Budgeting & Goals

TL;DR

Budgeting is a family experience, but it takes patience and practice to properly discuss money.

Getting your money situation on track goes through several rough stages:

  1. Build up an emergency fund.
  2. Pay off your debt.
  3. Save up 3โ€“8 months of regular living expenses.
  4. Invest at least 15% of your income into a retirement fund.
  5. Save for your children (if you have any).
  6. Pay off your house.
  7. Devote most of your extra income toward giving.
  8. Near the end of your career, make retirement plans.
  9. Retire gracefully.
  10. Plan for your passing.

Make short-term goals that feed into your larger goals.

Precise budgeting isn’t always possible, but it’s not difficult if you give yourself fudge room.

Building a budget is relatively straightforward:

  1. Add all your incomes together.
  2. Assign all the fixed or near-fixed amounts.
  3. Assign all the expenses that fluctuate up and down.
  4. Put the remainder into large expenses you want to save for.
  5. “Tweak” the budget to save or earn more.
  6. As you become familiar, break out other reports to analyze your spending from different angles.

Use multiple accounts to track your money as it’s used.

You will sometimes fail, but treat it as a teachable moment for yourself and move on.

What makes budgeting hard?

People hate the word “budget” for four major reasons:
  1. It implies poverty because it’s managing a scarce resource.
  2. It was used to abuse them or someone they knew.
  3. They’ve never had a budget that worked.
  4. They’re afraid of what they may find.

Whether you like them or not, we all need budgets:
  • Budgeting helps us “feel” money’s impact.
  • Without budgets, we feel money’s impact after we’ve spent it.
  • You have other people in your life, most importantly your family, that your financial decisions affect.
  • The only way to wisely manage money is through experience, which starts with budgets.

Budgets will always improve your life if you honor a few rules:
  1. Instead of wanting it or hoping for it, legitimately make the budget.
  2. Create realistic, achievable goals.
  3. Create enough categories to understand where the money goes.
  4. Avoid so many categories that it’s difficult to follow the flow of money.
  5. Legitimately live by that budget and adjust it as needed.

Include your family

You will need your life partner on the same page as you:
  • A budget only works when everyone who spends and earns honors it.
  • Disagreements about money are normal.
    • The only solution is to talk through them.
    • Learn to compromise with your partner to succeed with them.
  • If you can’t trust your partner with your money and aren’t married to them, separate your assets to avoid more misery.

Money conflicts take time and practice to work through:
  • Start with “why” you make money decisions, not “what” those decisions are.
  • Openly share strengths, weaknesses, concerns, and ideas.
  • Hold each other accountable to agreed-on goals.

One of you won’t like budgeting as much as the other one:
  1. Whoever is more eager to make the budget should make it.
  2. That person should set the draft budget in front of their partner and say nothing.
  3. The other person must amend something in the budget.
  4. The meeting should only last 15 minutes, with both of them agreeing to stick to the budget.

If you have children, involve them in the meetings to teach them how planning affects your financial life and theirs.

Start with the big picture

Managing wealth moves through a rough pattern of stages:

A. Have an emergency fund (takes ~2-4 months):
  • It should be $500โ€“1000 you never touch for purchases, enough to pay off one short-term emergency.
  • Only use it for things that satisfy all three of the following:
    1. It’s unexpected
    2. It’s fully necessary
    3. It’s urgent
  • You need an emergency fund to give you and your partner security to pursue larger financial goals.
  • An emergency fund is a personally funded insurance policy, not an investment.
    • Keep it in a savings account or mutual fund company’s money market account
    • Don’t go into debt to get your emergency fund.
  • While you’re saving for your emergency fund, help others in their crisis.

B. Pay off your debt (takes ~15-18 months):
  • Since paying off debt isn’t saving, get an emergency fund first.
  • Don’t borrow any more money.
  • Learn to save money.
    • It’s natural at this stage to eat out more, buy creature comforts, and pay debts less.
  • Renegotiate loan interest rates as soon as possible:
    1. Set aside time to negotiate rates.
    2. Ask for a higher-up when you call the credit card company.
    3. If you have good credit, you’re likely eligible for an adjustment.
  • If it helps your willpower, use a debt snowball:
    1. List all the debts in order from either smallest to largest or from highest to lowest interest rate.
    2. Pay everything extra on the first debt while making minimum payments on the rest.
    3. After you’ve paid off the first debt, put that dedicated amount into the next lowest debt.
    4. Keep yourself motivated by logging everything you’ve paid off.
    5. Repeat until debt-free.
  • Understand the various repayment plans for student loans:
    • One missed payment might change the arrangement entirely and create an excessive financial burden.
    • Proactively communicate with the loan servicer.
  • If you have a credit card, balance transfer to a 0% interest account:
    • Since you’re paying the card off, ignore the credit limit.
    • Cut the card up or stick it in a drawer, and never use it.
    • Your deadline to pay off the card is at the end of that 0% rate.
  • When you’ve finally paid off a credit card, close it after it has been $0 for a few months:
    • Watch for fear tactics like your FICO score being adversely affected or losing rewards points.
    • Be prepared to decline promotional extras like extra miles or fee waivers.
    • They may hesitate to close the account.
    • Track when and who you speak to, with confirmation numbers.
  • As tempting as it may be, don’t invest until you’ve paid off your debt:
    • Interest rates on consumer debt are almost always higher than the return on some of the best investments.
    • Investing returns are not guaranteed, but debt is.
    • Don’t get a second house until you’ve paid off the first one.
    • Being in debt takes the focus away from the time and effort necessary for wise investing.
  • If the housing market is decent, and you still have a mortgage, sell your house and downsize.
    • If you have too many possessions, a smaller house is a good reason to sell them.
  • Start helping others in distinct ways, like prayer shoe boxes and giving small items to the less fortunate.

C. Save up 3โ€“8 months of regular living expenses (takes ~12โ€“15 months):
  • Some things will ravage your sense of security if you haven’t saved (e.g., unemployment, underemployment, medical emergencies).
  • Saving 3โ€“6 months guarantees you can prevent any single large event from driving you into debt.
  • Invest as you feel comfortable at this stage.
  • Give small gifts to those around you and develop habits to sacrifice for others’ well-being.

D. Invest at least 15% of your household income into your retirement (varies from lifestyle decisions):
  • Investing and reinvesting will magnify your financial position later.
  • Debt is guaranteed, but investing isn’t, so don’t invest before paying off your debt.
  • Start providing for others’ significant expenses and needs.

E. Save for your children (varies based on their expected education and lifestyle):
  • Save for your children only after you’ve accumulated enough to survive through your retirement:
    • You should be able to live off your asset growth without having to dip into the principal you’ve invested.
    • You will burden your children tremendously later in their lives if you require them to support you.
    • Their college doesn’t guarantee success, but expecting them to take care of you increases their chances of failure.
  • Never use insurance, savings bonds, or prepaid tuition to save for your child’s college.
  • Help others to build their own lives and substantially invest time and money into them.

F. Pay off your home (takes ~10 years):
  • Your wealth-building habits will eventually lead to overpaying your mortgage.
  • By this point, you should have some experience significantly transforming others’ lives with your money.

G. Devote most of your extra income to giving:
  • Spending money on others gives far more satisfaction and happiness than spending it on yourself.
  • Give strategically:
    • Treat people to quality-time activities.
    • Give generous gratuities and tips to service workers.
    • Help build churches, homeless shelters, and non-profit organizations.
    • Invest into family and friends who need help or are starting a business.
  • At least some of your income will likely help your parents near the end of their lives.
  • Avoid giving to the wrong places:
    • Many of the large non-profits that advertise their activities spend tons of money on “administrative expenses” or “consulting fees”.
    • Avoid expensive charity fund-raising events.
    • Don’t give to politicians or political movements.
    • Be careful with street beggars:
      • Some people make a substantial living out of looking miserable.
      • Give to non-profit organizations like homeless shelters, soup kitchens, and job training instead.
    • Watch for overreach with family members:
      • Don’t give money to family members who don’t need it or consistently make terrible life decisions.
      • Never, ever loan money to a family member without a legally binding contract: either ask for a business plan or don’t expect it back.
      • Don’t be afraid to tell them the truth.
      • Never let a family member use guilt to get what they want.

H. Near the end of your career, make retirement plans:
  • Consider your new retirement lifestyle:
    • After retirement, your lifestyle will cost about 90% of its current rate.
    • Estimate how long until you start receiving your money.
  • Prepare for taxes on any tax-deferred investments.
  • Retirement may be the end of your career, but isn’t the end of living and doing things:
    • If you stop working entirely, you’ll quickly lose your health and mind, so only retire if you have plans already.
    • Most people who retire have no idea what to do with themselves.
  • Act on your plans as soon as possible:
    • Make your money last longer by downsizing your home and re-evaluating your life insurance needs once the kids are gone.
    • Make plans to move to another city or country years in advance.
    • Since your age will eventually catch up with you, increase your health insurance.
    • Increase giving if you don’t need as much for your lifestyle.
  • If you have a complicated situation, go over the details with a financial analyst.

I. Retire gracefully:
  • Though the average lifespan can be as high as 90, typical retirement is usually around age 65.
  • Don’t be afraid to retire early if the situation calls for it, but don’t get hurt from collecting too early:
    • If you collect on any after-tax retirement accounts before age 55, you’ll pay a stiff excise (penalty) tax.
    • The government may help you stay alive, but not much else.
    • Don’t take Social Security until at least age 67, but preferably age 70.
    • The longer you wait, the higher the amount you’ll collect.
    • Get an approximation from your body whether you can work for a few more years to boost your post-retirement lifestyle.
    • Social Security will only allow you to survive, so don’t expect it to help you maintain your lifestyle.
    • Since idle cash will depreciate quickly from inflation, don’t dump all of your savings out of the stock market.
    • Sometimes you can avoid heavy taxation by moving the money into an after-tax account (e.g., Roth IRA) from your tax-deferred accounts (e.g., Traditional IRA).
  • Start lowering your work hours to prepare and adapt to your new lifestyle.
  • Set up a power of attorney to handle what will happen when you become ill and can’t handle yourself:
    • Most people will need a durable power of attorney.
    • Designate a medical power of attorney for unforeseen medical expenses.
    • Designate a trustee to honestly and accurately carry out your will.

J. Plan for your passing:
  • Your surviving household will need ~10-12 times your income to take care of themselves after you’re gone.
  • Update your will to ensure your surviving family and friends receive the assets they want.
  • You need a new will for almost any major change in relationship or high-value asset.
  • Set up a trust to streamline the process.
    • Make a revocable living trust or living will to permit flexibility in your decisions and minimize taxation.
    • Run an experiment with a smaller gift if you’re not sure how your beneficiaries will respond.
    • Create a marital trust for your spouse to receive assets.
    • Set up a pet trust if you need someone to take care of your pets.
    • Make a spendthrift trust to deliver the trust in installments.
    • Try giving indirectly through a college or organization you want them to attend.
    • Start a non-profit family foundation or charity with the beneficiaries as co-directors.
  • Set incentive rules on trust-held assets:
    • Reaching a certain age
    • Getting a college degree
    • Having a child of their own
    • Income-match their income or give a larger income-match for more worthwhile work (e.g., a teacher versus a banker).
    • Provide disbursements for specific pre-defined goals.
  • Self-made online wills are a one-size-fits-all solution and can’t always account for life’s complicated situations:
    • You may unintentionally give someone more power over your estate than you want if you aren’t careful.
    • Name the executor, who should be someone you trust right now while you’re still alive.
    • Get signatures from at least two witnesses who aren’t beneficiaries listed somewhere on the will.
  • Get a more detailed will written by a lawyer, but research exactly what you’ve arranged.
  • Specify what will happen at your funeral and consider prepaying it:
    • You’ll need a burial plot, but can create a legacy with a family plot.
    • If you want cremation, you’ll need a funeral director.
    • Specify the maximum permissible amount for funeral expenses to avoid the family over-spending on your funeral.
      • Mortician services charge extortionate rates for elaborate caskets, embalming over refrigeration, and many useless features.
  • Decide if you want to pre-pay anything while your family waits for their money to transfer.
  • Make preparations for your digital and paper life:
    • Set up a master file of everything related to social networks or internet accounts.
    • Include passwords and links to everything you’d like managed or erased when you’re gone.
    • Gather all your important papers and documents in one place.
  • Since you’re not taking any money with you, arrange your financial situation to be completely hands-off, ideally without legally owning any significant amount of money when you pass on.

Make short-term goals from your large ones

Your goals should be realistic, but should also challenge you:
  • You should be able to measure your short-term goals, and they shouldn’t look ahead more than a month.

You will never have a “perfect month” to track your spending:
  • You’ll likely fail the first few months, but it only takes a few months to become decent at it.
  • Though many types of software are available to simplify budgeting, use a spreadsheet or do it by hand for the first few months to understand how it works.
  • After enough less-than-perfect months, you’ll know how much fudge room you’ll need for unexpected circumstances.

At its core, budgets aren’t difficult

Good budgeting spends according to predetermined priorities:
  1. Spend on the Four Walls:
    1. Food
    2. Shelter & utilities
    3. Necessary clothing
    4. Transportation
  2. Save some for later.
  3. Invest some.
  4. Tithe or donate some.

A Conscious Spending Plan is the easiest form of budgeting:
  • Send all the money you need to your savings and investing.
  • Anything else left over is free for you to spend on what you want.

Zero Based Budgeting is the most controlling plan:
  • Income – Expenses – Everything Else = $0
  • In other words, give every dollar a job

How to build a budget

Make your budget before the period begins.

1. Add all your household incomes together

Paycheck(s):
  • If a paycheck amount varies, average out several months’ pay or use a seasonal prior-year number.
  • To simplify, budget each paycheck individually or make pay day the start of the budget period.

Make an estimate and average out sporadic incomes:
  • Self-employment and business income
  • Refunds/reimbursements
  • Temporary jobs
  • Interest and dividend income
  • Gifts received, income tax return, etc.

When you hit a windfall, always accommodate that new income toward long-term goals.

2. Assign all the fixed or near-fixed amounts

Shelter (~25-35% of income):
  • Rent/mortgage
  • HOA dues
  • Homeowner’s/renter’s insurance
  • Property taxes

    • Utilities (~5-10% of income):
    • TV, internet, phone(s)
    • Electricity, gas, trash, water

    Debts (~5-10% of income):
    • Can include credit card payments, student loan, car payment, and personal debts
    • After paying off debts, this should become investments

    Health and medical (~5-10% of income):
    • Health, dental, vision insurance
    • Medications
    • Over the counter drugs and supplements
    • Gym membership

    Household supplies:
    • Cleaning supplies
    • Toiletries
    • Lawn & garden

    Childcare

    3. Assign the expenses that fluctuate up and down

    Entertainment and fun money (~5-10% of income):
    • Movies, music, books, toys, games, electronics
    • Social expenses like barbecues, parties, concerts, church functions, outdoor recreation
    • Hobbies

    Food (~5-15% of income):
    • Groceries
    • Dining out, which should include tips and tax

    Transportation (~10-15% of income)”

    Household fixtures:
    • Appliances
    • Tools
    • Furniture
    • Office supplies

    Personal care (~5-10% of income):
    • Cosmetics
    • Haircuts and salon services

    Pet expenses:
    • Toys/supplies
    • Food/treats
    • Veterinarian fees
    • Grooming
    • Carrier bag/crate
    • Flea and pest treatment

    Charitable donations (should be 10-15% of income):
    • Tithes
    • Giving account
    • Charities
    • Spontaneous giving

    Clothing (~2-7% of income)

    Education expenses

    Children’s allowances/commissions

    ATM withdrawals

    If you want immense control over your money, never include a “miscellaneous” group.

    4. Put the remainder toward large expenses you’re saving for

    Saving for larger purposes should be ~10% of income at first, but should eventually go as high as 30%:

    5. “Tweak” your budget

    Find things you can remove or shave down:
    • Look at one category at a time to find anything you can change.
    • Shaving off a few dollars from each category can save a surprising amount.

    Dive into details of each category to analyze any overspending.

    Consider how to make more side money.

    6. Break out other reports as you become familiar with budgeting

    Track your cash flow:
    1. Start with your cumulative net worth at a beginning date.
    2. Show all income and expenses in chronological order.
    3. Track consistent cycles of money coming in and out.
    4. Your available amount will move up and down, but correct management will make it climb over weeks and months.

    Break out any other plans and worksheets that could benefit your lifestyle:
    • Allocated spending plan
    • Business budget
    • Charitable giving plan
    • Christmas gift budget
    • College funding plan
    • Debt reduction plan
    • Detailed cash flow plan
    • Emergency funding
    • Home repairs plan
    • Insurance budget
    • Project budget
    • Retirement funding
    • Tax reduction plan
    • Travel budget
    • Wedding budget
    • Will or estate plan

    Living below your current means will open you up to future means:
    • Your clearest sign of budget success will be when you’re living on last month’s income.
    • When you have control over your finances, every windfall will advance your goals and every financial hardship won’t be as devastating.

    Track finances as they happen

    Use a reputable bank:
    • Use at least two bank accounts to track your finances.
      • One to track routine monthly expenses.
      • The other one to track one-time purchases.
      • You can also use a third account for variable expenses like food and gas.
      • Place money for easily over-spent expenses like food and entertainment in an envelope, on a prepaid card or in a separate bank account.
      • Use a “three pot” system between you and your partner, with a shared account and at least one for each.
      • To have extreme control over your accounts, have all the income in 1 account, then distribute it to the other accounts as needed.
    • Savings accounts are good for managing money if you keep your money somewhere between 1 month and 5 years.
      • You can’t transact more than about 6 times per month with savings accounts.
      • For anything longer, you should consider investing accounts.

    Get a bank that doesn’t charge any maintenance fees beyond overdraft fees:
    • You’re already lending a bank your money for them to invest elsewhere, so they shouldn’t charge additional fees to use your money.
    • Maintenance fees are a relic from when it required paper documentation for everything, but $5 a month becomes $60 a year.
    • Bank overdraft fees come from sloppy and lazy money habits and are a sign of a crisis.
    • Most online bank products are competitively priced, allow as many free cash withdrawals as you need, and are extremely convenient.
    • If you want a decent savings interest rate, consider a credit union (owned partly by the customers).
    • Sign up for real-time text alerts that show purchases and when the remaining balance gets low.

    Move money to where it needs to go with automatic payments and pre-authorized transfers:
    • By doing this, you won’t “feel” it hit your spending account (and won’t feel the expenses for essentials).
    • Use direct deposit with your paychecks.
    • Pay your bills online on a calendar to remember to pay.
    • Make sure to track any auto-pay to make sure it clears!
    • When your card expires, and you get a new one, make sure to update all your autopay accounts, or simply use a bank account number.

    Make a visual representation of your status to make it feel tangible:
    • Use milestones with incentives marked at each one.
    • Put up a chart or a jar filled with beads in a common area of the house.

    Always keep a mental track of how much you have:
    • Use a spreadsheet template or online software that automatically imports data.
    • Track online purchases with an app like Slice.

    You will sometimes recklessly spend or not hit your goals

    Don’t dwell on it:
    1. Own your mistake.
    2. Forgive yourself and move on.
    3. Let your failure motivate you to do better next time.
    4. Find out what you did wrong and vow to not repeat it.

    Make an increased commitment to your goals:
    • Think about a “spending freeze” where you don’t spend any money for a set period and only devote it to your goals.
    • Create a rewards system for yourself if you need motivation, and use the budget to incentivize splurging in its time and place.

    Budgeting is easy to understand

    Most of the challenges in money management come through adapting day-to-day routines.

    However, a few wise spending concepts will take you a long way.

    This page is Part 3 of my Managing Money series. Part 1 was Why Money Management Matters and Part 2 was Everything About Debt.