Budgeting as it is normally implemented sets you up to fail. Here’s what to do instead.
If there is one word in the personal finance lexicon that makes people cringe, it has to be the word budget. Every well-meaning article suggests you build and stick to an ambitious budget. Bucket methods, envelope methods…
The whole thing is exhausting, not to mention ineffectual for many of us. Budgeting – as espoused by many advice givers – sets you up to fail.
What do I mean?
The Problem With Regular Budget Advice
Pretend I’ve asked you to build me an airplane for as low a price as possible. Who would do the job better: you or someone who has been in airplane parts procurement for 7 years?
When you’ve had time to build up expertise, you collect tips, tricks, strategies, and sources that allow you to get the best price.
You also get the time to figure out what can be sacrificed with little impact and what causes a huge difference to the experience. Maybe the size of the seats matters more to passengers than the materials used to make them, and so you can’t cut costs by ordering the small seats but you can lower the cost by using cheap cushioning.
Typical budget advice doesn’t allow time for you to build your expertise.
You sit down with a blank budget spreadsheet, and you’re supposed to enter numbers that are 20%, 30%, 40% lower than what you’re currently spending. And you’re supposed to reach that new target right now.
That’s a recipe for disaster.
If you knew how to easily and painlessly go from $600 to $300 on groceries, wouldn’t you have already done so?
It’s an impossible task: learn a bunch of techniques across a bunch of categories all at the same time. And show the results within a week.
All-Or-Nothing: A Losing Strategy
This method rarely works in any avenue of life. If your 8 year-old son wanted to play basketball, would you tell him to try his first shot from the half court line, and then chastise him when he inevitably fails?
That’s exactly what people do to themselves when it comes to budgets. They write down a budget they’d like to adhere to in their ideal life, but they spend very little time thinking about how to bridge the gap smoothly from what their life looks like now and that magic nirvana in which they are content with a minimalist and inexpensive life.
They ask for too much, too soon.
Your success rests on how well you can bridge the gap from what life actually looks like now to that new, more frugal life. You need to steadily ramp towards your end goal as opposed to going cold turkey.
Introducing The Reverse Budget
Instead of building a pie in the sky ideal spending plan for someone who doesn’t actually exist, we can start with what life looks like now and then slowly modify the picture as you add new techniques.
It’s the absolute reverse of a typical budget: You start with what life looks like now and make slow improvements over time until you like the picture you’re looking at.
1) Start With A Picture Of Today
You want to have a good grasp of your expenses today. How much do you spend on eating out, transportation, small daily luxuries, etc.? How has that trended over time? Did your once a month hang-out session with the guys turn into 4 overpriced beers every Friday night at that hipster bar downtown?
To do this completely inventory, I like to use a solution that will automate the data collection process for me. You can manually tabulate this yourself, but I use a free service called Personal Capital that allows you to track your net worth and expenses.
You can hook up all your accounts to one central dashboard, and it will automatically tag each purchase by category. It will do so for all statements it can download from each individual credit card and bank account, so even if you hook everything up in June it will likely be have enough data to show you your spending back in April.
Most importantly once it’s hooked up it will continue to download the new monthly data so that you’ll get a running history of your spending and can use their drill-down capabilities to analyze your spending behavior.
So take a look at what your expenses look like today.
Which categories are your largest line items? Which categories surprise you by being larger than you expected?
2) Select One to Two Categories To Focus On
After looking at your current spending, pick just one or two categories on which you will focus your efforts.
You can employ one of two approaches.
The first is trying to tackle the areas that can have the most dollar impact. Generally that would be housing, transportation, and either food or healthcare. This was the method I used – I spent a lot of my time thinking about the biggest line items and worked hard to keep these down.
The second is to try and build momentum by starting with easy wins. Maybe this is focusing on your eating out and entertainment budget and cutting out a daily Starbuck’s purchase.
You know yourself best and can determine which will work for you. As I said, I like the impact approach for myself. These are generally the most painful adjustments, so doing them upfront when I have the motivation and energy works well for me.
Most of us can significantly reduce our spending by moving to a cheaper home or considering a roommate. I encourage you to really explore this idea, even if it requires some radical rethinking. Maybe you spend time reading about the surprising lifestyle inflation when it comes to growing house size and slowly come to realize you are okay with a smaller space. Then you start looking into condo options in your area that are within walking distance of work. Or maybe you start to learn about house hacking. You may not be able to move immediately because of a lease agreement. Not to worry. Doing the work upfront and crafting your plan in concrete terms is worthwhile work, and you can set a specific date to execute that plan.
3) Make One Improvement Each Week In Your Chosen Category
You will continue to do work each week trying to find new techniques for the category you chose.
When I investigated my restaurant budget, for example, I discovered I was spending over $900 a month on restaurants. The culprit for me was takeout, which was easy to grab while I was walking around and didn’t feel like a fancy luxury since I was casually eating in front of my computer.
Once I realized it was happening and consciously thought about the tradeoffs (i.e. I’d rather spend money on social outings with others than eating expensive meals by myself out of a brown paper bag), I was able to quickly reduce this line item without a significant reduction in happiness. I then started thinking about easy cooking ideas, and was able to streamline my grocery purchases.
Whatever category you are focused on, there are specialized resources and interest groups on the internet to give you tips.
If it’s housing, you can start reading frugal housing blogs and forums.
If it’s reducing your grocery bill, there are some truly crazy nuts who have figured out how to super-coupon their way to 30 cent loaves of bread or who can share a 10-recipe plan that uses ingredients that cost $30 a week. They will introduce you to new ideas like batch-and-freeze to take advantage of bulk pricing, share meal plans crafted around inexpensive ingredients, and stock you up with really easy recipes that don’t require a lot of work so you don’t regret switching from takeout to home cooking.
4) Set A 3-Month Check-In
Set a broad goal – you’d like to reduce your overall spending by $X or Y% – for your 3 month check-in.
Pick something actually achievable – more important than getting there fast is increasing the likelihood that you stick to it and build momentum.
The first 6 months is the hardest time and most fraught with peril.Because of this, you want to carefully engineer your plan and set yourself up for success.
Base and Stretch Goals
For goal-setting, I like to have both a base goal and a stretch goal. Your base goal might be a 10% reduction in your monthly expenses with a stretch goal of 15%. If you could do that in 3 months, that would be fantastic! After you achieve that, you can use the following 3 months to shave another 10%, 20%, or 30% from your expenses. Base and stretch goals allows you to reach for the more ambitious outcomes while acknowledging what is realistic.
5) Rinse and Repeat
After you’ve done a first pass through every category, it helps to revisit old categories. You can may come across new ideas to implement as well as spot lifestyle inflation creep and nip it in the bud.
Eating out is my weakness and requires regular monitoring. Because I love to eat, my spending on restaurants creeps up when left unchecked. I find I have to revisit this category regularly in order to keep it to a figure I’m happy with. We all have our soft spots. What’s yours?
How Long Should This Take?
You might be wondering how long this process takes in total. That is a remnant of old budget thinking. Reverse budgeting is a perpetual cycle, where you continue to see improvements in your life over time. Will you ever be done finding ways to streamline your spending? I certainly haven’t found that to be the case. I
If you are starting a process like this for the first time, though, you probably have a set of changes that could be classified as low-hanging fruit. The first round of changes usually takes 6-12 months to do thoroughly.
Keep in mind that you will see significant change well within the first 3 months.
But to get through every category at least once and to be able to implement changes while waiting for certain conditions (i.e. a lease ending so you can move somewhere cheaper) to be met can take a year.
Take comfort in the fact that every month you will be cashing extra dollars into your bank account as you ramp towards your ideal picture. And really, a year to complete a total transformation of your spending that could very well cut your expenses by as much as 40-50% is not much time at all in the scheme of your life. If traditional budgeting has failed you, you can only see improvement from here.
If you have struggled with the process of budgeting in the past, you are not alone. Consider the five-step process for a reverse budget, which will make real changes in the way you relate to money:
- Start with a picture of your spending now
- Pick just one or two categories on which to focus at a time
- Make one change each week in those categories
- Set a base and stretch goal at your 3-month checkin
- Cycle through old categories (rinse and repeat)
What has been your experience with budgeting? Are there any techniques you can share that have helped you to significantly reduce your spending?