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Wednesday, April 15, 2009

Personal Budgeting vs. A Spending Plan

The origin of the term "budget" is debatable, but most sources track it back to the french or Latin words for bag or pouch.

I don't use a budget. I don't like the idea of having a small bag determine how my financial life flows, it's too restrictive. I prefer to think of my monthly cash flow as a spending plan. It gives a feeling of bounty, when in fact, many of us who feel poor are actually rich in resources.

For example, my spending plan includes $200 per month for health insurance. I don't see that as an expense, I see it as something that I purchase in order to protect myself and my family from catastrophic financial burdens. That's a good plan!

The most important spending plan that I ever ran across is called The 60% Solution by Richard Jenkins on MSN money. He was wondering if adding all these receipts in personal software was really helping him control his money. Here is an excerpt from the article:

"After analyzing our spending patterns over a couple of years using our Microsoft Money data file, I determined that we needed to keep our committed expenses at or below 60% of our gross income to come out ahead at the end of the month.

Committed expenses:
Basic food and clothing needs.
Essential household expenses.
Insurance premiums.
Charitable contributions.
All of our bills -- even such non-essentials as our satellite TV service.
ALL of our taxes."

The other 40% of dollars are divided up into Long Term Savings (10%), Short Term Savings (10%), Retirement (10%), and fun money (10%). That last 10% is so that you feel good about life and can continue to face the office every day, is my guess.

So, it's not just a budget -- it's a way of looking at the overall picture that helps you make the important decisions.

"The key is keeping a lid on those committed expenses. You can categorize them if you want, but it isn't really necessary. In fact, you could make a budget with just three categories: committed expenses, fun money and irregular expenses," Jenkins writes in his post.

The most powerful paragraph is:

"Now, let's take the really hard case: Even excluding debt payments, reducing your committed expenses to 60% still seems like an impossible goal. If that describes your situation, the odds are good that you're facing one of the following problems:

*You have a more expensive home than you can afford.
*You've committed to car or boat payments that are larger than you can afford.
*Your children are in a private school that you can't really afford.
*There's just a big, ugly gap between your income and your lifestyle.

If it's one of the first three, you can undo the damage by slowly unwinding the commitments you've made and choosing something less appealing but ultimately more appropriate."

I took Jenkins' advice and closely looked at my 60%. That's when I realized that my house was pushing my "have to" expenses into 75% including mortage, mortgage interest and maintenance, fees etc. and there wasn't any way I could continue to do that at my salary and recoup half of what I was putting into the house. Once I sold my house, I had a six-figure nest egg and I'm still saving each month because I'm renting instead of owning (which is a good deal, btw, just check out the New York Times Rent Vs. Buy calculator).

Take a look at it, slowly if you have to, but add up your expenses and see if you can do the 60% - 40% break out. (Or somewhere close 65-35, etc.).

What happens when you do that? Please let us know in your comments below...

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