I hate being told what to do. It’s just part of my makeup. If you have a great idea for me, something that would change my life, but frame it as something that I need to do, it won’t go over too well with me. I don’t need to do anything. But present it as a suggestion, and I’m all ears. Then I can consider your idea with an open mind and see if it really does have merit.
I look at budgeting in the same light. In its most common form, a budget restricts how you can spend your money. You set aside X dollars for eating out, and once you’ve hit that limit, no more eating out for that month. Seems a little silly and doesn’t work for me. If we happen to go over the “budget” for eating out one month, we’ll make up for it by spending more weekends at home the following month. We like to be boring anyways.
A Better Way to Budget
I believe some form of budget is necessary for everyone. It serves as a plan for where you want to go. With any goal, if you don’t lay out a plan for how you’re going to achieve it, it’s just not going to happen. Goals without a plan to achieve them are just dreams.
My budgeting system is flexible, yet purposeful at the same time. The goal is to determine my monthly cash flow and find out how much I can save each month. My budget allows me to easily accomplish this by spreading out big one time expenses throughout the entire year. That way my budget doesn’t go into disarray when those large bills come due. I’ve used this system for the past 10+ years and it has served me well. Here are the basics.
Step 1: Determine Your Average Monthly Spend
We utilize credit cards for everything possible. It makes tracking expenses easier, provides more protection than cash, and you earn rewards. All of our variable spending and any fixed monthly expenses we can charge go on our credit card.
You’ll first need to track your expenses for 6 months. Calculate the average monthly spend for groceries, gas, household items, etc. Add in recurring monthly charges that are billed to your credit card. Utility bills, cell phone, internet, regular monthly donations, etc. This is your average monthly spend on your credit card. Some months you’ll go over, other months you’ll be under. More on that later.
Add to your monthly credit card spend any reoccurring charges that hit your bank account. This could be debt payments, check to the cleaning lady, etc. Now you have your average monthly spend.
Step 2: Determine Your Savings Buckets
On a monthly basis, you’ll want to save for big one-time expenses. This spreads the expenses out evenly throughout the year and helps you maintain an even cash flow. I have a savings account for general savings that is linked to my checking account. I track the balance in Excel so I know what I have saved up for. Picture something like this:
For instance, if I budget $4,800 for vacation this year, I will plan on transferring $400 to my Vacation bucket within my savings account each month. This can easily be done by setting up an auto transfer from checking to savings each month. That way a balance builds up evenly throughout the year. When I buy airfare and hotel for the vacation on my credit card, I draw from this bucket to fund it. This helps smooth monthly expenses so my cash flow holds relatively steady each month.
Step 3: Calculate Your Monthly Excess
As someone focusing on saving for retirement, you’re going to be living well below your means, right? In Step 1 and 2 you calculated your monthly cash outflow. This includes variable spending such as gas and groceries, fixed payments like your mortgage, and large one-time expenses. Subtract this total from your monthly take home pay and you have your excess cash flow. What to do with this cash? Your entire excess cash should be invested according to your investment plan. Currently, my monthly excess goes into Wealthfront and Fundrise. These transfers can be automated if you have a consistent investing plan, which makes the process easier on you.
Step 4: Plot Your Cash Flow
In an Excel spreadsheet, start with the current balance in your checking account. Then, plot out your upcoming income and expenses, as well as transfers to your savings buckets. Utilize the average credit card spend you calculated in Step 1 and add in your other expenses that are charged directly to your bank account. And finally, throw in each payday. It will look something like this:
Step 5: Manage Your Monthly Cash Flow
The goal is to manage your cash flow so you never fall below zero at your low point during the month. The low point will typically fall right after your credit card bill is paid (in full, of course). I try not to have the low point fall below $300, so there’s enough to cover withdraws if need be. I also don’t want it too high as I want to maximize the use of my excess cash. My checking and savings accounts are at the same bank, so it’s easy to immediately transfer money from savings into checking if I need to make a large withdrawal (did someone say Vegas?).
You’ll notice in Step 1 that the calculated credit card spend will include an average of your variable expenses. Some months these expenses will be lower than the average, and other months they’ll be higher. Say you ran up a huge bar tab on vacation forgetting you weren’t at an all inclusive. You find that you’ve spent more than you had originally budgeted for. When this happens you’ll need to borrow from another bucket. For instance, the money you’ve set aside for home improvements. If you can’t do that, then you’ll have to make up for it by cutting into your excess. This, of course, cuts down on the amount you can invest, which we want to avoid if possible.
Vision Without Execution is Hallucination
I like this method because it maximizes your savings. Paying yourself first is a good method to use, but you’re not going to maximize your savings doing it. Instead of investing your excess cash flow, you’ll end up finding a way to spend it.
This method is also very simple to use. I spend a few minutes each week updating our projected cash flow as expenses happen, and 20-30 minutes a month going through our credit card bill. Yes, it takes some self-control to use this method and not go hog wild on your credit card. But hey, we’re adults. No excuses. And if you want to reach FI sooner you’re going to have to put in some work and maximize your excess cash flow into investments and savings.
That’s the vision I have when it comes to maximizing my dollars. But as Thomas Edison said, vision without execution is hallucination. Whatever method you decide for budgeting, here are four important tips to execute your plan:
1) Don’t let big one-time expenses trip you up
I used to hate December from a budgeting perspective because our budget would go into the hole for the month as we spent up on Christmas gifts. Then it dawned on me. Why not budget for this throughout the year? That way when December rolls around, I have a stockpile of cash to draw from and it doesn’t screw up my budget for the month.
2) Use the allowance method for personal spending
The easiest, fairest, and most pain free method for personal spending in a relationship is to use an allowance system. Sit down with your spouse and agree on a reasonable amount for a monthly personal allowance. This amount can be spent however each person chooses. No questions asked. Also utilize a couples allowance which will cover dinners, movies, or anything you do as a couple that costs money. Set up an automatic transfer to savings each month and keep a running balance for how much each can spend. If you go over, know that you have less available to spend the next month. This keeps personal spending in check and cuts down on the biggest source of variability in your monthly credit card bill. My wife and I have used this method for years. Our friends make fun of it, but we’re not the ones arguing over expenses each month now are we?
3) Pay for all expenses with a credit card
This gives you a 30-60 day float for when you have to pay for the expense, it’s easier to track, and you get rewards. One not so minor caveat. Be sure to pay off the balance each month!
4) Calculate Your Monthly Excess Cash Flow
Don’t just settle for the pay yourself first method. How will you know how much to pay yourself if you don’t know the max amount you can pay yourself? Instead of taking money off the top and spending the rest, calculate your average monthly cash flow. Then set up auto transfers to your investment account. The more you save the faster you reach FI.
Readers, what method do you use for budgeting? Share your tips for methods that work well for you. What difficulties have you found budgeting for a couple vs. when you were single? What strategies do you use to overcome them?