Unit Budgeting - A New Way To Save Money |
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By: David Lewis Posted: 2007-06-13 10:52:32 |
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The data that is available from the Federal Reserve Board is staggering. In 1989, credit card debt in America had reached $238 billion. By 2005, this number had almost tripled topping out at around $800 billion. The average Middle Class American family owes approximately $9,000 in credit card debt. When interest rates fell to "all time lows" and homeowners rushed to the banks to cash out all of their available equity on interest-only adjustable rate mortgages, they learned a harsh lesson when interest rates began to rise.With the end of their interest only payment options coming due, we are seeing the results of the lack of a good budgeting system. The practice of excessively living beyond our means by treating credit as a source of wealth and not looking to the future is at last being exposed for what it really is: a harsh road to foreclosure and bankruptcy.What about the folks who are not $9,000 or even $1,000 in debt, and yet never seem to have much money, and even if or when they do, they never seem to be able to make it last or put it to it's best use? What the about those who do have a lot of extra money? What about those who make several thousand dollars more per month than what their bills amount to? Are they in serious trouble as well? Sadly, I'm afraid so. What is amazing is that the cause is the same for the well off as it is for the poor: the lack of a good budgeting system.The Traditional ApproachThere are numerous "traditional" methods of budgeting, which include simply balancing your checkbook and making sure you keep track of all of the checks you write. There are software programs like MS Money and Quicken that allow you to see where your money is being spent. There are a few pencil and paper methods where you are told to write down everything you spend your money on and make sure that that never exceeds your monthly income.The common trait among all of these methods; however, is that they take a pragmatic approach to budgeting. Rather than relying on principle, they treat each expense or "budget problem" as unique. As such, there can be many different methods to budget your money, and the success or failure of a particular system depends on whether "it works" (at least in the short-term) regardless of the long-term consequences of the method. It is not surprising, then, that we see several different popular methods all claiming to be "the right one" or "the best".These methods are also 100% reactionary. Which means you are passively reacting to your money, your bills, and your financial life in general. The system depends on you reconciling your checkbook, or your spreadsheet, or whatever you're using after you've already made purchases. These methods can only record and track your spending history, not help you control your current and future financial situation. The result is a static report of your past.If you find yourself in a position where you never seem to have any money or enough money at the end of the month, this is the reason why. You cannot simply react to the world around you and try to control it at the same time. This passive, reactionary approach to budgeting often leaves an individual wondering "what am I doing wrong? I know what my expenses are, I know how much money I make every week/month, why can't I seem to get ahead?"If you find yourself with a lot of "extra" money, it is entirely possible, and in fact probable that you are losing money in the form of opportunity cost. Often times, those who are well off don't see the need for a budget. They perceive it as something only the poor or the less well off folks need. However, budgeting in principle is good, therefore it is good no matter who you are - rich, middle class, or poor. To illustrate this point consider the situation of the famous pop singer Elton John who, earning $25 million a year, was spending so much money that he had to take out a $40 million loan just to pay off his debts. Even if you are thrifty, budgeting can be the difference between controlling where and what your savings is doing (in terms of return on investment) or simply passively reacting to it.Then, there are what I call the "inspirational" methods. These are budgeting "tips" which set unrealistic expectations on you such as "just cut back on going out to the movies" or "always buy the generic brand" when grocery shopping. These methods attempt to control your lifestyle and dictate your wants and desires. It is no surprise that, usually, these systems fail for most people because they present you with a dichotomy (a split) between "needs" and "wants" that makes life generally unpleasant. I'm not saying that there aren't things that you should cut back on or that you don't need to change your lifestyle in order to become financially successful. But, whatever changes you make to your life should be your choice, not your advisor's.The "Unit Method"The Unit Method of budgeting takes a fundamentally different approach to managing your money. Instead of taking the pragmatic, reactionary approach, we are going to take a pro-active approach. Instead of simply reacting to each individual expense, we are going to plan for them and budget them before they ever happen. Instead of passively monitoring our savings, we are going to control it. Instead of telling you what to cut back on, to start buying the generic brands, or how you should live your life, we are going to let you make that choice.To begin with, you need to gather together everything you spend your money on. It may be helpful to grab a cheap notebook and write down everything you spend your money on for an entire week, or an entire month, just to get an idea of where all of your money is going. Write down the specifics as well as how much money you spend on each item. Don't forget the date that you made the purchase.The next step is to collect all of your regular expenses. Total up everything that you spend your money on in a year (including when you spend it). You want to look ahead 12 months because you don't want to forget expenses that may only come once or twice a year - like taxes, or car insurance, etc. Some examples of regular expenses (just to get you thinking) are:
Taxes (if using gross income or you are self employed) Mortgage Payment Second Mortgage payment Household (yard) Gas Elect/Water/ Gar Gas (for your automobile) Auto Insurance Maintenance (car maintenance like oil changes, tune ups, etc.) Automobile Registration TV Life Insurance Loans (car loans, personal loans, educational loans) Credit Cards Babysitting/Daycare Clothing Grocery Eating Out Nonfood grocery items (cleaning supplies, toilet paper, soap, laundry detergent, etc.) Medical Bills Hair cut/personal care items Charitable Donations Emergency Fund College Fund Dry Cleaning Birthday gifts Christmas gifts Holidays and other gifts (i.e. Valentine's Day) Maintenance (home repairs, etc.) Retirement Savings Magazine Subscriptions Membership dues (elks club, moose, club, or other social organization) Dates (going out to "dinner and a movie" with your sweetheart) Video rentals Entertainment/"Play Money" (i.e. any hobbies) After you've gathered all of your expenses together, it's time to do some thinking. The method that we will be using to develop your "bulletproof" budget actually involves two processes: differentiation and integration. What you need to do is try to identify similarities among two or more concrete or specific expenditures and differentiate them from the rest of your expenditures. This should be done as simplistically as possible. Then, we need to integrate these similar expenditures while omitting their specifics and thus forming a new "unit". This new "unit" becomes the basis for our budget and will allow you to easily track and control everything in your financial life.The list I gave you above already accomplished part of the job for you. I merely asked you to do this process in reverse to come up with the concretes. For example, if you look at your expenditures and you find that you have a Discover card, 3 Chase cards, a Capital One card, and a Visa - we would group these together by their similarities, omit their specifics and form a new "unit" around them. From now on all credit cards can be filed under this "unit".But, what do we call this "unit"? Do we simply refer to the unit as "credit cards"? Is this the common denominator? Perhaps. We could group all credit cards together and form a unit called "Credit Cards". However, perhaps we could do better than that. What is a credit card? What is its essence? What is its purpose? What does it allow us to do? Aren't we borrowing money when we charge up a credit card? Isn't the major distinction between this expense and all of the other ones really the fact that these are all some type of loan? I think that this would be a more accurate association than just "credit cards". "Credit cards" denote what they are but not their purpose. Their purpose is to provide us with credit - with a loan, and unsecured loan, but a loan just the same. This is the key to making the "Unit Method" really work for you. You must find the most accurate associations between your expenses.So, based on this, we form the unit "Loans" and file each credit card under this new unit. Now that we have begun to form our first unit, what other loans do we have? A loan out for an automobile? A college loan? A personal loan? We can also group these expenditures by their similarities, their common denominator - the fact that they are also loans - omit their specifics, and add them to the "Loans" unit. Again, we do not care what kind of loan they are, the term, the interest rate and so on, only that they are loans.The same thing can be done with "Entertainment", "Insurance", "Taxes", and so on. Remember when making associations to discover the purpose of the expense, not just what it is. After you have put together a list of all of your new budget "units" you can then simply file each concrete or individual specific expenditure under the new "unit". These become "unit items". For expenses we may use the general term "expense items". For savings "savings items". For investments, "investment items" and so on. For example:Loans: Wells Fargo (mortgage loan) Bank of America (personal loan) Community Bank (automobile loan) Chase card #1 Chase Card #2 Chase Card #3 Discover Card Capital One Visa Now, we must reintroduce the specifics to each individual expense because we must determine the budget for the new "unit" that we have created. So, if your mortgage payment is $600/mo, your Bank of America personal loan is $250/mo, your auto loan is $300/mo, Chase #1 is $50/mo, Chase #2 is $60/mo, Chase #3 is $50/mo, Discover is $50/mo, Capital One is $50/mo, and Visa is $40/month, then the budget for this "unit" is $1,450. Continue to do this for all of your budget "units" and add up the total. Now compare this with your paychecks and any other income that you might have. If you make more money than all of your newly created "units", then you're fine. If not, then this gives you a clear signal that something is wrong and an easy way to adjust your total budget. You can look for the "unit" that has the biggest budget and try to cut out some of the "waste", or if you don't think that this is possible, you can always call me to set up an appointment and I can help you.The next step in the process is to do your very last reconciliation to find out your true checking and savings account balance. After you've done this, then you divide up your checking account balance into your newly created budget units appropriately (start allocating money in your checking account into your new budget units - pay attention to when each specific expense item is due). Put your savings account balance, if any, into your "savings" unit. You should have a total for each budget unit and additionally you should know what each individual expense within that unit is, so there should be no problem doing this. So, for example, when you assign your money to your expense items and budget units it would look something like this (using the previous example as a model):Loans: (total - $1,450) Wells Fargo (mortgage loan) - $600 Bank of America (personal loan) - $250 Community Bank (automobile loan) - $300 Chase card #1 - $50 Chase Card #2 - $60 Chase Card #3 - $50 Discover Card - $50 Capital One - $50 Visa - $40 When you are creating your budget units, don't forget to create a "savings" unit and an "investments" unit. The two should be kept separate because the function of "savings" is to preserve wealth. The function of investments is to grow your wealth (or grow your savings). They have two distinct and separate purposes. Even if you have little or no savings or no investments right now, these will (eventually) become an essential part of your budget.From now on, every time you get paid, you must allocate all of your paycheck to your budget units, and specifically to the items within each budget unit. How you do this is totally up to you, but remember to pay attention to when each expense item is due. If an expense item is due on the 15th of the month, for example, you must budget enough money into the appropriate budget unit and assign it to that particular expense item before the 15th of the month (for obvious reasons). Every dollar from every paycheck is given a "job". Which means, you should never have any money "left over" at the end of the month. Whether it is assigned to your "savings" unit, your "entertainment" unit, or to another budget unit, every single dollar must be assigned somewhere.You may subtract money from one unit to add it to another. Or you may move money around within any given budget unit to meet unexpected or variable expenses. This gives you full control over where you spend your money. You choose where to cut back. You choose how to change your lifestyle (if you need or want to). But, you can no longer "overspend" - the system will not let you. Reality will assert itself. Which means, you only have a limited amount of income and no more. Every single time that you purchase anything (or, before you purchase it) you must deduct that amount from one of your specific, individual [expense] items within your budget unit(s). If you find yourself having a tough time with this, either pay cash for everything, or ask your bank for a pre-paid debit or credit card. These are special cards that you "load" money onto. They work just like a normal credit or debit card except that you cannot overdraw your card. There is a fixed amount of money on the card (that you specify), and when it's gone, it's gone. This may be especially helpful if you are having a tough time controlling your "entertainment", "grocery", or another budget unit that can easily be overdrawn.If you find that you have no money left in a particular [expense] item, then you can no longer spend any more money on that particular expense. It should also be noted that it is usually of no benefit to you to move money around anyway because each expense item is there for a purpose. For example, you wouldn't normally move money out of your auto loan [expense] item because you need that money there to make your auto payment.The only time it may be beneficial for you to move money around in your budget units or from one unit to another may be when you are working with something like an "entertainment" unit where the money you spend is for enjoyment or entertainment purposes.After you have set up a model budget and have all of your expenses and savings written down and assigned to their respective budget units, it is extremely easy to plug this into almost any "paper and pencil" spreadsheet or accounting software. There are a few that seem to work much better than most because they are modeled around this type of zero-based budgeting. My personal favorite (the one I use myself) is called "Budget" by Snowmint Creative Solutions. I have contracted with the payment processor to be able to bring this program to you in two different formats:Budget 4.0 Budget (for Windows Operating Systems) Budget (for Mac OS) Although not designed specifically for "Unit Budgeting", the Budget software can be made to work very well with it and, as I said, this is the software that I personally prefer to use. I recommend that you get it.If you prefer a "paper and pencil" method, then the very best spreadsheet available is Budget Map. Of course, if you are using a "paper and pencil" method, then you might find any basic accounting ledger book useful. I think that the software solution is easiest so I prefer that method.The "Unit Method" vs. The "Envelope Method"A question that sometimes comes up is: "this looks an awful lot like the "envelope method", what's the difference?". The major difference is that the "Unit Method" is designed for lifestyles of scale - even though both methods are a form of zero-based budgeting. I've heard many financial advisors say to me (and even to their clients) "I don't expect to make you rich (or make the client rich), but I'll help keep you from becoming poor". I look at this as a sort of "glass is half empty" approach to financial planning.The "Unit Method" anticipates that your financial life will become more complicated, that you will have more money - specifically more savings - and that you will need an easy way to manage and track not merely expenses, but your savings and investments also.There is nothing inherently wrong with the envelope method - if you have a limited amount expenses, savings, and income. In fact, if you prefer to refer to your [expense] items as "envelopes", obviously it will not affect the system in any way. The "units" are an essential component however. Without them, all of your expenses are disjointed. With enough "envelopes" or [expense] items, it becomes very difficult to keep track of them all (and thus provide an opportunity for your budget system to fail you). In addition, as your savings begins to grow, you will accumulate more and more "envelopes" or [savings] "items" within your savings unit (as you diversify your savings into different savings vehicles). You will need some way to easily organize and keep track of all of the various "items".Eventually, you will transition from being swamped with debt to being swamped with savings. However, the need for managing this money is the same in principle as the need for managing your debts and expenses and so it will require (perhaps more so than before) a strong, efficient, yet simple method of budgeting to control every penny you earn (and spend) so that you can make, track, and achieve your personal goals easily and efficiently. |
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