Budgeting EP.87

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Budgeting EP.87

This week on Wealth Talks Tom and John talk about the keys to a successful budget. Listen to this episode and discover how a percent based budget can provide you more freedom and scalability than a traditional flatline budget based on fixed expenses.


Tom: Welcome to Wealth Talks where we talk about solutions, money and other things that create wealth in your life. John, it’s good to have you back here in the studio. Last time when we recorded one of these you were out working on a building.

John: Yes, that’s right. And the building is coming along very well.

Tom: Well here we are already in 2017 moving along and something that we probably should address that we haven’t really talked about on this podcast ever is budgeting. We’ve alluded to it here and there, but we’ve never really dedicated a whole session to it.

John: And that’s because we don’t advocate following a strict dollar for dollar budget most of the time. Generally people need something a little bit more flexible, shall we say, and yet that’s the whole point of a budget and that it is not supposed to be flexible.

Tom: Well I like what you said at the last wealth summit, when you said that, you know, not everything fits on a spreadsheet and Jacob Lew said that a budget is not a collection of numbers, but it’s an expression of our values and our aspirations. So what is it…

John: That’s very good.

Tom: …that you, our listener, aspire to do with money? What are your desires, what are your aspirations, what do you value? And based on that you will create a budget. And if you don’t create a budget around those values then you really have to question yourself and get in a corner and really think about it. Is that really my desire or do I really value this or am I just giving platitudes and speaking words that I’ve heard that sound good.

John: Yeah. Yes and you know with the whole thing of a budget, people have different methods of doing this. They can use computer spreadsheets,…

Tom: Sure!

John: …they can use… I know, a popular method is just using what’s called the envelope method where you put certain…

Tom: Right.

John: …amount of money into the envelope. I have to say that, that way of budgeting is fairly limited and there’s a limit as to how far you can scale that as your financial condition improves, so I wouldn’t see that as a long term budget plan.

Tom: But it’s often a place where we start with clients that have never ever saved in their life because an envelope is a very tangible thing that you can look at and see what’s happening kind of gives you motivation to keep doing what you are doing.

John: And it’s separate from the rest of your money because that is one thing that many budget gurus often recommend is to have your savings even in a separate bank, from the bank where you do your everyday checking, everyday living. Because if you can’t see it right there, then you know you don’t have it to spend. An envelope can do the same thing, it puts it away in a separate category, sure you can see it and look at it, watch how it’s growing but it’s not in the category of spending money. Ironically, we do the same thing with policies. That money is going away or to a place where it’s not in our everyday spending money.

Tom: Or a different checking account…

John: You need to watch it grow.

Tom: …discretionary checking account or business checking account or personal. We are doing the same thing, it’s just on a grander scale and it’s not so tangible where you can pick it up and look at it. I would like to say too that, you know, although we do not advocate budgeting like everyone else, you know, how much you’re going to spend on gas and how much you’re going to spend on entertainment and all that, this week or that or the next. We do understand that we all live on a budget.

John: Oh yeah.

Tom: Unless we’ve been born with a silver spoon in our mouth and we never really have to worry about it and someone else is budgeting for us, we all live on a certain amount of income and the thing is as to why we don’t advocate a strict budget is because even if you are on a fixed salary, expenditures and expenses fluctuate. You know, you don’t have an electric bill that is the same every month. Now you can allow the electric company to budget your electric bills so it evens it out, but even then it’s not going to be exactly the same every month. We don’t have the same entertainment budget every month. And so we have to… even if we work throughout the summer we might have bonuses that come in.  So we’ve got a different income level. So the key here is always to think in percent and that’s something that we talk about in winning your financial game is that once we get over a fixed number type game, we can start playing the percentage game and when we’re talking about a percentage then a budget makes more sense because if it’s based on percentages we can always meet our goal

John: Yes and you can always scale

Tom: We can always scale and it stays consistent. I always tell people it doesn’t matter if you’re making a minimum wage or million dollars a week. Thinking in percent just makes the most sense.

John: And so we start out with a 10-20-70 principle with our clients. And that is thinking in percent. 10 percent at least should be going to savings. 20 percent to creditors and that is, those are debts like credit cards and consumer loans type of things, and then the 70 percent towards living expenses which includes the mortgage and car and necessity type loans

Tom: Like a student loan and things like that

John: Yeah, so that’s a very good starting point for a lot of people. But remember it doesn’t have to stay at 10-20-70. When you get your creditors paid off then it can be a 30-70 split. And when your income is coming more from passive income, rather than from what you work with your hands every day and produce. Now even the 30-70 percentage might change. It might be a 50-50.

Tom: Yes, and I’ve seen a 10-10-80. You know, but the good thing about any of these is they’re percentages

John: Yes, and the key is to always save first.

Tom: Exactly, it’s got to be the first thing on your list otherwise it won’t happen. It should be literally considered the first bill every time you get a pay check.

John: Now I remember hearing you talk about how you used to think that paying yourself first meant something different.

Tom: Well, for years I thought that it meant paying the bills that we accrued in life, rather than making myself a bill every month. I was just talking to a client last night that couldn’t understand this, because they didn’t realize that growth and money didn’t come from any place else except what we do with it.

They really believed that putting money in a 401K or an IRA would just create this huge amount of money for them that they could live happily ever after on. They didn’t understand that those investments really aren’t savings accounts, that they fluctuate, and it’s someone else that’s controlling the money that makes any growth in those at all. But they’re also very susceptible to the errors of other people that are managing that money.

John: Sure

Tom: And they don’t suffer from those errors. It’s the person, that put the money in that account to begin with, that suffers.

John: Yeah, they are taking the risk and the people that are managing the money get the benefits of it, a lion’s share of it

Tom: We are taking a 100 percent of the risk and only getting maybe, you know, a very small fraction of the profits generated from that capital

So, the 10-20-70 rule is a really stable rule because most Americans are really only saving about between 4 and 6 percent if they’re saving that at all. And they’re not really saving it… they’re putting it in some type of investment fund which is going to fluctuate, which is going to penalize them whenever there is a market correction. And those market corrections happen about every 4-6 years, historically. And so here’s this yo-yo thing. So, if we shoot for 10 percent with the methods that we use, we can help someone get to 30 percent savings pretty quick. Do you want to explain how to do that John?

John: Yes. For different people it works a little bit differently. But for somebody that has, say, credit card debt. Then they start saving the 10 percent and they put that into, we use a life insurance policies, some people use a savings account. But here’s the thing. By using life insurance policy and then taking a policy loan you can pay down the credit card debt, and then, redirecting those savings back to the asset that we’ve created in the life insurance.

Now, we’ve paid off the debt just like the person would have done with the savings account. But there is an asset that’s growing. And there was death benefit protection that whole time. So we’ve just bought two things for one.

Tom: Absolutely

John: We’ve upped that savings level to a 30 percent and they have an asset to show for it.

Tom: And it actually can be a little bit more than 30 percent, when you consider the interest that you were going to pay to those other creditors all over time. And the nice thing about that is that it didn’t take the,

John: Doesn’t change your cash flow

Tom: It doesn’t change your cash flow and it really didn’t hurt your lifestyle, because the same amount of money is flowing, it’s just flowing back to you instead of away from you to your creditors.

John: Yes

Tom: And that’s really important because this is why the large banks and the large corporations and the rich of the rich in this country are still buying lots and lots of life insurance. Is they understand this concept that it is a place for money to continue to grow at a nominal to average rate of return while you get to leverage it to finance the things that we normally lose interest and principle by financing.

John: Yeah that reminds me of an article I just posted on Facebook the other day. There was a gentleman on Forbes.com writing how the rich are still going to be buying life insurance and why they’re going to be doing that, even though it looks like the estate tax might be rolled back under Donald Trump.

Tom: Yes, it’s a… and it’s because there is such a value in this stable product that’s been around for hundreds of years, always generating you know a stable dividend internal rate of return over the years. Unlike other products where you know there can be sharp swings either up or down, you’re not caught in the down turns and losing what you thought was yours.

John: Now the whole key with the budget too I want to mention is that it needs to, it needs to fit your situation because so many people try to treat the budget like a diet and what happens then?

Tom: Well you know, that if someone’s… their goal is to really clamp down and live on a tight budget, it’s kind of like someone going on a low calorie diet or some fad diet that’s coming around. Whether it’s the Malibu Beach diet or the Hollywood next to you know whatever it is. There’s always and there’s always a good diet.

And they will lose weight because if you cut calories you will lose weight. That’s just the physiological fact. But what happens to the body when we cut calories that we need, is it sends these brain waves out thinking that you’re depriving yourself because you are. You’re depriving yourself of the calories that you need to function on a daily basis and that stirs up a ravenous hunger and so the appetite bounces way up and these people go out and binge and they end up gaining all the weight back they lost plus a few extra pounds.

That’s the same thing that happens in a people that are trying to provide a real strict budget to their income and to their living expenses. They may be able to get it down, they may even be able to live on that budget for a few months or even a couple of few years and then all of a sudden they just get desperate because they feel so deprived of the things that they are working so hard to have that they will binge on credit and we’ve seen it hundreds and hundreds of times where they end up in worse condition after they’ve played with this really strict budget than if they’d never played it at all.

John: So what’s the key to avoiding that? Is there a parallel in dieting and budgeting that can be   applied to get something that’s balanced and sustainable?

Tom: Well we have to understand that life is full of ups and downs. Crescendos and Decrescendos just like music is. If we listen to a flat line beat at the next band or concert we went to we’d be very disappointed.

John: Yes.

Tom: Okay, we want to hear the ups and downs and that’s what life is all about. Relationships are like that too. There’s the good exhilarating times and there’s the low times that bring you closer together. And so you know money management there’s no difference in that, there are going to be good times and there’s going to be bad times and when we try to flat line it with the budget it makes life really, really boring. Really uneventful and blah. So we have to plan by thinking in percent.

John: Yes.

Tom: So regardless if we’re at the bottom of our scale and finances and things are tight and not having enough. If we stick to the percentage rule, than in the good times they’ll happen more frequently because we have put that discipline in there and so when we get to the very high times we won’t over expand and realize and get in to a position that we can’t sustain once, the decrescendo comes and that’s really what it’s all about. It’s being able to not flat line it, not necessarily balance everything out, so it’s all in a line. But to be able to go with the flow, and going with the flow is much easier when we’re thinking of percentage rather than a dollar amount.

John: Yes. So… people, people think of that… they know that there these bad times that can come along with a budget and so they often put aside emergency funds to account for those. So in the 10-20-70 rule that we’re considering here where is the emergency fund. What becomes that emergency fund?

Tom: Well we like to keep our savings in life insurance. There’s no place safer, there’s no other tool besides participating whole life insurance that can give you all the benefits. We can look at bonds, we can look at CD’s, we can look at money managed accounts, mutual funds, all those things. They do not provide the security, the safety or the sustainability that life insurance does. And so that’s where our quote on quote emergency funds are they’re stored in a life insurance policy and they’re there at the snap of a finger when you need them.

John: And they’re there with the rest of our savings too. So it’s not a separate emergency fund we’re selling and we don’t need to keep a reserve there.

Tom: Yes, and for people that have a little less discipline about money in their bank account, that they might be threatened to spend it. Just having that one extra step, of asking the insurance company to send you that money, can sometimes keep them saving money when otherwise they might spend that.

John: True. Yes.

Tom: And of course as you progress that discipline comes where you don’t touch money that you need for emergencies, but in the beginning that could be very helpful to someone.

John: Yeah. And so for the people who need to keep quote emergency fund a little bit more accessible because it’s going to take a few days for the insurance company to get money there using a line of credit…

Tom: Oh, absolutely

John: can actually be a great option because then you can request the policy loan, dip into the line of credit and then pay it right back off.

Tom: You know you’re talking about emergencies and John and that’s really important and again why we use the life insurance.  I cannot begin to count the people that have lost a spouse or a loved one and that’s an emergency.

John: That’s an ultimate emergency, yes.

Tom: And you can never save enough money for that emergency. You just flat can’t and that’s why the multiplying factor of life insurance over your premium dollars is the ultimate emergency savings account.

John: There you go.

Tom: It’s the ultimate. It’s there for us even as we have a long term period in the future which is another emergency that Americans are not saving for. 70 percent of us are going to need long term care and yet nobody has an extra million dollars sitting around in a slush fund waiting to take care of us and that’s what it could cost us in long term care and so that’s where life insurance is the ultimate emergencies savings fund.

John: Yes.

Tom: So budgets being what they are, they try to flat line us, they try to make our life very boring. They do if we follow a very strict one but when we put it into percent, when we start realizing that the budget is an expression of our values and aspirations like Jacob Lew said, budgets can indeed become very exciting because they help us reach our objectives and fulfil our goals.

John: Yes,

Tom: And without planning around a percentage budget we are really asking to fail.

John: So keep this podcast episode in mind especially I know many of you have created New Year’s resolutions for, 2017 keep that in mind as you’re working on those financial aspirations that you’ve set for yourself and also you know we talked about some parallel to some dieting ones.  Dieting and budgeting are very similar and so hopefully you’ll have some tips to help your new year’s resolution all around.

Tom: Well John, we’ll be back next week talking about solutions, money and other things that create wealth in your life because wealth is not just money but money sure makes creating wealth a whole lot easier.

John: That’s right.

Tom: I like what Zig Ziglar said, you know money isn’t everything but it’s right up there next to oxygen and when you need it there’s no substitute and so you all have a great rest of the week and we’ll be back next week.