Managing a Financial Windfall

When substantial, unanticipated money comes your way it can create a once-in-a-lifetime opportunity for you to re-chart the path of your life. Depending on the amount and on your age there are a number of good choices possible, and a few pitfalls you should avoid.

When I was 27 years old and living from paycheck to paycheck, I inherited some money from my Aunt Katee. It wasn’t a huge sum, but it was enough to change my life for the better. I paid off my credit cards and car loan, put a down payment on a townhouse, and bought some furniture. Admittedly, I also splurged a little by going on a cruise with a girlfriend (my first non-family-centric vacation ever). In hindsight, I feel good about all of my decisions. What I feel best about is that I know exactly where the money went – I didn’t just piss it away little by little on frivolous purchases.

Looking back, I would give this advice to young adults who come into a financial windfall:

PAY OFF TOXIC DEBT - NOW
First, pay off any credit cards, or high interest loans like car loans. Resolve not to accrue any more toxic debt if it can be avoided. Put your credit cards away somewhere safe, and use them sparingly and wisely. Cancel department store cards and cut them up.

WRITE DOWN YOUR LIFE GOALS
Spend some time thinking about what you want out of life. Money can’t buy love or happiness, but it can help you attain other goals. Do you want to own a home, start a business, live abroad, share your life with someone, and/or have a family? Be sure decisions you make with your money support your life goals. Understand that your goals may change over time. This is fine; but keep thinking and talking about them.

CREATE A BUDGET
Do you know where your money goes today? Get a handle on it, before you start spending your newly-acquired funds. Determine whether you want or need to revise your budget going forward.

TAKE TIME TO MAKE DECISIONS
You may get plenty of unsolicited advice (and requests) from family and friends. Don’t make major decisions too quickly. This is your money and your life at stake. The money can sit in the bank for a while you think it over and get advice.

INVEST IN YOUR EDUCATION
Nothing will enhance your quality of life long-term like a good education. If you don’t already have your college degree – invest some money toward that goal. There is nothing that can replace having a positive college experience, or that credential on your resume. Aside from what you learn, you will meet smart people who will become influential friends for life, and part of your supportive network. Do not miss this opportunity.

PROTECT YOURSELF
Be sure you are properly insured. You need health insurance, comprehensive automobile and property insurance (including liability coverage). If you’ve been relying on your parents for coverage, it’s time to make the leap to independence. Open an Individual Retirement Account (IRA). You may think it’s too early to plan for retirement, but it’s not.

RETAIN SOME CASH

No matter what you decide to do, you will want to retain a portion of your windfall in liquid cash reserves. Unexpected things happen, and sometimes you need immediate cash that is not tied up in investments.

INVEST WISELY

You will need some advice if you have money to invest. There are a confusing variety of options available. Ask an experienced, trusted friend or relative to recommend a financial advisor.

INDULGE YOURSELF A LITTLE

It’s OK to give yourself a little treat in celebration, but it should be something memorable and lasting – not a budget-busting trip to the mall. Set an amount aside for your planned indulgence and stick with it. Your long-term goals are more important.

A windfall can have a life-changing impact if properly managed. This is your money and your life at stake. Make good decisions and reap a lifetime of rewards.

Day of (Budget) Reckoning

With the start of 2010, we tackled the task of analyzing our 2009 expenses. I think we were both a little concerned about how well we had stayed within our budget, since we weren’t disciplined enough to track expenses month by month. I’m sure we will address this monthly from now on, because it took Ron several days to work on the whole year at once. Some electronic records are unspecific, and as time goes by, the memory fades. But Ron was tenacious, digging through all the details a month at a time, categorizing expenses into our pre-defined categories.

Before I tell you about the results, I should explain that for the purpose of modeling and analysis, we actually have four budgets with different levels of discretionary spending. Our Extravagant budget allows a generous level of discretionary spending, especially in the Entertainment and Travel categories. On the other extreme of the scale, the Low budget cuts discretionary expenses to the bare minimum. The Low budget is about 40% below Extravagant. In between, are High and Average budgets. These variations allow us to employ the appropriate annual budget based on economic conditions and/or other external factors.

We closed 2009 with our expenses about 3% under the High budget. We are very satisfied with this result, because we admit that we lived large last year while acclimating to retired life. Our expectation was that we would be closer to the Extravagant level. At the expense category level, we had just a few anomalies. Our Food expenses were slightly above budget, because we cooked at home more (better for our diet and keeping our Dining expenses well within budget). Housing ran above budget due to the cost of refinancing our mortgage last year, and monthly parking jumped from $180 to $225. (Ongoing, our mortgage payment drops $200 per month.) Transportation expenses were much lower than budgeted, as we replaced most auto usage with public transportation. Utilities came in about 50% under budget, probably because we had a really mild summer and we hardly had to use air conditioning at all. I am proud that I stayed well within my Clothing budget. The truth is that I am now happy to live in t-shirts or sweaters and jeans 90% of the time.

FYI, the big Mediterranean cruise was covered under our Capital budget – not included in expenses.

This year, we’ll do our analysis monthly, to give us a chance to make budget and/or spending adjustments throughout the year. It really gives us confidence in our retirement plans to have this data and analysis to validate our long term financials.

Determining "Your Number"

Some retirement planners start out by asking you how much money you think you need to retire comfortably. You can’t possibly answer the question unless you have already done a lot of groundwork to determine a good number. Don’t you dare pick a number at random because it seems right to you! “Gee, a million dollars should do it.” A million dollars ain’t what it used to be, folks. Consider this: If you retire at 65, live until 85, and need an average of $70,000 per year to live comfortably for 20 years – you need $1.4 million. But it’s not really that simple, unless you plan to hide cash under your mattress (not recommended), and don’t have any other assets that will help create an income for you. How can you determine “your number” and end up with a result and a financial goal that makes you comfortable? If you’re following my blog and taking some action, there are some inputs you have at this point that will help. You know how much money it takes for you to live on today. You have a budget and track your spending. You have aligned your spending with your priorities. You have one or more means of saving money for your future. You have an idea of how much income you should expect from Social Security. And you have some idea of what your retired life will look like. Haven’t been doing your homework, eh? Remember, you can’t achieve your goals until you have goals – so get started.

To get to “your number”, you need to project your future expenses – for the rest of your life. This is not impossible – but it will be an educated estimate. Start with the year you hope to retire, and with your current budget as a base. Adjust the inflows (e.g. salary) and outflows (expenses), based on what you know about how you will live after you retire. Start with the big ticket items first: Investment/Retirement Income, Social Security, Housing, Transportation, Medical, Food, Utilities, and TV/Internet/Telephone.

Year over year, there will be some inflation in our expenses. See the fantastic web site maintained by the Bureau of Labor Statistics (www.bls.gov) for a goldmine of data that will be helpful in many aspects of your planning. For a history of annual inflation in the Consumer Price Index, go to ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt.

Finally, consider how your life may change over time, and account for major changes in your expenses in your timeline for the future. For example, Ron and I picked a year by which we expect to sell our home and move into assisted living together. That creates a temporary leap in liquid assets (from the home sale), and then a heightened, steady depletion of assets for the ongoing expense of assisted living. We expect to buy a new car every 7 years (up until the point we assume we shouldn’t be driving any more).

Creating your projected post-retirement budget is a lot of work. Once you start, it will also be a continued work in progress as the vision of your retired life crystallizes. So get your budget spreadsheet out, copy it to a new tab and start modifying it (with years on the X axis and expense/income categories on the Y axis) to project your future needs.

Aligning Spending with Priorities

For the past few weeks, I have written about the first steps required to prepare for your retirement planning. Most recently I recommended that you identify the expense categories you want to establish and track your normal spending patterns for at least three months. Be sure that in those three months all of your expenses are reflected (e.g. insurance or property taxes that may be paid less frequently, and holiday gifts that have impact at the end of the year).

Now that you know where your money is going, establish a budget. Set a number for each expense category you have defined. This new “spending plan” may be more conservative than your current spending habits – especially if you discovered some surprises that beg for better discipline. Now is the time to address any conflict between your short term desires and your long term goals.

Spend some time thinking about what is really important to you when building the foundation for your future. Talk earnestly with your spouse/partner to align your plans. Do your spending and saving habits support or thwart your long term priorities? Make thoughtful decisions about adjusting your spending in order to accelerate progress toward reaching important goals.

Each of you has your own unique needs and priorities to assure you can enjoy your life the way you dream it can be. But I can give you some examples of the adjustments my husband and I made to get our spending in line with our plans for retirement.

· Our library cards have allowed us to reduce spending at the bookstore.
· We shopped for new rates on auto insurance and substantially reduced our rate without sacrificing coverage.
· Prepared/pre-packaged food is more expensive than raw ingredients. We changed our grocery-buying and cooking habits and saved a lot of money.
· I do my own manicures, and my husband does my pedicures. (He said it was OK to tell you.)

One more thought for you… You may be able to reduce your housing expense by re-negotiating your mortgage. If your mortgage rate is already low, consider making payments every two weeks instead of once a month. This won’t reduce your monthly outflow, but will increase of the equity you have in your home by speeding the reduction of the principle on your note.

Apply discipline to align your spending habits with your priorities and your long term goals. Live your life today while planning a full life for the future. One should not exclude the other.

Planning for Your Dreams

Last night Ron and I enjoyed the sunset (and the distant chaos of rush hour traffic) from a serene rooftop lounge in Chicago, and toasted each other with, “We’re living the dream.” Our dream is the culmination of years of planning and decision-making. We know how we reached our goals, and are happy to share some ideas with you.

The first step in any plan for the future is to get a handle on what your expenses and spending patterns are today. Use this as the basis for establishing a realistic budget. Start by tracking spending against a budget to create more awareness about where your money is going.

You can document and analyze your ongoing expenditures with an Excel spreadsheet – or a piece of paper for that matter. To some extent, HOW you pay can ease your tracking efforts. If you deal mostly in cash, you need to save receipts for review. Our preferred methods of payment are a bank debit card and American Express. Both give us detailed online records that we use to categorize purchases for comparison to the budget numbers. (In addition, with the American Express Rewards program we accrue points that are redeemable for gift cards.)

Once you are knowledgeable about your spending habits, you may want to make some adjustments to pull things into line with your saving goals. Looking objectively at expenses in a consolidated form, you may become aware of untapped opportunities to be thrifty and save more for your future.

Below are some examples of “non-essentials” that eat up discretionary income. No judgment intended – just food for thought:

· $25 a week to have a landscaping service = $100 per month
· Internet access on your cell phone = $40 per month
· Premium movie channels on cable that you rarely watch = $30 per month

I’m not suggesting that you sacrifice quality of life today. Just make deliberate choices, weighing your needs today with your dreams for the future. Your philosophies may well be different than ours. None of us truly know what the future will bring, and should live our lives to the fullest every day. (Being a victim of cancer in 2002 changed my perspective on that for good!) We saved aggressively to try to ensure that our retired life could be full and enjoyable, but certainly never felt deprived.

Next week, I will begin a series on the specifics of how we built our plan for retirement. Ron masterminded our plan, so I will be interviewing him to document the approach and some tips you may be able to use.