By: Joseph Goldy, CFP®
Following a significant life event, such as divorce or the loss of a spouse, people face a common question: How will being newly independent affect my family's lifestyle?
During this financially delicate period, a decrease in household income, the ability to remain in the family home, and the long-term impact on a person's retirement plan are all top of mind.
While we cannot always promise that lifestyle changes won't be necessary, we find that clients' real fear is not the lifestyle change itself but the uncertainty. Humans are pretty good at adapting to their situation when they know what they're dealing with and have a plan to address it. But anxiety levels rise when the future appears uncertain, and people often succumb to poor financial decisions based on emotion.
First and foremost, our job as planners is to make sure a client's expectations are realistic and that they understand the reasoning behind any tradeoffs when necessary. By crafting a plan together, we help remove uncertainty from the situation and provide clarity. Once people can better understand the financial impact of a life-changing event, they make better decisions based on facts rather than feelings.
Here are a few areas where a significant event, commonly divorce or loss of a spouse, may impact a client's lifestyle.
Decrease in Family Income
If two incomes suddenly become one, it can have a significant financial impact on someone's lifestyle. For this reason, when we meet with clients who find themselves in a newly independent stage of life, one of the first things we do is review their cash flow.
We purposely do not call it a budget since we're not telling someone where they can and cannot spend their money. Instead, it is about helping clients find balance in their spending patterns by tracking, often for the first time, money inflows and outflows. Reviewing cash flow is an enlightening exercise for many clients and helps to serve as the launchpad for all planning going forward.
Once someone understands where their money is going each month, it naturally prompts a conversation about priorities. Is a big budget for entertainment or dining out as important as paying off debt or contributing toward a retirement plan? Again, tradeoffs may be necessary, but there is often a sense of relief for newly independent clients once they see their spending habits and understand they have more control in this area than at first realized.
Maintaining the Home
Perhaps one of the most significant decisions for someone is whether they can continue living in the family home or even if they can afford to live in their current town. Although everyone's situation is unique, we use the 28/36 rule as a basic guideline. Ideally, no more than 28% of someone's gross monthly income should go toward housing costs, including mortgage, taxes, insurance, and HOA fees.
Introducing this guideline in the conversation is helpful for someone to see where they stand relative to what many banks use as a benchmark. As with the cash flow exercise, it helps facilitate a conversation about whether staying in the family home makes financial sense based on new household income and debt levels versus possibly downsizing or renting. Particularly in the current housing environment where home prices and mortgage rates are rising, selling the family home and renting might make more sense.
(The 36 in the 28/36 rule refers to total debt payments, whereby all debt: mortgage, auto, credit card, student, etc., should be 36% or less of gross monthly income.)
Changes to Retirement Plans
Any changes to retirement funding today would undoubtedly impact a client's future lifestyle. For clients facing a reduction in income in their newly independent stage, an all-too-easy financial pitfall is to immediately scale back funding toward their retirement plan to free up monthly cash flow. It can be challenging to see the importance of prioritizing a goal that may be a decade or more in the future when other immediate needs seem more pressing.
Yet, we strongly encourage clients to maintain retirement funding whenever possible since it can be tough to get back on track after reducing or stopping monthly contributions. We educate newly independent clients about the three most significant factors working in an investor's favor to save for retirement successfully.
Those three factors are time, compounding investment returns, and systematic contributions. The more time you allow your retirement investments to grow in the market, the more time the returns on those investments can compound. This compounding of returns starts to have an exponential effect on the growth of a portfolio the longer you're invested.
Additionally, recurring retirement plan contributions benefit investors by taking the emotion out of investing and providing a dollar-cost averaging plan. You're taking advantage of market pullbacks to buy more shares when stocks go on sale. Putting your retirement savings on autopilot with regular deductions from your paycheck is one of the best things someone can do to save for the future.
Ultimately, when someone experiences an event that leaves them in a position to make all financial decisions alone, it can be unsettling to think of lifestyle changes and their impact on your family. However, by working closely with your wealth advisor, any lifestyle changes can often be managed and overcome with a revised plan based on your new financial reality. Knowing you have a realistic roadmap in place for the future takes the guesswork out of "what may come" and is the key to moving ahead with confidence in your newly independent phase of life.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.