Monday, May 19th, 2008...9:23 pm

How to Create a Spending Plan: Part II, Iterating

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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.

  1. 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.
  2. 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.

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