You Have Much in Common with Olivia Rodriguez
Day 8. The mechanics of Olivia's financial solution can be your financial inspiration
You do have a lot in common with Olivia Rodriguez! It isn’t that she is 25 and brilliant, works for a hospital, or is a fan of pickleball and GFore clothing. It is simpler than that. She hears about the importance of a budget. Then, like most of us, her eyes glaze over, and she reads something else. You, too?
We are here together at Personal Finance Economics, so I assume your self-selection will keep you with me for another paragraph or two on the words “budget” and how economics-based personal finance fits.
Every household has its financial life when it decides to establish a budget. But where should they start?
The typical approach to defining a budget involves understanding existing spending by categorizing it and tabulating actual costs. Knowing recent spending provides some information about preferences but little about whether the budget is good.
Life-cycle theory helps us judge a budget.
Olivia Rodriguez is our test case. Works in risk management at a large Dallas hospital. She is well-educated, curious, and in need of a path to understand her best budget.
Outgoing
Olivia’s starting point is a listing of monthly expenses. Here is a snapshot of the monthly costs annualized using the expense worksheet tool available in Chapter 1 of the book and this post.
Incoming
How does Olivia’s spending fit her resources and future employment expectations? Today, Olivia has cash assets (bank checking and savings accounts) totaling $7,500. Olivia is 25 years old and has three years of work behind her. She has a decent set of initial assets: $3,500 in a bank checking account, $4,000 in a bank savings account, and $12,000 in a brokerage account. Olivia intends to work until age 70 (46 years total), and her salary this year, $80,000, is expected to grow at a modest rate annually, 2%.
Olivia has every reason to believe she will have a long life and assumes a maximum age of 95. For planning purposes, that is 71 remaining years, 46 years of work, and 25 years of retirement.
Olivia knows her human capital is relatively high, and she wants to plan to leave money to any heirs at the end of life. In today’s dollars, she thinks $500,000 is a good number.
The Economic Solution
A well-oiled economic approach offers Olivia more room to increase her living standard by $7,025, more than 10%! And her new spending choices are hers.
Olivia is just an illustrative case study.
I care more about your solution and the mechanics for you to build your prototype are in Chapter 2 of the book and the last three slide posts in the Start Here series.
This last slide deck, which completes the build-out of a life-cycle model prototype, contains much information. Today’s class notes for you are attached as a PDF.