll also have to pay attention to how the software reports transfers. For example, if you move money from your savings account to your IRA, that's not an actual expense, but it might initially show up that way.
Software is great for interpreting data, but we have to take a bit of time to review the data for accuracy. It's likely you'll have to spend some time upfront properly categorizing income and expenses for at least some transactions.
What's nice is that most of the software solutions have built-in artificial intelligence designed to save time. For example, once you code a transaction a certain way, the software learns from that so that when the same transaction appears in the future, it's automatically categorized the way you want.
OUR SOLUTION FOR CLIENTS
We utilize financial planning software to help us analyze and present information to clients. Part of that software includes a cash flow application that works the same way as the other personal accounting software solutions mentioned earlier.
By default, clients that engage us in a Wealth Management relationship (investing + planning) have access to our built-in cash flow application. It helps us understand where money flows, prepare spending budgets, and most importantly, model expenses and their impact on big picture goals.
We're also happy to offer our cash flow & budgeting tool, free to clients that hire us for investment management only. Just ask and we'll get you set up.
Here's a sample, starting with the Income & Expense overview.
Within the software, you can click any of the color-coded categories to bring up a list of transactions tied to that category. This interactive nature is helpful to understand (and fix) any transaction initially coded as "uncategorized".
Below the pie chart overview is a list of every transaction feeding into the graphs. Here is a sample showing different line items.
This is the section where users can review how transactions are imported for category accuracy. If a transaction isn't properly coded, it's simple to adjust the reporting label by clicking the type of category.
To gain granular clarity, transactions can be sorted by Account, Category, and Time Frame. There's even a search box to track down specific transactions.
The most powerful feature of the software is the ability to see long term trends. This is accomplished by adjusting the time frame to view income and expenses over year-to-date or 1-year time frames. There's even an option to view the numbers since the initial setup, which might be several years in some cases.
The utility for understanding cash flow is threefold. First, it helps us determine average income and expense numbers that can be used for financial planning purposes. Projecting current cash flow into the future helps mitigate the risk of either under or overestimating expenses. Better data always equals a more accurate plan. It's worth spending time getting intimate with your cash flow.
Second, it helps us determine household spending, i.e., our budget. The obvious benefit here is that it helps us determine a framework to separate fixed versus discretionary expenses. This increases the likelihood we won't overspend.
The third benefit to understanding cash flow, and probably the most impactful, is that it can positively influence behavior. Imagine your car with 100,000 miles requires a $2,500 repair. How easy is it for all of us to justify to ourselves we'd be better off with a new car instead of electing to fix what we already own? We've all had this thought at one point and many of us have acted on it.
If you understand your cash flow in the context of your big picture goals like retiring, putting your kids through college, or buying that special mountain gateway property, then you're less likely to spend money on stuff you don't need or that can wait. Buying that new car might make you feel better in the short term, but after only 4 or 5 months into financed payments, you're already in a place where keeping the old car would've been smarter in retrospect.
Whether you've never tracked income and expenses or you're an OCD perfectionist who already meticulously maintains an expense spreadsheet, using software can improve your life. It can save time as well as modify behavior. It only takes an hour or so of initial setup discipline and approximately 10 minutes each month to maintain. The time investment is minimal and the long term benefits are real.
If you're already a client at Aspen Leaf Wealth Management or thinking about hiring us, ask us for a demo. It's easy to walk prospective users through our software via a screen share session. Nothing compares to actually seeing the software live and taking it for a personal test drive. Use the "Contact" link above to get in touch.