Effective Budgeting: Step 5 (or in reality 1) in Securing Financial Freedom

Welcome back to Money Matters! While starting with budgeting might seem logical, understanding the foundational aspects of a financial plan is crucial to understanding the reason for effective budget management. Let’s explore various methods that cater to individual needs and preferences:

1. Zero-Based Budgeting: This method involves assigning every dollar a purpose, ensuring that income minus expenses equals zero. It requires meticulous expense tracking and categorization, including savings and investments.
2. The 50/30/20 Rule: Divide income into needs (50%), wants (30%), and savings and debt repayment (20%).
3. Envelope System: Allocate cash into categorized envelopes representing different expenses. Once the cash in an envelope is depleted, spending in that category stops for the month.
4. Automated Budgeting: Utilize apps or bank tools for automatic transfers, expense tracking, and alerts for overspending.
5. Pay Yourself First: Prioritize savings by setting aside a portion of income before other expenses.
6. Track and Adjust: Continuously monitor expenses and income to adapt the budget to changing financial goals.

In my role at Choreo, the integration of technology into financial management takes center stage. You might think my solution to budgeting would be a technological one, akin to method 4 above, and you’d be partly right. I started early in my career and marriage by using Mint.com as my budget tool. I linked my bank accounts, investment accounts, debt accounts, etc., and set up categories that made sense for our lives. But despite having all that data at my fingertips, there was a major problem – having information about where our money was going didn’t necessarily translate into the discipline needed to change our spending behaviors. It resulted in acquiring knowledge without actual behavioral change.

My wife and I experimented with various methods over the years, but one stood out as the most effective. Surprisingly, it wasn’t a high-tech solution but rather the envelope method. Instead of relying on high-tech software, we withdrew our budgeted cash each pay period and divided it into separate envelopes, each representing a spending category. This hands-on approach forced us to manage our spending more consciously.

Regardless of the method chosen, where should one begin? Here’s a suggested approach:

1. Download and Categorize Transactions: Start by gathering transaction data from all your accounts over the past year. This comprehensive data will provide insights into your spending patterns throughout different seasons and events.
2. Simplify Categories: When categorizing expenses, simplicity is key.
   1. Essentials: This category covers unavoidable expenses crucial for daily living, such as rent/mortgage, utilities (electricity, water, gas), groceries, transportation (fuel, public transit costs), and essential subscriptions (like health or necessary digital services).
   2. Credit Card and Loan Payments: Focus on tracking and allocating funds for paying off credit card balances, personal loans, or any other debts. Differentiate between the actual expenses incurred using credit cards and the payments made to settle these expenses.
   3. Health and Fitness: Include expenses related to healthcare, including insurance premiums, medical expenses, gym memberships, or wellness programs.
   4. Home: This category involves maintenance costs, repairs, home improvement projects, or any expenses related to your residence that aren’t covered under utilities or mortgage/rent.
   5. Insurance: Cover all forms of insurance payments, including home insurance, life insurance, car insurance, and any other relevant insurance policies.
   6. Emergency Fund: Allocate a specific amount towards building and maintaining an emergency fund. This fund acts as a safety net for unexpected expenses or financial hardships.
   7. Extra Savings and Cash: This category serves as a catch-all for additional savings beyond emergency funds. It could include funds for specific goals, such as a vacation fund, future investments, or any discretionary spending.
   8. Discretionary Cash: Reserve this category specifically for managing cash transactions, handling various day-to-day expenses that might not be explicitly covered by other categories. It could encompass spending on miscellaneous items like entertainment, dining out, shopping, or other discretionary spending.

By simplifying and clearly defining these categories, you gain a clearer view of your spending habits. This approach enables better monitoring, easier adjustments, and a more effective allocation of funds towards your financial goals. Tailoring categories to suit your lifestyle and financial priorities is crucial for the success of your budgeting endeavor.

1. Calculate Household Net Take-Home Income: This step involves determining the net income received after tax deductions, health insurance, retirement savings, and other employer-based expenses. This net income forms the basis for budgeting.
2. Determine the Bottom Line: Subtract total budgeted expenses from the total household net take-home income. This calculation reveals your financial standing, potentially highlighting a deficit or surplus.
3. Negotiate Expenses or Seek Additional Income: Once you have your bottom line, it’s time to negotiate expenses. This could involve assessing what expenses can be reduced or eliminated. It’s a challenging and emotional task that may involve discussions with your partner or family. If reaching a balanced budget seems impossible with current expenses, exploring ways to increase income might become necessary. This could involve seeking additional sources of revenue or taking on extra work.
4. Committing to the Budget: The final and most crucial step is to commit to the budget. Staying dedicated to the outlined plan requires discipline and conscious effort. Regularly track expenses and income to ensure you’re adhering to the set budget. Adjustments might be necessary over time due to changes in circumstances or financial goals.

Each step in this approach is vital for successful budgeting. It’s not merely about creating a plan but also about actively implementing and adapting it to your evolving financial landscape. Remember, these steps serve as a roadmap toward financial stability and the achievement of your desired goals.

Our next discussion will delve into goals-based planning. By allocating a portion of our budget to savings, we pave the way for life goals. This is where dreams meet planning—a favorite phase indeed.

Join us next time as we embark on the enriching journey of goals-based planning and explore common aspirations.

Matt Bankston, CFP®, Co-Publisher of the Shreveport Bossier Journal, also serves as a Managing Director at Choreo Advisors, an independent firm focused on redefining the RIA’s role in the wealth advisory industry. Choreo, LLC is registered as an investment adviser with the U.S. Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training of the adviser or its representatives.