In a previous post I discussed the difference between being a bucket carrier and building a pipeline. Everyone starts out a bucket carrier – at least those who weren’t fortunate enough to be born with the name “Hilton” or “Heinz.” Those who make and spend all of their income from carrying buckets, however, will toil their whole lives and end up with little to show for it. They also put themselves at great risk because if their ability to carry buckets stops – through a job loss, an illness, or another event – their income will stop. Those who spend some of their time building pipelines – buying assets – will be able to eventually stop carrying buckets without seeing their standard of living decline. Carrying buckets is easy when you’re young but it gets more difficult as you age.
Building the pipeline is done by directing a portion of your income to purchasing assets such as common stocks. Because assets provide income to you, as your assets grow your income will grow as well. It is often difficult to stay on track and continue to invest, however, since the increased income will be very little at first and seem to take forever to grow. One also may fall into the trap of being too aggressive in building assets and never take the time to enjoy life at all.
Building a pipeline is particularly difficult when married and one of you is a spender by nature as is nearly always the case (opposites attract). Indeed, investing can become a great source of tension in a marriage when one individual would like to spend money as it comes in and the other wants to save and invest. In any marriage a budget is a critical process to allow both individuals to agree on priorities. Adding the pipelines to the budget can be a good way both satisfy the spender that building assets has merit and prevent the saver from overdoing it and never enjoying life. Here’s how:
1. Each month, a budget should be prepared that lists all expected income from work and other sources. Each dollar of that income should then be allocated to one of three categories: expenses, savings, or giving. It is during the preparation of the budget that agreements are made as to how much will be spent or saved on various things. After the budget is made and agreed upon, a pact must be made that the spending and saving will follow the budget. If there is a critical need to change the budget due to an unforeseen expense, it must be revisited and revised such that the source of the additional money is identified. This forces both parties to see the effect of the change.
2. For each of the pipelines, the expected annual amount of income provided should be determined. It should then be agreed upon how much of that income should be reinvested and how much should be spent during the year. The additional amount to be spent should be tracked each month and allocated as needed. This will show the spender that the addition of assets is in fact increasing the available income and prevent the saver from never using any of the additional income. For common stocks, an average income of 10% should be assumed. For bonds and other interest paying assets the actual income to be received should be assumed.
3. The projected increase in earnings from the addition of pipelines should also be tracked using the assumptions stated above. This will provide a direct link between investing and an increase in income.
For example, let’s assume that a couple has $10,000 in common stocks and a net income of $60,000 of $5,000 per month. The budget without the pipeline income might look like the following for the first month:
Expenses (itemized) $4000
Note that every dollar is allocated somewhere. Given the pipeline balance of $10,000, an average annual income of $1,000 could be assumed. Note that the actual income on any given year will vary wildly – this is just a long-term average. Let’s assume that the couple agrees to reinvest 70% of the income, or $700, and spend 30% of the income, or $300. Let’s say during the second month that the couple wishes to buy a new chair with $200 of the pipeline income. The budget would then look like:
Income $5,000, Pipeline Income $200, Pipeline Closing Balance $100
Expenses (itemized) $4200
At the end of the first year, assuming that $600 per month was put into common stocks and a 10% return was realized, the pipeline will have grown:
Total = Initial ($10,000) + Gain($1,000) + Additions($7200) – Withdrawals($300) = $17,900. This means that the assumed income from the pipeline for the second year will now be $1,790. By seeing this income increase from year to year, the spender will see the value of investing and the saver will realize that some money can be withdrawn as the assets begin to provide income without seriously affecting one’s financial future.
By adding the income from the pipeline to the budget, a better picture of one’s financial state can be gained that will both motivate the continuation of savings and prevent saving too much and enjoying life to little.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.