Four Tips for Successful Budgeting— in Working Years and Retirement

It is rare that we encounter clients whose expenses are so much lower than their incomes that they have no need to consider their monthly budget.  For most of us, we begin budgeting with that first entry-level job out of college or perhaps are forced to evaluate our monthly expenses due to some life change down the road, such as a new house, kids in college, or upcoming retirement.  If/when you find yourself needing to manage your expenses more closely in light of your income, consider the following tips.

• Getting Started:  Take advantage of online or built-in resources.  To effectively budget, you need to have some idea of where your money is going—to mortgage, rent, or other housing costs; to gas, car payments, or car maintenance; to groceries, eating out, or other entertainment; etc.  Setting up a simple spreadsheet and spending a couple of hours with your bank and credit card statements from the past few months can give you a rough answer to these questions.  However, there are several online budgeting tools that can provide insight into how you are spending your money even faster, and many credit card companies also offer an annual “spending report” that categorizes your expenses on a given credit card (though both of these tools may require input and/or review to make sure expenses are properly categorized).  This will help you identify whether and where you need or want to make changes.  Are you staying out of debt and saving adequately for retirement and other financial goals?  If not, you need to choose which areas of your budget to trim and set goals for how much you will save going forward.

• Big Expenses Make a Big Difference:  Cutting small expenses may help your budget, but consider whether you need or want to cut big expenses instead.  Many articles and books on budgeting focus on eliminating small expenses, noting that small changes can add up to significant amounts over time—for example, bringing a lunch to work instead of eating out, making coffee at home instead of getting Starbucks, limiting Amazon purchases to what you actually need, etc.  However, as personal finance writer Bob Veres observes, “Compared with some of the other expenses in your budget, those are nickels and dimes.”  If you need to make significant changes to your spending level, focus on the most significant expenses—e.g. housing and transportation costs.  Choosing a lower-rent apartment or a less expensive house— or perhaps renting out a room in your house— could improve your monthly budget much more than brewing your own daily cup of coffee.  The same goes for choosing a less expensive car.

• Budgeting Methods:  A successful budget doesn’t necessarily entail meticulous record-keeping.  Once you identify where to cut back expenses and establish savings goals, do you need to return to your spreadsheet or budgeting app every month to see how you have measured up?  Not necessarily.  For some individuals, closely tracking their spending in each category might be the best way to stay on target.  However, an alternative method is just to create what budget gurus describe as a “false sense of scarcity.”  If you determine that, to meet your financial goals, you should be saving 10% of salary to your 401(k) and $500 to your savings account each month, you can set up automatic 401(k) contributions from your paycheck and an automatic $500 transfer out of your checking account at the beginning of each month.  Once that money is “out of sight, out of mind,” you can comfortably spend the remainder of your monthly income in whichever category you desire.  Moving the money to savings at the start of the month helps you to create a “scarcity mindset.”  With limited resources, you are forced to prioritize spending and make trade-offs, especially later in the month as your balance dwindles.  As long as you stay out of debt and your checking account balance doesn’t decrease over time, you can be confident that you are staying on budget and progressing toward your financial goals.

• Underestimating Expenditures:  Don’t forget to expect the unexpected.  There are three main types of budget expenses—“fixed and expected,” which occur every month in set amounts (e.g. mortgage or insurance premiums); “variable and expected,” which occur every month but the amount changes (e.g. grocery bills or utilities), and “variable and unexpected,” which occur irregularly with varying amounts (e.g. major car repairs, travel, Christmas gifts).  Individuals tend to underestimate their expenses because they fail to account for the “variable and unexpected” ones, which may only come once or twice per year but often can be significant.  To budget effectively, you should set aside funds monthly for unexpected expenses, in addition to long-term goals.  If the $500 per month that you’re saving outside of your 401(k) is for long-term goals (buying a house, helping kids with college expenses, saving for retirement), make sure that you are saving an additional amount each month to cover the unexpected.  Look at how much you have spent for major car repairs, home repairs, gifts, vacations, out-of-pocket medical, and other significant lump sum expenses over the past two years; divide that number by 24; and transfer that amount to a savings account at the beginning of each month as well, so that it’s available when the unexpected expenses inevitably arise.

Budgeting doesn’t have to be a time-consuming and arduous task.  Nor does it have to steal all of the joy you derive from spending your hard-earned income.  In fact, exerting some discipline over how you spend can make you more grateful for the splurges in your budget when you make them.  You may actually enjoy that Starbucks coffee more if you reserve it as a special once-per-week treat.  You may be more grateful for a spacious house if you lived for a decade in a smaller house first.  If you have questions about how to budget or how much you can comfortably spend and still meet your financial goals, don’t hesitate to give us a call.