#36 7 Steps to Help Fight Through a Market Correction [Podcast]

You don't like to lose money. Nobody does. That's one reason it is so hard to stick to a long-term investment plan when we feel like we're getting punched in the face by the markets. Just like a boxer, it's natural to want step back and protect ourselves. This natural reaction, however, has caused most investors to underperform the very assets they invest in.  In this episode, I discuss 7 steps to help you fight through a normal market correction.

Invest Wisely: 7 Steps to Fighting Through a Market Correction

A 2014 Dalbar Study once again shows that average investors drastically underperform the very assets they invest in. Over the last 10 years the average investors, investing in a mix of stocks and bonds, had an average annual return of 2.6%. Over that same period, the S&P 500 had an average return of 7.4% and fixed income averaged 4.6%.

One of the biggest contributors to this is our natural reaction to run from pain.  It's a strong instinct that I struggle with during every market downturn.

In this episode, I introduce 7 steps you can take to help fight through a market correction so you can invest wisely for retirement.

  1. STOP listening to financial media and market "experts." They only magnify your fear.

  2. Learn the nature of the markets you invest in. Develop a clear understanding of how they work.

  3. Determine your appetite and need for market risk. How much volatility can you stomach? How much market risk do you need to achieve your goals?

  4. Set a portfolio allocation that fits your needs.

  5. Rebalance it religiously to manage your risk and potential return goals.

  6. Maintain enough cash reserves. This will help your long-term assets be focused on long-term objectives.

  7. Revisit steps 1 thru 7 religiously to adjust as your life unfold.

Not sure how?Find someone to help.

Investing wisely is easy to understand.  The hard part is sticking to a well thought out plan when you get punched in the face by a market correction.

Plan Well: Budgets That Work With Jim Munchbach

Recently I had the pleasure of talking with Jim Munchbach from imakeyourmoneycount.com about how to find a budget that works for you. Jim is a Certified Financial Planner, State Farm agent and instructor of Introduction to Personal Finance at the University of Houston.

Here are some of the topics we cover:

  • Why it's important to track your spending

  • Finding the truth about your financial behavior

  • A budget that works, if you hate to budget

  • How a budget helps you create free cash flow in order to save

  • The value in learning to track your spending

  • It's not the tool that is important, it's the goal

  • How to manager your cash flow like a business

  • The law of spending and saving

Retirement Toolbox:  Retirement Planning Worksheet

This worksheet may help you determine if your current retirement savings effort is on course or if you need to chart a new direction to help reach the retirement destination that you desire. To help you, I’ve added a new worksheet to the Retirement Toolbox titled Retirement Planning Worksheet.


The Retirement Answer Man Episode #36

Welcome to the Retirement Answer Man Show. My name is Roger Whitney and this is the show dedicated to helping you find that balance between living well today without sacrificing your tomorrow, and that can be pretty hard, especially when we’re dealing with markets like this; it’s hard to find that balance. We want to just put everything in a mattress, I think.

In our Invest Wisely segment, I want to continue our discussion about market corrections. If you listened last week, I explained how market corrections are a lot like forest fires – they happen from time to time in nature and they’re vitally important to the overall health and growth of an economy or a forest.

Well, that’s all well and good but, when you’re in the middle of a forest fire or a market correction, it can feel pretty hot, and last week felt pretty hot in the market so, I think, at one point, the S&P 500 was down 4.5 percent just for the week. Now, it recovered a little bit from there, but we’re still feeling the heat. This week, in the Invest Wisely segment, I want to equip you a little bit to be able to manage through a market correction. That’s what we’re going to do in that segment.

In our Plan Well segment, I’m going to have a conversation with Jim Munchbach. Now, Jim is a financial blogger. He is in the finance industry and he is a guest professor at the University of Houston. He teaches the Introduction to Personal Finance to students which is a great course. I wish I would have had a course like that in college.

Jim and I recently talked about budgeting and how to find a budget that works for you. I thought we’d go back to the basics and have a discussion and hopefully that will give you some guidance to find a budget that will work for you because each budget style works a little bit differently.

You can find me on the internet at rogerwhitney.com and, this week, I uploaded a new worksheet to the Retirement Answer Library on my website. It’s entitled Retirement Planning Worksheet – I know, pretty fancy title, but this worksheet may help you determine if your current retirement savings effort is on course or if you need to chart a new direction to help you reach the retirement destination that you desire.

This is a two-page fillable worksheet so you can actually fill in the blanks on this worksheet. It will give you a quick snapshot as to whether you’re on track for your basic retirement planning goals. Now, it’s not going to solve everything for you but it’s a great place to start to see if you’re even in the ball park, then that can hopefully spur you to start planning well and investing wisely in your life.

If you would like access to the Retirement Planning worksheet, go to rogerwhitney.com and register for the Retirement Answer Library. It is a totally free resource. In addition to this new worksheet, there’s over 20 worksheets designed to help you plan well and invest wisely for your retirement. Just go to rogerwhitney.com if you’d like access to this new worksheet.

Well, before we get started today, I’ve got to do the all-important disclosure and that is only you know your entire financial situation so consider this podcast, and my blog, and really, bluntly, anything you read on the internet as helpful hints and education. In order to plan well and invest wisely in your life, make sure you consult the people that know you best – that could be your tax advisor, your legal advisor, or your financial advisor. That’s just not a great legal disclosure; that is a fundamental principle of planning well in your life.

In our Invest Wisely segment today, I want to continue our conversation about market corrections and how to invest wisely as you go through them. Hopefully, I gave you a good perspective of why they’re something we should embrace as a natural cycle of things and how they can actually help us in the long term.

Now, I want to get a little bit more focused on what do we do when we’re feeling the fire. What do we do when we’re feeling the heat of a market correction like we are right now? Last week, we sure did. Over the last month or so, the S&P 500 is down over 9 percent from its high. International stock index is down over 14 percent from its high so we’re definitely feeling the heat of this market correction.

One of my favorite quotes about investing came from somebody who wasn’t talking about investing at all. It came from Mike Tyson, and Mike Tyson said, “Everybody has a plan until we get punched in the face.” Now, that’s my Mike Tyson impression – probably pretty poor. “Everybody has a plan until we get punched in the face.”

Now, what happens if you get punched in the face? You put up your gloves. You back away. You want to get away from the danger that you’re feeling, regardless of what your plan is, and that’s a lot how a market correction is. We all have a plan of what we’re trying to get to, but then, when we feel that heat, when we get that first jab to the face, our natural reaction is to get away – totally reasonable emotional response.

Let me restate that and I think I heard this from someone and I can’t recall who it is. Let me restate that from an investing standpoint. We are all long-term investors until we feel that short-term pain. When we feel that short-term pain of loss, just like in a boxing match, we want to put our gloves up. We want to back away from where that pain is coming from, regardless of what that plan was, once we’re in the reality of things, our emotional response – our fight or flight – take over and that’s not just supposition on my part, if that’s the right word. It’s been shown in studies that that’s how the normal investor reacts.

DALBAR is a research firm that has studied investment behavior – and I think I’ve referred to it before – for decades. Their 2014 study showed that an average investor that had a blend of stocks and bonds, over the last ten years, had an average return of 2.6 percent. Over that exact same time period, the S&P 500 had an average return of 7.4 percent and the bond index or the fixed-income index had an average return of 4.6 percent – significantly higher than what the average investor had.

Now, think of the last ten years, what did we have to go through? Well, we went through a huge drawdown in 2007 to 2009. That drawdown – a good average in balance portfolio – was actually down roughly 43 percent from peak to trough. Even with that, the S&P 500 and the bond index, over the last ten years, have had very reasonable average annual returns. But, during that same time period, the average person – you and I – averaged 2.6 percent.

Now, why is that? Why did we drastically underperform the very things that we were invested in? And yet, fees have a little bit to do with that, but the primary reason is our reactionary decision-making, the selling and buying, those periods of time when we get punched in the face and we back away. We sell at the wrong time and, those other times we’re feeling really strong, we lean in a little bit too much and get a little bit too optimistic. Those natural emotional responses of when we’re feeling optimistic, we lean in and we do more and more which means we’re buying higher and higher in a market.

And then, when we get fearful, when we get punched in the face and things go down, we sell, we back away, which is selling low. We’re doing exactly the opposite of what a rational investor would do which is to buy low and to sell high which, emotionally, is perfectly logical but, rationally, creates subpar performance over time.

So, how do we equip ourselves not to be reactionary in our decision-making? That’s a really hard thing to do. Although it’s really easy to understand, it’s hard to do.

Now that we know that market corrections are going to happen normally in the markets and we see that. Now that we established last week that market corrections are a natural cycle of things in the economy – just like in the environment – and we see that we’re all emotionally driven people, and that, even if we have long-term plans, when we feel that short-term pain, we have that natural emotional response to that short-term pain.

How do we equip ourselves to invest wisely?

Well, I want to give you some steps. We’re not going to be able to complete this entire thought, but hopefully this will be the beginning of a journey for you to be able to invest wisely in your life, and there’s good news and bad news with this, okay?

The good news is all of this is really easy to understand – that’s the good news. It’s really easy to understand. We’re not going to get into deep math here. The bad news, on the other side, is it’s really hard to do consistently because of how we’re emotionally wired. That’s the good news, bad news.

Let me start building a framework to give you some tips and perspective to deal with these market corrections.

The first tip is to stop listening to the mainstream financial press and the “market experts.” They focus entirely on the wrong things. They focus on whatever it is the emotion is at the time or whichever way the wind is blowing. When things are really optimistic, the financial press and market experts are going to magnify that optimism which is exactly what you don’t want if you’re going to invest wisely in your life because it’s going to make you optimistic and it’s going to make you take more risks than you may need to to invest wisely in your life.

On the flip side of that – like now when markets are scary, negative – they’re going to magnify what’s going on and make you even more pessimistic which can encourage you to do exactly the wrong thing that could be in your best interest in terms of investing wisely.

Number one tip is stop watching the financial media and market experts because they’re going to magnify whatever emotions there are this day and that is exactly what you want to avoid.

The second tip is to learn the nature of markets. Learn how markets have worked over time because we have decades and decades of data showing us how the equity markets work, how the bond markets work, how inflation cycles, how international stocks cycle. There is a lot of research and data to help you understand the nature of markets.

Now, I don’t want you to become a market historian. But, if you understand the nature of the volatility and the expected returns and how they cycle, that will better equip you to understand what you’re getting into from an investment standpoint so you can invest wisely in your life.

Either do the research yourself or find a prudent financial advisor that understands the nature and that has the heart of a teacher to give you the wisdom so you don’t have to learn all the knowledge and the data behind it. A good financial advisor will be that type of teacher.

Once you have this foundation, then you can start to determine how much risk you really need to achieve the things that you care about most. There’s two parts to that. One is you need to understand how much risk you can emotionally handle. When I talk about risk, I talk about this volatility that we’re feeling – the things going up and things going down. Some of us are hard-wired not to be able to handle a lot and some of us can handle more. It’s important to understand that and you can’t end there and that’s where most risk tolerance questionnaires end is just how much risk you can handle.

Even more important, determine how much volatility or investment risk you need to take to actually achieve the goals that you care about. If your goals are such that you could literally be in cash and not take any investment risk and just take inflation risk but still achieve everything that you care about, you’re either not thinking big enough or that might be a good strategy. You’ve got to determine your “why are you investing in the first place?”

1. Stop listening to the financial press. That will clear your mind from the clutter.

2. Learn the history and nature of markets. That will give you some knowledge.

3. And then, you can start to determine what it is you actually need from an investment and risk profile to achieve what you actually care about most. Once you do that, now you can start to build those foundations.

4. You want to make sure you maintain adequate cash reserves – and I’ve talked about this in previous shows – because long-term investing is ultimately a long-term venture. It’s taking advantage of the growth of the world economy over time. That’s not a short-term proposition so you always want to make sure you have the appropriate level of cash reserves so you can have that emotional comfort of “I don’t have to worry about where my money is going to come from for life happening or for the next one to two years. I can actually leave my long-term assets to be long-term because I’m not going to have to sell them – that’s why cash reserves are so important – and I’ve had shows on how to determine how much cash reserves you should have and I’ll reference those in the show notes.

5. Once you do that, you can set a long-term allocation. Set a long-term allocation that fits the kind of risk you can handle and positions you to achieve the goals that you care about most. And then, once you set that allocation based on those two things, then you can revisit those periodically to make sure you’re never too hot, never taking too much risk even if you’re optimistic, and never too cold, making sure that you’re not too conservative just because of your emotional make-up which we all have.

If you take these practical steps or find a well-versed prudent advisor to help you walk through this process, you’re going to be well-positioned to invest wisely in your life and to be able to handle market corrections and be able to find that balance between living well today without sacrificing your tomorrow.

What are we talking about here? We’re talking about replacing the fear with knowledge, understanding what you’re getting into, replacing emotion with having a plan, and ultimately replacing the doubts in the world with faith that you have a plan. Failing to plan is planning to fail. If you take these steps, you’ll be well on your way to planning well and investing wisely in your life.

If you have any questions or worries about the current markets, shoot me an email. I’ll respond to you. I’ll either answer your question on the podcast or in a blog. But, even if I don’t do that, I will respond to you to try to help give you some perspective and I’m always available to help you invest wisely in your life.

Well, now let’s move on to our Plan Well segment.

I had a talk with Jim Munchbach and he teaches Introduction to Personal Finance in the University of Houston. He has a blog called imakeyourmoneycount.com and has a podcast that he does for his students. But, even though these are for his college students, they’re great podcasts to listen to because they focus on the basics of personal finance.

He and I recently had a talk about budgets that work and the various types of budgets that are out there and some of the advantages and disadvantages of all the different types of make sure that they fit; how you operate as a person so you can actually implement one that you’ll use.

Here’s my conversation with Jim Munchbach.

JIM: I’m not going to introduce this except to say this is Jim Munchbach from I Make Your Money Count podcast and I’m talking with a really cool guy, Roger Whitney.

Roger, introduce yourself.

ROGER: Well, I am the Retirement Answer Man and I own a registered investment advisory firm and I advise clients and my website – rogerwhitney.com – is where I hone my craft is how I say it as. I take the problems that I’m dealing with with clients and I talk about them and how I figure out solutions for them and then I answer questions. It’s a nice circle where you get to serve a lot of people and you get to become a better craftsman in this thing advice.

JIM: That’s very cool, and I like your website. I was checking it out. You used the Get Noticed them, I believe. Is that correct?

ROGER: Exactly. Exactly – a nice ready-made theme.

JIM: Yeah, it is, and you’ve done a great job taking it to the next level. Also, you’ve got some great content on your site. I started listening to your podcast after I missed an opportunity to hang out with you in Dallas at Podcast Movement, but I came home and started checking out your podcast and I really like your attitude about retirement planning. And then, my students at the University of Houston, this week, their assignment is to do their first budget.

ROGER: Lucky them! Lucky them!

JIM: Yeah. So, when I heard how you framed retirement planning, it really resonated with me and so I was very curious to know how you would instruct or give someone guidance about creating a budget. And so, I went to Episode #19 and listened to that episode and downloaded your worksheet which is great. I’m going to – with your permission – steal it and force it on the 80 percent of my students who really don’t want to do a budget the traditional way.

ROGER: Well, yeah, hopefully it’ll be a breath of fresh air because doing a real detailed budget the way we’re taught is really hard to do. It basically makes us become a bookkeeper, doesn’t it?

JIM: Yeah. You know, I think I sent you the assignment that I actually gave my students this week and, you know, that’s kind of the assignment – to do some bookkeeping so that they can have a picture – a snapshot – of where their money is going which is really a great use of a budget to control spending. But the process is just like going on a diet; it’s just not fun.

ROGER: Well, I think it’s a really important exercise and the process that I teach and use myself – you still have to do that at the beginning. It’s like math class; you have to learn how the calculations actually work before you can just use a calculator and there’s some value in that that you don’t really see at the time in terms of understanding what’s underneath the hood of those calculations. The same thing works with a budget. Having to go through the tedious task of line item by line item and category by category really sucks. But it will serve you when you don’t have to do that anymore because you understand that it’s underneath the hood.

JIM: Absolutely. One of the things we’re going to do – we do it every semester – the students are required to track their spending for 60 days and that’s different than a budget. That’s just tracking. That’s just to know where did your money go in the last 60 days. From there, they’ll do a little budgeting work as well. But I love the way you did it and I was hoping we could spend a few minutes and go through… I printed out and I have your worksheet. Do you have a few minutes to go over that with me for my students?

ROGER: Oh, you bet! I have it in front of me as well. I’m an old man so I can’t remember everything so I’ve got to look at it.

JIM: Are you looking at it on a Mac?

ROGER: Of course.

JIM: I like you more and more every time I talk to you.

ROGER: Well, we’ll have to share app ideas. In fact, one of my favorite workshops is how to use iPads for business and highlighting all the different apps I use so we could geek out on that in another show maybe.

JIM: That would be awesome. My wife does not know this yet and she probably won’t listen to this episode because she’s teaching fourth grade and she’s very busy. She loves me; she’d listen to it if I told her to but I’m not going to tell her about this episode because I’m about to confess, yesterday, I got a new iPad. She doesn’t like it when new screens show up, but I got a Generation 4 with Siri because I was using an iPad 2 and I couldn’t use Siri so I wasn’t really using my iPad and I needed it. Now, I have Siri on my iPad.

ROGER: There you go. There you go.

JIM: I’m pretty excited.

ROGER: Yeah, I’m waiting for September 9th so I can see what gadgets they’re coming out with then I’ll have to do some budgeting myself.

JIM: Are they making big improvements to iPad this go around?

ROGER: Nobody knows. There’s some speculation that they might make a bigger one. I don’t know. I don’t know. I think the iPhone’s the major one.

JIM: Yeah, I can’t use the iPhone as much as I’d like to. The screen is just way too small.

ROGER: Well, they’re supposed to have a bigger one so you might have some budgeting issues there, too.

JIM: Well, see, that’s what I’m going to use for justifying my purchase with my wife. Because I upgraded the iPad, I don’t even need a bigger screen on my iPhone. I’ll just use my iPad more.

ROGER: There you go.

JIM: I’m happy. So, let’s roll. Let’s talk about what I would title. In fact, I’m going to title my episode, when I post this on my podcast at imakeyourmoneycount.com, I’m going to name this episode “The Best Budget That Works.”

ROGER: Wow! That’s pretty cool.

JIM: Well, when you think about it, a budget is important, but we really – typically, most of us – hate doing them. And so, to me, the best budget that works – and this has always been true, I’ve known this for many years – the best budget that works is the budget that you actually use.

ROGER: Pretty much, isn’t it? It’s the same thing with anything in life. You’ve got to use it; otherwise, there’s a lot of knowledge but there’s no wisdom that comes from anything unless you actually use it.

JIM: Right. When I read, when I downloaded your worksheet, your budget, your approach, I was like, “This really is the best budget that works. This is an intuitive approach to budgeting,” and I’m excited to share it so I’m going to shut up now and I’m going to let you take it from there, Roger.

ROGER: Okay. Well, let me explain how I came to it. I think when you’re younger especially, I grew up – and I’m sure Jim grew up – having to reconcile a checkbook and that has pretty much gone away. I have a son that goes to Texas Tech University and he’s never even written a check, I don’t think. It’s been debit cards. Having to track every single transaction is extremely painful.

Now, you know, we’re in this mode of quantifying our life with, you know, bits and things like that – mint.com and Quicken and all these tools – that are great for tracking every transaction and then putting them in categories and really knowing to the penny where every penny is going.

The problem with that is – with myself, and this is how I basically came up with this concept, and I’m a financial guy – when I get home, I don’t want to go enter categories on what I’m spending money on. I’m too tired and I want to spend time with my family or my kids – or if you’re younger, you want to spend time outside or with your friends or whatever else – and it ended up becoming a second job where you had to be a bookkeeper.

At the end of the day, if you set a budget which is part of the assignment which is a good step you have to go through so you understand the spending, you know, part of setting a budget is sitting and going, “Okay, so much is going to go to eating out and so much is going to go to my phone bill,” and all these different categories that you forecast out what you’re going to spend.

Inevitably, what happens is you never hit categories. They’re always a plus or minus. You’re never on target so those categories are just guidelines at best so that you’re constantly having to fiddle with your budget.

What I came to – basically, this is the lazy man’s way of budgeting – is the whole point of budgeting – just like a business, if you’re running a business – is to control your overhead which is what your spending is, your overhead for your lifestyle, you could categorize it that way, and know what revenue you have coming in which is whatever income you have coming in. The issue is exactly like a business.

How do you do that? The reason you do that, first off, is so you can create free cash flow. As a young person, you just want to create some free cash flow because that free cash flow will go to your balance sheet – which is a whole other conversation – and that free cash flow, you can make the decision to invest it in your life or your career, you can pay down debt, you can save an emergency fund, put it in savings, or you can invest it in long-term.

But you’re never going to create a net worth – or become a millionaire or whatever that goal is – over time unless you create free cash flow, and it all starts with your day-to-day spending because your net worth statement is basically an accumulation and a representation of every spending decision you’ve ever made over a long period of time. I had worked with people that make millions of dollars and don’t have a dime to their name because they spend millions of dollars.

The point of this budget was, rather than to have to be a bookkeeper on-going, how do you set up a system to make sure you capture free cash flow and control your lifestyle which is the point of a budget and then take that cash flow and apply it to your balance sheet without having to do all the work of budgeting and using Quicken or Mint and going in there every single month and having to figure out every category. That was the whole point of it.

JIM: It sounds to me, Roger, like what you described here, what you were trying to achieve is we have a goal – we want free cash flow, we want to get the money into the free cash category . And so, that’s what it’s all about. That’s the goal – not the bookkeeping.

ROGER: Exactly. I mean, who cares if your telecom budget is over by 10 percent or under by 10 percent or eating out category. The problem with budget is there’s this idea of these one-off events that you can’t budget for. Well, trust me – for your students especially – their lives are fairly simple now. The percentage of one-off events are going to happen over and over again so you’re never going to not have one-off events as you get older so you can never account for those.

Now, I have some clients that are extremely nerdy that do. I mean, they just love their balance sheets. But, for the rest of us who don’t want to do that but still want to have the benefits of budgeting, that’s sort of why I came up with this for.

JIM: I love that. So, you have step one, step two, step three, step four, and then that’s it – just basically four steps.

ROGER: And it gets simpler as it goes.

Step one is to determine your monthly lifestyle budget – this is basically what the assignment is for the students, it sounds like, at least tracking their spending.

JIM: Right.

ROGER: What I do is – and this is what I did originally and this is what I teach clients when we have these lifestyle calculations because the last thing I want to do is get into a client’s budget, that’s just not fun and it’s talking to somebody about their values, I’d rather deal with bigger picture items – what I do is I have them download their three monthly statements and basically do what you’re asking your students to do – track all your expenditures for three months. Three months should give you a good capsulation – if that’s the word – of what your lifestyle is. And then, also track whatever income that you have coming in and list those. And then, you’re going to get an average.

I’ll use an example. Let’s say, over those three months, on average, you spend $7,000 a month. You know, one month it was a little higher, one month it was a little lower. Let’s say that’s the average. At the end of those three months, you say, “Okay, I’m bringing in $8,000 a month; I’m spending $7,000 a month.” Let’s set up, let’s make that our lifestyle budget because what will happen – I know this happens with my son and I’m guessing this happens with you, Jim, and I know it happens with me – if that money is in my checking account, it’ll get spent. It just does because we live in a culture of consumerism and we can’t help ourselves and we always need something else, especially if you’re buying Apple products and things like that. You always need something else.

What I do is we set up an income account which is a separate account from your checking account and we have all of your income – or your revenue – come into that income account. In this example, the income account would have $8,000 a month coming into it from the income from work or whatever else. The numbers don’t matter; it’s just an example.

Once you’ve decided what your lifestyle budget was, you do the three months of analysis of your spending patterns and you say, “Well, it’s always right around $7,000 a month,” so you establish $7,000 as your spending lifestyle budget. And then, once a month, you transfer money from your income account over to a separate account which is your checking account. That’s exactly what I do in my life. The numbers are a little bit different, but it’s the same concept.

You know, when we’re recording this, it was September 1st this week so I transferred over my monthly allocation for lifestyle. In this example, let’s say it was $7,000. I don’t care how I spend it. Some months, I’ll spend it more on eating out; some months, I’ll spend it more at Best Buy or Amazon. But my goal is to spend that spending account down to close to zero at the end of every month.

Inevitably, what happens, as we get closer to the end of the month, I start to feel a little bit more poor and start to be a little bit conservative if I overspent early on. But the idea is to stay to that theoretical $7,000 a month lifestyle budget because what will happen – and you see this – we’re used to spending what we get, right? The money comes in and we’re just used to spending it.

JIM: So, the difference here, Roger, is the money comes into one account – that’s where everything that comes in, if I get paid from State Farm, it goes into that account; if I get paid from the University of Houston, it goes into the one account. But then, I have my checking account, it’s going to be my working account.

ROGER: Exactly.

JIM: It’s where I’m going to pay the utilities, pay the rent, pay the house, whatever – everything gets paid out of that account. So, I transfer however much my lifestyle budget is into that account – whether it’s every two weeks or every month or whatever. You do it every month, right?

ROGER: I do it every month, but it doesn’t really matter the frequency. The key is you want to have them separate because you want to have it be an intentional decision to go grab extra money if you have to.

JIM: And you could even then start a third account and say, “I want an account that’s going to be exclusively my emergency fund that has some walls around it.”

ROGER: Yeah, you could do that as well and I’ll explain a little bit about how I do that – at least in my life and this just works for me. I have clients that have different variations of it.

JIM: It’s funny. My wife and I do something very much like this. We’ve done it for almost 30 years and I never thought of it as what you’re describing but it really is very much like what you’re describing for the very reasons that you developed it because I hated and I was terrible at it – the bookkeeping thing and trying to keep X amount in each category. It just didn’t work.

ROGER: Yeah, and we’re financial guys that geek out on this stuff and love this stuff and we hate to budget.

JIM: Absolutely.

ROGER: That’s telling you something.

The two goals again are to control your lifestyle because we all know we need to do that and to capture that excess cash flow so you can make an intentional decision about what to do with it. As you get to that third or fourth week of the month, if you have those extraordinary items, you either account for them within your $7,000 a month in this example or you have an intentional conversation with yourself and go grab the amount that you need so you don’t run out of money. You know, it’s a subtle difference, but what that difference does is it makes it an intentional decision rather than just spending every dime just because the money’s in the account.

JIM: Absolutely.

ROGER: What I do – and you can do this monthly or you could do it, like you said, setting up a separate account – in this example, after three months, we would have $3,000 built up in that income account that was excess cash flow, free cash flow that we just captured into that account. At the end of three months, what I do is I take my net worth statement and I see I have this extra $3,000 a month and then I decide how I’m going to allocate that. That could be to my emergency fund because I’m building that up, it could be to debt reduction, it could be to long-term savings, it could be to gifting. And then, every three months, I make decisions like that on my balance sheet. That way, I’m always intentionally figuring out what I’m doing with this free cash flow rather than just having it hit my bank account, telling myself I’m going to save later on but then end up buying iPads and, you know, whatever else.

JIM: So, tell me one more time, you’re making an allocation. It’s a financial statement, basically, right? It’s not going necessarily into a separate account. It’s just you’re accounting for it. You’re making that decision. Did I miss something?

ROGER: Well, I have that income account and I do have the spending account – they are totally separate.

JIM: Right. But, it comes to every three months, once you recognize, “Now we have this free cash flow, excess cash flow,” and you’re going to allocate it. Now, you have a net worth statement?

ROGER: Yeah, I do a net worth statement every quarter and then, if I’m allocating it to an emergency fund, then I’ll transfer the money to wherever I hold that emergency fund; if I’m allocating it to an investment account, I’ll transfer it over and then I’ll begin the whole process again for the next quarter.

JIM: Cool. And so, then it’s like, if you’re using mint.com or whatever you are to look at your financial accounts, you actually put the money in that account, it shows up on the statement which would, in essence, be your net worth statement which could be an app like Mint where you see.

ROGER: Yeah, if you had everything tied into it then it could, yeah, exactly – Mint. I use Excel.

JIM: So, you use Excel, but then you’re really updating it yourself for the accounts and the account balances, right?

ROGER: Yeah, I get the concept of account aggregation and having that snapshot, but the problem I have with it personally is it does it all automatically so they just become more numbers than anything else. By updating the Excel – and it only takes ten minutes – I actually go through the process of typing in the numbers and adjusting it. There’s something to that, I think.

JIM: I think you’re right. If you’re a student listening to this episode, I want to just kind of pause here and affirm you, if you’re one of those students who have told me that you want to use an Excel spreadsheet, I have spent a lot of time trying to kind of push back on that because what makes sense to me is to have this automated way to do it. But, what Roger is saying, it makes a lot of sense to me that there’s tremendous value in learning to exercise that small discipline of going and updating your Excel spreadsheet kind of manually without having it done automatically.

That’s a great perspective, Roger. I appreciate that a lot. I needed to hear that.

ROGER: Well, I think, Jim, to a point, it’s not the tool; it’s the goal. Some people thrive with that automated fashion and all the manipulations you can do inside a Mint or something like that and that’s cool, it’s just that’s a tool for them, but that tool doesn’t work for everybody.

JIM: Sure, and Excel is an amazing tool. You can do a lot of very cool things with it. I got two assignments – early assignments – from students who already did their budget which isn’t due until Tuesday.

ROGER: I always hated those kids.

JIM: Oh, man, they were awesome. I think they were showing off. It was, like, they’re perfectly done with graphs and I think they used Excel and created graphs using Excel, but they were beautiful.

ROGER: That’s funny.

JIM: You’re a geek for that, I’m sure.

ROGER: Oh, yeah. Now, one thing you can do too with this process is, okay, let’s say you’re three months in and then, three months in a row, you had to go grab extra money from that income account because you weren’t spending $7,000 – you were spending $7,300 or whatever. If that happens three months in a row, or the opposite happens – you’re always having money left over in there – then what you do is you analyze those three months, you do some forensic accounting, and then you can go dig deep and go into all the categories and say, “What am I missing here? Why is there this delta between what I’m supposed to be spending and it’s consistent?” and then that will tell you whether you should adjust upwards or downwards that money being transferred over every month. It acts as a red flag so you don’t have to account for it every month when there’s nothing wrong. It just gives you a red flag to go back and revisit.

JIM: Cool. That makes sense.

You mentioned forensic accounting. This coming Tuesday, I’m going to spend pretty much the entire class period kind of demonstrating the value of a budget like a rear-view mirror kind of “where did the money go?” and I call that forensic accounting and I’m going to use a case study of someone who’s actually in my family and I’ve tried to help them manage money and, in the process, had to do some forensic accounting to figure out, “Okay, what’s going on here? Where is the money going?” So, I like that term.

ROGER: You’ll be surprised. Well, you won’t because you know this, Jim. But most people – it doesn’t matter intelligence or profession level or anything else – have no clue where their money is going.

JIM: And that’s why, when I push back on the Excel, my basic assumption is with my students that most of them don’t know where their money is going and, if they tell me they’re going to use an Excel spreadsheet, I doubt that they’re going to do it.

ROGER: Because of the work involved?

JIM: Yeah. You know, my goal is to have them be able – at the end of 60 days – to look and see the truth about their own financial behavior which I know is a massive step forward for these students and yet that’s my goal and I tell them that. If you’re listening and you’re a student, that’s the goal. If you’re a discipline student and you like to use Excel, that’s awesome. But what Roger just said is so spot-on and we’re both certified financial planner practitioners. We’ve worked with people in every area of finance, at every level of income and wealth, and the truth is most people don’t know where their money is going. The wealthy are a bit of an exception because they didn’t get wealthy by accident.

ROGER: Yeah, and a good framework is to think of it as managing your life like a business. It’s no different. What does a business do? They have overhead, they create revenue, they capture excess cash flow, and then they deploy it on their balance sheet. That’s all a business does.

JIM: And, like you said, if after three months or three years or three quarters, they find out that they’re making more money, a good business owner, a good board of directors will be saying, “Okay, we don’t want that money to just sit in the bank. We want to deploy it. We want to employ it. We want that money to work for us.” And so, they don’t just let it sit there in the spending account not being spent, knowing that, next year, somebody will figure out how to spend it.

ROGER: Exactly, and a business owner will do that and buy the fancy headquarters, buy a nicer fleet of cars, buy fancier computers without really intentionally allocating the assets whereas a good business owner will put it on their balance sheet and they’ll say, “Okay, well, we can upgrade these areas, we can reinvest it in our business,” which, on a personal level might be a certification or excess earnings or something to make you more attractive in the marketplace, “and then allocate the rest of it to earnings or debt reduction and everything else.” So, it is a business-like mindset and most people, they’re intimidated by that word, but the quicker you can do that, the better off you’ll be because, I mean, like you, I’ve seen thousands of balance sheets in situations and I know people that make millions of dollars a year that don’t have a dime to their name and I know people that have had modest or average incomes that are very wealthy because of the difference of how they do exactly what we just talked about with this budgeting.

JIM: Roger, when I produce this show, when I get ready to play it, I think I’m going to find what you just said, I’m going to copy it, and I’m going to paste it in, like, five times and let it be repeated over and over. Let’s hear it – no, I’m kidding.

ROGER: I don’t even remember what I said now!

JIM: Well, basically, you said the same thing I told my students. I said, you know, “Listen, students of mine, it’s true. We both know people who make millions of dollars or a million dollars a year, but they spend it all and have no net worth to show for it. on the other hand, we know a lot of people who make a very moderate amount of money but they manage it in such a way that they accumulate net worth over their lifetime in significant amounts – not as in insignificant amounts but in very significant amounts – and it’s not rocket science. It’s about the law of spending and saving which is spend less than you earn and save more for what matters most.”

ROGER: And, now, we’re going to sound like two old men preaching, but I’m going to say one more thing to that or add one more thing to that and that is – and this is just from my perspective and not just my journey but, you know, I’ve had the privilege of seeing the journey of hundreds of people – the ones that follow the path that we’re talking about that we feel is correct, they’re much more happier and much more self-fulfilled – they truly are.

JIM: Yeah. Roger, I appreciate you and I hope we get to do a whole lot more of these, and I don’t want to end before we’re done, but is there anything else you want to share about the best budget that works?

ROGER: It’s simple and it achieves what we want it to achieve, I think, and it’s just how I do it and it’s a work in progress and it’s a good framework to make it your own and do it the way that fits so you’ll actually use it like you talked about and that’s the best tool – the one that you actually use.

JIM: Absolutely. My friend, this has been incredibly rewarding for me, just to get to hang out with another CFP brother who, you know, we don’t know each other very well, we’re getting to know each other and, like I said, I do hope we can do this again real soon.

ROGER: You bet! This was awesome!

Well, I want to thank you so much for joining me for this week’s Retirement Answer Man Show. I think these are very important topics.

If you have any questions or concerns, you’re always free to contact me. Just go to rogerwhitney.com and click on You Ask, I ANSWER and I’ll respond as best I can to any of your concerns or your questions.

If you’d like access to the Retirement Planning worksheet, just go to rogerwhitney.com and click on the Retirement Answer Library and you can get all those resources for free.

Until next week, this is Roger Whitney, hoping that you plan well and invest wisely.


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