Creating a spending plan is a beautiful thing because it is the only way to ensure that our money will go to the things we want most, not just to the things we want now. This is a critical distinction, because the two are often mutually exclusive. We can never have enough money to buy everything we want.
Therefore, we should think of our spending plan as a friend who helps us get what we want most, not as an enemy to all happiness. If we have already allocated the proper amounts to taxes, tithing, insurance, and savings, then we are most of the way there. In fact, we do not even have to keep track of where the rest of it goes if we do not want to. The most important thing is to distinguish between fixed, totally necessary expenses (such as mortgage payments and utilities) and discretionary expenses (such as eating out and taking vacations). We must be sure we have enough to cover the fixed expenses first, and then we can spend whatever is left on the extras.
In our family, as we have learned to discipline ourselves we have realized that sticking to our spending plan actually feels more liberating than restrictive. Our diligence has resulted in the freedom to buy a bigger house, take better vacations, save more for the future, and more aggressively pay down debts. It also feels very satisfying, even sanctifying, to make personal sacrifices in order to consistently live within our predetermined spending plan. We feel much more powerful and at peace about our future than we felt before.
Believe it or not, sometimes it can even be kind of fun to make everything work within the plan, almost like a game. This came as a surprise to me, but the more I thought about it, the more sense it made because rules and boundaries are the essence of any game. How much fun would it be to play football without any rules or boundaries? How exciting would it be to play a video game with unlimited lives, unlimited ammunition, and no time limit? The boundaries are what make any game interesting and meaningful, including the game of money management.
The first step to creating a realistic spending plan is to track what we are currently spending. When we start keeping track, our spending will automatically go down because we will be more aware of where it is all going. Ideally we would analyze the past year’s worth of spending to come up with some meaningful goals, but I would recommend reviewing at least the past three months.
Keep in mind that although some regular expenses may occur only on a quarterly or annual basis, they should still be included in the spending plan. Also remember that some expenses, such as utilities, may vary widely depending on the season. That is why a twelve-month record would be the most accurate. We must not make it too complicated, though, or we will never get it done. Modern technology makes this process much easier than it used to be. We might even be able to just download our spending history from our online banking.
When labeling purchases, be sure not to create too many categories. Broad categories will give a clearer sense of what is really happening, and will be less cumbersome to keep track of over time.
The following six broad categories are the essentials I would recommend closely tracking:
- Fixed Spending
- Discretionary Spending
Here I have listed sample subcategories to give a clearer picture of what might be included in each broad category:
- Federal income taxes
- Social Security and Medicare taxes
- State and local income taxes
- Property taxes
- Other charitable donations
- Auto insurance
- Homeowners insurance
- Umbrella liability insurance
- Medical insurance
- Disability insurance
- Long term care insurance
- Term life insurance (not whole life)
- Contributions to savings and investment accounts which we are not planning to spend in the near future
- Contributions to retirement accounts
- Whole life insurance premiums
- Mortgage payments for real estate property that we do not personally occupy
- Investments in business interests
- Fixed Spending (expenses that are the same every month or over which we have very little control)
- Mortgage payments
- Other debt payments
- Utilities, cable, internet, phone
- Automobile fuel and maintenance
- Household services such as cleaning, landscaping, pest control, and pool service
- Education expenses (private school, college tuition, books, subscriptions, athletic training, music lessons, dance lessons, etc.)
- Discretionary Spending (expenses that are non-essential or more easily controlled)
- Groceries (although essential, can be controlled somewhat by our choice of products and vendors)
- Dining out
- Furniture and household décor
- Home improvement
I strongly recommend setting up two separate checking accounts to help control spending. This makes living by the spending plan a cinch because we can use the primary checking account to cover the first five categories and the secondary account to cover all discretionary spending. With this system, all income is originally deposited into the primary checking account. Then at the beginning of each month we calculate how much we will need for the first five categories and transfer whatever is left over to the discretionary account. We can spend our discretionary account all the way down to zero each month if we want to, without worrying about robbing from the essentials. At any time we can look up our discretionary account balance online to see how much more we can spend on fun things that month, without having to track how much we spent so far. At the beginning of the next month we simply repeat the process, making adjustments as needed.
My wife Andrea and I have been using this method for a while, and it works great. We both love it because it gives her complete control over all discretionary items without wondering how much she can afford to spend each month. Before we used this system I felt like she was always coming to me for “permission” to buy every little thing because she never knew exactly where we stood financially. Sometimes this resulted in resentment because we would often disagree on how much should be spent on certain things.
I tried to get her to handle all of our personal finances to avoid this situation, but she hated doing it. This new system has been great for our marriage because now I don’t have to agree with or even know about how much she spends on specific items because she always does a great job staying within the amount we have allocated to discretionary spending. She really enjoys being able to choose what to buy because if she wants to spend a little less on groceries or eating out one month, she can splurge on something else without having to ask whether we can afford it.
Those who do not like using debit cards or checks may consider withdrawing a certain amount of cash at the beginning of each month to cover discretionary spending instead of setting up a separate checking account. Once the cash is gone, all discretionary spending should stop until the beginning of the next month.
Some people prefer to use credit cards for everything so they can rack up as many rewards points as possible. However, I have observed that most people find it much more difficult to control discretionary spending when using credit cards because they don’t realize how much they have spent until they get the huge bill at the end of the month. Using debit cards or cash clarifies how much money we have left in our spending plan for the month. The ability to stay within a predetermined amount of discretionary spending that fits our overall priorities is much more valuable than any credit card rewards could ever be.
Once we are committed to a spending plan, it can be fun to see how far we can stretch our discretionary account by looking for great deals. Sometimes I am amazed by how much more we can get for our money when buying deeply discounted or quality used items. However, we must be careful not to be penny wise and pound foolish. We may be tempted to buy lots of things we see that we don’t really need when searching for a “great deal” on something we do need. Stay on task when shopping.
What about the amount of time required to find these deals? We may unwittingly spend hours researching the best deal, especially online, when in the end we might only save $10 or find a marginal improvement in quality. The amount of time we spend researching the best deal should be proportionate to the cost of the item.
Many people spend hours clipping coupons and bouncing around from store to store to save a few dollars, yet pay thousands more than necessary in insurance premiums, taxes, or investment fees every year because they “don’t have time” to meet with a financial planner who can help them optimize these costs. We should never underestimate the value of our time. Time is money, so we must treat it with just as much respect, if not more.
Adam Dawson, CFP® is a Principal at Capstone Capital and the author of Timeless Principles of Financial Security.
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