One of the most common pieces of financial advice that you’ll hear is to create a budget – and then stick to it. But, in many ways, budgets are like diets. They involve discipline and self-deprivation, and neither of these things are fun. Thus, most budgets end up failing, just like most diets end up failing.
Today I want to talk about budgeting strategies for those of you who, like me, hate budgeting. For starters, I want to remind you of a strategy that I’ve dubbed “reverse budgeting.” This is the strategy that we’ve used for years, and it’s been great. It’s both easy to set up and easy to maintain. Here’s what I’m talking about:
Instead of setting up a detailed budget, complete with projections of how much weâ€™re going to spend in particular categories, we have predetermined (and rather aggressive) savings goals. Beyond that, we mostly let the chips fall where they may. Of course, we also have a few other targets (like giving a prescribed percentage to charity). But, for the most part, as long as weâ€™re hitting our savings targets, we donâ€™t really worry about the details of where the rest of our money is going.
If you do decide to go this route, I encourage you to start by sitting down to define some goals and run the numbers. What are you trying to achieve? How much money will it take to get there? And how much money can you commit to setting aside?
If you’re not sure how much you need to be saving, then you might consider following (or aspiring to) something like “The Balanced Money Formula,” which is outlined in the excellent book “All Your Worth: The Ultimate Lifetime Money Plan” by Elizabeth Warren and Amelia Warren Tyagi.
The Balanced Money Formula is based on your net (i.e., after-tax) income. According to the formula, you shouldn’t be spending more than 50% of your net income on “needs” (such as food, housing, utilities, basic transportation, and so forth). Obviously, the less you can spend the better, but let’s just stick with that 50% for now.
Next up, “wants”… You can spend up to 30% of your net income on this category. This includes all sorts of discretionary items, including things like entertainment, vacation travel, dining out, clothing beyond the essentials, etc. And yes, even things like cable TV and internet service should be included here. These things may seem essential, but they’re not truly “needs.”
And finally, savings… You should be saving/investing at least 20% of your net income for future needs. Note that I would recommend inverting the order here, and ranking these as follows: (1) needs, (2) savings, (3) wants. By re-ordering things, you protect against overspending on wants and leaving too little for savings.
Okay, now that you have goals, here are some tips for making them a reality:
Automate your savings
From here, I recommend automating your finances at least to the point where your savings and investment contributions are automatically deducted up front. That way you won’t slip up and forget. And by taking out the money up front, you won’t be tempted to spend it. Out of sight, out of mind.
Save (part of) every raise
In the future, as your income rises, simply commit to setting aside a a fixed proportion of every raise to increase your investment contributions. For example, when my wife and I were first getting started, it was a stretch to save 5% of my income – but we did it. And from there forward, we added at least half of every raise to that amount.
A year into my job, when I got a 3% raise, we bumped our savings up to 6.5% of my (now higher) income. A year after that, I got a 4% raise, and suddenly were were saving 8.5% of my (now even higher!) income. And so on. The beauty of this approach is that you won’t miss that extra money since you didn’t it in the first place.
Consider using separate buckets
Depending on the nature of your goals, you might benefit from splitting your savings up into multiple “buckets.” For example, you can stash you emergency fund in a local savings account, save for multiple near-term goals in dedicated sub-accounts at ING Direct, save for longer-term (but pre-retirement) goals in a taxable brokerage account, and so forth.
But don’t overdo it. The whole point of this exercise is to get you away from the tedium that will drive you to abandon your budget. If you streamline the front end but make the back end too complex, you’ll throw in the towel when the novelty wears off. In other words, make your system as complex as it needs to be, but no more so.
Don’t spend money that you don’t have
Finally, for this “save first” approach to work, you cannot spend money that you don’t have. Yes, it’s fine to use credit cards – we do so all the time. But you cannot allow yourself to carry a balance. If you do, then you’re not truly saving as much as you think you are, and the whole system will crumble.