Burn Rate: Turning Down the Heat on Your Finances

By | Financial Planning

In the startup world, the metric “Burn Rate” is often applied to help potential investors look at the viability of a new company. Put simply, how long (in months) would it take for a company to “burn” through all its cash reserves? A startup that’s burning hot and fast might be able to create a huge buzz in its marketplace, but may not have the staying power to manage itself financially through the medium-to-long term of its life cycle.

Burn rate applies to personal finance, too. There are two types of burn rate: net and gross. Your gross burn rate is simply how much you’re spending each month. Your net burn rate is your monthly losses (gross costs subtracted from your income.) A survey sponsored by Mackenzie Investments found that an average Canadian spends $100 of discretionary income in just four days (which works out to $9,125 per year, in case you were wondering.)

Burn rate is not always bad, however. Most people generally want to keep it as low as they can (some analysts suggest as low as 35%), but it’s important to also consider the sources of income. If you are generating most of your income from active sources (ie. your paycheck) – a high burn rate can become very risky. On the other hand, devoting some energy to forming a passive income source (like investments or a TFSA) will divert immediately available funds from your wallet, but generally help protect you against burning up in the longer term as they build security against volatility in your cash reserves.

Most people will try to cut down on their burn rate by making lifestyle decisions about their spending. There’s no one acceptable percentage to shoot for: everyone’s personal financial situation is different. However, do the math and see what’s comfortable for you. Lots of commenters have told us that they would love to build their passive income reserves, if only they had something left at the end of the day to contribute: we recognize this challenge. Starting with the lifestyle decisions you need to make will allow you to build some breathing room, which, when contributed to “slow burning” investments in your financial health, will build up more and more protection against getting burnt out to the bottom of your cash reserves.

“Burning” money on investments in your financial future or improving your credit should not be something you’re afraid to do, as these commitments will likely feed back into improving your burn rate in aggregate.

 

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