Why budgets work (and don’t)
Some financial experts will argue budgets don’t work because you can’t possibly predict the future. You can’t possibly set aside an accurate amount of money for various expenses that may or may not happen. You can’t possibly know how much you might earn or spend in any given week, month or year.
That’s true.
Then again, you don’t know what the weather will accurately be tomorrow. That doesn’t mean you don’t listen or look for a weather update on your phone so you don’t get stuck in the rain. You probably need to arrive at work on time now and then. (I do.) So, to do so, you’ll likely listen to the odd traffic report to avoid hang ups. If not, at least you’ll consider leaving the house early for any important meeting.
If you’re like me, you generally want good things to happen to you (and your family) and you typically want to avoid negative things from happening to you as much as possible as well. To help with this, this means you plan to some degree.
Planning is a life skill. Yet the older I get, I recognize this is a skill many people either don’t have or care to practice or worse still, they expect other people to plan for them.
I’ve often wondered why that is – why do some people fail to plan?
While some financial experts might also argue many financial mistakes are a result of following conventional wisdom – following the herd too often – I’m one that happens to believe embracing at least some time-tested financial practices are both a) good and b) certainly better than nothing at all.
This means I believe:
- Saving some money (heck even $5 for something) is better than no savings at all. Doesn’t matter how much.
- Putting some money into short-term savings is a good thing.
- Putting some money into investments, for long-term savings, is generally an excellent habit to start and maintain when you’re young. I could argue it doesn’t matter really what the investments are.
- Spending less than you make is always smart.
- Paying off debt and avoiding leveraged investing is, for most people, usually very smart.
- Owning insurance for events you cannot predict, for items you cannot afford to pay for in a financial catastrophe is extremely smart.
Embracing these financial practices, our simple budget can be largely categorized into the following big buckets:
- Money I need now, every day (e.g., I need to buy food, I need hydro, I need internet).
- Money I need to insure what I cannot afford to lose (e.g., my house).
- Money I need in the short-term (e.g., I need to pay my property taxes in June).
- Money I need should something go wrong (e.g, our fridge died (yes, this just happened)).
- Money I need in the future (e.g., in semi-retirement or retirement).
These are simple, rational facts about where our money needs to go.
Yet money is a very emotional thing.
People get excited, frustrated, and overwhelmed by money from time to time. I’m guilty of these emotions as well. Our lizard brains are often clouded with powerful emotions – we’re not human without them. Our judgments in life (and with money) are often compromised by the forces around us. I make bad decisions too.
Why budgets work (and don’t) summary
I think if you can start looking at budgets through the lens of needs and choices (without emotions) as part of a rational decision making model then you’ll have an opportunity to strengthen some long-lost cognitive muscles.
That means you’ll be able to manage a budget and be far wealthier for it.
What’s your take on budgets? Do they work? Or are they a complete waste of time promoted by the financial industry? Tell me your take below.
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've surpassed my goal and now investing beyond the 7-figure portfolio to start semi-retirement with. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Hi Mark.
We started out 20 years ago with cash envelopes and a Blueline accounting book just to make sure all the bills were paid on time and to avoid a bad credit rating( my credit rating is now 900 and my wife’s is 861). Money was tight. I even remember one time we had paid all the bills, buying groceries and having $5 left over. We rented a movie at Blockbuster with it. Fast forward to today and Excel has been our choice for the last decade. With 3 years to retirement, my favourite excel page is the annual net worth tab where we have tracked our financial growth to seven figures. We will continue to use a spreadsheet to track retirement spending when we finally get there.
My mantra has always been: It’s not how much money you manage to make, it’s how you manage the money you make. Couldn’t have got here without a budget.
Gotta go watch a movie on Netflix.
Cheers.
Nice story Carl and thanks for sharing. My parents used to use a Blueline accounting book as well. I have fond memories of them keeping this ledger and taking about bills, groceries, our activities at the kitchen table.
How you manage money is far more important than how much you make although the latter certainly helps!
Very smart to automate what you can Richard. It takes emotions and bad behaviour out of the equation!
I don’t really budget because I find that people change their monthly budget according to their needs anyways (e.g. oh, I’m going to add $300 to my clothing budget this month). I like to spend what is leftover after paying myself first. But everyone is different (hence personal finance being personal) and what works for one might not work for another.
Great post as always Mark.
Thanks!
I hear ya GYM. We actually do that too re: spend what is leftover after paying ourselves first.
https://www.myownadvisor.ca/better-way-budget/
“After paying ourselves first we pretty much spend whatever we want from there. We could likely save a bit more money running a detailed budget but that’s not us. Personal finance is personal, there is a time and place for detailed budgets but maybe this budgeting paradigm can work for you too.”
Hi Mark,
Sounds like you are very logical and doing well on budgeting. ?
Although “retired” in 2008, we never tracked our spending numbers until 2010, when David S from MoneySence asked us to do so. We had a rough idea for our 2002 spending only because the financial firm who did a plan for us then asked.
We are now tracking our spending, and use the spending to adjust our next year budget, on a spreadsheet. It is very tedious work unless one enjoys doing it. 😉 We feel it can be very useful for people who don’t have saving habit and tend to over-spend. If you are a natural saver, always live within your means and don’t do impulsive buys, budgeting or not probably wouldn’t make much difference. But it is a good practice and only way to be accurate when the numbers are requested.
Thanks Freedom…lots of truth in what you wrote: “If you are a natural saver, always live within your means and don’t do impulsive buys, budgeting or not probably wouldn’t make much difference.” Some folks therefore embrace a planning and a “live within your means gene” and others do not.
I couldn’t run a detailed budget myself. Too much work for little value.
One of the best blogposts you’ve written (IMO). Budgets/planning have little to do with financial behaviour and a lot to do with behavioural finance.
re: Yet money is a very emotional thing.
It’s been studied to have a greater effect on the brain than either sex or death.
re: People get excited, frustrated, and overwhelmed by it from time to time. Our lizard brains are often clouded with powerful emotions…
The profit centres which populate and dominate our Capitalist society — aka “the forces around us” — know this and do all they can to make sure our lizard brains stay fully engaged (and our executive brains stay fully clouded) in order to keep the gross sales flowing. Most people’s brain power is already accounted for, whether they realize it or not.
re: However with some awareness of our fragile mind…
Awareness is a tough ask in modern society. See above.
re: You don’t need to be perfect. You just need to plan more often than not.
This is where many people fail. Your ‘rights’ merely have to outweigh your ‘wrongs’ — in either multitude and/or magnitude. The best and brightest don’t always “win”, more times than not it’s the ones that just do…and keep on doing. Ex. Wayne Gretzky is #43 on the all-time shooting percentage ranking (shots that result in a goal), but he is #1 on the goals scored ranking. Far from perfect, yet immortalized as ‘The Great One’.
May 24! (kind of…)
Thanks SST. You and I agree on a number of things above. Certainly the best of the best lose more than they win but they make history with their craft thanks to sticking to some great fundamentals and constantly working harder than others on the mental and physical sides of their game.
Enjoy the long weekend!
Had this discussion the other day about what makes a “greatest” player — is it one who garners the most wins or one who’s play changes the rules of the game (e.g. NBA’s Bill Russell vs Michael Jordan)?
In the financial ‘game’, players such as Soros have made far more money than someone like Bogle…but the latter completely revolutionized the industry and in turn has created exponentially more wealth than Soros ever has/could.
“Great” can mean many things including transformational change. I could argue that point.
We use a budget system… well more like keeping track of our expenses and allocate a certain percentage of our income to specific spending categories. Some months we are under the allocation, some months we are over. I think it’s more important to be able to analyze spending trend and see if there are areas you can improve on.
I’ve always liked budgets. They can serve two purposes, first they can set goals to achieve. You want to earn, save or spend a certain amount. It’s something to work towards or provide restraint on the spending side. Second it gets you thinking about the future. The old adage, have a plan.
We’ve always kept track of all our income and expenses and ike most things, habit makes things easier and the longer one does it the better they get at it.
Very much my point…budgets help today, near-future and tomorrow. Even if you don’t necessarily write it down, I can’t imagine how folks “get ahead” if they don’t at least think this way. Re: budgets = estimates of income and expenditures for a period of time.
Plan the work, work the plan. Easy to say but very hard for most to do.
True. For 30 years in my working life I lived budgets revenue & expense right down to daily numbers. I was as good as my last month.
Not for for home life but I admit I pretty well knew everything in my head and still do. It comes pretty natural but probably not for all people.
Goals – absolutely – Have made those for nearly 40 years now. Work, income, running, saving etc.
Great stuff to read about your goals…for 40 years…awesome. You are driven.
Well, it seemed to work for me at least and I agree with SST- basically more rights than wrongs on most things.
It’s killing me on the running now. Can’t. Hamstrings very bad, hurt always now and physio not working…yet. Hate to concede defeat….
I look at what you’re doing, planning and think you’re now the driven one! Keep it up and good luck!
Rest up RBull!! Thanks for the encouragement. Going to take my parents to see our pre-constr. condo today.
Nice!
You’re welcome.
Rest up…hard for me but I’m nearly there. I won’t get into long story but basically physiotherapist wants me to keep methodically keep working it up.
Nicely reasoned and informational piece Mark.
We’ve never operated with a budget. We’ve had a good degree of self control and prioritized elimating debt (9-12% rates at the time), while saving enough for retirement. However, pretty much just bought what we wanted after that. That may not work for a lot of people.
Since retiring we’re more careful with spending and I keep a simple spreadsheet of our monthly/annual spending totals. This allows us compare to our planned withdrawals using VPW, along with other income.
;-)…somebody else have a recent birthday?
Hope you had a good one too!
Definitely not work for a lot of people. I had a colleague who have to have budgeted for a tablet. He is the single breadwinner with two kids. The major reason I did not quit my job after having two kids is that I don’t want to have to budget for a tablet.
I figure once we retired we need to be more aware on our spending.
I can relate on not wanting to budget for a tablet. For me that would be painful.
Retirement is when we become more careful on spending – mainly so we had more for our discretionary $ fun stuff.
Like why I make my own “craft” beer (might be a stretch, but it’s well praised) (very expensive in NS) – 103 litres in house now to be drank, and going to put one more batch 22 litres on – ready for the summer – mexican cerveza with some added lime.
Puts the pressure on to stay fit and kick the butts of the decades younger guys. LOL
Big fan of VPW. I have a draft started on that one and will post eventually as a primer for folks who don’t yet know about that method.
Looking forward to it.
I’m also a big fan for those wanting to spend both income and tap into capital over time, and having some flexibility in adjusting income based on asset performance.
I use it as best case scenario, backed down the return assumptions, moved the last withdrawal age to 99, and stay way below what is suggested so its income only presently- for a conservative approach overall. We’ll see how we’re doing and adjust as time goes on.
There is some beauty in the VPW. I hope to leverage it as well at some point.
As the old saying goes…..”Beauty is in the eye of the beholder.”
However I see the same beauty. Its not perfection but I’ve never seen anything more appealing, or practical.
I am certain you’ll be leveraging it at the appropriate time!
I love the ‘that sucks’ bucket!
As for our budget, I can only skim off money that is left over. For my comfort this means I pay the bills first (so not the ‘pay myself first’ principle) and what is left over is divided over similar funds like you mentioned. We don’t make a lot of money and we have three children. They all come with small expenses ( a pizza day, a dance night ) and although we give them allowances the announcement of those activities is only the evening before and the available cash in the house is disbursed from me or my spouse.
Keeping a budget like this means every little purchase needs to be recorded, which I do but we managed to build up quite a nice backup this way.
Ha, well, when the fridge dies, it sucks!
Actually, we don’t record every little purchase. On the contrary, we siphon money into each bucket and then we don’t worry about it. For example, you can filter $10 per week for short-term; $25 per week for long-term; $25 per week for the ‘that sucks’ budget. Then you simply pay your bills and live your life and insure what you need to.
We never had a budget. We do have self-control on spending though I guess. We try to buy things not only just because it’s cool and we can afford it, we try to buy things only we really need or want it. That’s why we buy top gear gadgets, but not replace them as often as some of our friends. Some of my friends already replaced their phone two or three times, I am still using my old cell and no plan to replace it. The battery run dead a few monthes ago and I just bought a new battery instead of buy a new phone.
Smart May. Not surprised regarding your spending (or saving) habits!
Thanks Mark. I think we are rather lucky to have decent jobs. I am grateful and feel blessed.
Absolutely you are.
If people use a budget to somehow regulate or restrict themselves I’m not sure that is going to work for a lot of people. I use a running five year spending plan that also serves as my cheque book reconciliation . At each year end, I add another year and make inflation adjustments to all expenditures and indexed incomes Now of course it’s always being refined and some expenditures/income are just wild ass guesses but it’s better than nothing. I can see such a tool being more necessary and helpful where the spread between expenses and income is tighter. In our case, if we want something, we just buy it and adjust the spending plan as necessary.
I don’t think people should restrict themselves, rather, they need to think about those five buckets I wrote about and consider the facts that apply to their own money situation. As long as they are basing most money decisions on facts vs. what other people are telling them to do vs. being manipulated by TV or the internet or social media, then that’s good.
I think some spreadsheets, other tools are helpful for many people. At the end of the day, it’s about behaviours. Otherwise it’s a fool with a tool.
“In our case, if we want something, we just buy it and adjust the spending plan as necessary.” You’ve earned the right 🙂