Budgeting is a Philosophy
Budgeting is less about techniques, methods, and mechanics, but a philosophy. It’s about being a good steward (or manager) with what you have. So many times, people get hung up on the “how to” of budgeting than the “why to”. Anyone that has written about budgeting has their own way to do it. I have my own way too. I love my way. It has worked great for us for decades. Is my way right for you? Maybe, maybe not.
My point is, there are many ways to create a working budget. We can be as simple or as complicated as we want it to be. We may start simple and build on our budget until it becomes very involved looking at different scenarios and simulations. We might start more complex and then begin to see that we have a really good handle and later scale it back. Again, what we are talking about here is techniques, methods, and mechanics. This is about function and style. Trust me, there is one out there that fits you! But it’s less about the how to and more about philosophy of why to.
Remember when we discussed in the last section about Destination My FI future forward thinking? If you haven’t already done so, I want you to dig in deep and understand your reason for budgeting. What is your “why”? There are some people out there that argue that you don’t even need a budget if your spending is in line with your values. Although I fundamentally agree, I argue that not all people can simply do this without first seeing it laid out.
To the point that “you don’t need a budget if you are spending in line with your values,” I can honestly say, my wife and I could throw our budget away now and be okay. Before you stop reading, let me explain. We have been budgeting for decades. At first, we needed it to understand what was coming in and what was going out. We had to assign every dollar and discuss what was important and what could be cut. Although it is sometimes hard, this is when you can have great discussions about what you value.
You really need to have a very intimate relationship with the incoming and outgoing money that you manage to consider not using one at all. Without some sort of budget, you do not have a history or basis for understanding where you are going. Even though I believe at this point in our life we could stop budgeting, we still do. I love it. There is no question what we can and can’t do, and where we are going financially.
Building Your Budget-The Foundation
Time to begin. We will be walking through the steps to make an effective budget. One that we don’t work for, but works for us. Start by thinking about some of the basics. What are the broad areas? We will break these down to smaller subcategories later.
Income
What are all the sources of your income? Is it primarily a job? Investments? Real estate? This may seem to be easy at first, but for some, it could be more complicated. Maybe you have a family business that kicks off distributions. You could have an irregular income. Maybe you work for commissions and your income is dependent on sales. You might have a side hustle that brings in a little extra. Jot down your sources and the frequency of each.
Expenses
What are you currently spending your money on? Easy question to ask, but a hard one to answer. I will give you some tips on how to examine this more granular later. For now, think about the broad categories: Housing, Taxes, Utilities, Services, Insurance, Groceries, Auto, Personal Allowance, Pets, Maintenance, Dining Out, Entertainment, Gifts, etc.
Here is a tip and what I always recommend. If you do not know where your money is going, get a tablet or open a spreadsheet on your computer and start documenting each time you spend something. Before you jump to trying to figure out how you will manage your budget, figure out what it is you are even spending money on. By starting to build this list and adding to it each time you spend, you will have the beginnings of creating a budget. Don’t worry about it being pretty or if everything is under the correct category. Remember, this is your budget and it has to work for you. If it makes sense to you, that is all that matters. It is more important to have the complete list of items listed and eventually the correct amounts spent than anything. Once everything is captured, we can start working the data. The math doesn’t lie.
You can look at past credit card and/or bank statements if you want to try to construct a history. Many financial institutions have decent spending summaries that are easy to download, sort, and filter. If you are not into data analytics, tech savvy, or just don’t want to spend the time, start where you are and move forward. Just start tracking your expenses.
This might take a full month or so to compile a basic list. Then, as the year goes on, you’ll find things you’ve missed. Just when you think you have everything considered, another bill will come in. No worries. Just add it in and keep going.
Remember, in this stage we are just beginning to make a list of all of our sources of income and all of our expenses. What’s coming in and what’s going out? This is our starting point.
I also want to mention for the tech savvy, there are dozens of budgeting apps. Although I am familiar with a few, I do not feel qualified to give my opinion on any of them since I don’t use them. Many people use them. That could be an option for you to explore.
I am kind of a nerd, so I started years ago building our budget into a workbook on my computer. It has grown over time adding in more complexity than any person should ever possibly want or need. I have recently thought about redoing it from scratch with the sole purpose of making it simpler.
Fixed vs Variable Expenses
Another way to look at your expenses is fixed vs variable. Fixed expenses are expenses that do not change month to month (i.e. car payments, mortgage, insurance, etc.) Fixed expenses don’t always, but sometimes, have an annual increase. Variable expenses can move wildly from month to month. These are typically calculated by usage (i.e. fuel, utilities, groceries, etc.) thus giving you a little more control. You may be able to reduce a variable expense by cutting back or changing to an alternate option (i.e. eating in vs. eating out).
Nondiscretionary Expenses
These are the expenses that are nearly impossible to live without. Things like taxes, utilities, and insurance. These are some of the most difficult areas to cut in your budget. Although we’ve certainly heard the stories of people that live completely off the grid or don’t use internet and phones, that’s not something we will explore here. I do not have any advice for those that want to live that extreme. But if you can do it, more power to you!
Necessary expenses are difficult to argue against. We can shop around, refinance, move/downsize, but these are hard to go without. This is an area we can explore if there are options. But if we cannot find an alternative, these have to be paid to avoid losing a service or something being taken away from us.
Discretionary Expenses
These would be categorized as things that we want or may make our life better, but are not needed for survival. Some examples of these are clothing, entertainment, dining out, and streaming movie services. Yes, we need clothing, but we do not have to be a walking billboard for a big brand. I always find it interesting that we will willingly pay a company lots of our hard-earned money to wear their logo, just to turn around and see that same company pay someone (like an athlete) a large sum to wear their logo. Likewise, we need to find ways to enjoy our time and money, but if it puts our families or futures at risk, we have to ask ourselves if it can be something we do differently or go without.
We have found that this is the area of the budget we personally spend the most time discussing and debating, at least in the early years. Here is where we discover if we are influenced too much by what others think of us, or if we can be content doing life different than our family and friends. This is where we get creative and put on our Destination My FI thinking hats.
Can we have friends over for a potluck and evening bonfire instead of going out? Can we switch to a lower cost service provider? Can we limit the amount of sports our kids can participate in a calendar year? This stuff isn’t easy to work through, but in our experience, is the space where you can make major headway. You may find lots of dollars that can be captured and deployed differently.
A look at Values
What are our values? If we desire to give to a charity we love, spend time fishing with the grandkids, or living in a mountain community, we need to examine our expenses to see if they line up with those values. We may be spending away our retirement years while providing the executives at the companies we are doing business with big bonuses.
If we are on a Destination My FI journey, we need to be the commander of our incoming dollars. We take each one and deploy it to a very specific task. We want our dollars to work for us, not the other way around! We already spend so much time away from family and friends working, often doing work we don’t love. We spend money thinking it will give us joy (a fair trade for work), but in the end are left unhappy, anxious, and in debt. Not to mention any thoughts of accomplishing our goals are miles away. We end up working very hard, digging a proverbial hole in the sand that is collapsing all around us.
What, instead, if we looked at who we really are? What we believe in? What we live for? If we are not doing that right now, what is it going to take to get us there? No one can come in and sort this out for us. We need to set the foundation and shore up the structure.
Saving/Investing
What are we currently saving and/or investing? At this point, it doesn’t matter how we have, but how much is being put aside and where? We might be putting weekly contributions into a retirement account like a company 401k, 403b, SEP, or an IRA. We may be putting excess into a taxable (non-retirement) account. We need to ensure we are capturing all this information to get a complete picture of our entire budget.
If you are currently saving for retirement or investing regularly, make sure you include it. You may find you will need to adjust it one way or the other. I will go more in depth about my thoughts on investing and things to consider at a later time. How much we can afford to invest is an important part of our budget. What if we are spending too much now without considering the future? This has to be examined.
Start!
Some people need some encouragement to get going. Here it is….START!
For now, just start making your personal list.
Where do you get paid from? How often?
Where does your money go? What is fixed vs. variable or nondiscretionary vs. discretionary?
What items within your spending align with your value system and which ones do not?
What are you currently setting aside in some sort of savings or investment account? How often?
By getting a better understanding of our income and outgo, we get a better picture of our budget. This helps us set a plan. This helps us get our earnings, spending, and saving in line and can help get us on a direct path. This is how we begin our Destination My FI!