When asking questions to clients, the one that usually stumps people is “How much do you spend in a year?”
They can answer about what they have, what they owe, how much they make, even how much insurance they have, but the discussion slows down considerably around spending.
In most cases, as the advisor, we don’t care what money is being spent on. We just need to have an accurate sense of the total.
Not surprisingly, how much people spend has a big impact on their financial picture.
Take a scenario of a 60 year old couple. They have $500,000 in RRSPs, $500,000 in non-registered savings, and a $500,000 house with no debt. If they spend $90,000 a year, we estimate they will likely leave an estate of over $400,000. If they spend $100,000 a year, we estimate they will run out of money in their lifetime.
Even if they say that they know how much money they spend, we find that often this number underestimates the actual spend. There are always the ‘one-off’ expenses that seem to happen regularly. There is also the odd expense that is simply forgotten.
When they finally do an analysis, they often look at certain expenses and say “do we really spend that much on that?”
Other times, they will say, “that explains why we have had trouble saving more?” The review may lead to changes that lower expenses, or even without changes, will at least provide greater clarity as to why finances are the way they are.
I actually believe that the expense number is the most important number in financial planning. We have all heard of people saying that they are working towards THE NUMBER. This is usually some amount of savings that — when achieved — will allow them to retire in style. What I have found is that the expense number can be the foundation to everything. It is almost like the sports debate about offense vs. defense. I view expenses as the defense, and income and assets as the offense. Just like in many sports, the offense gets the glory, but the game is won on defence.
I once spoke to someone in their early 60s. They told me that they have little savings and no pension, and that they are very worried about their retirement. When we went through their situation, I found the following. They were a married couple. They had $25,000 of RRSPs. They had a $400,000 house. They had no debt, and no pension. As it turned out, they are also likely going to be just fine financially. The reason is that they spend about $28,000 a year.
By the time this couple is 65, they will collect well over $30,000 a year indexed, based on CPP, Old Age Security and what is called the Guaranteed Income Supplement or GIS.
In addition, this couple can keep their house, go to a bank and get a line of credit of $100,000 secured by their house (likely very doable even with their low retirement income, but easier to get while still working), and use this line of credit as both an emergency fund, and also to possibly supplement their income by a few thousand dollars a year if needed.
The other alternative is to sell their house, invest the proceeds conservatively, and at 3%, generate $12,000 a year in additional income to cover off extra rental expenses.
The point is that with virtually no savings outside of their home, because of their low expense lifestyle, they are still in decent shape. They are potentially in better shape than the other couple with $1-million in savings, who live a $100,000 a year lifestyle.
Once you can properly answer the question “How much do you spend in a year?” then the rest of the financial order will fall into place. You can begin to get accurate advice on tax savings, appropriate investment asset allocation, and truly answer whether you will be at risk of outliving your money, or instead need to focus more on estate planning.
If you do nothing else to shore up your financial picture, understand what you are spending, and you will have answered the hardest financial question of them all.
Ted can be reached at email@example.com or by phone at 416-733-3292 x221 or 1-888-816-8927 x221
Reproduced from the National Post newspaper article 2nd October 2013.