Friday, February 7, 2014

Living on a Formal Budget (Part II)

OK: Here we go! Our hypothetical young person from the section on the Lazy Man’s Budget has decided to hear my advice. He is going to try to live on a budget, so he can save for some desirables, like vacation with his girl friend who lives in another city.

This example is intentionally simple. If you have a husband or a wife, children, and a home it will get more complicated. The object is to keep it as simple as possible as long as it captures every penny in categories that make sense to you. For example, you may want to include makeup, deodorant, shampoo, and such things along with prescriptions in the drug store category rather than breaking down your receipt into two or three categories. However, if you buy your cigarettes at the grocery store, by all means separate that expense out of your food budget into a separate line. The purpose here is mindfulness. A budget, properly organized, will allow you to quickly determine where you are spending your money. If you are happy with the results, good! If you are unhappy, you will know what you need to change.

Here is where we left the young person. His take home pay was $2,000 a month. His quick and dirty budget told him he was too close to the edge.

$500 Rent
$150 Electricity: If your bill in December was $130 it is a safe bet that it will be higher in January.
Water: Included in the rent.
$300 Car Payment:
$130 Gasoline:
$25 Minimum Credit Card Payment
$35 Cable TV
$125 Cell Phone: Unlimited Data Plan
$300 Grocery Store Food:
$100 Restaurant Food and Beverages:
$100 Clothing Allowance

Total: $1,765
Allowance: $1,400
Difference: -$365

Since last time our example; let’s give him a name; Jim has received a raise. His take home pay is now $2,080 a month. In addition, he is looking for overtime. His willingness to work odd hours to cover for absent or tardy coworkers is adding an extra $100 a month, but this is money that is not guaranteed.

In addition Jim wants to start three envelopes, give something to the homeless shelter located a couple of blocks down the street from his apartment, and build his savings.

How does his first attempt at a budget appear?

$2,080 Take Home Pay

$208 Emergency Fund
$20 Charity (Hey, it’s a start.)
$208 Contingency Fund

That leaves him $1,644. He knows that isn’t going to be enough, so we back up and try again.

$108 Emergency Fund
$20 Charity (Hey, it’s a start.)
$108 Contingency Fund

Now he has $1,844.

$500 Rent
$150 Electricity:
$0 Water: Included in the rent.
$300 Car Payment:
$130 Gasoline:
$25 Minimum Credit Card Payment
$35 Cable TV
$125 Cell Phone: Unlimited Data Plan
$300 Grocery Store Food:
$100 Restaurant Food and Beverages:
$0 Clothing Allowance

That leaves him with $179 after covering the basics.

Jim has a credit card balance of $800. He also has $600 in savings. He wants to start envelopes for car repair, insurance ($1,200 auto and renters), and vacation.

He knows he needs to start an envelope for insurance that is going to take $100 a month. That leaves him with only $79. He wants to put $30 a month into the car repair envelope, so he is left with $49 for vacation.

Jim knows there is a good chance he will take home an extra $100 in overtime. He can plan for that money in his basic budget, but he can plan on how to use it if he gets it. His decision is to split any overtime between vacation and paying down that credit card. Of course, I would go after the credit card balance before planning a vacation, but this isn't my budget. It is Jim’s budget.

After carefully accounting for every single penny expended, here is how the month worked out for Jim.

$2,080 base pay + $80 in overtime

$108 Emergency Fund (New Emergency Fund Balance $708)
$20 Charity (Hey, it’s a start.) Spent as planned
$108 Contingency Fund

$500 Rent: Spent as planned.
$150 Electricity: Actual bill $140. Difference $10 Jim put on some more clothes so he could turn down the thermostat.
$0 Water: Included in the rent.
$300 Car Payment: Spent as planned.
$130 Gasoline: $150 actual. Difference -$20. A refinery in Texas burned down causing a spike in fuel prices.
$25 Minimum Credit Card Payment Spent as planned.
$35 Cable TV Spent as planned.
$125 Cell Phone: Unlimited Data Plan Spent as planned.
$300 Grocery Store Food: $290 actual Difference: $10
$100 Restaurant Food and Beverages: $150 Actual--Difference: -$50 Whoops!
$0 Clothing Allowance $0 Spent

$100 Insurance Envelope New Balance $100
$ 30 Car Repair Envelope New Balance $30
$ 49 Vacation Envelope New Balance $49

In this example Jim had to take a total of $50 out of the Contingency Fund to cover the Super Bowl party at the local sports bar, leaving a balance of $58 at the end of the month.

Question: Where does this money go?

Answer: Anywhere Jim wants it to go. It is his budget. He is a little worried about only having $100 in the Car Insurance Envelope so he decided to raise that to $158 with the leftover money.

Leftover money? What a concept!

$80 in overtime was split as planned.

$40 went along with the $25 minimum payment lowering the credit card balance to $735. $40 went to the vacation envelope raising that total to $89.

Conclusion and Proof

When you start out try to keep this process as simple as possible. The less effort required in the beginning the more likely it will be that you will continue to live on a budget. Be honest, remembering the proof is in the pudding. If your net worth increases at a regular and acceptable rate your budget is working. If you net worth is decreasing, what you are doing is not working.

No comments:

Post a Comment