Spending well

Doug and Miranda¹ have achieved substantial financial success, yet they both feel uneasy. Before retirement, Doug served as an executive in a large technology company, and Miranda was a successful entrepreneur who sold her business.

They transitioned from pinching pennies early in their marriage to, over the years, spending much more freely. Outwardly, they are enjoying a good life filled with nice things and positive experiences. And yet, something seems to be missing. Their spending doesn’t feel entirely under control, and they have nagging questions as to whether their lifestyle is truly sustainable. They also sense their spending is not really aligned with what they care about most. This disquiet has grown to a point where they have enlisted the guidance of their Merrill advisor, Catherine. They want to assess their current spending patterns and develop a more refined spending approach to give them greater peace of mind.

As Catherine listens, she identifies two different but related questions. The first is the practical question: Do I have enough? The second is more philosophical: Enough for what? She suggests the first question might be compared to climbing a ladder. To make the climb, the ladder has to be sturdy and have all its rungs. These are practical considerations. However, in regard to the second question, if the ladder is not placed against the right wall, it only takes the climber to the wrong place faster. Making sure the ladder is leaning against the right wall, and making sure it’s taking you where you want to go, is the deeper, more fundamental, concern.

Many clients at first think that simply understanding their spending patterns and tracking their money is enough. Catherine suggests this might be likened to thinking like a chief financial officer. She notes that while applying these disciplines is helpful, to answer these more profound questions about what truly matters, Doug and Miranda would be better served if they started thinking like chief executive officers (CEOs). Catherine has seen that embracing the role of CEO in their own lives induces a fundamental shift in her clients. Their nagging anxiety around spending patterns and the future are replaced with clarity, a strong sense of purpose and values-driven strategic decision-making.

The first question, “Is my spending sustainable?” is essentially a question about the rate of consumption, and the answer derives from a set of quantitative facts. Catherine notes advisors can tell a client with a high degree of probability whether they have enough wealth to last throughout their lifetime by applying risk analytics and investment planning tools.

By contrast, CEOs are far more interested in production than in consumption. Since Doug and Miranda want to be more mindful about their approach to spending, Catherine advises them to gain clarity about what it is they are trying to produce. While her clients don’t always realize it at first, with a little prodding, Catherine has found they are most often trying to produce the same outcome: a sense of happiness or well-being.² Once clients recognize what’s truly driving their spending and shift from asking quantitative questions about money to qualitative questions about well-being, Catherine has noted their spending patterns also shift. Clients who think like CEOs and embrace the production of well-being as their ultimate goal also become more intentional and more confident about their spending, investment and capital allocation decisions.³

The tools CEOs use to address these questions include profit and loss statements, mission statements and investment policies. While some of these statements are generally created and managed by chief financial officers, it’s the CEO who, with the advice of the executive team, uses them to drive the company. They become essential tools for making strategic decisions, monitoring progress and adjusting course.

Catherine advises Doug and Miranda that these same tools, adapted slightly, can be used to address the production of personal and family well-being. These tools first help catalyze answers to deep questions about what’s most important, but the work shouldn’t stop there. Catherine encountered clients in the past who had developed some of these statements and policies but viewed them as static forms.

These clients were missing the opportunity to assess whether their spending was truly aligned with their overarching money goals. Other clients didn’t at first understand how these statements and principles fit together. Individually, these tools are useful. But when used together and treated as living documents, they create a powerfully integrated approach to intentional spending. Collectively, these tools allow clients to take charge of their financial lives—and their personal sense of well-being—as never before.

In the hands of a CEO, the profit and loss (P&L) statement tells a story about what was important, what was accomplished, what went wrong and where opportunities lie. A personal income and expense statement is similar to a P&L statement.

Doug and Miranda are like many who kept close tabs on their expenses when they were younger, but loosened up on their budgeting as money became more abundant. This meant they have lost access to important information about their spending patterns and insight into the values those patterns reflect. Catherine reminded Doug and Miranda of the maxim “Show me your checkbook, and I’ll tell you your values.” By creating an income and expense statement for a year, Doug and Miranda can more clearly see what values have been driving their spending.

Clients who start tracking their expenses anew often find they’ve been spending less on things they deem important and more on categories that don’t seem so vital. The point here is not to create judgment, but to bring awareness, which opens up a greater range of intentional choices. Some will see no need to adjust, while in others the exercise will catalyze a deep evaluation of priorities and commitments.

• Start tracking now (perhaps using personal finance software).
• Don’t feel you have to capture things perfectly. Stop at “good enough.”
• A bookkeeper can help you reconstruct your last year’s expenses.
• Create broad enough categories that you don’t have to be too detailed but enough categories so that you don’t end up with a large “miscellaneous” number.

To inform their current plans, CEOs look at both historical performance and strategic priorities for the business. Individuals can similarly operationalize their priorities by assessing the current state of spending and by identifying core values that will guide spending, which are tied closely to the wealth purpose statement.

1. The statement of principles

The statement of principles distills the core values articulated in your wealth purpose statement into actionable ideas that will guide your use of money, including spending and investing. This statement should consist of four to six easy-to-remember directives. Some examples include: “Invest in experiences, not things,” “Think before you buy,” “No family gifts without skin in the game.” Your principles should be your own.

2. Investment policy statement

Your spending decisions should be linked closely to your broader investment approach. We suggest using the wealth purpose statement and statement of principles to develop an investment policy statement (IPS), which will in turn guide your investments. In your IPS, you will articulate your investment goals and objectives and the approaches your investment advisor should employ to meet these objectives.⁶ The IPS should also address matters such as the investment time horizon, target asset allocation, risk tolerance and liquidity requirements, benchmarks for measuring returns, and the periodic review and modification of the statement. It might also include directions about the environmental, social and governance (ESG)⁷ practices of an investment and socially responsible investing

3. Spending plan

A spending plan draws from all the exercises and tools mentioned. Starting with the income and expense statement, the spending plan includes an additional column labeled “anticipated.” Put amounts next to each category that reflect your re-evaluated spending priorities over the next year. These amounts should derive from careful analysis of your prior year’s income and expense statement, your wealth purpose, principles and investment policy statements. We suggest you carefully review these new numbers again, to make sure they align with your true priorities, and to ensure you are putting your money where your heart is. Discuss how this plan reflects your investment in the personal, family and social dimensions of well-being.

At minimum, a balance sheet provides a snapshot of assets and liabilities. In the corporate world, the balance sheet is a critical tool for planning and examining the deployment of financial capital over time. Many individuals don’t have a robust balance sheet that allows them to engage in deep analysis about their progress toward their most important goals. Unlike a simple financial analysis of assets and liabilities, as you put together a balance sheet, you might also include your intangible wealth,⁸ corresponding to the different forms of well-being noted earlier. Intangible wealth can include individual capital (the growth and development of individuals in the family), family capital (the strength of the culture of the family as it learns together and prepares for the future) and social capital (the impact the family has on the world).