You can’t discuss financial systems without addressing the elephant in the room: the budget. As much as everyone hates the process of creating and adhering to a spending plan, the budget is simply the best money system for building wealth over the long term.
The underlying principle of a budget is the key to all financial improvement: spend less than you earn. On paper, it’s a simple concept based on arithmetic. If you want to have more wealth at the end of this month than you had at the end of last month, your outflows — all your spending — must remain less than your inflows — all your income.
A budget makes it easier to stick to this concept. After the system becomes ingrained, you don’t even have to think about it. Well, you can think less about your spending with the knowledge that as long as you stick to your budget, your wealth will continue to grow.
Designing a budget that fits and works
At the turn of the century, my financial situation was a disaster. When I finally hit my rock bottom — I lost a job, I lost my apartment, I lost my girlfriend — my situation shocked me into a reality check. I had been ignoring everything negative, living in some fantasy in which things I ignore would not exist. I was an adult — young, but an adult — and I knew what a budget was, but someone, and in this case my father, had to sit me down and figure out a budget.
We worked out the numbers on the back of an envelope or a piece of paper. I figured out how much I had to pay on my student loans each month — a bill I was ignoring. We determined my expenses precisely. Before long I got a new job and was on my way to living within that budget.
It was a quick and dirty budget, but perhaps because I understood the importance, especially at a critical financial time for me, I managed to shift my attitude towards my money management and stay within the budget.
Sometimes, budgets need to be quick and dirty like that. For me, the effectiveness comes from the fear of repeating a very difficult situation, not necessarily the budget system itself. Moving back in with my father, although he was gracious, was something I did not want to have to do again. I was motivated to stay on top of my finances.
Without fear’s strong motivation, the pressure to budget isn’t as strong. That’s where designing a good system comes in — you don’t have to rely on motivation as much as habitual behavior.
Base your budget on Maslow’s Hierarchy of Needs. Use the pyramid, with physiological needs like food, water, and shelter at the bottom, to prioritize your budget categories. Paying the rent and buying groceries comes first. Self-fulfillment, like hobbies, television, and the internet, comes last. If you have to reduce or eliminate a category from your budget, make sure it’s something from the top of the pyramid.
Use simple figures. Yes, you could use software like Quicken to monitor your budget. You can even use a system where you create email alerts to warn you when you’re getting close to your spending limit by linking your bank accounts to your financial applications. This can easily get overwhelming, and when you believe your can’t handle a system that’s too complicated, you won’t stick to it.
Rather than budgeting $200 for dining out each month, for example, limit yourself to four restaurant meals outside of the home. It’s easier to count the number of restaurant meals than to track the dollars you spend — but you should be tracking your expenses and income anyway.
Encourage flexibility. One reason people avoid budgets is because spending plans are seen as strict. Budgets don’t have to strict; in fact, they’re often more effective when they are flexible.
- Spent less than budgeted in one category? Put the excess into an online savings account or allow yourself more room to spend in that category in the next month.
- Need more in your budget for a one-time event? Borrow from a category in which you’ll underspend this month.
- Consider budgeting in some categories on a yearly basis rather than a monthly basis. Some categories might benefit from a weekly or even daily budget.
Sticking to the budget.
The perfect plan can be fantastic on paper, but it’s worthless if you don’t stick to it. The beauty of a good system is that it shouldn’t require motivation every day. It should be a natural part of your life. Part of that is turning the budget into a habit, and part is incorporating the budget into your overall philosophy of life.
Review daily. After you put your kids to sleep or when you’re otherwise relaxing after dinner, collect your receipts from the day and have a little discussion with yourself or your partner about your finances. Try to notice anything out of the ordinary. I used to spend this time every day entering receipts into Quicken, downloading transaction from my bank, and making sure all the information was correct. For many years, this was just a habit, and I could figure out right away if I was in danger of exceeding my budget.
Don’t spend a lot of time, but do it every weekday for a month. Even if you don’t like routines, and there was a time I avoided routine in my personal life as much as possible, make it happen.
Don’t be scared to talk about it. I’ve found that saying something out loud, or perhaps publishing a web site about progress, makes something real. You don’t have to share the details to help your approach to budgeting manifest. Because the budget is a convenient excuse, you have a reason to casually mention your approach to money. If a friend wants you to spend money you can’t, you can tell this friend, “It’s not in my budget.”
Just those five words can make you feel empowered about your financial choices while at the same time making your budget more real. If you keep the fact that you are paying attention to your spending to yourself, there is less pressure to abide by the guidelines you set for yourself. When you acknowledge out loud you have a plan and you’re motivated to stick to it, a fear of embarrassment or public failure can help compel you, or at least encourage you, to continue to make good decisions.
Once your budget becomes a money system ingrained in your approach to managing your money, it will help you build wealth over the long term without having to consciously think about spending less than you earn every day.
How has a budget helped you build your wealth?