We often believe that because we’re making more, we must be getting wealthier. That’s not necessarily true. There’s no doubt that with more money comes greater flexibility on how much you spend on your lifestyle—or save to build net worth. Unfortunately, it’s human nature to spend to match the increases we get. As an advisor, one of your jobs is to help clients reduce their spending rate as their income grows, or wealth building gets difficult.
On this episode of Elementality, Reese and Matt explain how the Element Burn Rate (Br), helps you illustrate to clients the yin and yang of spending and saving. By using different incomes as examples, they illustrate what they would consider to be high, low, and healthy spending rates for each income level.
Podcast Transcript
Reese Harper:
Most clients think they want help knowing how to improve their budget and spend, and they wanna spend less. Everyone wants to spend less. Everyone wants that, inherently. Even if they love spending, they feel guilty about it, and they wanna try to spend less, they wanna figure out areas to cut, but if you attack specific things like, “Well, it’s the truck or, well, it’s the house, or well, you’re just an idiot. Reese, you’re eating meatball subs and Philly cheeses steaks all the time. If you just cut out your food budget, you’d be fine.” If you go after the wrong thing, like it’s… Good luck having that conversation again. No one wants to be criticized on the thing they might love the most.
Jordan Haines:
Welcome to Elementality. I’m Jordan Haines, Financial Planning Specialist at Elements. Each episode, Reese and Matt will discuss major challenges faced by financial advisors and the things they can do to navigate the complexities of delivering quality financial advice to clients. We hope you enjoy this episode.
Reese Harper:
Welcome to another episode of Elementality everybody, I’m your host Reese Harper here with America’s financial advisor, Matt Glaser.
Matt Glazer:
I’m not sure. I know you’ve been looking for a while for a name that I can go by here.
Reese Harper:
A stage name.
Matt Glazer:
Yeah, stage name. I just don’t… The weight, there’s like lots of positive and negative weight with that label, and I’m not loving it.
Reese Harper:
That’s the second time I’ve gone with it. Folks, both times, we’ve got a questionable reaction from the crowd. So Matt, I’m gonna go ahead and probably try that one more week and to see, and then if it’s still… If I’m still getting that same reaction, I may have to switch nicknames.
Matt Glazer:
Yeah, I’m good with the parking lot on that one, to be honest.
Reese Harper:
Think about America… Like you’re America’s financial advisor, like… That’s a…
Matt Glazer:
Just… I don’t… Hey listeners, I have, in no way, signed off, suggested this idea to Reese in the first place, so just know that my humility is very high here.
Reese Harper:
Yeah, he has a lot of books in his office though.
Matt Glazer:
A lot of books in my office though.
Reese Harper:
That’s true.
Matt Glazer:
They’re gonna make their way to Reese’s empty bookshelves in his house.
Reese Harper:
Well, my bookshelves are full, they’re just… They’re few… I have a few full book shelves, we need more, more bookshelves than what we planned for, ’cause…
Matt Glazer:
I gotta tell you about this one book that I have.
Reese Harper:
Okay.
Matt Glazer:
I had a friend in high school, still a good friend of mine, and his family are prolific readers. They’re very… Incredibly smart family. And they had a wall, like giant wall of books in their basement in high school, and they still live there, they probably still have this wall. And I liked this one book off the shelf that was really interesting, and I was gifted that book from the wall. And the book is… Let me go grab it really quick.
Reese Harper:
America’s financial advisor just walked over to the bookshelf.
Matt Glazer:
[laughter] You gotta stop that. The book is called. “Why Do dogs Have Wet Noses and Other Imponderables?” It’s a really fascinating book. The couple of the example questions on the cover: Why is there no channel one on television?”
Reese Harper:
Oh yeah, that is a good question.
Matt Glazer:
Why don’t woodpeckers get headaches?
Reese Harper:
Dude, I was out looking yesterday morning at a woodpecker, I took a video of it, me and my wife were like, “Man, that’s gotta give you a major headache.”
Matt Glazer:
Last one here, let me… I’ll open the cover here and just select one from the list… Well, no, that’s a really easy question.
Reese Harper:
I’m having a Philly today for lunch, folks. Matt is from Philadelphia and I’m eating a Philly right now.
Matt Glazer:
Yeah, I mean, there’s lots of questions I have about that, but that’s… I will save that for another day. Last question here before we get into it, why do the agitators in washing machines go back and forth rather than spin 360 degrees?
Reese Harper:
Wow.
Matt Glazer:
So it’s a great book.
Reese Harper:
Well, as a pivot and a segue into our topic of the day, I struggled with this segue, so right now on my desk, it was a hard decision to make from DoorDash, Muncheez is a great little local establishment, and I can pick from six sandwiches. I have… I really wasn’t sure, ’cause depending on the day, they’re either the meat balls, and their meat ball serve are either dry or they’re excellent, or perhaps the bread itself for the meat ball is dry or perfectly crispy on the outside but soft on the inside. I just have preferences how I want these sandwiches to be, so I had to order two. I had to order both the Philly and the meat ball sub, 6-inch, just to make sure that if one was bad, I had a hedge.
Matt Glazer:
I mean, this is a vintage Reese move.
Reese Harper:
So like, what does that say about me? And how would that affect my personal spending? If every decision I make in my entire life results in one hedge and one purchase, then I’m gonna be spending twice as much as I need to, to survive. And the topic of today is burn rate, it’s personal spending. And I just wanted to kick this conversation off with the guilt and shame I fear about eating two sandwiches for lunch when one would have been fine.
Matt Glazer:
Honestly, I did not know how you were gonna segue that. That was impressive. And I know we just came up with this topic recently, so I know that that was not planned, and I just… I think everyone should…
Reese Harper:
Thank you, sir.
Matt Glazer:
Round of applause for the segue.
Reese Harper:
And I’ll say, for those of you who are interested, they’re both amazing today. They’re really both great.
Matt Glazer:
Alright, let’s jump into it. We’re writing, we’re codifying rules and heuristics, and specific score ranges around the elements for our product right now. And when you work in this framework and system for the better portion of a decade, it becomes pretty innate to you, and so pulling that out of Reese has been difficult because once you do this for a while, it becomes a feeling and you just kind of know on the surface where someone stands for a given financial domain. Be it savings, be it burn rate and spending, be it liquidity, whatever. So this has been a really great exercise in trying to, more specifically, codify… No, in stark terms, binary terms, black and white, what is low, what is high, what is healthy, what’s unhealthy, what is atypically out of range. And so, due to the limited amount of time in the day, we’re gonna kill two birds with one stone here and try and do that work on this episode here. So I’m gonna tease some information about burn rate, Reese, out of you. So first, why don’t you start at a high level, just to level set with everyone for folks that might not be familiar with Elements, what is burn rate?
Reese Harper:
Burn rate is one of four cash flow elements. We break down someone’s gross income into Savings, Spending, Debt and Taxes. Spending is currently just a gross number, that is one of those four sub-categories, and what we try to do is make sure that someone is spending a healthy percentage of their gross income, or a low percentage, or a reasonable percentage.
Matt Glazer:
We have savings, we have debt payments, we have spending, lifestyle spending, we have taxes. As a percentage of income, generally speaking, let’s just first set some bounds around this range. What is what you would describe as… We struggle a lot of times with not wanting to be judgmental in the way we name these things.
Reese Harper:
Yeah, totally.
Matt Glazer:
And try to be more objective. But let’s just say, what would you describe as… What would be a healthy, or acceptable, or reasonable range for spending? And are there any other factors that influence what that range would be? Like someone’s level of income, or someone’s level of net worth, or… Anything else? Help me understand the bounds of the range here on burn rate, like the bounds of the range here on burn rate.
Reese Harper:
Well, let’s start with is there any factor that would dictate ’cause there’s not one percentage, you couldn’t say it’s 50% for everybody. Because when someone’s making 60,000 a year, and we know that it costs… In almost every major metro market to just stay above the poverty line, it’s gonna cost a few thousand, 2500 a month, 3000 a month. Well, that particular customer is gonna be under a lot of stress to be able to… At 60,000 of income, not gonna be able to fit that poverty level spending in as easily… I mean, take it, what do they had 36,000 of income. They’re gonna have 100% burn rate. They’re not gonna pay any taxes, they’re gonna have all their money going to spending, they probably don’t own a house, and they have no debt payments ’cause they can’t afford it, and their rent’s gonna have to be figured into that, and then they’re not gonna be able to save any money, and they’re gonna depend on social security.
Matt Glazer:
So income is influential. Lower income, you would expect… A reasonable burn rate for someone with lower income would be a higher burn rate than someone with higher income where you would… A more reasonable burn rate would be lower than that person.
Reese Harper:
Yeah. Like, if I found someone with a million dollars of income, of gross income per year, it wouldn’t be unusual to see their burn rate be as low as 25% or 30%.
Matt Glazer:
Mm-hmm.
Reese Harper:
It’d be unlikely to see them as low as 10%, but you could see someone at 25% or 30%, and feel like they were being very reasonable, that was very conservative, but it’s also possible at that same income level of a million dollars of gross income per year, to see someone who would be spending 65% of that. You know.
Matt Glazer:
So let’s take… Can we take a cul-de-sac on the million dollar person earner, that’s income, right? A million dollar earner that’s spending only 25% of that. What does the rest of that person look like? What do their other elements look like? What does their lifestyle look like?
Reese Harper:
Well, at a million dollars of gross income, your effective tax rate is gonna be north of 40% for most people. Depending on the state you live in, it could be… If it was California, it might be pushing high 40s, probably wouldn’t be north of 50 effective rate, not marginal. So like, total gross income, how much of that million dollars we’re gonna pay to taxes. It’s gonna be more than 400,000 for most people. And so if you’ve got… We break out debt payment separately from personal spending, and so most people are gonna carry… Most people can get a mortgage legally underwritten for north of, or at 40% of their gross income. [chuckle]
Reese Harper:
And so depending on how housing… Depending on how salient, depending on how aware, how top-of-mind someone is with their finances, they might have just literally went to the mortgage broker and said, “What can I qualify for?” And they were like, “A million doors of income? A five-million-dollar house.” ‘Cause you can afford 30 grand a month in debt payments, or something. And you’re like, “Okay.” And so if that scenario… You can think about that scenario where they took the largest mortgage they could get and they pay an effective tax rate of 40%, you could be left in a very, very tight situation, and if you’re… You’ll save no money in that scenario, you’ll have no… ’cause your spending is gonna likely be at least 15% to 20% of your gross income, even if the… Spending is often correlated with debt payments meaning… With primary residence debt payment. So whatever… If your primary residence is 15% of your gross income at… We can’t get into debt today. I’m starting to get into another tangent, but…
Matt Glazer:
Yeah, stay out of that.
Reese Harper:
Let’s just say spending is correlated with debt payments, on your primary residence generally.
Matt Glazer:
Yeah, a higher standard of living requires higher living expenses. So that million dollar earner who has a 25% burn rate, are you implying that that person, it’s typically… Well, everything is by choice, but that’s typically less by choice that they’re just spending 25% on lifestyle, it’s typically more driven by other correlating factors like the house that they live in? Or their… Well, yeah, I mean, in this case, the house that they live in. That part of their life.
Reese Harper:
Well, it’s unquestionably, it’s been my experience that, unquestionably, as people’s income rises… As someone’s income rises, so does their preference for things to spend it on. So it’s just… I have seen people that have a 50%, or 60% burn rate when they’re making 150,000. And they hold that all the way up till like… Like, as they make more money, their burn rate just escalates with it, and no additional savings shows up, and their debt payments also escalate. So, like…
Reese Harper:
It’s one thing if you have a million-dollar mortgage when you’re making 150,000. That would be pretty crushing, that would be 60,000 of payments a year on 150,000 of income. I don’t even know if you could qualify for a mortgage, that’s more than… That’s right at 40%, a little over 40%. So it’s unlikely… I’ve seen people in that scenario, instead of holding that mortgage at a million, while they continue to increase their income, and their percentage of debt payments goes down, they just continue to upgrade that property, or upgrade, or buy a second home, or have a third property, and they’re still at like a 40% debt to income ratio all the way up to a million dollars of income. You know. And so, that’s why the bigger someone’s income gets, you have major flexibility in terms of increasing your savings rate, and improving the rate at which your net worth grows. But a lot of that just depends on how much you escalate your burn rate, and how much you escalate your debt rate, they kind of are correlated.
Matt Glazer:
Let’s come back to the debt rate piece of this in a moment. But if I had to give you a piece of paper and a pen and one line, and you had to draw the continuum of scores for burn rate, we can’t account for income here. I mean, account for what you have, but you can’t stratify it by income, you can’t stratify it by net worth. It’s just like, what is from the high point of the healthy range to the low point of the healthy range, what is the core healthy range for burn rate, based on what you’ve seen with your clients?
Reese Harper:
Well, at the low end of the income level, you’re good… I would start by saying if I’m at the low end of the income level, what is healthy for me? What’s healthy, if I’m at a lower income range? And I would just look at someone’s income at probably, let’s just keep it simple for the audience today, even though I would probably not keep it this simple for a spreadsheet that I was building. And Let’s say we had $100,000 of income, and then we had again at 200,000 and 300,000. At 100,000 of income, if my burn rate was at… If it was below 50%, I would be really pleased with that. If my burn rate was below 50% on 100,000 of income, that’d be very… I’d be very excited. At 100,000 of income if I was getting uncomfortably high, that’s probably when I’m north of 80%, right? I’m north of 80% on a burn rate and 100,000 of income. I have no… I’m probably gonna be going backwards at that point. I would feel great at about 50% or less, and I would probably get uncomfortable at 65. And alarm bells are freaking out at 80. Like that’s kind of the range.
Matt Glazer:
So for the $100,000 earner, generally speaking, a 40%-60% burn rate would be kind of like a, “Yeah, it feels reasonable.” kind of range. The lower the better in terms of health, the higher, just the more awareness of spending is required just to make sure it doesn’t get in trouble.
Reese Harper:
Yeah.
Matt Glazer:
Okay, so let’s take it up a notch. We go from 40%-60% for the $100,000 household to the $200,000 household. Has that changed dramatically? Are we talking like it goes up a couple of points or…
Reese Harper:
Well, the reason it needs to… It doesn’t go up. It could go up. But the reason you have to be careful is that now taxes start to come into play, and they didn’t come into play at 100,000 of income for most people, unless you’re single. If we’re dealing with a married family, or anyone with a dependent, 100,000, you’re not gonna pay much tax, and in some states, nothing. But we get to 200,000, you’re gonna see effective tax rates get in the double digits, and first in some places be 20% or more. And so you have to be really careful to… If you’re holding… If 60 was okay at 100,000. And now we have… Because then we would have been able to have some debt payment, reasonable debt payment and maybe 5% to 10% savings at 100,000. Now, we lost that if we hold our burn rate at the same ratio. We just picked up 100,000 in new income, we have to have a lower ratio because we have more tax. And so that… If it were $200,000 of income, I would say it’s gotta… It’s… I have… I’m more comfortable with the lower end of the range, 40-60, and I don’t know if I’m comfortable at 60.
Matt Glazer:
Are you comfortable at 50?
Reese Harper:
I’m comfortable at 50.
Matt Glazer:
Yeah, so maybe it comes down…
Reese Harper:
I’m not comfortable, but I think it’s fine.
Matt Glazer:
So maybe it comes down like 35-50, something like that?
Reese Harper:
Yeah, let’s say I’m more comfortable on 100k at 50 than I am at 200k at 50.
Matt Glazer:
Yeah.
Reese Harper:
And it’s because I have some empathy for how hard it is for the person at 100 to be able to make all that fit.
Matt Glazer:
And can you… Lets… Okay, so we’ve…
Reese Harper:
‘Cause the fundamental difference here is, when you make 200,000 versus make 100,000, your fundamental needs should not have changed dramatically, in terms of what makes you happy, content, present, a comfortable life, there’s just not enough of a variation yet. This is the point where you go from no taxes to taxes. And so you can’t really increase your lifestyle dramatically without some cost. That’s why you feel a lot of people are like, “I’ve made a lot more money, but man, I just don’t feel like I’m getting ahead.” Maybe this isn’t obvious to people, you’re gonna be able to spend more money. Does that make sense? If we hold your burn rate at 40%, you go from spending four grand a month on discretionary lifestyle expenses at 100k, to where at 200k, you’re gonna to double that, okay. Now you’re at eight grand a month on discretionary, independent of your mortgage. So it’s not like we’re saying, “ooh let’s not increase our lifestyle expenses.” It’s just a red flag if they are going up at a higher rate than they were when your income was low.
Jordan Haines:
Hi, there, it’s Jordan, are you on the hunt for ways to grow your book, speed up your planning process, and better serve your rising star clients and prospects? Then it’s time to find out how Elements is helping advisors like you all across the country, modernize their approach to financial planning. To chat with us go to getelements.com/demo, and we’ll show you how Elements can help future-proof your business.
Matt Glazer:
You were talking about a relative comparison to a prior point in time in terms of understanding if there’s some lifestyle creep that’s appropriate or not. What about for just a static point in time? Picture yourself as a doctor, with bloodwork on a patient that comes back and there’s a tolerance range for a given… You know… A cholesterol, blood pressure, whatever it is, does that change your answer in any way? Can you make a judgment on someone’s burn rate at a point in time?
Reese Harper:
Oh, yeah.
Matt Glazer:
Not really considering… Yeah.
Reese Harper:
You can, you can. And… I mean it can raise some caution. Like if somebody came to me with 300,000 in gross income and a 60% burn rate, massive alarm bells going off. I’m really trying to get down to that 40% burn rate for
a $300,000 earner. I’m not trying to… It’s more of an active target now, because I’ve got… Even at 40%, it’s 10,000 a month of discretionary spending independent of their mortgage. That’s a pretty comfortable life. If you come to me on a $300,000 income person and say, “What’s really scary?” Now scary is definitely… It’s definitely scary above 50%.
Matt Glazer:
Yeah.
Reese Harper:Where before it was scary at like 75 or 80 at 100k. Now 50 is scary. And now I’m starting to wonder, “Can I even get to a 20% savings rate because I’ve got… I know I’m gonna have a 40% or high 30s tax rate. So if I’m at 50 plus 30, and then I’m trying to save 10. And I know I’ve got a mortgage out there, I’m just toast.”
Matt Glazer:
Yeah, yeah.
Reese Harper:
So I’m targeting like… I have a substantial number of clients that are high six figures, low seven figures of income, and they’re very comfortable with burn rates down in the high 20s, low 30s. They’re spending tens of thousands of dollars a month in discretionary spending. But they’ve gone from a 60%-70% burn rate all the way down to 20 in order to have a nice fat 30% savings rate as their income was higher, and you just have to decline that spending as your income grows, or there won’t be any room for wealth building.
Matt Glazer:
Talk to me, Reese, about how burn rate as a concept and a tool has enabled them to make the right decisions about spending as their level of income, or just general affluence has changed over time, you know, in a world where burn rate was a thing and a framework, and a structure for this conversation versus a world where it’s just an absolute dollar of spending. Help me understand.
Reese Harper:
That’s a good question. Most clients, like, they want help knowing how to improve their budget and spend, and they want to spend less. Everyone wants to spend less. Everyone wants that, inherently. Like, even if they love spending, they feel guilty about it and they wanna try to spend less, they wanna figure out areas to cut. But if you attack specific things like, “Well, it’s the truck, or well it’s the house, or well, you’re just an idiot, Reese, you’re eating meatball subs and Philly cheese steaks all the time. If you just cut out your food budget, you’d be fine.”
Reese Harper:
If you go after the wrong thing, like it’s… Good luck having that conversation again. No one wants to be criticized on the thing that they might love the most. Or I got an old A-frame cabin up in Big Cottonwood Canyon. If you told me like, “Why do you have that cabin? You’d be able to have a 30% savings rate Reese, if you didn’t have that cabin” I’d be like, “That’s my memories.” or some kind of emotional reaction. But if you come to me and just say “Okay. Hmm, at X amount of income Reese, normally what I see is this range. You’re in atypically high category. And that might be fine. Some people choose to have a lifestyle that’s a little more comfortable, and they don’t mind working longer.” And I’d be like, “That’s me.”
Reese Harper:
And you’re like, “Yep, that’s fine. The concern I have, Reese, is, we also need to build some liquidity consistently, because there’s always a chance that people don’t wanna hear your podcast anymore, and that you’re not that interesting as you think you might be, and within a couple of years someone else is gonna come, and they’re gonna have all the podcast listeners, and you’re gonna not have an income. So, I just wanna protect you from that.” And I go like, “Yeah, you’re probably right.” But you didn’t attack my spending, you attacked the category in which my spending was located, which is atypically high. And because I’m an atypically high spender, you’re concerned for me. Now, you’re not isolating me, you’re like, “I’m having this conversation with every atypically high client in my book, Reese. And trust me, there’s a lot of them. You’re not alone here. But this is a range that starts… I have to ask some questions and dig deeper to really understand, are we gonna be okay?” It’s so not threatening. It’s just not threatening.
Reese Harper:
But, where before, when we’re like, “Okay, I don’t know if you’re gonna hit your Monte Carlo simulation. It just doesn’t look right. I can’t make it look right, and probably a budgeting problem. Let’s start getting into the details. Open the komono and show me the categorization of your personal checking account, and I’ll start going in there.” It’s just too private. It’s too aggressive, and people don’t like you getting in their… Now, if they’re really young, and it’s the first time they’ve ever had a budget, they love it. But give it a couple years of you helping people categorize their budgeting transactions, their interest will fade, they’ll wanna have a little bit more privacy. And so, I just like attacking it in these categories, making the category be the discussion, not the person and their spending pattern, and then that… It does result in really significant positive change.
Reese Harper:
Thanks everyone for paying attention, listening. This is a topic we love, and if you wanna learn more about these ranges, and you wanna understand a little bit more about how to categorize financial health, book a demo, get on our calendar, check it out. We have Jake and Cameron can walk you through everything, and you can kind of see what each range is for each of these elements, and Matt and me will continue to try to define them as precisely as we can.
Matt Glazer:
Thanks, Reese.
Jordan Haines:
Next time, on Elementality.
Blaine Pearson:
For a lot of these retirees, who spent 40 years working and billowed up this big pile of money and your financial advisor says, “Okay, go spend it.” It’s like saying, “This is my baby, I’ve worked on this for 40 years, it’s my 401K, and it’s now a rollover IRA,” or what have you. And I think that we could do better with the behavioral aspects of preparing for retirement, both in pre-retirement stage, the actual transition into retirement, and then even post-retirement.
Abby Morton:
You can learn more about the Elements Financial Planning System at getelements.com/meet, and schedule a time to speak with one of our friendly financial planning experts. Elementality’s executive creators are Reese Harper and Matt Glazer. Elementality is produced by Abby Morton and directed by Jordan Haines. Have a good one.