Creating A Spending Plan

What many people refer to as a budget I like to call a spending plan. We enjoy spending, but most of us are not too keen on budgeting. In this article we’ll refer to it as a spending plan. Creating a plan is a good decision, but it’s helpful to articulate your reasons for doing so. Keeping those reasons in mind can augment your willpower when times are tough (or when that flat-screen TV is on sale, but it’s not in the plan).

Are you looking to enhance your savings? Stop living paycheck-to-paycheck? Trying to get out of debt? Make sure your spending reflects your values? Or to achieve your long-term financial goals?

Once you’ve determined the reasons – yes, there can be, and probably are, more than one – it’s time to figure out your income. Start with your after-tax wages from your paycheck. Add to that any after-tax wages your spouse earns. Do you receive any alimony or child support? Add that to your total. What about business income? Any dividends or income from investment? Rental real estate? Side hustles? Include all of these sources, along with anything else that generates a regular income.

After you’ve finished tabulating your income, now determine your bills. The easiest way is to grab your checkbook or last two monthly bank statements. You’ll also want to add all your cash expenses. This can be difficult, but one way is to keep a log going forward of where all your cash goes. Compare that to your ATM withdrawals from your bank statements to verify you’ve caught most of the items.

Now you’ll want to categorize all those expenses. Start with two broad categories: necessities and discretionary spending. Within those, you’ll want to label each expenditure. Categories in my budget are: food, utilities, my mortgage, any car payments, gas, debt repayment, an emergency fund, and what I call the budget accounts (I’ll explain these in a moment).

What if you get paid on commission, or some other form of variable income? How do you create a plan if you’re, say, a real estate agent? Your income could be $10,000 one month and $0 the next. The first step is to look at your historical earnings. If you’ve been doing the same type of work for more than a year, what did you make over the last twelve months? Now, you need to reflect on whether that number is a decent representation of what you’ll earn in the next twelve months.

Here is the process I used when I was a commissioned salesperson. I had the good fortune to get a base salary in addition to my commissions. I simply budgeted mostly to my salary and used my commission checks for discretionary expenses.

Now that you’ve got your income and expenses mapped out, it is time pull out your spending goals. What are you trying to accomplish with this exercise? Are you starting, or enhancing, your retirement fund? Saving for the down payment on a house? Working to get out of debt? Whatever your reasons, keep those goals front and center as we move on.

The budget accounts I mentioned earlier cover what are more intermittent, non-monthly expenses: car insurance (I pay every six months rather than monthly), property taxes (I don’t escrow those payments), home and car repair, vacations, clothes, gifts, Christmas. It’s this last that convinced me to start using budget accounts. Every year, in January or February, I was recovering from Christmas spending, trying to get caught up on credit card charges. It occurred to me that Christmas, while not a monthly bill, happens pretty regularly (December 25th comes around every year). What if I start putting a set amount of money into my savings account to cover the bills at the end of the year? This had two benefits – I had the cash in the bank to cover all those outlays; and it gave me an amount to work with. Rather than just spending haphazardly, I chose an amount (in this case $100 per month) and that was my Christmas fund. It was successful enough that I expanded the concept. Car repairs are a given, but they don’t arise monthly. So, I started putting another chunk of money away for auto maintenance. I’ll post a copy of the template I use at the end of this article.

Subtract your expenses from your income. Also subtract the money you think appropriate for your budget accounts. Is there any income left over?

Now, you’ll want to return to your spending goals. I’ll use retirement as an example of those goals. How much income will you need to put away for retirement? If this is a number you don’t know how to calculate, I suggest you read through my previous article, “What the heck is an annuity and why would I want one?” You may also want to reference the article, “Financial Rules of Thumb and Tools,” which has links to several online calculators that may help you come up with this number.

But what if you didn’t have anything left after subtracting all your expenses (or worse, the expenses exceed your income)? Obviously, you’ll want to make some changes to your spending. One exercise I’ve used with clients is to have them write down their ten largest expenses by dollar amount, with the largest at the top. You should be able to do this easily with the list you created in the previous steps. Put that list away in a drawer.

Next, after a few days, come up with a list of your ten most important outlays. Your mortgage or rent is likely on this list, as well as food. What about saving for your children’s college? Retirement savings? Having an emergency fund? Perhaps saving for a specific goal – a car, a boat, a house or a vacation? Once you have your ten most important “bills” (or destinations for your savings), compare the two lists.

Items that are on your ten most important list, but not one of your ten biggest expenses are places where you want to make changes. Things that are on your ten biggest bills, but not on your ten most important, are areas where you could make cuts to fund those changes. It may be that your cable bill makes the ten biggest expenditures, but is not your most important bill – that would be a place where you might trim. But anything that makes one list but not the other is a prod to change, be it entertainment, new clothes, or even coffee at Starbucks. In the end, you want the way you spend your hard-earned money to reflect the things that are most important to you, not the choices of the moment.

The last step in this process is to track your progress. Most of your bills will go up over time, so you’ll have to adjust for those price increases. But your estimates in the earlier steps might not have been as accurate as you’d hoped, so you’ll also fine-tune your spending plan as you go. I inspect my plan quarterly to see if, for example, my utilities are trending over (or under) my assumptions.

The biggest benefits I’ve realized from this process is to feel much more in control of my spending. And it allows me to confirm that my expenditures reflect my priorities, rather than spending by the seat of my pants.

This is what’s called a zero-based budget – meaning, at the end of it, there’s no excess. Every dollar goes into one of the budget lines, or it goes into savings. In the next article, we’ll look at a few alternatives to the zero-based budget, and discuss the pros and cons of each.

generic spending plan worksheet.xls

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