I have a love/hate relationship with budgets. But mostly, I hate them.
It’s not because I don’t like pie charts and spreadsheets. (I do.) I don’t like budgets because I hate telling you to write them when I know myself how boring, pointless, and difficult it is.
It’s like the doctor finishing up a physical saying: “You’re healthy. Just lose 20 pounds”. (Happened to me yesterday.) I already knew that, thanks, but dropping a few pounds is easier said then done. Do you know how many freaking books there are on losing weight?
And do you know how many people try to lose weight (AGAIN) every January 1st?
Having the right information is useless if you’re not going to do anything with it. And it is doing something that is so hard.
Budgeting is the same.
WHY BUDGETS FAIL
Old-school personal finance books tell you that if you just create a budget and stick to it, then—POOF!—all your money problems will be solved.
But anybody who has ever tried budgeting knows that it’s complete crap.
You know you should budget, but you also know you’re not really going to do it. Learning how to budget isn’t the problem. You can visit any one of hundreds of personal finance blogs to read about budgeting techniques. You can download free spreadsheets here and on countless other sites. You can pick up one of dozens of books. You can use any one of dozens of budgeting apps — many free.
But even if you write down every dollar you spend for 30 days (which, done manually, is a complete pain in the ass), you are still human.
As a human, you are intelligent enough to know that on Jan 1st, you can afford to spend $200 on food and drinks out this month. Unfortunately, as a human, you are quite susceptible to temptation. This means that on Friday, January 20th, after having already spent $190 on going out in the preceding weeks, your willpower will be tested. While you are out with friends, three quarters of a vodka tonic sloshing in your gut, will you:
- A. Say: “I have to go home, this drink puts me over budget?”
- B. Order one—maybe two more drinks—and then do dinner? After all, it’s Friday, you’ve worked hard, you deserve it, budget be damned.
- C. Completely forget you had set a $200 budget in the first place, and have no idea you’ve already spent $190 on going out.
Over the past five plus years, I’ve experimented a lot with budgets. I’ve set monthly budgets, annual budgets, and weekly budgets. I’ve tracked my spending using paper and pencil, spreadsheets, and apps like Mint.com. And I’ve learned two things:
Tracking spending manually is pointless. I never keep up. And I’m a financial blogger…a total nerd about this stuff. If I can’t do it, I don’t expect you to.
Monthly budgets are fairly useless because we underestimate our monthly expenses. Think about it. Although there are some things you pay for every month: housing, transportation, utilities, food, and debt payments, there are lots of things you pay for less than every month: car repairs, home improvements, trips and vacations, holiday presents, and insurance payments, to name a few.
For some people, these less predictable expenses may only be 10% or so of your total spending, but for me, especially after becoming a homeowner, they’ve crept up to more like 30% (home repairs aren’t cheap).
What this means, of course, is that if I take my annual take-home pay, divide it by 12, and proceed to spend that amount every month, I’m going to be in trouble when that unexpected car repair comes up, or it’s December and I have to do my holiday shopping.
We need to fix the following problems:
- Our human tendency to cave in the face of temptation.
- The futility of tracking every dollar ourselves.
- The difficulty of getting an accurate sum of monthly expenses.
How do we do it? And how do we make it simple?
For one, we agree to stop obsessing over the detailed, track-ever-penny budgets we’ve always been told were the solution.
THE SIMPLE SPENDING PLAN
I’ve been outlining this post for a week or so. Then, yesterday, a funny thing happened. I was in the doctor’s office waiting for my physical and I picked up the Nov. 2011 issue of Money Magazine and randomly turned to a page that actually recommended the same thing: stop budgeting!
As a way to reduce financial stress, the piece recommended to ease off budgeting, saying:
“Money (or its lack) is the nation’s most common source of stress, reports the American Psychological Association. Making a detailed budget — a widely advised fix — only makes things worse, says Cleveland financial planner Kenneth Robinson, based on a decade of work with clients; the problem is that people hate to think about where they’ll need to cut back.”
In other words, when money is tight, focusing on that shitty fact day in and day out doesn’t do us much good.
Money’s fix for the problem is the same as mine:
- Put your money on autopilot.
- After the big things are take care of, you’ll only need to track “what’s left to spend”…on whatever you want.
This idea isn’t new.
THE IMPORTANCE OF AUTOMATION
I first read about automatic finances over 10 years ago in The Automatic Millionaire by David Bach. The entire book is devoted to setting up automated systems to manage and invest your money. This does two glorious things:
- It eliminates worry. You stop wasting time thinking about stupid things like “did I pay the electric bill this month?”
- It protects you from yourself. Automated finances make it harder for you to sabotage your money. No more late credit card payments and the associated fees and damage to your credit score. No more skipped IRA contributions. And on and on.
Another writer who has taken the idea of automated finances to the next level is behavioral finance guru Ramit Sethi. He lays out simple plans for automating your personal finances on both his blog, I Will Teach You To Be Rich, and in his book by the same name. He’s a vocal advocate of what so many other financial “experts” for some reason refuse to acknowledge: Our generation does not want people our parents’ age telling us to just “set up a budget” and “cut back on lattes”…the latter a direct jab at Bach, who trademarked the term “Latte Factor” to describe how daily coffee habit can eat into long-term wealth.
Check out Bach’s book, Sethi’s blog and book, or what I’m going to cover in the next few days. But when you finish reading, my only hope is that you’ll actually do what it takes to put your finances on autopilot.
Your wallet will be better off.
AUTOPILOT SPEND TRACKING
Forget about manually tracking every beer and burger. The goal is to set up a system that keeps track of all of your spending electronically without any additional work from you so that you can access it if an when you need to.
The Single Card Method
One of the best ways technology can help our wallets, I think, is by eliminating the need to use cash, and therefore, eliminating the need to keep track of our cash expenses.
Now this is counterintuitive to what a lot of old-school financial gurus say:
- “Cash is king!”
- “You spend less with cash!”
- “You can’t overspend with cash! When it’s gone it’s gone.”
That’s all true, but the fact is cash also can get lost and stolen. And, more importantly, cash is on the way out. Electronic payments are here, like it or not, and the times you need cash (for anything) over a debit or credit card are fewer and fewer.
But the best thing, in my opinion, about using a credit or debit card, is that you automatically have a record of all of your spending. You don’t have to do a damned thing.
Credit vs. debit
Credit cards are slightly better than debit cards because most give you ways to sort and even tag your transactions, although some banks are starting to offer this for debit cards, too. With most cards, you can also export your transactions to spreadsheet…which, for the nerds like me, is where the fun begins.
Using Personal Finance Managers
As an alternative to the Single Card Method, there are personal finance management (PFM) tools. These applications link to your credit and debit cards, aggregate your transactions, and can even categorize them automatically. You set spending limits, and they can send an email or text when you hit them.
These apps are powerful and effective…if, of course, you remember to login occasionally and make sure the categories are right and view your tallies. But even if you don’t, that’s OK. The important thing is that data is there if you need it (for example, you want to know if you can afford to move to a bigger apartment and need to analyze your past spending).
YOUR MONTHLY NUT
Setting up a personal finance app or downloading all of your credit card transactions is great for historical analysis of where all of your money goes. Looking forward, however, this data is less important. What you need to know are your fixed monthly expenses. Things like:
- Your rent or mortgage
- Utilities and insurance
- Loan payments (student, auto, etc.)
- Minimum credit card payments
- Desired savings, investments, or additional debt payments*
That last one is important. It’s vital that you calculate how much you want to save, invest, or use to pay down debt first. (What we usually do is look at how much we want to spend, and then take whatever’s left and save it. Problem is, there’s not usually much left.) To find what’s left:
- Total your fixed monthly expenses (your Nut).
- Figure out your net (take-home) pay, per month.
- Subtract your Nut from your take-home pay.
This is what’s left to spend. On whatever. Food, gas, beer, travel. Of course, if something big happens, you may need to spend money on that and have less for fun stuff. That sucks, but it’s also why you should have a buffer, which we’ll talk about in another post very soon.
Want my free “Simple Spending Plan” worksheet? Subscribe now for instant access.
If There’s Nothing Left…
“But wait!”, you say. “After my nut, I don’t have anything left!”
OK. Deep breath.
If money is tight, it’s likely there won’t be much (or any) left to spend after you’ve laid out your necessary monthly expenses and what you hope to save.
In the short-term, you can reduce–but not eliminate–your savings goals while at the same time trimming spending. Do what you must to get these in check so you’re not going into debt.
At the same time, this is time to look at making the kinds of big changes that can impact your overall financial picture. Forget about trying to trim your food budget by $25. Look at big places you can save. Can you get a roommate? Can you refinance your mortgage? Or, can you earn more money?
Cutting little things gets a little bit of money. Making big changes gets you a lot of money.
YOUR SPENDING ALLOWANCE
The amount of money that you have left after your Nut (fixed monthly expenses and savings) is what I call your Spending Allowance. It’s how much you can spend this month without worrying. On whatever you want.
Using whatever method you’ve setup for Autopilot Spend Tracking, you can keep a simple eye on how much your Spending Allowance you’ve used month-do-date. For example, by setting up a goal in Mint or by using the Single Card Method for all of your day-to-day spending. (This is what I do. If my family’s Spending Allowance is $2,500 in a month, I can eye our credit card balance throughout the month. If it reaches $2,000 too far before the end of the month, for example, I know it’s time to ramp down the spending a bit.)
This is a lot to digest. But here’s what’s important:
- Budgets are overrated. They create stress and we don’t stick with them.
- All you need is a Spending Allowance. Instead of tracking dozens of categories of spending, know how much you can spend per month—your Spending Allowance—after you’ve covered big expenses and savings.
- Forget manual spend tracking. Keep an eye on how much of your Spending Allowance you’ve spent with Mint or by simply using one credit card for everything you buy. Cash is dead.
YOUR ACTION ITEMS
Read all you want, but this information won’t help you unless you put it to work in your life. This week:
- Determine your Nut and Spending Allowance using my simple spending plan, free when you subscribe here.
- Decide how you will track your spending going forward?
- Leave a comment letting me know:
- What you hate about budgeting. Be specific.
- Your biggest worry or stress about managing your money day to day.
I’ll try to answer your questions in the upcoming series. In a couple days we’ll talk in detail about building your Bank Account Buffer. This is a tiny emergency fund of $500-$1,000 that can cushion you from unexpected expenses like car repairs so when they happen they don’t eat up your entire Spending Allowance for the month. Then we’ll move on to discuss ways to put your bills and savings on autopilot.