Most of us budget for our “planned” expenses but don’t do a good job of contemplating that one-off splurge or the unexpected. What to do?
Our clients count on us to deliver quality advice on the financial decisions they know they need to make. Sometimes this includes projecting how much money they’ll need to earn, save, or have available to fund their goals. The first step in my process is finding out how much it takes for them to live now. Not to project what things will look like in inflation adjusted terms, not to calculate their life expectancy, not to tell them what dollar amount they need to retire, but just to figure out how much they spend now. Easy right?
“Well, that’s only because…”
I would conservatively estimate that over 80% of the households I’ve worked with during my career could not guess within 25% how much money they spend each month. Why? There is a huge temptation to only account for the “every month” expenses: the cable, the groceries, the mortgage, the utilities, the tuition. Clients often tell me how “last month we spent more than that, but it’s only because” of this huge unexpected expense for that month.
Without exception, planned budgets must account for the “oopsie” each month that was not expected. A root canal, new tires, a roof repair, a family member in need, a vacation, a furniture purchase, a new furnace, a new washing machine or a medical emergency are just a few of the more common “off the menu” expenses that pop up. Other than vacation or possibly furniture, all of the aforementioned are typically surprises. It’s safe to say that the average household has one of these $200-$2,000 (or more) surprises each month. Wondering why your budget seems to be short by $1,000 per month no matter how hard you try to itemize? The answer is not budgeting for – or expecting – the unexpected.
Earnings minus savings divided by 12
Every budget needs room for the unexpected. Every financial plan should set aside an emergency fund. This is how to plan realistically. You know what you earn. You know what you save. Subtract save from earn and now you know what you spend each year, including taxes. Look at your tax return to figure out your total tax bill. The balance divided by 12 gives you your monthly spending. Your $3,600 annual vacation means you spend $300 per month on travel.
No financial plan worth its salt can afford to skip this step!
This post was originally posted on legacykc.com.