Welcome to episode 21 of the Life and Finances Together podcast. We’re so excited for today's topic because it's an integral part of our business and it's something that deserves the spotlight for how much value it adds to financial planning.
When we introduce cash flow during our financial planning process, the response we usually get is a blank stare with clients asking, “You're going to make me do a cash flow?” It’s almost as if we’re asking them to confess their spending habits, and suddenly we feel like financial priests.
We’ll always say getting your cash flow under control is critical. Understanding your cash flow is 80% of the financial planning battle.
Many people assume financial planning is all about investments, market performance, or economic forecasts. And yes, those things matter – but they pale in comparison to the power of understanding where your money is going. If you don't have your hands around your cash flow, it's going to be a difficult ride. And of the things we're going to talk about today, your cash flow really tells us a lot about you.
Think about it – where you spend your money tells a story about what matters to you; what's important to you. It reveals where your values are. Some people want to travel more. Or maybe you’d prefer to stay close to home and spend time with your grandkids. Those are two completely different lifestyles with dramatically different financial footprints.
One of the best things is to put it down on a piece of paper and say, “this is what I think we want to do, and what's the price tag associated with these things?” Once you get your hands around that, you can see that general rules of thumb don’t really apply.
Vague rules of thumb like “you’ll need 70% of your gross income in retirement” don’t factor in all the costs that your cash flow reveals. You're not going to retire on Friday and change your lifestyle when you wake up the following Monday on your first full day of retirement. You live your values, and your spending reflects that. So, it’s vital to capture the real numbers.
One of the biggest mistakes we see is clients estimating their spending with one big number – “I think I spend around $150,000 a year.” But when we ask, “on what?” there’s often no clear answer. You're going to miss something with generalities.
This is where breaking down your expenses—discretionary vs. non-discretionary—makes a huge difference. By understanding the details, we can identify opportunities to save, adjust, or prepare. For example, if a client is short on their retirement savings goals, we can look at whether cutting discretionary expenses today to free up room is feasible for our client.
But that may not be a possibility for everyone. You might be maxed out on housing and essentials – “I'm paying my mortgage, I'm paying for the groceries, I'm paying for just the necessities, and I don't have an extra dime to put towards savings.” Well, that's what we need to analyze, and we’ll plan accordingly. The details let us personalize your strategy.
People ask, “why do I have to have the detail?” Because it enables us to make adjustments. If you just say, “I think I spent $150,000, but maybe we need to cut back for whatever reason.” Well, you don't know where to cut back if you don't have that detail.
Let’s go back to the example of someone saying they want to travel in retirement. Will you be traveling the same amount you are now? Are you going to travel twice as much?
Well, we’ll need to increase your budget and factor in inflation rates. So that's really where we can dive into the next piece of cash flow analysis; knowing what your expenses are but also having the appropriate growth rates and cost of living adjustments on them.
Inflation affects different things at vastly different rates. Healthcare being the prime example. Healthcare costs, premiums, out of pocket costs, all of these are things that keep most people up at night about retirement. Well, that inflation rate's been dramatically different than CPI – the normal inflation of other goods and services.
Healthcare inflation is estimated to be around 8%. Which we refer to as Medical Armageddon. Doing the math - which is how we describe doing the financial plan - we always are incorporating Medical Armageddon, what those healthcare costs are going to be. And there's a lot of uncertainty as it relates to that. What are the inflation rates for other things that you're going to want to purchase? Other services – like travel expenses - that want to partake in? Understand the key component there is those inflation rates are going to be different for different expenses.
And then there’s the other thing that’s hard to predict - what about the one-off expenses? When we have clients fill out their cash flow, they start out with something basic. “This is what we think our expenses are for every month, every year, etc.”
And then life throws you a curve ball. You need to replace the roof. You've got a furnace that breaks. Possibly something health-related throws you off track. Or maybe it’s something fun, like finally buying that classic car you’ve been eyeing for decades.
All these things need to be incorporated into your base cash flow. Because it all goes together.
One of the questions we hear most often is: “What’s my wiggle room number?” In other words, how much more can I spend without putting my retirement at risk? So we'll often look at what the known expenses are, try to factor for the unknown, and determine what their wiggle room is. And we'll say, hey, you can spend approximately this much more per year for every year of your retirement and still have a certain amount left over that we deem comfortable.
That wiggle room number is a way for us to figure out how much more that you could spend without putting yourself in financial harm's way. And hopefully in your financial plan, there is a little bit more left over from what we've put together in the development of your cashflow and the development of your retirement projections. But this wiggle room number is key. It's important.
But we’re not perfect. We could still miss a few things, and we can’t always account for everything. Expenses are going to change different life events like a child finishing school or a mortgage being paid off.
An important part of cash flow planning is understanding that when life events happen, when these things come at you, how will expenses differ? And we're not just talking about these lump sums that we just got done talking about, right, these unexpected expenses. We're talking about life events. If somebody passes away, if we have a long-term care event, things that you truly have to budget for.
Clients don't like having these discussions. It's just like getting their estate planning documents done – no one likes to discuss their own mortality. But these are things that you have to think about. And we'll have these detailed discussions with the clients because we will run different scenarios for all kinds of major life events.
We’ll start with their base plan where they're both living until 90. Then we run the uncomfortable scenarios; the stress test of one spouse’s premature death, for example. What is that going to look like? Are you still going to double your vacation budget? Are you still going to do the home remodel? Are you still going to buy the vacation home or is that going to be too much for one of you to handle? So that's why the more detailed, the better. These are tough conversations, but they’re necessary ones.
Long-term care is also another main stress test that we run for clients that can really change expenses. A lot of times when we start to run that scenario, people will ask to run the stress test with both of them in the nursing home.
When the more difficult financial situation is if one spouse is in a long-term care facility and the other is not. Why? We now have to take care of the spouse with a long-term care expense, but we still have to maintain the lifestyle, the home and everything else that goes along with it, for the spouse outside the nursing home.
It may feel a little like overkill, but it's worth looking at because your life doesn't stop. The grandkids, the kids, things that come up, yes, it's unfortunate we have one spouse that's in a nursing home and we have to make sure that they have the best care possible.
You don't want to underestimate or undervalue what that cost is.
And with our stress tests, we've gone as far as looking at the cost of having in-home care and current day costs associated with those. And again, calling back to something earlier, these medical expenses are going to grow a little bit faster than some of your normal expenses. But we look at costs for in-home care as well as having to go into a long-term care facility in today’s dollars. And we will run the stress test to see, along with that, the spouse that's not in the facility doesn't need that care, still has these living expenses, has to maintain the home. How does that impact the plan? And we are always wondering “can we weather that storm?”
If one of you goes into a nursing home, maybe we have a premature death, what is that going to look like? Can we handle it? And we're not just saying you need to buy some additional insurance. And no, the answer isn’t always “buy more insurance.” Insurance helps in certain situations, but it’s not a substitute for thorough, thoughtful planning to weather those storms.
And that's why it's so important to understand the whole picture as it relates to your cash flow. It isn't until you look at these things in detail, run your stress tests, get the details down on your cashflow, understand where you're spending it, understand where your value set is. It isn't until you've done that work that you're truly bringing life and finances together.
Thanks so much for reading along with us today and learning about the Rinvelt and David cashflow planning process. For questions about our financial services or finances in general, please give us a call, send us an email, and of course please like and subscribe to our podcast and stay tuned for our next episode.
