Simple Suggestions To Lower Your Stress When Big Expenses Happen (#49)

Host Josh Nelson talks about ways to lower your stress when it comes to expected, and unexpected, big expenses. He offers three simple suggestions and goes into detail on how easy it can be to implement them.

Contact Josh Nelson for a free consultation about how you can best handle any expected, and unexpected, big expenses. 
https://josh@keystonefinancial.com

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Transcript

Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money.       

This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. We love feedback and we'd love it if you would pass it on to me directly at josh@keystonefinancial.com . Let the financial fun begin! 

Thanks so much for joining me today. We're approaching one year of the Wiser Financial Advisor, so thank you for being part of what we're doing. We're consistently growing and getting more subscribers and listeners on the podcast; we're continuing to develop it and always looking for feedback, so please let us know if there are any topics you'd like us to cover. It's always fun to hear your feedback, whether positive or negative. And of course, we want to be introduced to your friends, coworkers, and family. Please subscribe and be counted as one of our people to be notified when new episodes come out. 

Today, I'm going to talk about planning for big expenses. This is a topic that comes up a lot because it doesn't neatly fit into budget planning like our normal stuff. We think about house payments, utilities, groceries, those sort of things that we spend on a month-to-month basis. We're not really surprised by those things. So when thinking about big expenses, I put them in a couple of different categories. One of those is true emergencies, things that we couldn't have planned for ahead of time, which I refer to as Murphy's Law types of expenses. In other words, bad stuff is going to happen because it's just part of life. Cars will break down. There will be medical issues, things you don’t expect. So those are the Murphy's Law type of emergency expenses. 

The second type of big expense involves things that aren't really emergencies, and we'll dig into those.

I'm bringing up this topic because the team here at Keystone has been having fun with a program called Smart Dollar, a financial wellness program for employers that they can roll out to their employees. Keystone has invested in that program for our staff members and we're all participating in it. It's a great financial education program! One of the features is to provide great tools to plan for things like expenses, budgeting, paying off debt, and of course accumulating money for the future. We want to be a firm that eats our own cooking; we want to make sure we're following the same principles that we advise our clients about. We want our team to have the same great tools our clients have. So, as we're going through the Smart Dollar program, people are working on their budgets. And one question that comes up a lot from clients and from people that just ask us questions—or sometimes even our own team members is: “Well, how do we plan for these things?”

Let's talk about emergencies first. Again, this is the Murphy's Law stuff, things that are just going to happen in our lives. We always recommend a Financial Planning principle that pretty much any Financial Advisor will tell you: Have somewhere between three to twelve months’ worth of living expenses set aside in cash. Cash means put into savings or checking, someplace extremely safe, probably paying zero interest, but very liquid. It needs to be accessible and safe, not something you have to liquidate investments to get to or go out and borrow money to get to. Here at Keystone, we tend to recommend somewhere between three to six months’ worth of living expenses set aside. To arrive at the right amount, of course you need to estimate what your normal monthly expenses might be. We find that's a pretty good proxy for covering most emergencies. It might not cover a really big emergency, but most things like if your tires need to be replaced or your car breaks down, things like that. And then, if you need to spend money out of your emergency fund, be sure to build it back up again afterward. 

The second category of big expenses is what we'll spend the majority of time talking about today. What about the ones that really aren't emergencies? What about things like home improvements, like if you want to put a deck on the back of your house, or refinish the basement? Say you want to go on vacation or pay for kids’ college or grandkids’ college, or even replace a vehicle that still runs but has a lot of miles on it. These are not emergencies, and usually they're not unexpected. These are things that we know are coming up, at least if we're doing some kind of planning, even if it's just in our heads. We know they’re coming up, so they could be planned for ahead of time, but in a lot of cases people just don't do that planning.

There are three principles I want to talk about today with regard to saving for big expenses, and the focus will be mainly those expenses that we could be planning ahead for, such as the ones I just mentioned.

Principle number one: You don't want to be like most people. You don't want to wing it. Average Americans don’t do any planning or budgeting. They leave everything to chance and in a lot of cases, they’re engaging in Pollyanna thinking, going on the idea that things are going to work out without planning. Bankrate.com has a study out that fewer than four in ten Americans could handle an unexpected $1000 expense such as a medical bill or a car repair. That's a lot of people leaving things to chance by not keeping much in emergency funds. No wonder the average American doesn't retire with a whole lot. In fact, most people retire because they have to physically; their body isn’t able to stay on the job. About 30% of Americans are living on Social Security and don't have any kind of nest egg or retirement fund. So you don't want to be like the average person. You don't want to be like folks who don't do any planning. And it doesn't matter how much money you make, we can throw out all kinds of big examples like Mike Tyson and Johnny Depp, people who have spent hundreds of millions of dollars and then gone bankrupt. So this is not about income. This is about planning ahead rather than being like the average person.

Number two principle is for people who just absorb big expenses into their existing budget. That's most common among the people who do some planning ahead—they've got enough income, which is a blessing—enough to absorb expenses like replacing tires or even replacing big ticket items like vehicles. It doesn’t throw off their budget to do that. Sometimes people actually cash-flow college expenses without having saved up college funds in advance. They just pay the bills as they come up. That's a great problem, of course, if that's the case. However, when you get into the big expenses, unless you have an extraordinarily high income there is some planning ahead that needs to be done. 

Financial principles to remember if you’re going about it by absorbing the expense: Don't go into debt. Don’t take out car loans and rack up credit card debt, especially if you've worked hard to get debt free. You never want to go back into debt. In the last couple of episodes, we talked about the principle of being debt-free. Having stuff paid off just feels good; there's a feeling of peace that comes with that, so we never want to go back into debt once we get out.

What if you're retired? If you're taking your monthly expenses out of a retirement fund, remember the 4% Rule. We've talked about this before here on Wiser Financial Advisor. The 4%.Rule is that you don't want to draw more than about four percent out of your investment portfolio on an annual basis, which means you're adjusting if the portfolio goes down in value. Say we have a big recession like we had back in the financial crash of 2008 and 2009, or the dot-com crash of 2000 to 2002. The market was down and it was down a lot. In fact, both of those markets ended up dropping more than 50 percent. So of course when we talk about that 4%, we'll want to be adjusting for 4% of whatever your investment portfolio is now. If you really wanted to push the line, sometimes we'll say, “Yeah, you can go up to 5% of your portfolio.” I will tell you though, that your odds are starting to get a little bit rougher there as far as running out of money. 

Remember, that is the number one fear of any retiree—running out of money sometime during their lifetime. That's right, the number one thing that scares people in retirement is not death. Dying is number two. Number one is running out of money, so we want to be careful about that. Remember that 4% Rule. Again, you could go up to 5% and be riding the line. 4% is a more conservative number.

So maybe your normal monthly expenses get covered by 4% a year, but then you need to replace a vehicle and now that throws your annual drop to 10% or something crazy. Remember, if you're not planning ahead and you're not building those expenses into the budget, they will still need to be accounted for someplace, and they do need to fit within that 4 to 5% per year. 

Number three: People plan ahead and look at the budget and think about these things in advance. Those who do this have different ways of going about it but more or less it means creating what’s called a sinking fund. This is a fund where money is purposely set aside for things like a vehicle replacement or to cover other expenses that will come up. I'll use myself as an example here, and it's funny about things like this, once you start doing them you think, “Why didn't I do this before?” 

So, because I’m self-employed and have a business, I get to do the quarterly estimated taxes that come with that. When you’re self-employed, taxes aren't taken out of payroll the way they are when you have an employer. When you’re self-employed, you have to pay quarterly estimated payments. So with me, what would end up happening was that a couple times a year my accountant would say, “Hey, we need x amount of money to send to the IRS and State of Colorado. And I would get sticker shock and say, “Oh my gosh,” and be surprised every time. Then I’d have to write a big check and it didn't feel good to see the savings go down like that.

Then I started thinking about it, and it's like, “Josh, this is not a big surprise. It's not like the tax code is a secret code that nobody knows and you’re getting surprised every six months at the whim of Congress, and what rate they made at that six month period. That's not the case. There’s a way to plan ahead.”

So, what I started doing finally was to set aside money into a separate savings account every month and just built up the funds so they were sitting there and then the taxes didn’t need to come out of the rest of our budget or normal checking or savings account. Once I did that, my stress level went way down because I didn’t have to freak out every time the accountant told me to write a check for taxes.

So, why don't we do that with everything? Why not for vehicle replacements or paying for kids’ college or home improvements?

Some of our clients will set aside a whole bunch of separate savings accounts. Most banks and credit unions will allow you to do this. Some will even allow you to go in and name your account “home improvement” or “new car.” And you can set up automatic transfers that will go in on the days you want them with the amounts you want. Sometimes clients have this really dialed in, and it's impressive how detailed they can get with their budgeting, but their stress level is fairly low because the money is already sitting there. So a sinking fund can be really effective.

Think of it this way: If you get your car paid off, and let's say it was a $600 a month payment. Well, what if you took that $600 and started shuffling it into a different account and building it up for the vehicle in the future?  

Now, one thing I'll throw out as far as Dave Ramsey’s debt snowball approach, which is for paying off debt as fast as possible: He would have you pay off all your debts first before building up savings and retirement funds or investments. So it does depend on the situation. As always, it depends, right? If you ask me a question, the answer is always, “Well, it depends. It depends on your situation. Until I know your particular situation, as a Financial Planner I really can't give you a good recommendation, but in general, that sinking fund can be an effective strategy.”

Once all debt is paid off, a sinking fund could be a good way to make sure you don’t go into debt in the future and don't get crazy surprises like I used to get with income taxes.

Now, let's say your car gets totaled or something like that. Maybe you didn't have good car insurance.  Things are going to happen that fit into that Murphy's Law category we talked about above. But here, I’m talking about the things we can plan ahead for. It’s possible to at least roughly anticipate when vehicles are going to need to be replaced or when we're going to want to replace them. Often, we end up replacing them before they need to be replaced, but ultimately those are the sorts of things we want to plan ahead for, making sure they're at least on the radar. 

You know it's an expense that will be coming up, and you don't want to be completely surprised by it, because when surprise is part of the picture, oftentimes that ends up resulting in some emotional decisions and sometimes really bad timing, depending on what is happening.

So, those are the three main things I wanted to kind of throw out at you today when it comes to those big expenses.

Number one, we don't want to be like most people.  We don't want to wing it, and the average American is just winging it. You may need to hire a Financial Planner because you may not have the expertise or the time or the desire to really learn about the financial world. Maybe you just know that you need help from somebody to sit down with you who can look at this in a knowledgeable way. We're a fiduciary, so it means that we have to look out for your best interest and so you have a financial friend, someone who can look at things honestly and tell you what things should look like to accomplish what you want.

Number two principle is for those who absorb big expenses into your budget. If you're going to do that, be doing some planning ahead, at least to get the timing down and make sure you’re not going back into debt or pulling too much out of your portfolio to cover things.

Number three is creating a sinking fund, which can be a really effective strategy as far as covering big expenses that we can plan ahead for.

There are lots of different ways to approach saving for big expenses, but ultimately you want to be doing it purposefully. If you have a house; if you've got a car; if you've got a family, a dog, any of these things, you're going to have stuff come up. I do too, so does Bill Gates and Elon Musk and everyone else. The dollar amounts are all different, but remember, sometimes people have blown hundreds of millions of dollars and still gone bankrupt. We want to be following these financial principles, these wisdom principles about how it's important to think ahead, plan ahead. 

So I hope that was helpful today. I would love to hear any comments you've got on this. Hey, if there's anything we can do to serve you and your family better, let us know. Please help us promote the podcast by hitting subscribe and of course, sharing this with any coworkers, friends or family. As we're coming up to the one year mark of this podcast, I'm very proud to be your Financial Advisor, your fiduciary, and your financial friend watching out for your best interests.

I hope you have a wonderful week and God bless.

The opinions voiced in this episode of the Wiser Financial Advisor with host Josh Nelson are for general information only and not intended to provide specific advice or recommendations for any individual. Investment advisory services offered through Keystone Financial Services, an SEC Registered Investment Advisor. This episode has been prepared for informational purposes only and is not intended to provide and should not be relied upon for, tax, legal, or accounting advice. You should consult your own tax, legal and accounting advisors.