That’s where budgeting comes in. It’s an important topic for everyone, regardless of wealth.
The traditional method
This is the approach in which you set spending targets for various categories, and then track what you actually spend for each. For example, I might have a spending goal of $200 per month for eating out. If I track my purchases and realize I’m spending $400 here, then I know I need to make an adjustment.
This method works well for people who struggle with spending habits because it allows you to identify problem areas. It’s also good for those who like data and getting down into the weeds.
The tricky part can be knowing how to set your goals. You may need to track your expenses for a few months to get a feel for what’s normal, and then base your goals on that. There are some rules of thumb, such as “save at least 10% for the future” or “don’t spend more than 30% on housing”.
For other categories, a lot has to do with personal preference. I might spend a lot more on gas and airfare than someone who hates traveling, but they may spend more on groceries and household goods. If you need more help setting goals, there are several online templates such as this one.
You also need a tool for tracking your goals and your spending. Many people use a simple spreadsheet that they create themselves. There are also very cool tools online like Mint.com and YouNeedABudget.com that let you link your bank account and your credit/debit cards, and automatically categorize each transaction for you, and measure your goals. There is some manual work to be done to make sure everything is classified right, but it’s very helpful.
The downside of this method is that it’s pretty hands-on. You’ll need to manually categorize some transactions, or at least making sure that your online tools are doing it correctly. It also requires you to be honest with yourself about what areas need work. Simply tracking them is only part of the equation; in order to be successful, you’ve got to be willing to recognize problems and adjust accordingly.
The reverse method
In the traditional budgeting method, you start with tracking spending and go from there. But what if there was a way to control your spending without going into that much detail? That’s where reverse budgeting comes in. With reverse budgeting, you worry about your personal spending last. That may seem odd…how can that possibly work?
The key is that you determine some important factors from the outset that will lead to a responsible budget:
Pay yourself first
- Set savings goals in advance and make them happen automatically. A good example is if you have a company retirement plan like a 401k.
- If you know you need to save 15% of your income to accomplish your goals, then set your 401k contributions to 15%. They’ll come out of your paycheck before it even hits your bank. This way, no matter what you spend on other stuff, you know your long-term savings is taken care of.
- This also works for shorter-term goals, such as saving for a home. Set up automatic transfers from your checking account to a savings account that you can’t get to easily.
Pay everyone else next
- This mostly refers to bills. You already know that there are certain things you have to pay for, like mortgage or rent, insurance, or paying off debt. You probably have a reasonable estimate of what those payments will be every month.
- This also includes expenses that are technically “optional”, but you’re committed to paying them each month, i.e. Netflix.
- You can set up automatic billing to cover these expenses, so the money gets taken out automatically. Since you can accurately estimate these costs each month, there should not be any surprises.
With whatever money is left over after paying yourself and everyone else, you can spend as you please
- If you’ve automated things as much as possible, you know that whatever is left over in the checking account after bills are paid is fair game.
- You don’t need to worry about what specifically it gets spent on. It doesn’t matter if you spend $20 or $200 on clothes, because you’ve already taken care of the important stuff. Those secondary categories tend to work themselves out.
- Note: don’t go crazy and accumulate ongoing credit card debt! You can use credit cards for spending, as long as you’ve got enough money in your checking account to pay them off every month.
The reverse method does assume that you have a reasonable idea of what you can afford based on your income and aren’t locking up so much money in these ongoing payments that you have none left over. If that’s the case, you should proceed with the traditional method to figure out where things are going wrong.
However, for those of you that feel you’re already doing okay with your budget, but want to make sure you’re in total control, the reverse method can be very useful.
Here at WealthPoint, we frequently assist clients with their budgets. If you’d like some help putting a budgeting strategy together, or just a second opinion on what you’re already doing, we would love to help. A good budget is often the first step toward accomplishing your financial goals.
Thanks for reading!