Is Budget a Four-Letter Word!
Is budget a four letter word? In many households, it is stronger than a four-letter word.
In reality, it is misunderstood and over complicated. The better terminology is naming it a Spending Plan. A budget makes one feel constrained, restricted, and controlled. A Spending Plan should elicit freedom. A Spending Plan should give people flexibility. And a Spending Plan gives one control over their finances. One should not be controlled by their finances, but have control over it.
Treat Your Income as a Business: You are Valuable!
Whether you earn $25,000, $100,000, or $300,000+ per year, your future income is generally your biggest asset. Earning $50,000, with slight, inflation-like increases each year, for 25 years is a significant sum of money, over $1.6 million. If an investor or insurance company were to buy your annual income, they would probably offer you a lump sum of nearly $1 million for your next 25 years of service! You are worth a lot! This is referred to as your biggest asset—Human Capital, your earning power.
Nearly all private or public businesses worth their salt will operate on a budget, or spending plan. They have to so in order to survive, and potentially thrive. The businesses know where the money is going. They pay marketing expenses, insurance expenses, employee expenses, and so on. They have dollars allocated for certain line items. When gasoline prices are $5.00/gallon, the transportation line item becomes over budget, but it is a necessary and mandatory expense. Something else must get reduced. If a certain department feels they need more funds, then a meeting is held to determine such. We as individuals need to do the same.
How do I Gain Freedom & Flexibility with a Spending Plan?
Picture a fish. A fish is restricted and contained by the environment it swims in. A fresh water fish will survive and thrive in the right environment: in Lake Michigan, at the right depth of water, at the right temperature of water. This fish, while contained only to Lake Michigan, is free to go wherever it would like within the correct environment. While Lake Michigan is large, it is trivial when compared to the Pacific Ocean. If this fish is taken out of Lake Michigan, and allowed to be “free” in the Pacific Ocean, it is consumed or dies. Although the Pacific is over a 100 times the size of Lake Michigan and the fish is “freer”, it stands no chance and will perish shortly. Within the confines of Lake Michigan, this fish has freedom and flexibility, even though it is constrained in some sense.
People and businesses are no different. Some properly placed barriers, restrictions, and controls will actually free us to be flexible within the environment that is created around us. A well constructed Spending Plan can help eliminate the sarcastic eye brow raises that usually rise to full-on arguments.
When the husband continually purchases shoes, with no budget or plan, this creates dissention within a marriage. The normal thought process is, “if he is spending all this money here, then I am justified to spend whatever I want here”. This is normal human behavior. If allotted $50 a month in the Spending Plan, Shane, who loves shoes, is freed to spend $600 a year on shoes. No arguments. It is in the agreed upon plan and dedicated for such. Shane can save all twelve months worth of his shoe money for a designer brand come Christmas, or Shane can buy a pair of on-sale, durable sneakers every month. He has the flexibility and control.
This principal can be applied to many controversial household purchases: sporting events, shoes, apparel, golf, entertainment, music, technology gadgets, massages, hair services, etc. The list can go on and on, depending on preferences. The freedom and flexibility can only be experienced by creating a realistic Spending Plan.
Where do the Funds Go? Just. Start. Tracking.
The truth is that most people don’t know where their money goes. At the end of the month it’s gone, but a new paycheck is coming through. This has two problems. First, it works until it doesn’t. The first time one has a significant health issue, household repair, or car problem, debt is incurred. Once debt occurs, interest is paid and the funds each month run out quicker. You play catch-up for a year; get back to normal, and then the car breaks again. Start right back over, rinse and repeat.
The second problem with living paycheck to paycheck is that one isn’t saving for the big tickets. Some of the big tickets in our society are college funding for children and retirement funding. Deciding to enjoy a respectable lifestyle during your retirement years is not a decision made at age 60 or beyond. This is a decision that is made much younger in life: when you decide that it is worth the slight delayed gratification of spending your income today and save it for a later tomorrow.
When an individual or family actually tracks their spending, they will see where all their funds go. Some will realize that they spend $9,000 a year on travel baseball for their 12 year old son. Some will realize they spend $3,800 on going out to lunch every day. The key is to just start tracking the numbers. When starting, the tracking will show you where the funds go. This will be an eye opening experience for most.
Once the tracking of expenses is done, the individual can then determine what is essential, important, a desire, and not important. After the tracking, then one can draft a Spending Plan. If married, the Spending Plan should be discussed fully, and as fair as possible. Keep in mind that this is a draft, and can be altered at a later date. Some expenses will be fixed with no wiggle room: auto insurance is a prime example. Others, like housing costs, might bring into question the size of house you are choosing to afford. Others yet, such as entertainment, can fluctuate greatly.
Tools & Resources
The availability of mobile apps, websites, and excel spreadsheet templates makes this process easier than ever. Many of these resources are at no cost. Additionally, professional services can be used. Many financial planners have hourly fee schedules that can be affordable. If you are using a professional to help manage your long-term assets, you might be afforded this consultation at no additional costs.
Securities & Advisory Services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Optimal Wealth & Investments and LPL Financial are separate entities.