The importance of a budget never really goes away but it doesn’t have to be as scary as some make it out to be. I’ll review three stages in life and the types of things that could be in your budget at those times.
As a young adult, learning how to create, and stick to, a budget is essential for developing a process that allows you to meet your obligations and reach your financial goals. The process is fairly straightforward. You compare income and expenses over a period of time and decide what to do with the excess or what to do about the shortage. In reality, however, managing a budget isn’t that simple.
Decisions need to be made about what is needed versus what is wanted. Investing early for retirement is one of the best ways to assure you have enough to be comfortable in your latter years. When it comes to budgets, remember the golden rule: “Pay yourself first”. This means save first and then look at what you have left over for expenses. Take the first step and open an account and then set it up for automatic contributions. This could be a company 401(k) (which might have matching contributions) or an individual or Roth IRA. The power of compounding is strong and your best friend is time. The earlier you start the more potential you have for growth.
During your middle years, new expenses can come up; a mortgage, babies, 529 plans for your kids’ college expenses, cars, vacations, etc. This is the point where even a good planner can run into road bumps. Debt is something to be used as a means to an end, but too often people get caught up in their lifestyles and get in over their heads. Used appropriately, debt should enhance your life without taking it over. Seriously consider the amount of your mortgage payment relative to your earnings and long-term plans. Do not just look at the maximum amount a bank will approve you for. If credit cards are to be used, make sure you’re getting the lowest interest rate possible without annual fees. These years are when the bulk of your retirement dollars are saved, so continue to invest while increasing the percentage you put in each year, even if it’s just half a percent.
Retirement does not mean your off the hook and can just spend your savings with reckless abandon. People are living longer these days and running out of money is a real risk. Establishing a realistic withdrawal rate coupled with a more conservative investment allocation will help get you through your twilight years. This point, in particular, is even more important as we continue to have some of the lowest interest rates in history. Looking at investments like closed-end bond funds that you can buy at a discount helps add yield in this difficult environment.
Although you may be able to budget in things like more travel, you still need to be cognizant of new expenses. Health, in particular, is a huge unknown and can be a major portion of your spending in your latter years. Establishing an estate plan, with a will, healthcare proxy and power of attorney is essential to making sure your wishes are carried out the way you want them to be. Too many people don’t want to spend the money on a will (or just don’t want to think about dying) and put it off until it’s too late. Another critical point is to make sure the beneficiary designations on your retirement accounts are up to date. If there is a discrepancy between them, for someone who divorces and remarries for example, you may end up giving your assets to someone other than who you intended them to go to. For some, it may be appropriate to establish a trust, both to avoid probate and to keep the government from dipping in should you have to go into a nursing home. There are specific rules and look back periods, so be sure to consult with an estate planning attorney when considering this type of instrument. The cost can vary widely and depends, in part, on whether it’s a “simple” trust or a “complex” trust. Finally, you may want to gift some of your assets while you’re still alive. Whether it’s appreciated securities or cash up to the annual limit you can give tax free, it may be rewarding to see the impact of your inheritance before you actually pass away.
By developing a carefully planned budget you can establish the bedrock of your financial future over the various stages of life. In each stage, a financial advisor can help you create a plan and keep you on track. He or she can act as a quarterback by coordinating with your CPA and attorney to make sure everyone is on the same page. Ultimately, using a budget is more than just crunching numbers. It’s a means to create security and happiness which is more important than dollars and cents in the end.