This is a guest post from Robert Brokamp of The Motley Fool. Robert is a Certified Financial Planner and the adviser for The Motley Fool's Rule Your Retirement service. He contributes one new article to Get Rich Slowly every two weeks.
How do you know what it costs to be you? That's my question for the day, dear GRS reader.
I've come a bit full-circle in what I think is most important when it comes to financial success. When I was a young, low-paid teacher, I focused on penny-pinching and budgeting. As I got older, I spent more time on investments. Now, I'm coming back to the importance of keeping tabs on expenses. Perhaps it's because investing hasn't been as rewarding over the past several years. Perhaps it's because it seems like financial security seems a bit more precarious these days. Maybe it's because the way I think about the whole kit-and-kaboodle — whether you call it budgeting, or cash-flow management, or a spending plan — a bit differently.
After I left teaching, I became a financial adviser with one of those big-name, full-service brokerages. During our three weeks of training in the Big Apple, we never learned about budgeting — it never even came up. Neither did debt management, financial calculations, or how to choose the right investment account. We only learned about investing (sorta), how to find clients with lots of money, and how to sell, sell, sell.
Back in 1999, I left the suits for the no-dress-code Motley Fool (well, we have a few rules — such as no Viking helmets with strapless evening gowns), and I wrote a few articles about budgeting. I also began using Quicken, but I pretty much stuck to using a trusty spreadsheet for determining how much we made, where it was going, and where it should go. I didn't maintain it as regularly as I should have, but it was crucial to have when we had to make a big decision, such as buying a house or having another kid.
Budgeting often conjures up connotations of self-restraint and denial, but as a financial planner, I've begun to value it more for its informational purposes. Consider the following:
- How can you determine whether your emergency fund is big enough without knowing how much you spend each month?
- How can you plan for retirement without knowing how much money you'll need each year in retirement?
- How do you determine the proper size of a life insurance policy without knowing how much your family would need if you joined that Great Tax Shelter in the Sky?
Yet I also recognize that staying on top of the ebb and flow of the household cash flow can be a challenge. So I thought I'd consult the one type of financial adviser who is more likely to know a thing about budgeting, and those are fee-only advisers, especially those who get paid by the hour (as opposed to being paid by commission). You won't find these people at Merrill Lynch or Morgan Stanley. They tend to be independent Certified Financial Planners who belong to like-minded associations, such as the Garrett Planning Network or the National Association of Personal Financial Advisors (NAPFA). Many of these folks have spent years helping people analyze their expenses and build a budget.
Specifically, I asked the Garrett folks — who kindly let me attend their annual retreat a couple of weeks back — what works, and what they recommend for their clients. I also pinged some of my more budget-savvy friends and colleagues for their tips.
Here's what they all told me.
Find the right tools
One of the reasons many people don't have a proactive plan for where their money will go is because they haven't found the system that works for them. To be effective and enduring, it has to suit a person's resources, habits, and personality. It becomes even more complicated when a spouse or partner is involved.
It all starts with choosing the technology that you're eager to interact with, even if that's just a notebook. In fact, that's what some planners recommend. Here's the advice of Jennifer Cole, CFA: “Get a small notebook and write down everything you spend, as you spend it. The act of writing it down may cause you to think twice before opening your wallet. And it will help you discover where the ‘missing money' goes.” In their new book Willpower: Rediscovering the Greatest Human Strength, John Tierney and Roy Baumeister cite a study in which dieters who kept a food diary lost twice as much weight as other dieters. I suspect this same principle of “more awareness equals less consumption” applies to spending as well as eating.
These days, you have plenty of options for keeping tabs on your cash:
- Spreadsheets: Ever since VisiCalc (the first spreadsheet program for personal computers, available in 1979), people have used rows and columns to analyze and track their spending. Nowadays it's even easier because there are plenty of free templates available on the Google Docs and Microsoft Office websites. Plus, if you have a smart phone, you don't have to wait until you get home to enter information; just pull the file down from the cloud. This also makes it easier for couples to both have access to the family financial info from just about anywhere.
- The old envelope system and modern equivalents: The theory behind this strategy is to set aside a certain amount each paycheck for various expenses — whether they be the weekly grocery bill or the annual insurance premium — and put the money in an envelope until it's needed. Know you spend $1,000 during the holidays? If you get paid twice a month, then you'd stuff $42 from each paycheck into the “holidays” envelope. While you can use actual envelopes, new-fangled services such as Mvelopes, PearBudget, Inzolo, and YouNeedABudget.com can help with the process. Or you can just set up separate savings accounts and have money automatically transferred after every paycheck clears.
- Financial software and websites: There's no shortage of services looking to help you with your spending, including Quicken, Mint, Hello Wallet, and GnuCash, which download information from your various accounts and help categorize your spending, often including pretty pictures and graphs. Then there are those that help you save for specific goals, such as SmartyPig and Payoff. (Have experiences with these tools? Let us hear the pros and cons in the comments section below.)
- Mobile applications: Surprise — there's an app for that! Besides the apps that go along with the aforementioned financial software and websites, there are several others, such as Budget, EasyMoney, HomeBudget, and Moneydance. Another way to use your phone to track spending: Leave a voicemail for yourself every time you open your wallet, and tally up the expenses at the end of the day.
- Pencil and paper: You don't need to plug in to budget. For clients who prefer the old-fashioned method, Liane Warcup, CFP, recommends The Budget Kit by Judy Lawrence, which features “fantastic worksheets and serves as a simple and thorough guide to creating and keeping a budget.” For a handy expense tracker to keep in your wallet, check out the “Spend Less Kit” a few fellow Fools created several years ago.
Find the system that will stick
The method of monitoring your money you choose will depend on the types of things you'll actually do. If you know you're not the type of person to record every expense in a notebook or on your phone, then look into one of the tools that will pull information from your bank and credit card statements (though you'll lose track of purchases made with cash).
Also, you have to be realistic about how much detail is necessary and doable. Justin Nichols, CFP, teaches a personal finance class at Kansas State and requires his students to track their spending. He says, “I think one reason people are overwhelmed is that they see a budget with 112 categories. So I have my students take a simplified approach: All their variable expenses are entered into just one weekly line item. In the end, it doesn't matter how much they spent eating out or on haircuts, it only matters that all their combined variable spending per week is within their budgeted amount. Then, if they blow their budget week in and week out, they can dig deeper into the detail tab to see what item is putting them over.”
Then there's the whole question of when you'll actually make yourself sit down and do the work. I like the advice of Robert Oliver, CFA, CFP: “I recommend setting aside a specific time each week to work on paying the bills and tracking expenses. For me, it's Sunday night after my kids are in bed. I find a weekly process is good to make sure nothing slips through the cracks and to assure that receipts and transactions don't build to an overwhelming level.”
Reap the benefits of smart money management
The type of spending plan you choose will depend on your circumstances. If you're in debt, not saving enough for your goals, or regularly find yourself crunched for cash, then a detailed, robust plan is necessary, at least until you've eliminated the debt, built an emergency fund, and have boosted your savings. On the other hand, if you're debt-free and have no problem saving enough for your goals, it's less necessary; however, you still might give some of these tips a try — you may discover ways you've been spending money in a less-than-optimal way.A quick way to track this can be by checking your credit report.
Just remember that planning to have enough for retirement and other goals starts with having a plan for how you'll manage your day-to-day expenses. As Michele Clark, CFP, told me, “After nearly 20 years of working with individuals, I've noticed a trend. The people who know where their money goes are the people who have managed to save enough of it to afford their goals. The people who are flying by the seat of their pants are usually not on track to meet their goals, and our conversations are about working longer and student loans for their children.”