Enough is enough. You’re tired of wondering where your hard-earned dollars are going each month, or maybe you’re struggling to explain why it’s seemingly so difficult to save money yet so easy to increase your debt burden. Bottom line: You want a way to better control your financial destiny, to give yourself the best chance of getting where you want to go in life. But how?
For many people, the simplest, most effective way to gain insight into, and control over, their finances is with a spending plan. “This isn’t rocket science,” says certified financial planner Timothy A. Knotts, co-founder of the Hogan-Knotts Financial Group in Red Bank, NJ. What it is, he says, is a straightforward exercise that in many cases yields quick and significant results for people with the wherewithal to follow it.
Here’s a quick primer from the Financial Planning Association on how to develop and use a spending plan to gain a clearer — and likely brighter — financial picture:
A person’s first questions are likely to be WHY develop a spending plan? What’s in it for me? “A spending plan allows us to save for our financial goals and objectives,” Knotts explains. “What it does is allows us to pay ourselves first, so we’re less likely to elevate our spending on things we don’t really need.”
WHAT is a spending plan? It’s a blueprint detailing how the money you (and your household) have coming in will be allocated to cover nondiscretionary items (needs, such as food, shelter and a retirement nest egg) and discretionary items (wants, such as vacations and luxury goods).
HOW to create a spending plan? Here are the basic steps:
- Calculate your monthly income — how much your household takes in each month.
- Put a minimum of 10% of after-tax household income (and preferably closer to 15 or 20%) aside in a retirement savings vehicle such as a 401(k), IRA or pension plan. Saving for retirement is a nondiscretionary item. Doing so via an automatic transfer into that savings vehicle is wise, says Knotts, for convenience and because it takes the decision out of your hands each month.
- Now allocate the remaining 90% of monthly income across the following categories, ordered roughly according to priority:
- Taxes — money to cover property, quarterly income taxes (if self-employed), etc. This is one of those fixed, “absolutely have to be paid” nondiscretionary items.
- Fixed insurance payments to cover premiums for health, dental, auto, homeowner, life, disability and other policies. This is another nondiscretionary item.
- Fixed debt repayment to cover a mortgage, car loan, home equity line of credit, college/education loans, credit card balances and other debts. This also falls into the nondiscretionary category.
- Utilities such as electricity, gas, telephone, Internet, water and sewer. These are variable “absolutely have to be paid” nondiscretionary items.
- Food and miscellaneous other variable nondiscretionary items, including groceries, clothes, automobile expenses (fuel and upkeep), unreimbursed medical expenses and the like. Knotts suggests tracking monthly variable expenses such as these and utilities over a period of 3-6 months to get a firm idea of how much you’ll need to set aside.
- Discretionary payments are essentially whatever you have left after allocating enough to cover all the aforementioned nondiscretionary items. This is what you use to cover your wants: taking a vacation; paying for a gym or club membership; dining out; purchasing electronics for yourself and gifts for others.
- Set realistic goals. Dangle a carrot for yourself — goals that you keep in mind to help stick to the plan, whether it’s saving for a home or an exotic vacation, reducing credit card debt, saving for a child’s college education, etc. Put these goals in writing as part of the plan.
- Decide on a few simple principals to guide your spending, then write those into the plan — things like “use cash instead of credit cards whenever possible” or “eat in more and dine out less.”
- Build flexibility into your spending plan to accommodate unforeseen events and changing circumstances (pay raise, medical emergency, replacing an appliance, repairing a car, etc.). Revisit and revise the spending plan to reflect these circumstances.
- Reward yourself and members of your household for their hard work sticking to the spending plan. Establish incentives for following the plan —a night out, a massage, a day at the amusement park. Even a modest reward will help reinforce why you’re doing this in the first place.
HOW to structure a spending plan? You need a framework in which to track spending. That might be as simple as a spreadsheet or a ledger sheet and pencil. Otherwise, turn to one of the many online tools and apps available for computer, tablet and smartphone. The website Mint.com offers a range of free online personal finance tools, along with a downloadable app for the iPhone, Android and iPad. Another free resource is the Financial Planning Association’s guide, Budgeting: Managing Your Money With a Spending Plan.
HOW to give yourself the best chance of sticking with a spending plan? To make the spending plan attainable and worthwhile:
WHERE and to WHOM to turn for guidance? A single meeting with a financial planner can net you a spending plan that’s thorough, understandable and easy to implement. Visit the Financial Planning Association’s national database at www.PlannerSearch.org to find a personal finance expert near you. When you find one you trust, be sure to check back with them periodically to assess how the plan is working and whether it needs adjusting.
October 2014 — This column is provided by the Financial Planning Association® (FPA®) of Silicon Valley, the principle professional organization for Certified Financial Planner™ (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Silicon Valley if you use this column in whole or in part. The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.