Budgets are often a hot topic. Some see them as essential, while others have no interest. This is the first of two articles I’ve written that look at budgeting through a pro/con lens. Today I argue that Budgeting is for Beginners. (See the follow up post: Budgeting is for Professionals).
First, it’s probably worth taking a second to make sure we’re all on the same page when it comes to defining a budget. A budget is a spending plan. It’s a forward guess as to where you’ll be allocating your dollars for the current month and beyond. It gives you a bird’s eye view of expenses so you can make sure that your expenses line up with your values and expectations. A spending report is not a budget. Budgets are done in advance of the actual spending. To budget, you’ve got to come up with numbers that reflect your expected spending for each category. Once your money runs out from a category, you have to do two things: either (1) stop spending or (2) allocate funds from a different source to the category.
For many people, budgeting has two major problems. It implies guilty feelings when you overspend in a category and it’s generally a pain in the ass to keep track of everything. If you’re like most people, you’ll often find that budgets are also pretty boring since they look the same each month.
In fact, most lawyers could probably get away with as little as six months of budgeting (here’s a budget for a first-year associate). Once you establish how much money is coming in and how much you want to save, does it really matter how you divide up the “spending” portion? If you’re budgeting with a significant other, most of the budget fights are going to happen in the first few months of living on a budget. After everything is ironed out, spending will be on autopilot and it’s hard to imagine fighting over something on month 18 (unless you never really resolved the original conflict).
The other big reason to avoid budgeting after six months is that the big decisions have all been made. You’ve already decided what job to take (income), the type of housing to buy or rent, what type of care to drive, etc. You’ll be left with only projecting whether household expenses should be $100 or $150 next month, which isn’t likely to have a major impact on your long term success.
The other reason why lawyers might not need to budget is because it’s a lot of work when you can have an online service creating a spending record for you automatically. For example, if you hook up your accounts to Mint, you only need to check in after each month, review the data and then decide if you’re going to alter spending habits going forward. Spending reports take a lot less work and trigger less guilty feelings (i.e. I spent $X last month on restaurants, which was a bit more than I wanted, but that’s okay because I’ll spend less this month).
IF you’re a little more hardcore, rather than using Mint to develop a spending report, you might have a spreadsheet that keeps track of your fixed and variable expenses. Since the fixed monthly costs (housing, cell phone, insurance premiums) don’t change, they’re the ones staring you in the face and daring you to lower them. If you work on reducing your fixed monthly expenses, you’ll free up more cash flow which will allow you to save more money (shocking, I know). While it might seem straightforward, spending records are usually very helpful in reducing fixed expenses. If you decide you want to save more, a spending record makes it pretty easy to see that you can get some big wins by going after your biggest monthly costs.
There really seems to be only a few different types of people when it comes to spending money: (1) you have the people that don’t budget or track anything, but simply look at their bank account balance to determine how much money they have to spend; (2) next, you have the “pay yourself first” crowd that sets a savings target, moves that money out of their spending account each month and then spends the rest as they please; and (3) people that allocate each incoming dollar to a specific purpose and then follow up throughout the month to see whether the dollars are being spent as expected.
If you’re in the first category, a budget could be really helpful in getting a grasp on spending. If you predict that you’ll spend a certain amount of money in different categories and then find you’re spending 3X your expectation, perhaps you’ll change your behavior accordingly. Financial spending is like eating, something we do every day and something we’re drastically likely to underreport in our own mind.
If you’re in the third category, a budget might be an over obsession with your spreadsheet. It’s not at all uncommon for a new grad with $200K in loans to become hyper-focused on a spreadsheet during the early years. While watching every penny can lead to financial success, it can also promote burnout and there’s something to be said for whether you might have a better use for your time such as making a little side money or developing other skills.
Another reason to skip a budget, is that your income should be increasing over time. Is there any point to budget if you focus on paying yourself first and saving your raises? What does it really get you to save an additional 1%? Have you shaved off 3 months from your retirement date? And, again, wouldn’t that time be better spent finding something to do now that you enjoy? Sure, you may waste a few dollars here and there but you’ll probably be happier for it.
For all of these reasons, I come across many people that are “Post-Budget”. Interestingly, many are still eager to talk about budgeting and whether they should be doing it or not. Most seem like they’re looking for justification and reinforcement that budgeting isn’t necessary. I’m happy to oblige. As long as you’re making conscious decisions and reviewing a spending record, these people will be just fine by focusing on their savings rate, making good investment decisions and increasing income.
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Personal Capital keeping track of his money and is always negotiating better student loan refinancing bonuses for readers of the site.
I’ve never budgeted. If we spent excessively, it might make sense to figure out where everything was going. But, since we don’t, it just seems like a waste of time for us.
However, I do keep track of everything in Quicken religiously (still can’t make the full jump to Mint!). I then push every penny possible to savings and investments.
— Jim
I think the majority of people paying attention to and writing about finances follow the spending report route. It’s hard to see much fault, although maybe Friday’s article will convince you differently!
Ah, a teaser, eh? I like it! See you on Friday! 🙂
— Jim
I tend to think there is another level of budgeting past the beginner stage. To me there are two types of budgeting:
1 – Control Based Budgeting
2 – Allocation Based Budgeting
Number 1 is for beginners and should be treated very rigidly. I practice #2 by putting together an annual budget by category in anticipation of where I think we are going to spend our money. It is not to control our spending, just to see how we plan to spend our money and to check to see that we are on track with our savings goals.
Obviously tools like Mint and Personal Capital make it really easy to track the actual spending.
I’m curious why to even bother with the allocation aspect. If you’re on track for saving $X each month, does it matter to you how the spending pie is allocated or do you track it out of curiosity?
Our spending and savings tends to be very lumpy so we like to have an idea of what our spending will be based on not only our historical spending pattern but also things we have planned like: home improvement projects, trips, special one time expenses, etc.
Going through this exercise forces us to rationalize expenses and figure out what we need to cut in order to achieve our savings goals. Until this year it has been a 50% savings rate, but with our increased income, we are trying to let a large part of that flow through and increase our savings rate above 50%.
It also keeps our spending in check, otherwise I honestly think we would easily spend 20% more than we do without going through this exercise every year. It is also probably because I have worked in finance for so long and I am use to doing an annual budget every year 🙂
Dom
I’ve never been a budgeter (Budgets are Not Sexy) and only recently became a spending tracker, so you can put me in the second category of “pay yourself first” professionals.
You know, you could write a whole children’s book from this series.
Budgets are for Beginners
Credit Cards are for the Cautious
Debt is for Dimwits
Earned Income is for Everyone
Cheers!
-PoF
Yeah, the “pay yourself first” group seems to be the majority. I used to follow that approach but found it sub-optimal for high income individuals. It allowed me to save thousands of dollars a month and feel like I was doing a good job. It was only when I forced myself to budget that I was able to really increase my savings rate.
If you are going to “pay yourself first”, I think your live on half challenge is the way to do it rather than to focus on saving a certain fixed dollar amount.
I am the exception that defines the rule you wrote about in a comment above, in that I am a personal finance writer that does not track my spending. Instead, I use a budget as a plan for how to allocate my money, and then have flexibility of choice within that framework.
I find tracking far more tedious than budgeting, as once you have the fixed costs nailed down to their monthly sums, the only “firm” part of your budget is set. It’s easy to keep up to date (in advance) once a sum changes, or a new fixed expense pops up. The rest I just allocate as I wish, and I chop and change my allocation from time to time, but the real strength of the budget is how quickly you can see how changes affect your finances. Just switch around a couple of numbers, reduce the income or add an expense, and you can clearly see how it affects your monthly situation.
In the end, though, it’s all about finding something that works for you. I like budgeting because it keeps me in complete control of my fixed financial commitments, and how much I have to allocate as I please. Others may like tracking their transactions because they perceive that results in even better control, in hindsight, and that’s fine. Whatever works 🙂 It’s interesting to hear other perspectives though, and sometimes eye opening, too.
Are you doing this budgeting with a spreadsheet or some other way? It’s interesting that you find tracking more tedious, since I think a lot of people would use some type of automated solution like Mint to track their spending as opposed to actively budgeting. Agreed, that this is the “personal” side of personal finance and that whatever works is probably the way to go. I wonder how many people are tricking themselves though when they review a spending report and think they’ll do better next month …
I used to be in the pay yourself first crowd but that has been modified as my income has increased. I know what my fixed costs are each month. I have an estimate for variable costs like groceries, gas, household items, etc. My wife and I each get an allowance that we spend no questions asked, and we have a couples allowance for going out. We save the rest. On the variable spending, some months we’re a little over and others we’re under. I don’t stress about it as our spending habits are pretty locked in so everything tends to average out over the year. We’ve reached a point where our income far exceeds the lifestyle we want to live, so any raises or bonuses goes straight to savings.