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Budgeting is one of the least liked parts of the financial planning process. However, getting a real sense of essential and discretionary expenses in a privacy-protected manner may be far less complicated than you think.
Tech now allows anyone to utilize software and quickly link up bank accounts. Your data is uploaded, and algorithms can automatically create beautiful spreadsheets useful for a detailed analysis. However, it’s fair to ask if all this is necessary and what are the privacy considerations that go hand and hand with uploaded data?
If you prefer, a similar level of accuracy can be attained with a little due diligence. I admit it’s genuinely impressive when clients have ultra-detailed spreadsheets, but for many, all the apps and programs can serve as more of a distraction, and sometimes it’s easy to lose focus on what is needed.

Just getting a sense of expenses

Two main items are needed to get a good sense of expenses—a total of essential expenses and discretionary expenses. In some cases, adding an “expiration date” could be helpful, just so it’s clear that the expense is not something that goes on forever. Also, some expenses are one-time expenses, and it may be most appropriate to have a capture-all such as “annual house fixups.” There will inevitably be a certain degree of a grey area. That’s not a problem because we’re just trying to get a sense of expenses in this exercise.
It’s not challenging to get expenses down on paper- and quickly. If you spend more than 30 minutes, you may be spending too much time on it. Focus on the larger items such as a mortgage, property tax, and insurance. Look at a pay stub to see how much you’re contributing to tax, retirement accounts, Health Savings Accounts, Disability benefits, and health insurance.
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From there, it’s usually just food and other personal expenses. Suppose you tend to use one or two credit cards for most purchases. You can download a statement and rely on an average running balance. Identify patterns in credit card bills and use them to gauge spending habits.
The bonus of gathering expenses in this way is that you are also more hands-on with the process. If something appears off, it can be red-flagged for later analysis versus just having the algorithms collect everything and a potential erroneous expense slipping through the cracks.

The value of a professional’s perspective

A good advisor (Advice Only Financial Advisor) will complete many plans, and I find what tends to happen is that people in a geographic area will fall into one of a few expense “buckets.” We’re all shopping at the same places, buying the same stuff, so some distinct and identifiable patterns in spending and groups exist. When working with many people, an advisor has this knowledge to offer and very quickly should be able to tell if your expenses seem believable. Remember, it’s not about getting it accurate down to the penny; it’s just getting it “about right” for realistic analysis. The main reason for this is that expenses will always be a moving target; you will only get it reasonably close anyway. Us professionals will mainly want to know not how much coffee you drink but if the general spending “vector” appears sustainable. Or if there are fundamental changes required to spend to make the plan more sustainable (i.e., downsizing, moving to a new location, saving more, making more, or spending less). Most of the time, this is easier said than done.

What’s a burn rate?

To quickly get a sense of spending, create a one-page excel file with two columns. One for “essential expenses” and one for “discretionary expenses.” The reason that essential expenses are separate from discretionary expenses is that should you ever need to go back and find room for improvement – then reviewing discretionary expenses is initially going to be most appropriate. ‘Wiggle room’ tends to come from discretionary expenses.
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Once totaled, calculate the withdrawal rate or “burn rate” on total portfolio assets. To do this, divide your total annual expenses by total portfolio assets to arrive at a percentage. To be clear, “portfolio assets” are your spendable assets, so this would not include the house where you currently reside. In theory, investment real estate may be considered spendable if sold. Of course, you’ll have to consider any dips in income resulting from any sellable assets. I generally refer to cash, brokerage accounts, 401(k)s, and IRA-type accounts when referring to spendable assets. These accounts will supplement “income” later in retirement. You might have specific dollars that should not be considered retirement money (such as money for one-time house fixups). In that case, you might consider excluding those from the calculation and the expense itself.
It is essential to point out that this exercise on its own is not a financial plan. It’s merely an exercise to get a sense of the sustainability of your retirement plan. It is a controlled “lab experiment” and does not include every conceivable variable. A more comprehensive cash flow analysis done by a professional is likely more appropriate.
For example, Social Security income, a pension, taxes, or possibly rental real estate income will likely need to be factored in. The benefit of this exercise is to provide readers with a quick and easy way to get a sense of how the plan is shaping up and then from there, if needed, add back in income, take out specific expenses, redo the calculation as needed to get a more granular sense of your personal “burn rate.”

Recommendation: Rebuilding the Retirement Planning Buckets

What is a sustainable “burn rate”?

A burn rate is a withdrawal rate or the amount of money drawn from a portfolio throughout retirement to meet needs. The 4% rule states that the plan may become unsustainable if a withdrawal rate is more than 4%. Depending on age and other variables, a higher withdrawal rate may not be a cause for panic. Generally, if a withdrawal rate exceeds 4%, some consideration could be required to reduce the percentage to a more sustainable percentage. Additionally, the 4% rule is highly debatable. It doesn’t account for issues such as sequence risk – or the risk of lower returns in the early years, compromising the portfolio’s sustainability long term. Failure, in that case, could occur despite a portfolio not exceeding a 4% withdrawal rate. In other words, even the 4% rule is no guarantee of sustainability; it’s simply an indicator.
The last thing to point out is that if you’re a bit behind, it may make sense to look back at those identified expenses and see where there can be improvements. Going through the exercise outlined earlier, you likely already know where the “wiggle room” can be found. Having more of a hands-on approach is why it’s a good idea to have separated essential from discretionary expenses. You now have an easy way to identify those potential nuggets of improvement.
In general, though, I am not a fan of assuming spending can be reduced or eliminated. The reason is that it may not happen. Unless it becomes apparent that change has to happen and is inevitable, if a plan proves to be unsustainable, there may need to be some tough choices ahead.

Editor’s note: This blog offers informal investment and financial planning advice. We know nothing about your unique financial situation. The buying and selling of any financial product or security should only be considered in context. If appropriate, seek the counsel of experienced, ideally objective, financial, tax, or estate planning professionals. Past performance is not indicative of future performance.

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