We can do two things with our money: spend it or save it. (Actually, there are other possibilities — eating it! smoking it! — but we'll limit our discussion to what sane people do.) For most people, spending is in the driver's seat, getting the largest chunk of monthly cash flow and — let's be honest — a lot more fun. Yet we all know that we should be saving money, and that a good deal of our spending is the financial equivalent of eating a Twinkie: It provides a short burst of pleasure, but no lasting value. In fact, it can undermine future well-being (and possibly make us fat).
Many financial planners suggest that the first step toward reaching a spending-saving détente is analyzing your spending and creating a budget. But there are few problems with traditional budgeting:
- It's difficult to monitor every specific category — e.g., utilities, food, clothing, entertainment — and make sure you're spending just so much and no more.
- It can be time-consuming and tiresome.
- It focuses more on spending — and often the restraint of spending, which can feel like a straitjacket — while saving can seem like an afterthought.
I myself have found budgeting more difficult as my family has grown and my life and finances have become more complicated. So after a good deal of thought and research, the Brokamp family is flipping the process around. Rather than seeing how much we spend and then saving the rest, we're determining how much we need to save, and then spending the rest — what I'm calling “goals-based budgeting.”
- It doesn't require that you track every penny (though it does require regular monitoring and calculating).
- It doesn't require that you remember how much you're allowed to spend on each category. Rather, you just keep tabs on one important number — how much you have in the bank — and adjust spending accordingly.
- Money is kept in separate accounts and labeled with specific purposes.
- For those who find spending difficult (yes, such people exist), this provides peace of mind that important goals are being funded, so it's okay to enjoy something now.
Sound good? Here's how to do it.
Step One: Figure Out How Much to Save
Goals-based budgeting begins with — surprise! — your goals. Once you've identified them, you have to figure out how much they'll cost, and how much you need to save on a regular basis to achieve them. Those topics require some soul-searching and number-crunching that deserve more than a passing mention. But in this article, mention them passingly I will, and point you to other articles, such as The Best Ways to Boost Your Retirement and How Much Should You Save for Retirement?, as well as some Foolish online calculators.
Step Two: Square Up What's Left Over
Now you need to make sure your savings calculation is compatible with your expenditures. This is where having a record of past spending comes in handy (nay, necessary). If you figure you'll have to save 40% of your income to meet your goals, yet you spend 80% of your paycheck, you'll have to adjust spending, goals, or both.
Step Three: Put It All on Autopilot
One article I came across while searching for a better budget was “To ‘B' or Not to ‘B'” on the website of Certified Financial Planner Sherrill St. Germain, a fee-only advisor in Nashua, N.H., and a member of the Garrett Planning Network. She calls her method “reverse budgeting,” and it starts with automatic transfers of money to several accounts. This includes her Roth 401(k) and health savings account, but also separate savings accounts with specific names, such as:
- “Emergency Fund”
- “Taxes” (which, as a self-employed person, she must pay quarterly)
- “Maui” (her vacation)
- And, possibly coming soon, “Mountain Bike”
Her online bank, ING Direct, allows her to maintain and label separate accounts (as do several other banks).
That takes care of the goals. For the spending part, St. Germain recommends an annual analysis of expenditures. Based on that analysis, have a certain amount transferred to your checking account each month to cover living expenses. This is the one number you have to keep an eye on as the month progresses, and will help you decide if you should purchase that pair of shoes or spiffy gadget. On the other hand, if it looks like you're on track, you can spend guilt-free. Also, if you tend to have big-ticket items that show up annually rather than monthly — such as life insurance premiums or holiday gift giving — consider having a separate savings account for those.
Step Four: Monitor Regularly, Tweak as Necessary
This system requires that you check your monthly expenses account once or twice a week to make sure you're not running out of money before you've run out of month. As St. Germain wrote:
If that account dips below its predefined acceptable level, that's a red flag that something's not going according to plan. Could be overspending, could be under budgeting. Either way, it's time to dig into the details, figure out what's going on…
The monitoring of your goals doesn't have to happen as often — maybe once a year — but it too is a crucial step in making sure you'll have enough money when you need it.
In the End, Do What Works for You
Having a plan for every dollar is probably the ideal from a financial perspective. But we know that system doesn't always work for most people. A goals-based budget is another way to approach the process, and at this point it's a work in progress (feel free to suggest your own budgeting tips in the comments below). But the best budget is the one that is adjusted for your situation, habits, and tolerance for looking at little numbers.