Most people associate budgets with sacrifice. But in truth, budgets are about choices -- not just choices of whether to buy this or that, but choices about how we want to live our lives, now and in the future. Whether you are at the beginning of a career, starting a family or approaching retirement, creating a plan for achieving financial objectives is essential. And, let's face it: The more prudent you can be on the current expenditure side today, the more you can save and invest for retirement.
Often, the "budgets" people create aren't really comprehensive, causing them to abandon them after the first month because they find themselves "over budget." Instead of thinking "budget," try thinking in terms of a personal spending plan. Developing a plan takes the mystery out of where your money goes and addresses the "out of sight, out of mind" trap. It moves finances from the general (also known as the unconscious) into the specific. Although a "general" spending plan may feel more comfortable, the phone company doesn't care if you "generally" don't have enough money to pay the bill on time.
Being clear about current spending, prioritizing financial goals and determining a timeline for accomplishing them, may lead you to decide to spend money differently, without having to give up anything.
Developing a plan isn't about sacrifice. Recognizing that you're spending money on things that aren't really important and making a decision to shift that money toward something that is important, such as investing for retirement, can be incredibly powerful.
1. Collect the facts. The first step in developing a plan is to collect the facts. Think in terms of what bills you have, how much is owed, and when they're due, as well as where else money is spent, such as groceries, school supplies, eating out, books, movies, etc.
Once the obvious is recorded, review an old check register or credit card statement and add anything else that may have been missed. Remember, during this step, don't edit or avoid recording something because you're afraid that the total will be too high. All of the facts are important.
2. Identify your goals. Next, identify your financial goals -- immediate, short term and long range. As with any goal-setting exercise, use this opportunity to write down the obvious ones and brainstorm any that may be less obvious. These take a little longer to surface, so stick with the exercise. Regardless of your stage in life, be sure that investing for retirement features prominently on your list. Most importantly: Don't edit. Just write.
The next step is to specify whether each goal is immediate, short-term, or long-range. In defining these time-frames, think in terms of when to begin to save for or apply money to the goal.
Goals typically have costs associated with them, so it's important to estimate these. After determining the total cost for each goal and the target completion date, divide the total cost by the number of months between the present and the completion date. This is the amount that you'll need to set aside monthly to be able to accomplish each goal.
It may be reassuring to know that the majority of people who undertake this process for the first time are spending either exactly what they earn or more. And it makes absolutely no difference how much they earn -- it all gets spent and then some. Rather than panic, return to the facts.
3. Consider the choices. There are really only two choices: Earn more or spend less. First, let's look at spending less. Go to your list of monthly expenses. Considering each of the expense items and determine into which one of these three categories it falls:
-- Committed expenditures: expenses resulting from an existing commitment (mortgage, rent, car loan, insurance premium, utilities, education and, to some extent, food)
-- Somewhat discretionary: expenses for which you have some control over the amount and timing (vacations, gifts, eating out, clothing, investments)
-- Very discretionary: expenses you can choose to spend or not (a dream vacation)
A note about balancing "spending" and "investing." Before looking at how to reduce spending, let's consider the investments item in the category of "somewhat discretionary." If you were to look back on this exercise during your retirement years, you would probably advise your younger self to move investments to "committed expenditures." This would ensure that ongoing contributions to 401(k), individual retirement account or other retirement accounts would not fall victim to spending cuts that should be managed through items that truly are "discretionary."
Also, remember that retirement spending doesn't end once you're in retirement. Whether it's planning to invest for retirement or managing your spending during those years, the personal spending plan exercise should be a regular part of your financial planning.
Once categories have been assigned for each expense item, focus on the "very discretionary" items. Can they be eliminated or deferred until a later date? Or can the amount be reduced if they are, in fact, necessary? If the answer to either question is yes, do it. Change those items on your list of expenses and calculate how this changes the total.
Next, focus on the "somewhat discretionary" items. Although generally these can't be eliminated entirely, the amount spent on them usually can be reduced. If these changes haven't been enough, think about additional sources of income. And be creative. How might you earn additional income?
4. Revisit the plan over time. Remember, this process can be updated at any time based on new information. The process works -- all you have to do is fill in the facts and keep updating the plan based on those new facts.
With this plan, you can see exactly how money is spent, goals are prioritized and a plan to fund them is developed. It enables and empowers you to make conscious decisions and choices around finances. It is through dedication to those choices that achievement of goals is possible.
The spending plan process is really quite simple, but many people find that, having completed the process, the true work is just beginning. It's all about choice.
Karen Ramsey has over 20 years of experience as a fee-only certified financial planner professional. The author of two books on personal finance, she provides professional investment management to clients throughout the U.S. via her low-account minimum, web-interactive service RamseyInvesting.com .
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