A Case of The Tail Wagging The Dog
There is a big debate in personal finance circles about the need for a budget. On one side are those who argue creating and managing a budget is necessary for any level of financial success. They argue without a budget you are cast adrift, doomed to spend money with abandon on frivolous and unnecessary purchases. Under their guidance, if you are grocery shopping and run out of money in your budget or envelope or pre-paid debit card, you should begin putting groceries back.
Squared off against these pro-budget activists are financial pundits who say budgets are a waste of time. That budgets are limiting and boring, and making a budget is pointless because budgets are impossible to actually follow. They argue if you begin by putting money in your savings at the beginning of the month, you can ignore any need to budget and spend with wild abandon on whatever your heart desires. Under their guidance, you should become the financial equivalent of the dog from UP! – constantly jumping from purchase to purchase based on whatever new thing catches SQUIRREL!
A Flawed Definition
This debate, however, centers on a fundamentally flawed definition of what a budget is. The problem is it assumes budgeting is a limiting activity in which you identify how you are going to spend your money and then blindly follow stringent guidelines. Both sides view your budget as the deciding factor in your life.
A Better Definition of Budgeting
This concept that a budget is the deciding factor in your life suggests that a small part of your life should control the whole of your life; a case of the tail wagging the dog. Instead, a budget should be viewed as a living document which outlines how you want to spend your money, and should be updated and changed as necessary to meet your ever changing needs, goals, and desires.
A proper budget should list off all the things you want to spend your money on, such as groceries, rent, vacations, saving for a down payment on a home, and retirement. Your budget then simply documents how you want to allocate your income into those categories. As your desires change, so does the documentation.
The True Value of Budgeting
The value of budgeting doesn’t come from having a document to blindly follow. Instead, the value of budgeting comes from having a single page on which you can see all the things you want to spend your money on. By seeing it on one page, you can easily understand how choosing to go out for dinner an extra night will impact your other spending. The money has to come from somewhere, and a budget allows you to choose where the money will come from.
The exercise of budgeting shouldn’t be designed to limit you, but to give you the freedom to spend money in the manner you wish to spend it.
Every time you adjust your budget to do something not in your budget, the money has to come from somewhere. Since your boss isn’t going to randomly give you extra money, the only place it can come from is another area of your budget. This concept is called your opportunity cost; all of the other opportunities you give up when you make a choice to spend money. Every dollar you spend means one less dollar you can use anywhere else in your life.
This is not to say you shouldn’t spend the money. You earn money to spend it and enjoy your life. Although you need to save money for future spending, like your retirement or a child’s education, you also need to spend money today to enjoy your life and your family. Ultimately, every dollar you ever earn will either have been spent or given away on the day you die.
The trick is to understand the concept of opportunity cost and identify which specific opportunity you want to give up in order to spend the money. Say you want to spend an extra $200 on a night out to celebrate a family member announcing a pregnancy. Without a budget, you would either spend the money without concern to how you would pay your rent, or you might be paralyzed from enjoying yourself out of fear you can’t afford it.
Having a budget allows you to quickly and easily see where the money could come from and how this decision will impact other things you want to do. You could take the money from your planned trip to Europe, from your weekly date nights, or from your savings for a new home. Or you could decide the celebration isn’t as important as your other goals and decide to send a card and small gift instead. There is no wrong choice, so long as you make the choice realizing what you are getting and what you are giving up.
Another reason your budget must be seen as a living document is your costs are constantly changing. Devoting $600 and not a penny more to groceries each month sounds like a great idea. But what happens when food prices go up? In order to ‘stick to the budget’ you either have to lower the quality of your food or buy less food. Neither of these is good for the health of your family.
Many costs in your life fluctuate dramatically throughout the year and from year to year. Food, gas, utility bills, entertainment, and clothing costs all change regularly throughout the year. And even ‘set costs’ like your rent will increase over time.
A budget should adjust to account for these changing costs. Sticking to a rigid budget is neither realistic in today’s world nor is it financially sound. Instead, constantly look for how your spending is changing, and identify where you want to adjust to make up for that spending. If your food costs are going up, look for other expenditures where you can adjust your budget, such as if gas prices have dropped.
There are times, however, when all your costs seem to be going up at the same time. A typical family will increase much of their spending during the summer months. They are dining out more, spending more on entertainment, paying higher utility bills, and paying more for gas as the price at the pump increases. In these circumstances, you’ll likely need to adjust your budget by putting less money toward savings. To deal with this problem, increase your savings rate during the ‘cheaper’ months so your average savings through the year hits the mark you’ve set.
Over time, even the perfect budget will become obsolete. The reason is your priorities, and your budget should change with them. Ask any parent and they will tell you having their first child has zero impact on their life or their priorities; everything pretty much stays the same. Or maybe I have that backwards.
Significant changes in your life will cause you to dramatically shift how you want to spend your money. Even subtle changes can have dramatic impacts on your priorities and desired spending. Few people can say they enjoy doing the exact same list of things they enjoyed 5 years past.
As your life changes, your budget will need to change and update to fit your new desired lifestyle. At least once a year you should reevaluate your priorities and identify the things you currently spend money on which are no longer important to you. As new priorities rise above old priorities, cut the spending on the old priorities so you can free up money to spend on what you now desire.
Sticking to the same budget year after year will guarantee your spending will not be consistent with the life you want. Instead, your budget will be based on someone else’s’ life; the ‘you’ from five years ago.
Build a Budget in 15 Minutes
Challenge yourself to build a budget you'll actually stick to. It takes just 15 minutes to build a budget based on your priorities and how you want to spend your money. Visit our budget challenge page and commit to getting in the best financial shape of your life.
Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at email@example.com