How can I budget for both short-term expenses and long-term goals?
Budgeting is a critical element of financial planning. The basics of a financial plan include income, expenses, assets, and liabilities. When you budget, you need to estimate the individual expense items you are facing currently, the expense items that will be ongoing, one-time expenses that may lie ahead, and the impact of changes in your personal life (e.g., marriage, retirement, children, etc.). Along with the expense budget, you will need to do the same estimating for income, including current earnings, prospective increases/decreases, nonrecurring income, retirement income, etc. When these cash flows are assembled with the details of what you own and what you owe, you will have an understanding of your current situation and the resources that will determine whether you will have enough to live in your preferred lifestyle in the years ahead. It's a matter of assembling all of your financial information and comparing it with your goals.
As for any budget, you should first identify which are fixed expenses (such as food, shelter, gas, ins., health, tax, etc.). Those are your recurring expenses and probably will never go away. Then, you category other non-recurring expenses as discretionary expenses, such as travel, emergency set of tires, etc. At this time, you tally up the total cost and compare that to your take home-pay. If you have any positive cash flow (more pay than the expenses), you can start to allocate how much for each goal, whether it’s saving for retirement or a down payment of the house.
This probably is the way that most Americans do their budget, and that’s why many end up living from pay-check to pay-check. Instead, I encourage you to change the order by pay yourself first. Whenever you earn your pay, the first thing to do is to automatically transfer 10%-15% to another checking/savings account as a general saving (no name goal) fund. This is very much like the government withholding your tax, or your HR for your 401(k). You can use the same logic for fund each goal. I have a client who has multiple savings accounts under various goal names, such as birthday savings, Christmas savings, travel savings, etc. I readily admit it can be a hassle to manage multiple checking/savings, but it works for certain individuals. You just have to find your balance. The truth is simple. By stashing money away first, it reduces your urge to spend. Thus, the money you don’t see is the money you don’t spend, and you would never spend out of control unless it’s a disastrous emergency that wipes out the entire savings.
So, give it a try and modify it to your liking. Happy Savings!
Kudos for prioritizing a budget.
I think a lot of people overcomplicate budgets and the term budget is perceived like a bad word (like diet). Being on a budget doesn't mean you can't afford things, it just means you know where your money is going. The key, like dieting, is not to Yo -Yo back and forth between good habits and bad. For example, we spend more money on going out to eat than we probably should. However, it is our form of entertainment and it is in our budget. You have to include some fun things in your budget or it won't last long, it won't become a habit.
Here are 4 steps to a budget you can keep.
- Record all of your spending (every cent) for 30 days.
- Review fixed expenses- are there any that can be removed or renegotiated?
- Review variable expenses- are there any that can be removed or reduced?
- Reallocate the newly found funds to your biggest priorities.
Rinse and repeat periodically.
It may be worth it to work with a local CFP to help you prioritize the appropriate split between the short term and long term. Everyone is different there. It depends on where you are versus where you want to be.
I have found that it often helps clients to think of their finances in different buckets. The first bucket has funds for short-term expenses, like an emergency fund. The second may be for intermediate-term expenses/goals, like a trip. And the third bucket for long-term expenses, like retirement.
Our minds will often use models to efficiently make decisions. This can be good and bad. This 3-bucket model can offer a healthy model to reach your goals. The tough part is deciding how to fill each bucket, and what to fill them with.
Mark Struthers CFA, CFP®
The first step in planning for long-term goals is actually determining how much you spend on short-term expenses. Once you know how much money is spent on the here-and-now, you can assess how much money can be put into investment vehicles for the future.
Regular monthly expenses such as cable or cell phone bills should be easy to assess, but what about less frequent expenses like yearly insurance premiums? You can take these large lump sums and pro-rate them over the number of months from the time that you start the budget to when the event occurs. For example, if it's currently December and your $2,000 insurance premium is due at the end of next October, you should put aside $200 per month for the next 10 months (January-October). This will take care of uneven expenses like holidays, birthdays and insurance premiums.
After you determine your monthly expenses and pro-rate annual expenses, subtract them from your monthly income in order to figure out how much income you have left to contribute toward your long-term goals.
Long-term goals can be considered anything longer than one year into the future. This includes buying a car or home, sending the kids to college or planning for retirement. Your long-term goals should come with a solid estimate of their costs. Start by writing down several long-term goals along with your best guess on how long it will be before money would be needed. An example list may look something like this:
- College expenses - Child 1 (current age 8); $20,000/year beginning in 10 years
- College expenses - Child 2 (current age 3); $24,000/year beginning in 15 years
- New car purchase - $30,000 in two years ($4,000 upfront + $400/month for seven years)
- Vacation to Europe - $10,000 for a three-week vacation within three years
Afterward, you should use a spreadsheet or other software program to figure out how much must be be put away for these future events. Suitable investments can then be determined according to time frame and your overall risk tolerance. Historical asset returns can be used to estimate how much the investments will hopefully appreciate over several years. (To learn more, see Projected Returns: Honing The Craft.)
The goal is to determine if the amount of money that you have remaining after paying your short-term expenses will allow you to meet your goal. If it doesn't, you need to adjust your goals, cut expenses and/or earn more income. It's important to regularly update the status of you long-term goals and short-term expenses. New regular expenses can emerge, and if you don't make changes to your plan, you'll come up short.