Posted: June 20, 2012
Seven essential financial questions: No. 2
Do you have a budget you follow?Michael Hood
(Editor's note: This is the second of a seven-part series.)
To help with clients, I have created a basic financial planning process using Seven Essential Questions as the foundation. The best feature of this process is that it produces a plan which is personal, unique, and can be immediately put to use.
The idea of being laser-focused on financial planning may seem unrealistic given all the demands in our daily lives. Many pressing things fill our time and financial planning is rarely one of them. If a financial matter does demand our attention, it is often because there is a crisis. One of the main goals of financial planning is to avoid the need for crisis management.
Essential Question #2: Do you have a budget that you follow?
Are you in control of your spending? If you are like most people, you know how difficult that can be. As financial planner Mike Smith says, “Controlling your spending is hard because today wants all of your money and it rarely leaves any left over for tomorrow.” Given the relative ease with which we can obtain credit, not only can we spend more money than we make, we are actually encouraged to do so.
It seems that if we want something today, the “normal” thing to do is get out the credit card and worry about the consequences later. Obviously, spending more than we earn makes it impossible to save money for the future. A great question to ask yourself is, “If I handle my money for the next 10 years the same way I did last month, will I end up where I want to end up?”
The only way to live on less than you earn is to use a budget. When it comes to this topic, I have met two types of people: those who enjoy the process of budgeting and those who can’t stand the thought of a budget. For those who enjoy budgeting, this should be fun. For those who hate the idea, you will find this simple budget process to be worth the effort and not nearly as painful as you may have imagined.
There are at least a million ways to approach budgeting. One of my favorites is the very effective method taught by Dave Ramsey in his book The Total Money Makeover. He asks you to sit down each month and write out a spending plan for the upcoming month. He describes this monthly process as, “…telling (your) money where to go instead of wondering where it went.”
You start by listing the basics, such as food, gasoline, mortgage and utilities. Continue to list your spending items, including all of your regular monthly bills and expenses. If you do regular charitable giving, be sure to list it with your basic expenses. Remember cell phones, cable television, and anything else that you spend money on each month. You want to put money away for long-term savings, so it needs to be listed as an item at the top of your regular budget.
Next, list all of your non-monthly budget items, such as semi-annual insurance payments, a quarterly water bill, or annual magazine subscriptions. Once you have written everything down, if you are married, make sure that you are both in agreement. Then let that written and accepted budget be the “law” for the upcoming month.
It normally takes about three months of going through this process for it to become second nature and work without frustration. Be quick to forgive yourself (and your spouse!) if you forget any budget items. Adjust the budget for the next month and keep moving forward.
One tool that I have found helpful is the old-time cash envelope method. Many of our grandparents used this as the main way to manage their money. The basic concept is you put money in multiple envelopes at the beginning of the month. Each envelope contains money for one budget category such as groceries or gas. The envelopes are the “law.” The beauty of the system is its simplicity: once the cash is gone, it’s gone.
Actually seeing a finite amount of money available for a particular area of the budget helps reinforce the idea of disciplined spending. My family used this system for the entertainment category of our budget because it often got out of control. It worked so well that we now use it from time to time for any area that is giving us trouble. Give the cash envelope method a try. You might be surprised how well it works.
The bottom line is that budgeting must be done on a monthly basis. Over time you can make revisions to fit your personality and lifestyle. Some folks like running their budget with the cash envelope system. Others prefer doing their spending from a checking account or with a credit card that they pay off each month. Pick the method that works best for you, but stay within your budget. You will know it is working if you are spending less than you make and consistently putting money into your long-term savings accounts.
Try to have fun with the budgeting process and be tolerant of setbacks in the beginning. I know it sounds odd to use the words fun and budget in the same sentence. If you approach budgeting more as a game than as a burden, it really can be fun and energizing as you watch your debt go down and your savings go up.
Whatever method you use, the important thing to note is that it will take planning and discipline to ensure that the future is not forgotten as you spend for today.
1. A budget will put you in control of your spending.
2. Always spend less than you earn.
3. Make your budget be the “law.”
Michael Hood, CIMA®, is a Certified Financial Planner™ and First Vice President of Wealth Management for Morgan Stanley Smith Barney in Denver. He can be reached at 303-925-9648 or firstname.lastname@example.org. Visit his website at http://fa.smithbarney.com/hood.