My guess is that most people would answer with, “To control our spending.” Or perhaps, “So we don’t spend too much money.” Or if you’re a nerd, “To properly allocate limited resources.”
That does make sense, doesn’t it? Many people come to realize that they need to budget because they know they make lots of money, but they don’t know where it all disappears to at the end of each month. Indeed, just about every seminar or book on money goes over this basic cornerstone of financial management.
Here’s a quick and dirty summary of how most people teach how to do budgets.
- List your projected monthly income.
- List your projected monthly expenses.
- Assign the dollar amounts that you are willing to spend to each category of expenses.
- Make sure you don’t spend more than what you’ve allocated.
That’s pretty much the most bare-bones summary of how to budget that I know how to give. The goal is to simply to provide boundaries to our spending.
But here in the Crumbsaver household, this isn’t how we think about budgets.
Another Way to Look at It
To us, our budget is the plan to help us reach our goals. But the goal isn’t simply to spend less than what we make. That’s like saying, “Our goal for this road trip is to not run out of gas.” That should be a given! What we are interested in is reaching the destination, and not running out of gas is simply a prerequisite for us to reach that objective. Let’s not mix up the “end” with the “means.”
So the way we look at our budget is to start with the end in mind. That means not starting with our income and expenses. Rather, we start by listing all of the savings goals—that’s the destination we are striving for—then work backwards from there.
So we list all of our financial goals and project how much they will cost. Some examples are major purchases (new car, new technology, home renovation), special trips, debt payoff, large expenses that come up annually (property tax, home insurance, Christmas), kid’s college, etc. Then we total them up to have one big target for our savings. This is our “Savings Budget”.
Then we look at our monthly spending. This monthly spending plan or our “Spending Budget” exists for one very simple reason: To enable as much of our income to go toward the “Savings Budget” as possible. It’s not unlike how businesses look at their budgets: To optimize expenses to increase the bottom-line net income as much as possible.
In other words, the purpose of our budget is to MAXIMIZE SAVINGS rather than to merely CONTROL SPENDING. I believe this shift in focus can massively alter our relationship and success with money.
Spending Control vs. Savings Maximization
Suppose we have an extra $20 at the end of the month in our “Clothing” budget category. If success is defined as “not over spending”, then we could rationalize buying a new $20 pair of shoes and still feel good about ourselves. But if success is determined by maximizing our savings, then this would be a defeat because we spent $20 that otherwise could have been saved for other goals.
If we were budgeting just to CONTROL SPENDING, our enjoyment would be derived from making maximum purchases without going over, whereas when budgeting to MAXIMIZE SAVINGS, our enjoyment comes from having a good time while spending the least. (Preferably nothing!)
Budgeting to CONTROL SPENDING creates the question, “What is the most I can get away with spending and still be safe?” Whereas budgeting to MAXIMIZE SAVINGS asks, “How can I optimize my expenses so I spend as little as possible?”
Budgeting to CONTROL SPENDING places “Savings” as one category of expenses among many. Whereas budgeting to MAXIMIZE SAVINGS has “Savings” as the entire purpose of the budget at all.
The Spending Budget
In many ways our “Spending Budget” looks similar to the typical “spending control” budget in that there are dollar figures assigned to expense categories, but how we arrive at the final figures is slightly different than typical. Most budget tutorials offer suggested percentages of income to spend for each category like this:
- 25-35% for Housing
- 5-10% for Utilities
- 10-15% for Transportation
- 5-10% for Savings
- And so on…
These figures are suggested guidelines to help people from overspending their income. But for us, we begin with the assumption that the ideal budget is to have $0 in every expense category. Then we allow expenses only as they are necessary. In other words, if we earn $5,000 a month, we don’t say, “Wow, I can buy a house with mortgage payments of $1250-1500! (25-35%)” Instead we say, “What’s the least we can spend on housing and how can we get it to $0 as quickly as possible?” In fact, that’s exactly what we did. Our mortgage was 11% of our income, we prioritized its payoff in our “Savings Budget”, and now our mortgage payment is exactly $0. (You can read about our 2-Year Mortgage Payoff here.)
We comb through every budget category in this way to optimize as close to $0 as possible. Another example is our electricity bill. We invested in solar panels for our house that now more than pays for our monthly electricity, so not only do we pay $0, we actually get MONEY BACK from our electric company. Maybe it’s possible to have a budget that’s even BETTER than $0!
We’ve even optimized our food budget to be drastically below the national average, and Deb has written a whole series about it here: How to Eat for Less than $60 a Month.
You will notice that in most budget tutorials, “Savings” is simply one line item among the many categories to spend on. Our approach differs in that “Savings” is the ENTIRE POINT of living on a budget. We don’t simply set aside the recommended 5, 10% or however much and say, “Yay! We’ve saved!” With our continual spending optimization, we’re now regularly saving OVER 50% of our take-home pay. This has remained true even in the months this year since the baby’s been born and Deb quit work to stay home.
In short, in our month-to-month “Spending Budget”, we are constantly looking for ways to cut costs and to be more efficient. Everything that is not spent at the end of the month is considered our “Net Income” and gets put aside to go toward the items listed in our “Savings Budget”. Those are the TRUE goals that we’re striving toward after all.
The Savings Budget
The “Savings Budget” is the true heart of our budgeting method, and here are a few guiding principles that we live by in crafting it:
- Prioritize savings goals for investments that will further compound your ability to save more and spend less going forward. For example, our example of paying off the mortgage and investing in solar panels helps increase the rate at which we can save. Paying off debt should be at the top of anyone’s “Savings Budget”.
- Don’t forget charitable giving goals. As we shared in one of our very early posts on why to live a frugal life, the ability to give more is one of the major goals in our finances. So if that is a value that you also uphold, build it into your plan.
- Segregate short-term and long-term savings into appropriate accounts. As I’ve discussed in the post on investment risk, FDIC-insured accounts (or NCUA, if you’re at a credit union) are good for keeping money needed for the short term but higher-yielding investment accounts are better for keeping money that won’t be needed for many years. This type of allocation will help mitigate against short-term volatility but also against long-term inflation.
- Keep the goals in front of you. I find it hugely more motivating to look at what I’m actually achieving (hitting savings goals) rather than focusing on what I can’t spend. While adjusting our lifestyle to spend less is indeed essential, focusing on the end goal helps us realize why we’re doing it.
- This “Savings Budget” reveals our true priorities in life. Coming up with this list is a tremendously helpful exercise to prompt us in planning our future. If you’ve never done it before, this list is a mirror of who we are. Looking over the list of things you want to save up for might surprise you at what your priorities are! So pick your goals wisely!
- Keep it simple. One of the mental tricks in personal finance is to simplify things as much as possible so there are just one or two actions that we are driving at. The total figure in our “Savings Budget” gives us that one, single target that we are trying to hit. If your figure is $50,000, your one aim is to save up that amount as quickly as possible. It’s much easier to keep up the intensity that way.
Frugal Fanny Shows Us How
Let’s pretend that this is a sample “Savings Budget” for someone we’ll call Frugal Fanny. Her short-term and long-term goals are listed below in order of priority:
|1. Emergency Fund|
|2. Credit Card Debt|
|4. New Phone|
|5. New Car|
|6. New Computer|
|7. House Down Payment|
|2. College Fund|
*These figures are based on a projected 8% rate of return.
Notice the distinction between short-term (defined as 5-years or shorter) and long-term goals. The short-term funds go into an insured account like a savings account, while the long-term funds should be invested in something like good index funds. This distinction also helps us feel the victories in hitting the smaller and more immediate goals rather than getting overwhelmed by the huge amounts we need to hit over the long term.
Additionally, you see that priority is largely determined by the proximity of the need. It’s more important to have an emergency fund and to pay off debt than anything else.
Assuming that Frugal Fanny has a take-home pay of $5000/month (about $60,000/year), she will need to save 11% of her pay ($550) simply to meet the monthly requirement for her two long-term goals. Let’s say she’s been following traditional advice and has been saving an additional 4% or $200 per month for a tidy 15% savings rate, it will take her 21 YEARS to reach $50,000. That’s a problem because she needs that $50,000 within the next 5 years! Working backwards from her “Savings Budget” she figures that to reach her goals in 5 years, she needs to save at least $10,000 a year ($833/month) on top of her long-term goals. Including her long-term saving goals, she’ll need to clock in at a minimum 28% savings rate. So her monthly “Spending Budget” should reflect this reality and be adjusted accordingly to allow at least that amount of cash to be leftover each month to go toward her goals.
Now if Frugal Fanny lives up to her name and goes all out in spending optimization and pushes her total savings rate up to 50%, here’s how the numbers shake out:
- $2500 total saved each month.
- $550 for retirement and college long-term savings.
- $1950 for short-term savings.
- $50,000 target hit in 26 months, or just a hair over TWO YEARS.
Ladies and Gentlemen, THIS is how budgeting is supposed to motivate us to save us money!
We realize that different people have different temperaments, and so one budgeting methodology may fit better for one person than another. Some people who are prone to overspending may really NEED a budget simply to control their spending. While others who are prone to saving (I think it’s safe to say we fall in this category) may need structure to help streamline their savings. Whatever your personal preference, just know that you need a plan for your money, and that financial independence doesn’t happen accidentally.
So while we don’t necessarily have anything against the traditional “spending control” philosophy of budgeting and know that it has helped lots of people, we think that it captures only part of the picture. So here’s a quick summary of how we choose to do it:
- Create a “Savings Budget” by listing all savings goals, their projected amounts, and level of priority.
- Create a “Spending Budget” that optimizes spending in order to maximize the amount saved per month.
- The info from the “Savings Budget” helps set target amounts to save in the “Spending Budget”.
- All “net income” from month-to-month goes into savings.
- As savings goals are met, items in the “Savings Budget” get purchased. (Yay!)
A couple years ago, we shared our actual monthly spending budget and our savings goals at the time. It might be a helpful counterpart to this post to illustrate with some of our real-life numbers. You can catch it here: Revealing Our Monthly Budget.
So how do you do your personal budget? I know some people are much more sophisticated while others have much simpler systems. Please share with us!