As a daily money manager, I often reflect on the concepts of financial planning. Like any skill, it seems to be something that comes naturally to some people and not to others.  If you’re in the “not” group, don’t worry!  Like any skill, it can be learned!

Today, I want to take you on a little trip down memory lane and share a story from my childhood that illustrates a fundamental concept of successful budgeting that I think many people don’t appreciate:  tradeoffs.

Spenders and Savers

When I was young, our family would go on vacation every summer. My parents would give my brother and me each $10 to spend however we wanted.

My brother, in his excitement, would spend all his money at the first stop on something like candy – which promptly got consumed as soon as we were in the car – and then be upset the rest of the trip when he saw something like a toy that he wanted more and didn’t have money to buy it. Of course, he asked mom and dad for more money, but they didn’t cave, so he spent the trip being upset that he couldn’t afford what he really wanted. 

I, on the other hand, would skeptically evaluate any item I was interested in purchasing. I was just sure there might be something better waiting for me at the next stop! I had fun shopping at every stop, imagining what great things I could buy. And at the end of the trip, I either came home with something I loved or with $10 to put in my piggy bank.

My brother was a spender by nature. He saw something he wanted. He had the money to purchase it. And that’s as far as his evaluation went… He didn’t consider the tradeoffs. So he spent the trip being upset. To him, it didn’t seem fair that I had money and he didn’t.

Was it unfair? We were both given the same amount, but we just approached the spending decision differently.

If you are a spender, listen up!! This may not be obvious to you, but it is reality, and it is the key to living on a balanced budget: With every single dollar you spend, you are making a choice to give up the option of spending it somewhere else. If you’re not looking at your money that way, you’re hurting yourself!

Budgeting is a way to evaluate those tradeoffs ahead of time so that you can make sure your money is going to the things that are most important to you. It’s like having a list of all the options the beginning of the trip, so that when you see the candy at the first store, you know that the cost isn’t just $10… to get the candy, you will have to give up the toy you really want. 

So having a budget sounds great, right?  It is, if you’re honest with yourself and willing to make tough choices to get what you want. The great thing about a budget is that it puts you in control.  You have the whole picture so you can decide which things are worth the tradeoff and which things aren’t.

Step 1: Set Goals & Priorities

The first thing you need to do is to spend some time figuring out and writing down what is most important to you. There’s no right or wrong answer here.

• What does success mean to you?  What do you want your life to look like in 6 months?  A year?  Five years?
• What does your ideal lifestyle look like?  What lifestyle could you live with for a while?
• Are you saving for a down payment on a house? Want to travel more? Or maybe you’re focused on paying off debt?
• Are you a single mom going through a divorce and want to make sure you can provide for your kids and save for their education, while showing them how to be financially responsible?
• Are you concerned about the costs of long-term care as you get older and want to make sure you have enough money to cover your future needs?

Whatever your goals, write them down and prioritize them. This will give you a clear direction and help you stay focused.

Step 2: Evaluate the Current State

This step is all about taking a good, hard look at what money you have coming in and where it is going. It is sitting down and going through the data from your past bank statements to understand what actually happened. I recommend evaluating the past 2 years if the information is available.

List all your sources of income and how much you take home each month. Is it consistent and predictable?

Now track your expenses, putting every single expense into a category. This might seem tedious, but it’s absolutely crucial. Use tools like budgeting apps to automate this step, but make sure you review the information and update categories the app gets wrong.

Finally, classify each expense category as “needs” or “wants”. Needs are essential expenses like rent, utilities, groceries, and transportation. Wants are things you can live without, like dining out, hobbies, entertainment, and that daily latte. There should be very few categories classified as needs.

Now reflect on these questions:

• Did you spend more than you made? What about in individual months – were there any months where you had more expenses than you had income?
• How much of your income is going towards needs vs. wants?
• List the expense categories from highest to lowest to review the things that consumed the most money.  How does this list compare to your priority list?
• Were there things high on your priority list that you didn’t have the money for?
• Were there things lower in your priority list that you did spend money on?
• Are there categories that surprised you on how much was spent?  Why was this surprising?

This step can be eye-opening. If you are seeing some things that make you feel a bit overwhelmed or like they’re not lining up like they should… don’t worry, and don’t pass judgment on yourself! That just means you see the problem and now can work on the solution.

Step 3: Create the Plan

Now comes the part that brings clarity: creating your budget plan. By doing this, you can see (and decide) ahead of time exactly where your money will go instead of wondering after the fact where it went.

Start by filling in the income you will take home each month. If your income is irregular, budget on the low end so that you won’t be caught off guard when you get one of those smaller paychecks. 

Next we’ll fill in expenses. The order here is very important. First, fill in your needs, using your past history as a guide to estimate what these will be in the future. If you have some expenses that are irregular, budget on the higher side so you don’t get caught off guard in the months where it is higher.

Now take a checkpoint by totaling up your expenses so far… are they less than your income? If so, keep going… you have more money to budget! If not, then it’s time for a reality check… you are living above your means, and it is not sustainable. Go back and ask yourself what needs to change to make your income more than your expenses. Do you need to find another income source? Do you need to move to a place with lower rent?

Once you have your needs accounted for and still have money left over, now fill in your wants one at a time, starting with the highest priority item. After each item is added, take another checkpoint: does your income still cover all your expenses? When you’ve used up all your income, that is the last expense item to put your budget.

Now take a look at all the items from your past spending that didn’t make the budgeted expenses. This is the reality part. These are your tradeoffs. Are you willing to give up those things going forward to get the things that were highest on your priority list? If not, maybe you missed an important item on your priority list. It’s not too late… go back and add the item to your priority list, then work back through adding in the expenses in the new priority order and see what falls off the end of the list. Is that a better tradeoff? 

Take your time. Go through this as many times as you need to. Be realistic. You will probably find that all your wants don’t make it onto the list. Maybe you find that some of them have to be temporarily postponed to get something higher on your priority list. The goal is to understand the tradeoffs and make the intentional decision on where you are going to put your money.

Step 4: Monitor & Adjust

Now that you have your plan, all you have to do is follow the plan. From now on, when something comes up, you don’t need to evaluate whether to spend the money on it. That decision was already made. Is it in the budget? If so, the answer is yes. If not, the answer is no. 

But what if something unexpected comes up (because, of course, it will!!)? Your budget is still your friend! All you have to do is go back to your budget and figure out where that thing falls in your priority list. Like when you first created the budget, go through the process of inserting it and see what other expense falls off the bottom. If that’s a trade you’re willing to make, then adopt that change to your budget and keep going! 

By regularly monitoring your spending against your budget, you will have situations where you spend more or less than what you had budgeted. When that happens, make adjustments to your spending or your plan going forward so that they align better. Budgeting is an ongoing exercise.

If you’re wondering where the answer is that tells you how to fit everything in and not make any tradeoffs, then my friend, you are in the wrong place. And you probably need to hear this… Every dollar is a tradeoff. Refusing to accept this fact will not change reality. It will just make you less successful.

What Next?

Bookmark our Money Morsels blog and check back regularly for more information to help you be successful!

If this all feels overwhelming or you need help getting started, consider hiring someone with experience to help you. At Advocate Money Management, we offer Budgeting packages and custom consulting options to help you be successful. Schedule a free consultation with us today to tell us about your situation and find out if we may be able to help.

Happy budgeting!

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Do you have any childhood money lessons that have stuck with you? Share them in the comments below!