Budgeting
Since the financial crisis of 2008, as times got tougher, people started looking for more ways they could save money. Budgeting your monthly expenses and finding ways to cut back on those expenses has become an obsession for some and a business model for others who have taken advantage of that obsession. Some people have become so obsessed with this concept that they are taking a minimalist approach, where, for instance, they may live in a van for 5 years to save up enough money to pay all of their debt off. This is an example of extreme budgeting and making life sacrifices to meet those goals. There’s nothing wrong with doing this if that’s what you want to do. These extreme budgeters are not what most people want or need to do with their finances.
As a Certified Financial Planner™, part of helping people with their finances is to help them review their debt to income and help them find a happy medium between their current debt level to their income. Some people may wake up and find themselves in a tough place financially where they have racked up a lot of credit card debt on top of their home and the auto payments. Sometimes those same people that wake up and find themselves in these situations think they can flip a switch and they’re going to find ways to pay off all of their debts and cut back on everything. That’s a great attitude to have, but you’re setting yourself up for failure. You have to take small calculated steps. If you just jump right in to the extreme budgeting mindset, it’s not going to end well. It’s kind of like dieting. New Year’s rolls around and everyone wants to diet. Next thing you know, a month or two down the road, you’re off the diet. Here are some tips to help you start paying down your debts and budgeting your money in moderation.
- Start Small
Wanting to budget is fantastic. Everyone should want to keep a closer grip on where they spend their money each month. It’s better to start out small and work your way up. Start paying an extra $100 a month on that credit card with the highest rate. Or cut back a little bit on eating out. You don’t have to go from eating out 3 or 4 nights a week to not at all. Maybe cut back on 1 or 2 meals a week. Or maybe just order water at the restaurant instead of tea. As you start seeing more money in your bank account at the end of the month, pay that credit card off completely. Then just keep it up. The little changes can pay off if you stay consistent. You’re not taking such a big shock to your lifestyle when you start small.
- Not All Debt is Bad Debt
There seems to be a mindset that all debt is bad. That’s not exactly true. I don’t know of too many people who can up and buy a $200,000 home with the money they have in the bank. Mortgage debt is considered good debt because you’re buying a home for your family to live in, it’s an asset that should appreciate in value over time, and the interest you pay on the mortgage is deductible if you itemize on your tax return. Vehicle debt is another debt that is not so bad. You have to have a means to get back and forth to work to make a living. The extreme budgeters or minimalist might take a bicycle or public transportation and not have a car payment or car insurance to worry about. In some areas, like where I live, you don’t have those options. There is no public transportation and riding a bicycle just is not feasible for most people due to the terrain and access. You still need to make sure you can afford that home and vehicle. Just because that’s good debt doesn’t mean you go buy the $60,000 BMW off the lot or the $500,000 home in the fancy neighborhood. You still have to live within your means. A good rule of thumb is your housing related expenses should not be more than 28% of your Gross income, such as the mortgage payment, the insurance and the taxes. To be conservative, you could try to keep all of your debt (excluding student loans) and housing expensing under the 28% of Gross Income. If you do that, then you are on the right path and you should have plenty left over to save for retirement and finish paying down your other debts.
- Remember To Pay Yourself
Another idea I think people completely misunderstand is paying yourself. With this extreme budgeting and extreme debt reduction mindset, people are more concerned with paying all of their debts off before putting money into a retirement plan for themselves. Back to the first point, start small. That applies to paying yourself too. If you can only pay yourself $25 a week, that’s fine. Put that $25 into an IRA or your company’s retirement plan where you are invested a mutual fund made up of stocks and bonds or an index fund linked to the market. In the long run, that $25 a week will be worth a whole lot more than you realize, especially the sooner you can start saving. I’ve seen people who buy into these debt reduction programs and that’s what they want you to do, is pay off all your debt. Remember there is such a thing as Good Debt. If you are taking all of your money to pay off your good debt, and not paying yourself, you are ultimately making it tougher on your future self when it’s time to retire.
Just remember, to start small, pay off the bad debt, and pay yourself. If you follow these 3 basic concepts and stay consistent you should be able to stay on the right track financially.