Believe it or not, most people I talk to don’t have a spending plan! They also feel financial independence is nothing but a pipe dream. True financial independence means having enough wealth to live on without working. For some, it may mean living a certain lifestyle.
That said, so many of the people I talk to do not have a budget! Dictionary.com is instructive with its definition of budget:
- An estimate, often itemized, of expected income and expense for a given period in the future.
- A plan of operations based on such an estimate.
Many of us rely on mental accounting. In our heads, we subtract the expenses from our income. If you do this, do you account for taxes and income and outgoing interest payments? In my experience, only a few have an itemized budget. In that case, they may only try to get today’s spending to add up which may include credit card payments with open-ended interest payments. Some use online methods which often miscategorize expenses or provide misleading results. So where should you start?
Start with a spending plan
I define a spending plan as a plan of savings, debt payments, and expense payments that will lead you to your long-term goal(s) such as retirement, your children’s college, or some type of wealth accumulation goal.
Do you really know where your money goes today? Do you know how much you pay in taxes and employee benefits? If not, you’re not alone. Most people focus on what actually hits their checking account. However, often you can affect how much is taken out for taxes based on withholding.
Once you start to tally up what you spend, do you find yourself with large miscellaneous amounts? This can easily happen when you pull money out of the ATM for various expenses. But, do those withdrawals start adding up to 10% or more of your budget?
If so, you should find another way to pay that helps you keep track. Years ago, I started using and refilling a debit card from one of my coffee hangouts. It helped me realize that I needed to find an alternative way to caffeinate! Once you know where you’re at— it’s time to calculate what it takes to get you there.
What spending plan gets you to your goals?
First, clarify your goal(s). I want to retire at 65 on $75,000 per year. How much do you need to save, based on your risk tolerance (asset allocation) from now until age 65 (timer period)?
Now start with a new budget. Then plug that number into your goals spending plan. When you save that amount do things balance out? Note that if you have a 401(k) or can save into an IRA, you will reduce your taxes, so it may look like you are going over budget when you may not.
You may find that you need to back into what you can spend around your savings goal amount. Typically, rent, mortgage, condo fees, student loans, and car notes are your biggest expenses. If you rent, it is easier to downsize to make room for your primary goals.
Do you get a large refund check from Uncle Sam? If that happens regularly, consider changing your withholding so that you can have the cash flow today. A $2400 refund check, could have been a $200/month cash reserve deposit, $2400 Roth IRA, $200 savings to your kid’s college fund.
Moreover, do you have adequate life insurance and disability income protection? If not, get some quotes so that you fit them into your spending plan. You don’t want life’s unwanted events to derail your plan or the plans of your family.
When you go out to buy that new car, understand that the monthly payments for the upsized dream vehicle may be at the expense of your cash reserve, Roth IRA, or your kid’s college fund. If a student loan is an issue, I have helped a clients free up significant cash flow to redeploy to a new financial independence spending plan.
Your debt picture may be such that the answers aren’t straightforward. I recommend seeking out professional help. Financial professionals such as CERTIFIED FINANCIAL PLANNER professionals and others can see things that you cannot.
Remember that all financial professionals are not alike. Many times someone may be called an expert when they have no formal education in the subject matter. It is important to become knowledgeable about the types of financial professionals.
Once you know where your money is going what can you reallocate?
Few situations are hopeless. Most require clarity and patience. If your current situation took years to create, it may take time to correct. Often a more realistic look at resources and expectations based on resources is needed. Your spending may not have been sustainable in the first place given your income. Reallocating your attention to what you really want, can help decrease angst.
I believe that with a spending plan, professional guidance, and persistence you can achieve your money goals.