“I think it’s time,” he said. “We’ve been aggressively saving for years and even went to a Social Security seminar! We’re ready to retire and want to ensure the numbers look okay.” You could sense the clients’ excitement as they started describing their plans for a cross-country road trip and being able to spend more time with their grandchildren. “It sounds like you all have put a lot of thought into what retirement looks like. And you’ve certainly put in a lot of hard work to prepare. But it’s been a few years since we’ve updated your annual expenses in our software… do you have any idea what your current annual spending looks like?” The look of excitement changed to dread. It was as if all the air had been sucked out of the room with a single question.
Few things conjure up as much fear as having to examine your own spending. And certainly, few things can cause as many marital conflicts as talking about “the budget.” But budgeting doesn’t have to be scary. In fact, just changing the term “budget” to “spending plan” can change those conversations from daunting and miserable to upbeat and optimistic.
A favorite piece of financial guidance is to “spend less than you make and save more than you think you need to. It is not that different from when a doctor tells a patient to eat healthy foods or a dentist tells you to brush and floss your teeth twice daily. It’s not complicated, but for many reasons, with personal finances, it is challenging.
Spending is perhaps one of the most significant factor in building wealth and determining when/how you will retire. Long-term changes in how much you spend can have huge ramifications on your ability to plan for financial goals. Not only that, but it is one of the only things you have control over in the financial planning process. (For example, you don’t have control over what investment returns you get, but you do have control over your standard of living). And how much you need to save is directly related to how much you spend! The higher your standard of living, the more money you will need to save to retire.
The traditional thought is that budgets help you keep your spending in check. This theory is partly true. Budgeting can provide structure, consistency, and accountability with how you spend money. We emphasize “can” because people often create budgets but fail to stick with them. This failure is because overly optimistic budgets don’t necessarily help change behaviors. More important than developing a budget is developing a way to systematize spending to influence behavior and develop good habits. We’ll call this a spending plan.
Spending Plan vs. Budget
What is a spending plan, and how is it different than a budget? I describe a spending plan as giving every dollar a job and ensuring it’s doing that job each month/pay period. To get started, I find it helpful to use a “three buckets” mentality. Think about categorizing each dollar into either “past obligations,” “current expenses,” or “future goals.” Past obligations are your fixed, reoccurring expenses. Future goals are things you want to do or need to do someday, like saving for retirement, college, or that dream vacation. Current expenses are your variable expenses that can differ on a weekly basis. Variables include groceries, gas, Home Depot trips, eating out, etc.
A key to establishing a spending plan is to automate transfers and thereby limit your control over spending decisions. As counterintuitive as it might sound, limiting your control over spending decisions will help keep your spending on track. So how do we accomplish this? With multiple checking accounts, savings accounts, and automatic transfers. Here’s how:
Step 1: Create a checking account that all money flows into. This is where your paychecks should be deposited. We’ll call this the Bills/General Account Bucket. All of your “past obligations” will be paid from here. Set up automatic drafts for these bills to come out of this account on monthly (or whatever the required frequency). Don’t carry a debit card for this account, as you should not be spending from here.
Step 2: Create a savings account for each of your “future goals.” These goals would be things like that trip to Europe or saving for a down payment on a house. It could also be to build an emergency fund. Again, you want to set up automatic transfers to go into these accounts, or buckets, on a regular basis. Most of the time, people try to save whatever is left over (pro tip: this doesn’t always work out well), but we want you to be disciplined about setting aside money for these goals.
Step 3: Create a checking account for all your weekly variable spending. We’ll call this your Household/Spending Account Bucket. This account should house the money left over in your paycheck after your fixed expenses and savings amounts. You should set up a monthly/twice monthly/weekly transfer from the Bills Bucket to this one. Since this amount varies from month to month, it may take a few months to get it right. This is the only account you should carry a debit card for.
One of the reasons this system works is that it helps break down your paycheck into smaller portions that are easier to manage. If you are a two-income household and get paid once a month, you may have A LOT of cash hit your account at once. The temptation when we see those big numbers is to not worry as much about spending extra on a trip to Target or date night because it doesn’t seem like a big deal. While in reality, much of your income is already spoken for (or, in the case of savings, should be spoken for). Paying yourself a spending allowance helps keep spending in check because that amount is likely much smaller than your total pay.
In our house, we’ve tried everything from traditional budgets to cash envelopes, but this is our favorite method. We “pay ourselves” into the Spending Bucket twice per month. Then throughout the month, I can pull up our banking app to see how much we have left until our next spending allowance deposit. If we are running low, I know I should skip the Starbucks drive-thru or avoid buying an extra item at Home Depot.
Sticking to a budget doesn’t have to be frightening. Determine what dollars are already spoken for and set up a spending plan for whatever is left. If you can learn to systematize your spending, you won’t have to be afraid to talk about expenses. If this concept is still giving you financial nightmares, then it might be the right time to contact a Bridgeworth advisor. We are here for you when you are ready to talk.
Bridgeworth Wealth Management is a Registered Investment Adviser.
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