Budgeting is a lot like dieting.
They both work in theory, but in the real world they are almost worthless.
Surprisingly, the secret to controlling spending is to abandon strict and impossible rules.
And forget the complicated online programs too.
Few people are disciplined enough to track their spending, but more importantly, monitoring expenses does little to change behavior.
If you track your restaurant purchases, for example, and discover you spend $300 a month, what does that tell you? It does not answer how much you value eating out and arbitrary historical numbers do little to modify your spending.
Perhaps the $300 is a frivolous waste, or maybe restaurants are the only place your family gets quality time together. In this case, the $300 a month may be the most important thing you buy. What’s outrageous to some families is insignificant to others.
Instead of boring recording keeping, you need to figure out what is really important to you. Your buying choices when funds are limited is what brings your true values to the surface.
The system that works best for most people……is to ignore complicated record keeping systems, except for businesses, and instead use a simple, three account system and cash.
That surprises most people, but by simplifying your finances, you will reach your savings goals more easily.
QUICK START — Three Account System
The more automated this system, the more effective it will be. With today’s technology, bill payments, direct deposit and automatic bank transfers can be completely automated, which helps ensure this system stays in place.
Start with three bank accounts (it’s easiest at one bank).
Account #1—Mandatory Expenses
Direct deposit all income into account #1. Use account #1 to pay mandatory, fixed expenses such as rent, car payments, and contributions to savings.
- Determine mandatory monthly expenses (mortgage, car payments, utility bills, etc).
- Open checking account #1
- Have all income automatically deposited into account #1
- Set up automatic monthly payments to for each mandatory expenses
- Set up automatic savings / retirement contributions
If your monthly savings and retirement contributions are not automatically deducted from your paycheck, have these funds drafted from this account as well.
That makes savings mandatory and a priority on par with paying the rent instead of waiting to see if there is anything left over at the end of the month. Otherwise said, “Pay yourself first.”
Account #2 – Discretionary Expenses
- Determine and add up discretionary expenses
- Open checking account #2
- Create monthly automatic transfer from account #1 to account #2 for total monthly discretionary expenses (groceries, cable, dry cleaning, and entertainment)
- Use account #2 to pay discretionary expenses
Groceries are discretionary because your options range from steak and lobster to freeze-dried noodles. This system allows you to automatically moderate your discretionary spending based on how much money is in account #2.
If there is a plenty of money, steak may be an option. But if the account balance is running low, peanut butter and jelly may be the menu for a couple of days.
If at the end of each month you regularly have money left over, you may decide to decrease the money transferred to account #2, which will allow more money for credit card payments or savings.
Account #3 – Emergency Fund / Annual Expenses
- Determine large annual expenses
- Add all annual expenses, divide by 12
- Set up checking account #3
- Create monthly automatic transfer from account #1 to account #3 to cover monthly portion of annual expenses.
This account is used to pay large annual expenses like home and auto insurance, taxes, and don’t forget saving for vacations and grown up toys like boats. This account can also hold emergency cash reserves.
Auto, home, and life insurance and taxes are usually due annually instead of monthly. Unless you plan in advance, you might end up using the credit cards, which is a mistake. The goal is to get out of debt.
Cash – Luxuries
Many books and advisors use the Starbucks example, suggesting that if you skipped the fancy coffees you would save enough to retire and blah, blah, blah.
Perhaps there’s a shred of truth in that. However, there is no right or wrong amount you should spend on luxuries and no financial advisor should ever impose his or her values on you.
But if there are things you want to spend less on, here is a simple way.
Set a limit and make a weekly cash withdrawal for those luxuries. Once you spend the money, you’re done until the following week.
That is the easiest and most effective way to limit spending without ridiculous record keeping.
This simple cash method limits spending and removes any guilt you may have previously felt when spending on small luxuries.
Instead of tracking your expenses, it lets you decide what you value most and automatically adjust your spending accordingly.
You never have to worry about running out of money for the critical bills.
It is budgeting, without budgeting.
And zero record keeping.
This article is adapted from the best selling book “How to be Rich: The Couple’s Guide to a Rich Life Without Worrying About Money.”