Stop budgeting the old way - try this instead
Welcome back to another addition of Written by A(ndrew) I(ntelligence)! In today’s article, we are going to be talking about old school line item budgeting, why most of us fail and get discouraged, and what you can try instead. Read on!
I cannot think of something more turbulent and hypertensive than creating a household budget. What starts as an exercise to get organized, can quickly turn into a sour experience. Sitting across from couples (and even single people) through this discussion can get heated…money sure brings out the best in us :).
The problem in my opinion is that traditional budgeting is too restrictive, and does not apply to the real world. You can set certain limits for certain expenses all you want, and track your spreadsheet until you are blue in the face, but the fact of the matter is that we do not live in a vacuum and we all will spend a different amount of money each month. That’s the cold hard truth America.
For those of you who are unfamiliar with budgeting, the process starts by setting a target $ amount for each category of things we all spend money on. This target is set before the month, and once the month is over progress is tracked by lining up the actual dollars spent against the initial amount set. The categories could include an allocated $ amount to groceries, mortgage/rent/car payments, home maintenance, automobile gasoline, utility bills, recreation & entertainment, clothing, and anything else your heart desires. Budgeting for fixed expenses like mortgage, rent, and car payments is easy because they typically stay the same month to month. The difficulty lies in managing the variable expenses. In the end, the goal is to help curtail reckless spending so money can be saved and put away.
So when one spouse starts talking about their budget, going line by line for each piece and how the couple keeps blowing past their targets, the emotions of the other spouse slowly bubble to the surface. What seems like a rules based system for one spouse is handcuffs for the other.
Budgeting largely fails because of discouragement. I have seen a couple work really hard to look back at their spending, set good parameters for themselves, and then fall off the rails after a couple months. Mostly because they forgot to factor in that cars need oil changes, kids sports teams have sign ups, and bachelor/bachelorette parties require gifts. These expenses don’t warrant a raid of the emergency fund, but they aren’t things that happen each month either.
Traditionally the flow of a budget works like this. A paycheck hits the checking account, and as expenses come up, this money is spent. Once all expenses are paid, whatever is left before a the new check comes should be moved to some form of savings or investment account. Sounds simple right?
Well like I said earlier, you could plan out all your known monthly expenses, but that doesn’t stop other ones from sneaking in! So that oil change or surprise birthday dinner swoops in and takes the money that was supposed to move to savings. After a few months of this, budgeting seems like a waste of time and the whole thing gets scrapped.
If you have fallen into this “budgeting is useless” mindset, I have something for you to try. Its called the reverse budget, or the "pay yourself first method”. In this set up, once you get your paycheck money automatically moves right to your savings account of choice (HYSA, taxable brokerage, IRA, etc.). What’s left over should be the money you have left to spend on monthly expenses and fun activities. How about that!
This is how you get started. First, use the same traditional line item budget you made prior. Find out how much you want to allocate to groceries, loan payments, shopping, utilities, recreation, you name it. Add all these up (+ a small buffer amount just to be safe) and subtract it from your after tax paycheck. The difference is the amount you automatically send to your savings vehicle!
What I love about this method is three things
It takes the thinking out of saving and investing
Eliminates end of month guilt when you look at your credit card statement thinking you spent too much
Forces you to spend only what is left in the account
So now there is no longer a need to worry about “should I save this, or is it ok for me to go out with my friends and family?”. Since you already saved when the paycheck came in, you can spend guilt free!
To show you how much more effective this is compared to traditional budgeting and saving what is left over after the month, take a look at your workplace retirement account (401(k) / 403(b) / etc.). See that balance? Did you ever think you would be able to save this much? No, you probably didn’t. Because what seems like a large balance is just a collection of small biweekly contributions you likely forgot about. Workplace retirement accounts are set to automatically deduct from your paycheck, and you never see that money hit a checking account. Every two weeks these auto contributions eliminate being forced to think about what amount should be saved. It just goes! And the best part is people build their lives off of the $ amount that hits the checking account, not what is shown in the gross pay line on their paystub.
By copying this same process, you can automate your savings to brokerage accounts, IRAs, HYSAs the same way to make it easier to achieve your goals.
Before I go I am going to give you a personal story about me and my budgeting history. In college and the first years of my work after graduation, I was a serious line item budgeter. I documented every single transaction in a spreadsheet I made from scratch. I would literally type out expenses line by line from my credit card and checking account statements, categorize and organize them, and compare them against what I thought I should be spending. I was able to compare each month against each other, and track how my spending had changed overtime. While doing this I was able to get my savings rate well north of 50%, and still had some money left for my fun categories. As I got older I just got tired of doing all the work, as it would easily take a few hours, so I started to fall behind. I would take one month off, then come back, then forget for another two months, then do all the work to catch back up. You know the deal.
One of the biggest emotions I felt when not religiously following my budget was a sense of falling behind. Since I had nothing to track and no benchmark to reference, I constantly felt as if I was overspending and ruining my savings plan. I would tell myself “Ok, let’s put $500 away” but I’d check my upcoming credit card bill and realize I had a big one time purchase on there so I couldn’t transfer. Or the next month I had $150 left over but my analysis paralysis would not allow me to decide whether I wanted to save it in my Roth IRA, or use it to take my wife (then girlfriend) out to a nice dinner. Since I was no longer tracking my spending and did not have my structure, I was essentially hoping I would have some money left over at the end of the month. And even when I did I was afraid I would need it in the future so I would just leave it in the checking account. I lost what I had going for me!
With my personality and fear of missing out on a major responsibility, Reverse Budgeting works best. I can rest assured I am doing the right thing by putting money away, and I do not have to worry about my spending because I know what is left over is for me to do as I please. Unfortunately now with the business still in its infancy it’s survival mode, so saving really isn’t in the picture now. But once it kicks up I know what I’ll be doing!
If this blog resonated with you, I am glad. Budgeting may seem lame and unnecessary, but it truly is the first key to financial success. Get a system down that works for you and stick with it.
Next time you get stuck in the weeds going line by line, call someone who’s been through it before.
Until next time,
Andrew