One of the most common pieces of financial advice that you’ll hear is to create a budget – and then stick to it. It’s one important step to gaining control of your money. But, in many ways, budgets are like diets. They involve discipline and self-deprivation, and neither of these things are fun. Thus, most budgets end up failing, just like most diets end up failing.
Today I want to talk about budgeting strategies for those of you who, like me, hate budgeting. For starters, I want to remind you of a strategy that I’ve dubbed “reverse budgeting.” This is the strategy that we’ve used for years, and it’s been great. It’s both easy to set up and easy to maintain. Here’s what I’m talking about:
Instead of setting up a detailed budget, complete with projections of how much we’re going to spend in particular categories, we have predetermined (and rather aggressive) savings goals. Beyond that, we mostly let the chips fall where they may. Of course, we also have a few other targets (like giving a prescribed percentage to charity). But, for the most part, as long as we’re hitting our savings targets, we don’t really worry about the details of where the rest of our money is going.
If you do decide to go this route, I encourage you to start by sitting down to define some goals and run the numbers. What are you trying to achieve? How much money will it take to get there? And how much money can you commit to setting aside?
If you’re not sure how much you need to be saving, then you might consider following (or aspiring to) something like “The Balanced Money Formula, ” which is outlined in the excellent book “All Your Worth: The Ultimate Lifetime Money Plan” by Elizabeth Warren and Amelia Warren Tyagi.
The Balanced Money Formula is based on your net (i.e., after-tax) income. According to the formula, you shouldn’t be spending more than 50% of your net income on “needs” (such as food, housing, utilities, basic transportation, and so forth). Obviously, the less you can spend the better, but let’s just stick with that 50% for now.
Next up, “wants”… You can spend up to 30% of your net income on this category. This includes all sorts of discretionary items, including things like entertainment, vacation travel, dining out, clothing beyond the essentials, etc. And yes, even things like cable TV and internet service should be included here. These things may seem essential, but they’re not truly “needs.”
And finally, savings… You should be saving/investing at least 20% of your net income for future needs. Note that I would recommend inverting the order here, and ranking these as follows: (1) needs, (2) savings, (3) wants. By re-ordering things, you protect against overspending on wants and leaving too little for savings.
Okay, now that you have goals, here are some tips for making them a reality:
Automate your savings
From here, I recommend automating your finances at least to the point where your savings and investment contributions are automatically deducted up front. That way you won’t slip up and forget. And by taking out the money up front, you won’t be tempted to spend it. Out of sight, out of mind.
Save (part of) every raise
In the future, as your income rises, simply commit to setting aside a a fixed proportion of every raise to increase your investment contributions. For example, when my wife and I were first getting started, it was a stretch to save 5% of my income – but we did it. And from there forward, we added at least half of every raise to that amount.
A year into my job, when I got a 3% raise, we bumped our savings up to 6.5% of my (now higher) income. A year after that, I got a 4% raise, and suddenly were were saving 8.5% of my (now even higher!) income. And so on. The beauty of this approach is that you won’t miss that extra money since you didn’t it in the first place.
Consider using separate buckets
Depending on the nature of your goals, you might benefit from splitting your savings up into multiple “buckets.” For example, you can stash you emergency fund in a local savings account, save for multiple near-term goals in dedicated sub-accounts at ING Direct, save for longer-term (but pre-retirement) goals in a taxable brokerage account, and so forth.
But don’t overdo it. The whole point of this exercise is to get you away from the tedium that will drive you to abandon your budget. If you streamline the front end but make the back end too complex, you’ll throw in the towel when the novelty wears off. In other words, make your system as complex as it needs to be, but no more so.
Don’t spend money that you don’t have
Finally, for this “save first” approach to work, you cannot spend money that you don’t have. Yes, it’s fine to use credit cards – we do so all the time. But you cannot allow yourself to carry a balance. If you do, then you’re not truly saving as much as you think you are, and the whole system will crumble.
What’s up everybody, here every one is sharring these familiarity, therefore it’s
good to reasd this web site, and I used to go to see this
website everyday.
Wish I read this before I took my vacation! Guess I have to practice some self-control next time and ingrain this article into my cerebrum. 50,20,30…got it!
I am not crazy about budgeting but we do have our method that works for us and we have savings, strong credit and feel good about the future. I know that we need to be more aggressive at some point as insurance for our future and to help our kids but right now we feel pretty good.
You can do budgeting on a conceptual level. Budgeting is for saving and investing. You always save when you save before you spend. You seldom save when you spend before you save. We all know that we must live within our means and spend less than we make.
If you follow this, you don’t need budgeting. That covers just about all personal finance. Very few people consistently follow budget. Some use elaborate spreadsheets and databases. They quit following their own budget a couple of months later.
Heather: If you can generate an accurate budget, and IF you can stick to it, then I’m sure it would work quite well. But the majority of people can’t and/or don’t. For them, a reverse budget type of approach makes sure that the saving/investing gets taken care of. In the end, any system is only as good as the implementation.
From my own perspective, I don’t think it would make much difference – other than I’d be exceedingly unhappy reconciling a budget every month. Yes, if we generated a super tight budget, we could save/invest more than we do. But we could achieve the exact same thing by setting our saving/investing goals higher and having less left over for the fun stuff – if that’s what we wanted to do. As things stand, however, we’re saving/investing a LOT, and I don’t feel a need to increase that any further at the expense of some of the niceties in life.
Ultimately, I think it all boils down to discipline. Both approaches require it, but in different ways.
BG/Kev: I played around with Yodlee (which powers, or at least used to power, Mint.com) back when it first came out, but having that info out there gave me the creeps. The only account aggregation that I do now is to have Vanguard pull in our Fidelity balances so we can track our investments all in one place. But we don’t aggregate our banks, credit cards, etc.
BG just summed up my fears with Mint. I’ve been trying it out for the last few weeks and have been very impressed with it so far – especially when you consider the price. It’s not a Quicken replacement for me, but I still find it very useful.
With that being said… I feel like I threw the Keys to the Kingdom out there and it makes me nervous every time I think about it. So I will probably be pulling the plug on it soon enough. I don’t want to be one of those people who are “afraid” of the internet, but I’m just not ready to make it that convenient for someone to wreck my life.
Heather) We used to be on a “Ramsey” budget, until we got our stuff under control. I highly recommend people follow his first couple of baby-steps (especially people struggling with debt).
Sian) I don’t trust an online company with accounts and passwords to all of my finances. Double so, for an online company that doesn’t charge for their services, and presumably would have ZERO accountability in case of breach.
If they had an “off-line” tool that does what Mint.com does, I’d trust that tool with my account information (and I’d keep it locked down inside a True-crypt container as well).
I would be interested to see who does better and saves more in the long run. Those with or without a budget. We do a detailed, to the penny “Ramsey” budget every month and it has revolutionized our money and money “fights” in our marriage. I don’t know how people live responsibly without one!
I agree – -budgets are too deprivation draconian driven. I challenge you to use mint.com to see where that discretionary spend is going. Believe it or not the undoing of good intentions happens when the discretionary spend gets out of whack with some of the things you do to live life, create memories etc. The concept is like the latte factor (David Bach). When the money goes blithely to a small joy and causes you to forego a spring break that rejuvenates you, that’s not good either. The reason I love mint.com is that it allows you to bank where its most cost effective and gives you a free tool to monitor where things are going. Your Wanter ™ lurks in that discretionary spend and can prove to be the undoing of what you truly would love. Money is supposed to facilitate living life!
This is exactly how we do it too. We basically ensure all the bills are paid, and treat savings as a bill. We have automatic 401k contributions (withheld in paycheck), and also extra savings via Vanguard (529 savings), and Ally (online savings account). The Ally account is an e-fund++, meaning that has a minimum amount for the sole purpose of emergencies, and then extras in there are pre-allocated for bills that aren’t monthly (like medical, car repairs, property-taxes, etc).
Anything left over after the “bills” are paid is what we live on until the next paycheck. That ‘living’ money is recorded, but not tracked for spending efficiencies.
BTW: that ‘living money’ is roughly 40% of take home pay. Savings are roughly 30% of gross.