A budget is similar to a diet. What a diet is to physical health, a budget is to financial health. Both are developed to improve yourself, but neither are typically sustainable. More often than not they’re temporary lifestyle changes, not permanent behavioral changes. As a result, we’ve found the best way to budget is through automation.
The Traditional Budget
Budgets traditionally are defined as an estimate of income and expenditure over a set period of time. The traditional budget focuses on tracking expenses and determining how, and where to cut back. They aim to identify expenses that aren’t exactly necessary in order to pay off debt, increase savings, or reach another financial goal. The best part about building a traditional budget is people sometimes don’t realize where they’re spending money. Identifying how much you’re spending on coffee every month CAN result in behavioral changes if it’s shocking enough to warrant a change.
Applications like Mint.com offer free software to help itemize expenditures and build budgets. Or try our free tool!
The downside to traditional budgets is they take time, effort, and can make money less enjoyable. Realistically, It’s hard to hold yourself accountable for reviewing a budget every month. Use a software like Mint.com with account aggregation, to identify where you’re spending money, not to track whether you’re spending too much. At the very minimum, It’s a good idea to know what your fixed expenses are, and/or what expenses you can control or cut back on.
Lastly, the traditional budget can make money less enjoyable. If you’re out shopping, getting drinks, or playing a round of golf, you don’t always want to be thinking about your budget. Can I afford this shirt? Should I go out for beers this weekend? Am I able to spend Saturday with the boys? I’ve found trying to stick to a monthly budget force these questions into your head. While I’m not advocating for reckless spending, money should be enjoyable. We’ve found a better way to ensure great savings habits, debt repayment, and ability to enjoy your money!
The Best Way to Budget: Automation
Everyone who receives a monthly or bi-weekly paycheck probably has their money directly deposited into their checking account. Rather than receiving the check by mail and having to deposit at the bank, it’s done for you automatically. This same process can apply, in most cases to student loan payments, mortgage payments, 401(k) contributions, etc. Every part of personal finances can be automated. Below I’ve discussed a few ways to automate different financial goals. Ultimately, you’ll arrive at a monthly budget for remaining expenses and leisure.
Emergency Fund and Debt Obligations
When a paycheck hits your account (usually predictable), set up an automatic transfer to your savings account in order to build up an emergency fund if you don’t have one already. Typically, emergency funds consist of 3-6 months of living expenses. If you’re already making student loan payments automatically great, if not, set up payments for that as well. Student loans should be a priority, however, that does not mean ignoring other financial goals, such as an emergency fund or investing. Other debt obligations such as a mortgage or credit cards, should be high on the priority list as well.
If you’re participating in a 401(k) plan, contributions are automatically deducted from your paycheck by your employer. It takes very little effort to set up a 401(k) and begin contributing. As most companies these days avoid pension plans, it’s more important than ever to start contributing to a tax-advantaged retirement plan like a 401(k) early and often. Most advisors will recommend saving anywhere from 15-20% of gross income. Obviously, the greater the percentage the better. However, being realistic, the average millennial graduates with 30k+ in student debt. It can be hard to enjoy yourself, pay off debt, and save more than 15%, to begin with. It’s a great target to shoot for if able. Otherwise, it’s a goal to work towards.
Another automation tip with 401(k)’s I’d suggest implementing is contribution increases. A lot of plans have annual contribution increases available. Meaning, rather than having to manually go in and increase contributions (one of those things we’ll say we’ll do, but don’t get around to ever) the plan will do it for you. Even starting with an annual increase of 1% can vastly change your retirement savings picture over time. If you receive a salary increase, bonus, or wage increase each year, you’ll hardly notice the bump in 401(k) contributions.
If you’ve paid off debt, and want to put more money towards retirement savings. Opening an IRA or Roth IRA is a great way to go. Unlike, a 401(k) you have many more investment choices. You can automate contributions to an IRA just like you would a 401(k). The only difference is you’ll have to set up the transfers with the broker/dealer and your bank. Most brokers offer this feature. Again, even if you start with as little as $50 every two weeks, that adds up to $1200 annually. Buy a low-cost index fund and let the power of compounding take over.
Brokerage Account Contributions
If you don’t want to lock up money in a retirement account, or lucky enough to have maxed all your retirement contributions, you may consider opening a brokerage account. Just as you would transfer money to a savings account to build an emergency fund, transferring money directly to a brokerage account is just as easy. Align transfers on the same day or day after your paycheck normally hits your checking account.
The End Result
Once everything is automated you’ll know whatever cash left in checking is available for remaining expenses and leisure. Given that you’re actively contributing to, or established an emergency fund, making progress towards paying off high-interest debt, and saving roughly 15-20% of gross income towards retirement savings. Now, the key is not overspending. What obviously gets people into trouble, is spending money they don’t have. Credit card debt can spiral out of control quickly, if you find yourself spending more than what you’ve accumulated in your checking account, take some time to review the traditional budget and see where you need to cut back.
Putting personal finances on autopilot is the best way to budget. Once the processes are put in place, all it takes is remaining disciplined. As opposed to reviewing, and stressing over a traditional monthly budget with every expenditure. Automation results in true behavioral changes because it clearly defines the amount you’re able to spend each month once other financial priorities are taken care of.
What struggles or successes have you encountered using traditional budgeting? How about automation?
Check out our account aggregation software that contains a budgeting module here and get started on an automated budget today.
Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR™ and Co-Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!