In Part III of our continuing series on cash management and budgeting, we discussed the importance of identifying your highest financial priorities like retirement, children’s education, or buying a home when preparing your budget. Your savings for these priorities should be the first items in your budget. Once these objectives are identified and quantified, then you should fill in all the remaining spending that takes place in your household. Not surprisingly, most households find themselves in the red. There just isn’t enough income to cover the savings needed to fund your life’s goals and continue your current spending patterns. Learning to pay yourself first and then live on what is left takes some thoughtfulness and some time.
There are three things you can do to balance your budget deficit over time; reduce your current spending, liquidate your debt, and automatically allocate future income growth to debt reduction or savings. Obviously, debt reduction and future income increases are the most impactful but also take the most time and attention to evolve. It’s cliché, but it’s more journey than event.
There is a science to reducing debt as efficiently as possible. The major targets are student loans and consumer debt with credit cards holding the most potential for immediate, meaningful change. Each liquidated loan becomes new monthly savings that can be applied against remaining debt, sometimes called the debt “snowball”. There are many published resources on managing the debt liquidation snowball.
Now assume that your pay increases by 3% per year and you automatically add it to your retirement account each year via payroll deduction. What will your retirement contribution look like in 5 years?
But the immediate, low hanging fruit can be found in some common expense items. Warning: There is some behavior modification involved, so it’s important to visualize what our cost savings will “buy” us in terms of future wealth. Let’s assume that we can find $100/ week in cost savings that we capture and turn into ongoing investments that fund our long term financial goals. In 20 years at a 6% growth rate we will accumulate $202,762. Now personalize this further. What if over time, using all three techniques, you could increase your savings and investments to 20% of your take home income? Keep that picture firmly in mind as you look at some ways to get started.
Food, clothing and household supplies: Plan your meals, save money, eat healthy, make dining out a truly unique experience.
- Plan for dinner at home. Much of our impulse “dining out” happens because there’s nothing planned for dinner.
- Make coffee at home. $2-5/day per person.
- Brown bag your lunch. $10-15/day per person.
- Coupons and reward cards. Seriously, a family of four can save 30-40% on food, household supplies and clothing by taking advantage of manufacturer’s coupons and store rewards. It’s easier than you think. Entire websites are devoted to communicating the techniques, reporting this week’s opportunities and delivering the coupons and discounts. Think of it as printing money.
Eliminate unused services and subscriptions: What are you paying for and not using?
- Cable TV.
- Health club memberships.
What rates can be shopped or negotiated?
- Insurance; auto and home.
- Bundled internet/phone/TV subscriptions.
- Cell phone plans.
What can be downsized? Automobiles, vacations, home purchase or apartment rental.
In conclusion: What part of your spending is unplanned, impulsive or in response to marketing or social influences that aren’t really meaningful to you? Are you seeing a pattern emerging? Budgeting is about being intentional and leads us to the idea of a method where the vast majority of our financial decisions are preplanned and automated. We limit our discretionary spending to a small allowance for things we truly value.
In the final installment of this series, we will connect all the dots and examine exactly how that method looks in real time.
Winfred Jacob, CFP®
Senior Financial Advisor