Your Personal Budget Plan Just Got a Whole Lot Easier

by Neal Frankle, CFP ®

How much do you think you spend each month on your personal budget plan ? Take a guess. (We’ll need to refer back to your number later, so please write it down. Thanks.) You know what?

Most people underestimate their monthly budget by 30%.

Can you see how dangerous that mistake can be? Let me give you an example.

The Plan... Pictures, Images and Photos

I asked Bob how much he thought he spent on average each month and he said $4,000. Then, I asked him what he earned and he proudly reported that he brought home over $4,500/month. So I asked him what he did with the $6,000 he saved last year. ($500 not spent each month…12 months…$6,000 over the year. Right?) He looked at me as if I were from Mars.

Bob told me that he hadn’t saved $6,000 over the last 12 months. He actually increased his credit card debt by over $12,000. In other words, Bob was spending $5,500 on average – not $4,000…right? (He spent $12,000 more than he earned last year, which works out to be (on average) $1,000 a month more than he earned. Since he earned $4,500/month, he spent $5,500 on average.) This fellow needed to learn how to stop spending money – stat!

Thinking you spend $4,000 a month but really spending $5,500 is like thinking you’re flying over the ocean when you’re really over the Rocky Mountains. Sooner or later something very unpleasant is going to happen. If you care about reaching any financial goal, you should deeply care about knowing what you spend on average. Why?

Because if you don’t know what you spend on average, you’ll never reach your financial goals. You’ll never know what you can and cannot afford to buy or do. You won’t know if that vacation or car is within your reach or not. You’ll never be financially balanced. You might have some foggy ideas, but you’ll never really know. You’ll never be at peace with your spending or financial situation. On top of that, you’ll never be able to hold on to a credit score you can be proud of.

While you might be spending too much, you also might not be spending enough if you don’t have this information.

Anna, another lady I met earns $4,500 each month and spends only about $2,000. Because she’s been on her own for many years, she’s deathly afraid of overspending. But because she didn’t take the time to calculate her average monthly spending, she went without for too many years.

That’s a high price to pay. Especially when you consider how easy it is to get this information.

So here is the question:

How to budget? Here are the steps I recommend:

1. Don’t start by using budget tracking software or writing down every time you spend.

Don’t get me wrong. If you’ve been tracking all your expense for years, don’t stop. I use You Need A Budget and I love it. But if you haven’t, now is the wrong time to start. Lots of folks invest in some software package or start writing things down and then stop.

Oh…they might start off by doing it for a few days, weeks or months. But sooner or later, too many stop. Why?

Special Tip — To see how powerful this is, get your credit score now and then check it again in 120 days. You’ll probably see a big improvement. You can even get your free credit score, no credit card or trials required.

I conjure up a few reasons:

1. It’s a lot of work.

2. It takes time.

3. It’s a possible reminder of how out of control we are or have been. It’s a negative re-enforcer. It’s just not any fun.

4. We track our spending but our partner doesn’t. As a result, the data is meaningless.

On top of these reasons, some folks can’t see the benefits of doing it. They think they can’t change anything about their financial situation anyway, so they just throw their hands up and hope for the best.

I’m not going to deal with that last issue in this post (I’ll leave that for another time). But I think there is a way for you to track your spending in under five minutes a month and to have fun doing it. And if you implement these suggestions, you’ll know what you and your family spend – even if your partner doesn’t participate.

2. Turn your bank statement in to your bookkeeper.

Your bank statement tells you what you spend each month. It’s the number that is next to the “total withdrawals” column. Usually that number includes:

Total checks written

Total ATM withdrawals

Total automatic payments

That’s it. That’s everything you spend…right?

All you care about (at first) is making sure you spend less than you earn on average. For now, it doesn’t matter how you spend the money.

(Just make sure you use one checking account to pay all your bills and you’ll have all the information at your fingertips. If you use more than one account to pay bills, increase your credit card balance each month or earn and spend cash, the process is more complicated.)

3. Track that one number.

A. Take a few minutes right now and go round up your checking account statements for each of the last 12 months. I’ll wait right here.

B. Open Excel and create a new spreadsheet.

C. List “Month” in Column A and “Total Withdrawals” in Column B. Input the data for each of the last 12 months.

D. Calculate a 12-month moving average to determine what you spend on average.

You are interested in the average, not what you spend in any particular month. Some months are more expensive than others. Some months include property taxes. Other months include vacations and car repairs. These are all facts of life. Expenses aren’t all predictable, but they do find a way of popping up…don’t they? That’s why the average spending is much more important than what happens in any particular month.

E. Update the spreadsheet every month and recalculate your 12-month average spending.

It might take you 45 minutes the first time you do this. But it will only take you five minutes each month to update the information from then on, and it’s well worth it.

In fact, it’s much more powerful than trying to track every expense. And even if you do track your daily expenses, this is an important exercise. You have to calculate a running average in order to see what direction you are going in.

If the 12-month average goes down, you are doing great – you are decreasing your spending. Maybe you can quit that second job. If not, you need to do more work. Go through this exercise the first time and compare the number to the initial estimate you made when you first started reading this post. Are you shocked? Told ya.

Some diehard folks might say that tracking each expense is more important than calculating the average spending. I disagree and here’s why:

a. Tracking your daily spending is only meaningful to you once you see what you spend on average.

b. You will be much more motivated to do a good job tracking all your expenses once you know what the average spending looks like.

c. If you aren’t willing to spend five minutes a month on this, you won’t be willing to spend two hours a week (at least) tracking everything.

4. Talk about it.

Once you have the information, you want to use it most effectively. You want to use it first to see if your average spending is greater than your income. Even if you earn more than you spend on average, this information will help you cut spending and save more. Let me give you an example.

Even though I think I know how to make a small business successful, my income went down when the recession hit last year. As a result, I did this exercise and shared it with my family (my wife and each of my children).

When I did that, everyone became a savings fan – it happened almost magically. I’m also happy to say that they had a balanced approach. They saw how stable our situation was, so they weren’t afraid. But they also saw that we had to decrease spending in order to reach our savings goals.

This process didn’t dictate what to cut – and I think that’s the beauty. It empowered each of us differently. Since we knew we had to cut back, each member of the family made their own value calculation and independently cut their spending. It really brought us together. I wasn’t the bad guy or the ogre.

“Spending less” became a mindset, and believe it or not, it was kind of fun. The results were also really inspiring. The great thing about this is that it gets everyone on the same side. It’s also simple, quick, 100% accurate and effective.

5. Remain watchful.

After you do this for a few months, you may learn that you need to do more to cut costs. This might be the time to start writing down every expense or using software to do it for you.

At this point, you may have to make some “executive decisions” and enforce some cuts, but at least everyone in your family will understand the situation. You have a better chance of the people in your family staying on board. They will understand why you need to make the spending cuts.

6. Don’t stop living.

Just because you cut your spending doesn’t mean you have to live like a pauper. Sometimes a $5 coffee at Starbucks will save you thousands of therapy bills. Find ways to really enjoy your life, and if that means spending a bit more once in a while…do it.

We went on vacation a few months back. Before coming home, my wife suggested we all rent bikes. It was going to cost $40 for an hour. To tell you the truth, I really didn’t want to spend the money. But because I’d done the exercise above, I knew I was being unreasonably cheap…so we did it. That bike ride turned out to be the best part of our vacation. That $40 made the entire trip worthwhile. It’s what I remember most about that vacation.

Relax your rules moderately and mindfully – but don’t do it too often.

How you can put this into action.

You already know how important I think this is for your financial well-being. If you agree, then the best things you can do right now are:

a. Do the exercise I suggested you do above if you haven’t already done so

b. Schedule time in your calendar right now to update your spreadsheet each month

c. Schedule time each month to discuss your progress with your family

Now it’s your turn. What tricks do you use to get your family on the “savings train”? Will you share all the data with your partner and children? Why or why not?


NOTE: I originally wrote this in March and it appeared on Frugal Dad at that time. I updated it and reworked it. Since I feel this issue is the key to financial freedom, I felt it was important to keep the topic “top of mind.”



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