This is a guest post from Joshua Timberman, whose passion for personal finance started after reading Dave Ramsey's The Total Money Makeover. He became debt-free in November. He is the Financial Peace University coordinator at his church, and is an active participant at Get Rich Slowly and other personal finance blogs.
The most important thing to do with your money is to give it a plan. A budget. A spending plan. A cash-flow plan. Call it what you will, but having a plan for how you spend money will set you free to actually enjoy it.
Managing money and impulses
Everyone who has any kind of income needs a budget. Successful companies and governments manage their money with budgets. Even unsuccessful companies and governments do budgets (though it can be argued they don't have the right approach). To get ahead with money, you need to manage it. And that is what a budget really is: Money management, on purpose, written down.
If you don't write down how you're going to spend the money you make, it will walk out the door on impulsive purchases. This leads to spending more than you can make, and leads to bad money habits like “90-days, same as cash” financing on stupid things, or ridiculous car loans because you had that new-car itch.
I plan my impulses. I build into my budget a set amount of money that I can spend on whatever I want without guilt. This is a relatively small amount — usually $100 per month — but the important thing is that I'm doing it on purpose, and not letting my impulsiveness get the better of me. I've been doing this for three years now, so I have some practice, but I didn't start with a lot of experience, and it didn't work for a few months, but things came together eventually.
The cash-flow planning method
Making a budget work takes effort. I won't hide that fact. Experts talk about different methods. Some will say use theirs, and others will say use whatever works. I will share the method I use. I recommend it because after trying several others, this works the best for me and my wife, and for the people I have worked with through Dave Ramsey's Financial Peace University at our church. Dave's idea is very simple.
- Plan the entire month's income on paper.
- Spend every single dollar. This is a “zero-based” plan.
- Cover the necessities before additional bills.
- Get an accountability partner to go over your budget with you.
- Revise as needed when emergencies or unplanned events come up.
- Plan for emergencies or unplanned events!
Planning your budget on paper
Planning the entire month's income on paper is fairly straightforward. Yes, it helps if you're salaried because you know how much you'll make each month. If you don't know how much you'll make each month due to commission or hourly wages, focus on the necessities first.
Write everything down. Dave makes his forms freely available on his web site. Print these out and use them. These cover a lot of categories that many people may forget. By writing down the budget on paper, it becomes more real. You're more likely to actually live by what the paper says, especially if you pin it to a bulletin board you see every day. (Watch for a follow-up post on more modern methods for cash-flow planning.)
Creating a zero-based budget
The zero-based plan means that every dollar, every penny is spent. This makes some people nervous. I was skeptical about this at first as well: “What if I bounce a check?” “What if I overdraft?”
Here's the thing. When you tell every dollar what to do, and then you actually live that way, you know that a check will never bounce again, and you won't overdraft your account. We don't even have “overdraft protection” on our checking account because we don't need it. While you're getting used to budgeting, give yourself extra money in the areas where you know you spend more, especially food and entertainment. Remember that the goal is a balanced budget, so in order to reach zero at the end, you'll need to adjust categories accordingly.
When you look at Dave's form, you'll see that it has a certain order:
- He starts with giving, because if it doesn't come first, it will be postponed or removed. The subject of giving is a topic unto itself, so I won't cover it here.
- Savings comes next. Did you know that on average, Americans have a negative savings rate? There's many reasons for that, but like giving, it needs to be a priority before anyone will actually do it.
- After giving and saving comes the “four walls,” as Ramsey puts it: food, clothing, shelter, and transportation are the necessities that we all need to take care of. Food and clothing should be obvious; shelter means mortgage/rent, utilities and required maintenance, and transportation is car payments, gas and vehicle maintenance.
- After the four walls comes the personal expenses, and then the bills or debt payments.
Working with a partner
An accountability partner is your spouse or significant other, or a friend or relative that will be honest with you and dish out the tough love. If someone doesn't love you enough to hurt your feelings about bad choices you're making, they're not qualified to be an accountability partner. For married couples, it is absolutely imperative that both people are on board with the financial planning, or disaster will strike the land.
Expecting the unexpected
Once the budget is prepared, and agreed upon by you and your spouse or accountability partner, it isn't necessarily set in stone. I know that life happens. Do yourself a favor and set aside some money each month for incidental expenses. This shouldn't be too much, as you should have an emergency fund to cover the larger events. At least $1000 if you're still in debt, 3-6 months expenses if not. Large events do not include Christmas! That happens every year at the same time, so plan for it!
To get things rolling with your budget, first download Dave Ramsey's cash flow plan forms. The “monthly cash flow planning” form is the main one for most people. Further instructions are included on the form. For those with irregular income, use the “irregular income budget” form on the same page. Instructions are also included with that.
Get started today! It doesn't matter that we're in the middle of a month. And keep in mind your budget won't work at first. It didn't for us, and even after three years we still make mistakes. I can tell you though, if we hadn't kept at it, we wouldn't have the sense of freedom we have. Telling your money what to do makes it go further. Plan your spending every single month and you'll find the freedom I'm talking about, and you'll realize you make more than you thought.