Alexander B Collins, ChFC®, CFP®
Senior Partner with Quantified Financial Partners
There is no way to create the ‘perfect’ budget. Expenses are always changing. It’s important to allow your budget to flex and to have the ability to stretch for unforeseen costs. Let’s start by breaking these down into small, medium & large expenses and then we will talk about how to address each one of these.
Small unexpected costs
In the “small” category we’ll include anything that is an extra $25 to a couple hundred dollars that you did not expect to spend. These are the little expenses that pop up when ‘life happens’. We talk about this as the ‘sauce of life’. Whether this is an unexpected art project for one of the kids, a flat tire/dead battery or other minor car issue or paying for copays for a trip to the doctor – these should be relatively easy to deal with and frequent in occurrence.
These are the couple hundred to a couple thousand dollar expenses. It’s coming home to the hot water heater having sprung a leak, damage to your living space from an upstairs neighbor; or your teen backing into the fence requiring fence repair and body work. These are going to be more disruptive to the budget but also significantly less frequent.
These are the “oh FUDGE” expenses! These are the $5-10K+ or something that requires adding a major monthly payment. Finding out that you need a new roof when you expected it to last another 5-10 years, a major car repair or losing your job. These expenses are rarely planned for and throw a major monkey wrench into planning. It’s not “oh no big deal, I’ll just go pull $25K from the bank to cover this.”
Lastly, there are ‘we can’t possibly recover from this’ events. Examples of these are losing a loved one, becoming disabled and no longer being able to work. These are the things that we hope and pray will never happen to us.
Now that we’ve identified the issues that can pop up – how do we address them - proactively and/or rolling with the punches?
Small expenses – When working on your monthly budet, don’t plan down to the last penny. Make sure that you have some amount of fluff or discretionary spending. The goal here is to be able to absorb minor expenses that pop up unexpectedly. Depending on your life, these may happen frequently. For example, if you have $300 a month of rolling but changing expenses – budget for $500/mo. If at the end of the month it’s not used, bank the remaining into a rainy day fund. Also, when something occurs, you can temporarily reduce the ‘discretionary spending’ – less meals out, less entertainment, etc., while you make up for ‘extra expenses’.
Medium and high expenses – Many of these expenses occur periodically, but we don’t know the timing. The critical thing here is to budget for them over time. For example, a new roof may cost $10K or more and last 20-50 years. Budget for home repairs over a 5-10 year period and create a plan for how to pay for the big expenses when they occur.
It’s great to plan for expenses but how do you pay for it? The easy answer is to have multiple accounts that can be tapped in case of emergency. To start, you should have at least 3 months of expenses in the bank. Ideally, you build up to the point of having 1 year’s worth of income, liquid, in promise-based assets. Promised-based assets don’t fluctuate based upon the opinion of others, so not stocks, bonds, real estate, etc.
We encourage clients to create 3 or more sources of liquidity.
- Cash in the bank. Depending upon income level, typical expenses, how much income fluctuates, this is usually anywhere from $10K to $200K.
- Next, is a home equity line of credit or HELOC. This is a variable line of credit tied to the home. There is no cost of having a line of credit with no balance (at least with most financial institutions). This is a good way to have access to extra funds if necessary. If you draw down on the HELOC, you will want to have a plan to pay it off.
- Another way to create liquidity is some combination of a cash value life insurance and brokerage account. The brokerage account is an example of an opinion-based asset. Cash value life insurance, depending upon the type of policy can be promise-based or opinion-based.
By using multiple assets and resources, you can mix and match to suit your situation. There is no one tool that is best – in fact, creating balance between multiple tools tailored to your situation will almost always create the best solution.
Lastly, there are the expenses that we can’t possibly save to protect against. For these things, we need to use insurance. These are the things that we hope will never occur. If they do, then we can’t possibly have saved enough to protect against it. For example, if you become disabled at age 45 and unable to work, then you may need to consider this as a forced retirement. We use insurance to protect against the things that we can’t protect against. The typical things that we want to use insurance to protect against are income, life, health, home, cars & lawsuits. These events may be devastating but with the proper planning can be managed to avoid a depreciation to livelihood.
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Therefore, the information should be relied upon only when coordinated with individual professional advice. Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 333 N. Indian Hill Blvd., Claremont, CA 91711. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Quantified Financial Partners is not registered in any state or the U.S. Securities and Exchange Commission as a Registered Investment Advisor. Quantified Financial Partners is not an affiliate or subsidiary of PAS or Guardian. AR insurance license #7264699 CA insurance License #OH24806. #2021-115884 Exp 02/23