Welcome back to another fun week of budgeting—or at least as fun as budgeting can be. Over the past two weeks, you worked hard to estimate your monthly expenses and then took action to review your credit card and bank statements to see if your estimates were accurate. As you begin the next phase of your budgeting journey, keep the larger picture in mind. Sometimes, reviewing your financials and creating a budget can be encouraging. You can see how much you saved in a given month, plan for larger expenses, and leverage your budget to make meaningful spending decisions. Other times, this process can be discouraging. The larger picture to remember is that this is an ever-evolving process. And like any process, it takes time to improve and perfect. Even as a CPA, I too ride the emotional roller coaster. The key is to not get discouraged and give up.
With that being said, I want to break down the first two high-level categories within a budget, explaining the difference between discretionary and non-discretionary expenses. These two concepts may or may not be familiar to you. Needless to say, both are extremely important to learn. Knowing the difference is critical to improving your spending behavior and putting more money in your pocket at the end of the month. Non-discretionary expenses are those you must pay every month. When you hear non-discretionary, think non-optional or non-negotiable. These expenses include your rent, groceries, debt payments, utilities, gas, and so on. In contrast are discretionary expenses. These are the items you get to spend your money on at your discretion. Expenses such as entertainment, dining out, and traveling would be categorized as discretionary. One conventional personal finance approach suggests that you allocate 60% of your take-home pay to non-discretionary expenses and the remaining 40% to discretionary expenses. Of course, these percentages can go up and down depending on where you live, how much debt you have, and your individual life circumstances. An alternative to the 60/40 approach is the 50/30/20 approach. This strategy suggests that you spend 50% of your income on your non-discretionary expenses, 30% on paying down your debt, and 20% towards both your long- and short-term goals. The reason I like these percentage-split strategies is that they are simple, easy to follow, and don’t require much thought or time to implement. However, what I don’t particularly like about these strategies is their lack of flexibility and the limited information they provide. If you’re way over or way under on your discretionary or non-discretionary spending, these strategies don’t tell you why. From what I’ve seen, those who only implement these percentage approaches and then try to refine their spending behavior typically overcorrect or under correct their behavior so much that any changes are not long-lasting. What I recommend is that you calculate these percentages but take it to the next level by using budget categories.
Underneath the larger umbrellas of non-discretionary and discretionary expenses are your budget categories. As you may have already started to do, or at least thought about, your expenses can be categorized into different buckets. These buckets can be very high-level, such as “Entertainment,” or very specific, such as “Dining Out.” When designing your budget, the advice I like to impart to my clients is to customize your budget categories to fit your needs and goals. Ideally, you want your budget to be both user-friendly and informative about your current income and spending behaviors. As you will see in future articles, the information your budget reveals will lay the foundation for curbing your spending behavior in the long term and ensuring that you are on track to meet your financial goals. Going back to the “Entertainment” and “Dining Out” example: If, hypothetically, your goal was to reduce your spending by cutting back on going out, you need to create a budget category that will allow you to see how much you are spending in that area. Simply having an “Entertainment” budget category will not give you the information you need to act on. Additionally, I recommend distinguishing between “Dining Out” and “Ordering In.” Doing so will give you information on which area you’re spending the most. An important side note: When you are setting your financial goals, try implementing a “so that” phrase. For this example, it might be “I want to cut back on eating out so that I can go on my dream vacation to Greece.” If you don’t incentivize yourself and incorporate your larger life goals, you won’t be excited to change your behavior and will likely fall back into your old ways.
My two cents: Begin to create your budget categories by bucketing your expenses into non-discretionary and discretionary. Calculate the percentage of your non-discretionary and discretionary expenses. Check in with where you are with the conventional percentage approaches. Where would you like to be in 1 month? 6 months? 1 year? Afterward, start categorizing your expenses. Make sure these categories are descriptive enough to give you information about your spending behavior, but not so descriptive that the process becomes overly complicated. I’ve often found that keeping it simple, at least to start, is the best approach. If you spend in an area more than three times in any given month, make a category for it. If you feel like you are struggling or want to improve in a particular spending area, make a category for it. As always, this is your money and your budget. Make it yours!
I’d love to hear from you! If you are, or know someone who is, struggling with their personal or business finances, reach out to me at jslimitedgroup@outlook.com. I read every email, and I always love hearing about the areas you find helpful or learning about ways I can improve. My goal is to always help people and make financial education accessible.
Alternatively, if you're feeling stuck and would like to book a 1:1 session with me, please send me an email at jslimitedgroup@outlook.com or call/text me at (970) 903-3709. The first session is always free, so what do you have to lose?
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