One of the craziest things I find out when talking to people about money is how few have a budget. Even the ones who say they keep a budget, often mix up having a budget and balancing a checkbook. I guess this explains why Americans savings rate are so low.
In the last couple decades, I don’t think anyone has emphasized the necessity of having a budget more than the Get-Out-of-Debt-Guy himself, Dave Ramsey. ***Side Note – I have been referencing Dave way more than I ever thought I would in the blog*** The Ramsey team has done a really good job pointing out that a budget is not something designed to restrict your life. In fact, the opposite is quite true. While there are many different definitions of what a budget is, I think that John Maxwell says it best:
A budget is telling your money where to go, instead of wondering where it went.
As mentioned above, I am always surprised by how few people have budgets in their life. The more I think about them, it seems like they can be be separated into 4 main categories:
- People who do not have a Budget and Wing It every month
- People who only Balance the Checkbook
- People with a Defined Budget
- People who have an Ultra Optimized Budget – Had to throw in “Ultra” to make sure you know it’s the Anchorman of Budgets. It’s kind of a big deal.
No budget is pretty self-explanatory. These people are winging it throughout the month not really paying attention to where the money is going. If they run low on funds, they simply whip out one of their many credit cards and hope that it is not maxed out yet. These are the people who find themselves sweating when they pay the bills, and cannot seem to make any headway.
There is another subset of the “No-Budgeters” where their Income/Cost_of_Living ratio is high enough that even if they don’t pay attention, there is still enough room to make it through the month. While not detrimental today, the long term cost of not investing that money will be astronomical.
Balance the Checkbook
The people who simply balance the checkbook are a little more sophisticated than the previous group. They don’t necessarily have a plan for the month but they understand how much money is left at any given time because they are watching the balance in their bank account. This is the group that my wife and I fell into for the first couple years of our marriage while we tried to figure this stuff out. The main problem with this group, is that they can manage to make it by but never end up saving because they are judging all of their spending decisions by what is left in the account.
There are examples where some people will invest first and spend whatever is left afterwards. They are essentially following the balance the checkbook approach; however, I would argue that is actually a form of budgeting (a primitive form, but still defining what gets saved and what gets spent).
Next are the group of people that have a budget with an understanding of what money comes in every month and what expenses have to be paid out. They use this information as the backbone of their budget and then build the remaining money allocation around that. Each expense in the month is accounted for and tracked. Once a specific category is out of money (ie eating out) then there is no more money to be spent on that category. A budget is not meant to be restrictive though, it is meant to define where you want to spend your money. If a category runs out of money and you want to spend more anyways, you just have to choose which other category you are going to spend less in. All we are looking for are conscious decisions on how to allocate this resource.
Ultra Optimized Budget
Finally, you have what I would call the Ultra Optimized Budget. At the surface this is simply a budget; however, these people have invested time into understanding what is important to their life goals and happiness and cut out all of the waste. They try to find ways to optimize their spending and therefore reduce the amount tied up in expenses. This in turn allows them to set aside a substantial amount of savings and propel them into FI at an accelerated rate with minimal life impact. We are not talking about cutting out all vacations and fun activities. Cut out the waste!
To me, the most overwhelming part of the process is that while the fundamentals are mostly the same, there can be some nuances on how to budget. With that said, there is one method that is better than any other… the best budget is…wait for it… one that you will actually follow!
So as you are working on your’s, don’t try and pick the fanciest process that makes it too complicated to maintain. Find the process that works for you and is easy for you to use (even if it is just a pencil and paper).
My wife and I have spent years tweaking our budgeting process and decided we should probably just go ahead and share it here:
- Understand your income. Some people live on straight salary which is very defined with minimal fluctuation month to month. Others are hourly with overtime variations or even commission work which is not guaranteed. If you fall into the second group, you will have to estimate your budget based on what you think it will be and then make adjustments when you see the money hit the bank.
- Note: For this post, let’s stick to take home pay. I will come back at later date to talk more about optimizing various expenses and taxes that occur before the money hits the bank but for now let focus on take home.
- Identify your expenses. Look back on how much you have spent over the last couple months and try to categorize them into Buckets. Here is the list that I currently use:
A couple of things to note from the above. I split our budget into ~18-20 buckets (normally there are some special categories depending on the month ex. birthdays/weddings that need to be added).
Plan for Utilities Based on Season
You do have to be careful with water and power bills because they can swing with the seasons. I generally take the conservative approach and pencil them in for the worst-case scenario and redistribute any extra money later on in the month once we know the exact amount:
Let’s say that our highest power bill of the year is ~$200 during the summer months. I will then use $200 in my initial budget to account for power every month. If it has been a relatively mild weather and the power bill comes back at $150 then I instantly have another $50 to throw into another category like savings, emergencies etc. By doing this, we have found that it becomes a game of “how much can we trim off power this month?”.
Align Your Bills With Your Pay
Another take away from above is that we run our budget on a monthly basis because that is how our bills cycle. If you start trying to break it down by week, it becomes very complicated depending on which bills are due.
THE SIMPLER YOU MAKE THE PROCESS THE MORE LIKELY YOU WILL SUCCEED.
I cannot stress this enough.
We actually get paid twice a month but that does not dictate how we access our money. We have two checking accounts setup so that when our middle-of-the-month check comes in, it goes into a separate account in order to keep it from being spent. Then, when we get to the last day of the month, and our second check arrives, we combined both checks together into the account that we are actively spending out of (this sounds more complicated than it is so I added a picture below). The second account is tied to our debit cards and all of our auto-drafting. By doing this, we start with a full month of income all in one spot so that it does not matter which day a particular bill hits.
As long as an expense is represented in the budget, it is accounted for in the bank at the beginning of the month.
This freedom allows us to focus on other more important things in our finances. As we go through the next month, and we once again get the mid month paycheck, it goes into isolation in the backup account until the end of the month where we combined it with the end of month check and continue the cycle. This method requires a little upfront work to get setup, but once it’s in place, there are no more worries about which date a bill will hit.
What are Food Weeks?
The third topic I want to touch on is how we handle food. We break down our food budget into “food weeks”. We did this because we have found that food is the most difficult category to manage on a monthly basis. We would eat like kings for the first two weeks and then struggle to scrape together food for the last two weeks (on the worst months we would actually dip into savings just to buy a few essentials). That was not sustainable. By splitting it into weeks it is a lot more manageable. It also aligns with our food shopping patterns which generally fall on the weekend.
We loosely follow the $2 rule which is trying to budget two dollars per person per meal per week but we tend to load up the first week a little heavier than the others due to the fact that we buy some items in bulk from Costco that will last the month.
Once you have all of your expenses laid out, start to determine what your essentials are, you will learn to spot room to tighten down. This process will take a couple months to refine and you will underestimate some categories and overestimate others. As this occurs, keep notes and adjust. It is not critical to get it perfect the first time. Do not let perfect get in the way of good because then you will never start. Focus on getting incrementally better as you understand your family’s needs. Once you have a working budget, then start tightening down the categories and throw the remaining into savings or your more prefered buckets.
Eventually you will see patterns of waste such as paying to have Netflix, Hulu, Disney, etc all at the same time. Who needs to watch that much TV! Not only is it wasting your precious time, but once you are caught up on your shows you are paying to wait for new releases. If instead you kept one of those channels for a couple months and then swapped to another, you would save money and allow them time to generate more content before you come back.
You will realize that you can eat just as well for a significantly reduced cost if you simply do a better job meal planning. Buy things that you use often and don’t expire quickly in bulk. Also, adjust you food plan based on in-season produce and weekly sales. I am serious. We do our shopping for the week all in one trip and taking 45 minutes to plan ahead of time saves us a couple hundred dollars a month.
Ditch things like a landline, cable, and subscriptions to magazines you don’t read!
We hope you found this information useful and picked up on our not-so-subtle messaging! Here is a quick snapshot of how our budget looks. Visuals like this pie chart can also help you reflect on where your biggest buckets are and help to challenge where your money is really going:
What are you thoughts? Do you have some budget tips and hacks?
Until Next time, continue to Choose Beta