Why I Don't Use A Budget
Updated: Aug 16, 2020
Your whole life, people have been telling you how important it is to have a budget. If budgets are so important, then why do 60% of people not have one?
The reason so few people use a budget is that most budgets are arbitrary templates that are not based on people’s individual goals or circumstances. It feels too much like a chore, so people simply don’t stick to their budget.
In this article, I will be discussing why budgeting is important, why most budget templates fail, and what I do instead of following a traditional budget template.
A budget is an opportunity to write down your financial priorities
A budget is simply a reflection of your financial priorities. If you chose to budget for saving for retirement, you are declaring that it is a financial priority. Conversely, by not including something in your budget, you are declaring that item is not a priority.
Creating a budget is a worthwhile exercise because it forces you to prioritize your financial goals. By the time you get through paying for your big 3 living expenses of housing, transportation, and food, odds are you won’t have a lot of money left over for other goals.
If you love to travel and want to save to buy a house but only have $500 left over at the end of the month, how do you allocate that money; to the house or to travel? The answer will reveal, which is a bigger priority for you.
Why many people can’t stick to a budget
The reason most people quit on their budget is that they are following a budget template. When you follow a budget template, you aren’t budgeting for your financial priorities, you are budgeting based on someone else’s financial priorities.
For example, the 50/20/30 rule is one of the most popular budget templates.
Here’s how a 50/20/30 budget works.
50% of your money should be spent on “needs.”
30% of your money should be spent on “wants.”
20% of your money should go to saving and investing
Don’t get me wrong; budget templates like the 50/20/30 rule are useful if your spending is out of control, and you quickly need to make some necessary changes to your finances.
But once you have your spending under control, a template budget can begin to feel like a chore. Once it starts to feel like a chore, that’s when most people drop their budget.
What I do instead of following a strict budget
I’ve always liked the concept of “paying yourself first.” This simply means that before you pay any bills or spend any money, you set aside a portion of your paycheck and save it.
Saving could mean a lot of things, it could mean saving in an emergency fund, for retirement, paying down debt or saving for a specific goal like buying a house or your child’s education.
I take the pay yourself first approach to budgeting. Rather than adhering to arbitrary spending rules like spending 20% of my income on wants, I figure out how much money I need to save each month to accomplish my financial goals, automate that savings process and spend whatever is leftover.
I refer to this loose form of budgeting as a goals-based budget.
How to set up a goals-based budget in 6 steps
List out your financial priorities. For example, saving for retirement.
Set goals around each priority. For example, I would like to be able to retire by 65.
Figure out how much you need to save each month to accomplish those goals. For example, to retire at 65, I might need to save $800 per month towards retirement.
Figure out if you have enough money to accomplish each goal. For example, maybe after paying for your necessary living expenses like rent and groceries, you discover you only have $500 leftover to save towards retirement.
Make adjustments to free up more money or review and set less aggressive goals. If you were $300 short of your, monthly retirement savings goal, you might look for $300 worth of spending you can cut, find a way to make $300 more each month, or pushback your retirement age based on being able to save $500 rather than $800.
Automate your savings. Once you land on savings goals, you can afford, ensure you achieve those goals by automating your savings.
An example of a goals-based budget
Step 1: List your financial priorities
In this example of building a goals-based budget, I will assume you have three top financial priorities.
Build an emergency fund.
Pay off debt.
Save for retirement.
Step 2: Set goals based on your priorities
Once you have established your financial priorities, it’s essential to set some SMART goals around those priorities. By SMART I mean;
Merely saying “I want to get out of debt” is not a SMART goal. Saying, I want to get out of debt in three years using the avalanche method to debt repayment, is an example of a SMART goal.
Based on the three financial priorities above, here is an example of 3 goals.
Having a 6-month emergency fund saved up in the next 12-months.
Having all non-mortgage debt paid off in the next three years, using the avalanche method.
Saving enough every month to have the option of retiring by the age of 65.
Step 3: Figure out how much you need to save each month to accomplish those goals
Having a goal is nice, knowing how much of you need to save to accomplish those goals is the next step to making them become a reality.
Building a 6-month emergency fund in the next 12-months
Figuring out how much you need to save in your emergency fund is a three-step process.
Step 1: Track your spending and figure out how much you spend on essential spending each month.
Step 2: Deciding how many months you would like your emergency fund to cover essential spending.
Step 3: Multiply the amount in step 1 by the number in step 2. This tells you the total size emergency fund you need in place. Subtract how much you already have saved for an emergency fund.
Step 4: Set a goal for how many months you would like to have your emergency fund fully funded.
Divide the total in step 3 by the number of months in step 4.
Here’s a quick example to illustrate how this works.
Step 1: After tracking your spending, you learn you spend $2,040 per month on essential spendings like housing, transportation, food, and utilities. You also spend $460 on the minimum payments on all of your debts. That brings you up to $2,500 per month on essential spending.
Step 2: You decide you want your emergency fund to cover 6-months’ worth of essential spending.
Step 3: That means you need $15,000 saved in an emergency fund. Let’s say you currently have $3,000 saved in an emergency fund. That means you still need to save $12,000.
Step 4: Recall your goal to have a fully-funded emergency fund in 12-months.
Step 5: That means you need to save $1,000 per month over the next 12-months to achieve your goal.
Having all non-mortgage debt paid off in the next three years, using the avalanche method
Let’s assume you have the following non-mortgage debt.
A credit card with a $3,000 balance, a 20% interest rate, and a $60 minimum monthly payment.
A car loan with a $10,000 balance, a 6% interest rate, and a $300 minimum monthly payment.
A personal loan with a $5,000 balance, an 8.5% interest rate, and a $100 minimum monthly payment.
Using the avalanche method, you pay your debts off in order of the loan with the highest rate of interest to the lowest rate of interest. That means the order in which you would pay off your debt would be as follows.
To pay each of these debts off in three years using the avalanche method would mean you would need to pay $585 towards your debt each month.
First, you would pay $185 towards the credit card while maintaining the minimum payments on the car and personal loans. In 20-months, you would have the credit card paid off.
Next, you would pay $273.45 towards the personal loan and maintaining the minimum payment on the car loan. By month 33, the personal loan would be paid off.
Finally, you would pay $585 towards the car loan. By month-36 (three years), the car loan would be paid off.
Saving enough every month to have the option of retiring by the age of 65
When putting together a DIY retirement savings plan, there are several vital variables you need to consider.
Years until retirement.
How long you expect to live.
Percentage of pre-retirement income you would like to have in retirement.
Workplace retirement plans and pensions.
Government benefits and pensions.
Assumed return on investment for your retirement portfolio.
How much money you currently have saved for retirement.
Let’s assume the following in our example.
Your 35 years old.
You would like to retire at 65.
You currently make $70,000 per year and would like to have 70% of that income in retirement.
Current retirement savings total $100,000.
At work, you have access to a defined contribution retirement plan where you and your employer each contribute 8% of your salary into a retirement plan.
You assume a 5% rate of return on your retirement portfolio.
Based on all of the assumptions made above, in this example, you would need to save an additional $322 in addition to what you and your employer contribute to your retirement savings plan.
Totaling up the amount needed to save for all three financial goals
Monthly savings into emergency fund: $1,000 (for 12 months)
Monthly payments on debt: $585 (for 3 years)
Monthly retirement savings: $322 (for 30 years)
Total amount needed each month to accomplish your three financial goals: $1,907
Step 4: Figure out if you have enough money to accomplish all your goals
The crucial question after figuring out how much money you would need to set aside to accomplish your goals is if you can afford it.
Step 1: Calculate your monthly take-home pay.
Step 2: Subtract the amount needed to accomplish your goals.
Step 3: Subtract the amount of money needed to pay for your essential living expenses.
Step 4: Track your spending and determine the minimum amount you could spend on variable spending (this includes things that you value and random purchases). Subtract this from your take-home pay as well.
Step 5: If you are left with a positive number, you are in good shape. If you are left with a negative number, there is more work to be done.
Returning to our example, here is how that process would work.
Step 1: Let’s assume on a $70,000 annual salary you clear $4,333 per month after taxes and deductions.
Step 2: After accounting for the $1,907 you need to accomplish your financial goals, you are left with $2,426.
Step 3: After subtracting $2,040 needed for your essential living expenses, you are left with $386.
Step 4: After tracking your spending, you determine that the lowest level of non-essential spending, you would be comfortable with is $1,000.
Step 5: That would leave you with a $614 monthly budget deficit.
Clearly, there is more work to be done.
Step 5: Make adjustments as needed
If, after creating your goals based budget, you find you can’t afford to pay for your living expenses and save towards all of your financial goals, you have four options to balance your budget.
Increase your take-home pay. Perhaps by taking on a side-hustle or work overtime hours.
Live more frugally. The low hanging fruit to cut spending would be to look at your big-3 spending of housing, transportation, and food.
Rework your goals to make them less aggressive. For example, if you pushed your goal of being able to retire by 65 to 68 could free up over $200 per month.
Prioritize your goals. If you still can’t make the budget work, it might be time to prioritize your goals. For example, you might want to focus on building your emergency fund before getting aggressive on debt or saving for retirement. The good news is that once your emergency fund is fully-funded, you no longer need to save for it every month. In this example, that would free up $1,000 per month.
Through some combination of the above four options, you can balance your goals based budget.
Step 6: Automate your savings
Saying that you are going to prioritize and save for your goals is an excellent first step. However, there is still a big liability you’ll have to deal with; yourself. Everyone has Nobel intentions when it comes to budgeting and saving, but many people lack the discipline to maintain their savings plans over the long term.
That is why I am a big fan of automating as much of my financial life as possible. By doing so, I take the savings decision out of my hand.
Most banks allow you to easily set up an automated withdrawal from your checking account on every pay-day and have that money placed into a savings or investment account. This will ensure that you follow through on your savings plan because there are no further decisions required on your part.
The other great thing about automating your savings and debt repayment is that eventually, you won’t even notice the money is gone. The money is never in your checking account long enough for you to spend. After a while, you adjust your spending as if that money was never there.
Setting up your goals based budget
Budgeting is important because it forces you to prioritize your financial goals. A budget template can be a good way to get started, especially if you need help reigning in your spending.
However, many people find it challenging to stick with budget templates for the long term. The simple reason is that your life is not a template. If you’re going to stick with a budget for the long term, it should allow for more flexible spending.
That is why I am a fan of the goals-based budgeting approach, which is a six-step process.
Step 1: List out your financial priorities.
Step 2: Set goals around each priority.
Step 3: Figure out how much you need to save each month to accomplish those goals.
Step 4: Figure out if you have enough money to accomplish each goal.
Step 5: Make adjustments to free up more money or review and set less aggressive goals.
Step 6 Automate your savings and spend whatever is leftover; however, you please.
The final thought I’ll leave you with is to remind you that the goals based budget process should be reviewed and adjusted periodically. As your goals change, so must your budget.
Once you start achieving financial goals, you will have an important decision to make; what to do with the money you were saving towards the goal that has now been accomplished.
Ideally, you will reallocate that money towards new goals that will help you live a prosperous and happy life.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions