Element 4.3: Budget Your Spending and Saving

“Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.”⁽¹²⁸⁾

Most financial insecurity today is the product of unwise choices. Lack of budgeting, spending more than you earn, building up debt without concern for how to repay it, and other unwise financial habits create havoc and cause stress. A commitment to budgeting is key to obtaining a healthy financial life, building wealth, and achieving your personal goals. People, like nations, build wealth through saving and investment, but this takes strategic planning. There must be a plan in place to guide how the spending, saving, and investment are directed toward wealth creation. For the individual or household, that plan is a budget. A budget helps you channel your funds toward sound spending, regular saving, and diversified investments in a manner that will provide you with the most value from your income. Think of your budget as your wealth GPS. It will direct you to your goals or alert you when you’re veering away from them.

Effective budgeting is an ongoing process, not a one-time event. It is comprised of two specific actions. First, you must create the initial budget⁽¹²⁹⁾ that is simply a document that identifies all your planned or expected spending for a particular time period. Most people create a monthly budget, but a yearly budget is also common. It is important to carefully consider all your spending, not just the highly visible spending like groceries, car payments, and rent or mortgage. Do not forget about birthday gifts, license tag renewal fees, streaming subscriptions, and oil changes for your car. Estimate your monthly or annual income, then identify where you are going to spend every penny. We recommend zero-based budgeting, which means that saving and investment are specific items in your budget, not just the leftover balance (if there is any). Many experts recommend a basic allocation of 50% for “needs” (thing you must pay like rent or tuition), 30% for “wants” (things you enjoy but could skip like meals out or movies), and 20% for “savings.” Of course, often savings are a means of setting aside funds for future expenses such as buying a car or a flat or starting a family. You may also responsibly borrow for such events such as investing in education so long as your planning, looking into the future clearly anticipates enough income beyond you day-to-day needs to repay the loan on time. We will discuss borrowing and lending extensively in the next element.

The second action is documentation of actual spending and making needed budget adjustments. Keeping track of all spending and placing it into the categories of your budget provides valuable information about your habits and the progress made toward achievement of your financial goals. Tracking your spending will also help you develop a better, more precise budget in the future. For example, if you fail to include a spending item or two in your initial budget, when that actual spending is observed, you can then make sure to adjust your budget accordingly. Suppose you budget €100 for restaurant meals for the month but then realize that you spent €150. You will know that to either change your budget or your spending to account for this difference. The documentation of your actual spending provides you with a feedback mechanism that will help you adjust your budget and spending on an ongoing basis so you never get too far from your goals. It’s best to train yourself to do it on a daily basis.

Budgeting your income and monitoring your behavior will help you evaluate your spending and direct it toward the categories that will provide you with the most overall value. Four simple steps will get you on the path to financial stability: Begin immediately, set goals, get tools, and design a budget to meet your goals.

Step 1. Start now and increase the likelihood of success! Don’t fool yourself into thinking that budgeting is only for people with jobs or high salaries or that you’ll start “later.” Children receiving allowance, students receiving support from their parents, and people without direct incomes should still budget and develop goals. Budgeting will not be easier when you are older or when you are earning more money. In fact, it will probably be more complex. It is easy to procrastinate. People who budget, spend their money wisely, and save for the future generally started early when their incomes were relatively low.⁽¹³⁰⁾

Step 2. Set goals. Incentives matter. Recognize this in your personal life and let your goals drive your actions. Set short, medium, and long-term financial goals and incorporate them into your budget. Short-term milestones can be achieved within the next year and provide immediate gratification. Depending on your situation, they might include the elimination of the credit-card debt on your highest interest-rate loan (although except in emergencies accumulating such debt in the first pace was probably not a great idea), a significant increase in your emergency fund for coverage of unexpected expenditures, or money for an upgrade of your phone or other technological device. Midterm goals are achieved over a longer period—anywhere between one and three years. Purchasing a pre-owned car with cash, making a down payment on a flat or other home, and building a solid savings account leading to a well-diversified portfolio are examples of goals that will generally require more time to achieve. Finally, saving and investing for your children’s college and for retirement, and paying off student loans or a home mortgage provide examples of longer-term goals many people will want to pursue.

As indicated earlier, saving and investing should be specific categories in your budget. The sooner you start spending strategically, saving, and investing, the more wealth you will build. What is not so obvious is how much more wealth you can accumulate by starting early. Even the smallest amount saved or invested today can make a noticeably significant difference. Consider the following long-range plan:

Suppose you started regularly saving as little as €2 a day for two years when you turn twenty-two years of age. That’s probably not as much as you will spend on coffee, bottled water, snacks, or have in loose change at the end of the day. Then from your twenty-fourth until your twenty-sixth birthday, you increased saving to €3 a day. That’s just a Euro more, and your income will probably have increased. Between the ages of twenty-six and thirty, bump up your savings amount to €4 per day. By not spending this amount daily and putting it aside in an account with a positive rate of return, you won’t cramp your style much. By the time you reach thirty, you will have saved €9,490, plus the interest received—quite a nice sum. Saving €2, €3, or €4 a day really adds up.

But here’s the real surprise. By the time you retire at age 67, the saving from just this early nine-year period can add more than €150,000 to your wealth if invested conservatively, and that’s in today’s purchasing power. This will be the case if you earn a real rate of return of about 7 percent—what the stock market has yielded historically (more on this rate of return and the power of compound interest in future elements). Moreover, if you start early, you are far more likely to continue with a regular savings plan throughout your life.

Step 3. Use budgeting tools. Do not re-create the wheel by starting with a blank piece of paper to develop a budget. With today’s websites, spreadsheets, and apps, budgeting has never been easier. A plethora of resources exist at little or no cost. You can conduct an internet search for “budgeting tools” and find numerous high-quality and secure budgeting options. Choose one that helps you become meticulous in logging your expenses and income, keeps your financial goals in front of you, issues payment reminders, helps you control any impulses to spend outside your budget, and links you to options on how to achieve these goals. Make a habit of using your selected budgeting tool. Keeping track of your spending and income can be easy with the right tools. The trick is just to set aside 5 minutes every day to record your activity. People are often shocked to see just how their money has trickled away without their realizing it.

Step 4. Devise a plan of action Create a personal budget with actual and proposed items to achieve your goals. Although we constantly think about all the things we “need” to buy, there are very few things we are really required to have beyond adequate food, clean water, basic shelter, simple clothes and a smartphone. The best way to see where you can begin to achieve your goals is by listing your “needs” and separating them from your “wants.” Reduce your wants to make way for savings and investing, and for devising a plan within your budget to meet your short, medium, and long-term goals. This places you in the driver’s seat of your financial life.

An architect does not build a house without a blueprint. A surgeon does not remove a patient’s appendix without coordinating her plans with other members of the medical team. An athlete does not end up competing at the Olympics without committing to a philosophy of success long before reaching the Olympics. Developing a detailed plan of action, sticking to it, and updating it when necessary are essential if you are going to succeed in all aspects of life, including your financial life.

Each budgetary item needs to be evaluated within the context of the others. Since you have limited income, increased spending in one area translates into decreased spending in another, unless new sources of income are identified. As stressed in Part 1, every choice has an opportunity cost. Consider yours when making a spending decision. Examine the big picture through your budgetary lens. Figure out your monthly basics: Show how much you earn, pay in taxes, save, invest, spend, and face in debt.

Regardless of your occupation, income, or position in life, the two actions in the budgeting process—creation of your budget and tracking and adjusting your spending to improve your welfare—will help you systematically examine and guide your spending to get where you want to go. Make your plan crystal clear and become the CEO of you. Commit to creating a budget that organizes your spending, controls your debt, provides emergency funds, helps you meet various financial goals, and supplies funds for investing.

Dave Ramsey, a leading financial advisor in the United States, highlights the importance of making a personal commitment to forming sound money habits. “The thing I have discovered about working with personal finance is that the good news is that it is not rocket science. Personal finance is about 80 percent behavior. It is only about 20 percent head knowledge.”⁽¹³¹⁾ After reading the entirety of Part 4, you will have the head knowledge. Are you ready to focus and commit to aligning your consumption, saving, borrowing, and earning decisions with those that promise financial stability and lead to a rewarding life?