You’ve seen those people show up on the talk shows. People who have won millions in the lottery, only to be poor again a few years later? Amazingly, they blew it all. They thought they had a bottomless barrel of money, but they end up with nothing, and maybe even a lot of debt.
The problem with the lottery winners, is that they didn’t have any idea of how to restrain their spending. (Another problem is unscrupulous financial advisors, but that is a different story.) People like you and me can sit in our armchairs and go “tsk tsk, I would have found a way to hold onto it.” But is that really true?
Take a look at how you deal with a paycheck. Do you have lottery winner syndrome with your paycheck? Once you get your hands on it, do you blow it all? So many people get their paycheck and spend spend spend. They go out to dinners, pick up tabs for drinks, buy stuff, and then have to hold their breath to make it to the next paycheck. This binge starve cycle would be rudely interrupted by inconveniences such as rent money due, credit card bill, electricity bill, cell phone bill. There always seems to be something owed that ruins the paycheck party. One of my friends used to say when she was getting short on funds, “I’m going to sit very very still and not spend any money.”
There is a cure of lottery winner syndrome. It’s called a budget.
YOU need a budget. No matter how rich or poor you are, you need a budget. This is what the lottery winners have shown us. If you have years and years of earning a paycheck and not much to show for it, you need a budget. If you are a millionaire, you need a budget. If you are broke, you especially need a budget.
How to make a budget.
1. Get your courage up, and get ready for REALITY.
This is one of the hardest and most fundamental truths you are going to have to face in your life. It is the truth of what you can afford, and what you cannot afford. It is really hard, because if the numbers don’t fall out right, you have to make some very big life changing decisions. You may have to move to a cheaper place, you may have to get a second job, you may have to sell some stuff.
If you are someone who hid from financial reality, this is a very hard thing to do. Your self esteem may be affected, you may even feel a deep sense of shame. I’m telling you, a lot of people don’t have a budget because they don’t have the spiritual strength to face the reality of their lives. They just muddle along, hoping for the best, but then stress out every time the rent is due or the have to pay the credit card bill. These monthly shocks to the system are a signal to your inner self, that it is time to face reality. It’s time apply courage, and look at the numbers.
2. Find the absolute must have amount you need to survive monthly
The first thing to do when making a budget is to make a list of all of your monthly expenses you need to survive. These are the payments you must make in order to maintain a functioning home for yourself and cover your requirements. These fixed expenses are your “must haves” and they typically include:
Car Payment & Car Insurance
Utilities (Electricity, Gas, Water)
Cell Phone Bill
Gas (Estimate $70 to start)
Food (Estimate $450 for one person)
On a sheet of paper, list our your “must haves” and what you typically pay. Add them up, and you have to make this nut in order to live. It’s a pretty big and scary number for most people! Wow!
As you start tracking expenses, you will get a more accurate idea of what you spend on food, gas, and transportation. Notice I didn’t put here other monthly payments such as cable TV, gym memberships, or other monthly payments that don’t have anything to do with food, shelter, communication, and getting around. You will notice that most of the numbers here are fixed or fairly stable – like your rent, utilities. The big variable figure here is the food expenses. Just a couple of more dinners out a month can cause your food budget to ballon by a hundred or more dollars, which can add up to a thousand plus dollars a year.
Take your “must haves” total and see how much of salary covers these expenses. Ideally, your “must haves” are covered by 50% of your take home pay. Half of your monthly salary should go into paying for all of life’s necessities. What about the rest of your paycheck? 30% of your paycheck goes to “fun money” and 20% to savings or debt repayment.
You may be wondering where these percentages come from. They are recommended by current Massachusetts Senator Elizabeth Warren, founder of the Consumer Finance Protection Bureau. She wrote a personal finance book with her daughter, Amelia Tyagi, called, “All Your Worth.” I have been living by this budget since 2005. Although 50% for “must have” seems a little low, it is amazing how incidental expenses suck away at the remaining 30% allocated to “fun money”. Going out to movies, new winter coat, haircut, new sneakers, clothing, gym membership, anything and everything you can think of that eventually gets hauled in through your front door. Saving that 20% just isn’t possible unless that 50% is lined up and that 30% is restrained. I’ve lived by this budget since 2005. The 50/30/20 plan is based on good sense. It is difficult, but it works.
The 50% “must have” figure contains a very important number. The amount of money you can spend on rent or mortgage is tucked into the 50% number. People think that if their rent or mortgage is a little less than half of their take home, they are going to make it. This just isn’t true, and what happens is people start hitting their credit cards to cover must haves, they cannot save anything out of their paycheck, and a downward spiral starts.
3. Now that you have a 50/30/20 budget, here is the plan.
Start tracking every expense you have. Save EVERY receipt and make note of every payment you make. Develop a method that works for you. I’ve been using an excel spreadsheet since 2005 to track all expenses. Some people prefer paper and pencil. The name of the game here is to get a handle on actual spending for a month or two, and see how close you are to the 50/30/20 plan. Examine if saving that 20% is feasible and possible, and what it is going to take to get there. If you are every fortunate, you will be able to save much more than 20% of your take home pay a month. Maybe you can shrink the 50% and 30% and make the 20% bigger without going insane. If you are like most people, sacrifices and changes are going to have to be made in order to just make 50/30/2o happen. One you have a handle on your budget and the percentages, you can start to strategize. If you have credit card debt or other debts, you can strategize – how much of that 30% and that 20% can I put towards debt repayment? Here is a framework for a lifetime financial plan:
1) Save $1000 cash as a baseline emergency fund
2) Get out of Credit Card Debt and pay off any store credit cards.
3) Save 3 – 5 months of “must have” living expenses in cash. You know what this is because of your budget.
4) Save 15% of household income in a company 401K or Vanguard IRA plan. This is your retirement savings. You will never withdraw money from this plan until your retirement.
5) If you have kids, open up a Vanguard 529 plan and start saving for your kids college education.
6) Save for other goals with the remaining monthly funds. Such as a new car, or vacation, or put more towards the mortgage. You can also create an investment account outside your 401K.
If you have credit card debt, you may be in for a long road. If you have $4,000 worth of credit card debt and $500 in that 20%, it is going to take you 9 months to get out of debt if you throw all of your 20% savings in getting out of debt. If you an squeeze back on your 30% fun money and throw more at your debt, you can get out sooner. Just think of how amazing it will feel to not have to deal with that scary bill every month.
For great encouragement and information on getting out of debt, I recommend you read “Dave Ramsey’s Total Money Makeover” book. His great strength is being a support when you need to get out of debt. Some people may find his evangelical Christianity and political conservatism offensive, and there are much better sources for investment advice. However, for getting out of debt, Dave is the man.
While you are working on your budget and getting out of debt, I highly recommend you read the most recent edition of Erik Tyson’s “Personal Finance for Dummies”, “The Bogleheads Guide to Investing,” and Elizabeth Warren’s “All Your Worth.” With these books, you can access more knowledge of budgeting and investing.
It almost sounds a little bit crazy, but I think employers who hire students right out of college should have basic personal finance workshops as a part of job orientation training. I think people will be able to work with much clearer minds without all of that financial stress nagging at them.