20 years ago, I became good friends with a man whom I worked side by side with in one of my mid-career positions. This man is truly brilliant and also very financially savvy, and we’ve remained close family friends. A few years ago, he retired, full time, at the Age Of 50! Today, he’s sharing some thoughts with you on one of the most important tools he’s used to achieve this amazing accomplishment. Take his advice – he knows what he’s talking about. Above is a picture of my friend enjoying his retirement in Yosemite National Park this week.
It’s an honor to contribute to The Retirement Manifesto, Fritz’s labor of love. My wife and I have known Fritz and Jackie for about 20 years now and have shared many good moments, weekends and vacations. During this shared time we’ve had many discussions on life in general, our goals and aspirations as well as how to achieve these.
My wife and I are an example of how the concepts described in The Retirement Manifesto work to achieve early retirement. We married young, developed a joint life plan, had 2 children, worked hard, enjoyed life, started saving and investing young, with a good dose of luck and the power of compounding we became financially independent by age 50. We have been enjoying the freedom afforded by “retirement” ever since: exploring our great country and the world; spending quality time with family and friends; following our passions.
We got there by using the basic tools of:
- Agreeing to a common life plan,
- Tracking spending and net worth,
- Allocating financial resources,
- Not borrowing but investing,
- Managing long-term cash flow plan and…
- ….having fun!
Budgeting – One Of The Best Tools In The Box
All of the above tools are very important but for this article I will focus on Budgeting (resource allocation and tracking).
Let me start by saying that I realize that to most people Budgeting has a negative connotation: constraining spending. Budgeting is actually a management process which gives you control over your financial resources and enables you to fund your dreams and goals. But more than this, the budgeting process gave my wife and I the opportunity to sit down and discuss our plans for the next year and agree on how to fund it.
Financial issues are often an important source of tension within a couple; this is a tool that can help to minimize these issues. I can’t overemphasize this; to be successful the process must be done with your significant other and in a spirit of respect for each other’s opinion. Agreeing to a common plan is essential, you don’t want to end up trying to control your spouse’s spending but for each of you to manage your own actions with a view to achieve the plan.
Management is about establishing goals, allocating resources, executing, measuring actuals and adjusting as required. The budgeting process is no different.
The key steps to budgeting:
- Determine the categories you will use to allocate your total cash inflows. The categories should be meaningful for analysis and decision making. Attached is a Budget Category Spreadsheet of the categories we presently use (yes it continues into retirement!). Note that the categories can be as broad or specific as you want; as long as it helps you identify issues and make decisions. The categories will change as you go through different phases of your life so adjust as needed.
- Allocate your expected cash inflows for the following year into the categories. Make sure that you both “sign-off” on the final version of the budget and document by sharing a copy (print or electronic). We then split the annual amount into monthly buckets.
- Decide on the tracking tool you will be using. We have used many over the years (pen and paper, Quicken, Excel spreadsheets…) but have settled on Excel as it is easy to use and is very flexible. The downside to Excel is that you need to enter all your expenses manually. Quicken was actually very good, importing transactions and balances from credit cards and financial institutions but it only works if you use their standards categories, which didn’t work for us. There are many alternatives out there so you will need to invest some time to decide which will work best for you.
- Track expenses. This includes a “month end” process where you make sure all financial activity has been captured
- Review the Actuals vs Budget on a quarterly basis. Life is messy, things happen so when you look at your results you will most likely need to adjust the plan. We simply create a Forecast column to readjust the total amounts (if revenue has changed) as well as the allocation between categories to reflect our new reality, while still meeting our savings / investment targets. Again agreeing on the Forecast is essential.
- Finally, use the Year End actuals/forecast to help with creating the Budget for the following year.
Seeing where you’ve spent your money at the end of the first year will most likely be an eye opener and will help with allocation decisions for the next year.
This may sound like a lot of work, but once you’ve gone through a few cycles the time you will need to invest in the process will be minimal. The impact is worth the effort!