This is the fifth article in a six-part series in which we walked you through, in a very detailed way, how to prepare a budget. As a reminder, so far we covered the following:
- Why do you need a budget
- What information you need to gather
- How to use a spreadsheet to project income and expenses for 12 months
- How to create your budget using our 33/33/33 approach
If you’ve worked through the articles you should now have a budget in place. Congrats! The ultimate goal is to be stress free by living within your means and hit savings targets that you set yourself. Before wrapping up this series, it is worth spending a few minutes discussing the major problems you could encounter, or more specifically, the reasons why people allow their budgets to be unsuccessful.
There is no bad budget; it’s a plan that you created. But too often the budget becomes a looming monster with a life of its own; it doesn’t belong to you; it’s not something designed to help; it’s a thing controlling you; you start to despise it . The budget from hell.
If you get to this point, just take a deep breath…
But don’t despair, you’re not alone. For many people, budgeting and sticking to a budget has always been a sore topic. But with the help of spreadsheets, a methodical approach, and good common sense, preparing a budget and living by it doesn’t have to be a painful experience. Besides, help is always available.
Let’s review the common budgeting pitfalls to avoid.
You ignore the value of an additional dollar saved today
Quite simply, you don’t make saving a priority and do not recognize you could bear a heavy cost of “regret”. The regret arises in retirement when you wished you had saved more in your early years; but of course it’s too late then.
Because of the long time frame involved, you forget how money can grow. For example, $100 invested now, earning 4% on average, with interest continuously reinvested, will be worth $219 in 20 years or $324 in 30 years. These amounts are significant when you are in retirement.
Don’t let low interest rates now distract you; interest rates move in cycles of high and low periods. Instead, you should focus on what would be the average return over your working life to retirement.
Unable to commit
This should be self-explanatory: it’s just easier to spend without having to reference your spending to a plan.
We think the biggest problem is a budget forces you to pay attention to your spending habits and lifestyle choices. It sometimes forces you to think that you need another job or more income. It forces a re-think of an easy breezy spending lifestyle, where the only restriction was the amount of cash in your wallet or room on your credit card. Every payment now becomes laborious: should I, could I, what’s the impact, am I over-spending, etc. Sorry, we don’t think this debate with yourself is a bad thing.
As a reminder, what really is a budget? A budget is the most important component of your plan for financial freedom. It is the way you put your finances in order by beginning to proactively manage your expenses to deliver a targeted level of savings each year. The accumulation of these savings provides for your long-term financial peace of mind.
Rationalize your luxuries
You’ve become accustomed to an “easy” lifestyle! You enjoy eating out regularly (cooking too hard, man!), you must have the latest electronic gadget, or the hippest clothes, and as for the after work drinks lime on Friday, you’d never miss that! Most of all you’ve managed to convince yourself that these expenses are necessities: they’re necessary for your mental health and quality of life, right? We know the feeling!
But let’s face it. You really could live without these items, so they’re definitely not needs but “luxuries”. The first step is admitting it. Now for the real question: Can you really afford these expenses or are you living beyond your means?
When preparing your budget, if you cannot comfortably include these items, then it’s time to let them go, or cut down, at least for a while.
It’s difficult to break your spending habits
We all have weaknesses and stock up on crap. Or we regularly make therapeutic purchases that make us feel better after our boss just annoyed the daylights out of us (we love amazon on those days…).
Are you seduced by your favourite store and always end up spending hundreds of dollars on clothes and the latest bling? Impulse buying happens to the best of us, and really, it’s all right in moderation. But if you’re a chronically impulsive shopper, this can do far-reaching damage to your budget goals.
It may be time for some behavioral changes: you might need to take a different route to avoid passing by your fave store, leave home your credit card or log-on to your favourite online stores less frequently.
What about turning off those online shopping deal alerts for a while? Remember a deal is not a deal if you really don’t need the item or couldn’t afford it in the first place!
Unrealistic expense cuts
One very common budgeting mistake is including expense cuts that are simply unrealistic.
But it’s better to be realistic: most entertainment is unnecessary and we spend far too much money on it. Ok, you like to lime on Fridays. No problem. Try not drinking alcohol one Friday every month (instead of four times!). Tell your friends you are detoxing if you rather not own up with what you are doing. But walk away from that evening with a couple extra bills in your wallet. Is this really impossible?
Don’t try to tackle the expense reductions too aggressively and become demotivated when you can’t achieve them. Or you might achieve them but end up thoroughly bummed because you’re living like a hermit.
Just be sensible and let your plan work for you. Achieve your targets incrementally.
Did you prepare your budget and found that your bottom line was in deficit? Then, did you go on a hunting expedition for additional income to try and cover your expenses? If you’ve included “magic money” in your budget, then you may be setting yourself up for disappointment.
“Magic money” refers to income that may not materialize in the foreseeable future; it’s very “iffy”. For example an increase from a promotion you’re hoping to get, or alimony your good-for-nothing ex should be paying but you may never receive, a Christmas bonus or a performance-based bonus that is not guaranteed. “Magic money” should not feature in your budget.
“Magic money,” if received, should go into your savings for retirement, your house purchase or mortgage repayment, home improvement, or other longer term goals.
Budgets must include everything you earn and spend. Often, when we first sit and compile our list of expenses, we write down all our monthly expenses (mortgage payments, rent, car loan payment, utilities, meals, etc.) and then out of the woodworks pops the forgotten car insurance renewal notice, the professional and sporting memberships, school supplies and other annual expenses. And usually, these things come at the most awful of times when you’re already in a deficit month.
Do take the time to think through all of your irregular expenses so that you don’t wind up feeling like your budget has failed you, and be sure to include items such as small family vacations and gifts.
You should also include amounts for unexpected events such as car or house repairs, medical and dental costs, to avoid alarming blows to your budget. Typically clothes are forgotten: invariably some time during the year you need to replace or buy new clothes so don’t forgot to budget for it.
Try to be thorough but don’t be too disappointed if you forgot something; just adjust and keep going.
You don’t give yourself time to fine tune your budget
So you tried budgeting and after a month or two you gave up. You are not alone.
Keep at it! Living by a budget takes time; it’s an incremental process and may take a few months for you to adjust your habits to be in line with your budget. But it also needs to be fine-tuned periodically so that it can be really useful.
Trust us, once you stick to it for a couple months, it becomes second nature, and every expense decision is intuitively made in the context of what your budget can afford.
And when you hit that target savings level…we can’t describe how great the feeling is. You’re now in control…
In the next and final article in this series we explain the important connection between a short-term event like making your annual budget to your total net worth and retirement goals. Click here to continue reading.
Do you have thoughts or experiences to share? We’d love to hear from you in the comments below!