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The Cookie Jar Method of Budgeting

Ask anyone on the street if they have ever heard of the cookie jar method of budgeting and they will probably say no. Basically, it involves using a cash based accounting system to monitor household spending, usually for the variable items like food, clothing and car expenses, with cash available for the month held in a cookie jar. As money is spent, the expenditure is marked on a log, until the money is gone. Then all discretionary spending comes to a halt until he next fistful of cash is inserted, usually on payday.

This makeshift budget method was largely adopted by blue collar working class families to monitor spending between paydays and to ensure that something always remained to put food on the table. In decades past, credit was scarce, banks unstable and checkbooks were not as widely used. Personal savings were necessary to weather any crises, so the cookie jar needed to be paired with a stowaway pot for the unexpected. Sometimes, when remodeling, people still find these jars tucked into the wood framing of their homes, left by a previous owner. (For more, see: How Much in Savings You Need to Live Comfortably.)

When banks increased their rates of interest paid on savings accounts, the stowaway jars eventually ended up as deposits at a local savings and loan. When the deposits grew, they went into purchases of real estate and investments for the future.

American Households Overspending

I mention these old time methods of cash based accounting because of a current report that American households are overspending again. Americans may be repeating the mistakes leading up to the crash of 2008.

The report from WalletHub.Com indicates that after years of paydown, household debt began climbing again this year during the second quarter. At the current rate of overspend, Americans will owe $60 billion in new credit card debt at the end of 2017, up from $30.5 billion at the start of the year. This is clearly an unsustainable trend.

The cookie jar method of spending ensures working capital necessary to sustain a household. It is also a check and balance to ensure that essentials like the mortgage or rent is paid.

When households spend on credit cards, the spending is more likely to exceed revenues coming into the household. And the cardholders are more likely to spend on wants rather than needs. While average household credit card debt now stands at $7,996, many people owe far in excess of this amount. Managing such a debt load makes planning for important life milestones difficult, whether these relate to financing a child’s college expenses or one’s own retirement.

I make a living from managing investments, once a nest egg is accumulated. Accumulating a nest egg, however, presupposes a savings discipline either driven by willpower, tax aversion or both.  On the average, most people should be saving 20% of their income into tax deferred and taxable investments. Many people save far less. (For related reading, see: 5 Painless Ways to Save More Money.)

How to Start Saving

So how to get back in the habit to save? There are some great personal finance authors out there, but one that stands out for me is Dave Ramsey. His book, The Total Money Makeover, celebrates going debt free like some people embrace evangelical religion. Mr. Ramsey does both, as his life values guide him to save more for the goals he really wants to fund. Before coming to this perspective, he climbed back up from life’s bottom in previous bankruptcy fiascos. Now he preaches success to others.

So back to the cookie jar. It is not the spare change jar. During this exercise, it will be the source of your monthly working capital. If you choose to try getting your household spending under control, you need to know how much you spend on the biggest categories for the budget after housing. Here are some ratios to guide you. Use them to cut back as needed.

Savings Ratio: Ideally, 12%-20% of income. Varies with age.

Food: Usually 12.5% of income, as per the U.S. Bureau of Labor Statistics from 2013-2014.

Housing Expense: Housing loan principal + private mortgage insurance + hazard insurance + property taxes + homeowners association dues/divided by gross monthly income. Rule of thumb: Housing expenses should not exceed 28% of gross income. On the average, these actually run about 34% of income for most households, says the U.S. Bureau of Labor Statistics.

Healthcare: The U.S. average is 12.5% of income.

Transportation: 16% of income, on average, says the government.

Non-Housing Debt: Ideally, less than 20% of gross income.

Savings Goal for Retirement: While having $1 million in investments may be ideal for most, many people will have problems attaining this goal. If your income gap after Social Security will be $40,000 a year, you need to think about the sum necessary to generate this amount in interest, dividends and gains indefinitely into a 20 to 30-year retirement. Otherwise, you may find yourself relocating to take the house equity to use for financing daily expenses. This money too will run out if you are short on investments.

Stay the course, put aside the savings for life’s serious goals and carefully evaluate returns on your investments to start growing your capital at a decent clip. The rule of 72 can be your guide. Divide 72 by your rate of return to determine how long before your money will double. But first you need to save.

What’s good for the cookie jar is good for the wallet. (For more from this author, see: How to Use Tax Mapping to Cut Taxes in Retirement.)