Plan future expenses
To ensure that your financial planning is set up properly, it’s NOT enough to consider only current expenses. It’s very important to take into account for future expenses, particularly those that you know will appear.
Let’s run a simple scenario as an example. For simplicity sake, imagine your after-tax take-home income, from both you and your spouse, is $100,000 a year. You expect to get two promotions in 2025 and 2028, which will increase your income by 15% and 10% from the year before respectively. Except those two years, your income will grow on average by 3% every year till you retire. Regarding current and future expenses, here are the big items:
- Your current monthly expense is $4,000. The natural increase in this expense line item is 2% a year, unless specified otherwise.
- You plan to have two children. One born in 2025 and the other in 2028. It will cost approximately $20,000 to deliver each kid.
- The first kid will see the monthly expense grow to $5,500 and the second will push it to $7,000.
- The estimated amount that you want to give them for college tuition fee is $100,000 each by 2043, when they are 18 years old. Hence, the combined college fund will total $200,000 by 2043.
- You and your spouse understand that unfortunate events can happen to anyone. As a result, you both want to set aside 10% of your annual take-home income for emergencies.
- For investments, you budget it at 20% of your annual income.
- Life is short. You want to see the world and travel. Hence, travel will take 5%, if possible.
- Whatever left will go to the disposable fund that can be used for any purposes.
Using the information above, here is what the numbers look like every year between 2023 and 2035
If you notice, I am pretty conservative with the income estimate. Growing the top line, as long as other expenses don’t grow proportionately, will bring more flexibility, freedom and choice. This is why folks want a higher salary or have a side gig. One source of income isn’t sufficient to sustain various financial needs. Also, I don’t include the fund for retirement which can be $2 million for person. The exclusion is driven by the fact that our 401K already comes out of our paycheck prior to the scenario and that the Emergency, Investment, Travel and Disposable Fund, if unused, can all be funneled into retirement.
Regardless, it’s obvious that the paycheck now doesn’t seem very big any more, does it? If it’s not possible to grow income sustainably, then there must be restrictions on the number of financial needs and there must be also compromises. That fancy car that you dream about, that new TV and furniture set that you crave or that yearly trip to Europe that you brag about, they need to be either axed or paid for by money slated either for emergencies or investments. It all comes down to preferences and willingness to compromise. But without an exercise like this, a normal person with little adequate personal finance awareness would get themselves deep into debt or make decisions that would not leave much margin for accidents.
Nobody knows what their future holds. Hence, the point of this exercise is not to be 100% accurate. Rather, it’s about putting more thoughts on one’s financial status and life priorities, which is ultimately what all this boils down to.
The 2x Rule
I “stole” this tip from a book called Just Keep Buying: Proven Ways To Save Money And Build Your Wealth. Essentially, this rule dictates that anytime I want to splash money on something, I must put the same amount of money on investing (most likely an index). This simple tip is a brilliant way to tamp down my urge to spend impulsively or too discretionally. It creates a moment of doubt in your mind and makes you wonder how much you want the item at hand and whether you are willing to pay double for it. For example,I have told my wife numerous times in the past year that I wanted to buy new Apple gadgets, but the thought of having to put the same amount in investing deterred me and made me realize that I didn’t need those new toys that much. The end result is that I am still using a 10-year-old Mac and a 3-year-old iPhone.
Personal finance, as the name may already give it away, is very personal. What works for me may not work for you. These tools are helpful, but their usefulness depends on how you use them, whether you do so religiously and what your life circumstances are. Mike Tyson said it best: everyone has a plan till they get punched in the face. Nonetheless, it’s better to be prepared to some extent than to be caught completely off guard.