9
It’s Not a Budget
Let honesty and industry be thy constant companions, and spend one penny less than thy clear gains; then shall thy pocket begin to thrive; creditors will not insult, nor want oppress, nor hungerness bite, nor nakedness freeze thee.
Benjamin Franklin
Okay now, where were we? Ah yes, you had just begun preparing your first monthly Spending Record (chap. 5) when we switched gears to get the Contingency Fund firmly planted into your brain (chap. 6). That accomplished, we moved on to your Rapid Debt-Repayment Plan (chap. 7). And if that wasn’t enough to raise your hope meter level to an all-time high, the promise of a fully funded Freedom Account (chap. 8) filled you with more optimism and confidence than you’ve known since the day you finally learned to ride a two-wheeler.
By now you should be starting to figure out why your attempts to “get on a budget” in the past were less than successful. You were trying to put together your financial puzzle with only some of the pieces.
It’s possible that in the past you would write down all your expenses, deduct them from your income, and to your surprise and delight, your income was sufficient to cover your expenses. Things should be okay! But that never seemed to work out. For some reason you always came up short.
Here’s the problem. Your list of expenses was so far off the mark that it’s no wonder you weren’t hitting the target. Now that you’ve been able to step back and see the larger picture, the lights are starting to come on. Now you can see the gaping holes in your financial picture. And things will be different now that you have gathered together all the puzzle pieces.
It is time to take the information you learned when you tracked your spending for a full month and what you learned about your new Contingency Fund, Rapid Debt-Repayment Plan, and Freedom Account and put them together to create your first monthly Spending Plan.
The Spending Plan
A Spending Plan gives you a reasonable way to manage every bit of money that comes into your life, before you spend any of it. In a way, it is like “pre-spending” your money. Think of it this way. Your Spending Plan is how you tell your money where to go so you will never again wonder where it went.
Your Unique Format
Unlike the RDRP and Freedom Account, which are very structured and function the same way for everyone regardless of the specific financial situation, there is no single Spending Plan format that works for every situation. Therefore, I want to leave the exact layout for your unique Spending Plan to your discretion.
You may want to create your Spending Plan on your computer using an Excel spreadsheet. You may prefer to use a free web-based program like Mint or software you download to your computer like Mvelopes.com or YouNeedaBudget.com. There are many options, and you need to explore which one will work the best for you. You may want your plan to interface with your smart phone or other mobile device so you can carry your Spending Plan in your pocket. Or you may do better with the tried-and-true paper and pen. You may need a very detailed format, while others prefer to streamline and simplify.
I am going to teach you the principles of the Spending Plan and then trust you to implement them in the way that suits you best. Later in this chapter, you’ll find an example of a monthly Spending Plan, one you can use as your starting point.
Fixed Monthly Expenses
Look at the Spending Record you created based on your thirty days of tracking (chap. 5). Mark each expenditure that represents a fixed monthly expense.
A fixed monthly expense occurs every month and in the same amount. These are your predictable expenses. They’re not going to change, and you have become accustomed to paying them. Your rent or mortgage and car payment are examples of fixed monthly expenses. The amount you have determined you will give away each month is now a fixed monthly expense that I will simply call giving. Your Contingency Fund deposit (chap. 6) is now a fixed monthly expense. So is your RDRP total payment as well as the monthly deposit to your Freedom Account.
Let me tell you why this matter of fixed monthly expenses is so important. I doubt whether your fixed monthly expenses have contributed to your financial challenges in the past. The fixed amounts that are due every month do not take you by surprise. You’re never shocked to discover that your rent or mortgage payment is due this month, next month, and every month. It’s things like a busted water pipe or three wedding showers in two weeks that come out of nowhere to really mess up your money. It’s human nature to get used to things that happen the same way all the time.
One of the keys to successful debt-proof living is your willingness to convert as many of your expenses—yes, even the unexpected, irregular, and intermittent ones—into fixed monthly expenses. Once you do this, in a few months you will get used to them just as you are used to your other fixed monthly expenses. And that is when you will start to understand what financial freedom is all about.
Don’t panic! I know that adding fixed monthly amounts for giving, your Contingency Fund, your RDRP, and your Freedom Account to your Spending Plan at first will seem impossible. But stick with me. Try to put aside your emotions and think of this as an academic exercise. I so want for you to see how this can and will work for you.
Okay, so you have now listed on your Spending Plan form of choice the fixed monthly expenses you will have in the coming month, including rent or mortgage, giving, Contingency Fund (or savings as we called it in the 10-10-80 formula), RDRP (unless you have absolutely no unsecured debts), and Freedom Account. Good! You are making progress.
Variable Monthly Expenses
Next, look at your Spending Record and identify entries or categories that are your variable monthly expenses. These are bills you get and expenses you have every month, but the amount varies—your utility bills, landline and mobile telephones, food, gasoline, and so forth.
This is important: Your variable monthly expenses hold the key to making debt-proof living successful in your life. You have control over these expenses. This is where you have flexibility and where you can make changes to get your lifestyle down to 80 percent of your income.
Refer to your Spending Record (the one you made from your thirty days of tracking) and see how much you spent during the month on groceries—not fast food or restaurant food but just groceries.
Let’s say you spent $452 on groceries in the month you tracked your spending. That is your benchmark. As you anticipate the coming month, what would you like that number to be? You may decide that $452 was too high considering you also spent $280 on fast food and another $175 in restaurants (yes, the food issue is a big one for most people in this country and a place where a lot of money leaks out undetected).
You need to come up with an amount for groceries that you will not go over in the coming month. If you spent $452 last month without any kind of cost-cutting strategy, do you think you could get that down to $425 next month? How about $400? That’s a nice round number. Or are you ready to get serious about this and do all you can to knock $100 off last month’s performance?
Don’t get hung up now about how you will reduce your spending. Your task now is to set spending targets for each category that when added together do not exceed your average monthly income.
You are pre-spending your monthly income on paper. You are getting a feel for how things look and feel before you commit. At this point your money is like wet cement; you can keep changing things until they are just the way you want them for this month. You’re in charge here, so this Spending Plan is as fluid as you need it to be.
Break It Down into Weeks
An important aspect of your thirty-day tracking was dividing the month into four reasonably equal weeks—something you can do for every month no matter how many days in that month (week 1: days 1–7; week 2: days 8–14; week 3: days 15–21; week 4: days 22–end of month).
Most people get paid once each week or every two weeks. Fewer are paid only once a month. This alone presents a challenge for many of us because most of our bills are on a once-a-month schedule. Breaking your Spending Plan into weeks will be helpful as you decide which monthly bills will be paid from each paycheck.
The key is to get this down on paper. You need a visual representation of an entire month, where your paychecks land during that month as well as the due dates for your bills.
Rework the Plan
If you are able on your first attempt to plan your spending for the coming month, including your fixed monthly expenses of giving, Contingency Fund, RDRP, and Freedom Account, so that the total of all planned spending does not exceed your average monthly net income, may I say, Hooray! Wow, that was remarkable.
And for the rest of you, it’s okay. Don’t get discouraged. Just go back to the drawing board and keep working at it. You may need to sharpen your pencil a few times and renew your determination to do whatever it takes to stop spending beyond your means.
Look at your Spending Plan—the one that looks like it may never balance. For each entry, ask yourself, Is this essential or optional? The way to tell is by anticipating the consequences if you remove it from your plan for the coming month. If you’re looking at the $200 fast-food entry, the worst thing that will happen is that you’ll have to eat at home or pack a lunch. (And the problem with that would be . . . ?)
Look closely at any item you designate optional. Is that something you can either reduce significantly or forgo for the next month or two as you get on your feet? Or perhaps you may decide to pare way back in every area rather than eliminate any spending categories.
Keep this in mind: Essential expenses are those required to preserve life, to keep your job, or to meet a legal obligation. The consequences for failure to pay essential expenses can be severe—from having your car repossessed to placing your health in jeopardy to having legal action taken against you. New clothes are optional, music lessons are optional, sports are optional, gifts and entertainment are optional. Gasoline to get to work is essential, a debt payment is essential, medications are essential, basic food and shelter are essential.
Unlike your Spending Record, which shows what happened, the Spending Plan decides ahead of time what will happen based on what happened in the past and what you want to see happen in the future. Your Spending Plan says, “I have this much money to manage, and this is how I intend to do it.”
You may be way ahead of me on this, but let me point out something very important to your success in debt-proof living. Many expenses that you failed to anticipate in the past that caused you to rely on credit to get by have now become regular monthly expenses just like your rent or mortgage payment. Those are the puzzle pieces you were missing before. This is huge and explains how debt-proof living will change your life.
It is possible that when you listed your expenses in the past you did not see saving as a fixed monthly expense. Ditto for giving. In the past, if someone asked you to write a Spending Plan, more than likely you entered a monthly payment for each of your unsecured debts. Now you have just one RDRP monthly payment. (Oh, how this is going to simplify things for you.) And you have your Freedom Account to look after all your irregular, unexpected, and intermittent needs.
All the puzzle pieces are face up on the table. You know what you have, and perhaps for the first time you’re beginning to see how everything fits together.
Continue Tracking
Following is an example of a monthly Spending Plan. Each of the four weeks has two columns: plan and actual. In the first column, you enter the planned amount to be spent. The second column contains how much you actually spent.
As illustrated, you will keep tracking your spending so that at the end of next month you will be able to compare what you actually spent with what you planned to spend in each category. Your fixed monthly expenses should not be a problem because, again, they are fixed. You are not likely at this point to be overpaying your mortgage or underpaying your rent. Fixed monthly expenses are what they are: fixed. They remain the same from one month to the next.
And then there are those rascally variable monthly expenses. These areas require careful attention, and you must track your spending to make sure you are not spending more than you planned to spend. Do you have any latitude? Can you change your mind in the middle of the month and rework your plan? Sure, but only to the extent that spending does not exceed earning—and I do not mean future fantasy earnings or credit but money you have now.
Refigure, Replan for Next Month
At the end of the month, write next to each amount on your Spending Plan the amount you actually spent. Add up your columns. Figure out how close you came to planning your income for the month. Where did you miss, and where did you come in under the planned amount?
Using the results of your first monthly Spending Plan, create next month’s Spending Plan. Enter your fixed monthly expenses. Easy. Now look at the variables. Get serious with yourself and decide exactly what you want your money to do in the coming month. Then just lay down the law and make sure that’s exactly what it does!
Each month the process gets easier. Each month you will grow more accustomed to planning your spending. And each month it will get easier to say no to unplanned spending—to anything that will add debt or slow down your progress to get out of debt.
The Envelope Method
An option you may want to consider as you learn a new way to manage your money is the envelope method. As you may have guessed, this method uses ordinary envelopes—one for each spending category on your monthly Spending Plan. You cash your paycheck and divvy up the money among the envelopes as stated on the plan.
Now you spend from the envelopes, which you are not carrying around with you but are keeping in a very secret and safe place. When an envelope is empty, you don’t spend any more on that category until the next fill-up.
You can either retain your regular household checking account for payments that must be mailed or buy money orders from the post office or other source. Yes, it is a pain, and it takes time to stand in line to buy a money order. But you cannot bounce a money order and you cannot overdraw an envelope. If you have demonstrated that you are not yet able to manage a regular checking account responsibly, you should consider the envelope method to help you grow up financially.
Managing Day to Day
Creating a monthly Spending Plan is one thing. Managing it, your Contingency Fund, your Rapid Debt-Repayment Plan, your Freedom Account, and your money too will be quite another. It can be overwhelming at first, not because any of this is unreasonable but because it is new.
In the beginning, you may feel overwhelmed as you move from your old ways of spending all you have and then using plastic to finish out the month. The transition period may be challenging, particularly if you are behind in your bills or facing expenses that are greater than the money you have to work with. While I cannot anticipate every possibility, I will tell you that you can do this. You can start with small steps (but please push yourself to the maximum effort possible). For example, if you simply cannot save and give 10 percent in the first month, give and save something. Make it 5 percent, then next month push it to 6, then 7, and so on.
You may be thinking that this sounds like way too much work. But living in debt is much more trouble. If you compare debt-proof living to the way you have been letting your money run wild, it is work. However, if you’re reading this, it tells me you are looking for a better way. Compared to having no system, debt-proof living does require time and effort. However, you will see that the time and effort debt-proof living takes once you have your system up and running are minimal. Once you get things in order, the system will run so smoothly that you’ll wonder how you ever got along before.
On Your Way to Financial Freedom
I wouldn’t be surprised if you have a tiny headache by now. The fact that you are still with me shows your determination and commitment to take charge of your finances. Good for you. And now you deserve a little break from the present to visualize the future.
Imagine where you will be one year from today if you are diligent to follow the debt-proof living method you’ve learned to this point. You will have a respectable Contingency Fund, and you will be funding your own financial emergencies from your Freedom Account.
I’m going to project a few other things as well. Because you will have become a conscientious giver, you will be blessed in ways you cannot even imagine right now. I believe your income will have increased while your expenses will have decreased. You will be on your way to living financially free—the reason you picked up this book in the first place.
The day will come, and sooner than you think, when your Contingency Fund will reach the goal you have set. So you may be asking, “Can I stop saving money then?” No, never! Forever you must pay yourself 10 percent. It’s part of your Spending Plan—part of your financial life now. And as you continue to save, you will move up the savings levels.
Savings Level 1: Contingency Fund
When you save money, you are building a wall of protection between you and the edge. The first level of your wall is your Contingency Fund. Every dollar you place in that account is another brick that will keep you from tumbling over the edge. And each time you dip into your Contingency Fund to cover emergencies, you have to replace the bricks. Every month, as your fund grows, you add more and more bricks to stand between you and financial crisis.
Once you have accumulated $10,000 (or your designated amount) in your Contingency Fund, you will stop contributing 10 percent of your net income to that account. It is time to move your savings to the next level.
Savings Level 2: Boost Your Freedom Account
Your Freedom Account has been up and running all along, but it’s possible you have been funding only the first two or three subaccounts.
You will move to savings level 2 as soon as your Contingency Fund is at goal. In savings level 2, your 10 percent savings becomes an additional deposit into your Freedom Account to give it a second source of funding. You should stay at level 2 until each of the subaccounts in your Freedom Account is funded adequately up to one year in advance.
If, for example, your property taxes are $3,000 a year, you would want a balance of at least $3,000 in that subaccount. Likewise, your Christmas or holiday subaccount should have a balance equal to what you intend to spend on that in the coming year.
In savings level 2, you get the opportunity to fund all the subaccounts you have designed but that may have been inactive because you were unable to increase your monthly contribution to include them. Once you reach the fully funded goal, you are ready to move on.
Savings Level 3: Finish Your Rapid Debt-Repayment Plan
At savings level 3, your 10 percent savings should go to speed the process of getting debt-free, so it becomes a second source of funding for your Rapid Debt-Repayment Plan. For example, if your 10 percent savings is $400 a month and your regular monthly RDRP payment is $339, once you enter savings level 3, you put $739 toward your Rapid Debt-Repayment Plan. Now you’re cookin’ with gas, my friend!
Once you complete your RDRP and you are debt-free, you go right on to savings level 4.
Savings Level 4: Investment Portfolio
By the time you reach savings level 4, you will have your Contingency Fund in place, your Freedom Account will be fully funded for at least one year in advance (imagine how wonderful that will be!), and you will be free of all unsecured debt. Wow, you made it! And now the fun begins.
In savings level 4, you begin building wealth for yourself, your family, and your future and retirement. You have so many options at this level. For example, with your 10 percent savings you can:
· accumulate a down payment to buy a house, or . . .
· prepay the principal on your present mortgage(s) so you can own your home sooner and not have to pay a ton of interest on that mortgage, or . . .
· start building an investment portfolio of stocks, bonds, and mutual funds, or . . .
· create a combination plan in which you are both prepaying your mortgage and investing
Savings level 4 is where you will be for the rest of your income-producing life.
Frequently Asked Questions
Q: Nice theory, but I need 100 percent of my paycheck just to get by. I cannot save 10 percent. What should I do?
A: Saving 10 percent of your income is the goal. If you can’t start with 10 percent, start with 5 percent. Still can’t do it? Even if it’s $5 a week, that’s enough to get your Contingency Fund up and running. Now start reducing your expenses dramatically until your lifestyle fits within 80 percent of your income. You will discover soon enough that saving is addictive, and I mean that in a good way. It becomes a habit that brings you contentment and a sense of joy and purpose.
Q: I can’t do both, so which should I work on first, a Contingency Fund or a Freedom Account?
A: You can do both if you start out small. It costs nothing to set up your Freedom Account. Prepare the subaccount pages and determine the monthly deposit required for each. This exercise will clear the fog and give you a boost because you are taking steps in the right direction. If you cannot begin funding both, the Contingency Fund should come first. As expenses come up that would normally be paid from your Freedom Account, it would be better to cover them from your Contingency Fund than to use credit. If you do this, you should quickly repay your Contingency Fund so you do not lose ground.
Q: I contribute to my employer’s 401(k) retirement plan. Can I just make this my Contingency Fund?
A: No, because retirement accounts are not liquid in the sense that you can make arbitrary withdrawals. But that’s only one problem. Cashing a retirement account can be very expensive because of the penalties and taxes. Your retirement account is really a frozen asset that is out of reach for now. If you cannot build a Contingency Fund under your current circumstances, consider reducing your 401(k) contributions temporarily to free up the money to build your Contingency Fund. It is so important to your financial freedom that I want you to consider it mandatory for you to do this.
Q: Isn’t it dumb to let $10,000 sit in a bank when it could be invested in mutual funds or stocks and bonds?
A: No, not when you consider that this is primarily an emergency fund, not an investment. If you become suddenly unemployed, you want to have the funds available and intact. There are a variety of safe places to put your Contingency Fund where it is immediately available, safe, and still earning the highest rate of interest currently available.
Q: It does not make sense to me to put any of my money into a Contingency Fund while I am in debt and paying double-digit interest to credit card companies. Shouldn’t I use all my available money to pay my debts first, then start saving?
A: If you do not have some kind of emergency fund, you’ll be forced to use credit if your car breaks down or your water heater fails. If you keep following that pattern, you’ll never get out of debt. If, on the other hand, you diligently build this wall of protection level by level, one brick at a time, you will be able to repay your debts quickly while building a Contingency Fund and a Freedom Account. You can keep your promise to incur no new debts and still keep your boat afloat. And you will be well on your way to reaching savings level 4.