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Don’t budge on your budget

 

accounting-bill-black-53621A budget is a method to allocate resources between multiple sources or areas requiring resources.  In some ways this concept is fairly straightforward, but as we know, perfecting this is not done easily.  In the news it is normal to hear the word budget frequently.  In politics, budgets are a hot topic in our local, state, federal, or international governments.  That beckons the question… if our highly educated and intellectual representatives are unable to find balance on this straightforward topic, how can we hope to?

Well, two reasons:

1)      You are in control of your spending. 

2)      You can more easily identify where your money is going. 

You may not like it and it may not always “feel” fair, but you control where your money is spent.  Additionally, with the fact that you control your spending, it is not uncommon to not know where those dollars are going from check to check.  On a high level, I have used a budget for years, but I have never truly tracked every dollar that I spend.  I think there is a fair amount of insight to gain from obtaining that level of detail in spending.  My goal is to push myself and family toward financial freedom prior to age 45.

Introduction to budgeting

Let’s get this started with some basics.  First, let’s identify our sources of income and for many, this may be a very lonely category… at least initially.  Whether the volume of sources is small or large or the size of your income source is particularly large or small, your income is going to play one of the most important roles in achieving your financial goals.  It is also one piece of the puzzle that you may feel like you have the least amount of control over.  Why might you feel that you have little control over this area of your budget?

Maybe you have a boss that doesn’t see the value that you provide at work and you struggle to gain a promotion. 

Maybe you don’t have time to find a “side hustle” or secondary source of income. 

Maybe you weren’t one of the lucky ones who inherited a rental property or have the funds to purchase one. 

All of these may be true, but they are not going to prevent you from moving forward as many of us, probably the majority, are in those shoes right now.  Identifying how to increase income is going to be one method available to you to increase your savings, allocate a large percentage of money toward expenses, or invest.  Here are some alternative ways that you might want to explore for increasing your income, but I won’t lie to you in saying that they are going to be easy or without a trade-off of time or upfront investment.  But remember, we want to take baby steps and set goals!

Budget Input #1: Income

Okay so let’s start identifying our sources of income.  In this exercise you can take a look at your situation from your household or individual income.  For me, I will consider the income of my wife and I together.  Also, all income mentioned will be considered to be after taxes are considered.  In essence, I want to budget based upon what actually hits our bank account.

Income: Annual Monthly
Mr. Pro Finance Wages $55,857.24 $4,654.77
Mrs. Pro Finance Wages $28,800.00 $2,400.00
Rental Property $7,956.00 $663.00
Total After Tax Income: $92,613.24 $7,717.77

For our household income, I get paid one time per month and Mrs. Pro Finance is paid biweekly which turns out to be right around $2400 after taxes each month.  The rental property has generally worked out well for us over the past few years in covering all expenses it incurs.

The rental property is a 2 BR condo that I bought and lived in prior to moving in with my wife.  She also owned her own condo prior to our moving in together.  On the negative side, unfortunately the condo has depreciated in value from my purchase about 4 years ago.  However, the plus side is that I have been able to maintain tenants since moving out so I we grow our equity each month the renter pays the mortgage.

Other areas of income you may want to consider are second jobs, dividends, bonds, or CD’s.  For purposes of this exercise, I do recommend only including income that increases your spending power.  For example, you aren’t going to want include your dividends if you have them setup to reinvest and have no intention of using them to increase your spending power each month.  For us, we do have some investments in taxable accounts, but any income generated from those is reinvested and therefore I will not include them in our budget on the income side.

One additional item I want to touch on here, but will dedicate additional time to later is that for many of us earning a salary or wages from our employers is our primary source of income.  We are trading our time for our money and I want you to keep in mind that you never want to forget to pay yourself.  There are resources out there that talk specifically about how you want to pay yourself first and I am a firm believer in this as you will see in the next section.  Again, remember your goals.  I strive to be able to get a point in life where I am building enough wealth/assets/sources of income that will cover my expenses without having to trade my time by going into a job.

Budget Input #1: Expense Tiers

The next piece of our personal little income statement is going to be our expenses.  Now for this section I am going to think about my expenses in terms of priority with three separate classifications for expenses.  By bucketing expenses, you will be able to have a macro view point while maintaining the supporting details available for review as well.  Let’s take a look at my definitions on the priority levels and I would encourage you to keep in mind that your buckets may look different, but try to stick with the theme in outlining your expenses.

Tier 1: Critical / Need to Live

This is the most important bucket of all because spending in this category should constitute our necessities.  I wouldn’t go so far as to call them the Bare Necessities because as some of the “nitty gritty” naysayers would say, some of the items in this bucket are actually required to live… gasp!  I would agree that what I include this section  are not all 100% required to sustain your life, but I think that they fit the criteria to be considered by most as critical for the lives that we live today.  In creating your list, don’t try and stretch the truth by adding many luxuries to this tier.  I can understand 1-2 if they are items that you feel you cannot truly live without, but try not to add Starbucks coffee or Netflix to this section :).  My critical tier of expenses is shown below and in no particular order.

Housing:  $1987 (includes tax/insurance) – 25.7% of after tax income.

In my point above discussing what should fall into which category, several friends have casually argued with me over this being added into the critical tier.  In my opinion, their point is taking the tier way too literally  to the point that they are not being realistic.  In most cases, if you are concerned about your finances enough to be reading about budgets, you probably consider your dwelling as a critical component of your life.  Housing itself is an interesting topic and you may debate with yourself on whether it makes sense to buy or rent.  Perhaps you want to buy, but don’t know whether you should carry a mortgage out for 15 or 30 years or potentially pay down/off early.  Whether you currently rent or own, try and include the total monthly costs to live there.  In my scenario, my wife and I own our home and have a 30 year mortgage with 1 year under our belts.  29 long years to go and the monthly payment is $1987 (including tax and homeowners insurance).  That may seem like a TON or a bargain depending on where you live in the world.

You may have seen or heard a rule or ten from friends and family on what amount of money should be spent on your mortgage.  You can find many of these rules of thumb discussed here, but the best thing that we were able to do is find the home that we can grow into as we add to our family, secure a good interest rate, and buy at a good time where our initial money goes further and compounds over time.  Some of these factors are in your control and some aren’t, but I think having safe/adequate housing is critical in living your life.

Vehicle: $525 – 6.8% of after tax income

This item I would agree can be a lot more debatable than housing especially if you have flexibility to move your location to closer proximity to the places you spend most of your time at.  In my neck of the woods, I have a 15 minute highway commute to work each day.  Over on the FIRE forum on Reddit, you can find several folks that found residences within walking or biking distance to their work.  In addition, if you live in a large metropolis you may not need a car and having one may blow up your budget further when you try and find a place to park.  For my wife and I, we carry one car loan on a 2017 SUV with 0% interest.  My previous vehicle was totaled, luckily with no injuries to anyone, and in my search for a new vehicle I drifted toward a reliable SUV that I felt (barring another accident) might last me 10 years and have room to grow into.  Who knows where transportation will stand in 10 years so the smarter option would be to get a reliable used, but the 0% interest was very attractive to me.  Ideally, my wife will hang onto her car for another 4 years (it’s a 2014) so we are not in the position to need to carry two loans.  One loan for two people is better than two loans, but no loans on a car is best of all by far.

Electric / Gas / Trash / Water – $305 – 4% of after tax income

Like the other categories, the amount you need to spend on your utility expenses can vary dramatically from person to person.  Do you need to run the AC 24/7 in the summer or can you get by some days with the windows down?  For my family, we generally get by with Midwest moderate temperatures most of the year, but definitely run the AC in summer and heat during the winter.  Our trash and water are obviously needed also and I think we do a fairly good job of monitoring these costs each month by keeping the thermostat in check.

Cell Phones – $220 – 2.9% of after tax income

I know what you are thinking.  How can someone with FIRE on their mind view a cell phone as anything but a luxury?  Well, cell phones have become an integral part of day to day life.  They are critical for communication as the house phone days are passing.  Being connected to the internet is important for our jobs and for our safety.  My wife and I, like many others, are reliant on our cell phones and consider this to be a critical expense.  On the size of the bill, it would be high for two people.  However, we pay a higher cost to be involved with Verizon who carries the most reliable service in our area and we also pay for two family members on our plan.  One of the family members lost their job a few years ago and I offered to pick up that bill for them (they had paid my bill for years) and I have held onto it as my income has grown over time.  It’s important for me to be able to help family out when possible even at the opportunity cost of a higher savings rate.

Food and Fuel:  $550 – 7.1% of after tax income

These expenses are critical for us to function, attend work, survive, etc. and yet they are not a steadfast number in the budget.  What I mean by that is from month to month we may have increased food spending or fuel usage.  This variation makes it difficult to 100% line up where costs are allocated.  I am going to a deeper dive into this category and see if we can shore up and try to establish a firm target for these expenses.

Insurance (Health and Car):  $150 – 1.9% of after tax income

Fortunately for my wife and I, our health insurance is covered through pretax dollars.  Our car insurance works out to be $150 per month for both of our vehicles.  As you will see for our emergency fund, we actually dedicate this $150 into the emergency fund each month so it gains 1.9% interest and then make an annual payment sometime in June/July.

Budget Input #2: Pay Yourself

Now that you have your basic needs and requirements financially satisfied, let’s take a look at allocating funds to the most important person – YOU.  Paying yourself is common lingo that the experts use in ensuring that you are putting your money to work for you.  If you have not seen this or been exposed to this terminology before, you may be thinking that paying yourself refers to allowing yourself room in your budget to spend on things you enjoy… like sewing, golf, or building paper planes.  While having hobbies is important, think of this part of your budget as putting your money to work for you or investing it so the money you work for begins to work for you.  Each of the areas that my family budgets for paying ourselves will be highlighted in another section in the event you want some additional information or maybe a clear understanding of Roth IRA vs Traditional IRA and what tools might be available to be advantageous toward taxes.  And as a final reminder, we are looking at after tax dollars or where can manually put your money in your checking account.  I will reference a few pre-tax items, but the percentages are going to be based on where money we first receive is allocated.

Mr. Pro Finance Roth IRA:  $458.33 – 5.9% of after tax income

I contribute the maximum allowable Roth IRA contribution each year spread evenly over a 12 month period.  Due to cash flows, I am unable to fully fund a lump sum amount 1x per year so the monthly contribution works for us.  A Roth IRA is a great savings vehicle because you are contributing after tax dollars meaning your growth and withdrawals are tax free when all criteria on withdrawals are met.  Depending on your personal situation, you will need to determine if a Roth IRA is the correct vehicle or a Traditional IRA (pre-tax contributions) makes more sense.  That will require you to have a good understanding of where you fall on the tax bracket and also whether your income will allow the contribution to a Roth IRA.  In my opinion, generally if you are offered a 401k or 403b and have maxed your annual contribution to take advantage of your tax savings, you will want to have a Roth IRA as the next vehicle.

New Car Fund: $215 – 2.8% of after tax income

As I discussed above in the vehicle expense that we currently have each month on a 0% interest car loan, we are in a position where we allocate 2.8% of current money each month toward a future car purchase.  Hopefully my wife’s vehicle holds up a few years so that we can continue to save more money for a down payment on solid used or new car.  In an ideal world, we will be able to continue to maintain our current lifestyle and not have the burden of two loan payments on a car.  Now, with the fact that my car loan is at 0% interest, mostly anything that I choose to do with this $215 would make more sense than paying it toward our loan.  If you had interest on a car loan, you may rethink saving/investing these funds.  With an expectation that we will not need this money for at least a two year period, we have been investing and adding $215 per month into Vanguard’s Mega Cap Growth ETF.  I will purchase as many shares as I can afford each month and the balance sits in the money market fund with Vanguard until I add more funds the following month.  I have this spreadsheet setup to forecast how much money we can expect to have toward a car at any given month using some conservative market assumptions.

Mortgage Investment: $500 – 6.5% of after tax income

This is definitely a controversial topic between fans and expert of personal finance and budgeting.  You have well-known advisers like Dave Ramsey suggesting that paying off all debt is one of the most important objectives while others argue that taking the 30 year mortgage and investing the difference between the 15 year payment will put you in a better position after fast forwarding 15 years in your life.  The decision on how to handle a mortgage comes down to two primary inputs, which are your budget and risk tolerance.  You can use some tools to assist in guiding you toward a decision that will provide the strongest economic benefit but the answer will not be known by anyone until 15 years goes by.  In this post, I discuss my methodology to come to my decision in choosing the 30 year mortgage and maintaining the discipline to add the difference to a separate investment vehicle.  For now, this money is invested in Vanguard’s Total Stock Market ETF (VTI).  My intent is to move this into VTSAX as the balance moves over the minimum of $10,000.

Emergency Fund: $200 – 2.6% of after tax income

This bucket actually receives $350 each month because the $150 listed under insurance is added to our high interest savings account.  $150 per month equals our annual insurance payment for our cars and having that money in our high interest savings account helps ensure we have the funds available when the time comes to pay up insurance and also earn a little bit of money with rates currently at 1.9%.  The additional $200 is not really meant for anything specific, but we are trying to contribute a little monthly for life’s unexpected expenses.  We have drawn on this money for some additional taxes needing paid last year and currently for treatment on our dog that we adopted from a shelter.  Unfortunately, he came had heartworm disease and due to the timing, our treatment is not going to be covered by the company that we have been using to prevent this.  We understand that the cost for this could be around $1000 so having money set aside each month helps to avoid breaking the bank, creating additional financial stress, or disrupting your investment plan.

Vacation Fund: $450 – 5.83% of after tax income

Here’s another category that you will need to decide the value it means to you.  As discussed in FIRE vs YOLO, vacations are an item that you can spend a serious amount of money on or run on the cheap depending on your interests.  For our family, we want to be able to enjoy life while we have youth while also preparing for the later years.  My recommendation is to try and set aside a little bit of money for a vacation even if it is 2% or less of your budget.  That money can be added to an investment vehicle or put in a savings account depending on when you think you might be taking that vacation.  You’re going to want to kick back and escape the stress of daily life and work unless your only focus is to permanently escape the work zone as soon as possible.  One risk I am hedging on that front is whether something tragic may prevent me from having some of the experiences that I am capable of having at my current age.  But like all budgets, to each their own!

M1Finance:  $100 – 1.3% of after tax income

Last month I began investing in the M1Finance app and created my own pie.  I have a review on this app and why I decided to utilize this platform here.  At a high level, I really liked the idea of acting as head of my own mutual fund or ETF.  The application also allows entry to stocks that would normally be unobtainable to me based on my budgets because you can accumulate partial shares of stock.  Aside from my review, you can find M1Finance site here and in the event you want to sign up, they have a referral that benefits us equally as long as you follow the terms and conditions (currently $10 bonus but subject to change).

Condo Repair Fund:  $30 – .4% of after tax income

This is an account that can be viewed as a secondary emergency fund, but the targeted emergencies would only be for funding issues resulting with our rental property.  We are allocating 17.6% of the pre-tax rental income into this fund.  The remaining income is set aside for mortgage payment and additional pay down toward the mortgage.  In the first couple of years of renting, our expenses were very low from this fund and we were able to stockpile cash, but the past year has required several services and repairs.  Having the ability to pay for those has been a lifesaver without dipping into other savings.  As of right now, however we are also paying our condo association fees and an annual assessment that comes to $120 per month meaning in reality we are only saving $30 a month toward an emergency.

Child Fund: $150 – 1.9% of after tax income

Last year my wife and I decided to try and put aside $150 a month toward savings for a baby.  We knew having a family was something that would be on our radar in the coming year and wanted to get a jump start on preparation for some of the expected expenses.  Since the possibility was there that we may need the money in less than 1 year, I put the money in Vanguard’s Total Long Term Bond ETF.  In comparison to the stock ETFs, this was a major mistake at least so far.  It’s nothing catastrophic, but it’s not unusual for the account to be holding an unrealized loss of $5-$50.  In fact, I do not think it has been positive from the purchase point, but we are getting several dollars a month in payment, which helps offset the loss.  Hopefully by cash out time we will have both a gain and the bond payments to spend on our child.

Cryptocurrency:  $100 – 1.3% of after tax income

This is a new category that we are contributing to as of the past month.  Without having much knowledge on the subject, I was very skeptical of crypto and had avoided it.  Luckily for me, I didn’t buy too much in the hype and lose tons of money buying at the highs of 2017.  However, with the potential for increased stability, additional vendor acceptance, and more information out on the subject, we are starting to add a tiny position to crypto.  My current take is that crypto should not be a primary investment vehicle.  In fact, I’m not really treating it that way at all, but I have liked the ability to pay for items online using Bitcoin.  Bitcoin is the only currency that I am going to purchasing as of now and if I am on the right side of some price appreciation, all the better.

Mr. Pro Finance Personal Savings: $100 – 1.3% of after tax income

Each month I try and put a small amount of money aside into a savings account for items that I would normally put in the luxury category.  This method of savings is designed to put to use the pay yourself strategy.  Paying myself and setting aside this money will hopefully net some positive returns in the future that will pay for some of the items that I’d like to buy at some point, but are not necessary to live.  Some of these things might be tickets to a sports game, a new tv, or a saltwater fish tank.  In keeping with the Vanguard accounts, I am putting $25 per month in an always accessible savings account and $75 per month into Vanguard INTL High Dividend Yield Index ETF.  This was merely an attempt to diversify from what most of my other portfolio holds again keeping in mind that we are talking about 1.3% of our monthly income.

Mrs. Pro Finance Personal Savings: $200 – 2.6% of after tax income

My wife puts aside some extra money in her savings each month for her own security.  It’s important to have some money set aside for your peace of mind or to be able to pick up a larger expense or non-regular expenses like putting our dog in a kennel if we are out of town for a weekend.

Budget Input #3: Non-Critical

The final tier of expenses are going to be your expenses that are not necessary to live.  This section is going to be one that you want to target if you find that you need more money to allocate into another bucket or tier.  The easy example is Cable television.  As you will see this is on our list but should it be?  That’s arguable because it’s a decent monthly expense and our usage of cable TV decreases every year or so we have noticed.  However, in many ways there are social standards or expectations that we may feel we need to meet or pay for.  Retool that mindset and gain control of your finances.

Condo Association Fees:  $120 – 1.6% of after tax income

As mentioned above, our association dues and assessment amount to $120 per month and we are separating money in a savings account to pay for these fees.  In order to avoid running the risk of a late fee, I try and lump together my payments upfront for the entire year.  I have this expense in the luxury section because it is not our primary home and we could sell the condo and continue to live our lives with little to zero interruption, but that is probably not a wise decision when considering the current local real estate market.

Cable TV and Internet: $145 – 1.9% of after tax income

This will break the hearts of many FIRE enthusiasts, and I question our decision to have the cable piece of this expense quite frequently.  It does come back to some social standards where we host parties to watch certain games and my wife enjoys watching certain sitcoms.  I have found that I have little to zero desire to watch television shows.  The only shows that I can tolerate still are Seinfeld which I have seen all the episodes already several times, football, basketball, and Stranger Things, which is exclusive to Netflix.  I’m a Game of Thrones fan too, but like Stranger Things, these are not on TV regularly.  The internet is an entirely different story as we are very reliant and spend lots of time connecting with family / friends / news / research online.

Rental Condo (Mortgage / Insurance / Taxes):  $700 – 9.1% of after tax income

My condo was purchased by myself several years ago when my salary was much lower than it is today.  Because of my inexperience at the time and some oddities with the financing for a condo with high renter occupancy, I ended up with an adjustable rate mortgage.  Initially this was awesome as my rate dropped down to 2.75% at one point, but has since moved back up to 4.5%.  This fluctuation is something that hurts the bottom line in getting the mortgage paid off.  Because of the changes, I put a little extra toward this expense each month to try and reduce the carrying balance of the mortgage that is not locked in.

Mr. Pro Finance Student Loans:  $250 – 3.2% of after tax income

My student loan balance is right around $6,000 total and I overpay toward it each month.  I expect to have a windfall in an annual bonus from work in early 2019 that will allow me to payoff this balance and then swap the $250 payment toward my student loan to a 529 plan for Mr. or Miss Pro Finance junior who should arrive next year.  At that point, this expense will be reclassified as a Pay Yourself bucket.

Mrs. Pro Finance Hobbies/Presents:  $100– 1.3% of after tax income

My wife is a talented artist who paints, does ceramics, and some wood working.  In a given month she might purchase some paints or supplies or take part in a wine and paint night with friends.

Miscellaneous: $166.44 – 2.2% of after tax income

This bucket is made up of a variety of items like fantasy football or other hobbies that I have such as paying for this blog site.  Things that I enjoy and do not return money as an investment.

Next Steps:

Now that your budget is outlined and you have your categories defined correctly in the appropriate buckets for their priority level, your next step is analyze your spending from the tier level.  Let’s take a look at where my family’s spending currently shakes out and what items we may be able to improve upon!

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