Budget. It’s a term that strikes fear in almost everyone at one time or another. But, while many people view investing as the key to financial success, it’s really budgeting that unlocks the door. After all, you need assets in order to invest them.
Because budgeting is so often negatively associated with tedium, denial, frustration and failure, let’s instead discuss how to craft a spending and savings plan. A spending and savings plan is a positive, powerful tool for achieving financial freedom. It isn’t a strict set of rules restricting what you can spend, but rather an affirmative plan based on your own unique values and goals. It helps set boundaries around spending money on what brings you joy, today and in the future. Here are six simple steps to creating one.
Step 1: Know where your money goes. You absolutely cannot start on any meaningful journey without first understanding where you’ll begin. Take an hour to sort through your most recent two or three months of spending to determine where your dollars are going right now. Many people can do a lot of this with just two sets of documents, their bank statements and credit card statements. There’s no judgement here, only data.
Some categories will be easy. You likely already know what you are spending on rent/mortgage, utilities and various other bills, such as Netflix and your cell phone. It is equally important, though, to categorize your variable spending, such as on groceries, eating out, fuel, clothing and entertainment. This will be the most time-intensive step of the process, but also likely the most impactful for pointing you toward productive spending in the future.
Step 2: Take notice. Highlight the amounts in any categories you listed that capture your attention as being outside your expectations or desire. Perhaps you are spending more than you’d like on dining out, or your charitable donations are not as high as you aspire for them to be. Again, no judgement (at least not from anyone but you). Don’t focus on what you think you “should” do, but simply on what seems outside your own unique parameters.
Step 3: Make a first draft. Outline a draft spending and savings plan using the categories you created in Step 1, but re-allocate amounts based on the adjustments you’d like to see from Step 2. Continuing our example, maybe you’ll adjust down higher spending from the dining out category and move that amount to the charitable giving category.
Now, review the draft to see what may be missing. Make sure to include spots for an emergency fund (at least three months of expenses in cash), variable expenses (one-time but foreseeable hits to your bank account, like holiday gifts, car repairs and taxes), and future financial goals (paying off debt, saving for retirement, and big purchases).
A further word about saving for retirement. If your employer matches your 401(k) contributions up to a certain limit, withhold at least that amount, at a minimum. Work with a trusted, fiduciary advisor if you have questions about how much you should be saving, although 10%-15% is a good rule of thumb to use as a starting point.
Step 4: Prioritize. Now that you are aware of your current spending and have drafted a plan refined to better align with your goals, finish up by prioritizing these categories. Put your basic needs and highest priorities at the top, then rank each category by descending importance. If you have a coffee-shop category that brings you great joy (and necessary brain function) each day, don’t be shy about prioritizing it above another discretionary category, such as entertainment. This is your plan, so make sure it works realistically for you.
If, some months, you find yourself coming up short in funding your lower-ranked categories, you at least know your needs are covered and your highest-priority goals are accomplished. Download the flow chart to help you prioritize competing objectives.
Step 5: Implement. Once you’ve set your larger categories and goals, move to autopilot where it’s appropriate. Auto-pay your bills so you don’t miss a payment, set up a recurring transfer to automatically move your savings goal dollars to the correct accounts each pay period, and possibly even consider taking out cash or using a prepaid debit card for discretionary categories to avoid the temptation to overspend. Still, take the time to review your spending each month, especially if your income or expenses will vary.
Step 6: Adjust. Life never moves in a straight line, so it will absolutely be necessary to adjust your plan at least a few times each year. Again, a trusted advisor can help make sure your long-term savings goals remain on track and your plan functions as tax-efficiently as possible.
If your income gets a bump due to a raise or bonus, another great rule of thumb is to put at least 50% of the increase toward your future goals, such as retirement, and the other 50% (or less, if possible) toward current spending. This will help you avoid “lifestyle creep” and keep your savings goals in line with your lifestyle expenses.
If a serious situation, such as short-term illness or a job transition, causes your spending to temporarily overextend your income, rely on your emergency fund to carry you through. If your emergency fund is not sufficient, or it is a longer-term situation, take the time to honestly evaluate your spending plan to find areas to scale back.
While for most people money at times feels scarce, there is a lot to be said for the peace of mind that comes from a plan tailored to alleviate the pressure of balancing current expenses and future financial goals, on your own terms.
Bethany Ketron is a Wealth Advisor in Buckingham Strategic Wealth’s Dallas office.
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