Are You Asking the Wrong Question?

Whenever you face a financial decision, what question do you ask yourself? If that question is, Can I afford this today?; you are asking the wrong question. The impact of financial decisions carries far beyond the moment they are made. A debt will affect you for the term of the loan. The decision to retire will affect you for the rest of your life. Even the purchase of a couch can have an impact on your finances for weeks or months into the future.

What is the right question to ask?

So what is the right question? It depends on the circumstances. The proper question for a 60-month car finance purchase is, Can I afford the monthly payment for the next five years? A decision to retire requires the question: Will I be able to afford to live on my retirement income and accumulated assets, taking inflation and increased health costs into account, for the next 20 to 30 years? The appropriate question for non-essential everyday expenditures such as eating out, going to the movies, or the purchase of a clothing accessory is, Can I afford this and still make my essential expenditures for the balance of the month, including any unanticipated expenses such as medical co-pays and repairs on vehicles or appliances?

You take change into consideration when you ask the right question

If you are honest, asking the right question forces you to think about the future. In thinking about the future, you must account for change, and not just any change; you must account for what might go wrong. How have circumstances changed in your life over the last year, three years, five years? Has your cost of living increased? Have you been laid off or had your hours cut? Have you experienced health problems that kept you from working? Have you experienced periods when there was a reduction or interruption of income? Have you had to pay medical deductibles and/or co-pays, auto insurance deductibles, auto repair expenses, appliance repair or replacement expenses, or repair expenses to your house?

Account for change in the future with savings

How do you account for what might go wrong in the future? You do it with savings. You need cash in reserve to handle expenses that exceed your monthly take-home pay and to cope with reductions or interruptions in income. If you don’t have savings, your answer to the purchase question is always “no”; you cannot afford to purchase anything that is not an essential expense such as food, rent, utilities, fuel, insurance, maintenance drugs, and any payments on debt. If you don’t have at least three to six months of living expense in an emergency fund to replace reduced or lost income, the answer to the purchase question is “no”; you cannot afford to purchase anything that is not an essential expense.

At a minimum, you need enough short-term savings to cover insurance deductibles and out-of-pocket expenses, a major repair to the automobile, and the replacement of a major appliance along with a separate emergency fund equal to three to six months of living expenses. Without this short-term cash on hand, you cannot account for the future, and therefore, cannot afford to purchase other than essentials.

Retirement requires accounting for change over a 20 to 30-year period of time. How do you know how inflation will affect your cost of living over two to three decades? Can you accurately predict your state of health and the costs of health care during that period of time? The truth is you can only make intelligent guesses about the future. The answer to dealing with an unpredictable future is to have a hefty cushion of retirement savings and let it grow, untouched, during the first decade of retirement. You can do this if you live on less than your retirement income during the early years of retirement.

What about the good things that could happen in the future?

Does accounting for what can go wrong in the future sound negative and pessimistic? What about the good things that can happen: a raise, a better paying job, or a bonus? True, the future may hold good fortune for you. The thing is, you cannot count on it. If you want to get out of debt and stay out of debt, it is absolutely necessary to account for what could go wrong in the future. If you don’t ask the right question and fail to account for the future, the future will not be kind to your finances, and you will be forced to take on debt to deal with unfavorable changes. On the other hand, when you ask the right question and account for the future, our experience has been, more often than not, that the future turns out to be bright.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

That List in Your Head

If you find yourself living from paycheck to paycheck without any savings to speak of except for a retirement account at work, that list in your head might be the problem. You know what I am talking about. It is that list of things you want to buy, places you want to go, and services you want to subscribe to that you keep in your head. How many times have you said to yourself, a family member, friend, or co-worker, “Once I get my hands on some money, I’m going to buy myself that new whatever, or I’m going to go to wherever, or I’m going to join whatever.” And when you finally have the money, you spend it on the list. If it takes too long to get something on the list, you finance it with debt. You just have to have that next whatever.

The list never ends

And the list is never exhausted. In fact, it grows and grows. Advertising convinces you to add to the list. Your family members, friends, neighbors, or co-workers purchase something new, and now you want to acquire it; so you add it to the list. You watch a movie or television program and want to emulate the lifestyle of the characters, the accoutrements of which are added to the list.

The list does not create lasting happiness

You think the next thing on the list will make you happy. And it does for a short while, but there is always the next thing. You live in expectation of acquiring the next thing. You live in the future which is not living at all.

The list in your head keeps you from getting ahead

Year after year, the list bleeds off your extra money: salary increases, income tax refunds, gift money, and windfalls, large and small, but you never satisfied, never really content despite your consumption and material acquisitions. Your finances never improve. Just like contentment, financial security eludes you. You can blame thirty years of stagnant income, globalization, the one percent, monetary policy, and government fiscal policy, but it is that list, that list in your head that keeps you from getting ahead.

Unconscious spending vs conscious spending

That list in your head is evidence of unconscious spending. An awareness of the list and its effects on your finances are the first steps to becoming a conscious spender. Conscious spending has a purpose behind it, not a list. Long and short-term financial goals based on your values and a plan to achieve them provide a rational basis for making conscious spending decisions. A budget that reflects your long and short-term financial goals and your plan to achieve them provides the information necessary to make prudent spending decisions. Conscious spending moves you toward your goals rather than just satisfying the latest form of material gratification on that list in your head.

Moving from unconscious spending to conscious spending

If you have grown tired of living paycheck-to-paycheck and getting only fleeting satisfaction out of consumption, forget that list in your head. Ignore it and set some long and short term financial goals that reflect your core values. Make a plan to achieve your goals and create a budget to implement the plan. You will become a conscious spender who is moving relentlessly toward the fulfillment of your goals, and you will enjoy enduring satisfaction as a result of your efforts.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

Long-term Savings: Focus on Income Not Lump Sum

It is easy to lose perspective when it comes to the money you have accumulated in long-term savings if you think of it as a lump sum. For example, would you say $50,000 is a lot of money? Most people would say that it is a lot of money because most people have yet to accumulate that amount. Not only that, but most people save money in anticipation of spending it. So yes, $50,000 is a lot of money to spend. But consider this, currently $50,000 will produce $1,000 a year in interest income when invested in a 5-year certificate of deposit at my local credit union. One thousand dollars will not cover a month of living expenses for most people. Now does $50,000 sound like a lot of money? Not if you plan to live off the income it generates.

Loss of perspective puts you at risk of a shortfall in retirement savings

Why is this important? Well, if you think $50,000 or $100,000 or even $200,000 is a lot of money, how are you going to accumulate the $1 million to $2 million it is estimated you will need to maintain your standard of living in retirement? You will not think that big, and you will come up far short when it is time to retire.

If you think of your savings as money to be spent, you will never save very much because at some point your savings balance will appear to be a lot of money, and you will spend part or all of it. Or you will quit saving and spend the money you used to deposit into savings thereby increasing your standard of living which will put you just that much farther behind in retirement saving.

One reason the average balance in 401k accounts is so small is people spend their retirement money long before they retire. They treat retirement savings like an emergency fund and dip into it every time there is an expense they cannot finance out of their monthly income or with credit. Nearly half the households in the country cannot come up with $400 cash without tapping retirement funds or borrowing. One reason short-term savings balances are so low is people tend to spend savings once they have accumulated a few hundred to a few thousand dollars. Often savings is used as a down payment on a financed purchase of some kind. Not only does this deplete savings, but it also adds to debt; money is spent that has not yet been earned which makes it more difficult to save in the future.

The choice to live off my long-term savings changed my perspective

In 1981, when I was broke and in debt, I thought if I could just accumulate $5,000 in savings, I’d have it made. I was making $1,200 per month, the most income I had made up to that point in my young life. I had less than nothing; so of course, $5,000 seemed like a lot of money. It would have been a good start on an emergency fund; $5,000 would have replaced four months of my salary if I had lost my job.

Once I had accumulated $5,000 in savings, it no longer seemed like that much money. By that time, my wife, Rosa, and I had decided to eventually live off of our long-term savings, not spend it. That choice changed my perspective completely. The $5000 I had in savings only produced $400 a year in interest back in the early 1980’s. It would take a lot more than that to become financially independent. I became a super saver.

Rosa and I targeted income rather than a lump sum amount

It may sound strange but the account balance in our combined long-term savings, while increasing steadily, never really figured into our thinking. We were not trying to accumulate X dollars in long-term savings, anymore; we were shooting for X amount of income generated by our long-term savings. After a few years, Rosa and I had a third revenue stream from the interest on our long-term savings equivalent to full-time minimum wage employment in addition to our two full-time salaries. We became a three-income couple. That third income, the interest income, continued to grow, year after year, until the Great Recession of 2007 hit and the Fed’s zero interest rate policy became a reality a year later. With interest rates plummeting, our interest income decreased by about 40% over the next eight years, but we kept saving even after we retired in 2009, because we knew that interest rates would remain low for many years. We needed more capital to offset lower interest rates.

We set aside and spent short-term savings

Although we did not spend our long-term savings, we did budget monthly for unpredictable expenses such as house maintenance and improvement; vehicle maintenance, repair, and replacement; appliance repair and replacement; and insurance deductibles. The balances in these accounts grew until they were needed and became part of our short-term savings. We also put money into a separate emergency fund to replace our income if there was a temporary interruption in income due to the loss of a job, an accident, or illness. The emergency fund also figured into our short-term savings. If there was a big ticket purchase we wanted to make, we saved for it in a targeted savings account which we considered short-term savings, as well.

The endgame for our long-term savings

As inflation eats away at our purchasing power in retirement, there will come a day when we will tap our long-term savings to supplement our monthly income and to pay for increasingly expensive medical care. Barring a catastrophic medical expense, we do not expect to begin to systematically spend down our capital until after age 75. However, we may decide to withdraw some capital earlier to enjoy a better quality of life.

If we live long enough, we will consume most, if not all, of our capital. Right now, at seven years into retirement and three years away from Social Security, we continue to add to our long-term savings. Income is still our focus with 25 years of retirement or more to go.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages