“Annual income twenty pounds, annual expenditure nineteen (pounds) nineteen (shillings) and six (pence), result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
—Charles Dickens, David Copperfield
“Where did the money go?”
My wife’s words lingered. I didn’t have an answer. Several months earlier we had received a very generous gift of $10,000 from a family member. Now it was gone. We didn’t know where it went.
It was hard to look in the mirror. When I did, I saw weakness and failure. It was embarrassing. We were doing it wrong. Life. I didn’t know what right looked like, but this definitely wasn’t it.
Squabbles over money start in this dark place. My wife and I had managed to mostly keep money issues from having a negative impact on our marriage. But I could sense an underlying mutual mistrust creeping in. I was sure that I was partially to blame, but I didn’t think that it could have been all me. Where had the money gone?
There were other times. It seemed the instant we found ourselves with some money, there was always an “important” reason why it had to be spent. But if these reasons were so important, why could we never seem to remember what they were?
Something had to change.
First, Admit You Have a Problem
Some popular personal finance authors eschew the idea that you can become wealthy by living below your means, instead advocating a focus on increasing your income. But it’s not an either/or decision. It’s both. No matter how big your paycheck is, you can’t be financially successful if you spend more than you earn. Once you have control of your money, you can focus on increasing your income. And it will be far more effective when you do.
Money troubles don’t just sort themselves out. Focused on their careers, businesses or investments, sometimes people suddenly find themselves with lots of money. Things can seem easy for a while. But surprisingly, many lose substantial fortunes as the money slips through their fingers. Only those who are deliberate with their spending habits can make money stick. This simply won’t happen unless you admit to yourself—and to your partner if you have one—that you aren’t good with money.
The good news is that getting money to stick is an acquired skill. Some people are naturally inclined, but anybody can learn it. And it is actionable. While increasing your income might take some time, taking charge of your spending can start right now.
Write It Down
It’s time to talk about the “b-word.” Most consider it a curse-word. The first thing that people think of when they hear the word “budget” is what they’re going to have to give up. Usually, this is because they are going to have to give something up.
But a budget is actually all about mindset.
I’m into goal-setting. I think that many of us drift through a life of mediocrity because we achieved our original goal of becoming an engineer/veterinarian/lawyer/accountant/teacher/whatever and then simply didn’t set any more goals. We just let life happen to us after that. Having a clear set of goals propels you forward.
A budget is nothing more or less than a set of goals for your money.
To get started, create a spreadsheet using Google Sheets or Excel or whatever. I like Google Docs because I can easily access them from home, work, my phone, etc.
Choose a period equal to how often you receive a paycheck. Everything you enter in the spreadsheet must align with this period. My wife and I both get paid bi-weekly, so it’s easy to align. If the pay frequencies for you and your partner aren’t aligned, use the shorter period. It is easier to prorate this way than the reverse.
Create the following columns: Item, Income, Expense.
In the first few rows, list all of the household income. For example, we’ll have a row for my salary and a row for my wife’s pay. In the “Income” column next to each item, list the net pay that you receive each pay period after taxes and other deductions.
Start by using net income—the money you actually receive in your account each paycheck. You can refine it later to account for taxes and deductions like retirement plan contributions. But if this is your first budget, you probably aren’t going to change those things right away so they’re not as important on day one.
Count the Cost
Now go through your bank account and identify every payment that comes out of your account automatically. Enter these into your spreadsheet in the “Expense” column. You may have to scroll back through your bank transactions for a whole year. This can seem daunting at first. But we found that even once we thought we were on a budget, automatic payments would suddenly come out of our account unexpectedly. This was because some of them were quarterly or annual payments; we hadn’t gone back far enough to catch them. You really aren’t in command of your money until nothing comes out of your account unexpectedly.
Prorate expenses that do not fit within your pay period. For example, if you have a car payment that is paid monthly but your pay period is bi-weekly, you should enter the bi-weekly amount needed into your budget. Simply multiply the monthly payment by 12 (months) to get an annual amount, and then divide by 26 (pay periods) to obtain the amount that needs to be set aside each pay period. I have a fourth column labelled “Notes” in my budget spreadsheet. In this column I usually make a comment about the actual payment amount. For example, if the budget number is $46.15 for my bi-weekly budget, I will write “$100 per month” in the Notes column. This just helps when you’re looking for the expense in your bank records.
Now identify all other expenses. Go through your account and identify each type of spending. Look back through at least the last three months, add up all expenses of that type, and average it out for a single pay period.
You should end up with a fair number of rows. Our budget has about 60 rows in it. You can group these into categories of related expenses if you want to get a feel for how much you’re spending in a particular area. For example, we group all of the car-related expenses, including insurance, fuel, vehicle registration fees, allowance for maintenance, etc. This allows us to add some additional data to our spreadsheet to see how much of our budget we’re spending on transportation.
Identify the Problem(s)
Once your spreadsheet contains everything on which you currently spend money, it’s time for a moment of truth. At the bottom, sum up the income column and the expenses column. Which one is bigger? If things aren’t going well, then your expenses will be bigger than your income.
If your income is greater than your expenses, great! Congratulations. The next question is by how much? There is a variety of theories, but some suggest you should be living on 90% of your net income. Others suggest even less. Jim Rohn suggests 70%, and that’s what we’re currently aiming for.
In either case, you need to figure out where you’re spending money unnecessarily.
We discovered that our money issues stemmed from two main behaviors:
- We habitually overspent in certain categories. For example, we had thought that we were spending about $200 per week on groceries. Because our bank accounts were such a mess, we tracked our spending for a few weeks by bringing home all grocery receipts. What we found was shocking. We were spending nearly $1,500 per month! Giving in to our middle class entitlement philosophy, we had been maintaining a diet that regularly included fillet steak, rack of lamb, and quality wine. This and a few other similar areas were ripe for cutting.
- We made arbitrary unplanned purchasing decisions. Our decision to spend lump sums of money for major purchases seemed to be solely based on whether we had the money and the desire. Vacations, a new computer, a TV or stereo—we didn’t save up for things. We just bought them.
If you have debt, this is where you will begin to see its effect more clearly. Loan payments erode your paycheck and make it more difficult to live within your means. Eliminating these naturally frees up room in your budget.
Tighten Your Belt
Cut. It’s time to start living within your means. It may be a blow to your pride. It may be a blow to your lifestyle. But you must cut.
My wife and I put ourselves on a personal spending budget. We each get $25 per week for fun money. That isn’t much. This is for things like coffee, buying fun things for ourselves like books, or going out for dinner. It also includes wine so that it doesn’t come from the grocery budget. Because of this, we can be a little pedantic when we decide to share a bottle of wine. If we’re splitting the bottle 60/40, we make sure it’s accurate by actually measuring it out in a Pyrex measuring cup!
Hard to believe, right?
Do we want to live like this forever? No and yes. It would be nice to have breathing room in our budget so that we can enjoy life the way we’d like without it feeling tight. But we also know that there will always need to be that feeling of restraint. It is a positive influence and keeps things in check. Without it, as money increases, appetites simply increase to match. We measure our wine cheerfully because we know that we are building something better for the future.
Part of the joy comes in finding less expensive ways to have fun. Once you get past the initial pain, it is actually very empowering to know that you are no longer a spendthrift. You begin to take pride in a more frugal existence and the resulting ability to be able to set something aside every paycheck.
Pay Yourself First
So far, we have been reactive. Now it is time to get proactive.
Once you have mastered the ability to live on less than you earn, you can start identifying where you actually want your money to go. If you’re keen to start investing in real estate to build wealth, you will want to start setting money aside for a deposit. You must do this deliberately. Immediately following the rows for “Income” in your budget, insert a line labelled “Pay Yourself First.”
Set the amount in the “Expense” column to be 10% of your net pay. If you have consumer debt, such as credit cards, car loans or student loans, use this money to pay those debts first. Otherwise, this is money that you’ll set aside every paycheck into a separate account. Wealth building has begun.
The remainder of your spending must now fit within 90% of your income. Adjust accordingly.
As you progress, you will probably look for ways to increase the amount that you can set aside. One of the hidden secrets of personal finance is that success is compounding. Before you know it, you will be in control of your finances. Money to invest will be building up in a separate account. You will be able to look into the mirror and know that you are starting to do life right.
How do you manage your budget? Any tips you’d add to this?
Let me know with a comment!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.