If you’ve heard it once, you’ve heard it at least twelve hundred times: In order to master your finances you must have a budget.
What is a budget, anyway? In the traditional sense, it is an amount you set as a limit for a certain category of spending. In the practical sense it is a way to set a theoretical amount of money you will spend on certain things.
In an even more practical sense, it is a way for you to make yourself feel like a loser every month.
I have used a budget for more than five years, month after month. And sometimes, especially as a student with limited expenses, I was able to successfully nail my budget for a given month. And it was awesome. More often, however, I got to the end of the month, painstakingly totaled up and categorized my expenses, and two hours later, found that I had overspent in one category or another and that I was “over” by a small margin. Crap!
A LOT of research has gone into budgeting over the years. Much of it is redundant, and I will not bore you with it here. Suffice to say that the spirit of budgeting is, after all, truly at the heart of sound financial management. The spirit of budgeting is having a plan that makes sure you fulfill your required commitments with a few strong ideas for everything else. Even the wealthiest among us is not free from the finite constraints of money – we’re not Congress, after all. And the best way to steward a finite resource is to have a plan. A plan that is flexible enough to account for life’s curve balls, yet structured enough so that your electricity stays on.
Budgeting in the traditional sense can work perfectly if you get paid once per month, withdraw all of it at once in cash, and have physical limits on how much you spend on things like food, gas, clothes, and saving. It’s also perfect for businesses when you set a limit on how much you will spend each month for things like advertising, and you have multiple accounts that you fund individually, and when the money’s gone, it’s gone for that month in that category.
So, why is budgeting dead if it is the heart of sound financial planning? The reason is simple: flexibility. Life happens. It’s happening now. The best budget cannot account for everything, and as my wife has said so well “the price of carrots goes up one week and we’ve blown our grocery budget,” and we feel like we’ve failed. It is true that being “over budget” by just a few dollars is not a real defeat, but it feels like one.
It may be ego, sure. But feeling like a champ every month when you look and see that your bank account is bigger at the end of the month than it was at the beginning is a real motivator. And your mind is at least 80% of financial management. When you can SEE financial progress, and FEEL like you’re on the right track, you will ACT like a winner every time you whip out your wallet.
Budgeting has a more effective and motivational cousin that is known around the internet as a cash flow plan. A cash flow plan differs from a budget in that it is not zero-based, meaning that all categories do not add up to exactly your monthly take-home pay. This makes it much easier to see growth month-to-month, provides greater flexibility, and eliminates much of the month-end number crunching. A cash-flow plan is a budget made for life.
So how does it work? Pretty much the same as a budget, but every single dollar doesn’t get assigned to something. Instead, groups of dollars get allocated to different uses, and you can leave a little money unassigned as a cushion for unexpected expenses. Instead of locking your money into boxes, you pour it into buckets, which are free to pour into other buckets should the need arise.
In practice, a cash flow plan starts at the top where your paycheck goes into your checking account – think of this as a big bucket at the top of a hill. Right away, your pour some money out into a savings account or cash for building your personal savings. right after that, money is poured into another bucket for your fixed living expenses – rent, insurance, car repairs, clothing, subscriptions/dues, specific saving goals, utilities, etc. if you want to set up a second checking and savings account for these things, or just keep track of how much money is in your main checking, it works the same. The remaining money in your main checking account now holds the remaining money that you can use until you get paid again and the process starts over. This money is now free to be poured into variable and intermittent expense buckets like gas, food, entertainment, and gifts, as well as unexpected minor expenses like finding the perfect gift or learning that you owe something on a past medical bill. At the end of the month, look at your main checking account and see if the balance is higher or lower than when the month started. If it is lower, look through your expenses and see where you might make changes for next month. If it is higher – congratulations, you are cash-flow positive! Feel like a champ, pat yourself on the back for your restrained spending, and either leave the remainder in as a greater cushion for next month, or put the extra into savings.
This system works best for people who have an emergency fund already in place, a healthy checking account starting balance I like to call a “zero number” (at least a couple thousand dollars), and are good at setting and sticking to goals. It also works well for natural savers and people who can restrain extraneous spending at will. If you love spending, have lots of debt payments, or if you are brand new to personal financial management, you may want to consider a more structured cash-flow plan, or even a traditional budget. That way, you build the habit of thinking long-term, sticking to a more rigid structure, and tracking your money in more detail before trying the more fluid cash-flow plan.
Working from a cash flow plan gives you the ability to deftly handle life’s little bumps in the road, especially as your cushion grows. Spike in your electric bill from an extra hot or cold month? No problem, the extra in your main bucket is there to cover it. Found out you owe more than you thought to repair your car? Write that check, stress free.
If you dip into the cushion, be sure to replenish it the next time you get paid to maintain that “zero number” balance in your checking account. I like to have a solid “zero number” that is as far above actual zero as possible, just to be safe.
There you have it, the downfall of tedious, time-consuming, and ego-bruising traditional budgeting. For more information about using a monthly cash flow plan, or to set up your own personal financial roadmap, contact us at Debt Freeks, and get personalized service right away.
Until next time,
Do Brave Deeds and Endure
– Ben at Debt Freeks