- Yesterday I was chatting with one of my company’s summer interns about his plans for the weekend. He told me that he was going skydiving. Wow! I thought, that’s awesome. I’ve always wanted to go skydiving, but never got around to it before I got married and became a parent. I explained to the intern that the second thought that went through my head after “Wow” was “life insurance policy.” I have a sizable life insurance policy in place already, but I’ve been meaning to read up on the fine points of it to figure out exactly what coverage I have. I find that I have many insurance policies, but don’t know what insurance I actually have. You always hear horror stories about people having insurance, but not being covered for some bizarre sequence of events. So back to the top of my to do list goes: Read and understand current insurance policies.
- A short phone call this week earned me about $150. I have been engaged in a kind of progressive credit card arbitrage. We got a cash back rewards credit card last summer that came with a high limit and a 0% APR on purchases for a year. We’ve been making minimum payments to the card while stashing the rest of the full payment in a high interest savings account. I had written in my credit card notes that the 0% offer expires in July. I called the credit card issuer to ask specifically when the offer expires. The answer is that the offer is good until the END of my August billing cycle, which means that I don’t have to settle up until the middle of September. I estimate that I should be able to earn about $150 dollars in extra interest on the money that is sitting in my Vanguard Money Market fund.
- We finally received our tax refund this week, which isn’t bad considering that we didn’t file until about 3 weeks ago. It took longer than expected to file this year due to some Traditional to Roth IRA conversions that we ended up being ineligible to make. So it took a while to figure out how to undo the conversion and then how to record that on the tax return.
- In case you’re wondering: this tax refund will be used to bolster our emergency funds which currently total $10,233. This is far short of 6 months worth of expenses, but we’re getting there.
Some articles that I enjoyed over the last two weeks:
- Gather Little By Little investigates the fine art of hypermiling — eking every possible mile out of a gallon of fuel for your car. We have been de facto hypermilers since 2001 when we purchased a diesel car that easily gets 45 miles per gallon. However, I have been independently implementing some of the suggestions that also appear in GLBL’s article and anecdotally seem to have improved city mileage to previously unheard of heights. I won’t know for sure until the next fillup, which may still be weeks away.
- The Boston Globe reports that People in Debt Feel Literal Pain. Wow! Debt troubles are pervasive! The lesson here: If you want to improve your health, get out of debt.
- Gametheorist writes about his children’s entrepreneurial teamwork in selling candy bars for their sports club fundraiser. What fascinated me about this was the posturing of the pricing in order to induce people to buy more. What further fascinated me is that it worked so well!
- Lastly, PaidTwice had another rough week in homeownership. Her week went from dreams about a more luxurious bath experience to a shorted circuit breaker to a major, necessary home repair. Isn’t it nearly always the case that just when we start to feel secure, comfortable, and in control of our lives Mr. Murphy comes knocking? This happens to me at work, with our finances, around the neighborhood, on the highway, etc. The best guard against Mr. Murphy is a healthy emergency fund, both in literal and figurative senses. Always try to foresee alternative outcomes and plan around them or hedge against them. We can’t foresee or prepare for everything, but a little planning can go a long way — see Point 1 at the top of this entry.
Click
here for actual spreadsheet.
“Budget” is a dirty word in many households, and it’s no surprise why. Budgets are hard to create, hard to keep, and nearly always imply sacrifice. So for the sake of being pleasant, I will refer to budgets in this post as Spending Plans. A budget is, after all, simply a way to spend and earn money on paper before you actually spend and earn it, and therefore the term spending plan makes more intuitive sense to me. Answers.com defines budget:
budg·et (bŭj’ĭt)
- An itemized summary of estimated or intended expenditures for a given period along with proposals for financing them: submitted the annual budget to Congress.
- A systematic plan for the expenditure of a usually fixed resource, such as money or time, during a given period: A new car will not be part of our budget this year.
The creation of a working spending plan frustrated me for many years, primarily because I was trying to create one using Quicken’s Auto Budget creation feature. The problem I had with it was similar to the problem I had with tracking spending in the past: Too many categories. I was being asked to figure out how much money I would spend on small things like a pair of sneakers simply because I had a Clothing:Men’s:Footware category in Quicken. So if I buy (1) $75 pair of sneakers per year, Quicken would fill in $6.25 per month for sneakers. Multiply this by dozens or a hundred other detailed categories and very quickly the whole thing become unruly.
As discussed in one of my first posts on Getting Out of Debt, one must first understand where his* money goes every month. Some things are easy to figure out: gather up your mortgage (or rent), auto loan, student loan, credit card, insurance, cell phone, and any other bills that are fixed monthly expenses. My list also includes things like Netflix, water, and internet access. List each of these items with the associated monthly payment. I use a Google Spreadsheet for this. You will notice that there are some discretionary expenses in here, and that’s okay for now.
Next, I went through the last few months of expenses in Quicken, and pulled out other essentials that aren’t necessarily the same cost from month to month or even year to year: food, fuel, pet care, utilities, etc. I put 4-6 months worth of each of these items on separate lines, and then averaged the each line to get a monthly expense. Utility bills usually have a 1 year rolling history of usage, so this can also be used to predict upcoming usage. Entering all these average or estimated expense creates a starting point.
The next thing I did was to look at expenses that occur on an annual basis: excise taxes on my vehicles, life insurance premiums, disability insurance premiums, Christmas presents, etc. I took each of these annual amounts and divided by 12 to figure out how much I need to allocate to each of these each month. I listed these next.
Last, but certainly not least, I have included my savings contributions. The last place inclusion should certainly not indicate the relative importance of these entries. Indeed, these may be the most important entries in the list under the “pay yourself first” mantra. If you already contribute to a 401(k) plan through payroll deductions, you may not need to even bother making an entry here.
Having entered most of your expenses (most discretionary expenses are still absent), it is now time to enter your income. For most of us, this will be rather easy since we get paid a fixed amount on a set period from few sources. Others with irregular and/or multiple source incomes will have to figure out a way to average this income to create a starting point for now.
Now add up all of the incomes and subtract all of the expenses. What’s left is what you can afford to spend on discretionary items. Is this number negative? If so, you had better go back through your expenses and start trimming until you get to at least zero. If you have an option to earn more income, that can help too. If the number is positive, then you’re already doing better than many people today. Now you need to decide if it’s positive enough to satisfy your wants during the month. The only way to change this number is to decrease other expenses or increase income. You have to weigh priorities against each other, and I strongly suggest that you contribute as much as possible towards consumer debt and savings. My sample budget spreadsheet includes a post-tax savings percentage calculator.
Congratulations! You have now created a budget! Next time we’ll look at how to tweak the budget to be closer to reality, as well as how to manage your budget going forward.
Please see Part II here.
*Too many Web 2.0 contributors would have written “their” (or worse “there”) here because of a political correctness fear of being labeled sexist. Personally, I prefer to use proper English, and “his” won the coin flip. In all likelihood I have made a grammatical or spelling mistake in this aside simply because it would be ironic.
Do you find that you’re pretty comfortable spending a certain amount on discretionary items? How about dinner out? Tickets to a show, concert, or sporting event? Houses? Do you find anything over this amount to be “expensive”?
I think everyone must have thresholds for certain kinds of purchases. These thresholds are based on many different factors: income, geographical region, habit, family situation, upbringing, debt load, etc…
Here’s what I tend to think is expensive:
- Any “thing” over $200 - $300
- Dinner for two that’s more than $75
- A single family home that’s more than $400k
- A car that’s more than $30k
- A ticket that’s over $100
- A movie ticket that’s over $10
I am very unlikely to consider spending more than these amounts on these things. Some of you are going to look at this list and think: Wow! That’s expensive! Others are going to look at this and think: Boy, are you cheap! But that’s my whole point — everything is relative. I may seem like a spendthrift to some or look frugal to others.
But what’s interesting is that there are a number of “things” over $300 that I would like to have. The problem with this is that something that costs, say, $2600 is completely unattainable, even though over the course of a year I will certainly spend greater than this amount on a large number of discretionary purchases. There are two obvious solutions to this dilemma: credit cards and budgeting. We should all know by now that credit cards should not be used to buy things in lieu of saving up for them.
Budgeting to buy an item like this is not an easy matter either. I only very rarely buy something that is $200 - $300 dollars, so I’m much more likely to spend in the ~$50 range. So let’s say that I put $50 per month aside for a $2600 purchase. If I start doing that this month, I’ll have saved the money for this by August of 2012. That’s A LONG TIME from now. In the mean time, I will certainly be foregoing something. Since my discretionary budget is already pretty low, it seems as though I just can’t afford something as expensive as this.
Do you have pre-conceived spending thresholds? Do you fall into predictable spending habits? How do you save for big ticket items?
Author’s note: Since I began working on this post last week, I did more research into one of the bigger ticket items that I’ve had my eye on and found that I could get a version of it for much cheaper than I had originally expected. It should be much easier to save for this purchase.
I participated in my first blog carnival this week at the Carnival of Personal Finance. I submitted my article about the parallels between losing weight and growing wealth. You can see it and all the other great articles at this week’s host Gather Little By Little. This week I also joined the conversation on a number of topics at other blogs. Some of the blogs that mentioned me or in which I participated were:
- Lynnae at BeingFrugal.net solicited the best financial advice that her readers had ever received. My words of wisdom were 1.Pay yourself first and 2. Anything you can measure can be improved.
- Glblguy at GatherLittleByLittle.com wondered why he still has to carry cash. I don’t usually carry much cash, and it tends to sit in my wallet for a long time. In the comments I shared my strategy for using my rewards credit card for everything I can.
- Frugal Dad at FrugalDad.com wondered whether it was cost effective to buy a new car for the explicit purpose of saving on gas mileage. I suggested that for people who continually carry loans, the cost of gas is minor compared to the other operational costs of a car.
Another article that caught my eye today comes from the Boston Globe’s Personal Finance Section which reported on a new study being conducted at my alma mater which will “explore how people make decisions about their money, and how technology can shape and assist in these choices.” This study is part of a new Center for Future Banking that seeks to understand how changes in technology will affect banking. This study will explore many of the questions that fascinate my about the social psychology of money decisions. It is a bit dubious, however, that Bank of America is providing the financing for the study… Lastly, I made some updates to my Blogroll at the right this week. Check out some of my fellow bloggers sites if you haven’t already. b
photo figure credit: ctsnow
