I recently started working out again after a yearlong hiatus. And for anyone who has jumped right back into working out, you know that the first couple of weeks are the worst. Your whole body feels sore and it can be hard to get back into the routine and commit to a schedule. Also, it can take months before you even start to see a difference in the mirror. It is much easier to just maintain a healthy lifestyle than to start from scratch every January 1st.
People who maintain a healthy lifestyle know that it’s not just the decision to lift a few weights for 30 minutes a day that will keep them in shape. It is being disciplined enough to make good decisions each day about what you will eat and drink along with staying active through exercise. It’s deciding to eat the grilled chicken instead of the fried pork chop, or the almonds instead of the potato chips. The choice may not seem like a big deal in the moment, but compound those decisions over months, years, and decades, and it could mean the difference between planning another vacation or watching Wheel of Fortune from your hospital bed.
We should think about our financial health in the same manner. It isn’t a hot stock or last year’s best performing mutual fund that will catapult you into financial independence. It is a lifetime of good financial decisions that over time will compound into something much more. But in order to make good decisions, you need to know where your money is currently being spent.
Creating a financial plan helps us define our goals and know what to save to reach them, but the budget is the tool that helps us implement this plan. Simply saying that you will just save what is left over at the end of the month is a recipe for failure. As humans we are great at finding ways to spend exactly what we earn (or more), no matter the amount. As our income rises, the house gets bigger, cars get nicer, and we tend to eat out more. Having a budget keeps us in check and gives us spending guidelines to ensure that we will be able to save the amount outlined in our financial plan.
Go ahead…get started today.
Even if you haven’t created a full financial plan yet, you can still start your budget in order to get organized and understand where there may be opportunities to spend less. When my wife and I did our original budget, we were surprised at the percentage of our income that went to restaurants. We started cooking at home a little more and were able to add the extra savings to our ROTH accounts. Small changes like this can have a major impact when compounded over decades. An extra $100 per month in your retirement account growing at 7% for 30 years will accumulate to over $120,000.
So how do you identify these opportunities to save?
The first step is getting your income and expenses down on paper and categorizing them. There are plenty of free templates or websites that can help with this. Some apps will even pull the data from your bank account and categorize it automatically. Even so, you will want to double check the information and make changes where necessary.
Once all of your expenses are categorized, you can begin to analyze the categories that are discretionary. This includes categories like restaurants, entertainment, and vacations. There are also non-discretionary categories like groceries and clothing that are necessary but are variable and can be changed if needed.
Remember that the goal here is to cut enough spending to reach your desired savings rate. I like to let my financial plan determine how much I need to save. If I see that in order to reach my goals I need to save an extra 5% of income, I can go to my budget and start shaving away expenses until I increase my net cash flow by 5%. By having a budget, I know that I can still pay for all of my expenses as well as stay on track for retirement.
But what if I can’t find any more expenses to reduce?
In this case you have a couple of options:
Reduce debt– We discussed reducing non-discretionary items, but you can only take those down so far. If you have debt payments that take up a large amount of your income, you should work with your advisor to reduce those. This may mean implementing a debt reduction strategy, selling a vehicle, or even downsizing your home. Depending on your situation, you may need to handle these items before you start allocating more toward your investments. This is especially true with credit card debt where interest rates can easily exceed 10%.
Increase income– If you work at a job that has flexible hours and allows overtime, you may consider working more hours. This can often be temporary until you can pay off a car or other item that will then free up enough cash for you to go back to regular hours. For younger investors, your income is by far your greatest asset. Investing in yourself and advancing your career can be a game changer for your financial plan. Gaining a designation or advanced degree can lead to higher compensation without having to work extra hours or do part-time work. Many companies even have tuition assistance programs to help with these expenses.
I don’t think I’m reaching when I say that most people would love to be financially independent. Being in control of your finances is a goal that is shared by many yet attained by few. Creating a budget will put you in control of your spending and help you save more than “whatever is left over”.
For more information on creating your financial plan and starting on your path to financial independence, click on the contact link at the top of the page.