What is a person’s “burn rate” and why is it important? Let’s assume, hypothetically, your gross income (before taxes) is $10,000/month. After taxes and expenses, you are left with $2,000 of savings. Your burn rate is effectively $8,000 or 80% of your gross. Is that good or bad? Depends…
How much control do you have over the income you earn? If you don’t have a lot of control, you had better have a great cushion to sustain you should you lose your job – because your burn rate is big! You’re spending $8,000/month. How much is enough for a person with this burn rate? A minimum cushion of $24,000 to $48,000 in savings at the bank is not an unreasonable cushion. It would allow you to maintain your lifestyle and meet you and your family’s obligations for 3-6 months. But let’s say, your burn rate is 2, 3 or 4 times that. Now you may be looking at a need for liquid cash closer to $200,000 (and, that’s not your company stock even though it’s liquid – remember, longest running bull market is starting to wane…). If you own your business, own real estate, etc. you may feel your income is more assured and thus your burn rate is more sustainable.
It is not unusual for the folks I meet to not know their “burn rate” and I meet lots of folks in the course of a year. They are usually high income earners, often both spouses work but, not always. They find themselves with enough money coming in that the family doesn’t have to think too hard about what they spend unless it’s a very large purchase. That is, until, life happens. A divorce, a loss of a job or a health crisis occurs, or god forbid, a death of the primary breadwinner. And, the higher up the food chain you are, the more you make, the older you are, the longer it can take to replace that high paying job. Can you meet your obligations and sustain your lifestyle through a job hiatus? You won’t know that until you know what your burn rate is.
The essence of financial planning is to help people clarify their needs and goals, assess where they are today, where they want to go, identify and resolve what could get in their way and then create a plan and investment strategy to get them there in the time frame they’d like. Part of the “where you are today” piece, is understanding your burn rate, what it takes to live the life you have created, are used too and don’t want to lose. Let me know if we can help.