- 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.
In Part I of this series, I explained a way of creating a spending plan. Now we should look at how to put it and keep it in action, as well as how to fine tune the plan. Now that the plan is in place, I would like to make a very important point about spending plans:
Spending plans are not static.
Many people set up a spending plan and then begin to hate it, eventually giving up on it altogether, as they feel boxed into having to spend a certain way every month. This is simply not the case.
At the end of every month, I review my spending plan for the previous month and determine how closely my plan met reality. Since many of my plan entries are averages, I usually compare with my plan from one or two months earlier to determine whether the number in the plan is correct or whether it should be adjusted up or down. As long as I’m hitting the average over a number of months, I don’t worry too much: underages simply get swept into my money market account, and overages are absorbed by that same account. If, however, the number in the plan is no longer average, I have to adjust the entry for the next month’s spending plan. Of late, I have adjusted Fuel and Food up, and Electricity, DirecTV, and Auto Insurance down.
Since I’m using a simple spreadsheet for my spending plan, it’s easy to create a plan for the coming month. To do so, I simply copy the current sheet in the spreadsheet to a new sheet, and then rename the sheet for the upcoming month. In addition to the changes that may be necessary to some of the average categories, any special spending categories or extra expected income should be entered. If there is special spending (upcoming car maintenance, wedding present, etc.), it should be accounted for such that spending in another category is reduced to compensate. Ideally, debt and savings should be tapped only AFTER discretionary spending is reduced. In the same way, if you’ve got extra income this month, consider applying some or all of it to your debt snowball (sometimes referred to as “snowflaking”…) or to additional savings before applying it to discretionary spending.
We looked at the concept of “snowballing” debt reduction in my post Getting Out of Debt. My sample budget includes a number of items that should fit into a debt snowball plan. As time goes by and the first debt disappears, you need to update your spending plan to reflect this, as well as to apply the snowball payment plus the minimum payment from the paid off debt to the next debt on the list.
If you get paid irregularly, on a term greater than 1 month, or get paid irregular amounts, entering the income section of your plan can be tricky. Chances are that if you’re in this camp, you’ve already learned how to budget pretty effectively. But if you haven’t, there are a few ways to handle this. These solutions all make some assumptions that you have an idea what your average income will be.
- If you have enough experience with your income to be able to create an average, then you can enter this and work off of it as if it were one of the expenses discussed above. You will have to review this monthly to be sure that you’re not spending more than you’re earning.
- You can enter the full amount that you expect to make in the coming month. If this expected income is greater than average, allocate the difference to savings. If the expected income is less than the average, draw the difference from savings as if it were another source of income.
If you don’t know what your average expected income will be, then you’d better eliminate most of your discretionary spending until you get a better handle on your income.
In conclusion, it takes some time to set up a spending plan. Once set up, it becomes a living document that is pretty easy to maintain from month to month. A spending plan has proven essential to meeting my savings and debt reduction plans.
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.
I’ve written about snowflaking here before as it relates to debt reduction, and I want to add another thought on the subject. As I discussed in a recent post, ScrapperMom got a raise AND missed a paycheck due to some personnel problems at the payroll service that her company uses. ScrapperMom gets paid bi-weekly, and when she missed her paycheck, the fix was to pay her for 3 weeks on the very next week, rather than for 4 weeks on her next regularly scheduled payday. The result of this was to shift her pay schedule by one week.
In making this shift, she ended up getting paid on the first of May, which sets up May to be a 3 paycheck month. As most people who get paid weekly or bi-weekly know, there are 4 or 2 “bonus” checks per year by virtue of the fact that there are really 13 months worth of weeks in a year (in the same way that a typical pregnancy is 10 months of weeks instead of 9…). Most of us understand that a month is 4 weeks, but a calendar month can be anywhere from 4 weeks (non leap year February) to 4.43 weeks (any 31 day month). Those extra fractions of a week per 30 or 31 day month add up to an extra “month” over the course of a year.
If you got this far, you may be thinking, “So what?” Well, so what is that most people are used to living on 4 weeks worth of paychecks per month, and that means that the “bonus” month worth of pay is just that: bonus. So what should you do with this bonus? Personally, we will be using all of our bonuses this year to reduce the balance on our car loan. Our debt reduction plan, as well as our budget, do not include these bonus paychecks. By applying them to debt reduction we will accelerate the payoff of our car. Later, these payments will snowball into paying off our final outstanding credit card, and later still into our savings goals.
By leaving these bonuses out of our monthly spending plan, we give ourselves a bit more breathing room if we need it and a faster route to getting out of debt.
Do you have a plan for your “bonus” checks? How will you spend it? Leave a comment below and let us know!
photo figure credit: ctsnow
