When you begin the process of financial planning you will likely be asked to put your overall expenses into your financial plan to help develop a baseline for your lifestyle. There can be confusion when getting this information put into the planning where you are not sure if something is a living expense or a liability, and how this should be accounted for in the planning.
Here is a way I have explained this to my clients to help them know if they are putting these items into their plan as a liability or as a living expense.
Living expenses are the expenses you pay to live your everyday life, and they likely don’t go away.
- Now these might seem overly simplistic, but there can be confusion in this for clients at times. Your home payment, auto payment and credit card payments are regular expenses, and you may feel like you must pay these to live. But these are not living expenses when it comes to your financial planning.
- Your living expenses are items such as:
- Utility payments (electric, water, gas, phone, cable, internet, etc.)
- Your insurances (Home, Auto & Liability)
- Your taxes
- Groceries and food costs (food, toiletries, household items, etc)
- Clothing
- Transportation (Gasoline, Maintenance, Parking, Bus, Registrations, Tolls, etc.)
- Notice that all of these Living Expenses are things that you pay month by month to maintain you and these are items that tend not to go away over time.
Liabilities are those items you pay for a period and have the potential to go away at some point.
- They key components I tell clients to think about when trying to determine a liability are:
- Does the expense have an Interest Rate?
- Does the expense have an End Date?
- If one, or both, of those components are present in the expense, you are likely looking at a liability payment.
- Common Liability payments are:
- Mortgage Payments/Home Equity Loans or Lines of Credit Payments
- Car Loan or Car Lease Payments
- Credit Card Payments
- Student Loan Payments
- These payments are usually temporary, or they are paid back with interest, in many cases both of these features apply. Because those features are present these are liabilities.
All your expenses are important for your financial planning. Having them differentiated is very important when looking at the long-term effects of these payments. If you have an item such as your mortgage listed in your living expenses, it will show as a payment you are making for the rest of your life. While a mortgage might seem like it takes a lifetime to pay off there is a point when you will pay off your home. The most common mortgage term is 30 years, not the remainder of your lifetime. Throughout the life of that loan you might pay more at times or refinance, but once you pay that loan off you are not going to have that payment any longer. You want your financial plan to show that this payment is no longer happening at some point, and if it is not accounted for properly, it may not show correctly.
Now, this does not mean that all the payments associated with your home go away. You will still have to pay property taxes and insurance on that home for the rest of the time you own it. These are the living expenses that you account for with your home. As long as you are in that house, you pay those expenses.
Having an accurate breakdown of the Living Expenses and Liabilities on your financial plan will be a big help in making sure that you have as accurate a picture as possible of what you are spending. Working to get these accurately input into your financial plan and working to keep track of these long term are part of maintaining your planning and working to make adjustments when needed.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.The opinions expressed in this material do not necessarily reflect the views of LPL Financial.
The examples are hypothetical and are not representative of any specific investment. Your results may vary.
