This is a topic I’ve been thinking about for a while, but I don’t think I’ve really outlined a step-by-step guide, so here it is.
First off, I’ll get the elephant-in-the-room out of the way. I think couples should combine their income. I know many couples who do not. I’ve been encouraged not to combine money when I get married, especially by people who have been through a divorce and believe that by keeping money separate, the divorce negotiations are more likely to go in their favor. Why do I think couple should combine their income:
- It is meaningful actualization of their long term commitment to each other. It is far easier to believe your partner is whole-hog committed if they are direct depositing their entire shabang into a shared account.
- By deciding the fate of ALL the dollars as a couple, it encourages the maximum amount of communication around values, long term goals, strategy, etc.
- It forces accountability because everybody can see where every dollar goes.
- The power of two focused people working on maximizing a pile of money is greater than the sum of the parts.
I don’t expect everybody to agree with this. I think it’s especially unappealing to many because they know they will lose spending power if they combine their income… and people HATE the idea of losing spending power. I accept that. The following part is a guide of how to work together to decide what should happen with the money, and I hope after a person reads it, they will have enough confidence to try it out.
Allright, so you’re sitting at a table. You have records of all the accounts, all the costs, all the incomes that both of you own. What now?
- Decide together on your minimum monthly fixed costs. This means, if everything goes to shit, what is the minimum you would have to spend to meet your basic needs (food, shelter, Internet, phone, transportation to work, etc.). Do not include any budget here for things like restaurants. We want short term survival-level planning. What is the minimum if you cut back on optional services (Netflix)? What percentage of this spending is housing? As a category, how much does housing cost, combining all its elements? How much is minimum payments on debt?
- Calculate your total pre-tax and total take home pay. What percentage of your take home pay is these fixed costs? How much of your take home pay is your housing category? Do you have money left over after paying your fixed costs? How much? If your fixed costs are higher than your income, by how much? How much are any savings likely to grow over time in an index fund?
- Calculate your current total potential emergency savings. How much do you have saved outside retirement? Inside retirement? Do you have 3-6 months of living expenses in an emergency fund? How much is your house worth?
These are the baseline numbers you’ll need. Next, I’d look at Dave Ramsey’s baby steps. Which step are you on? Does it make any sense to buy a home (e.g. would the home equity be <50% your net worth, would the payment be <25% take home pay, etc.)? When are you likely to be at baby step 4/5/6? Baby step 7?
I think the baby steps are pretty straight forward. Until consumer debt is paid off, there’s no restaurant budget. It’s only after you complete the emergency fund (baby step 3) that restaurants are even up for discussion. That’s kind of nice because you don’t have to worry about fighting about it until then ;-).
Allright, so after baby step #3, your financial head is above water. Now it’s time for you to discuss long term goals, and we’re going to do it by beginning from the end.
What age did your closest relatives die at? How long are you likely to live? Did they have any expensive, chronic conditions? How much are those likely to cost? When do you want to retire? How many years will retirement last? How much money do you want to spend in retirement? Do you want a vacation home? Dave Ramsey recommends 15% of pre-tax income into retirement. You may want more, but I definitely wouldn’t do less.
After a number for retirement is computed (e.g. we need $5M by 2044), now it’s time to talk about other long term goals. Will you have kids? Will you pay for their college? How much will college likely cost? You can estimate the cost of college by looking at the current cost of state schools, looking at the rate or increase in education (it’s quite high), and then estimate what year you’re likely to have a kid, and how much college will cost 18 years later.
What other goals do you have? What kind of charitable work do you want to do? Do you want your kid to go to private school? Do you want to pay for sports or music lessons? How much will that cost? Do you want to vacation in Hawaii every year? Every other year? Date night once a month? A sports car when you turn 50? This doesn’t need to be an all-inclusive list. It needs to be cool enough to inspire you both, and it will likely change over time.
Once we know the things you want, we can compute their cost and see if our current income covers them. For certain categories that are not as time sensitive, we can condition the purchase on reaching a certain net worth so that the purchase will be a small fraction of it (e.g. honey you can have any car you want as long as it’s <1% of our net worth at the time). Flexibility in the structure of consumptive spending is an important tool to give people the freedom to add non-shared interests into the budget while at the same time holding them accountable for keeping those non-shared interests in an acceptable proportion to the overall plan.
Sharing a budget doesn’t mean you have no freedom with money. You can also specify pocket money that comes out of the budget for each person. Depending on the amount of pocket money, you can restrict it to certain categories (gas, groceries, wine) or just call it blow money (if it’s only $100/month or whatever). Then the individual has the freedom to spend it or save it for a larger purchase over several months.
In this way, every dollar put into the account every month serves a purpose in the longer term mission of the couple. By doing this together, you’re affirming that you both prioritize your shared goals over your personal goals, and I think that’s a required condition for having a satisfying long term partnership.
The plan and the budget isn’t fixed. It can be renegotiated mid-month. It can be changed. But the point is, both partners have to follow the plan UNTIL it is discussed again. Many times couples don’t know what’s actually happening to all the money coming in, and they don’t have a mechanism to bring the train back onto the track when it derails. The budget and the discussions above are a framework to put both partners on a track to better understand the costs, income, investments. In the beginning, it is likely to change as you encounter recurring annual costs that were not included in the budget originally, and so it serves mostly as an excuse to learn and communicate rather than as a super accurate, sure fire plan.