In my years of financial planning for the affluent, undoubtedly the biggest frustration my clients have had has been with ‘budgeting.’ Regardless of the apps or technology used, traditional budgeting quite frankly stinks! Too often this tedious process leads to burn-out and a complete backlash in the opposite direction. This is often the last thing successful and busy people want to spend time and energy on.
“It’s clearly a budget; it’s got a lot of numbers in it.” – George Bush Jr.
In addition, people are often so worried about their budget and trying to identify if and how their purchases fit into their budget, that they never truly enjoy the purchases they have worked so hard to be able to make! Why do we keep subjecting ourselves to this? Is there a better way? If this sounds like something you have dealt with, keep reading because there is a better way…
How Do You Define Budgeting?
If you Google search ‘budgeting,’ you will find countless articles describing different approaches, methods and techniques, as well as definitions of what it actually is. When I refer to ‘budgeting’ here, I am referring to the traditional and most commonly thought-of method which involves:
- Categorizing Your Expenses (i.e.: food/groceries, personal expenses, dining out, travel, clothing, etc.)
- Setting Dollar Goals for Each Category (i.e.: spending $500/mo on groceries, $500/mo on dining out, $200/mo on clothing, etc.)
- Tracking What You Spend on an On-going Basis
- Comparing These Spending Patterns with Your Pre-Determined Goals In An Attempt to Control Your Spending Patterns
While this method sounds good on paper, and can be effective if you stick with it, the realities of actually implementing this method consistently is exhausting and is what often causes burn-out with the affluent. In addition to the very tedious nature of this method, the focus on categorization can cause these budgets to go awry and becomes confusing.
For example, if you purchase a new $2000 computer this year that you will utilize for both work and personal/fun use, do you categorize it as a professional development expense, or a fun expense? Or do you have to allocate it based on usage, like 50% each category? Also, if you start to overspend versus your pre-determined goals in one of the categories, do you then have to go back and identify if you are under spending in another category and reallocate that amount to the category you are going over on? How do you handle one-time or infrequent expenses in certain categories that may cause you to overspend in that category? Using the $2000 computer example again, which you may only purchase once every five years: if you categorize this as professional development, does that purchase then cut into and potentially eliminate your ability to spend on other professional development items for the year?
Although these are just examples, I have heard countless others from my clients when trying to implement this system.
So at this point you may be thinking: “Yes Ross, these are all the frustrations I have experienced, but what choice do I have? How do I assure that I accomplish my long-term goals and avoid overspending on things of lower importance / value in my life?”
Why Do People Budget? What is the Purpose?
I appreciated the effort my clients were putting into budgeting, but I wanted to make it easier for them. To do this, lets first take a step back and identify WHY we consider budgeting and WHAT the underlying goals are: 1.) avoiding overspending, 2.) putting money towards the most important goals.
Essentially it boils down to being proactive with your money (rather than reactive.) This is by far the most important component of achieving these underlying goals.
With this understanding, how can we improve this? How do we make this really easy and simple, yet still achieve the underlying goals of traditional budgeting?
“Begin with the end in mind.” – Stephen Covey
- To be proactive with your money, you must identify, quantify, and prioritize your goals. (See: "Take a Tech CEO Approach to Financial Planning".)
- Set-Up Systems
- You must set-up systems to assure that your money goes towards these most important goals.
Below is a system that I recommend to many of my clients. This system allows them to be proactive with their money, and the best part about it is that once it is set-up, it essentially runs automatically with very little work or maintenance. See the steps below and reference the visual:
- 1) Your income goes into one bank account
- 2) Auto-contributions are established / put in-place to then send the money to other accounts which are allocated for longer-term goals, particularly those that occur less frequently than once / month (see visual)
- Eg.. retirement savings / investment accounts
- Account for future travel
- College education
- Real-Estate Purchase
- Savings account / emergency Reserve
- Secondary reserve
- *Note that the savings / investments towards some of these goals can be combined into one account for simplicity
- 3) Spend the remaining cash in the account each month without worrying about
- 4) Maintain a reserve account with 3-6 months of expenses (not including taxes and savings) in the event that something major comes-up. However, the balance in this reserve account should remain relatively static over time. If you ever need to tap into this balance, immediately establish a new auto-contribution from the main account to replenish this reserve balance over a time-frame that seems reasonable.
- Note: if you are consistently drawing from the reserve account or find that you are unhappy with the amount you are able to spend, re-evaluate your priorities to either remind yourself of why you are saving / investing the rest of your cash-flow and or decide to change the amounts going to other savings / investment accounts, thereby providing you with more money to spend each month.
- Do NOT build-up credit card debt. If you are building up credit card debt and unable to pay it off every month, you are overspending and need to either re-evaluate your priorities and systems, or spend less going forward.
I hope you found this information helpful! Please let us know if you have any questions.