How often do we hear from personal finance gurus that we need a budget? If anything, I think those who don’t tell us to budget are a rare breed. Preaching the virtues of budgeting is a key message because it’s an easy recipe to convey and most of us eat it up. But it has a downside.
Guru Key Messages
Here are the key messages we hear about budgets.
They help us:
- Spend money wisely by carefully allocating our dollars.
- Pay down debt.
- Spend in line with our goals.
- Prevent us from spending on what we don’t really need.
Seems simple and straightforward enough. Right? At face value the benefits seem pretty logical, but they're an illusion.
First, let’s take a look at these messages one by one. Then, we can take a peek at the downsides they never bother to tell us about.
Two things happen when it comes to saving and budgeting: either we save right off the top or we save whatever’s left at the end of the month.
Saving right off the top: we might manually or automatically move part of our regular paycheque(s) to a savings or retirement account or we may have an employer put aside money on our behalf. Either way, a budget is not required to do that, especially if it gets allocated right up front.
Saving whatever’s left at the end of the month: some folks prefer to save at the end of the month. Whatever’s not spent goes to savings. That’s a riskier move because life happens and it’s far more likely that we dip into what would have gone to savings as opposed to restricting other types of spending.
Bottom line: When we Pay ourselves first we don’t have to “budget” our savings.
2. Spend More Wisely
I have seen very few budgeting tools that don’t include dozens of categories. Some relate to fixed/non-negotiable expenses (mortgage, car payment, utilities), some relate to relatively stable but more variable expenses (food), and finally to purely discretionary expenses (entertainment, beauty). There are also other categories that appear in a monthly budget that are not necessarily monthly expenses (clothing, car maintenance).
If you're tracking your budgeting per the recommendation, you can end up with an overwhelming number of categories and a number of additional savings accounts for the money you are needing to accrue for various purposes. Yikes!
But wait. There’s more. As we get into the month you’ve budgeted for, life happens and one of two things come about:
- We reallocate money from other categories to cover what's more important.
- We forego the expense or defer it to next month’s budget.
Either one of these coping methods is fine. No problem there…other than the fact that it happens every. single. month.
It's so much easier to just prepay expenses at the beginning of the month for recurring expenses, such as payments to creditors & monthly contracted services, and then work with a slush for what's left.
Bottom line: If we know how much disposable income we have, we can spend within that envelope, keeping a little extra just in case something comes up.*
Disposable income = Take home pay - Monthly obligations
*Note: Everyone needs a stash of cash for emergencies. Dipping into savings—you know, that account you’re not supposed to touch—to address emergencies makes it way too easy to do so repeatedly. A set amount set aside for the unexpected can keep us from dipping our hands into the larger cookie jar because the emergency savings account is a finite number (to start, it should be a minimum of $1,000 or 1% of yearly income, whichever is greater and growing to be 3 to 6 months of expenses).
3. Pay Down Debt
This section will sound eerily familiar (see #1).
Two things happen when it comes to debt and budgeting: either we pay a certain amount on our debts right off the top or we pay down our debts with whatever’s left at the end of the month.
Paying debts right off the top: we might manually or automatically move part of our regular paycheque(s) to a debt repayment and/or our employer may be mandated to garnish our wages. Either way, a budget is not required to do that, especially if it gets allocated right up front.
Paying debts with whatever’s left at the end of the month: some folks prefer to pay debts at the end of the month. Whatever’s not spent goes toward paying down debt. That’s a riskier move because life happens and we’re likely to take much longer to pay down debt because spending on the present is far more fun than paying for past expenditures.
Bottom line: By paying debt first we don’t have to “budget” our debt repayment.
4. Spend In Line With Our Goals
The idea is that if you create a category that reflects something you care about, you ensure you protect this money by either saving it or spending it monthly for a given purpose. To that, I offer a few thoughts:
- If it’s truly important to us, we'll save up for it if need be and we'll spend it for that purpose, regardless.
- If we don’t save up for or spend on what we say matters to us, by constantly stealing from or underfunding a category to cover other line items, then surprise! What we say is important and what we do don’t match and something needs to change. And that something is not in the spreadsheet. It's between our ears.
There are a number of ways to ensure that we spend on what we care about without having to budget for it:
- Save for it off the top by automating savings for this dream or goal.
- Pay for it up front.
- Pay as we go when we want to participate. If we care about it that much, we'll naturally cut back in other areas of our life to compensate.
Bottom line: A budget can't convince us something is important if we don't really care about it.
5. Prevent Us From Spending
Keeping track of our spending in a given category will tell us that we’ve reached our maximum allocation in that category. At that point, we can do one of 3 things:
- Stop spending in that category,
- Reallocate money from another category or
- Go over budget.
The choice is ours.
And it gets more complicated when we're budgeting for/with more than one person. When the categories are prescriptive, there’s likely to be dysfunctional behaviour. To understand this issue, we only need to look at what happens in most companies on a monthly, quarterly or yearly basis.
Those who manage corporate budgets know that “if you don’t use it, you lose it”. We feel the need to spend the money we have available whether we need to, want to or not. The drive has little to do with a deep desire to have what we're spending money on. It’s driven by the fear that the category will shrink at some point, leaving us with less than we might need in the future.
Instead of choosing to not spend all funds available in a given month because we don’t need to—which would make everyone better off assuming everyone plays fair—we resort to protecting our turf. I can hardly think of something more damaging to personal finances and to living an optimal life by spending on what will really make us better off.
The reality is that a budget doesn’t necessarily prevent us from overspending any better than knowing how we've historically spent our money. A bit of a review of past patterns, say looking at three months of expenses, will do the same thing. And, the more restrictive and detailed a budget is, the more likely we start to ignore it and do what we want to do.
Bottom line: Budgets can make us spend on things we really don't care about. Auditing past behaviour might be more effective.
6. A Communication Tool
Budgeting is supposed to be a team sport. We all sit down around the kitchen table, talk about what’s expected in the month ahead and agree on how much is allocated to what. There’s likely to be negotiation, a review of actuals from the previous month, and then everyone “signs off”. Sounds simple, right?
With all the money tracking tools available online, setting pen to paper is becoming increasingly meaningless. We can log in to our bank accounts, credit card statements and see our expenditures in realtime with a few taps on virtually any smartphone or tablet. These give us a play-by-play of our spending as the month progresses. We can always see our balances and so can our spouse (assuming you have joint accounts). With knowledge of past behaviour, we know where we stand. And, if larger or unexpected purchases are desired or required, everyone can simply agree that anything over a certain amount warrants a conversation to ensure surprise bumps in spending are kept to a minimum.
Bottom line: Realtime access to expenditures and bank balances throughout the month along with setting a spending threshold that triggers a conversation is sufficient to ensure regular money conversations occur.
What The Gurus Don't Talk About
I hope I’ve offered convincing counterarguments to the idea that a budget is an essential part of success in managing our personal finances. If I’ve missed anything, please share your thoughts below.
Now, we need to talk about the unintended consequences of monthly budgeting and whether the practice is needed at all.
Budgeting and the Scarcity Complex
Budgeting, as a behavioural tool, is like a diet. It’s restrictive, prescriptive and depressing, whether we've drawn it up ourselves or we’ve adopted someone else’s model. As soon as we start a diet, everything we can’t have starts to look appealing. We suddenly want that doughnut that we wouldn’t have given a second thought to, that leftover birthday cake in the lunchroom at work or the candy bar in the display at the gas station.
It happens to everyone who feels a given resource has become scarce. That’s why pre-scripted action doesn’t work over the long term.
Don’t believe me? Then tell me, how many dieters reach their goal weight and stay there? I’ll help you with that. The answer is less than 5%.
Budgeting alone will not help get and keep our finances lean and mean. It’s a fallacy that only leads to people beating themselves up for failing over and over again.
What makes people feel a resource is plentiful is having options as opposed to restrictions. Knowing we can allocate our funds as we want throughout the month has a wonderful effect: we stop constantly thinking about how much we have, which means we’re less preoccupied. For many, the result is we actually spend less and even have money left over that naturally spills into the following period. Yes. We have a nice, natural and unplanned extra cushion.
Budgeting and Time
Budgeting every month can be time consuming. Not only do you have to set your budget categories every month, but you need to review all sources of income (paycheques, unexpected windfalls, etc.) and all expenses (debit, cash, credit, other). Without this work—some of which can be alleviated with online tools such as Mint—and a discussion about what’s coming up this month, you can’t negotiate and set your upcoming spending regimen. That means the following has to happen:
- You have to time when you work on your budget just right. It has to match your pay periods and bill timing, otherwise it can be even messier.
- Everyone involved needs to save all receipts and/or have access to them electronically.
- Participants also need to be available to work on and discuss the numbers for the upcoming period.
- Once every line item is discussed and agreed upon, every change also needs to be discussed throughout the month to prevent misunderstandings and surprises at the end of the month.
The more involved a process is, the less likely it will stick once the initial excitement wanes. Many budgeting endeavours are abandoned within three months.
Budgeting and Behaviour
Whether we see opportunities or barriers often has to do with the story we tell ourselves and budgeting doesn’t influence that story. It’s an allocation tool that doesn’t deal with what takes place between our ears. How we think about money—about our relationship with money—is far more important than how much is in our clothing budget this month. Changing how we think means we’re likely to approach every money decision differently. When we’re successful, we’re likely to redefine wants vs needs and “I can’t" quickly becomes “I choose not to.”
As you can see, budgeting isn’t everything it’s cracked up to be and it definitely can do more harm than good.
If budgeting has this many drawbacks, why are some people so successful at managing their money? Their secret isn’t their mean budgeting skills—though some spreadsheet jockeys manage to maintain a budget over the long term—it’s their long-term vision of what they want and how they behave as a result of this vision that makes them successful.
Whether our vision is to be debt free, retire early, travel the world, or [fill in the blank], we need to translate it into a handful of tangible goals that are then broken down into what needs to be accomplished within a given period. For some it’s a yearly goal, for others it’s a monthly goal and for others still it might even be as specific as a weekly or daily behaviour. Whatever it is, it needs to be real and measurable. And, a shared goal that everyone buys into within a household makes it easy for everyone to modify their behaviours to align to it. It also makes money conversations a cinch.
Note: If you want to see our goals, check out our Million Dollar "To Do" List.
Once we know what we want to achieve, we need to track our progress. Numbers don’t lie. If we measure progress and the numbers either stagnate or start going the wrong way, we know we need to look at our behaviour and make some adjustments to get back on track. Examples of tracking include:
- Total savings growth or savings as a percentage of income.
- Total debt to equity ratio or net worth.
- Percentage of debt repaid.
- Fixed expenses as a percentage of take-home pay.
- Years remaining on mortgage.
- Years remaining on a car loan.
When it comes to financial goals, put money where your mouth is. It’s what you do first that counts. Whatever your number one goal is, take care of it first. That means that money needs to be allocated up front. No matter what, it’s non-negotiable. That’s why people who pay themselves first tend to be so successful at saving.
Here are a few examples:
- Set it and forget it:
- Automate your retirement savings.
- Automate savings toward a specific larger goal (save up for what you want).
- Automate your bill payments or prepay if the timing is a problem.
- Automate your debt repayment.
- Hindsight is 20/20: Performing periodic reviews of spending patterns ensures we’re behaving the way we think we are. These reviews can sometimes be eye-opening and help us tweak our lifestyle. Their frequency depends on need. The more predictable and stable our behaviour and the more we're on track to meet or exceed our goals, the more infrequent the reviews can be.
Keep Good Company
Who we spend time with matters. Making changes to who we spend time with can make the difference between being successful or not. There’s nothing like being around people who share the same goals and values when we’re trying to become a better version of ourselves. It’s even better when the people we gravitate towards are further along in fulfilling similar goals. Nothing replaces what that proximity and interaction offers: hope. If we know others have been successful and how they managed to do it, we're more likely to believe we can be successful too.
Luckily, the internet has made it easy to find like-minded people. There are countless personal finance forums, blogs, podcasts, even conferences to explore. It’s worth investing the time and effort to find the online communities that resonate with us and use the positive interactions with people who understand what we want to accomplish. The information, positive energy and the support we can receive make it much easier to stay focused and sometimes, it makes it even easier to get to the finish line. If you're looking for resources, you might want to check out the F2P blog roll on the bottom right-hand side of this page.
Don’t Sweat the Small Stuff
When you’re doing what you’ve set out to do and you’re making progress, don’t overanalyze. Reevaluating progress at regular intervals is fine, but if you’re micromanaging yourself, you’ll feel stuck and that feeling of scarcity can creep in and cause you to get off the rails. Staying focused on—and tracking—the big picture is what helps us succeed in the long run. Everything else is noise.
When you set goals and track your progress, natural milestones emerge. These can be reaching a certain percentage of your goal(s) and—of course—reaching the goal itself. It’s absolutely essential to celebrate positive steps along the way. Celebration keeps us focused and engaged, especially when a goal spans months, years or even decades.
Here are examples of what we might celebrate:
- Becoming current on all debt.
- Eliminating a creditor by closing a credit card, paying off a vehicle or a student loan.
- Reaching 50% of a savings goal for a new car or a dream vacation.
- Having 50% of a child’s college fund, then 75% and 100%. Yes!
- Reaching a certain level of savings to income: 5%, 10%, 15%, 30%, 50%, or more!
- Reaching a certain level of net worth: $10K, $100K, $250K, $1M (woohoo).
- The number of years of freedom (aka liquid courage) you’ve accumulated: 5 years, 10 years, 25 years.
- Paying off 25%, 50%, 75% or 100% of your mortgage.
- Years of work before retirement is an option: 20 years, 15 years, 10 years, zero!
A celebration doesn’t have to be over the top, but it’s a step that too many people don’t pay attention to and it’s a shame. Acknowledging how far we’ve come fuels us for the next phase. It reawakens the initial excitement and reminds us why we’re doing what we’re doing.
Have I convinced you that budgeting in and of itself is far from the answer? I hope so. If not, I’d love to hear your take on the best in money management principles.