When it comes to your finances & financial planning, everyone seems to go right to investments. Anyone who knows us or has worked with us knows that investments, while important, are only one aspect. Let’s begin with the easiest aspect of your finances, and that is spending.
We recommend you build a spending plan. A spending plan is an active strategy for getting where you want to go. Think of your spending plan as a road map that helps you reach your goals, and gives you a sense of direction. Your spending plan not only puts you in charge of how your money is being spent on a weekly, monthly, and yearly basis, but it also gives you a sense of control.
Where do we start? What are the steps to build this plan?
It takes some time and effort to develop a spending plan that is right for you and your family. Of course, there are guidelines provided by experts that you can follow, but in the end, you need to develop a plan that you can follow. Here are the steps you can take to develop your own spending plan. First thing is to keep a written record of your spending for at least a month using spreadsheets or a diary or whatever you are comfortable with. It is important to recognize things you spend money on. Start with categories: e.g., Housing (mortgage, property taxes, insurance); Food; Transportation (e.g., car payments, gas); Tuitions; Recurring Expenses; Other (e.g., entertainment).
Your spending record will only give you expenses that you made during that period. However, there are many expenses such as insurance payments, holiday gifts, or property taxes that occur annually, semiannually, or quarterly. Look at your canceled checks, your checkbook register, and any other receipts for the last year that can identify all of your out-of-pattern expenses. Add all your out-of-pattern expenses on a yearly basis and divide them into 12 so that you have a clear idea of how much you need on a monthly basis for your spending plan.
Of course, you want to make sure you have a good estimate of your income. If you are getting a regular salary, estimating your income is easy. Write down your monthly income minus federal and state taxes, Social Security taxes, and any other automatic deductions. Add other income such as dividends, interest, and child support. Make sure you include all types of income.
Tip: If you get paid weekly, biweekly, or semimonthly, you will need to convert your periodic salary to a monthly figure. For weekly paychecks, multiply your weekly income by 4.33 to get an accurate indication of your monthly income. For biweekly paychecks, multiply your biweekly income by 2.16. And for semimonthly paychecks (i.e., those who get paid on the first and fifteenth of each month, for instance), multiply your semimonthly income by 2.
If your income is irregular, you will have to start with the premise that your total income is somewhat predictable, but your paychecks come at uneven intervals. Look at your income over the last two years and project your income for the next 12 months. Divide that number by 12 and consider that to be your monthly income. Plan your spending with that income in mind. During months that you earn more than average, save the extra earnings for the months when you earn less.
A few other ideas to consider when you are thinking about your personal spending patterns.
People's spending habits do not change overnight so don't create a spending plan that is totally inconsistent with your current spending habits. Otherwise, you are likely to break that budget before it has a chance to succeed. Any budget that changes your lifestyle completely will be very hard to follow. If you are used to eating out at least twice a week and you create a spending plan that allows you to eat out only once a month, you are more likely to stray from the plan than if you create a plan that allows you to eat out once a week.
We know that life is full of the unexpected, so keep some flexibility in your budget. If a budget is too rigid it is likely to fail. In real life, unexpected things happen. Cars break down and friends drop in to visit, so leave room for those small occurrences.
Keep it simple and build a system that is easy to follow. After the initial monitoring period, you don't have to record every penny you spend. The less recordkeeping you have the easier it is to monitor your spending plan.
Keep fun in your plan. This is very important too. After working with people for years, I have never met anyone who wants to reduce their current lifestyle. We agree with this since no one knows how long we will be around and creating memories is also as important as creating a plan. But don’t trade the now for the future either.
Make sure you categorize and clearly separate categories. Assign exact amounts to each category. Often, people make the mistake of lumping too many expenses into one category or not creating a category for occasional expenses. This makes it difficult to track your spending and pinpoint exactly where your money went. For example, instead of creating a category for medical bills, separate them into doctor, dentist, prescriptions, etc.
Don’t plan out too far. Start out with a six-month plan and reevaluate every few months to see just how you are doing. It is difficult to build a plan for a year and stick with it.