Budgeting: Putting the Pieces Together

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Budgets are like a puzzle. You have a finite amount of money, regardless of how much you earn. You need to figure out where each piece of it is, and should be, allocated. It’s an honest look at your spending and saving rates. Many people have a negative attitude towards budgeting, thinking that it’s restrictive, time consuming, or unnecessary, but a budget is really something positive. It’s a tool to help you get where you want to be one day.

DWM works with clients to create custom financial plans. Why is that so important? The CFP website says it perfectly: “Creating a financial plan helps you see the big picture and set long and short-term life goals, a crucial step in mapping out your financial future. When you have a financial plan, it’s easier to make financial decisions and stay on track to meet your goals.” These plans help you define and quantify your goals. They’ll help you identify how much you will need to save to make these goals.

To create a realistic plan, one needs realistic numbers. One of the most important figures in all of this is the amount of money you spend, since the more you spend the less you have to save. Remember, you have a finite amount of money. Some people like to know exactly what they are spending, and we have clients that have created Excel budget spreadsheets that detail their spending down to the penny. On the other hand, some people don’t think about their spending (or live in denial about it) and have no clue. But burying your head in the sand doesn’t change reality. The money is still being spent whether you’re aware of how much you’re really spending on discretionary items vs saving for goals like retirement, or not. It’s better to face things now when you still have a chance to change your spending habits, and save to meet the goals that are important to you.

For DWM to provide you with a meaningful plan, we need solid numbers on your spending. So if you’re not currently tracking where your money goes, here is some advice to get you started:

  1. Take a look at your current spending. This is the part where many people stop before they get started because many budget worksheets contain 50+ categories. Trying to classify and tally everything into that many categories is daunting and time consuming. Instead, download a full year’s worth of transactions from your bank accounts’ and credit cards’ websites to an Excel spreadsheet, and sort by category or description to get an idea of where your money is really going. Label each category as Fixed, Goals, or Flexible according to the guidelines below in step two, and figure out what percentage of your take-home income each of the three composes. For some people there will be surprising or depressing revelations, but don’t be dismayed. You can take control of your spending habits. Now you’re ready for step two.
  1. Set goals and adjust your current spending accordingly. A good, easy to follow guideline is to divide your total take-home income 50/20/30:

–  Fixed expenses such as home, student, and car loans, utilities, insurance, memberships, and other expenses you are committed to and don’t vary much should make up 50% of your budget at the most.

–  Financial goals such as retirement, saving for college or a down payment on a vacation home, building an emergency fund, and paying off credit card debt should total at least 20%. (Note that you may be saving more towards retirement goals than reflected in this number because it only includes take-home income, and 401k contributions are deducted before your paycheck is deposited. For more on the ideal saving rate, see Brett’s recent blog.) For our clients, this is where a financial plan from DWM really helps you to know how much to allocate each month to meet your goals. Of course, we also review and offer our advice on fixed expenses and flexible spending as part of our comprehensive financial planning process.

–  Flexible spending makes up the other 30% (or less). This includes things that usually vary month to month like food (both grocery shopping and dining out), hobbies, medical costs, entertainment, shopping, gifts, etc. This portion may be spent on whatever you want or need, as long as you stay within budget.

This guideline is proportional (it uses a percentage of your income for each of the three categories), so it is scalable for all income levels.

We strongly suggest setting up automatic payments/contributions for the fixed expenses and financial goal categories. You will save time, avoid missed or late payments and contributions, and it can help keep your flexible spending portion in line. If 50/20/30 is a big change from your current spending and you are having a hard time cutting your fixed or flexible spending, start with adjusted percentages and continue to make small changes until your budget is in line with your goals. Monitor your actual-vs-budgeted spending monthly to see if your actual percentages are in line with your budget. Once you are consistently finding your percentages are where they should be, you can move on to step three.

  1. Re-evaluate as circumstances change. For example, if you receive a raise or bonus, your mortgage increases, decreases, or is paid off, you buy a new car or pay off an existing loan, when you are no longer saving or paying for college, etc. Otherwise, if you are making all your fixed expenses and financial goal payments/contributions without running up debt from flexible spending expenses, you know you’re doing fine and don’t have to track expenses each month.

So, look at how your income is being spent and be honest with yourself. With DWM on your team, you can develop a budget and make sound financial decisions that help you meet your short and long-term goals. Please contact us to update your plan or learn more about budgeting, saving, or our comprehensive financial planning process. Your future self will thank you.