Mullooly Asset Management
Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ
Mullooly Asset Management
Two Incomes, Two Outcomes: The Science of Spending Wisely
This episode unpacks the nuanced relationship between our monthly expenses, the ability to invest, and the risk we can afford to take on. You'll get an insider's look into why a couple with more breathing room in their budget can play the long game with their investments, while another might need to keep things liquid for life's unexpected expenses. If you're looking to tailor your financial plan to fit your life choices and goals, join me as I lay out the blueprint for aligning your income, expenses, and investment strategies to build the future you envision.
Welcome back to the podcast. This is episode number 476. This is your host, tom Malooly, and welcome back. We tell our new clients that we need to know your cash flow. Cash flow has two parts. There's the income and the expenses Income. Of course, we need to know what kind of income you're bringing into your household. More importantly, in a lot of ways, we need to know what your expenses look like and I will share two air quotes, fictitious examples. I can say fictitious, we're just not going to use names, but these are real life examples.
Speaker 1:Couple number one makes $300,000 a year combined. It's a married couple. Couple number two, also married, makes $300,000, also combined. Now I'm going to simplify some numbers just to make the example here, but let's say both. This is after paying federal taxes, state taxes, benefits, any medical costs, their 401k contributions. So they're both bringing home. We'll just ballpark it at $200,000 a year. I know they bring home less in both situations, but to make the story work, we'll keep this number at about $16,000 or a little over $16,000 a month. They're both bringing home. Let's just say a little over $16,000 a month.
Speaker 1:Couple number one has monthly expenses of $11,000 and they try their best to trim their expenses and keep their costs down, but their monthly expenses are just around $11,000 a month. Couple number two brings home the same money. Their monthly expenses are $15,000 a month. Both couples are they saving for retirement? Yes, both of them Are both couples paying their taxes on time? Yes, however, from a financial point of view, these couples couldn't be any more different. Couple number one is able to sock away an additional almost $5,500 every single month. That adds up over a year to be around $65,000 a year that they're just funneling away into the bank or into different investments. Couple number two brings home a little over $16,000 a month. Net after taxes, their expenses are $15,000. They can still save. They can save about $1,000 a month or about $12,000 a year.
Speaker 1:So I will tell you from our perspective as the planner and investment advisor, the investment picture for these couples looks vastly different. The the reason why is I'll just throw some numbers out. If you want to replace the bathroom if you need to or want to the opening bid starts around $25,000 for a new bathroom in New Jersey. If you want to replace the furnace and air conditioner in your home, depending on the size, it could start at $10,000 and escalate pretty quickly. You want to pay for college. Well, we could do a whole nother series of podcasts beyond that.
Speaker 1:So couple number one and couple number two make the same income. They both have different expenses per month. They both have different rates of savings per month. However, I will tell you that the investments that couple number one own are vastly different from what you're going to see in couple number two's account. Couple number two has to own different investments because they need to take less risk. The reason for that is because they may need this money in the short term. It's very possible that couple number two could call us up and say we had a pipe break over our bathroom, we need to replace everything in the bathroom and we're going to need $25,000 and that represents two years of savings.
Speaker 1:We're not judging them. We're not making any kind of statement about them. That is fine. They take vacations, they do what they want, they own a beautiful home here in Monmouth County. This is the life that they have chosen and that's fine. We're not judging them, but we want to make sure that their investments are in lower risk, lower volatile type of investments, because we don't want to be in a situation where we need to sell something for them to raise money and the markets are down and they're going to lose money on that. Likewise, we also don't want to be in a position where we have to sell and that'll trigger some capital gains taxes. So keep in mind, when we're talking about capital gains taxes, most people directly assume that we're talking about long-term capital gains where you may be taxed at, in some cases, 0%, but in many cases 15% and in some cases 20%. That may be less than your ordinary income, your marginal or your effective rate, but if you are just stocking money away and then you suddenly need to reverse course and take it out, you're probably going to have if you have a gain at all you're going to have a short-term capital gain. Short-term capital gains are taxed as if you earn them. It's ordinary income tax rates. So again, we don't judge people with their income or their expenses, but we need to have a handle on what their expenses look like so that we can better allocate their investment dollars.
Speaker 1:Now I want to tell you a true story of a client that I worked with who was divorced in 1994. She was my client back then. This woman never worked. She had side jobs and things. Her husband was the breadwinner. They got divorced now, 30 years ago, in 1994. Her settlement included some cash, but the main asset that she received in the divorce was a retirement account that was worth a little more than $250,000.
Speaker 1:So when I sat down with her in 1994, she was traumatized. This was going to be a whole new life for her that she really wasn't expecting. And I told her we need to get this money in this retirement account invested so that you can live off of this in the future. And she was like absolutely not, I can't do that. She was terrified at the idea of putting money to work. She was 53 years old at the time. She had said to me on several occasions through that year and the next year this is all I've got. I can't afford to lose it.
Speaker 1:Maybe you know someone that's in a situation like this, where they've suddenly been thrust into a new phase of their life and they're paralyzed. They can't make decisions and they can't see what the future is going to look like, because they think their whole world has changed. The best this account got invested was about 10% of the money got invested for the long term got invested for the long term. 90% of this money sat in treasury bills, short-term bond funds, cds, basically earning nothing more than the current rate of inflation. There really wasn't much in terms of earnings. So that was in 1994.
Speaker 1:Fast forward 15 years to 2010. This woman has really struggled to make ends meet. At some point along the way she moved in with her daughter and son-in-law and their family and her life completely changed. She said that she was poor, she felt poor, she had no money, she said. So she pinched pennies, she stayed home, sat on the couch. It was sad to see and her health started going downhill pretty quickly. But she still had money sitting in. That retirement account wasn't really growing, wasn't really doing what it could be doing.
Speaker 1:And now she's turning 70 years old, she starts to withdraw large chunks from this retirement account and she starts to see the balance in the account going down pretty rapidly. At one point she was pulling out about $5,000 a month. You do the math she's got $250,000 and she's taking five grand a month out. She's getting taxes withheld but she is now at the point where a year of withdrawals at five grand a month, that's $60,000. You can see the money isn't going to last very long. So she is starting to drain huge chunks from this IRA on a monthly basis and it's only then when she can start to see the finish line, in the sense that she's really starting to run out of money. She goes from terrified 53-year-old where this is all I've got. I can't afford to lose it to now asking do you think we can do something with this money? Can we invest a portion of it to grow this account? I'm going to run out of money very soon if I don't do something.
Speaker 1:There really wasn't anything we could do. It was absolutely the wrong time to get invested at that stage of the game because she was in the drawdown phase. It's a situation where she should have invested years back in the 1990s. It was just far too late for her when she finally came around to understanding what I was trying to tell her Now. Should she have gone all in into stocks? Probably not.
Speaker 1:I think that would be too drastic of a shift for her and the volatility even in the 90s would have been very hard to stomach. But she was 0% in things that can grow. She had very little exposure to stocks and to the market. So maybe something in between maybe 50% allocation would have made the situation a little better. The money could have lasted a little longer. It's too bad when you look back over a 30-year window and see what could have been done, but this is what shapes our process today at Malooly Asset Management, we had a couple in to meet with us recently. It was early in the first quarter of this year, 2024.
Speaker 1:We told this couple that we need to start with the basics. We want to build a balance sheet for them and put together a cashflow report that shows their income and their expenses. The couple both of them are in the finance industry and when we told them what our process was, they were astonished. The actual quote that we heard was what do you need to know that? For? What do you need to know our expenses for? No one else has ever asked us for this information. Take our word for it. It's not to pry. It's really to get a good understanding of where you're at so that we can take the proper amount of risk for your situation.
Speaker 1:I still think there's this overhanging belief that people are going to work with an advisor and they're going to have outsized returns, but they don't realize that that will usually come with outsized risk. That needs to come with it. So we want to right-size the amount of risk that we're taking for each person's situation. There's also and this came up in the conversation as well when I was a stockbroker, there was a New York Stock Exchange rule called Rule 405, which is know your client, and this is a very good policy to have as you're getting started with a new client.
Speaker 1:If you're working with a fiduciary, it's imperative that they know your situation, that they know what's going on in your life not just the numbers in your brokerage account, but also what this money is for and how this can be used to support your lifestyle. And if you're working with a fiduciary, you should want them to know as much as possible about your situation. So I'm still personally stunned when people come in to meet with us for the first time. We tell them that we want to build a balance sheet and a cash flow report for them, and then we want to project that into the future with inflation, to try and right size the amount of risk that we should be taking. I'm still stunned when people tell us that no one else in our industry is asking for this kind of information. Advisors are required to know this, so I'm kind of surprised that people aren't asking, or at least asking for the information and updating that as we go forward. We tell people all the time when we build the cash flow report.
Speaker 1:This is just a snapshot in time. This just tells us where you are in 2024. Your situation in 2025 could be drastically different and we want to know about that because we will update the numbers and rerun the scenarios to show you what impact that's going to have on your investments and some of the investment decisions that we're working on together with you. So this is super important and I'm a little surprised that more and more people in our industry just skip over this part. They just want to talk about their different investment ideas and their opportunities. We have to get through some basic stuff first before we can even start talking about investments. Sad to say, this was true in the 1980s when I got started in the business. Still true in 2024. We need to know your situation very well. That's true for any advisor. That's the message for podcast 476. Thanks, as always for tuning in.
Speaker 2:Tom Malooly is an investment advisor representative with Malooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not Thank you.