Because it is always a timely topic, we thought we would discuss household fiscal responsibility and try to provide readers with some tips for getting their fiscal house in order. As financial planners and CPA’s, we interact with people from all across the financial spectrum. Our experience has taught us that whether a household is in good financial condition or not has less to do with household income and more to do with household spending (Sound familiar, can you say federal government?). We see families who make more than $500,000 annually who can’t borrow a nickel because they are so maxed out with debt. We also see families who make $60,000 annually who have a house, two cars and no debt other than a mortgage. What it comes down to is simple math. You can’t spend more than you make indefinitely. You can do so in the short-term by borrowing to fund the difference, but at some point that option runs out. So, why do so many families find themselves in a financial mess? We believe there are three main reasons:
1) Inadequate Savings – Most families, even those in financial distress, can handle their regular monthly bills and expenses with the income they make. After all, many of the monthly expenses are based on factors we control (where you are going to live, what kind of car are you going to drive, where you are going to shop, etc.). Most families make these decisions based upon their current income. However, when the car unexpectedly breaks down or the roof on the house needs to be replaced and there is no safety net available, many households will put it on a credit card and worry about it later. The average US household had $5,700 in credit card debt at the end of March 2016. What is an even scarier statistic is if you take out the number of households that have no credit card debt, the average credit card debt per household balloons to $16,048. Since the US median household income in 2015 was $54,462, this means the average household that has credit card debt owes almost 30% of their gross annual income. Savings is a critical way to avoid letting these unplanned expenses ruin you. By spending less than you make, you can build up a reserve to cover you when the unexpected happens.
2) Lack of budgeting – You can’t possibly have a savings plan if you don’t take a hard look at what is coming in and what is going out. Invariably when we ask someone who is experiencing financial difficulties what their monthly budget is, they look at us like we have three heads. Balancing any budget requires knowledge of the revenue in and the expenses out. This is the only way to have a realistic vision of your financial situation. Budgeting is free and only requires time and discipline to achieve. We usually recommend starting with the easy side first, the revenue side. Figure out what your net pay is on a weekly or monthly basis. Next, tackle your fixed expenses: mortgage, real estate taxes, insurance, car payments and anything else that is a fixed amount every month. Subtract your fixed expenses from your net pay and that leaves you the balance for variable expenses. Variable expenses include everything else you spend money on including, but not limited to, food, clothing, gas, utilities, entertainment and miscellaneous services. We advise all clients to assign an amount under variable for savings. It doesn’t have to be a lot, even $25 or $50 per week. The idea is to get used to saving consistently. If there is nothing left for savings after your variable expenses or even worse if you are negative, then you have to reduce some expenses to bring your budget in line. This brings us to our final point.
3) Understanding the Difference between Wants and Needs – We live in an entitlement society. Many households believe they are entitled to a certain standard of living whether they can afford it or not. The same person who says they cannot save $100 a month will spend $200 per month on their teenagers’ cell phones. We need to go back to the age where basic needs were food, clothing and shelter. Basic needs do not include $200 per month for television, $75 per month for high speed internet, $200 per month for Smartphone service. These things are great if you can afford them but they are luxuries. If the only way you can afford these things is by charging them then you are in for financial ruin. Vacations are another big area we see households dooming themselves. Families used to save up for trips and then go. Now, many go away without $500 saved and charge $3,000-4,000 on the trip and worry about it later. Newsflash, if you don’t have the trip paid for before you leave, you shouldn’t be going.
It is easy to get yourself in a financial mess. It is much more difficult to be responsible, spend within your means, and choose only those things that you can truly afford. What the past twenty plus years dealing with peoples’ finances has taught us, is that in the long run, those that live within their means will be much happier than those that live extravagantly above their means because of the detrimental effects that financial stress can have on you physically as well as the health of your relationships. Money is still the leading cause of relationship failure……and unfortunately, always will be.
Tom Reynolds, CPA & Matt Reynolds CPA, CFP®
(Co-Managing Partners, CRA Financial)
Francis C. Thomas CPA, PFS (Investment Advisor)
Robert T. Martin, CFA, CFP® (Investment Advisor)
(This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial adviser, as well as your tax and/or legal advisers, regarding your personal circumstances before making investment decisions.)