Taking Control of Your Money Isn’t Complicated
A large number of individuals and families don’t have budgets, and the reasons are understandable:
- They find tracking details of their spending complicated.
- It makes them feel guilty.
- It takes away their freedom.
- (and various others)
Which is a little unfortunate since the ONLY requirement for a functional budget is simple:
Money IN > Money Out.
Yes, you will need a budget but depending on your situation and habits, you might not need one in the traditional sense. You just need the simplest budget that’ll meet the above criteria and your long term savings goals. I’ll introduce you to my Minimalist Budgeting system plus two optional add-ons that further enhance its effectiveness (but may require further micromanagement.)
The Minimalist Budget
If you’re a typical household living on a fairly stable income (i.e. salary) and housing expenses (i.e. renting or mortgage), then designate your after-tax income into the following 3 categories:
- Housing expenses
- Everything else
Housing expenses should generally be less than 1/3 of your take-home pay. If housing is currently 30-40% of your take-home pay, focus on increasing your income. If it’s greater than 40%, then it may be worth the effort to consider moving into a cheaper home, especially if you’re renting.
Next, decide how much you’d like to save every month for the “Savings” category. Don’t aim so high that you’ll unlikely succeed (i.e. 50%) or so low that it’s meaningless (i.e. 1%). Start with a reasonably low amount like 10% that you can easily achieve; then ramp it up to (ideally) over 20%. In the long run, you’d want to put most of your savings in Investments (especially tax-deferred or tax-exempt IRAs and 401Ks) but a Savings Account is fine when you’re starting out. You’d also want to designate portions of your Savings for paying off high interest debt (if you have any.)
When you’re first starting on your budget, use the following regimen at the beginning of the month or when you receive your monthly paycheck (if you get paid monthly):
- The day when you receive your monthly paycheck, transfer everything from your checking account to savings.
- Then, deposit your paycheck in your checking account.
- Next, pay yourself first. Transfer the % of your paycheck your designated for savings into your savings account.
- Then pay your mortgage, rent, and/or other housing expenses.
- Finally, pay the rest of your monthly expenses and discretionary spending with the rest of the funds in your checking account. Force yourself NOT to tap into your savings account. Try not to use any credit cards right now, even if you have no credit card debt.
- At the end of the month or right before your next payday, transfer what’s left in your checking account to your savings so it starts over at 0 again before.
Once you get the hang of the above routine, you can add credit cards into the mix (assuming you seldom carry a balance) and replace the “savings account” with an “investment account”, but these are beyond the scope of this article and may be discussed in future posts (so stay tuned)!
Add-On 1: The Squeeze Account (aka Emergency Fund)
If you have an unstable income, frequent unexpected expenses, and/or a household member who makes impulse purchases (and you choose to compromise with them rather than laying down the law and forcing them to stop), then designate a “Squeeze Account” to help accommodate short-term but unexpected financial demands.
Start by thinking of your money and other liquid assets as being held in 3 metaphorical “boxes”:
- Long-Term Savings
Each box may contain multiple accounts. For example, Long-Term Savings includes your Savings account as well as Investments, IRAs, 401K, etc. But at a higher level, just think them as “boxes” where your money and assets serving the same purpose are grouped together.
At the beginning of the month, deposit your paycheck into your Checking box (which is presumably empty prior to your deposit.) Transfer a set percentage (say 20%) to your Long-Term Savings. Then, pay your rent or mortgage (plus related housing expenses such as insurance, HOA, etc.) Then pay the rest of your bills and expenses for the month with the money left in your Checking box. If you’ve been disciplined with your spending, you will have some money left in your Checking box at the end of the month. Transfer that money to the Squeeze box. (This is the exact same procedure I advocated earlier EXCEPT you transfer the remaining money into your Squeeze box instead of savings.)
The Squeeze box is where money that you save in excess of your long-term savings goal is stored. For example, if you automatically transfer 20% from your paycheck to your Long-Term Savings box at the beginning of the month but only spent 70% of your paycheck during the course of the month, you’ll have an additional 10% left by the end. You’ll empty your Checking box at the end of the month into your Squeeze box which stores your money for short-term unexpected expenses and impulse purchases (since there may be negative implications of taking money out of your Long-Term Savings especially if they’re stored in Investments or IRAs.)
One of the most common incarnations of the Squeeze box is known as the Emergency Fund. This usually contains several months to several years of living expenses, usually in cash but can also be in very low-risk AND liquid investments. Money here needs to be accessible fairly hassle-free in case of a job loss or other emergency (i.e. unexpected hospital bill, car repair, house repair, etc.)
If your Squeeze box starts to exceed more than a few years of living expenses, then I highly recommend you transfer some of it to your Long-Term Savings, where it’s ideally invested in assets that will keep up with inflation in the long run (or use it to prepay high interest debts.) To put it simply, if you keep your Squeeze fund in cash over the long run, it will erode in purchasing power due to inflation. A large Squeeze box and/or savings goals that are easily met are also signs that you may need to increase your monthly savings goal.
Add-On 2: Your Daily Spending Allowance
This is more akin to traditional budgeting: your goal is to estimate and control how much money you spend every month so you have some left over to save. You should begin by listing every fixed monthly expense you have such as:
- Other Housing Expenses
- Phone bills
- Auto, Health, Life, etc. Insurance
- Memberships (i.e. Gym, Online Video, etc.)
If any of your recurring expenses are billed in intervals less frequent than once a month, then amortize the expense over every month (i.e. a $1200/year insurance policy is equivalent to $100/mo.)
(Yes, some expenses are tax deductible like the interest portion of your mortgage and you’ll receive a tax credit but let’s ignore that credit for now.)
Then estimate your monthly spending on variable expenses such as food, gas, electricity, etc. maybe erring a bit on the high side with respect to your long-term average. Add all of these expenses up and you have your monthly costs. Then subtract these expenses AND your monthly savings goal from your monthly paycheck. What’s left is your “discretionary money”.
To put it simply: Paycheck = Expenses + Savings + Discretionary.
Or: Discretionary = Paycheck – Expenses – Savings.
Suppose you receive $3000 in after-tax income every month. You spend $1000 on the essentials and save another $1000. That leaves you with $1000 in discretionary money.
Now divide your discretionary money by 30 (or the number of days in your current month.) 1000/30 = $33.33 per day in the example. This is a rough guideline as to how much you can spend on discretionary items, impulse purchases, or other “fun” every day. If you go several days without spending any discretionary money, you can combine it for a larger purchase in a single day.
Any discretionary money that is left over at the end of the month should go into your Squeeze box or (more preferably) your Long-Term Savings.
Don’t get too hung over the details here but really understand these principles, especially the simple budget consisting of only 3 categories: Housing, Savings, and Everything Else. Try to use the simplest budget that’ll fit your spending needs instead of micromanaging your spending or not planning it out altogether.