Getting Real Value from Budgets

Compound Interest 14When I reached my financial bottom in April 2006, one of my first responses was to simply start reading a lot about personal finance. I checked out a pile of books from the library on personal finance and tackled a lot of different suggestions from those books, along with some of my own ideas that I came up with as I went along.

One idea that was repeated over and over was how incredibly important and valuable having a budget was. I tried several different budgeting approaches and stuck with them for short periods, but the idea of a budget just never really stuck with me. The constant recording of expenses and estimates of spending in the future and so on always seemed like a bunch of busy work that never really went anywhere at all for me.

What did I do instead, then? I focused mostly on just watching what I spent. I did find a lot of value in simply jotting down every dime that I spent in a pocket notebook and, soon, I began to resist spending because I didn’t want to write it in that notebook any more. I began to really focus on how I spent my money in a few key categories – books being the big one. I set up some automatic transfers to take care of specific bills and to start saving for specific goals. Perhaps most importantly, though, I began to really change my behaviors and how I spent my time.

There are two big things to recognize from this story.

First of all, the actual personal finance choices I made were budgeting. Writing down my expenses, setting up automatic payments and savings, focusing on problem categories – those are exactly the type of things that make up budgeting.

More importantly, however, they led me to the same theoretical goal that budgeting has – a more responsible relationship with my money. That’s the destination of budgeting – a relationship with your money that enables you to have the freedom to effectively not worry about the money too much and just get on with your life.

If that’s the case, then why do so many people fail at budgeting – and why is it still recommended so often in personal finance books and on personal finance sites? I think the answer to that question explains why budgets are so often described in personal finance books – and also explains how people can get real value from “budgeting” their own way.

Budgets, Budgets, Budgets: Why?
Take a look at the people who are typically authoring personal finance books. They’re CPAs, CFAs, and other folks who deal with finances for a living. They’ve likely always been strong with math and never been afraid of dealing with large chunks of numbers – it always came natural to them.

I’ve always enjoyed math – in fact, I was just a few credits shy of a minor in mathematics in college – but I’ve never been much of a fan of business or accounting math. Large rows of financial figures have always caused my eyes to glass over. I enjoy chasing down a problem, but adding up figures and making estimates is not something I enjoy or naturally want to do with my time. I can do it, but it doesn’t feel natural to me.

The important distinction here is that the traditional way of doing a budget is something that comes from people who are financial planners and accountants – people who are naturally gifted with working with lots of numbers and spreadsheets. That’s great, but it doesn’t accommodate how many people look at the world.

Not everyone is as comfortable with numbers as a CPA or a CFA. That’s not to say they can’t do it, but numerical analysis isn’t as easy or natural for many people as it is for a person naturally drawn to accounting and financial fields. The advice given on budgeting in personal finance books often comes from those folks who are naturally gifted with numbers and thus their budgeting advice is often challenging for others to follow.

A Better Solution: Focus on the Goals
Instead of focusing so intently on the exact process of budgeting as shown in a personal finance book – and, even worse, viewing yourself as a failure if you can’t keep it up – focus instead on the goals of all of this.

Why are you thinking about budgeting in the first place?

Most of us try budgeting because we simply need more breathng room in our monthly and yearly finances, for various reasons: repaying debt, saving for a big goal, building an emergency fund, or something else entirely. We know that the route to this is getting our spending in check.

The solution, of course, is to trim a little spending out of a lot of areas in our life.

The usual way of doing this is to sit down, sort our spending into a lot of different categories, and make estimates and targets for monthly spending – a very number-heavy process.

But, really, all that budgeting is doing is saying “I need to cut spending in these specific areas.” It’s difficult to cut spending in a lot of areas, but those are great areas to cut back in.

Because of this, I wound up with a solution that worked really, really well for me. I like to call it zero-sum budgeting.

Let’s say, for example, that I have $200 a month set aside for our energy bill. I’m on the “budgeted” energy plan that averages out the energy costs for the year. I also have $100 a month budgeted to spend on whatever I want, so one month I use $50 of that to install a programmable thermostat and also on some caulk. I program the thermostat to turn off the heating and cooling when I’m asleep or at work and I use the caulk to air-seal my home. Next year, the energy bill gets reduced because you’re using less energy – now it’s just $165 a month.

Here’s the key part. Instead of just spending that extra $35 a month, I start putting $35 a month automatically into savings. Since I was already making ends meet with the $200 energy bill, It makes no difference in my day-to-day life if I just put $165 towards the bill and $35 into savings instead of just $200 into the bill.

You can do the same thing with any category of spending once you have a good estimate of how much you spend in that area. Let’s say, for example, you spend $50 on media purchases a month – DVDs, books, and so on. If you decide to “budget” just $25 a month for that, start off the month by automatically putting $25 into that account.

You can also do the same thing with “found money.” If you come into a small windfall, just stick some or all of it into the account. If you find a great way to save some cash as a one-time opportunity, put that saved money into the account.

What can I use the money in that account for? If I’m building up an emergency fund, I just let it keep building until it’s an amount I’m happy with – a few months’ worth of living expenses. If I’m paying off debt, I clean out the account each month and use it as an extra debt payment. If I’m saving for a goal, I just put that money towards whatever goal I’m saving for.

Two points.

First, this doesn’t work if you’re already spending more than you make. That type of behavior is not sustainable. If your credit card balance is going up each month, no amount of budgeting or planning matters until you’ve reached a point where that credit card bill goes down each month.

Second, it works best if you focus in on a specific area or two. Budgeting is a lot like dieting. If you go cold-turkey crazy, you’re going to have a very high likelihood of rebounding and undoing all of your good work. Instead, focus on one or two areas for conscious spending cutting and, at the same time, look for “one shot” opportunities to save money now or reduce ongoing expenses.

Any time you commit to financial change, willpower is required. However, it doesn’t require an accountant’s head for numbers. It requires a focus on goals, a willingness to actually make some behavior changes (one step at a time), and a desire for real change in your life.

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