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How to Set up a Budget

It’s so easy to get frustrated with our personal and household budgets. After all, who wants to categorize every single expense, estimate them months into the future, only to find out (it always seems) that your income is insufficient to meet your expenses. That stinks more than that moldy green stuff (that had once been fancy-smelling cheese) you once found in the bottom drawer of your fridge back in your 20’s.

Split your income into six expense categories using a money pie budget.So for all those who seek simplicity in life, I humbly present “The Money Pie.” This concept is not new, and I did not invent it, but I did create the name and the graphic :-).

Slice Your Expenses into 6 Categories

  • GIVE 10%: Be Generous
  • LIVE on 50%: Home, Clothing, Communication, Food, Transportation
  • PREPARE with 10%: Save for emergencies and short-term (1-3 years) goals
  • PLAN with 10%: Investing for retirement, a business start-up, or a down payment on a home
  • IMPROVE with 10%: Your own education or your child’s, business startup, or job-related training and continuing education
  • FUN with 10%: Whatever peaks your curiosity or fits your fancy

The first key is keeping our survival living expenses (“Live”) to 50% of our net income. If that’s not possible right now, make it a goal to either increase income (not expenses), decrease expenses, or both. The second and most important key is keeping ALL the other expenses to 90% of your net income so that you can splurge every month with 10% of your money (“Fun”).

Here’s an example of a household earning $27,000 gross a year and netting $23,000 (approximately $13/hour). The monthly net income is approximately $1,915.

Expense% of Net IncomeAmount per MonthUses
Give10%$191.50In Cash or Check

  • Donate to Charity
  • Donate to Church
  • Donate to Cause
  • Help Out a Friend/Neighbor/Stranger
Live50%$957.50In Checking Account

  • Housing (Rent & Utilities)
  • Food
  • Transportation
  • Phone
  • Clothing
Prepare10%$191.50In Savings Account

  • Replace Appliances or Furniture
  • Repair or Replace Vehicle
  • Medical Emergency
  • Vacation
  • Gift Giving (Birthdays, Christmas, etc.)
Plan10%$191.50In Retirement Account (401k, IRA, etc.)

  • Retirement and Long-term Goals
Improve10%$191.50In Savings Account

  • Formal Education
  • Start up a business
  • Trainings of Interest
Fun10%$191.50In Cash or Check or Debit

  • Fun
  • Recreation
  • Entertainment
  • Dining Out

 

So just figure out your own money pie and dig in, right?!

Okay, so it can be a bit more involved than that.

Direct Your Money to Budget Categories

Actually, once you “figure out your figures,” you should start to send the amounts automatically to the right accounts.

  • “Give” and “Live” (and possibly “Fun”) go into your checking account. Take advantage of bill pay or a business’ direct debit option to automate as many of your “Live” and “Give” expenses as possible.
  • Set up automatic transfers for your “Prepare” and “Improve” categories so that money flows automatically into your savings account(s).
  • For “Plan,” consider using a second and/or third direct deposit option through your employer so that this money never even goes into your checking account. Otherwise, set up an automatic transfer out of your checking and into your investment account soon after each payday.
  • Consider taking your “Fun” money and perhaps some of your “Live” expenses (gasoline and groceries) out in cash to spend as you so choose.

Practice Disciplined Spending

And remember to get your credit and debit cards and even your checkbook OUT of your wallet or purse, especially if you would not classify yourself as a particularly disciplined person when it comes to money (and if you’re among the 60% of Americans who live paycheck-to-paycheck or worse, you’re almost in that category by default).

At this point, I’m sure many are asking, “How am I supposed to ‘LIVE’ on 50% of my income?! That’s impossible!” Not impossible, but not easy either. The reality is that at many lower- and even some medium-income levels, we can’t live like we think we “deserve.” Having a $400 car payment when you’re bringing in just $2,000 a month net is a bad idea. Yet I can’t tell you how many people I meet are in a similar (or worse) situation. They get into an apartment, a car payment or two, and massive cell phone plans, and then they wonder why they can never seem to save anything for the future.

Reality Check Time!

  • If your basic monthly living expenses as listed above are 70% or more of your monthly net income, you’re headed for trouble (but you probably already know that).
  • If they’re between 50% and 70%, you’ll likely have trouble staying out of consumer debt and getting much into savings or investment accounts.
  • If you’re living on less than 50% of your income, you may either be trying to catch up from years of “savings neglect.” Be careful, though, that you’re not living on so little that your basic needs and wants (and those of your household members) frequently go unmet.

The money pie budget can inform couples on how to balance income and expenses.

What If I Fail?

As I think about this question, I see two possible meanings and several very different consequences. First, “What if I fail… to budget?” Essentially, this question asks what the possible consequences are for neglecting to budget. That’s pretty easy to answer. Nothing good.

The reality is that only 25% to 32% of Americans budget their spending regularly. That means that 68% to 75% of Americans live without a plan for their expenses at all. It should not be surprising that a very similar percentage of American households (60%) report that they barely break even (live paycheck-to-paycheck) or spend more than they earn each month.

Not budgeting might not cause problems in the short-term, but over time, when emergencies and unexpected expenses arise, the lack of a spending plan (which also correlates to having no savings plan) means that excessive debts, financial frustrations, family arguments, and potentially even bankruptcy are in the future. What does that look like in your neighborhood? Well, the chances are that if you count any row of 10 or 11 houses on your street, one of them has filed a bankruptcy in the past 10 years.

Budgeting for Unexpected Expenses

Using the money pie budget will immediately put you in an exclusive club. The “Preparing for Unexpected Expenses” club. The 10% Plan piece of the pie will do more to minimize the impact of car repairs, appliance failures, and emergency room visits than anything else you can do (besides possibly having proper insurance coverage). Without this piece of the pie, any unexpected expense becomes an emergency. With this piece of the pie, we can view the unexpected expense its non-financial light, and possibly even enjoy it. “Yay, the old, ugly fridge finally died. Let’s use part of our savings to get the one with the water dispenser in the door!”

A very different question is, “What if I fail… in my efforts to budget?” In my mind, the only people who fail in their efforts to budget are those who give up trying. We will all have months or even years where a spending plan seems like a futile effort. As long as we continue to try, that is the key. You might find that one type of budget makes you miserable with the amount of time or the lack of control it provides you while another type fits your personality much better. Keep at it. Be the little budgeting engine that could.

The Ultimate Goal of Budgeting

Living on 50% of our income really is the key, and I would bet you that you’ll be a happier person, couple and/or family living in a smaller home, driving a car that’s not brand new, and talking on a phone that uses 3G than you are with a big rent/mortgage payment, a new car payment, and a 4G unlimited cell-phone bill. Why, because if you’re living paycheck-to-paycheck, you’ll have difficulty finding ANY available cash to experience the fulfilling satisfaction of giving to causes you really care about, or to fund your interests, hobbies, and pleasures, which is where much of our satisfaction and happiness comes from in life… even if they include fancy-smelling cheeses.

Okay, NOW, bon appetit!

todd-christensen-portraitTodd Christensen

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  1. Sheila White

    I like the concept. We need to reduce our ‘fun’ part of the pie by selling our timeshare. Any suggestions ? The interest rate is 14%. I could pay it off with a fixed rate credit card. ( we have good credit) but would lose the tax write off on the interest. We’d like to sell it; have someone just take over the payments, we don’t know where to list it. Thank you for any suggestions you may have.

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