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How to make a spending plan
"Budget" might well be the dirtiest word in the financial language.
People hate budgets because budgets seem confining. Like diets, budgets are forever begun with grand intentions, only to be quickly ditched when spending restraints seem too much like a yoke preventing you from disbursing your money as you like.
But in today's environment, where unemployment is on the rise and where consumers are hung over after a multi-year credit binge, a budget is the very tonic many households need. It doesn't have to be painful if you understand one salient fact: You control your budget; it doesn't control you.
Every month, you dictate how you spend your limited financial resources. Your budget has no control over that. You can choose to eat out every day, or you can choose to replace your wardrobe, or you can choose to pay off additional principal on your debt balances, or you can choose to afford a getaway over a long weekend. Whatever you want to do with your money, you can do it.
A good plan starts with a good budget. Zero in on how you spend your money.
But here's the catch: You can't do everything.
And therein lies the problem. Too many people want their paycheck to cover everything they want, the instant they want it, and if the money's not in the budget, they turn to American Express and MasterCard. Bad, bad idea. That credit-reliant mindset got this country into the mess it's now in.
So, as you seek once again to hew to a budget, let's come at this problem from a different point of view. First, we're not going to call your budget a "budget," and, second, we're going to focus on the one component you have real control over, your discretionary spending.
What's in a name
Money is as much a way of thinking as it is a means of interacting in the consumer economy. As such, we'll attack the budget from a mental angle. From now on, start calling your budget a "spending plan," because that's exactly how it operates. It is your personal plan for spending your dollars in any given month.
Think about your life for a moment. Do you make the exact same purchases every single month? Of course not. What you buy differs from one month to the next. Yet many people use the "average cost per month" approach to budgeting, so that in any given month they can spend an average of $150 on clothes, and an average of $100 on a vacation, and an average of $300 on eating out, and so on.
But life doesn't work that way. You don't take a vacation every month, and the vacations you do take aren't costing you $100 when you take them. More important, you're not saving that $100 each month to cover the vacations when they do arise. You're spending the money on other items and then, when the vacation pops up, you're shoving the full cost—well more than $100—onto a credit card because the budget isn't prepared to handle the outsized outlay.
That's a seriously flawed way to plan your spending.
Instead, budget each month for exactly what you want to buy. You might not need new clothes this month, so how useful is a budget built on the premise that you'll spend $150 on shirts or skirts? Instead, you might rather spend that money on a dinner and a play for you and your partner. That's the expense you should be planning for, and that's the beauty of a spending plan: it doesn't tell you how to spend your money. You get to determine what you think is the best use of your cash each month.
And how do you plan for that?
By planning your discretionary income. That's the key to successful budgeting.
Managing discretionary dollars
Every month you have certain costs that do not change. The mortgage/rent, a car note, insurance payments, electricity and groceries (give or take a few dollars). Those costs are fixed, unless you pay off your car, reduce your electrical consumption, change your insurance policy or move to a cheaper or more pricey apartment (or you refinance your mortgage).
Add up all the fixed costs in your life and subtract that sum from your monthly take-home pay. The result is your discretionary income—all the money you have for the month to pay for the wants you harbor. Exceed that amount and you are living beyond your means. And if your fixed costs exceed your income, you have some serious issues to tackle that go well beyond this article.
The goal of successful budgeting is learning to live within the bounds of your discretionary income.
Once you know exactly how much money you can spend, then you can go about the process of determining how you want to spend it.
As each month approaches – say, on the 20th of the previous month – make a list of your spending desires. Some of these will be "needs," some will be "wants." A new suit for an interview that could increase your salary clearly fits the needs category and should be high on your list of costs that you cannot cut. The new video-game system is a want and should clearly fall to the bottom of the list, the items you consider only after your needs have been fulfilled.
Fund the needs first. If you run out of discretionary income before all your needs are met, then you must prioritize. Which needs can you push into next month? Can you borrow a suit from a friend for that interview so that you can allocate that money to another need?
If your needs are paid, and you still have cash to afford some wants, you must still prioritize. Is that video-game system more important than the vacation you hope to take with the family in six months? Would it make more sense financially to allocate some or all the cost of the game system to the vacation? Maybe you put half the money toward the vacation and half toward the game system and wait a month before buying.
This is what budgeting is really about: prioritizing your discretionary spending. You choose how you spend your money, and you do so, but only to the point that you have the money to afford your choices.
One of the great benefits of the monthly spending plan is that you can change it on the fly without throwing your finances into a tizzy. Friends phone and want you to share the cost of beach house over a long weekend. Look at your spending plan for the month, determine what discretionary costs you haven't yet incurred and where you can cut or scale them back, and you'll have the necessary funds for your beachside getaway – without tossing the expense onto your credit card.
Ultimately, a spending plan comes down to this fact: If you want to spend every last nickel on double-tall half-caff mocha latte grandes with sprinkles every working day, that's your call, so long as you explicitly recognize you're allocating all your money to that expense every month, and you don't also go out and buy all the other stuff you want, too. That's where households fall into the abyss—they overshoot their discretionary income each month, sloughing ever more costs onto their debt balance. When the fall comes, it's painful, as the U.S. has learned the hard way in the credit- and mortgage-crisis of 2008.
Stay within the limits of your discretionary income and you will never struggle with debt. And, you'll never bust your budget, er, spending plan.
Getting accustomed to the process might take a couple of months as you figure out how to prioritize spending. But once you're comfortable with that, planning your spending for the coming month will require just a few minutes of your time.
Saving and irregular expenses
The first item on your discretionary spending list every month should be an amount allocated to your savings account. A savings account is your first line of defense in a financial emergency, so fund the reserve every month to build an increasingly larger cushion with each passing month.
In theory, you should save at least 10% of every paycheck, more if you can afford it. But rules of thumb aren't static. If 10% is too much, start with whatever amount you can afford on a monthly basis, and work to increase that amount every six months.
Also, if you earn a pay raise or bonus at work, put half of the net into your savings and apply the other half to your discretionary income. This way, both your financial security and your lifestyle share the benefit. (Caveat: If you have debt that you're trying to extinguish, apply to your debt the half that would otherwise go otherwise to discretionary spending. Eradicating debt is far more important than enjoying an extra movie and meals out each month. And all of any bonus should pay down debt, since a bonus is found money that's not part of your monthly spending plan).
Financial life is filled with a variety of irregular expenses. These are costs such as insurance premiums, tuition payments, property tax bills and others that arise during the year, generally quarterly, semi-annually or annually. Though these are clearly routine payments, too many people treat them as emergency expenses because they don't have enough money in their checking account and their income for the month can't cover the cost. So they bill these expenses to their credit card or deplete savings.
This is simply bad planning, not bad luck.
If you know a certain expense will arise in, say, three months, then plan for it months in advance. Build the cost into your spending plan, either on the fixed or discretionary side of the ledger, whichever is appropriate. But don't leave the cash in your checking account; you'll be too tempted to spend it, or will forget what that money is for and allocate it to something else.
Instead, put the money in a separate savings account (not your normal savings account), and fund it every month with the dollars necessary to cover the various costs that you know will pop up from time to time. When the expenses arise, you'll
have the dollars ready to go and the outlay won't impact your spending plan that month. This strategy works well for any long-range expense you foresee for the year, from insurance premiums to vacations to Christmas spending. Just plan it all in advance and save along the way.
And that's it. That's successful budgeting. It's not hard. It doesn't have to be onerous on your lifestyle. All you have to do is recognize that you control your money, and you determine where you spend that money each month.