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Beyond the Numbers

Beyond the Numbers

Trusted advice to help you think big and plan bigger.

Invert Your Budgetary Thinking

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Portfolio Manager
Family Office Services, Cincinnati

With the holiday season upon us and hopefully most of our shopping completed, some of us may be experiencing the annual stresses associated with extra spending for family and friends that occurs at this time of year. This also may be a time that we lose focus on a budget given the overwhelming number of gifts that need to be purchased and stretching our wallets to buy the perfect gifts for our family and friends.

We thought this would be a great opportunity to highlight some ideas about budgeting, but probably not in the way you were taught to think about it in the past. We view this approach as the inverse of the traditional budget.

 

The Traditional Budget

When I first learned about budgeting, it was very much focused on spending – allotting a set amount each month to various categories and then tracking purchases to ensure I wasn’t overspending on any one category or in total. Then somewhere in the list there was a line item for savings, but it wasn’t the first priority in the process.

I didn’t like this approach for a few different reasons:

  • I always thought that I should start with the appropriate amount of savings and then allocate the amount left over to other categories.
  • It required putting exact amounts for each category, but there were always discrepancies and missing categories given the many unforeseeable events in life.
  • The process consumed a lot of time and mental energy because of the tracking required as I made everyday purchases. It also restrained me from going out for dinner, taking a trip, or buying something else that was out of the ordinary.

I have several friends and family members that adhere to a budget like the one I just described. I have noticed the inordinate amount of time they spend thinking about their budget (and money in general), tracking their spending, and agonizing over purchases (large or small). Personally, I want to focus my time and thoughts on other areas of my life and not on the opportunity cost of every purchase I make.

 

The Inverted Budget

I offer a different way to look at setting a budget, drawing upon my own experience, which has worked well for me for about 10 years:

Start with the amount you would like to have in reserve for an emergency fund for unforeseen expenses (e.g. car repairs), amount of higher interest debt to reduce (e.g. student loan debt), and the amount you would like to contribute to your retirement nest egg, and then determine the necessary amount of savings to reach these goals.

If you don’t know what these amounts are, then one of the benefits of this approach emerges. It forces you to do some level of financial planning and cash flow projections to determine your target savings amount that provides the foundation of your budget. We would be glad to help develop or update your planning projections to determine your appropriate savings amount while choosing the best vehicles (e.g. 401k, Roth IRA, HSA, etc.) to use as you accumulate savings. Beginning with savings may not come naturally, and can be overlooked as the month rolls by, so utilizing the magic of automatic paycheck contributions can take the thought out of the process. This is what we call “paying yourself first”.

Now that your savings plan is underway, you can focus on spending; budgeting for both regular and irregular expenses. With this approach, your required saving has guided the amount of spending rather than vice versa. It makes saving a priority and forces you to have spending discipline, particularly regarding wants vs. needs. It also deters you from using “rules of thumb” as savings and spending amounts, as those may not fit your specific situation.

 

Breaking It Down

As an example, a monthly budgeting process with this approach may look something like this:

  • Monthly Budget: $5000
  • Reduce Student Loan Balance: -$500
  • Add to Emergency Fund: -$500
  • 401k/IRA Savings: -$1000
  • Amount Remaining: $3000

With the remaining $3,000, spend first on your highest priority, necessity items (mortgage, car, insurance, food, etc.). Once those needs are met, any funds left over can go toward your wants. If you have little or nothing left over after you save and spend on necessities, then you should look for areas where you can curb spending.

We realize that if you start implementing this approach next month, it may not be possible to achieve your targeted savings amounts right away. If this is the case, develop a plan to slowly increase savings to the necessary levels over a period of months, which will allow for reducing spending slowly and not abruptly disrupt your lifestyle. And if you still like crunching the numbers and seeing your consumption trends over time, budgeting apps like Mint allow you to easily set spending goals in different categories. They also automatically track spending against those goals to let you know where you stand at a given point in time.

 

The Hidden Benefit

Now let’s say you get to the end of the month and you have excess funds available. This is the fun part of the inverted budget!

Rather than worrying about whether you should be saving more, paying down more of your mortgage, or adding to your cash reserves, you know that you have a sound financial plan and are confident about spending on the things you want. This has helped me enjoy the present while still planning for my family’s future. It also allows me to take the plunge and pay for experiences that I might not have otherwise. These experiences have produced a great return on investment: cherished memories with the people I love.

In 2017, I suggest you give this approach a try. My hope is that you will have more time, less worry, and enjoy life in the present while having confidence in your future. It has certainly worked that way for me. And if you get to December 2017 with some money left over, take the plunge. Plan an extra trip with your friends, or buy the perfect gift for your favorite family member – without the stress this time.

Happy Holidays from your team at JIC.