A budget is similar to a diet. What a diet is to physical health, a budget is to financial health. Both are developed to improve yourself, but neither are typically sustainable. More often than not, they're temporary lifestyle changes, not permanent behavioral changes. To help your healthy financial habits stick, budget through automation.
Budgeting: A Good Way to See Where Your Money Is Going
Budgets traditionally are defined as an estimate of income and expenditure over a set period of time. The traditional budget focuses on tracking expenses and determining how and where to cut back. They aim to identify expenses that aren't exactly necessary to pay off debt, increase savings, or reach another financial goal. The best part about building a traditional budget is people sometimes don't realize where they're spending money. Identifying how much you're spending on coffee every month can result in behavioral changes if it's shocking enough to warrant a change. There are many applications that offer free software to help build budgets and itemize expenditures. (For related reading, see: Best Budgeting Software for 2018.)
The downside to traditional budgets is they take time, effort, and can make money less enjoyable. Realistically, It's hard to hold yourself accountable for reviewing a budget every month. Using a software tool like mint.com that includes account aggregation is a helpful way to identify where you're spending money, not to track whether you're spending too much. At the very minimum, It's a good idea to know what your fixed expenses are, and/or what expenses you can control or cut back on.
Lastly, the traditional budget can make money less enjoyable. If you're out shopping, getting drinks or playing a round of golf, you don't always want to be thinking about your budget. "Can I afford this shirt? Should I go out for beers this weekend? Am I able to spend Saturday with the boys?" Trying to stick to a monthly budget forces these questions into your head. While I'm not advocating for reckless spending, money should be enjoyable. Here is a better way to ensure great savings habits and debt repayment while still enjoying your money. (For related reading, see: Enjoy Life Now and Still Save for Later.)
4 Steps Toward Automating Your Budget
Most people who receive a monthly or bi-weekly paycheck have their money directly deposited into their checking account. Rather than receiving the check by mail and having to deposit it at the bank, it's done for you automatically. This same process can apply, in most cases, to student loan payments, mortgage payments, 401(k) contributions, etc. Virtually every part of personal finances can be automated. Here a few ways to automate different financial goals. Ultimately, you'll arrive at a monthly budget for remaining expenses and leisure.
1. Emergency Fund and Debt Obligations
When a paycheck hits your account, set up an automatic transfer to your savings account to build up an emergency fund if you don't have one already. Typically, emergency funds consist of three to six months of living expenses. If you're already making student loan payments automatically, great, if not, set up payments for that as well. Student loans should be a priority, however, that does not mean ignoring other financial goals, such as an emergency fund or investing. Other debt obligations, such as a mortgage or credit cards, should be high on the priority list as well.
2. 401(k) Contributions
If you're participating in a 401(k) plan, contributions are automatically deducted from your paycheck by your employer. It takes very little effort to set up a 401(k) and begin contributing. As most companies these days avoid pension plans, it's more important than ever to start contributing to a tax-advantaged retirement plan like a 401(k) early and often. Most advisors will recommend saving anywhere from 15-20% of gross income. Obviously, the greater the percentage the better. However, being realistic, the average millennial graduates with $30,000+ in student debt. It can be hard to enjoy yourself, pay off debt and save more than 15%, to begin with. It's a great target to hit if you can, otherwise, it's a goal to work toward.
Another automation tip with 401(k)s is implementing contribution increases. A lot of plans have annual contribution increases available. Meaning, rather than having to manually go in and increase contributions (one of those things we'll say we'll do, but don't get around to ever), the plan will do it for you. Even starting with an annual increase of 1% can vastly change your retirement savings picture over time. If you receive a salary increase, bonus or wage increase each year, you'll hardly notice the bump in 401(k) contributions. (For related reading, see: 6 Ways to Maximize the Value of Your 401(k).)
3. IRA Contributions
If you've paid off debt and want to put more money towards retirement savings, opening an IRA or Roth IRA is a great way to go. Unlike a 401(k), you have many more investment choices. You can automate contributions to an IRA just like you would a 401(k). The only difference is you'll have to set up the transfers between the broker/dealer and your bank. Most brokers offer this feature. Again, even if you start with as little as $50 every two weeks, that adds up to $1200 annually. Buy a low-cost index fund and let the power of compounding take over.
4. Brokerage Account Contributions
If you don't want to lock up money in a retirement account, or you are lucky enough to have maxed out all your retirement contributions, you may consider opening a brokerage account. Just as you would transfer money to a savings account to build an emergency fund, transferring money directly to a brokerage account is just as easy. Align transfers for the day after your paycheck hits your checking account.
The Result of Putting Your Finances on Autopilot
Once everything is automated, you'll know whatever cash left in your checking account is available for remaining expenses and leisure, given that you're actively contributing to an emergency fund, making progress toward paying off high-interest debt and saving roughly 15-20% of gross income towards retirement savings. Now, the key is not overspending. What obviously gets people into trouble, is spending money they don't have. Credit card debt can spiral out of control quickly. If you find yourself spending more than what you've accumulated in your checking account, take some time to review your budget and see where you need to cut back.
Putting personal finances on autopilot is the best way to budget. Once the processes are put in place, all it takes is remaining disciplined. As opposed to constantly reviewing and stressing over a traditional monthly budget, automating important aspects of your personal finance can result in true behavioral changes because it clearly defines the amount you're able to spend each month once other financial priorities are taken care of. (For related reading, see: Pay Yourself First.)