I was talking to a friend recently who was recommending an app that helped him managed his budget. He was telling me how much easier it was than the complicated spreadsheet that he was previously using. After a few more minutes of him explaining how the app worked, I offered a different approach. Instead of keeping detailed records of all your expenses, simplify the process by paying yourself first. While I agree, that you should know your budget to see how much money you need to live off on a monthly and yearly basis, a detailed monthly tracking of your spending to the penny is not needed in your financial strategy.
Simply put, budgets do not work. They are stressful and an unnecessary use of time. You may follow them for a while but, much like the latest fad diet, you will lose interest in following them. While it is important to have a basic budget to monitor your overall finances, relying on money left over after your budget every month for savings is a futile effort. By taking money out of your monthly income in the beginning of the month you are not only ensuring a monthly savings plan, you will also be reducing your stress and the amount of effort needed. Here is how to create an automatic monthly savings and investment plan.
Below is a sample budget for a family of four living. This is a basic budget that does not leave much for extravagance. For instance, it assumes no child care cost (relying on a stay at home parent or extended family) nor any tuition for school private school. Extracurricular activity costs are excluded, such as dance or travel sports. Family vacations will be stay-cations with day trips. It also purposefully omits savings, we’ll get to that later. What it does provide is your essentials and a very comfortable lifestyle. A basic framework to provide you what really matters. A warm home with food on the table to enjoy with your loved ones.
|Health Care Cost *||200||2,400||3.39|
|College Savings **||1,000||12,000||16.93|
|Water & Sewer||200||2,400||3.39|
* Miscellaneous co-pays and deductibles, assuming your employer provides health insurance.
** 6k per year per child, assuming 2 kids.
*** Assuming cord cutting and streaming services.
Some people will see this budget and say it’s too tight to live on and other people will say that’s crazy, who has that type of money? Whatever your view is, it’s a sample budget to prove a point and hopefully give people some ideas on how to devise their own spending plan. You can revise the numbers to your own situation.
Now imagine following this budget and saying, whatever I have left over will go towards savings. That will be a difficult and arduous task, here is why. While you will be excited to follow the plan for the first few month’s it will quickly become tiresome. Imaging having to add up your grocery bill and saying, well I reached 800, I guess we can’t eat for the rest of the month. Or after a few month’s all your friends are taking an expensive trip and you say to yourself, well, we do have this extra money. Putting off one month’s of retirement money won’t be a big deal, let’s go.
Pay Your Savings Plan First
What I propose is taking savings out in the beginning. Let’s day that you’re take home pay, after taxes, is 8,000 a month. You would simply allocate 2,100 a month towards savings, which is 8,000 minus the 5,900 of living expense from the above budget. By doing this you no longer will worry about calculating monthly expenses or putting off savings, it’s done for you. You can even have the money automatically invest into an index fund. Automatic and easy, like a box of Kraft macaroni and cheese.
Here’s an example of how my wife and I altered our home repair savings plan. I’ve heard from others as well as my own experience that you will spend approximately 6,000 a year on miscellaneous home repair. Something you may not consider when purchasing a home. Some years it will be less, but then one random year you will need a new roof which will exceed your 6,000 annual budget. Overall, an average of 6,000 per year is a good approximation.
At the end of every month we would deduct any home repair cost and the remainder would go towards house savings. As you might imagine some month’s we forgot. On other month’s there was nothing left since we spent too much on other expenses. Essentially using the home repair budget to subsidize other parts of our lifestyle. After 2-3 years of this needless effort, we paid the house account first. Instantly we experienced the ease and reduced stress that it offered, (imagine the heavenly music and rainbows). Now when we have a home repair we simply withdraw from that account.
You may say to yourself, well if I need extra money, I will withdraw from savings and I can’t trust myself. There are a few tricks you can use to avoid the temptation. For example, you can set up various accounts. A brokerage account can receive your direct deposit from work. Then set up a monthly withdrawal to another bank account where you pay all your bills. One spouse can pay the living expenses while the other manages the investments. Automatically investing the money into an index fund will help as well. In addition to having the money work for you in the stock market, having to sell part of your index fund will provide an additional deterrent from dipping into savings.
Whichever way you choose to set up your accounts, the concept is simple. Don’t create extra work and set yourself up for failure with a pay yourself last mentality. By paying your savings plan first, you will not only ensure your monthly savings target, but most importantly reduce your stress. By doing this you will free up your time to invest in your career for making more money or your personal life for greater enjoyment.