When I meet with a prospective client for the first time we spend most of our time just talking. The primary purpose of our first meeting is for me to get to know them and for them to get to know me. In the course of our conversation I take notes and will have built a file by the time we are finished. Every situation is different but there is a core set of data I look for from every client. One thing I want to know from every client is their standard of living. I need to know how much it costs to maintain the client's household. Do you know how much it costs to maintain your standard of living? A lot of people have no idea.
Knowing this standard of living is crucial to financial planning. By knowing how much money your family needs every month we can determine how much money should be in your emergency reserve fund, if your life insurance is adequate, if you have enough disability insurance, perform retirement projections, and find sources to fund your financial goals.
If you do not know what your standard of living costs in monthly terms, how can you figure it out? The best way is to track your spending for a year in a program like Quicken or Microsoft Money. Then you can use the budgeting functions to determine how much you actually spent in each category. I prefer this method because it takes irregular spending into account. If you spend $1,800 on a vacation, this method will add $150 to your monthly budget. The problem is even if you start today it will take you a full year to have a meaningful result.
An acceptable alternative is to go back through your bank statements and determine how much you spent over the past month, quarter, six months, or year. This will not be nearly as accurate, but it is better than not having any idea.
One advantage of the Quicken/Money method is you can easily adjust your standard of living to fit the context. For example, if you decide you want to have a minimum of three months of expenses in your emergency reserve fund you may decide not to include vacation expenses in that calculation. The bank method also ignores the effects of borrowing and repayment. If you charge $1000 on a credit card but only pay back $100, your bank statement would say you spent $100 but Quicken/Money would recognize you spent $1000. The reverse is also true. If you charge $100 on your credit card but pay back $1000 towards the balance, the bank account would think you spent $1000 but the software would only recognize $100.
Being able to quantify your standard of living is empowering. Know it and you can begin to perform financial magic.
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