YourMoneyNumbers: Budget

The YourMoneyNumbers: Budget topic is the second in the YourMoneyNumbers (YMN) series. For more information on the YMN series click here.

Budget – the big B-word of personal finance. Some people love and embrace it, but for most of us, the budget is a BIG obstacle. A lot of times this is because when we budget we come face to face with all of our spending habits – some of which we may not really want to own up to. If your current budget status is “on a break” or “it’s complicated” – I hope this article gives you a few ideas on how to reacquaint yourself with making and keeping a budget. If you are an avid budgeter – I hope this post gives you a couple of calculations to better understand how well your budget is balanced.

Also – for any of you who have been turned off from someone telling you exactly how you should budget – have no fear! I don’t have any plans to tell you exactly what or how you should budget for your life – that’s totally up to you. I do think taking a good look at your budget (at least periodically) is essential for your financial health. This post will give a few approaches to consider – so you can see what might work best for you.

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Why Have a Budget?

Budgeting is often thought of as a constraint and – if you are currently facing some serious financial hurdles – certain budgeting techniques can really help you regain control of your spending habits. I also like to think of budgeting as a way to relieve some financial stress in your life. Budgeting is having a plan. You are aware of how your money is being spent each month and what types of expenses & goals are being met. Once you’ve demonstrated that you can live by your budget—it can become a form of freedom. Once you have worked a plan to achieve a financial goal into your budget, you don’t have to worry or chide yourself on other areas of spending – because as long as you stay on track – your financial goals will be met. If you are tracking your performance against your budget – you will quickly see if you have gone off-plan and you can respond accordingly.

Do You Have Any Budget Warning Signs?

I’m a firm believer that everyone can benefit from having/knowing their budget, but it is especially important if you have any of the following budget warning signs. Be aware of your personal situation. If these are happening to you – figuring out why they are happening may help you choose budgeting approach more suited for your needs.

Late Bill Payments

Late bill payment penalty fees can be very costly. There are a few key areas of your budgeting approach to which you should pay attention if you find yourself in this situation often. Are the late bill payments due to a lack of funds in time for the payment or because you forget to pay the bill on time? If due to the first – build up a buffer in your checking account to help cover large bills that come due early in your paycheck cycle. If the latter, automatic payments or a budgeting approach that focuses on when your payments are due may be the key to saving you many a penalty fee.

Overdrawn Accounts

Overdrawn accounts can be a double whammy when it comes to fees. You can get hit with a fee from both the billing company and your own bank. If you are experiencing overdrawn accounts, cash flow management is key. Are you overdrawn because you just generally spend more than you make? Do you spend within your monthly budget, but spend too much in the first half of the month before you’ve received your second paycheck? If your account is not technically overdrawn, are you depending on your high-interest credit card to bail you out at the end of the month? These are all signs that some work on your budget is needed.

Not Making Progress Towards Your Financial Goals

Are you capable of managing your cash flow each month, but just can’t seem to save or make progress on some of your long term financial goals? First, I think it is important to acknowledge reaching this point – especially if it took a good deal of work and discipline to live within your means. Great job! Once you have learned to live within a basic budget – it is much easier to start to work in more advanced financial goals and have success at achieving them. Can you trim spending in one area to boost another? Can you earn more income in order to speed up your ability to meet that goal.

No Warning Signs – Great! – Does Your Budget Reflect Your Values?

Do you think that you have budgeting down? You are in control of your cash flow and all of your financial goals have a place in your monthly budget — so you are all set right? The advanced budgeter goes beyond this to make sure that their budget truly reflects their values. If giving is really important to you – do you believe the percentage of your budget you spend on giving versus other categories reflects your values? Are there any areas of your spending that just seem really out of step with what you care about? For example, if you say you value your health, but are unable to spend on some exercise classes that you have been wanting to take. Is there another area you are spending money on that is less important to you? Once you are this self-aware of your budget—and are taking steps to align your spending with your values – you will likely feel really good about where your money goes each month.

It All Comes Down to Cash Flow & Meeting Your Goals

I Don’t Have a Budget – Where to Start

The first place to start is to track your income and spending in detail. Do whatever you need to do to make sure you capture all of your spending outlays. If you use cash – keep notes as to how you spent it. If you use credit cards (hopefully only for points, rewards, warranty benefits, etc.) or debit cards – make sure to collect the statements. The key here is to make sure you actually account for all of your income and all of your expenses. Do this for at least a month before you revisit your budget. It is far more effective to look at your budget from a position of what you are actually earning and spending instead of wishful thinking.

Once you’ve been following your spending for a month, it is time to pull together your budget. Some people use a simple pen/paper and others use online tools or app (be aware they may not capture everything). I personally am a fan of an excel spreadsheet. I’ve included a sample budget below – it is a sample budget for a couple (I used an above average earning couple to amplify a variety of categories/line items of spending). You should make categories that make sense for you.

Some helpful tips:

1. I include a frequency of payment – doing this reminds you of the quarterly, semi-annual or annual expenses you may face. By including these as a line item, you can estimate what you will need over the course of the year and then estimate the average monthly expense.
2. Subtract your expenses from your income – if it is positive and you have really accounted for all your typical expenses – you have a little bit of buffer that you can put towards your financial goals. If your average monthly cash flow is negative – that means you are in the red and likely eating away at any savings you may have accumulated in the past or taking on additional debt. A key goal would be to modify your spending to bring your expected monthly cash flow into the positive.
3. I’ve categorized expenses with income taxes, debt repayment, and savings separate from spending. This can be useful to look at – as we will explore later.
4. I have included a column where I have coded each non-income tax expense as a Need, Want, or Savings. If you don’t like to target goals for spending in a specific category, some people advocate focusing on keeping your spending to about 50% needs, 30% wants and 20% savings. In our sample budget, I would ask if we really need 73% of the line items or if some may really be wants that could be trimmed in tough times. If they were truly needs, I would focus on working to eliminate some of those expenses over time so that less of our budget was required to meet the monthly needs.
5. I create spending allocation by category chart that looks at each line item as a percentage of your overall budget – even if you don’t adhere to strict spending guidelines by category (I most certainly don’t). Take a careful look at your spending allocation table – are there any surprises? Do the percentages spent on each category meet your expectations and align with your values? If not, think about how you would like to adjust these moving forward.
6. If your income less your expenses is negative – check out the next section. In this sample budget, the difference between income and expenses is positive, so no major re-planning is required at this stage.

I’m In The Red!!! How Do I Get Cash Flow Positive?

When you calculate your cash flow and it is negative — the first step is to stop the bleeding. Time to start living within your means. It is near impossible to start taking the steps to really work on your financial health if you are constantly operating at a deficit. This step is probably one of the more “painful” ones of the process because it may take a bit of sacrifice to change your habits; however, it is also the most powerful. Once you are able to live within your means, you can start making choices to improve each area of your financial health. Remember – in this topic we are talking about your regular cash flow being positive. It is in the YourMoneyNumbers: Debt topic where you address paying down the debt you have already accumulated.

First – do a little analysis of your budget breakdown – ask yourself these questions:

• Are your “want” categories too large of a percentage of your budget – remember the recommendation is to keep it to about 30% of your spending – assuming you’re not exceeding your monthly income. It is time to be honest with yourself – if these are wants – how can you eliminate them from your budget until you are reliably able to live within your means.
• Are there other ways you can save money in your spending – coupons, meal planning, cooking at home instead of eating out? Only you know the major spending areas in your budget, but you can Google or search on Pinterest for a ton of ways to save money.
• Are you paying beyond the minimum payments on debts – while still accumulating debt? Obviously, I’m a big fan of paying off more than the minimum payment on high-interest rate debt, but not at the expense of accumulating more high-interest rate debt. Calculate your cash flow with the minimum payments and then if you have “extra” save a modest emergency fund of $1000 (if you don’t have one) and then use a “debt-snowball” or “debt-avalanche” approach to figure out where to put the extra part of your monthly cash flow.
• Can you increase your income to turn a deficit into a surplus? Are you able to work overtime or a side-hustle to make your cash flow situation positive?
• Are you “saving” money while also losing money each month? If you are putting money into a savings account while also exceeding your means each month, you may be giving yourself a false sense of security. If the money doesn’t actually stay in your savings account it doesn’t count as savings. Also – if it does stay in the account – but you are accumulating high-interest rate debt (I say higher than 5-6% though everyone has their own opinions on what “high” means) – no savings account and very few other investment options will outperform that interest rate. We will discuss how to balance saving versus debt repayment in the YourMoneyNumbers: Debt topic. For now, it is important to get a realistic budget that does not increase your high interest rate debt. Do not dig the hole any further!!!

Savings Rate

If you have a surplus in your budget, congrats! Have you ever calculated your savings rate? It is one of the most important numbers to maximize in order to solidify your financial health and predict how quickly you will be able to achieve financial independence. When you save more – it means you are actually living on a smaller portion of your income. Many people encourage you to target a 20% or greater savings rate.

Now some of you may be thinking – here she goes – telling me to save 20% of my income when I have trouble making ends meet as it is. I guess my message is – if you can get in the habit of saving something – anything – while preventing yourself from going further into debt – you have started a habit that can grow over time. This is the whole principle behind “paying yourself first” and “automated savings”. For one – smaller emergencies can then be managed with savings instead of taking on debt, or even worse not really being dealt with at all and then facing the ramifications (example: broken down car that leads to job loss because you were unable to get to work). Secondly, once you see the savings grow – it is a line in your budget that you can make a financial goal. If you receive a raise, windfall, tax refund – take a portion of it to beef up your savings rate.

Does a 20% Savings Rate still seem unattainable? Good news! It may be more achievable than you think. Here is a breakdown of the sample budget we used above. The savings rate is doing pretty well at 17% (includes emergency savings and investments); however, look at that debt repayment rate at 29%. Imagine if you kept the spend rate where it is now, but paid down all that debt. Once the debt was paid off – those payments that were in your monthly budget could now go towards saving. The key is to not continually inflate your spending.

Do you really need to save this much each month? Check out this post by Mr. Money Mustache. A savings rate of 10-15% is conventional wisdom that supports a traditional retirement timeline if you started early in your career saving at that level. If you are behind or want to reach financial independence earlier – a higher savings rate is recommended.

Budgeting Tricks and Techniques: Find Ones That Work For You

Automation

Pay Yourself First

I’m a big fan of starting a savings/investing habit where you pay yourself first. Treat your savings like any other monthly expense. If you are just starting out – it is easier to set aside this money now before you build up spending habits. I’d set a goal of a minimum of 10% of your income. For those of us who have already established spending habits without a savings habit, you will have to build it up over time. Try to cut extras out of your budget to increase your savings rate. Start at 1% and once you get used to that, up it to 2% and keep increasing it until you meet your target 20% (or higher if you are chasing goals like early retirement). What seems like small differences at first end up making a huge difference in your financial health in the long run.

Checking and Savings Account Management

If you have a problem with overdrawing your account or not being prepared for irregular bills, there are a few tricks that may help:

Checking Account Buffer

Build up a buffer in your checking account so that the receipt of your bills versus your paychecks is not a concern. Until you have that buffer, you will need to ensure your budgeting method vigilantly tracks the timing of your payments to ensure that you never overdraw your account or pay late fees on your bills. A good target would be to work aggressively for $1000 buffer and then over time build it up to about a month’s worth of expenses.

Sinking Funds

Typically, it is easy to remember to budget for monthly bills; however, quarterly, semi-annual, annual bills might be forgotten and then they are a “surprise”. A sinking fund is a way to allocate a portion of your monthly budget for an expense (typically a larger one) that is paid less frequently. Take a look at things like your tax bill, insurance premiums, dues, subscriptions, etc., that are paid on an irregular basis. Take the total and divide by either the number of pay periods or monthly (whatever makes sense for your budget) and put that amount aside in a separate savings account as a sinking fund (might as well earn a modest amount of interest and have it out of the checking account so it is less tempting to spend it before you need it). When the bill comes due, you already have set aside the money for it and you have considered it in your monthly budgeting. I personally have a few sinking funds set up – one covers my taxes and life insurance premiums (due semi-annually), a vacation/gift fund (don’t let holidays surprise you or derail your budget), and a kids’ activity fund (karate, summer camps, extra-curricular activities, etc.). I don’t count my sinking funds as savings (as I plan on spending that money – just at a later date) and it makes it so I set enough aside that when those costs come due that I have the money available.

Motivational Techniques:

Plot Income and Expenses Versus Time

So now that you have a budget – you should spot check how you are doing each month. One way to do this: each month simply plot on a chart how much you earned in income using one color and how much you spent in another color. If your income line stays above your expenses line, you are in a position to save or invest. If you are committed to paying yourself first, I still include my “savings” category in your expenses tally. By doing this, any difference can be used to pursue new financial goals that have not yet been worked into your budget. This technique provides you the feedback each month to keep your spending in check.

Track Savings Rate Over Time

If you track your savings rate – you can work toward increasing it to higher target levels over time. Your savings rate is one of the biggest factors in determining how quickly you can achieve financial independence. Try to make it that your savings rate never declines over time.

Using Cash Envelopes (or an electronic equivalent) for variable expenses

It’s been shown that people tend to spend less money if they actually have to part with the physical cash. One technique (advocated by Dave Ramsay and others) is to have cash in envelopes that are designated for a category. Once an envelope is empty – you are out and cannot spend additional funds in the category. There are electronic versions of this as well, but the real die-hards would not recommend those as you don’t get the same negative feedback from spending your actual cash. I think that this approach makes a lot of sense if you really need or desire to get your spending habits firmly under control and you need them to be at the forefront of your mind at every transaction. Obviously, there are a number of drawbacks – carrying cash around at all times, dealing with how couples manage who holds how much cash, some vendors don’t accept cash, etc.

Read Personal Finance Books or Blogs

If you want to transform the way you think about money, read a lot of different people’s perspectives. All their ideas or approaches may not resonate with you, but they may make you think about things differently. One book that really got me thinking in a different way would be Your Money or Your Life by Vicki Robin and Joe Dominguez. This book makes you look at your spending and your money in a different light – the hours of your life. Their “no-budgeting” method of budgeting has you calculate your spending in terms of how many hours it really took you to earn the money you spent and then evaluate how you felt about spending that money. Was the really nice pair of shoes that you will only wear a couple of times worth the full day of work it took you to earn the money to buy them? The book has been around for a long time, but was recently updated. It may be a good read for someone really looking to make financial or life changes and it includes a very detailed approach.

You can also check out the Quantify Financial Library and Resources page; I will be adding other reference books in the future!

Summary

1. Assess your cashflow. Find out if you have a surplus or a deficit.
2. If you are at a loss OR have new financial goals you want to fund – take steps to get cash flow positive or increase your surplus (then add those new goals into your budget).
3. Apply the budgeting tricks and techniques that work for you to optimize your monthly choices.
4. Give yourself a break you have a tough month or make a bad choice. You are doing better than if you were not paying attention to your budget.
5. Revisit your budget regularly:
   • weekly or every paycheck if you are really struggling with spending;
   • monthly if you are able to adhere to your budget and want to monitor for any blips;
   • quarterly if you have automated savings for most of your financial goals and have enough buffer to not have to worry about overdrawing your accounts.
6. Let the budget carry the financial stress rather than cause you financial stress. Know that by working to your budget you are consciously making choices that are working towards your financial goals.

Remember this is your budget – your priorities – you just want to make sure that your budget is healthy and serving your financial goals.

Let’s discuss your budgeting ideas in the comments below.

Click here for the collector post of all the YourMoneyNumbers Topics.

For other useful resources, check out the Quantify Financial Library and Resources page.