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The word “budget” tends to intimidate people. Who wants to feel limited in their spending? Plus, it may feel overwhelming to learn how you are truly spending your hard-earned money. BUT knowing exactly where your money goes is critical to achieving financial independence. So read on, and let’s overcome your budgeting fears.
Instead of the dreaded B-word, let’s talk about a Spending Plan. This means that YOU have control over how you spend your money.
If you want to spend $1,000 on eating at restaurants every month, you can, as long as you have enough money at the end of the month to cover all of your other bills. The choice is yours. Enjoy spending your hard earned money — just know where it is going with a Spending Plan.
The Spending Plan that you put together will reflect the things that you VALUE in your life. Remember that there is always a trade off between living for the here and now versus for the future. Many times, delayed gratification will bolster your long-term goals of pursuing your passions and interests.
Value spending is simply allocating money towards things that bring you joy and are meaningful to you. What good is it to live and die with a ton of money if you’re miserably penny-pinching all your life?
Value Spending on Food
Personally, I like to spend money on restaurant food. My monthly restaurant bill is roughly $240 while my monthly grocery bill is about $190. Because I like to spend more on eating out versus eating in, I have established my Spending Plan to align to those values.
Value Spending on Traveling
I also really enjoy travel and experiences. Because I was so focused on paying off my mortgage and filling up the house with nice things, I didn’t travel much in my 20’s. I mean seriously, what 25-year-old bachelor needs an 8-person dining room table with a matching China cabinet?
Once I got married, my wife and I traveled a bit. But we ended up having our first child on our third anniversary, so that put a damper on our future travel plans. There is so much that I still want to see.
So how to do you put together a Spending Plan?
Crawl, Walk, Run
The best place to start is Personal Capital. As I have mentioned before, all of your accounts will be aggregated such that you can have a clear idea of your net worth. Additionally, all of your income and expenses will also be itemized. Let’s go ahead and call this “cash flow”.
If you haven’t set up a Personal Capital account, I’d highly advise it. For those who decide to eschew technology, you’ll need to write everything down manually to derive the expenses that you incur on a monthly basis.
So, looking at last month, were you cash flow positive (green) for the month, or were you cash flow negative (red) for the month? This may be a splash of cold water for some.
Now that you have an idea of your monthly spending, let’s actually create a Spending Plan.
Zero-Based Spending Plan
I prefer the Zero-Based Spending Plan because it is very simple to use. Click here to see an example. Each month, every dollar that you make should fit into a category of your designation. If you have a paycheck that does not fluctuate, this means at the end of the month, you should not have any leftover money.
Most importantly, if you are married or dating someone, I highly encourage that BOTH of you get involved with the Spending Plan conversation. I can’t emphasize this enough. Communicate. The number one thing couples fight about is money. Breakdown these barriers, and start the conversation TODAY.
Cash Envelope System
Once you create a Spending Plan, try using a cash envelope system.
This method encourages one to take out cash each month and place it into various envelopes allocated towards different spending areas (e.g. Food, Clothing, Entertainment). When you use up all the cash in your envelope for a specific category, you are done for the month.
Of course, there are some expenses that you won’t be able to pay in cash, such as mortgage, electric, gas, water, etc. The envelope system, however, is excellent when it comes to discretionary spending like eating out, buying clothes, and general entertainment.
Why It Works
The reason why the cash system is so effective is because studies have shown that when consumers are more likely to spend less with cash than with a credit card. A credit card swipe is much easier than fishing out coins and bills. Plus, with cash, one’s spending limit is much more tangible and real. There is nothing more restrictive than not having enough cash to pay for something.
Technically speaking, the envelope system revolves around the loss aversion theory. People prefer to avoid losses over acquiring equivalent gains. Some studies have even show that losses are twice as powerful psychologically as gains received.
It’s no wonder that businesses don’t make a fuss over credit card usage because of the fees involved. Anything to get you to buy more is always beneficial for them.
Cash Is King
Some believe we are moving to a cashless society. When I was doing research, I thought I was going to find a lot of data supporting this theory as well. Do you know what I actually found? I was wrong. 46% of the U.S. population pays non-recurring bills with cash.
Do you realize that most German consumers exclusively use cash to pay for things? 82% of them to be precise! Some researchers hypothesize this is because Germans value their privacy and don’t want merchants to monitor their credit card transactions.
While researching, I also found that Germans hate debt. This is why only 35% of Germans actually own their home versus rent. This totally surprised me, but when given the nature of the German culture, hyperinflation in the 1920s, and World War II in the 1940s, it’s understandable why cash is king to them.
Negatives of Cash
Now, I’d be remiss if I didn’t talk about the three major downsides when it comes to paying everything with cash.
Manual Entree into Personal Capital
You’d have to input all of your expenses into Personal Capital or your preferred Spending Plan software. This can be a hassle if you are forgetful or just find it tedious. However, if you get into the habit of collecting your receipts, taking 15 minutes on a weekend to input really shouldn’t be that bad.
Carrying Large Amounts of Cash
Carrying around large amounts of cash may make you nervous. One way to alleviate that is to divide your withdrawals into amounts that you make you feel comfortable for the envelope system. So instead of withdrawing everything once a month, you could break it down into biweekly or weekly withdrawals.
No Cash Rewards
You wouldn’t be able to earn any cash rewards like those from your credit card or gain any sort of points when you make purchases. For people that use their points to travel, this could definitely be a negative aspect.
With that said, studies done by the US Consumer Financial Protection Bureau have shown that debt decreased by about 5% for groups of people who primarily paid cash for purchases over a six month period.