Saturday, May 11, 2013

The Big Bad Budget Boogie Man

Once again I am presenting Dave Ramsey’s Financial Peace University for my church. Next week is the dreaded budget class. This is where it either happens or it doesn’t happen. It has been demonstrated that if families who are in financial trouble choose to live on a formal budget there is a good chance they will get out of trouble. If the do not choose to live on a budget they are unlikely to get out of trouble. It’s that simple.

Unfortunately, the formal budget is almost universally viewed as the big bad boogie man of personal finance waiting to choke everything good out of your life. This is particularly true when families really need to make some fundamental changes in their financial behavior. Think about the language, live on or under a budget. Who wants to live on or under a piece of paper? Who wants to be held accountable by a piece of paper?

In 5 Reasons Budgets Fail - and what to do about them, Jodi Helmer explores some of the common complaints about budgets. The most obvious reason is that budgets are inflexible. Yea, limits are inflexible, just like your salary. You have your number. You have to live on that number. Sorry, but that is life in the real world. Over time you must spend less than you earn or you will get yourself into serious trouble. Dave Ramsey teaches that his students should allow a “blow” line on the budget. Every month allocate a portion of your money for mistakes, blown estimates, bad luck, and bad behavior. Money spent off this line requires no explanation. I would even take it one step further; separate his and her blow envelopes. If he wants to play a round of golf, it is none of your business. If she wants a new blouse, you can’t complain. The secret here is that the numbers are reasonable (after all necessities are covered) amounts of money that are allocated in advance.

Sometimes emergencies blow away the monthly budget. That is why you have an emergency fund. If the car breaks down and your budget can’t provide the funds to fix the problem, tap the emergency fund. That is why it is there. This then becomes an off budget expense. Once a family lives on a budget for a number of months a car repair ceases to be an emergency or a budget line expense. Consider, if you have placed $100 a month in the car repair “envelope” (a real envelope, a line on an Excel spreadsheet, or a sub-account in an electronic bank) every month for 10 months you have $1,000 available in a “pre-expended” account ready to buy a new set of tires. Withdraw $500 for the tires. Deposit $100 from the monthly budget. End of story. There, that wasn’t so hard.

Another major whine is, “Tracking every penny we spend is hard.” Yes, tracking your expenses to the penny, by line item, is a time consuming nuisance. The purpose of a budget is planning and tracking your expenses. If you are in the habit of throwing money this way and that whenever you feel like it, tracking every expense to the penny is going to seem unnatural and unpleasant. All I can say is that it works. There is no better way to learn about your habits, weaknesses, and strengths. The name of the game is self awareness. The purpose of a budget is not to stop you from spending money. The purpose of a budget is mindful spending. Ultimately, the purpose of the budget is to allow you to spend your money in a manner that is meaningful to you.

Here is one from the article that I haven’t seen anywhere else, Budgets Put a Focus on Price. Research indicates that people who live on a budget are more likely to buy on the basis of price rather than researching the market for the best buy. Shoppers that have set a price on a line in their budget for an item like a personal computer will spend that amount of money, even if a machine that meets their needs is available at a lower price. Jeff Larson of Brigham Young University, the author of the study, recommends that before placing such a purchase in a monthly budget, focus on the necessary features. Find a machine with the features and capabilities that meets your needs. First shop for features; then scan the marketplace; then add the cost to your monthly budget.

There are priorities in your budget. Of course you must start with your take home pay. Particularly if you are in trouble, start your budget with a line for savings. Even $1,000 in an emergency fund will take a lot of pressure off of the monthly budget.

Once you have subtracted something for the emergency fund, then focus on the necessities of life like shelter (mortgage or rent), food, critical utilities like power and water, clothing (from Goodwill if necessary), and transportation. For most situations this would be an affordable car, but public transportation is an option in some cases.

Once you have taken care of the basic necessities of life go after the minimum payments on your loans (excluding the mortgage) and credit cards.

Then look at everything else.

Dave Ramsey recommends what is termed a zero based budget. That is, every month every dollar coming into a household (by mutual agreement between husband and wife) is given a name before the month begins. The money is to be spent as planned or the budget must be renegotiated. At the end of the month salaries and other inflow minus expenditures and savings must exactly equal zero. Then the process begins again. The simplest version of the zero based budget is called the envelope system. At one time, this system literally used envelopes. For example when a paycheck came into a house a certain amount of cash would be placed in an envelope marked “food.” Any time anyone bought any food, the money had to come out of that envelope. When the envelope was empty, no more food was purchased until the next paycheck.

Living on a budget isn’t fun, but it does work.

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