Our reader, Mr. D needed a little help with their household budget. They just had a baby and decided that Mrs. D should stay home with the Baby D. As you can imagine, their household income took a hit and their monthly cash flow turned negative.
I went over their budget and made some suggestions below. I’m sure they would welcome your input as well. If you’d like a little help with your budget, please send me an email and we can put together an article like this.
Mr. and Mrs. D
Mr. and Mrs. D live in the Midwest in a home that they purchased in December 2011. They are both 28 years old. Mr. D works full-time for a financial firm. He is an MBA student and will be registering to begin the CFA program shortly (all employer-paid). Mrs. D used to work full-time until Baby D was born in February 2013. Mrs. D now works part-time for a family business, from home, while caring for Baby D.
Before Baby D, income was higher, but expenses were also higher; the displayed budget is the product of multiple trimmings. A cost-benefit analysis was done when Baby D was on the way and it was determined that Mrs. D would only bring in about $2,400.00/annual after-tax, once childcare costs were included. This led Mr. and Mrs. D to decide that Mrs. D should stay home, which is what both wanted anyway.
Goal – Mr. and Mrs. D wish to improve their monthly cash flow so more money can be put toward building up passive income.
Housing and living expense
- Housing Payment – This breaks down to $9,855.96/annual principal and interest (4.25% 30-year fixed), $3,320.00/annual taxes and $920.06/annual homeowner’s insurance. The difference is building up the escrow account.
- Housing Upkeep – This is primarily savings for big items such as a new roof or replacing a water heater. Month-to-month, this budget is uncommonly used, let alone maxed.
- Electric/Gas and Water/Sewage Utilities –We might end up going over budget.
- Internet Service – Used to have cable TV, now down to just internet only.
- Groceries and Consumables – This category covers almost anything that Mr. and Mrs. D buy from month-to-month – food, small household furnishings, cleaning supplies, light bulbs, toiletries, small household electronics, etc., etc. Mrs. D has recently begun to start couponing seriously, so there may be room to decrease this budget further.
- Baby D’s Expenses – Covers anything purchased for the baby, from diapers to clothes to a food processor purchased so Mrs. D can make baby food herself. While Baby D is only 5 ½ months old, there is often money left over in this budget at month-end.
- Gas (Car) – Mr. D is trying to work from home more, so hopefully this expense might go down. Also, having Baby D gives Mr. and Mrs. D a reason to push family members to visit them, rather than having to drive all over the state to visit.
- Car Insurance – Well-insured, not just the minimum coverage.
Entertainment and discretionary spending
- Eating Out and Entertainment – This includes streaming Netflix plan.
- Family Vacation Budget – One side of Mr. D’s family goes on an annual vacation, which Mr. and Mrs. D go on every year. Vacations have been becoming more local to accommodate a family member’s mobility/health issues.
- Christmas Gift Budget – This budget has been trimmed back from what it was previously.
- Other Gifts and Celebrations Budget – This budget has been trimmed back from what it was previously.
- High Deductible Health Plan – Based on anticipated birth of Baby D, this health plan was determined to be most beneficial. Mr. and Mrs. D will probably choose this plan going forward as well.
- Dental Insurance – Basic Dental plan offered by employer.
- Flex Spending Account – Funded to purchase new frames every other year and new lenses in the alternate years.
- Health Savings Account – Mr. and Mrs. D opened this HSA in 2013; after medical expenses associated with delivery, not much will be left in account at the end of the year. Mr. and Mrs. D wish to contribute as much as possible into this account until it has ~$10,000, to cover 2 years’ maximum out-of-pocket expenses.
Insurance and security
- Mr. D Term Life Insurance ($1MM coverage) – 20 year term
- Mrs. D Term Life Insurance ($1MM coverage) – 20 year term
- Mrs. D Variable Universal Life Insurance – This was originally purchased as an investment policy. Mr. D was the sales representative on the policy (used to work in sales before career change) and believes (probably more than most on financial blogs) that there is a value to using a VUL for tax deferred growth.
- Umbrella Liability Policy – $1MM in coverage
- Security System – Security company chosen after thorough competitor analysis. Non-discretionary expense.
- Mr. D Disability Insurance – Combined with employer-provided policy, should provide close to 90%-100% income replacement for long-term disability. His employer provides short-term disability coverage.
- Mrs. D Disability Insurance – Long-term coverage only, no short-term.
- Baby D’s Whole Life Insurance – Purchased from a mutual company with a strong history of paying dividends.
- Mrs. D’s Consolidated Student Loans – One is a private loan and one is a federal loan. The private loan has an interest rate of 8.4% and the federal loan has an interest rate of 6.125%. Mr. and Mrs. D plan to, in the coming months, switch payment plans so that the federal student loan payment will go down temporarily and then pay the difference toward the private loan. Reworking the payments in this manner will pay off all of the loans 2-3 years sooner than originally scheduled.
- Furniture Payment – Purchased couches when home was purchased. Zero percent financing until January 2014; balance will be paid off at that time. While the amount shown in the budget is assuming equal amortized payments, only the minimum payment is actually being made, so there will be a lump sum payoff.
- Dishwasher Payment – Zero percent financing until July 2014; balance will be paid off at that time. While the amount shown in the budget is assuming equal amortized payments, only the minimum payment is actually being made, so there will be a lump sum payoff.
- Emergency Account Savings – Not as high as we’d like this to be. Account has enough to pay for ~6 months of expenses.
Mr. and Mrs. D do not have anything budgeted toward “miscellaneous” expenses. While they agree that this should be done, as they are in deficit spending currently, it didn’t make sense for them to add it to the budget. Examples are dry cleaning, oil changes/vehicle maintenance, vehicle repairs, etc.
*NOTE ON “MAD MONEY”* – It is often said that without some money being budgeted as “mad money”, the success rate of sticking to a budget is very low. Mr. and Mrs. D use their “mad money” budgets individually on whatever they see fit, such as hobbies, eating out with friends, buying each other Christmas/birthday gifts, etc. This money is for anything that either Mr. or Mrs. D want to spend money on that isn’t really a “joint” expense – this includes clothes and similar items. Mr. D also puts as much money as he can into his employer’s stock purchase plan; his XIRR on the plan has been ~60% annualized since joining the plan in July 2009 and he hopes to maximize his contribution this year. Mr. D also makes very modest donations to his church with this money and pays a parking lot fee for work (public transportation not an option).
**SPECIAL NOTE** Mr. D has a 2nd job. He is also employed by the family business, but there are strings attached to his employment – Mr. D’s salary from the 2nd job can only be used for retirement savings and assorted other benefits (such as Vision Insurance and a Variable Universal Life policy on Mr. D) for Mr. D. Because of this arrangement, Mr. D has been able to contribute the maximum amount to a Roth 401(k) and the maximum amount to his Roth IRA. The salary can also be used to offset the increase in tax liability that this extra income generates, but the salary cannot be used for any other kind of expenses or other investments. Because no changes can be made to this income, the total income from this employment is not included at all above. This note is to help demonstrate that savings for retirement are actually occurring, in addition to Mr. D’s cash balance pension from his primary employer.
Mr. and Mrs. D have excellent credit; they put all eligible expenses on credit cards to gain rewards and pay the balance off each month. They recently applied for another credit card through their bank (to avoid monthly maintenance fees on their bank accounts) and were informed that their credit score was 791 (believed to be an average/composite of both scores).
Mr. D very much wants to use their credit to purchase a residential rental property, believing that a combination of leverage and tax benefits would greatly assist them toward financial independence. However, Mrs. D disagrees, pointing out the fact that neither of them have any skills in basic home repairs/maintenance and, with work, increasing studying demands made on Mr. D from the MBA and CFA programs, and Baby D, Mr. D doesn’t have the time to manage the property himself. Mr. D agrees, but feels that a property management service provides an easy solution (average costs 10% of gross rent receipts). Mrs. D doesn’t feel the possible return is worth the risk, especially with the expense of a property management service. Mr. D is considering taking his father as a partner in investing in a rental property, as his father has experience in being a landlord and would potentially have the liquid assets for a down payment and covering incidental expenses. They would still utilize a property management service if this occurred, as his father does not live locally.
Mr. D would be much more knowledgeable/comfortable maintaining a dividend portfolio, but loses the ability to leverage up as much as a rental would allow, plus there’s no depreciation benefit and the cost of borrowing is much higher when a physical asset isn’t involved.
Thanks Mr. D for sharing your household budget with us. My first impression is that the D’s household expense is pretty reasonable. Mr. D’s income will increase in the future (MBA) and they just need to keep the boat afloat until things improve. However, running on negative cash flow is a huge problem right now. They had a big change due to Baby D, but they have to concentrate on getting back to positive cash flow as soon as they can.
Currently, they are running in the red at about $6,000 annually. Let’s see what we can do with the budget.
First of all, I would pay off those short term debts so it will simplify the budgeting process. They will free up $2,300 annually. That’s just me, though.
Second I would trim the discretionary spending even more. This might seems harsh, but you have to spend less than you earn. There is no way around it.
The Gifts budget seems a bit excessive to me. Can they do something more affordable for a few years until Mr. D gets his big raise? Perhaps they can have fun locally and create memorable moments with Baby D instead of spending money on gifts. Also, Mr. D probably needs to sacrifice a little and reduce his Mad Money budget. How about 5% of his salary instead of 10%?
Let’s cut both Gifts budget in half. That will free up about $1,300. Mr. D’s Mad Money reduction could also save another $2,000.
We are still a little short though. Let’s see where else we can cut. How about Mrs. D’s long term disability insurance? She is not making much money now and a long term disability policy doesn’t seem worth it. From what I understand, the policy would pay about 50% of her current salary. That’s about $5,000 per year. That’s really not much in the grand scheme of things. It might be wise to remove this for now and then pick it up later once she makes more money.
We are really close now so I think it’s ok to take the rest from the emergency saving.
$2,300 – short term debt pay off
$1,300 – Gift budget reduction
$2,000 – Mr. D’s Mad Money reduction
$371 – Mrs. D’s long term disability policy cancellation
$29 – Reduce emergency saving
It was tough to cut $6,000 from the D’s budget because their expense is already reasonable. The good thing is this is only temporary. In a few years, Mr. D will make more money and they’ll have some relief. For now, they just have to bite the bullet and spend less money.
Their insurance budget also seems a bit excessive to me, but that’s their choice.
Put real estate investment on hold
I think I’m getting more conservative in my old age. I would put the real estate investment on hold for now. The D household is already stretched pretty thin. A big repair or two on the rental home could easily drain their emergency fund.
From what I understand, it would be difficult to get a mortgage loan with their current cash flow. Even with the great credit, most banks probably wouldn’t let them take out an additional mortgage. Mr. D could have a casual conversation with his bank and see if they would consider another mortgage for him. I would put the additional investment on the back burner until they are in a stronger financial position.
Follow up with Mr. D
Mrs. D’s disability insurance
The way it works is that it actually provides coverage at a higher amount than what she makes now. She got the policy when she was making more. My initial assumption was that, once she left her job, that she would be required to reduce the policy coverage to her new income level. However, when I contacted the insurance company, I was informed that that is not the case, but rather that she can continue have the policy at its current coverage level ($1,150 benefit monthly). So if she were ever to become disabled, she would actually bring home more money than what she currently makes ($13,800 nontaxable disability benefit versus the $12,000 annual salary she earns). If she were to become disabled, we’d need to pay for childcare, so that is why I personally like having the disability coverage at the current level.
As for our gift budget, below is our Christmas budget as an example. We recognize that some of the dollar amounts seem high, but we keep falling into the trap of trying to keep up with other family members. Especially on Mr. D’s side(s) of the family, gift-giving tends to be very generous; we could double most of our gift budgets and be in the norm for our family. Other Gifts and Celebrations are basically identical to this budget, except showing birthdays, Father’s Day, Mother’s Day and a few anniversaries. Little Baby D didn’t make the cut this year; we figure that’s what grandparents are for.
RB40’s Parting Words
Wow, Christmas is tough when you have a big extended family. We usually spend less than $100 total because we only buy gifts for a few people.
IMO, they should let the families know that they just had a baby this year and they are still trying to work out their budget. Perhaps for a few years they can make some DIY Christmas gifts instead of spending a lot of money. This will just be temporary until their financial situation improves so I don’t think the family would really mind.
What do you think the D household should do? Whatever they do, they should do it fast and get the cash flow back to positive ASAP. Good luck!