Do You Even Need a Budget?
By Kevin Estes
Not sure where to start
A T-Mobile employee recently asked me for ideas on how to budget for the new year.
I don’t know how to start other than putting my monthly bills in an Excel sheet.
Words matter
I spent 20 years in corporate finance and analytics.
Want to know a secret? We rarely used the word budget!
Internally, we used terms like “actual”, “projection”, and “forecast.”
For example:
Actuals came in $2 million favorable to forecast.
The word “favorable” represents another mental shift.
Who’s to say whether expenses are good or bad?
Wages could be up because the company crushed revenue.
Spending less on wages might have starved sales!
“Better” and “worse” are judgmental.
“Favorable” and “unfavorable” are factual.
The six-letter b-word (budget) was reserved for telling someone no.
Unfortunately, that’s not in the budget.
Was that in the original budget?
Would it make sense to prioritize that over something else in the budget?
In reality, it’s all about tradeoffs. If something’s important, it can and should be prioritized!
Mind games
Money evokes big feelings!
As much as I loathe the “girl math” and “boy math” trends, they highlight the fact that we play mind games with money.
Spending is behavior
Behavior is complex
Personal finance is deeply personal.
Want to pick a fight? Tell someone how they “should” spend their money… especially around the holidays!
Budgeting is like dieting
It might work for a few days, weeks, or even months. However, it won’t last if it feels like starvation.
Restrictive diets yo-yo. Big losses are followed by big gains.
As hard as that is on the body, it’s even harder on the brain. Here’s how someone may feel on an overly restrictive diet:
deprived on the way down,
guilty on the way up,
… and repeat.
It’s much more effective to make lasting lifestyle changes:
drinking water,
keeping fresh fruits and vegetables handy,
preparing tasty, healthy meals,
going for walks,
engaging in fun physical activities…
Mindful spending
Similarly, it’s better to spend mindfully than cut to a number.
Emergency funds are there for a reason! It’s also important to be able to jump on wonderful opportunities when they arise. Sometimes, it makes sense to spend.
How do you know if an expense is worth it? Here are three frameworks which may help.
1) Evaluate all expenses for a month
Is each worth it?
Whenever my wife and I go through this exercise, we find many expenses which are worth it to us and a few which aren’t.
Sometimes, we didn’t even know we were spending that money!
A subscription we stopped using months ago
Renting our router
Fraud
If something’s worth the investment, what’s the real benefit?
Is there are way to accomplish that without more expense?
Are there less expensive substitutes?
Would it make sense to spend more on it?
If something’s not worth it to you, how could you reduce the cost or cut it altogether?
If you’re struggling to evaluate expense, consider estimating how many hours it costs you:
Start with your base after-tax pay
Subtract any work-related expenses like commuting, convenience, and clothing
Divide by the total number of hours you devote to work each year - including dialing in early in the morning and late at night, commuting, traveling, studying, etc.
The result is your effective hourly wage.
Divide each expense by your hourly wage. Then, determine whether each is worth the hours you must work to fund it!
2) Recommend it?
A second way to evaluate expense is to decenter.
Would you recommend that expense to a good friend?
Why or why not?
What are its best attributes?
Its worst?
3) Wait $300 a day
We sometimes make different purchases in the heat of the moment than we would with more time to consider it. Think: TODAY ONLY sales and timeshare presentations!
The trick is determining how long to wait.
Everyone’s threshold is different. It also changes over time with inflation.
Here’s something which currently works for me on unnecessary expenses: wait $300 a day.
Let’s say you’re about to purchase a $300 tablet. Give it 24 hours.
For a $100 pair of shoes, consider waiting 8 hours.
If shopping online first thing in the morning, wait until after work.
Instead of buying it late at night, wait until the next morning.
Larger expenses benefit from more time:
$10,000 international family trip - give it a month before booking
$60,000 new car or truck - consider the purchase for six months
$200,000 down payment for a home - plan over a year and a half
Find and lower hidden expenses
Visibility is key to reducing expenses. You can’t cut what you can’t see!
Recurring monthly expenses
Many people have a good sense how much their recurring monthly expenses are. Their mortgage, cable bill, utilities, and subscriptions.
However, opportunities may be hidden in plain sight:
Mortgage - especially insurance and interest expenses - might be lowered by removing Private Mortgage Insurance (PMI) or refinancing to a lower interest rate
Cable - may be eligible for a discount once a promotional rate ends; also, it might be cheaper (and better) to buy a router instead of continuing to rent it
Subscriptions - it makes sense to cut an unused subscription and may make sense to choose a lower service tier after a price increase
Convenience expenses
Fuel
Gasoline and diesel can be a major expense for families. It’s shocking how much gas can vary from one location to the next!
What’s even more surprising is that it’s literally the same gasoline! Oil moves through our county many ways - including pipeline, rail, and barges. It’s then processed at refineries throughout the country. After it’s refined, it’s usually sent by pipeline to large storage terminals near major cities.
According to the U.S. Energy Information Administration:
Gasoline is usually sent by tanker truck from the large storage terminals to smaller blending terminals, where it is processed into finished motor gasoline. These smaller terminals are typically where fuel ethanol is blended into gasoline.
The only material difference in gasoline between companies is the additives they mix in when loading the tanker trucks and trailers. Sometimes, the additives are added directly to the tanks!
Paying more for the same thing is silly. It’s worth shopping around.
Gas stations in cities near major interstate highway exits are generally more expensive than other locations. High income areas tend to have more expensive gas - presumably because of real estate prices and customers’ willingness to pay more.
Driving a few blocks may save up to a dollar a gallon! Our family saw a dollar difference between gas stations on three corners of the same intersection last weekend!
The GasBuddy app has helped us check gas stations prices - especially when in an unfamiliar area. Less expensive gas stations tend to be consistently more affordable.
Snacks
Quick food and drinks are another convenience expense. The best way to reduce those costs is to keep a filled water bottle with you at all times.
The next best solution is to buy in bulk. Gross profit margins on snacks and drinks at convenience stores and vending machines are extremely high. It may pay to bring a snack wherever you go.
Meals Out
Purchasing meals out is a third major convenience expense. People often dine out because they don’t have time to cook.
Meal preparation is a way to limit these expenses. For instance, cooking a few chicken breasts over the weekend can significantly reduce meal prep throughout the week.
That chicken can be warmed mid-week and used:
as a main dish,
in fajitas,
on a salad,
in a sandwich…
A slow or pressure cooker can be used throughout the day to cook delicious foods while a family’s at work and school.
Pay ahead
Another way to reduce expenses is to pay ahead instead of paying monthly.
Auto insurance companies often offer significant discounts for paying six months or a year in advance. For instance, Progressive advertises up to a 15% paid in full discount. That’s a solid return on cash for six months!
Similar discounts may be available for paying a full year of private school tuition. It’s worth checking all major monthly expenses to see whether they offer a discount for early payment.
Hidden investment fees
The expense I probably like the least is hidden investment fees. Although they’re not itemized on account statements, they slowly eat into the investment.
Expenses can come to 1% or more of the investment every year. Because investments tend to rise over time, many people never notice. Worse, the expenses also tend to rise!
Here’s a pro tip: calculate your own investment expenses:
Review your latest statements to determine how much you have invested in any funds
Google search each fund’s ticker and then “expense ratio”
Record the expense ratio as an annual percentage
Multiply the investment’s expense ratio by the value invested in that fund
The result is how much you currently pay each year for the privilege to hold that investment
What - precisely - is the company doing to earn those expenses? Does that activity add any value above average market performance?
Forecast
While I feel budgeting is overrated, I view forecasting as critical.
What upcoming expenses do you expect? Vacations, gifts, meals out, activities, insurance, home maintenance/repair, and other irregular expenses are often missed.
Planning ahead can help avoid surprises and consumer interest charges.
Connect with a deeper why
Having a clear vision of the life you want to live can help you achieve it. If you don’t know where you’re going, any road will get you there.
An exercise called the 5 Whys may help. It’s a process to get to the root cause of an issue.
If someone has a tentative or superficial image of what they want to accomplish, it may make sense to ask “why” five times.
I want to own several real estate properties.
Why? (1)
Because I want to have passive income.
Why? (2)
Because I want to replace my current income.
Why? (3)
Because my work is sucking my soul out of me!
Why? (4)
Because I’m working long hours doing things I dislike.
Why? (5)
I guess because I don’t know anything else. It’s what I’ve always done and I’m paid well.
Now, THAT’S an insight!
This person yearns to explore. They want to do something new and different - perhaps multiple things.
Instead of buying a second job, that time might be spent exploring and developing new passions. I generally recommend people try a new lifestyle before they commit themselves to it full-time.
Without a clear why, the whats get in the way.
Zero based budget
My wife recently called me out on my “no budget” stance.
You do budget. It’s just a zero-based budget.
Instead of looking at our past expenses and assuming they’ll continue with some minor adjustments, we treat our “budget” as zero and then add back what we value.
Doing so allows us to challenge each expense. If an expense doesn’t add enough value, we cut it. We also consider alternatives.
Of course, my wife is right. I tend to follow the mantra:
Use it up, wear it out, or do without.
Hedonic adaptation
We humans are amazing at adapting to our circumstances.
Think back to the last vehicle you bought. How did it make you feel?
Great, initially - am I right? You loved exploring those new (to you) features.
What happened next?
That initial excitement probably faded over time. That’s hedonic adaptation!
The reverse is also true. Have you ever gone camping, to summer camp, or to college?
We initially miss luxuries. After a while, we get used to the new normal.
If you want to save a lot initially, pull back spending until it hurts. Then let the reins out… a little.
Just realize this approach may cause your spending to yo-yo!
If you’d like help getting a handle on your spending…
Disclaimer
In addition to the usual disclaimers, neither this post nor this image includes any financial, tax, or legal advice.
