Your Money and Your Mind – Part II – The Factors

Following Part I of my three part series, today I’m introducing Your Money and Your Mind – Part II:  The Factors.  To review the overarching perspective around this series:  it’s basically been my experience that when most people think about the topic of money, it usually can be distilled down to two central considerations:  1) how to make it and 2) how to allocate it.

For this reason, I think it is critically important in my work with clients to address three aspects of their mindset on money as described in my series on the topic.  In Part I (, I reviewed what I think is a critical shift in perspective as it relates to cash-flow, the life-blood of every family’s financial life.  In Part II (today), I lay out some helpful tools (“The Factors”) to help you make an informed decisions on just how much today’s spending is impacting your future.  Finally, in Part III (in the weeks to come) I’ll touch on the sometimes counter-intuitive mindset needed to successfully invest those assets over a long time horizon.

To briefly summarize Part I from two weeks ago:  Normally, a family’s cash flows with Bucket #1 (income) flowing into Bucket #2 (bills, other spending) and whatever is left over is Bucket #3 or what I call “The Juice”. But I believe this line of thinking is fundamentally flawed.  Why?  Because it is here in Bucket #3 (“The Juice”) where the funds for your ultimate dreams and goals live.  Instead of viewing this as “extra” money left over every month, this is really the sole funding source for those not-so-far-off goals of retirement, children’s education, vacations and/or a legacy.  So essentially, families need to weigh the importance of your goals (funded by “The Juice”) vs. the Land Rover, the fancy restaurants, the Coach purse or the new golf clubs, etc.

This is why I’ve developed and will detail three “Factors” to help clarify just how much spending “The Juice” today is really costing you tomorrow, as it relates to your future goals.  But, before using these Factors, you must first determine how much “Juice” is available.  This can only be done by looking back at a 6 or 12 months spending and / or tracking your income and spending over that same time period.  As I’ve noted in prior posts, I am happy to help teach you how to do this as part of my holistic approach to financial planning.

“The Factors”

We all make value judgments on spending, whether we know it or not.  When we are trying to figure out the impact of that vacation or vacation home, we all do some kind of mental math to rationalize the decision to spend or not to spend.  To help you quickly make an educated assessment, I think it’s helpful to frame up these decisions in the context of the broader plan.  That’s the genesis of the “Factors”.  Once you know them for your situation, you can quickly do one simple calculation and have a pretty good idea of the longer term ramifications of your decisions.

Of course these Factors are estimates as they use assumptions about investment growth, years until retirement, marginal tax rates, etc.  But, I am happy to help you develop your customized “Factors” based on your specific goals and appropriate assumptions as part of our cash flow meeting.  For illustration purposes of The Factors, I’m using a scenario where the following assumptions are employed:

1) Inflation adjusted investment return of 6% per year

2) 28% marginal federal tax bracket

3) 20 years until retirement

Now on to “The Factors”:

Monthly Savings Factor:  After tracking your spending, let’s say you find you spend $400 per month on dining out every month.  Looking at your cash flow, you think maybe you could cut that in half to $200 per month, saving $200 per month or $2,400 per year.  What would be the impact of this lifestyle decision on your future balance of your retirement account?  Doing the math, this $200 is really $278 of pre-tax income you are spending.  Investing that amount every month would result in?  $128,345 of retirement savings so your “Factor” = 642 (or $128,345 / $278).  So in this case for each dollar of discretionary spending eliminated and then saved each month, one can multiply by 642 (using my assumptions) to know how much you could add to your retirement savings.  (This ignores the potential tax benefits from a deductible contribution to an IRA or 401(k)- which would be another positive.)  So – do you want to figure out how much saving (then re-investing) $50 per month by cancelling your movie channels would positively impact you?  Just do some quick math ($50 x 642) and determine that move could mean an extra $32,086 retirement savings.

One Time Purchase Factor:  Instead of monthly spending, let’s use the decision whether to add that “optional winter gear package” to your new Volvo for an extra $4,000 or scale it back and only get the standard options.  By choosing the less expensive option, you obviously save $4,000 of after tax dollars, which is $5,556 pre-tax.  Without any future contributions (i.e. this is a one-time savings), this $5,556 would grow to $17,817 in 20 years, using my assumptions.  Your “Factor” = 4.45 ($17,817 / $5,556).  Again, when making this decision, take the savings and multiply it by 4.45 and that’s how much extra you could have in your retirement account by choosing the less extravagant set of options on your new car.  Making these kinds of judgment calls consistently will certainly provide a growth spurt to your retirement accounts- and you would probably never miss the heated sunroof, heated side mirrors, heated seats and ski / luggage rack.

Your “Hourly Rate” Factor:  Another helpful factor is figuring out how many hours of work equates to a purchase price.  So let’s say one earner in the household has total pre-tax salary of $150,000 each year and you’re thinking about taking that Disney Cruise with the kids for $10,000, which is $13,889 pre-tax.  Using a 50 hour work week, your hourly rate Factor = $58 per hour (pre-tax).  This means you must work 241 hours or about 9.3% of your work time this year to pay for this trip.  Worth it?  Maybe, maybe not.  But at least you can think about this more constructively.

So to wrap up: these are just tools to get you thinking and estimating.  The most important aspect of this exercise is awareness of where the money is going and just how much your decision to spend on “wants versus needs” is actually costing you.  Am I advocating not spending on anything fun?  Of course not.  But, what I am suggesting is knowing your “Factors” and doing some quick math could help you make some very informed decisions, the result of which could pay big dividends down the road and for the rest of your life.

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